impact of pension system structure on international financial capital allocation abstract recent findings indicate that pension system structure affects private savings and through them the aggregate foreign asset position of a country we present a two country overlapping generations model that explores the relationship between the magnitude of pension guarantees and the resulting portfolio choices of workers the existence of a pay as you go pension system lowers the wealth of the young workers who consequently borrow from abroad to supplement their current consumption and lowers the overall riskiness of their lifetime wealth prompting them to invest in risky equity financed by the selling of safe bonds in particular we are able to replicate and explain the venture capitalist positive net equity accompanied by negative net debt portfolio profile of the united states more broadly we find empirical support for our results in a cross country analysis using data from 110 economies greater amounts of pension spending are associated with international indebtedness long equity positions and short debt positions

designing supply contracts contract type and information asymmetry this paper studies the value to a supplier of obtaining better information about a buyer s cost structure and of being able to offer more general contracts we use the bilateral monopoly setting to analyze six scenarios three increasingly general contracts wholesale pricing schemes two part linear schemes and twopart nonlinear schemes each under full and incomplete information about the buyer s cost structure we allow both sides to refuse to trade by explicitly including reservation profit levels for both for the supplier this is implemented through a cutoff policy we derive the supplier s optimal contracts and profits for all six scenarios and examine the value of information and of more general contracts our key findings are as follows first the value of information is higher under two part contracts second the value of offering two part contracts is higher under full information and third the proportion of buyers the supplier will choose to exclude can be substantial

computational economics and economic theory substitutes or complements abstract this essay examines the idea and potential of a computational approach to theory discusses methodological issues raised by such computational methods and outlines the problems associated with the dissemination of computational methods and the exposition of computational results we argue that the study of a theory need not be confined to proving theorems that current and future computer technologies create new possibilities for theoretical analysis and that by resolving these issues we will create an intellectual atmosphere in which computational methods can make substantial contributions to economic analysis

arbitrage continuous trading and margin requirements this paper studies the impact that margin requirements have on both the existence of arbitrage opportunities and the valuation of call options in the context of the blackscholes economy margin restrictions are shown to exclude continuous trading arbitrage opportunities and with two additional hypotheses still to allow the black scholes call model to apply the black scholes economy consists of a continuously traded stock with a price process that follows a geometric brownian motion and a continuously traded bond with a price process that is deterministic continuous trading security market models constitute a significant area of continuing reesearch in financial economics these models form the basis of the option pricing methodology see merton 16 for a review and current intertemporal asset pricing models see merton 15 breeden 3 and cox ingersoll and ross 5 given the importance of these models it is of no surprise that there has been significant academic concern see dybvig 9 cox ingersoll and ross 4 p 341 and ingersoll 13 pp 13 25 over the discovery of a continuous trading strategy by harrison and kreps 10 called the doubling strategy that generates a sure dollar from a zero investment the existence of this doubling strategy violates a basic premise of the option pricing methodology the premise of no arbitrage opportunities given this violation the question naturally arises as to whether the option pricing methodology is internally consistent fortunately harrison and pliska 11 showed that the exclusion of arbitrage opportunities and the doubling strategy does not invalidate the familiar derivation of the black scholes call option formula the exogenous exclusion of these doubling strategies is somewhat arbitrary however types of constraints that exclude continuous trading arbitrage opportunities were studied by kreps 14 harrison and kreps 10 and dybvig 9 these papers provide constraints that are unsatisfactory from an institutional point of view since they have no market analogue margin requirements on the other hand have a market analogue one purpose of this paper is to show that margin requirements also exclude continuous trading arbitrage opportunities to make this argument self contained we first provide a unified framework that synthesizes the previously stated results our assertion concerning margin re

a utility adjusted newsvendor model with stochastic demand abstract we develop a continuous time newsvendor model to determine the optimal inventory level for commodities in an established financial market unlike most models in literature the newsvendor is not necessarily risk neutral and chooses the order quantity that maximises the expected utility of the cash flow at the end of the period the newsvendor exploits the correlation between stochastic demand and the price of the commodities in order to manage risks by investing in a portfolio of financial instruments the decision problem therefore includes not only the determination of the optimal ordering policy but also at the same time the selection of a portfolio that maximises her utility further we demonstrate that our model compared to a myopic approach i e no hedging requires significantly lower levels of inventory buffer to mitigate demand uncertainty thus better utilising capital

computing equilibria when asset markets are incomplete existence of equilibrium with incomplete markets is problematic because demand functions are typically not continuous discontinuities occur at prices for which a marketed asset suddenly becomes redundant we show that this discontinuity disappears if we allow an agent in the economy to introduce a new asset when such redundancies occur this enables us to prove existence with incomplete markets using a standard path following argument hence available algorithms for path following in r k can be applied to compute equilibria in the gei case we demonstrate this by computing equilibrium for a numerical example

value at risk and inventory control the purposes of this paper are two fold on the one hand we shall provide a decision analysis justification for the value at risk var approach based on ex post disappointment decision making arguments we shall show that the var approach is justified by a disappointment criterion in other words the asymmetric valuation between ex ante expected returns above an appropriate target return and the expected returns below that same target level provide an explanation for the var criterion when it is used as a tool for var efficiency design second this paper provides applications to inventory management based on var risk exposure although the mathematical problems arising from an application of the var approach tuned to current practice in financial risk management are difficult to solve analytically solutions can be found by application of standard computational and simulation techniques a number of cases are solved and formulated to demonstrate the paper s applicability

the risk averse and prudent newsboy the effects of risk and risk aversion in the single period inventory newsboy problem are examined comparative static effects of changes in the various price and cost parameters are determined and related to the newsboy s risk aversion the addition of a random background wealth and of an increase in the riskiness of newspaper demand are also examined although many of the comparative effects generally are ambiguous some fairly simple restrictions on preferences and or risk increases are shown to lead to qualitatively deterministic results

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

capacity reservation under spot market price uncertainty abstract capacity reservation contracts and spot markets are two alternative purchasing practices we focus on the cost effective management of the combined use of these two procurement sources due to the variability of the spot market prices and demand uncertainty the flexibility of combined sourcing can be advantageous spot market purchasing is a benefit in case of low spot market prices or insufficient reserved capacity and the capacity reservation contract is an operational risk hedging for high spot market price incidents the structure of the optimal combined purchasing policy is complex in this paper we consider a simple and easy to implement capacity reservation base stock policy and compare it to single sourcing options we examine the joint effect of demand and spot market price uncertainty our analysis shows that in the case of large spot market price variability the combined sourcing is superior over spot market sourcing even in the case of low average spot price the combined sourcing is also superior over long term sourcing even in the case of high average spot price if there is large spot market price variability analytical and simulation results are presented to show the effect of the different price cost and uncertainty parameters on the optimal capacity reservation base stock policy and on the expected percentage gain over single sourcing

learning by doing organizational forgetting and industry dynamics learning by doing and organizational forgetting have been shown to be important in a variety of industrial settings this paper provides a general model of dynamic competition that accounts for these economic fundamentals and shows how they shape industry structure and dynamics previously obtained results regarding the dominance properties of flrms pricing behavior no longer hold in this more general setting we show that forgetting does not simply negate learning rather learning and forgetting are distinct economic forces in particular a model with learning and forgetting can give rise to aggressive pricing behavior market dominance and multiple equilibria whereas a model with learning alone cannot

risk averse order policies with random prices in complete market and retailers private information we consider a retailer who orders products before the price for them becomes known the price is an outcome of perfect competition in a complete market since the demand is price sensitive the uncertainty in prices induces uncertain profits and associated risks in this paper we show that if the retailer is risk averse and as a result selects a utility function of profit to maximize then his subjective assessment of future prices is affected by the risk attitude this in turn introduces a bias in retailer s ordering policies by considering coordinated pricing and ordering policies we derive a relationship between risk aversion retailer s subjective private assessment and the market implied risk neutral forecast this relationship and the induced bias are then illustrated for two typical operations management strategies which involve either inventory considerations or promotions avoiding accumulation of stocks

computing equilibria in infinite horizon finance economies the case of one asset abstract we develop methods to compute equilibria in dynamic models with incomplete asset markets and heterogeneous agents using spline interpolation methods we approximate recursive trading policies of the agents and the equilibrium pricing functions we explore various methods for determining the coefficients of these approximations including time iteration methods and acceleration techniques exploring the optimization errors implied by the approximate equilibrium rules we examine the quality of our results the results are very encouraging since we are able to compute approximate equilibria in a few minutes or less attaining optimization errors on the order of one dollar per million dollars of wealth

computing equilibria in the general equilibrium model with incomplete asset markets abstract we present an intuitive homotopy algorithm for the computation of equilibria in the general equilibrium model with incomplete asset markets the central concept is the introduction of utility maximization problems for all but one agent with penalties for transactions on the asset markets we compute equilibria with homotopy path following techniques using the first order conditions of the agents optimization problems and gradually lifting the penalty restriction as the algorithm proceeds finally we present computational results from an implementation of the algorithm showing convincingly that the algorithm is very reliable in general and suitable for large scale computations

general equilibrium models and homotopy methods abstract our purpose is to argue the inevitable and lasting role which homotopy methods will play in both theoretical and applied economic analysis the essence of our position is that large equilibrium models are needed to anticipate adjustments in the economy following policy changes or shock events and that homotopy methods are needed to analyze these equilibrium models in addition to the computation of equilibria homotopy methods will play an important role in the study of multiplicity of equilibria t tonnement comparative statics and market instability

dual sourcing using capacity reservation and spot market optimal procurement policy and heuristic parameter determination abstract this contribution focuses on the cost effective management of the combined use of two procurement options the short term option is given by a spot market with random price whereas the long term alternative is characterized by a multi period capacity reservation contract with fixed purchase price and reservation level a reservation cost proportional with the reservation level has to be paid for the option of receiving any amount per period up to the reservation level a long term decision has to be made regarding the reserved capacity level and then it has to be decided period by period which quantities to procure from the two sources considering the multi period problem with stochastic demand and spot price the structure of the optimal combined purchasing policy is derived using stochastic dynamic programming exploiting these structural properties an advanced heuristic is developed to determine the respective policy parameters this heuristic is compared with two rolling horizon approaches which use the one period and two period optimal solution a comprehensive numerical study reveals that the approaches based on one period and two period solutions have considerable drawbacks while the advanced heuristic performs very well compared to the optimal solution finally by exploiting our numerical results we give some insights into the system s behavior under problem parameter variations

contingent claims contracting for purchasing decisions in inventory management option pricing is a common and important practice in the financial community and has become a fundamental theoretical construct in financial economics the theory is quite rich and has potential uses in many other problem domains this paper develops a variant of the theory as applied to inventory planning in particular we consider a risk management approach that uses negotiated option contracts for hedging against price and quantity uncertainty in inventory procurement we derive conditions for the inclusion of options in inventory control as a function both of managerial attitudes toward risk and of the correlation between price and demand

the relation between forward prices and futures prices abstract this paper consolidates the results of some recent work on the relation between forward prices and futures prices it develops a number of propositions characterizing the two prices these propositions contain several testable implications about the difference between forward and futures prices many of the propositions show that equilibrium forward and futures prices are equal to the values of particular assets even though they are not in themselves asset prices the paper then illustrates these results in the context of two valuation models and discusses the effects of taxes and other institutional factors

orders and inventory commodities with price and demand uncertainty in complete markets abstract the purpose of this paper is to price an order inventory control policy when both the demand and the price are uncertain and markets are complete inventory management is assumed to be equivalent to an investment for future and risky prospects for which a risk premium is required optimization of this risk premium defines the optimal order policy a number of examples are solved and we show how a zero inventory policy can be replicated by a portfolio of options and of course an optimal order quantity the approach developed in this paper underlies as well a common practice by certain firms who use materials that are traded in speculative financial markets in these situations managers combine their production based activities with speculations regarding their potential demand and the associated price of materials for demonstration purposes and to highlight the practicality of this approach an extensive application and numerical results are used in particular we consider a two period problem with an exponential utility function and a mean exponential demand which is a function of price

valuation of american call options on dividend paying stocks empirical tests abstract this paper examines the pricing performance of the valuation equation for american call options on stocks with known dividends and compares it with two suggested approximation methods the approximation obtained by substituting the stock price net of the present value of the escrowed dividends into the black scholes model is shown to induce spurious correlation between prediction error and 1 the standard deviation of stock return 2 the degree to which the option is in the money or out of the money 3 the probability of early exercise 4 the time to expiration of the option and 5 the dividend yield of the stock a new method of examining option market efficiency is developed and tested