the causes of preference reversal observed preference reversal cannot be adequately explained by violations of independence the reduction axiom or transitivity the primary cause of preference reversal is the failure of procedure invariance especially the overpricing of low probability high payoff bets this result violates regret theory and generalized nonindependent utility models preference reversal and a new reversal involving time preferences are explained by scale compatibility which implies that payoffs are weighted more heavily in pricing than in choice copyright 1990 by american economic association

the bond old bond spread abstract i document the profits on a trade that is long the old 30 year treasury bond and short the new 30 year treasury bond and is rolled over every auction cycle from june 1995 to november 1999 despite the systematic convergence of the spread over the auction cycle the average profits are close to zero the difference in repo market financing rates between the two bonds is a significant cost of carry in this trade i show that variation in the bond old bond spread is driven by the treasury supply of 30 year bonds as well as aggregate factors affecting investors preference for liquid assets

inefficient credit booms this paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks in particular it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post even though from a first best perspective the equilibrium always displays under borrowing from a second best point of view excessive borrowing can arise the inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market this generates a pecuniary externality that is not internalized in private contracts the model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis copyright 2008 wiley blackwell

expected utility skewness and the baseball betting market a subjective expected utility model is developed to explain the gambling behaviour of bettors on major league baseball games in the united states betting activity was examined over 15 seasons for the period 1978 1992 the observed overbetting of favourite teams by baseball bettors can be reconciled without abandoning the traditional assumption of risk aversion additionally there is some evidence to suggest that positive skewness has a discernible influence in the decision making process for higher odds contests

nonmonetary effects of the financial crisis in propagation of the great depression this paper examines the effects of the financial crisis of the 1930s onthe path of aggregate output during that period our approach is complementary to that of friedman and schwartz who emphasized the monetary impact of the bank failures we focus on non monetary primarily credit related aspects of the financial sector output link and consider the problems of debtors as well as those of the banking system we argue that the financial disruptions of 1930 33 reduced the efficiency of the credit allocation process and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand evidence suggests that effects of this type can help explain the unusual length and depth of the great depression this abstract was borrowed from another version of this item

the pricing of options on assets with stochastic volatilities one option pricing problem that has hitherto been unsolved is the pricing of a european call on an asset that has a stochastic volatility this paper examines this problem the option price is determined in series form for the case in which the stochastic volatility is independent of the stock price numerical solutions are also produced for the case in which the volatility is correlated with the stock price it is found that the black scholes price frequently overprices options and that the degree of overpricing increases with the time to maturity one option pricing problem that has hitherto remained unsolved is the pricing of a european call on a stock that has a stochastic volatility from the work of merton 12 garman 6 and cox ingersoll and ross 3 the differential equation that the option must satisfy is known the solution of this differential equation is independent of risk preferences if a the volatility is a traded asset or b the volatility is uncorrelated with aggregate consumption if either of these conditions holds the risk neutral valuation arguments of cox and ross 4 can be used in a straightfoward way this paper produces a solution in series form for the situation in which the stock price is instantaneously uncorrelated with the volatility we do not assume that the volatility is a traded asset also a constant correlation between the instantaneous rate of change of the volatility and the rate of change of aggregate consumption can be accommodated the option price is lower than the blackscholes b s 1 price when the option is close to being at the money and higher when it is deep in or deep out of the money the exercise prices for which overpricing by b s takes place are within about ten percent of the security price this is the range of exercise prices over which most option trading takes place so we may in general expect the b s price to overprice options this effect is exaggerated as the time to maturity increases one of the most surprising implications of this is that if the b s equation is used to determine the implied volatility of a near the money option the longer the time to maturity the lower the implied volatility numerical solutions for the case in which the volatility is correlated with the stock price are also examined the stochastic volatility problem has been examined by merton 13 geske 7 johnson 10 johnson and shanno 11 eisenberg 5 wiggins 16 and

no betting pareto dominance we argue that the notion of pareto dominance is not as compelling in the presence of uncertainty as it is under certainty in particular voluntary trade based on differences in tastes is commonly accepted as desirable because tastes cannot be wrong by contrast voluntary trade based on incompatible beliefs may indicate that at least one agent entertains mistaken beliefs we propose and characterize a weaker no betting notion of pareto domination which requires on top of unanimity of preference the existence of shared beliefs that can rationalize such preference for each agent

foreclosures house prices and the real economy from 2007 to 2009 states without a judicial requirement for foreclosures were twice as likely to foreclose on delinquent homeowners analysis of borders of states with differing foreclosure laws reveals a discrete jump in foreclosure propensity as one enters nonjudicial states using state judicial requirement as an instrument for foreclosures we show that foreclosures led to a large decline in house prices residential investment and consumer demand from 2007 to 2009 as foreclosures subsided from 2011 to 2013 the foreclosure rates in nonjudicial and judicial requirement states converged and we find some evidence of a stronger recovery in nonjudicial states

ex ante and ex post welfare optimality under uncertainty it is widely believed by economic theorists that if there were no transactions costs and if all information about the economy were perfectly shared by all then arrow debreu contingent commodity markets should bring about an ideal allocation the basis for this belief seems clear we have the two efficiency theorems of welfare economics which assure us that in the absence of external effects any competitive allocation is pareto efficient and that any pareto efficient allocation is competitive provided that appropriate lump sum transfers are made of course there are some reservations that need to be made local satiation and non convexities are well known to cause problems but these are not the problems i wish to discuss here to return to the usual argument the next step involves noticing how with contingent commodity markets the efficiency theorems of welfare economics carry over to an economy with uncertainty as explained for instance in chapter 7 of debreu s theorpj of value the fundamental value judgment that gives these efficiency theorems their normative interest is what may be called consumer sovereignty it is an assumption that the social welfare ordering should respect the preferences that govern consumers market behaviour it is a serious value judgment more serious than most economists have been prepared to concede but its seriousness increases when there is uncertainty we know full well that individuals misperceive the probabilities of certain events assuming that they even perceive any probabilities at all see for example kahneman and tversky 1979 nor are we always willing to accept as appropriate the attitudes to risk of individuals who seem either extremely reckless or extremely cautious societies are often willing to make some gestures towards property owners who have not insured themselves adequately against damage from fire flood or tempest and not just because of imperfect insurance markets or even misperceptions of probabilities in addition the inequalities of income that arise when some individuals take more risks than others are not necessarily seen to be desirable particularly if an individual has undertaken a useful but risky activity and has a very low income as a result of failure such gestures are examples of contingent lump sum transfers it seems clear that if such transfers occur to a sufficient extent they could supplant completely the securities markets which are usually sufficient to bring about pareto efficiency they may even be able to go further and correct the imperfections of an arrow debreu market allocation when individuals do misperceive probabilities or else have wrong attitudes to risk this is the main question i wish to consider here the idea that consumer sovereignty should not always extend to economies with uncertainty is not new it can be found in work by diamond 1967 dr6ze

money income prices and interest rates including data from the 1980s sharply weakens the postwar time series evidence indicating significant relationships between money however defined and nominal income or between money and either real income or prices separately focusing on data from 1970 onward destroys this evidence altogether evidence indicating cointegration of real income and real money balances with due allowance for the effect of interest rates also deteriorates when the sample extends through the 1980s a positive finding is that the spread between the commercial paper rate and the treasury bill rate consistently contains highly significant information about future movements in real income copyright 1992 by american economic association

effects of financial innovations on market volatility when beliefs are heterogeneous abstract consider a model with two logarithmic utility maximizer agents that observe aggregate consumption but disagree about its expected rate of change markets are incomplete we first show that volatility of the interest rate in an economy with additional information is higher in a complete markets economy with no additional information there are two differences in volatility with the previous the first one due to the increase in volatility of the wealth share of the individuals is always positive the second difference is the change in covariance between the components of the interest rate volatility and can be positive or negative

belief disagreements and collateral constraints belief disagreements have been suggested as a major contributing factor to the recent subprime mortgage crisis this paper theoretically evaluates this hypothesis i assume that optimists have limited wealth and take on leverage so as to take positions in line with their beliefs to have a significant effect on asset prices they need to borrow from traders with pessimistic beliefs using loans collateralized by the asset itself since pessimists do not value the collateral as much as optimists do they are reluctant to lend which provides an endogenous constraint on optimists ability to borrow and to influence asset prices i demonstrate that the tightness of this constraint depends on the nature of belief disagreements optimism concerning the probability of downside states has no or little effect on asset prices because these types of optimism are disciplined by this constraint instead optimism concerning the relative probability of upside states could have significant effects on asset prices this asymmetric disciplining effect is robust to allowing for short selling because pessimists that borrow the asset face a similar endogenous constraint these results emphasize that what investors disagree about matters for asset prices to a greater extent than the level of disagreements when richer contracts are available relatively complex contracts that resemble some of the recent financial innovations in the mortgage market endogenously emerge to facilitate betting

trader leverage and liquidity does trader leverage drive equity market liquidity we use the unique features of the margin trading system in india to identify a causal relationship between traders ability to borrow and a stock s market liquidity to quantify the impact of trader leverage we employ a regression discontinuity design that exploits threshold rules that determine a stock s margin trading eligibility we find that liquidity is higher when stocks become eligible for margin trading and that this liquidity enhancement is driven by margin traders contrarian strategies consistent with downward liquidity spirals due to deleveraging we also find that this effect reverses during crises

asset pricing with heterogeneous preferences beliefs and portfolio constraints portfolio constraints are widespread and have significant effects on asset prices this paper studies the effects of constraints in a dynamic economy populated by investors with different risk aversions and beliefs about the rate of economic growth the paper provides a comparison of various constraints and conditions under which these constraints help match certain empirical facts about asset prices under these conditions borrowing and short sale constraints decrease stock return volatilities whereas limited stock market participation constraints amplify them moreover borrowing constraints generate spikes in interest rates and volatilities and have stronger effects on asset prices than short sale constraints

inefficient investment waves we show that firms individually optimal liquidity management results in socially inefficient boom and bust patterns financially constrained firms decide on the level of their liquid resources facing cash flow shocks and time varying investment opportunities firms liquidity management decisions generate simultaneous waves in aggregate cash holdings and investment even if technology remains constant these investment waves are not constrained efficient in general because the social and private value of liquidity differs the resulting pecuniary externality affects incentives differentially depending on the state of the economy and often overinvestment occurs during booms and underinvestment occurs during recessions in general policies intended to mitigate underinvestment raise prices during recessions making overinvestment during booms worse however a well designed price support policy will increase welfare in both booms and recessions

leverage cycles and the anxious economy ing opportunities for emerging economies their access to international markets has turned out to be very volatile with frequent periods of market closures even worse as we will show emerging economies with sound fundamentals are the ones that issue less debt during these closures the goal of this paper is to present a theory of asset pricing that will shed light on the problems of emerging assets like emerging markets that are not yet mature enough to be attractive to the general public their marginal buyers are liquidity constrained investors with small wealth relative to the whole economy who are also marginal buyers of other risky assets we will use our theory to argue that the periodic problems faced by emerging asset classes are sometimes symptoms of what we call a global anxious economy rather than of their own fundamental weaknesses

a welfare criterion for models with distorted beliefs this paper proposes a welfare criterion for economies in which agents have heterogeneously distorted beliefs instead of taking a stand on whose belief is correct our criterion asserts an allocation to be belief neutral ine cient if it is ine cient under any convex combination of agents beliefs while this criterion gives an incomplete ranking of social allocations it can identify negative sum speculation in a broad range of prominent models with distorted beliefs

collateral constraints in a monetary economy this paper reviews the role of collateral constraints in transforming small monetary shocks into large persistent output fluctuations we do this by introducing money in the heterogeneous agent real economy of kiyotaki and moore 1997 money enters in a cash in advance constraint and money supply is managed via open market operations we find that a monetary shock generates persistent movements in aggregate output the amplitude of which depends upon whether or not debt contracts are indexed if only nominal contracts are traded money shocks can trigger large output fluctuations in this case a money expansion triggers a boom whereas money contractions generate recessions in contrast if contracts are indexed then amplification is not only smaller it can also generate the reverse results when the possibility of default and renegotiation is considered the model can generate asymmetric business cycles with recessions milder than booms finally monetary shocks generate a highly persistent dampening cycle rather than a smoothly declining deviation jel e32 e43 e44 e52

estimation and testing in models containing both jumps and conditional heteroscedasticity in this article we develop a test for the hypothesis that a series observed in discrete time is generated by a diffusion process this test is based on an overidentifying relation between variance and kurtosis parameters that holds for generalized autoregressive conditional heteroscedastic diffusions the proposed test is not specific to a particular data frequency and clearly indicates the presence of jumps in dollar exchange rates to assess the size and intensity of the jumps we estimate a model containing both jumps and conditional heteroscedasticity

a comparative analysis of independent director appointments on stock price behaviour an empirical investigation based on the markov regime switching model in 2002 the taiwanese government regulated that new companies should appoint independent directors for good corporate governance the purpose of this article is to compare appointing independent directors motivation of structural changes in stock behaviour the empirical results showed that the companies with mandatory or voluntary independent director appointments significantly reduced both stock returns and risks over 2000 2006

option valuation and hedging strategies with jumps in the volatility of asset returns we develop a model in which the volatility of risky assets is subject to random and discontinuous shifts over time we derive prices of claims contingent on such assets and analyze options based trading strategies to hedge against the risk of jumps in the return volatility unsystematic and systematic events such as takeovers major changes in business plans or shifts in economic policy regimes may drastically alter firms risk profiles our model captures the effect of such events on options markets lumpy arrival of information has long been recognized as a phenomenon of considerable importance in financial markets following merton 1976 1 much of the literature on contingent claims valuation under discontinuous information arrival has studied the case where jumps occur in asset values in this article we model the discontinuous resolution of uncertainty in a new way we allow for the volatility of an asset s return to change randomly and discretely we then derive and analyze valuation equations for claims contingent on such an asset we also show how certain traded options together with the underlying stock and a riskless bond can be used to insure against jumps in the volatility of an asset s returns stock price movements in our model fluctuate randomly between low and high volatility regimes discontinuous changes in the volatility of stock prices may be a result of significant changes in a firm s operating and financial structure its competitive environment or its corporate plan reorganizations caused by takeovers and mergers may also occasion such volatility shifts changes in uncertainty in our model could also be systematic and a result of aggregate supply shocks or shifts in economic policies and political regimes our model can also be interpreted as a model of a market where from time to time firms face the release of an important piece of information that may affect their stock prices significantly the market participants may be aware

a rule of one a rule ofone one rational person is enough to make a market one irrational person is enough to break a game let me explain the power of the market as an exchange institution rests in its ability to move resources from lowto highvalued uses the market works if one person is rational enough to look for arbitrage opportunities among the other irrational players he buys low and sells high the market collects and disseminates this information such that others

the future of the imf in spite of significant institutional and macroeconomic reforms over the last decade or two capital flows to developing economies remain highly volatile in 1996 net private capital flows to emerging markets reached us 230 billion by 1997 these flows had been cut in half by 1998 halved again and after a mild recovery during 1999 flows fell in 2000 and 2001 to slightly over one tenth the level of 1996 with the exception of developing asia 2002 does not look much rosier see international monetary fund 2002 p 12 table 1 3 the economic political and social costs of these large swings in capital flows are enormous the most vivid examples are seen in the economies that experience deep crises including since 1997 thailand indonesia malaysia korea russia brazil turkey and argentina while in many instances there are important domestic deficiencies behind these reversals there is also a well founded sense that international financial markets often exacerbate the problem it is not surprising then that as with the debt crisis of the early 1980 s and the mexican crisis of the 1990 s this new wave of crises has led to innumerable calls for deep reform to these markets nowhere is this more apparent than in the design of new rules of engagement for the international monetary fund the important work of multiple official and unofficial commissions leveraged by its own rethinking promises to transform this institution from the ground up in a nutshell most experts agree that the international monetary fund should be much more focused transparent predictable and quick in its interventions and its role limited to surveillance pre crisis and lenderof last resort bankruptcy court during crises activities this seems right i believe however that by focusing almost exclusively on the needs of countries undergoing deep crises highly illiquid and bankrupt economies these reform proposals have left unaddressed a significant fraction of the costs associated with capital flows reversals an important share of these costs are borne by countries that experience deep contractions but do not undergo full blown crises and much of the cost experienced by those countries that do fall into deep crises is experienced well before the open crisis phase develops often the latter is just the final stage of a prolonged and politically thorny economic period of sharply reduced access to international capital markets surely the anticipation of more orderly resolution and access to a few credit lines should the open crisis phase arrive would by backward induction eliminate some of the costs that precede these events as well but this benefit is indirect only and relies on a chain of reasoning that requires more rationality and trust in the new system discussants stanley fischer citigroup allan meltzer carnegie mellon university jeffrey sachs columbia university nicholas stern world bank

an optimal stochastic control framework for determining the cost of hedging of variable annuities abstract an implicit partial differential equation pde method is used to determine the cost of hedging for a guaranteed lifelong withdrawal benefit glwb variable annuity contract in the basic setting the underlying risky asset is assumed to evolve according to geometric brownian motion but this is generalised to the case of a markov regime switching process a similarity transformation is used to reduce a pricing problem with k regimes to the solution of k coupled one dimensional pdes resulting in a considerable gain in computational efficiency the methodology developed is flexible in the sense that it can calculate the cost of hedging for a variety of different withdrawal strategies by investors cases considered here include both optimal withdrawal strategies i e strategies which generate the highest possible cost of hedging for the insurer and sub optimal withdrawal strategies in which the policy holder s decisions depend on the moneyness of the embedded options numerical results are presented which demonstrate the sensitivity of the cost of hedging given the withdrawal specification to various economic and contractual assumptions

capital over the business cycle renting versus ownership we find that capital renting makes up one fifth of u s capital expenditures and it increases during downturns further we present cross country evidence that output losses after financial crises are smaller where renting is more prevalent to understand these findings we build a general equilibrium model with borrowing constraints and with the option to rent or buy capital the countercyclicality of rentals occurs because their supply increases as renting serves as an additional means of savings when credit markets malfunction moreover demand also shifts toward rentals as they become relatively cheaper by absorbing excess savings renting mitigates financial crises

bank assets liquidity and credit cycles abstract we study how bank collateral assets and their pledgeability affect the amplitude of credit cycles to this end we develop a tractable model where bankers intermediate funds between savers and borrowers if bankers default savers acquire the right to liquidate bankers assets however due to the vertically integrated structure of our credit economy savers anticipate that liquidating financial assets i e loans is conditional on borrowers being solvent on their debt obligations this friction limits the collateralization of bankers financial assets beyond that of real assets i e capital in this context increasing the pledgeability of financial assets eases more credit and reduces the spread between the loan and the deposit rate thus attenuating capital misallocation as it typically emerges in credit economies a la kiyotaki and moore 1997 we uncover a close connection between the collateralization of bank loans macroeconomic amplification and the degree of procyclicality of bank leverage

financial intermediaries and liquidity creation trading losses associated with information asymmetries can be mitigated by designing securities which split the cash flows of underlying assets these securities which can arise endogenously have values that do not depend on the information known only to informed agents bank debt deposits is an example of this type of liquid security which protect relatively uninformed agents and we provide a rationale for deposit insurance in this content high grade corporate debt and government bonds are other examples implying that a money market mutual fund based payments system may be an alternative to one based on insured bank deposits

the elastic provision of liquidity by private agents i study a model of investment by financially constrained firms that are heterogeneous with respect to their exposure to an aggregate liquidity shock a firm that is susceptible to the shock will mitigate its exposure by purchasing claims issued by a firm that is not liabilities of an unaffected firm may earn a liquidity premium due to their fungibility and because they are backed by productive investment their supply is elastic to the demand this segmentation implies that an aggregate liquidity shock has different consequences across sectors of the economy

valuation adverse selection and market collapses we study a market for funding real investment where valuation meaning investors devoting resources to acquiring information about future payoffs creates an adverse selection problem unlike previous models more valuation is associated with lower market prices and so greater returns to valuation this strategic complementarity in the capacity to do valuation generates multiple equilibria with multiple equilibria the equilibrium without valuation is most efficient despite funding some unprofitable investments switches to valuation equilibria valuation runs look like credit crunches a large investor can ensure the efficient equilibrium only if it can precommit to a price and potentially only if subsidized

collateral amplification under complete markets abstract this paper examines the robustness of the kiyotaki moore collateral amplification mechanism to the existence of complete markets for aggregate risk we show that when borrowers can hedge against aggregate shocks at fair prices the volatility of endogenous variables becomes identical to the first best in the absence of credit constraints the collateral amplification mechanism disappears to motivate the limited use of contingent contracts we introduce costs of issuing contingent debt and calibrate them to match the liquidity and safety premia the data we find that realistic costs of state contingent market participation can rationalize the predominant use of uncontingent debt amplification is restored in such an environment

regime switching in stochastic models of commodity prices an application to an optimal tree harvesting problem abstract this paper investigates whether a regime switching model of stochastic lumber prices is better for the analysis of optimal harvesting problems in forestry than a more traditional single regime model prices of lumber derivatives are used to calibrate a regime switching model with each of two regimes characterized by a different mean reverting process a single regime mean reverting process is also calibrated the value of a representative stand of trees and optimal harvesting prices are determined by specifying a hamilton jacobi bellman variational inequality which is solved for both pricing models using a implicit finite difference approach the regime switching model is found to more closely match the behavior of futures prices than the single regime model in addition analysis of a tree harvesting problem indicates significant differences in terms of land value and optimal harvest thresholds between the regime switching and single regime models

a model of capital and crises we develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices the model is cast within a dynamic general equilibrium economy and the role for intermediation is derived endogenously based on optimal contracting considerations low intermediary capital reduces the risk bearing capacity of the marginal investor we show how this force helps to explain patterns during financial crises the model replicates the observed rise during crises in sharpe ratios conditional volatility correlation in price movements of assets held by the intermediary sector and fall in riskless interest rates

on pricing and hedging options in regime switching models with feedback effect abstract we study the pricing and hedging of european style derivative securities in a markov regime switching model with a feedback effect depending on the economic condition we adopt a pricing kernel which prices both financial and economic risks explicitly in a dynamically incomplete market and we provide an equilibrium analysis a martingale representation for a european style index option s price is established based on the price kernel the martingale representation is then used to construct the local risk minimizing strategy explicitly and to characterize the corresponding pricing measure

context dependent preferences the standard theory of choice based on value maximization associates with each option a real value such that given an offered set the decision maker chooses the option with the highest value despite its simplicity and intuitive appeal there is a growing body of data that is inconsistent with this theory in particular the relative attractiveness of x compared to y often depends on the presence or absence of a third option z and the market share of an option can actually be increased by enlarging the offered set we review recent empirical findings that are inconsistent with value maximization and present a context dependent model that expresses the value of each option as an additive combination of two components a contingent weighting process that captures the effect of the background context and a binary comparison process that describes the effect of the local context the model accounts for observed violations of the standard theory and provides a framework for analyzing context dependent p

bank loan commitment contracts data theory and tests over 80 per cent of all commercial bank lending to corporations in the u s is done via bank loan commitments yet the authors have little empirical knowledge of loan commitment contracts in this paper they describe the rich contractual structure of bank loan commitments based on data pertaining to over 2 500 contracts the authors then develop a model which demonstrates that the observed complex structure of bank loan commitment contracts which typically include multiple fee structures borrower specific contracting variables and the standard material adverse change clause is important when the bank faces borrower adverse selection and moral hazard problems finally the authors verify the robustness of their model by confronting its additional testable predictions with the data copyright 1997 by ohio state university press

disagreement speculation and aggregate investment abstract when investors disagree speculation between them alters equilibrium prices in financial markets because managers maximize firm value given financial market prices disagreement alters firms value maximizing investment policies disagreement therefore impacts aggregate investment consumption and output in a production economy with recursive preferences and disasters we demonstrate that static disagreement among investors generates dynamic aggregate investment that is positively correlated with capital shocks leading to stochastic volatility in aggregate consumption investment and equity returns the direction of these effects is consistent with business cycle facts and with several features of the 2008 financial crisis

rare disasters asset prices and welfare costs a representative consumer model with epstein zin weil preferences and i i d shocks including rare disasters accords with observed equity premia and risk free rates if the coefficient of relative risk aversion equals 3 4 if the intertemporal elasticity of substitution exceeds one an increase in uncertainty lowers the price dividend ratio for equity and a rise in the expected growth rate raises this ratio calibrations indicate that society would willingly reduce gdp by around 20 percent each year to eliminate rare disasters the welfare cost from usual economic fluctuations is much smaller though still important corresponding to lowering gdp by about 1 5 percent each year

collateral constraints and asset prices abstract we study the effects of collateral constraints in an economy populated by investors with nonpledgeable labor incomes and heterogeneous preferences and beliefs we show that these constraints inflate stock prices and generate spikes and crashes in price dividend ratios and volatilities clustering of volatilities and leverage cycles they also lead to substantial decreases in interest rates and increases in sharpe ratios when investors are anxious about hitting constraints due to production crises in the economy furthermore stock prices have large collateral premiums over nonpledgeable incomes we derive asset prices and stationary distributions of the investors consumption shares in closed form

the performance of alternative valuation models in the otc currency options market abstract we compare option valuation models based on regime switching garch and jump diffusion processes to a standard smile model in which black and scholes 1973 implied volatilities are allowed to vary across strike prices the regime switching garch and jump diffusion models provide significant improvement over a fixed smile model in fitting gbp and jpy option prices both in sample and out of sample the jump diffusion model achieves the tightest fit a time varying smile model however provides hedging performance that is comparable to the other models for the gbp options this result suggests that standard option valuation techniques may provide a reasonable basis for trading and hedging strategies

are preferences stable the case of health care abstract experiments concerned with modelling individual preferences are based on the assumption of stability of preferences violations of the stability assumption have implications for the increasing amount of experimental work in health care concerned with the welfare implications of alternative policies this paper reports the results of a discrete choice experiment dce carried out to examine the effect of experience on stability of preferences within health care whilst the results provide evidence of stability further research is required before these results are generalised

contractual externalities and systemic risk we study effort and risk taking behaviour in an economy with a continuum of principal agent pairs where each agent exerts costly hidden effort principals write contracts based on both absolute and relative performance evaluations ape and rpe respectively to make individually optimal risk return trade offs but do not take into account their impact on endogenously determined aggregate variables this results in contractual externalities when these aggregate variables are used as benchmarks in contracts contractual externalities have welfare changing effects when principals put too much weight on ape or rpe due to information frictions relative to the second best if the expected productivity is high risk averse principals over incentivize their own agents triggering a rat race in effort exertion resulting in over investment in effort and excessive exposure to industry risks the opposite occurs when the expected productivity is low inducing pro cyclical investment and risk taking behaviours

credit cycles redux theoretical studies have shown that under unorthodox assumptions on preferences and production technologies collateral constraints can act as a powerful amplification and propagation mechanism of exogenous shocks we investigate whether or not this result holds under more standard assumptions we find that collateral constraints typically generate small output amplification large amplification is obtained as a knife edge type of result

model free hedge ratios and scale invariant models a price process is scale invariant if and only if the returns distribution is independent of the price measurement scale we show that most stochastic processes used for pricing options on financial assets have this property and that many models not previously recognised as scale invariant are indeed so we also prove that price hedge ratios for a wide class of contingent claims under a wide class of pricing models are model free in particular previous results on model free price hedge ratios of vanilla options based on scale invariant models are extended to any contingent claim with homogeneous pay off including complex path dependent options however model free hedge ratios only have the minimum variance property in scale invariant stochastic volatility models when price volatility correlation is zero in other stochastic volatility models and in scale invariant local volatility models model free hedge ratios are not minimum variance ratios and our empirical results demonstrate that they are less efficient than minimum variance hedge ratios

are preferences for skewness fixed or fungible are individual preferences for skewness fixed or fungible using preference reversals as a case study we find evidence that preferences remained stable as reversals disappear due to arbitrage across both market like and non market contexts

leverage and asset bubbles averting armageddon with chapter 11 an iconic model with high leverage and overvalued collateral assets is used to illustrate the amplification mechanism driving asset prices to overshoot equilibrium when an asset bubble bursts threatening widespread insolvency and what richard koo calls a balance sheet recession besides interest rates cuts asset purchases and capital restructuring are key to crisis resolution the usual bankruptcy procedures for doing this fail to internalise the price effects of asset fire sales to pay down debts however we discuss how official intervention in the form of super chapter 11 actions can help prevent asset price correction causing widespread economic disruption

how do we know that real wages are too high it is common belief that the wages that we observe are above the level that would prevail in a competitive labour market and also it is common to believe that wage moderation should be encouraged as a way to keep unemployment down this paper considers whether we can have confidence in these beliefs it presents a number of models designed to cast doubt on the conventional wisdom first we show that in an efficiency wage model in which there is involuntary unemployment a binding minimum wage may increase employment we then present a general equilibrium matching model in which there is involuntary unemployment but wages are below market clearing levels and raising wages can reduce unemployment we then consider the empirical evidence on employment and wage determination to argue that it is just as consistent with this model as with models in which wages are at or above market clearing levels

two cheers and a qualm for behavioral environmental economics behavioral economics can gain more in roads into environmental economics if we better understand why exchange institutions fail more effectively reduce health risks and environmental conflicts encourage more coordination and cooperation design better incentive systems more accurately estimate economic measures of value and promote more protection at less cost behavioral economics deserves two cheers for advancing ideas of context dependence and social preferences which we illustrate with two examples of recent research

option values under stochastic volatility theory and empirical estimates abstract this paper numerically solves the call option valuation problem given a fairly general continuous stochastic process for return volatility statistical estimators for volatility process parameters are derived and parameter estimates are calculated for several individual stocks and indices the resulting estimated option values do not differ dramatically from black scholes values in most cases although there is some evidence that for longer maturity index options black scholes overvalues out of the money calls in relation to in the money calls

the dynamic properties of financial market equilibrium with trading fees we incorporate trading fees in a long horizon dynamic general equilibrium model in which traders optimally and endogenously decide when and how much to trade a full characterization of equilibrium is provided which allows us to study the dynamics of equilibrium trades equilibrium asset prices and rates of return in the presence of trading fees we exhibit the effect of trading fees on deviations from the consumption capm and analyze the pricing of endogenous liquidity risk we compare for the same shocks the impulse responses of this model to those of a model in which trading is infrequent because of trader inattention the current version reflects material that was previously in two papers w21421 and w19155

the intended and unintended consequences of financial market regulations a general equilibrium analysis in a production economy with trade in financial markets motivated by the desire to share labor income risk and to speculate we show that speculation increases volatility of asset returns and investment growth increases the equity risk premium and reduces welfare regulatory measures such as constraints on stock positions borrowing constraints and the tobin tax have similar effects on financial and macroeconomic variables borrowing limits and a financial transaction tax improve welfare because they substantially reduce speculative trading without impairing excessively risk sharing trades

option arbitrage and strategy with large price changes abstract arbitrage pricing theorems are derived for options on stocks with jumps as a well as local movements the resulting valuation formulas depend on observable variables only closed form valuation expressions are obtained in the case of large positive and negative jumps these results translate into a simple algebra for characterizing the risk of arbitrage and investment portfolios a continuous time formulation of the infinite variance hypothesis leads to isomorphic pricing expressions

uncertainty shocks and balance sheet recessions this paper investigates the origin and propagation of balance sheet recessions i first show that in standard models driven by tfp shocks the balance sheet channel disappears when agents can write contracts on the aggregate state of the economy optimal contracts sever the link between leverage and aggregate risk sharing eliminating the concentration of aggregate risk that drives balance sheet recessions i then show that uncertainty shocks can help explain this concentration of aggregate risk and drive balance sheet recessions even with contracts on aggregate shocks the mechanism is quantitatively important and i explore implications for financial regulation

collateral constraints and the amplification mechanism abstract kiyotaki and moore j polit economy 105 1997 211 have offered a theory for how common shocks to credit constrained firms are amplified through changes in collateral values and transmitted as fluctuations in output i clarify and extend their model by showing that their collateral amplification mechanism is not robust to the introduction of markets that allow these firms to hedge against common shocks a theory of incomplete hedging is proposed in which the supply of hedging available in the economy is constrained by the aggregate value of collateral i illustrate how the constraint reinstates amplification effects and discuss empirical implications of this new mechanism

general equilibrium pricing of options on the market portfolio with discontinuous returns when the price process for a long lived asset is of a mixed jump diffusion type pricing of options on that asset by arbitrage is not possible if trading is allowed only in the underlaying asset and a risk less bond using a general equilibrium framework we derive and analyze option prices when the underlying asset is the market portfolio with discontinuous returns the premium for the risk of jumps and the diffusion risks forms a significant part of the prices of the options in this economy an attempted replication of call and put options by the black scholes type of trading strategies may require substantial infusion of funds when jumps occur we study the cost and risk implications of such dynamic hedging plans article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

financial innovation macroeconomic stability and systemic crises we present a general equilibrium model of intermediation designed to capture some of the key features of the modernnancial system the model incorporatesnan cial constraints and state contingent contracts and contains a clearly dened pe cuniary externality associated with assetre sales during periods of stress if a sufciently severe shock occurs during a credit expansion this externality is capa ble of generating a systemicnancial crisis that may be self fullling our model suggests thatnancial innovation and greater macroeconomic stability may have madenancial crises in developed countries less likely than in the past but poten tially more severe

endogenous cycles in a stiglitz weiss economy the literature on financial imperfections and business cycles has focused onpropagation mechanisms in this paper we model a purereversion mechanism such that the economy may converge to a two period equilibrium cycle this mechanism confirms that financial imperfections may have a dramatic amplification effect unlike in some related models contracts are complete indexation is not assumed away the welfare properties of a possible stabilizing policy are analyzed the model itself is a dynamic extension of the well known stiglitz weiss model of lending under moral hazard although stylized the model still captures some important features of credit cycles

optimal contracts and supply driven recessions abstract in models with financial frictions state contingent contracts stabilize the business cycle relative to contracts with predetermined repayments we show that this finding depends on whether predetermined repayments are set in real or nominal terms state contingent contracts may amplify supply driven recessions compared to contracts set in nominal terms