inflation and the informativeness of prices this paper studies the welfare effects of the relative price variability arising from inflation if customers and suppliers form long term relationships prices have an informational role a potential customer uses current prices as signals of future prices inflation reduces the informativeness of current prices causing customers to make costly mistakes about which relationships to enter in addition the reduced informativeness of prices makes demand less price elastic thereby increasing markups both effects can be quantitatively significant at moderate inflation rates

50th anniversary article option pricing valuation models and applications this paper surveys the literature on option pricing from its origins to the present an extensive review of valuation methods for european and american style claims is provided applications to complex securities and numerical methods are surveyed emphasis is placed on recent trends and developments in methodology and modeling

stochastic equilibria existence spanning number and the no expected financial gain from trade hypothesis stochastic equilibria under uncertainty with continuous time security trading and consumption are demonstrated in a general setting a common question is whether the current price of a security is an unbiased predictor of the future price of the security plus intermediate dividends this is the hypothesis of no expected financial gains from trade the relevance of this hypothesis in multi good economies is called into question by the following demonstrated fact for each set of probability assessments there exists a corresponding equilibrium one with the original agents original equilibrium allocations and no expected financial gains from trade under the given probability assessments the spanning number of the economy is defined as the fewest number of security markets required to sustain a complete markets equilibrium in a dynamic sense made precise in the paper the spanning number is linked directly to agent primitives in particular the manner in which new information resolves uncertainty over time the spanning number is shown to be invariant under bounded changes in expectations several examples are given in which the spanning number is finite even though the number of potential states of the world is infinite

fixed production capacity menu cost and the output inflation relationship this paper analyses the impact of inflation when firms face frictions in both price and quantity adjustments a vast literature examines the consequences of price adjustment costs assuming frictionless quantity adjustments however temporary quantity adjustments may be expensive for example because continual adjustments of the optimal production plant are impossible moreover recent findings suggest that frictions in quantity adjustment may remove the linkage between output and inflation in this paper we show that this is not the case when inflation is anticipated on the contrary a predetermined production capacity may significantly amplify the consequences of price adjustment costs

asset pricing in multiperiod securities markets the intertemporal models developed in this paper have been stimulated by the capital asset pricing model capm of sharpe and lintner and the role of factor structure in ross arbitrage pricing theory apt suppose that some one dimensional stochastic process s provides a sufficient statistic for aggregate consumption then a heuristic dynamic programming argument shows that s market wealth and the wealth derivative of the value function for any agent are all locally perfectly correlated it follows from merton s work that there is a linear relationship between the local mean return on a security and the local covariance of that return with the return on the market portfolio the formal development uses martingale representation and martingale projection to obtain an intertemporal capm the history of a scalar brownian motion plays the role of a sufficient statistic we motivate the assumption of a sufficient statistic for aggregate consumption by considering a countable set of securities whose payoffs have an approximate factor structure where the factor components are in the information set generated by an n dimensional brownian motion and the idiosyncratic components are weakly correlated the approximate factor structure on the security payoffs implies that the rates of return have locally an approximate factor structure the role of the market portfolio can now be played by a set of n well diversified portfolios

demand for home modifications a household production function approach coping with activity limitations that occur in old age is an important issue in the context of increasing life expectancy and the still inevitable onset of chronic conditions in old age elderly households can be viewed as coping with activity limitations by producing functionality with the use of direct inputs that include home modifications a model of the household production of functionality is developed within the general framework of household production function models of health hypotheses generated from this model are tested using a logit model for data from the survey of asset and health dynamics among the oldest old ahead the main findings of the empirical analysis are that the demand for home modifications is fairly income inelastic home modifications and personal care are substitutes to some degree the demand for home modifications increases with years of schooling and that particular health conditions and the use of other assistive devices are important determinants of the demand for

the term structure of interest rates in a partially observable economy this paper investigates the term structure of interest rates in a multiperiod production and exchange economy with incomplete information unable to observe their stochastic investment opportunities investors engage in dynamic bayesian inference this results in the endogenous identification of a more complex production function which generates a richer term structure resembling the one that actual market prices imply in addition this paper introduces a characteristic function of the term structure and demonstrates that in contrast with a fully observable economy the widely investigated expectations hypothesis holds true only if interest rates are nonstochastic this paper investigates the term structure of interest rates in a dynamic production and exchange economy with an unobservable productivity factor in order to estimate the unobservable stochastic investment opportunities rational investors engage in dynamic bayesian inference anticipated changes in investors quality of information about the fluctuations of the economic state variable affect equilibrium demands and prices this results in the endogenous identification of a more complex production function which induces a richer term structure term structures of interest rates in a partially observable economy resemble term structure curves that actual market prices imply this paper also introduces a characteristic function of the term structure and demonstrates that in contrast with a fully observable economy the widely investigated expectations

a general equilibrium model of portfolio insurance this article examines the effects of portfolio insurance on market and asset price dynamics in a general equilibrium continuous time model portfolio insurers are modeled as expected utility maximizing agents martingale methods are employed in solving the individual agents dynamic consumption portfolio problems comparisons are made between the optimal consumption processes optimally invested wealth and portfolio strategies of the portfolio insurers and normal agents at a general equilibrium level comparisons across economies reveal that the market volatility and risk premium are decreased and the asset and market price levels increased by the presence of portfolio insurance article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

schooling and seat belt use in the health production literature schooling has distinguished itself as the most important correlate of good health according to fuchs 11 economists have been so persuasive in their demonstration of the importance of schooling that medical researchers are increasingly drawing attention to lack of schooling as a risk factor in a variety of diseases 24 while there is little doubt among health economists about the empirical strength of the relation between schooling and health there is considerable controversy surrounding explanations for the empirical association grossman 15 16 maintains that schooling directly enhances health for example by increasing knowledge pertaining to healthy habits fuchs 11 12 on the other hand maintains that schooling serves as an empirical proxy for some unobserved third variable which also happens to be associated with health the third variable most frequently mentioned is time preference fuchs rejects the grossman idea that education plays a direct role in promoting health the debate has relevance for policy if schooling promotes health it could be argued that expenditures on schooling could be compared to for example expenditures on medical care as an alternative for increasing average life spans but if fuchs is right any expenditure comparisons would be futile

on viable diffusion price processes of the market portfolio the assumption that the market portfolio follows a specified diffusion process implies in a simple equilibrium framework that the representative individual must have a certain utility function which is identified in the paper not every diffusion process is viable i e can be endogenized to be the market portfolio s price process in such an equilibrium model the paper provides necessary and sufficient conditions for viability which imply that viable diffusion processes constitute a rather restricted family it is common in financial economics especially in the option pricing literature to take a certain price dynamics of an underlying asset as a primitive assumption the results are then seemingly preference free but it is known that if one wishes to embed such a partial equilibrium model in a general equilibrium framework this can be obtained only with certain individuals preferences for example the black scholes 1973 model in which the underlying asset follows a geometric brownian motion is known to be consistent with utility functions which exhibit constant proportional risk aversion cpra see rubinstein 1976 breeden and litzenberger 1978 brennan 1979 stapleton and subrahmanyam 1984 and bick 1987 by this we mean that if the market portfolio follows a geometric brownian motion then necessarily the utility function of the representative individual exhibits cpra conversely one can construct a simple economy with a stock and a riskless bond where identical individuals have cpra type utility functions and where the endogenous stock price enumerated by the bond follows a prespecified geometric brownian motion however the utility function which corresponds in equilibrium to a general diffusion process has never been identified this was the initial motivation for this paper the problem loosely stated is as follows suppose we are told that in a simple equilibrium model as above the market portfolio follows a given diffusion process what does it imply regarding individuals preferences it is clear that the problem is not well formulated if a dividend process is also postulated e g as in merton 1973 1977 in this case consistency with two processes the price process and the dividend process is to be required this

on the consistency of the black scholes model with a general equilibrium framework we construct a simple economy with consumption only at the final date in which we endogenize the stochastic behavior of prices assumed in the black scholes model certain preferences constant proportional risk aversion and beliefs are shown to be sufficient and necessary in certain respects for the existence of such an equilibrium the analysis is then generalized to a continuous consumption framework in which we embed the merton proportional dividend model

health behavior health knowledge and schooling the positive correlation between schooling and good health is well documented one explanation is that schooling helps people choose healthier life styles by improving their knowledge of the relationship between health behaviors and health outcomes that is schooling improves the household s allocative efficiency in producing health this empirical study uses direct measures of health knowledge to test this explanation part of the relationship between schooling and the consumption of cigarettes alcohol and exercise is explained by differences in health knowledge however most of schooling s effects on health behavior remain after differences in knowledge are controlled for

dynamic equilibrium with liquidity constraints this article studies an intertemporal economy with liquidity constrained and unconstrained individuals we use a stopping time approach to solve the finite horizonconstrained consumption portfolio problem with constant relative risk aversion and to examine the structure of equilibrium the impact of the constraint on the optimal consumption and the financing portfolio is assessed the equilibrium state price density is related to the exercise boundary of an american style contingent claim with nonlinear payoff this stopping time characterization enables us to prove the existence of an equilibrium and can be implemented numerically properties of equilibrium bond and stock returns are examined copyright 2003 oxford university press

hyperbolic discounting and the phillips curve using a standard dynamic general equilibrium model we show that the interaction of staggered nominal contracts with hyperbolic discounting leads to inflation having significant long run effects on real variables

inflation price competition and consumer search technology abstract this paper studies an s s pricing model in the presence of inflation and price competition in search markets i present a model in which consumers search technologies can influence firms price setting price dispersion and the market structure the result obtained shows that although price competition among firms is intensified in markets where consumers search technologies are more efficient price inflation is counter intuitively more likely to increase the monopoly power and stimulate entry of firms in these markets the model also provides new empirical implications for firms price setting behaviors

the impact of imperfect credibility in a transition to price stability in this paper we study the impact of a temporary lack of credibility in a transition to price stability we quantify the effects of a period of disinflation on temporary output losses and the impact of the lack of credibility on the optimal speed of disinflation we demonstrate that the disinflationary booms found by ball 1994 and ireland 1997 may or may not disappear in an environment with imperfect credibility depending on the speed of learning relative to the speed of disinflation finally we enquire whether the speed of the volcker disinflation was excessive or not

on equilibrium prices in continuous time abstract state prices are the fundamental building block for dynamic asset pricing models we provide here a general continuous time setup that allows to derive non trivial structural properties for state prices from economic fundamentals to this end we combine general equilibrium theory and theorie generale of stochastic processes to characterize state prices that lead to continuous price systems on the consumption set we also show that equilibria with such state prices exist

what is the price of prevention new evidence from a field experiment how does increasing access to treatment affect the demand for preventive testing in this paper we present results from a field experiment in nigeria in which we offered cervical cancer screening to women at randomly chosen prices to test our hypothesis we also offered women a lottery where the payoff was a subsidy towards the cost of cervical cancer treatment conditional upon a diagnosis of cervical cancer we find that women randomly selected to receive the conditional cancer treatment subsidy were about 4 percentage points more likely to take up screening than those in the control group we also show that reducing the price of screening by 10 cents increased take up by about 1 percentage point these results offer compelling evidence that the optimal set of subsidies to increase take up of preventive testing in developing countries must include subsidies towards treatment costs in addition to price subsidies

an intertemporal general equilibrium model of asset prices this paper develops a continuous time general equilibrium model of a simple but complete economy and uses it to examine the behavior of asset prices in this model asset prices and their stochastic properties are determined endogenously one principal result is a partial differential equation which asset prices must satisfy the solution of this equation gives the equilibrium price of any asset in terms of the underlying real variables in the economy in this paper we develop a general equilibrium asset pricing model for use in applied research an important feature of the model is its integration of real and financial markets among other things the model endogenously determines the stochastic process followed by the equilibrium price of any financial asset and shows how this process depends on the underlying real variables the model is fully consistent with rational expectations and maximizing behavior on the part of all agents our framework is general enough to include many of the fundamental forces affecting asset markets yet it is tractable enough to be specialized easily to produce specific testable results furthermore the model can be extended in a number of straightforward ways consequently it is well suited to a wide variety of applications for example in a companion paper cox ingersoll and ross 7 we use the model to develop a theory of the term structure of interest rates many studies have been concerned with various aspects of asset pricing under uncertainty the most relevant to our work are the important papers on intertemporal asset pricing by merton 19 and lucas 16 working in a continuous time framework merton derives a relationship among the equilibrium expected rates of return on assets he shows that when investment opportunities are changing randomly over time this relationship will include effects which have no analogue in a static one period model lucas considers an economy with homogeneous individuals and a single consumption good which is produced by a number of processes the random output of these processes is exogenously determined and perishable assets are defined as claims to all or a part of the output of a process and the equilibrium determines the asset prices our theory draws on some elements of both of these papers like merton we formulate our model in continuous time and make full use of the analytical tractability that this affords the economic structure of our model is somewhat similar to that of lucas however we include both endogenous production and

stochastic equilibrium discounting abstract this paper considers the determination of equilibrium asset prices in an infinite horizon diffusion model of an exchange economy it is shown that asset prices can be expressed as properly weighted sums of asset payouts equilibrium properties are also investigated under the assumption that the state of the economy follows its invariant distribution

the when issued market for government of canada treasury bills by working directly with the profit functions for both arbitrage and speculative trades this paper develops two distinct notions of market efficiency these notions provide the basis for evaluating the performance of the when issued market for canadian government treasury bills despite the maximum one week maturity of when issued forward contracts a number of instances of inefficient pricing behavior are observed

equilibrium interest rates and multiperiod bonds in a partially observable economy this paper analyzes the market for financial assets in a production and exchange economy with several realized outputs and a single unobservable source of nondiversifiable risk the paper demonstrates that for a large class of diffusion outputs and preferences optimizing consumers first estimate the realizations of the unobservable factor and then use these estimates to determine portfolio and consumption rules moreover the explicit consideration of this unobservable productivity factor affects equilibrium demands and prices the equilibrium spot rate of interest emerges as the best estimate of the unobservable factor and multiperiod default free bonds arise as the optimal hedge for the unobservable changes of the stochastic investment opportunity set this paper analyzes the market for financial assets in a production and exchange economy with several realized outputs and a single unobservable source of nondiversifiable risk the paper poses and answers three questions 1 how do consumers determine equilibrium demands and prices when their investment opportunities are unobservable 2 in equilibrium what financial assets provide an optimal hedge for the

on the fluctuations in consumption and market returns in the presence of labor and human capital an equilibrium analysis abstract we examine the effects of human capital on consumption stock market and other fluctuations in a general equilibrium continuous time model a representative consumer worker investor derives utility from consumption and leisure a representative firm demands labor as the sole input to a stochastic production technology driven by general possibly nonmultiplicative shocks for cobb douglas utility and multiplicative shocks labor is nonstochastic and consumption and stock market volatility are equated as under no human capital deviations from this are analyzed for logarithmic utility and constant elasticity of substitution production technology cases are identified where the presence of labor causes consumption to be smoother than the stock market

efficient funds for meager asset spaces abstract for finite state space models of securities markets there exists a portfolio of traded securities on which conventional call or put options suffice to complete securities markets 28 moreover these efficient funds are generic 2 18 the objective of this paper is to present a class of larger models of securities markets for which existence and genericity of efficient funds obtains conditions abstracted from the finite state space case serve to define a meager asset space it is shown that for meager asset spaces satisfying a separability condition efficient funds exist and are generic in a category theoretic sense

stopping inflations big and small previous studies of disinflation work with models in which firms use time dependent strategies changing nominal prices at intervals of fixed length these models may be criticized for failing to allow pricing behavior to adjust after a large shift in policy regime consequently this paper develops a model that permits firms to adopt strategies that are partially state dependent changing nominal prices whenever they depart sufficiently from their target values the paper uses this model to examine how the welfare costs and benefits of disinflation vary with the initial inflation rate and the speed of disinflation copyright 1997 by ohio state university press

existence of arrow radner equilibrium with endogenously complete markets under incomplete information abstract a stochastic pure exchange economy with incomplete information is studied where one risky asset and a locally riskless bond are traded the underlying risks are described by a k dimensional brownian motion with k 2 the brownian motion is not directly observable agents observe only asset prices and dividends existence of an arrow radner equilibrium is established in such an equilibrium asset prices result such that every informationally feasible consumption plan can be financed by trading in the risky asset and the bond in this sense the resulting asset market is complete journal of economic literature classification numbers g12 g14 d51

health insurance and the demand for medical care evidence from a randomized experiment we estimate how cost sharing the portion of the bill the patient pays affects the demand for medical services the data come from a randomized experiment a catastrophic insurance plan reduces expenditures 31 percent relative to zero out of pocket price the price elasticity is approximately 0 2 we reject the hypothesis that less favorable coverage of outpatient services increases total expenditure for example by deterring preventive care or inducing hospitalization

a p d e approach to asian options analytical and numerical evidence abstract we first derive a one state variable partial differential equation easy to implement which characterizes the price of a european type asian option this result is explained and related to previous literature we then derive new results on the hedging of an asian option and propose analytical and numerical analysis on the comparison between asian and european options our methodology which applies to fixed strike asian options as well as to floating strike asian options completes and clarifies various results in the literature in this paper we focus on backward starting asian options our approach is quite general however and we explain how to adapt our main results to the case of forward starting asian options

from hyperination to stable prices argentina s evidence on menu cost models we review and extend several comparative statics results of xed menu cost models of price setting rms facing real idiosyncratic shocks such as the type studied by golosov and lucas 2007 as well as by many others these results are confronted with their empirical counterparts using the micro data underlying argentina s consumer price index for a time period where ination rates vary from almost 5000 per year

securities markets diffusion state processes and arbitrage free shadow prices this paper develops the parametric restrictions imposed on diffusion state processes by the requirement of arbitrage free asset pricing using the equivalent martingale measure as a starting point the diffusion property is exploited to specify the shadow pricing func tion which takes conditional state variable probabilities under the reference measure into arbitrage free contingent claim prices the main results of the paper provide differential equations associated with the shadow price function that are used to identify restrictions on the parameters of assumed diffusion processes the paper concludes with an application to the cir model where the state variable the instantaneous interest rate is assumed to follow a square root process calculations are also provided for the parametric restrictions imposed on the brownian bridge and ou state variable processes

output effects of inflation with fixed price and quantity adjustment costs i introduction there is convincing evidence that fixed costs of price adjustment may be large levy et al 1997 found such costs to be 0 7 of a firm s revenue and zbaracki et al 2004 found them to be 1 22 in the presence of fixed costs of price adjustment a monopolistic firm does not adjust its nominal price continuously with the result that the real price and output generally deviate from their static monopoly level at low inflation rates the average output is higher than the static monopoly output if there is positive discounting danziger 1988 and depends on higher order derivatives of the profit and demand functions if there is no discounting benabou and konieczny 1994 1 most of the literature assumes that only price adjustments are costly while output can be continuously adjusted without cost however bresnahan and ramey 1994 document that there may be large fixed costs of quantity adjustments relatedly many publications show that adjusting labor and capital inputs involves significant fixed costs 2 such costs may derive from loss of organizational capital baily et al 2001 jovanovic and rousseau 2001 as well as from job protection rules severance pay and legal and administrative complications in a framework with both price and quantity adjustment costs andersen 1995 and andersen and toulemonde 2004 demonstrate that only intermediate size shock but not large or small shocks may affect output for a constant inflation rate danziger 2001 shows that a firm s permanent production decreases with inflation at low inflation rates if discounting is positive and danziger and kreiner 2002 that output capacity decreases with inflation if the elasticity of demand is constant and there is no discounting see also danziger 2003 the purpose of this article is to provide a simple general characterization of the output effects of a constant inflation rate if both price and quantity adjustments involve fixed costs it is assumed that quantity adjustments are at least as costly as price adjustments which implies that a firm s production is held constant at a permanent level 3 each firm then keeps its nominal price unchanged in periods of equal length and the nominal price is adjusted so that the initial real price is the same in each period thus a firm s optimal strategy consists of the initial real price the duration of the periods with unchanged nominal price and the permanent level of production the article shows that in the absence of discounting the effect of inflation on the aggregate production depends on how fast firms marginal real revenue decreases with demand and that this effect is fully determined by the elasticity of the marginal real revenue with respect to demand thus aggregate production decreases with inflation if the elasticity of the marginal real revenue always exceeds minus unity increases with inflation if the elasticity of the marginal real revenue is always less than minus unity and is invariant to inflation if the elasticity of the marginal real revenue always equals minus unity several studies have found that the comovement between output and prices is typically negative in the long run cooley and ohanian 1991 den haan 2000 den haan and sumner 2004 fiorito and kollintzas 1994 within the framework of the present model the negative comovement indicates that the empirically relevant situation is when the elasticity of the marginal real revenue always exceeds minus unity this will be the case among others if demand functions exhibit a constant price elasticity less than minus unity as assumed in danziger and kreiner 2002 ii the model consider an economy with a unit continuum of identical consumers and a unit continuum of monopolistic firms producing differentiated perishable products each firm and its product are indexed by i which is uniformly distributed on 0 1

the demand for preventive medical care the idea that people invest in health capital is an essential part of models of the demand for health but the investment motives behind health decision are often obscured by other factors this empirical paper investigates the demand for adult preventive medical care where the investment motives are relatively clear cut several important results demonstrate the usefulness of the approach first the analysis finds that annual use of two preventive services decreases with age although not the only plausible explanation the results are consistent with individuals shortens over the lifecycle second schooling is found to be an important determinant of demand with the more educated much more likely to use the services neither lifecycle nor schooling effects are consistently found in studies of the demand for culture care finally the empirical analysis also provides additional evidence on the responsiveness of the demand for preventive care to change in insurance coverage an important issue for heal

the consumption based capital asset pricing model the paper provides conditions on the primitives of a continuous time economy under which there exist equilibria obeying the consumption based capital asset pricing model ccapm the paper also extends the equilibrium characterization of interest rates of cox ingersoll and ross 1985 to multi agent economies we do not use a markovian state assumption this work provides sufficient conditions on agents primitives for the validity of the consumption based capital asset pricing model ccapm of breeden 1979 as a necessary condition breeden showed that in a continuous time equilibrium satisfying certain regularity conditions one can characterize returns on securities as follows the expected instantaneous rate of return on any security in excess of the riskless interest rate the security s expected excess rate of return is a multiple common to all securities of the instantaneous covariance of this excess return with aggregate consumption increments this common multiple is the arrow pratt measure of risk aversion of a representative agent rubinstein 1976 published a discrete time precursor of this result the exis tence of equilibria satisfying breeden s regularity conditions had been an open issue we also show that the validity of the ccapm does not depend on breeden s assumption of markov state information and present a general asset pricing model extending the results of cox ingersoll and ross 1985 as well as the discrete time results of rubinstein 1976 and lucas 1978 to a multi agent environment since the ccapm was first proposed much effort has been directed at finding sufficient conditions on the model primitives the given assets the agents preferences the agents consumption endowments and in a production econ omy the feasible production sets conditions sufficient for the existence of continuous time equilibria were shown in duffie 1986 but the equilibria demonstrated were not shown to satisfy the additional regularity required for the ccapm in particular breeden assumed that all agents choose pointwise interior consumption rates in order to characterize asset prices via the first order conditions of the bellman equation interiority was also assumed by huang 1987 in demonstrating a representative agent characterization of equilibrium an approach exploited here the use of dynamic programming and the bellman equation aside from the difficulty it imposes in verifying the existence of interior 1 financial support from the national science foundation is gratefully acknowledged we thank

on the infrequent adjustment of price by firms i introduction recent research by blinder 1991 indicates that as many as 75 percent of all firms change price no more than twice a year according to the wall street journal these findings seem to have caused considerable surprise 1 there is however nothing unusual about these results infrequent price adjustment by firms can be readily explained by the existence of very small price adjustment or menu costs and the fact that deviations from optimal price adjustment policies often result in negligible reductions in a firm s average rate of profit this paper brings together in a dynamic setting two ingredients in the literature that have previously been linked only in a static framework the small menu cost argument of mankiw 1985 and the near rational argument of akerlof and yellen 1985 numerical examples are used to answer the familiar objection that price adjustment costs are too small to be important the main conclusions of the paper remain valid for a wide variety of plausible parameter values and do not depend on extreme assumptions concerning the flatness of the firm s profit function the basic insight that under imperfect competition first order deviations from optimal behavior imply second order losses was first made by bowley 1924 25 this idea was further developed by akerlof and yellen 1985 since the firm s profit function is flat at its maximum point failure to adjust price in response to small exogenous shocks implies very small losses even if price adjustment is costless if there are some costs associated with changing price a policy of rigid prices in the face of small nominal shocks may be optimal this would seem to provide a micro explanation for sticky prices these ideas are usually expounded in the framework of a static two period model 2 further the conclusions reached are only valid for small deviations from optimal behavior the present paper extends the argument to a dynamic framework of continual inflation and its conclusions are shown to remain valid for large deviations from optimal pricing policies 3 the paper makes two main points first very small price adjustment costs often lead to surprising long intervals between price changes even when the length of this interval is chosen optimally second the loss of profits suffered by the firm when the interval between price changes is much greater than the optimal value is often negligible large deviations from optimal policies typically imply very small losses this is a much stronger claim than the familiar argument that small deviations from optimality imply second order losses and it does not follow from the envelope theorem if a firm adopts a simple rule of say changing price twice a year regardless of the inflation rate it may earn a level of profit practically indistinguishable from that it would earn if it behaved optimally at least for inflation rates experienced in the western democracies since world war ii the standard objection to the menu cost explanation of infrequent price adjustment is that these costs are much too small to explain observed pricing behavior the examples presented below show that this objection can be discounted seemingly trivial price adjustment costs as small as one millionth of the firm s annual revenue can explain price adjustment frequencies as low as once or twice a year at inflation rates of 20 percent per annum and above part of the explanation concerns the flatness of the firm s profit function over a wide range of plausible values of demand and cost parameters profit functions are sufficiently flat to explain observed frequencies of price adjustment even when the interval between price changes is optimal but there is more too it than this large deviations from optimal price adjustment policies imply surprisingly small losses even for profit functions that would never be described as flat in particular the loss in profit caused by large deviations in the interval between price changes from its optimal value are normally very small

seasonal patterns of futures hedging and the resolution of output uncertainty abstract optimal futures hedging is examined in a two good model with stochastic output and sequential information arrival a producer s optimal hedge depends on demand elasticity sensitivity of his output to weather his correlation with aggregate output and how rapidly his output uncertainty is resolved relative to other producers during different seasonal periods because regional output uncertainties are resolved at different times the optimal futures position of a grower will commonly reverse in direction during the crop year a producer with non stochastic output who faces price risk arising from demand shocks may remain unhedged or even maintain a long position

stochastic equilibria with incomplete financial markets abstract we demonstrate the existence of equilibria with incomplete financial markets for stochastic economies whose information structure is given by an event tree restricting attention to purely financial securities those paying in units of account e g dollars financial markets may be incomplete some consumption streams may be impossible to obtain by any trading strategy securities may be individually precluded from trade at arbitrary states and dates sufficient conditions for the existence of stochastic equilibria are continuous convex strictly monotonic preferences and strictly positive aggregate endowments these conditions are weakened a corollary states that any regime of security prices precluding arbitrage can be embedded in an equilibrium

a comparative study of portfolio insurance abstract this paper undertakes a comparative study of portfolio insurance under a variety of modeling strategies specifically we focus on portfolio insurers who derive utility from horizon wealth with marginal utility tending smoothly to infinity at some pre specified floor we solve for the optimal consumption portfolio wealth of these portfolio insurers and compare with constrained portfolio insurers and normal agents general equilibrium conditions are contrasted under pure exchange and production type models while the market price level is unambiguously increased under pure exchange under production the effect on market level is state dependent in both models the market volatility and risk premium are decreased by portfolio insurance the paper also investigates the possible relationship between portfolio insurance type trading strategies and market volatility

the relationship between arbitrage and first order stochastic dominance this paper joins together two fields of research in financial economics the first field studies stochastic dominance while the second field studies arbitrage pricing the two fields are linked together through the derivation and the proof of a characterization theorem the characterization theorem gives necessary and sufficient conditions for the existence of arbitrage opportunities in terms of the existence of two assets one of which first order stochastically dominates the other and the price of a particular contingent claim examples are provided to demonstrate the theorem s content this paper joins together two fields of research in financial economics the first field studies portfolio choice from the perspective of stochastic dominance see hadar and russell 5 6 hanoch and levy 7 levy and kroll 13 the second field studies arbitrage pricing its characterization and implications see ross 15 kreps 12 harrison and kreps 8 harrison and pliska 9 in these fields it is well known that the existence of arbitrage opportunities implies first order stochastic dominance and that the converse does not hold this paper provides a set of conditions under which the converse is true given complete markets the existence of an arbitrage opportunity is characterized in terms of the existence of two traded assets one of which stochastically dominates the other along with one additional condition the additional condition is roughly that state contingent prices must be zero over the states where the first asset dominates the second the theorem has a qualification however it is applicable only in markets which are complete not in the arrow debreu sense but in a weaker sense in the sense that all contingent claims on the primary assets must trade in many applications especially with respect to continuous trading models this condition is usually satisfied see duffie 2 and harrison and pliska 9 in the case of stochastically dominated assets this paper shows that the relationship of the assets to the state contingent prices is important in identifying arbitrage opportunities in this sense this paper is related to a recent paper of jagannathan 10 jagannathan studies the relationship of second order stochastic dominance not first order to call option valuation this characterization theorem relating arbitrage opportunities to stochastic dominance should provide a valuable tool in the area of stochastic dominance this theorem specifies conditions under which two assets can be compared using first order stochastic dominance on an individual basis for inclusion in the

an intertemporal general equilibrium asset pricing model the case of diffusion information this paper provides sufficient conditions for the equilibrium price system and a vector of exogenously specified state variable processes to form a diffusion process in a pure exchange economy the conditions involve smoothness of agents utility functions and certain nice properties of the aggregate endowment process and the dividend processes of traded assets in place of the dynamic programming a martingale representation technique is utilized to characterize equilibrium portfolio policies this technique is useful even when there does not exist a finite dimensional markov structure in the economy and thus the markovian stochastic dynamic programming is not applicable a gents are shown to hold certain hedging mutual funds and the riskless asset in contrast to earlier results the market portfolio does not have a special role in hedging since the markets are dynamically complete when there exists a finite dimensional markov system in the economy the dimension of the hedging demand identified through the markovian dynamic programming may be much larger than that identified by the martingale method copyright 1987 by the econometric society

optimal price setting with observation and menu costs we study the price setting problem of a firm in the presence of both observation and menu costs in this problem the firm optimally decides when to collect costly information on the adequacy of its price an activity which we refer to as a price review upon each review the firm chooses whether to adjust its price subject to a menu cost and when to conduct the next price review this behavior is consistent with recent survey evidence documenting that firms revise prices infrequently and that only a few price revisions yield a price adjustment the goal of the paper is to study how the firm s choices map into several observable statistics depending on the level and relative magnitude of the observation vs the menu cost the observable statistics are the frequency of price reviews the frequency of price adjustments the size distribution of price adjustments and the shape of the hazard rate of price adjustments we provide an analytical characterization of the firm s decisions and a mapping from the structural parameters to the observable statistics we compare these statistics with the ones obtained for the models with only one type of cost the predictions of the model can with suitable data be used to quantify the importance of the menu cost vs the information cost we also consider a version of the model where several price adjustment are allowed between observations a form of price plans or indexation we find that no indexation is optimal for small inflation rates

towards a semigroup pricing theory in an arbitrage free economy there will always exist a set of linear operators which map future contingent dividends of securities into their current prices it happens that such operators will also form an evolution semigroup as a consequence of intertemporal analysis of the no arbitrage restriction this paper summarizes some of the major implications of the semigroup properties but avoids almost all of the technical discussion which underlies them instead several practical examples are presented some wellknown continuous time results are replicated by this alternative method and certain new developments are explored it is well known that in an arbitrage free economy there exists a nonnegative linear operator mapping dividend streams into current prices 1 what is less well known is that these operators as a consequence of intertemporal no arbitrage must additionally possess a semigroup property this paper is an overview of work in progress which deals with the semigroup features but which is contained in rather longer and more complicated papers 2 here i shall attempt to make the main results and prospective results in some cases accessible to a broader financial economics readership at first blush the terminology itself is intimidating we shall be dealing with the apparently difficult notions of 1 linear operators 2 infinitesimal generators and 3 evolution semigroups these terms become less daunting when it is realized that almost everyone has encountered a simple example of each via the discounting of future payments consider a world of certainty where the discount function between dates t and t is given as tqt that is if the current time is t and a future payment is to be received at time t in the amount a then the present value of the future payment would be given as vt tq a we see that tq may be considered an operator since it maps future payments into current values it is linear since two contemporaneous payments may be added together first and then discounted or discounted individually and added with the same result and finally it is nonnegative since no positive future payment can ever have a present value of less than zero thus the certainty discount function is an instance of a nonnegative linear operator the infinitesimal generator may be thought of as the time derivative of the operator in our certainty case the rate of change of the discount function in other words we

the effect of patient s asymmetric information problem on elderly use of medical care it has been proposed that the patient s relative ignorance about medicine asymmetry of information between doctor and patient should place a patient in a disadvantaged position when purchasing medical care even if rapidly developing information technologies can enhance the patient s access to health information a patient doesn t have enough ability to understand interpret and evaluate it so the doctor s effort at sincerely helping patient understand and utilize health information by effective communication with patient might improve the patient s asymmetric information problem and affect the patient s use of medical care by way of its being a source of patient s solid trust on doctor this research seeks to determine whether a doctor s effort mentioned earlier can affect the elderly use of medical care this study used data from a survey sample of people aged more than 65 living in seoul and chuncheon korea the results suggest the doctor s effort level has a statistically significant positive

on inflation and output with costly price changes a simple unifying result we analyze the effect of inflation on the average output of monopolistic firms facing a small fixed cost of changing nominal prices using taylor expansions we derive a general closed form solution for the slope of the long run phillips curve this very simple unifying formula allows us to evaluate and clarify the role of three key factors the asymmetry of the profit function the convexity of the demand function and the discount rate these partial equilibrium effects remain important components of any general equilibrium model with s s pricing this abstract was borrowed from another version of this item

let them eat cake a note on comparing alternative models of the demand for medical care this article comments on the rand econometric approach to estimating and testing models of the demand for medical care as typified in duan et al 1983 the rand methodology is contrasted with more mainstream econometric approaches to similar empirical problems as developed in the sample selection literature it is shown that despite rand s claim their approach requires some fairly unusual assumptions on the model joint error distribution and functional form alternatively their model likelihood functions may be interpreted as being nested in more general sample selection model likelihood functions with easily testable parameter restrictions

endogenous completeness of diffusion driven equilibrium markets we study the existence of dynamic equilibria with endogenously complete markets in continuous time heterogenous agents economies driven by diffusion processes our main results show that under appropriate conditions on the transition density of the state variables market completeness can be deduced from the primitives of the economy in particular we prove that a sufficient condition for market completeness is that the volatility of dividends be invertible and provide higher order conditions that apply when this condition fails as is the case in the presence of fixed income securities in contrast to previous research our formulation does not require that securities pay terminal dividends and thus allows for both finite and infinite horizon economies

staggered wages and output dynamics under disinflation we study the output costs of a reduction in monetary growth in a dynamic general equilibrium model with staggered wages the money wage is fixed for two periods and is chosen according to intertemporal optimisation agents have labour market monopoly power we show that the introduction of microfoundations helps to resolve the puzzle raised by directly postulated models namely that disinflation in staggered pricing models causes a boom in our model disinflation whether unanticipated or anticipated unambiguously causes a slump

optimal health insurance for prevention and treatment this paper reexamines the efficiency based arguments for optimal health insurance extending the classic analysis to consider optimal coverage for prevention and treatment separately our paper considers the tradeoff between individuals risk reduction on the one hand and both ex ante and ex post moral hazard on the other we demonstrate that it is always desirable to offer at least some insurance coverage for preventive care if individual consumers ignore the impact of their preventive care on the health premium using a utility based framework we reconfirm the conventional tradeoff between risk avoidance by risk sharing and moral hazard for insuring treatment goods uncompensated losses that reduce effective income provide a new efficiency based argument for more generous insurance coverage for prevention and treatment of health conditions the optimal coinsurance rates for prevention and for treatment are not identical

a comparison of alternative models for the demand for medical care we have tested alternative models of the demand for medical care using experimental data the estimated response of demand to insurance plan is sensitive to the model used we therefore use a split sample analysis and find that a model that more closely approximates distributional assumptions and uses a nonparametric retransformation factor performs better in terms of mean squared forecast error simpler models are inferior either because they are not robust to outliers e g anova anocova or because they are inconsistent when strong distributional assumptions are violated e g a two parameter box cox transformation

stochastic multi agent equilibria in economies with jump diffusion uncertainty abstract we study a multi agent dynamic production economy that is subject to diffusive as well as shock sources of uncertainty using the theory of martingales and point processes we establish existence of an equilibrium in the economy the equilibrium commodity price asset prices and optimal policies of the individual agents are explicitly characterized we also establish the general existence of a risk neutral measure for equilibrium asset prices in the presence of jump risk

a target level of risk model of respiratory pathologies and smoking behaviour levels of morbidity and healthcare utilisation related to respiratory pathologies are correlated firstly with an indicator of the level of risk that individuals are prepared to take namely their individual target level of risk and then secondly with smoking behaviour the results based on a french survey with a sample of 13 150 individuals show that higher target levels of risk are associated with a higher probability of being ill with higher levels of tobacco consumption but with lower levels of consumption of preventive medicine more generally this article shows how a target level of risk model can be formalized in an economic optimizing approach