black markets for currency hoarding activity and policy reforms abstract in emerging market economies under development of financial markets leads to goods hoarding and foreign currency accumulation as forms of investment in this paper an asset market model supplemented by explicit treatment of smuggling and second economy activity is used to study the paths of black market exchange rates second economy prices hoarding stocks and privately held dollar balances following policy reforms we discuss conditions for overshooting and related dynamics of exchange rates and prices following official exchange rate adjustments price reforms and altered risks of monetary confiscation or currency reforms the saddlepath trajectory of financial adjustment is simulated using data from recent russian experience 1997 elsevier science b v

day of the week effects and asset returns the number of empirical studies using daily stock returns is rapidly increasing researchers generally assume that the distribution of stock returns is identical for all days of the week a convenient statistical assumption but not a necessary condition of market equilibrium nevertheless there are reasons to suspect that the distribution of returns may vary according to the day of the week the most obvious is the impact of weekends on monday s return since monday s return is calculated over three instead of one calender day the mean and variance may well be higher on monday compared with any other daily return perhaps three times as large previous research has examined the daily distribution of stock returns for a monday effect while fama 1965 does not compare daily mean returns he does report that monday s variance is about 20o greater than other daily returns with a traditional distributional assumption regarding the returns on a financial asset specifies that the expected returns are identical for all days of the week contrary to this plausible assumption this paper discovers that the expected returns on common stocks and treasury bills are not constant across days of the week the most notable evidence is for monday s returns where the mean is unusually low or even negative several explanations of the results are investigated but none proves satisfactory aside from documenting significant day of the week effects the implications of the results for tests of market efficiency are examined while market adjusted returns continue to exhibit day of the week effects these effects are no longer concentrated on monday during the last year we have had many conversations with our colleagues throughout the professions we are particularly thankful to the participants at sessions of the western and american finance associations where preliminary versions of this paper were presented special thanks are due to gene fama gailen hite jon ingersoll robert jarrow merton miller clifford smith and rex thompson the expert research assistance of frank rabinovitch and youngsup yun is gratefully acknowledged 1 the list of papers using daily stock returns is too long to name recent examples include charest 1978 dodd 1980 banz 1981 and reinganum 1981

exchange rate regime reforms with black market leakages abstract many countries have multiple exchange rate regimes with black or secondary currency markets operating alongside an exchange rate pegged or determined in interbank or auction markets leakages occur across these markets necessitating careful analysis of the dynamic effects of numerous policy instruments using a model with multiple exchange rates and leakages we trace the dynamic effects on official and parallel foreign exchange markets of exchange rate unification changes in foreign exchange surrender requirements taxes on trade and capital account transactions and official exchange rate devaluation simulations based on russia s recent experience demonstrate the qualitative importance of the results

approximate option valuation for arbitrary stochastic processes abstract we show how a given probability distribution can be approximated by an arbitrary distribution in terms of a series expansion involving second and higher moments this theoretical development is specialized to the problem of option valuation where the underlying security distribution if not lognormal can be approximated by a lognormally distributed random variable the resulting option price is expressed as the sum of a black scholes price plus adjustment terms which depend on the second and higher moments of the underlying security stochastic process this approach permits the impact on the option price of skewness and kurtosis of the underlying stock s distribution to be evaluated

optimal inattention to the stock market with information costs and transactions costs recurrent intervals of inattention to the stock market are optimal if consumers incur a utility cost to observe asset values when consumers observe the value of their wealth they decide whether to transfer funds between a transactions account from which consumption must be financed and an investment portfolio of equity and riskless bonds transfers of funds are subject to a transactions cost that reduces wealth and consists of two components one is proportional to the amount of assets transferred and the other is a fixed resource cost because it is costly to transfer funds the consumer may choose not to transfer any funds on a particular observation date in general the optimal adjustment rule including the size and direction of transfers and the time of the next observation is state dependent surprisingly unless the fixed resource cost of transferring funds is large the consumer s optimal behavior eventually evolves to a situation with a purely time dependent rule with a constant interval of time between observations this interval of time can be substantial even for tiny observation costs when this situation is attained the standard consumption euler equation holds between observation dates if the consumer is sufficiently risk averse

exchange rate behavior with currency inconvertibility abstract the paper analyzes exchange rate dynamics in a world where the domestic currency is inconvertible into foreign currency and there is a black market for foreign exchange the official exchnage rate is thus set by policy but the black market rate is determined by portfolio balance the stock of domestic money changes with the reported current account and the stock of foreign assets of the private sector changes with smuggling and other unreported current account transactions the effects of capital and current account disturbances as well as the effects of changes in the level and the rate of crawl of the official rate on the black market premium and on the currency substitution ratio are analyzed in variants of the basic model

the influence of black markets on a queue rationed centrally planned economy abstract in centrally planned economies in which prices are fixed and the rationing mechanism is waiting line queues we show that an equilibrium of waiting times exists we then introduce a black market in which individuals can trade commodities that they have acquired through the official economy an equilibrium of black market prices and waiting times is shown to exist further the economy with a black market is queue efficient however the introduction of black markets is not necessarily a pareto improvement over an economy without black markets even when we allow winners to compensate losers

a flow based explanation for return predictability this paper proposes and tests an investment ow based explanation for three empirical ndings on return predictability the persistence of mutual fund performance the smart

the distribution of foreign exchange price changes trading day effects and risk measurement this study investigates the nature of price changes in a variety of major and minor foreign exchange markets the results suggest that the log of price changes over one trading day intervals seems to follow a non normal stable distribution function different measures of location and to lesser extent scale are present for different days of the week dollar denominated price changes are high on mondays and wednesdays and low on thursdays and fridays for all currencies the wednesday thursday result is consistent with the settlement procedures used in foreign exchange transactions in the dollar the friday monday result is consistent with an increase in demand for the dollar prior to the weekend this study offers some previously unavailable results on the nature of price changes in a certain set of speculative markets in particular this is a study of the distributional characteristics of daily and weekly price changes for a number of major and minor foreign exchange markets the results document the existence of non normal stable distributions for price changes in foreign exchange markets these price change distributions differ by day of the week in ways that are only partly attributable to the institutional structure of the market the results of the study are interpreted within the context of understanding how foreign exchange markets operate and within the context of prior studies of stock market data concerned with summarizing the probability distribution of price changes for different intervals including days of the week since bachelier s 1 original treatise that contained the proposition that speculative market prices follow a process that could be described by a normal distribution there have been numerous alternative attempts to describe the stochastic processes which characterize speculative market prices these studies have not resulted in any generalized description of the probability distribution of price changes in such markets indeed the evidence suggests substantial differences in the process among various types of financial instruments the failure to achieve consensus can be traced to the lack of robustness in the statistical procedures employed to estimate processes and to differences in the underlying institutional or economic arrangements which are unique to that market the possibility of differences in the information set used to assess value or differences in technology for transmitting information makes it important to secure additional

can information heterogeneity explain the exchange rate determination puzzle empirical evidence shows that most exchange rate volatility at short to medium horizons is related to order flow and not to macroeconomic variables we introduce symmetric information dispersion about future macroeconomic fundamentals in a dynamic rational expectations model in order to explain these stylized facts consistent with the evidence the model implies that a observed fundamentals account for little of exchange rate volatility in the short to medium run b over long horizons the exchange rate is closely related to observed fundamentals c exchange rate changes are a weak predictor of future fundamentals and d the exchange rate is closely related to order flow

biases in option prices abstract this paper examines a european call model of option pricing over a data set which does not suffer from the early exercise problems that have plagued earlier studies of call options on common stocks we specifically examine a data set of american call prices on spot foreign exchange for which it is plausible to apply an adjusted version of the garman kohlhagen 1983 and grabbe 1983 european call option model we make adjustments for interest rate risk and find that the model is nearly unbiased in the valuation of foreign currency options we conclude that the geske roll 1984 conjecture about dividend uncertainty creating biases in stock option prices holds analogously in the foreign currency option market interest rate differential risk analogous to risky dividends thus appears to be an important element in the valuation of foreign currency options

investor attention overconfidence and category learning abstract motivated by psychological evidence that attention is a scarce cognitive resource we model investors attention allocation in learning and study the effects of this on asset price dynamics we show that limited investor attention leads to category learning behavior i e investors tend to process more market and sector wide information than firm specific information this endogenous structure of information when combined with investor overconfidence generates important features observed in return comovement that are otherwise difficult to explain with standard rational expectations models our model also demonstrates new cross sectional implications for return predictability

price distortion and shortage deformation or what happened to the soap the model of this paper generalizes the classical theory of consumer behavior to the more general case of prices that are not necessarily market clearing suppose that in addition to the money cost some sort of search waiting or other quasi fixed effort cost is needed to obtain goods the presence of this quasi fixed cost element will trigger an inventory policy a shortage equilibrium occurs when effort costs are such that in the corresponding inventory policy the flow of desired consumption does not exceed the available supply flow stock hoarding a critical phenomenon in the economics of shortage emerges as a natural component of this model a complete characterization of a stationary shortage equilibrium is given comparative statics and welfare analysis are performed the dynamic transition between steady states is analyzed to give insight into the mechanics of how shortages develop copyright 1991 by american economic association

smuggling and the black market for foreign exchange this paper develops a model of the black market for foreign exchange in which black market currency is demanded and supplied by firms engaged in smuggling it is demonstrated that quotas or foreign exchange rationing are not necessary to induce the coexistence of legal and black foreign exchange markets variants of the model analyze the implications of capital flight unbalanced trade quotas foreign exchange licensing and economies with more than two goods

common factors and local factors implications for term structures and exchange rates this paper studies a multi factor two country term structure and exchange rate model when a diversification effect for an international bond portfolio is expected it shows that the diversification gain calls upon certain restrictions on the process of the stochastic discount factor in a factor structured economy existence of local factors is shown to be a necessary condition for the gains from investing in foreign bonds further the exchange rate risk premia are shown to be a function of the differentials of the risk premia of the factors in bond returns empirical results reveal the tendency for investors to respond sensitively to rare shocks which is shown to be a potential solution to the forward premium puzzle

black markets for foreign exchange real exchange rates and inflation abstract the black market foreign exchange premium is a tax on exports creating a conflict between the financing of government spending and the allocative goal of stimulating exports the premium is solved for in a model that includes private portfolio choice dual exchange markets and money financing of the fiscal deficit the inflationary implications of switching to floats as a means of unifying official and black market rates are then analyzed inflation could rise substantially if the lost revenues from exports are replaced with a higher tax on money the paper is motivated with examples from sub saharan africa

optimal inattention to the stock market inattentive agents update their information sporadically and thus respond belatedly to news we generate optimally inattentive behavior by assuming that to observe the value of his investment portfolio the consumer must pay a cost that is proportional to the portfolio s contempo raneous value it is optimal for the consumer to check his investment portfolio at equally spaced points in time consuming from a riskless trans actions account in the interim the riskless transactions account that finances consump tion guarantees that funds are never unwittingly exhausted we show that the optimal interval of time between consecutive observations of the value of the portfolio is the unique positive solution to a nonlinear equation quantitatively even a small observation cost one basis point of wealth implies a substantial eight month decision interval under conventional parameter values

intertemporal speculation shortages and the political economy of price reform price controls often focus on commodities that are storable and can thus be used in intertemporal speculation second opposition to dismantling of controls is often based on claims of low supply response and greatly bolstered if a strong supply response fails to materialise this is especially relevant in eastern europe where experience with markets is limited we show the difficulties that these two factors create for gradual decontrol of prices we endogenise the probability of a collapse of the reform programme and show that such endogeneity in the presence of intertemporal speculation leads to a strong case against gradualism the smaller the initial price increase the lower the observed supply elasticity and the greater the probability that the programme of reform will be abandoned this implies that the policy that makes most sense from a microeconomic point of view decontrol immediately is also advisable from a macroeconomic point of view credibility problems which are at the core of the transitional output losses that characterise most stabilisation programmes will be much less under a cold turkey approach and so will therefore transitional unemployment

learning from prices and the dispersion in beliefs i study whether investors use an asset s price to update their beliefs about its payos i show that in a dynamic economy the relationship between the dispersion in investor beliefs and returnvolume characteristics can be used to empirically answer this question when investors have rational expectations re and condition on the price i show that belief dispersion is positively related to expected returns return volatility and correlation between volume and absolute returns but negatively related to return autocorrelation when investors do not use the price as in a dierence of opinions do model these relationships are reversed i test these predictions using the crosssection of returns volume and analyst forecast dispersion over dierent horizons the results are consistent with the re model at quarterly and longer horizons but reject both models at the monthly horizon i show that a hybrid model with some do investors and some re investors can match the short horizon evidence the empirical results are consistent with the idea that while some investors do not use the price in the short run they increase their conditioning on the price over time

further results on the constant elasticity of variance call option pricing model the black scholes 4 call option model is a member of the class of constant elasticity of variance call option models proposed by cox 6 while the black scholes model assumes that the volatility or instantaneous variance of return is constant through time the other members of the class allow the volatility to change with the stock price this property is of interest because empirical evidence suggests that returns to common stock are heteroscedastic and also that volatilities implied from the black scholes model and market prices of call options are not constant

overreaction delayed reaction and contrarian profits this paper presents a decomposition of short horizon contrarian profits into various sources based on an analysis os stock price reactions to common factors an firm specific information in sharp contrast with the conclusions in the extant literature we find that the lead lag structure in stock prices contributes less than 5 of the observed contrarian profits with most of the profits being attributable to stock price overreaction

forecasting the forecasts of others implications for asset pricing we develop a dynamic asset pricing model with heterogeneously informed agents unlike previous research we focus on the general case where differential information leads to the problem of forecasting the forecasts of others and to non trivial dynamics of higher order expectations in particular we prove that the model does not admit a finite number of state variables using numerical analysis we compare equilibria characterized by identical fundamentals but different information structure we demonstrate that the distribution of information has substantial impact on equilibrium prices and returns in particular we show that asymmetric information can generate momentum in returns and high trading volume

the dependence between hourly prices and trading volume this study provides evidence on joint characteristics of hourly common stock trading vol ume and returns on the new york stock exchange average volume traded shows signifi cant differences across trading hours of the day and across days of the week average returns differ across hours ofthe day and to some extent across days ofthe week there is a strong contemporaneous relation between trading volume and returns and also a rela tion between trading volume and returns lagged up to four hours furthermore the trading volume returns relation is steeper for positive returns than for nonpositive returns

strategic trading in a two sided foreign exchange auction abstract the market microstructure chosen for foreign exchange markets can influence trading volumes and equilibrium exchange rates with emerging markets and developing countries increasingly utilizing two sided auctions we show that the choice of the discrete t tonnement auction creates incentives for strategic behavior among market participants theoretical predictions on strategic under revelation of demand or supply positions are supported empirically using detailed data from a rare example of a t tonnement market the moscow interbank currency exchange our results suggest that market microstructures should be introduced alongside more traditional asset market fundamentals in studies of foreign exchange market activity especially in developing countries

a model of competitive stock trading volume a model of competitive stock trading is developed in which investors are heterogeneous in their information and private investment opportunities and rationally trade for both informational and noninformational motives i examine the link between the nature of heterogeneity among investors and the behavior of trading volume and its relation to price dynamics it is found that volume is positively correlated with absolute changes in prices and dividends i show that informational trading and noninformational trading lead to different dynamic relations between trading volume and stock returns

infrequent rebalancing return autocorrelation and seasonality a model of infrequent rebalancing can explain specific predictability patterns in the time series and cross section of stock returns first infrequent rebalancing produces return autocorrelations that are consistent with empirical evidence from intraday returns and new evidence from daily returns autocorrelations can switch sign and become positive at the rebalancing horizon second the cross sectional variance in expected returns is larger when more traders rebalance this effect generates seasonality in the cross section of stock returns which can help explain available empirical evidence

the pricing of call and put options on foreign exchange this paper derives pricing equations for european puts and calls on foreign exchange the call and put pricing formulas are unlike the black scholes equations for stock options in that there are two relevant interest rates interest rates are stochastic and boundary constraints differ in addition it is shown that both american call and put options have values larger than their european counterparts

the black market for dollars in brazil the model of the black market for dollars focuses on the interaction of portfolio decisions relevant to the holding of asset stocks and the determinants of net flows of dollars associated with tourism and smuggling a partial equilibrium model of the black market shows that the level of the premium is determined by the official real exchange rate and the official depreciation adjusted interest differential as well as seasonal factors associated with tourism expectations of future exchange rate changes under rational expectations are shown to affect the current level of the black market premium the empirical evidence provides ample support for the role of the key determinants of the premium as well as for an important seasonal pattern the magnitude of the seasonal variation is evidence of the imperfect substitutability between black dollars and cruzeiro assets in portfolios

differential information and dynamic behavior of stock trading volume this article develops a multiperiod rational expectations model of stock trading in which investors have differential information concerning the underlying value of the stock investors trade competitively in the stock market based on their private information and the information revealed by the market clearing prices as well as other public news we examine how trading volume is related to the information flow in the market and how investors trading reveals their private information article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

currency inconvertibility trade taxes and smuggling abstract in the classic analysis of smuggling importers choose the optimal mix of legal and illegal trade given trade taxes and the technology of detection this paper introduces an inconvertible currency in the framework so that illegal trade is valued at a rate higher than the fixed official exchange rate sections 2 and 3 show how the smuggling ratio and the domestic price markup for the import and export good are simultaneously determined with balanced legal and illegal trade changes in the long run black market premium are a weighted average of changes in trade taxes whereas changes in the smuggling ratios depend on the ration of trade taxes thus an import tariff and an export subsidy rising at the same rate would keep smuggling ratios constant but imply a rising black market premium sections 4 and 5 to determine the quantity of exports and imports a model of the economy is presented in section 6 featuring the production of exports and non traded goods and the consumption of imports and non traded goods as well as a government confiscating the amounts of traded goods unsuccessfully smuggled then export production may fall and welfare may rise if trade taxes have a negative effect on the relative price of exports and imports stronger than the positive effect on smuggled exports and imports which is always welfare reducing section 7 introduces the short run determination of the black market premium via portfolio balance in this case rising trade taxes may be associated with a premium rising even faster if there is unreported capital flight and conversely

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 dynamics of short term mutual fund flows and returns a time series and cross sectional investigation abstract this study analyzes the dynamics of daily mutual fund flows a vector auto regression var of flows and returns shows that the behavior of fund investors is more consistent with contrarian rather than momentum characteristics past fund flows have a positive impact on future fund returns with the long term information effect dominating the transient price pressure effect seasonality in daily flows such as day of week and day of month patterns are present and daily flows are generally mean reverting probit regressions indicate that fund investment objective marketing policy and level of active management explain cross sectional variation in the behavioral patterns displayed in daily flows our results are robust to the different methods of calculating daily flows based on whether or not the day end tna figures include the current day s flow throughout the analysis we contrast the dynamics of daily flows with established results for monthly fund flows and find important differences between the two

devaluation exchange controls and black markets for foreign exchange in developing countries abstract this paper analyzes the response of external balance indicators to anticipated devaluation in a model incorporating the movement of black market exchange rates under rational expectations the analysis is then extended to the case of devaluation cycles to examine the behavior of black market rates and official trade statistics in the face of persistent inflation that appreciates the real exchange rate and motivates periodic devaluation the data confirm the predicted response of the black market rate to devaluation as well as the sensitivity of official exports data to movements in the black market rate

hedging demand and market intraday momentum hedging short gamma exposure requires trading in the direction of price movements thereby creating price momentum using intraday returns on over 60 futures on equities bonds commodities and currencies between 1974 and 2020 we document strong market intraday momentum everywhere the return during the last 30 minutes before the market close is positively predicted by the return during the rest of the day from previous market close to the last 30 minutes the predictive power is economically and statistically highly significant and reverts over the next days we provide novel evidence that links market intraday momentum to the gamma hedging demand from market participants such as market makers of options and leveraged etfs

on valuing american call options with the black scholes european formula empirical papers on option pricing have uncovered systematic differences between market prices and values produced by the black scholes european formula such biases have been found related to the exercise price the time to maturity and the variance we argue here that the american option variant of the black scholes formula has the potential to explain the first two biases and may partly explain the third it can also be used to understand the empirical finding that the striking price bias reverses itself in different sample periods the expected form of the striking price bias is explained in detail and is shown to be closely related to past empirical findings the black scholes european option pricing model tends to exhibit systematic empirical biases when used to value american call options the reported biases

presidential address asset price dynamics with slow moving capital i describe asset price dynamics caused by the slow movement of investment capital to trading opportunities the pattern of price responses to supply or demand shocks typically involves a sharp reaction to the shock and a subsequent and more extended reversal the amplitude of the immediate price impact and the pattern of the subsequent recovery can reflect institutional impediments to immediate trade such as search costs for trading counterparties or time to raise capital by intermediaries i discuss special impediments to capital formation during the recent financial crisis that caused asset price distortions which subsided afterward after presenting examples of price reactions to supply shocks in normal market settings i offer a simple illustrative model of price dynamics associated with slow moving capital due to the presence of inattentive investors i address the implications for asset price dynamics of the apparent slow movement of investment capital to trading opportunities the arrival of new capital to an investment opportunity can be delayed by fractions of a second in some markets for example an electronic limit order book market for equities or by months in other markets such as that for catastrophe risk insurance accordingly prices respond to supply or demand shocks with a sharp reaction because of the relatively small subset of capital and thus risk bearing capacity that is immediately available to absorb a shock on short notice such a price impact is substantially reversed over time as additional capital becomes available the amplitude of the immediate price impact and the pattern of the subsequent recovery can reflect many sorts of attention costs to trade as well as institutional impediments to capital movement such as search costs for trading

over the counter option market dividend protection and biases in the black scholes model a note most options are traded over the counter otc and are dividend protected the exercise price decreases on the ex date by an amount equal to the dividend this protection completely inhibits the early exercise of american call options nevertheless otc protected options have market values which differ systematically from blackscholes values for european options on non dividend paying stocks the pricing difference is related to both the variance of the underlying stock return and to time until expiration of the option but it is quite small in dollar amount

on the pricing of european and american foreign currency call options abstract this study uses cox ross analysis and dynamic programming techniques to price foreign currency call options we show that under certain conditions the american call price will exceed its european counterpart while under other conditions the two prices will be identical we find that the american premium is a complex function of the degree to which an option is in or out of the money and that this premium is greatest when an option is near in or out we present empirical evidence which shows that the american model significantly improves upon a european model however significant pricing errors associated with the american model remain

nonparametric tests of alternative option pricing models using all reported trades and quotes on the 30 most active cboe option classes from august 23 1976 through august 31 1978

trading volume and serial correlation in stock returns this paper investigates the relationship between aggregate stock market trading volume and the serial correlation of daily stock returns for both stock indexes and individual large stocks the first order daily return autocorrelation tends to decline with volume the paper explains this phenomenon using a model in which risk averse market makers accommodate buying or selling pressure from liquidity or noninformational traders changing expected stock returns reward market makers for playing this role the model implies that a stock price decline on a high volume day is more likely than a stock price decline on a low volume day to be associated with an increase in the expected stock return

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