pricing options on scenario trees abstract we examine valuation procedures that can be applied to incorporate options in scenario based portfolio optimization models stochastic programming models use discrete scenarios to represent the stochastic evolution of asset prices at issue is the adoption of suitable procedures to price options on the basis of the postulated discrete distributions of asset prices so as to ensure internally consistent portfolio optimization models we adapt and implement two methods to price european options in accordance with discrete distributions represented by scenario trees and assess their performance with numerical tests we consider features of option prices that are observed in practice we find that asymmetries and or leptokurtic features in the distribution of the underlying materially affect option prices we quantify the impact of higher moments skewness and excess kurtosis on option prices we demonstrate through empirical tests using market prices of the s p500 stock index and options on the index that the proposed procedures consistently approximate the observed prices of options under different market regimes especially for deep out of the money options

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

what price drug use the contribution of economics to an evidence based drugs policy abstract this paper presents a review of the recent economics literature in the area of illicit drug use particular attention is paid to the economics of addiction and the rational addiction model the welfare economics framework for analysing the social costs of drug use and the attempts that have been made by economists to evaluate recent or proposed policy interventions a dominant theme in this review is the problem of poor data availability this is particularly true when it comes to implementing the rational addiction model but it is also apparent in the literature on estimating the costs of illicit drug use to society as a whole one of the main conclusions of this review is that until recently public policy has not been particularly influenced by research carried out by economists it is not clear whether this is because economists have had to grapple with inadequate data and hence their conclusions are couched in uncertainty or whether it is because drugs researchers have assumed a very limited role for economists in their analysis

scenario modelling for selective hedging strategies abstract we study currency risk management in the context of scenario analysis we develop scenario based optimization models that jointly determine the portfolio composition and the hedging strategy within each currency thus the model prescribes optimal selective hedging policies we then study empirically the performance of the models the new elements of our empirical analysis are various horizons one month and one semester various currency bases explicit incorporation of realistic transaction costs the results show that selective hedging strategies dominate the alternatives under some conditions and that transaction costs are very important in determining the profitability of various currency risk management strategies for both stocks and bonds at the one month horizon

a dynamic stochastic programming model for international portfolio management we develop a multi stage stochastic programming model for international portfolio management in a dynamic setting we model uncertainty in asset prices and exchange rates in terms of scenario trees that reflect the empirical distributions implied by market data the model takes a holistic view of the problem it considers portfolio rebalancing decisions over multiple periods in accordance with the contingencies of the scenario tree the solution jointly determines capital allocations to international markets the selection of assets within each market and appropriate currency hedging levels we investigate the performance of alternative hedging strategies through extensive numerical tests with real market data we show that appropriate selection of currency forward contracts materially reduces risk in international portfolios we further find that multi stage models consistently outperform single stage models our results demonstrate that the stochastic programming framework provides a flexible and effective decision support tool for international portfolio management

the determinants of occupational success in britain this paper is concerned with measuring the true impact of certain human capital variables on an individual s occupational position the particular variables which are analysed are training qualifications and spells of sickness and unemployment the longitudinal nature of the data enables us to control for all relevant individual attributes which remain fixed over the period of the sample this is vitally important because these attributes are strongly correlated with the variables of interest and would seriously corrupt estimates derived from a single cross section a method of generating consistent estimates as n oo t fixed for a dynamic model with fixed effects is also illustrated

do drinkers earn less theoretical work by becker and others on human capital led initially to empirical research on the determinates of earnings interest in human capital has now spread to other areas especially health this movement is in conjunction with societal concerns regarding the role of diet and environmental factors on human well being and performance following becker 1 and grossman 9 economists expect to find a significant relationship between health and earnings health aspects of human capital have been extensively explored since the early work of grossman 9 10 good health is both beyond the control of the individual exogenous as a result of genetic factors and random events and controllable endogenous through the regulation of activities such as smoking drinking eating exercise and other informed choices this study examines the relation between earnings and drinking curiously little rigorous empirical work has been done on the relation between earnings and drinking irving fisher s claim to the contrary 1 there is little evidence that prohibition led to substantial if any productivity increases although it is established that excessive drinking leads to poor health the empirical evidence regarding earnings and drinking is mixed and inconclusive according to the u s government abusive drinkers earn less in their biennial reports to congress the national institute on alcohol abuse and alcoholism niaaa estimates the economic cost to society of alcohol abuse approximately half of this cost arises from the estimated loss in earnings productivity due to abusive drinking 2 their approach consists of estimating a wage equation which includes human capital variables as well as a dichotomous abusive drinking variable and quantity of alcohol consumed 3 berger and leigh 3 used a sample selection model to test whether drinkers earned more or less than nondrinkers they divided their sample from the 1972 73 quality of employment survey into two categories drinkers and nondrinkers using a sample selection correction estimator hedonic wage regressions for each category and by sex were estimated they found that drinkers moderate and abusive combined earned more than nondrinkers comparisons were then made between wages from each regression with demographic and human capital variables set at

international market correlation and volatility international correlations for stocks and bonds fluctuate widely over time as previous studies have found volatility appears to be contagious across markets in addition international correlation increases in periods of high market volatility although the correlation of individual foreign stock markets with the u s stock market has generally increased slightly over the past 37 years it has not increased during the past 10 years similarly the international correlation of bond markets increased in the early 1980s but it has had no discernible trend in the past 10 years the fairly low levels of international correlation among stocks or bonds suggests that national factors still strongly affect local asset prices the link between correlation and market volatility is bad news for global money managers because when the domestic market is subject to a strong negative shock is when the benefits of international risk diversification are needed most

a theory of rational addiction we develop a theory of rational addiction in which rationality means a consistent plan to maximize utility over time strong addiction to a good requires a big effect of past consumption of the good on current consumption such powerful complementarities cause some steady states to be unstable they are an important part of our analysis because even small deviations from the consumption at an unstable steady state can lead to large cumulative rises over time in addictive consumption or to rapid falls in consumption to abstention our theory also implies that cold turkey is used to end strong addictions that addicts often go on binges that addicts respond more to permanent than to temporary changes in prices of addictive goods and that anxiety and tensions can precipitate an addiction

the effect of illicit drug use on the wages of young adults this article examines the effects of cocaine and marijuana use on the wages of young adults the endogeneity of drug use in a wage equation is considered and a two stage least squares procedure is implemented the results suggest that increased use of marijuana or cocaine is associated with higher wages the positive relationship between drug use and the wage does not diminish with age i also investigate whether systematic differences in the return to measures of human capital investments can explain the positive relationship between drug use and wages

when information dominates comparison abstract we propose a micro econometric evaluation of the relation between life satisfaction and income distribution using a balanced panel survey of the russian population russian longitudinal monitoring survey rlms running from 1994 to 2000 covering 4685 individuals we show that in the context of the very volatile russian environment hirschman s q j econ 87 1973 544 tunnel effect conjecture seems to be confirmed variables reflecting income distribution do not influence satisfaction through social comparisons individuals rather seem to use their informational content in order to form their expectations the reference group s income thereby exerts a positive influence on individual satisfaction which contrasts with other studies on the subject inequality indices do not affect individual welfare

the returns and risk of alternative put option portfolio investment strategies this paper is the second in a series of analyses we have prepared based on simulations of a variety of portfolio strategies over a significant period of time the first of these analyses examined the fully covered call option writing strategy and the buying strategy which combines purchase of call options and commercial paper in the study presented here we examine the uncovered put writing strategy and the buying strategy which combines the purchase of put options and the underlying stocks as a preface to the simulations we analyze the quantitative discrepancies between the parity model of put pricing and a model which takes into account the possibility of early exercise of the put in connection with this analysis we simulate the returns to the conversion strategy which combines the purchase of put options and the underlying stocks with the simultaneous sale of the corresponding call options as in our earlier paper on call option strategies we find in this study that investors can use uncovered putoption writing and protective put optionbuying strategies to produce patterns of returns for investment portfolios not reproducible by any simple strategy of combining stock with fixed income securities put options are viewed as term insurance insuring against a loss in value of underlying stock investors sell insurance by using the uncovered put writing strategies and investors buy insurance protecting the value of stocks within a portfolio by using protective put optionbuying strategies no put strategy or call strategy can dominate any other strategy if options are priced correctly although there is no single best strategy for all investors they are not indifferent among strategies because the patterns of returns differ we therefore show these important patterns of returns on put option strategies not only using single stocks but also using portfolios of stocks this research was financed in part by grants from donaldson lufkin jenrette new york the center for research in security prices university of chicago and the national science foundation washington d c 1 merton scholes and gladstein 1978 in the present paper all references to our earlier paper are to this study

labor market effects of marijuana and cocaine use among young men using data on marijuana and cocaine use from the 1984 national longitudinal survey of youth the authors examine the hypothesis that drug use reduces labor market productivity as measured by wages from an analysis that controls for the probability of employment and the endogeneity of drug use they find that although long term and on the job use of marijuana negatively affected wages the net productivity effect for all marijuana users both those who engaged in long term or on the job use and those who did not was positive no statistically significant association was found between cocaine use and productivity

the effect of alcohol use on wages 1988 the effect of alcohol use on wages applied economics vol 20 no 10 pp 1343 1351

currency hedging for international portfolios this paper examines the benefits from currency hedging both for speculative and risk minimization motives in international bond and equity portfolios the riskreturn performances of globally diversified portfolios are compared with and without forward contracts over the period 1974 to 1990 inclusion of forward contracts results in statistically significant improvements in the performance of unconditional portfolios containing bonds conditional strategies are also implemented both in sample and out of sample and are shown to both significantly improve the risk return tradeoff of global portfolios and to outperform unconditional hedging strategies whether international portfolios should be hedged against currency risks is the subject of an active debate the theoretical side of the debate has been closely associated with two strands in the academic literature international asset pricing and optimal hedging in the futures markets in the international asset pricing model iapm of solnik 1974 optimal portfolios contain positions in forward contracts or equivalently foreign currency denominated bills these positions which can differ from the positions in foreign stocks have since been termed hedges black 1990 shows that under additional assumptions the hedge ratios should be identical for all investors regardless of their nationality universality and that investors should never fully hedge their foreign currency exposures similarly theoretical models from the futures literature produce demands for hedging instruments that contain both speculative and hedging components the empirical issue unanswered so far is whether adding forward contracts to international portfolios significantly improves the risk return profile of global investments empirical research has barely begun to respond to the challenges of theoretical models there exists little empirical evidence on either the relevance of black s universal hedge ratios or the optimality of hedge ratios less than one instead researchers have concentrated on the benefits of fully hedging exchange risk for example eun and resnick 1988 indicate that stock portfolios perform better when fully hedged but offer no statistical tests

measuring financial asset return and volatility spillovers with application to global equity markets we provide a simple and intuitive measure of interdependence of asset returns and or volatilities in particular we formulate and examine precise and separate measures of return spillovers and volatility spillovers our framework facilitates study of both non crisis and crisis episodes including trends and bursts in spillovers and both turn out to be empirically important in particular in an analysis of sixteen global equity markets from the early 1990s to the present we find striking evidence of divergent behavior in the dynamics of return spillovers vs volatility spillovers return spillovers display a gently increasing trend but no bursts whereas volatility spillovers display no trend but clear bursts

the currency hedging decision a search for synthesis in asset allocation many asset allocation and liability management decisions are controversial but the decision that frequently generates the most debate is the currency hedging decision strong feelings on currency exposure policy are usually based on the conviction that currency exposures should be determined by a simple mechanical process but not everyone advocates the same process a survey of the leading proposals to simplify the currency management process suggests that a baseline currency policy may lend itself to some mechanical rules but the rules are more complex than any of the widely advocated currency hedging policies suggest equity and fixed income managers as well as asset allocators will find currency issues easier to understand if they view currencies as they would view any other financial instrument the importance of currency management is clearer if a manager and client start from a 50 50 hedged unhedged currency benchmark and if currency and money market returns are combined the combination of currency and money market returns strips primary currency movements from stock and bond returns clarifying intermarket correlations and creating synthetic stock and bond futures portfolios no one can harbor illusions that this study or any similar effort can completely eliminate currency hedging controversies the argument has gone on too long and too many positions are ossified nonetheless most practitioners can understand the strengths and weaknesses of the various currency hedging viewpoints and the assumptions behind them can be evaluated dispassionately this dispassionate evaluation leads to a baseline currency policy but not to a rigid prescription for currency hedging designed to satisfy the demand for a simple rule the policy suggests an approach that can help a manager measure the cost or risk of a specific currency com

gender differences in labor market effects of alcoholism little is known about the role of specific health problems in affecting labor market productivity even less is known about gender differences in the labor market effects of such health problems current knowledge of health effects is based largely on samples composed exclusively of men a common practice in both economics and health research in the latter case even a congressional mandate to incorporate females in study samples is reputed to have had little effect patricia schroeder 1990 in this study we attempt to determine the structure of gender differences in labor market responses to alcoholism we use a relatively new data source that allows such comparisons by gender in a large community based sample previous studies have established that there are significant gender differences in labor market behavior differences in prevalence rates of alcoholism by gender are also well established it is estimated that 3 percent of females are currently suffering from alcoholism and twice that many have exhibited symptoms at some time for males the numbers are 10 and 20 percent respectively there is some medical evidence to indicate that physiologically women and men respond differently to alcohol for example a recent study suggests that women have greater vulnerability to the acute and chronic health conditions associated with alcoholism mario frezza et al 1990

asymmetric volatility transmission in international stock markets abstract the transmission mechanism of price and volatility spillovers across the new york tokyo and london stock markets is investigated the asymmetric impact of good news market advances and bad news market declines on volatility transmission is described by an extended multivariate exponential generalized autoregressive conditionally heteroskedastic egarch model using daily open to close returns we find strong evidence that volatility spillovers in a given market are much more pronounced when the news arriving from the last market to trade is bad a before and after october 1987 crash analysis reveals that the linkages and interactions among the three markets have increased substantially in the post crash era suggesting that national markets have grown more interdependent

a pint a day raises a man s pay but smoking blows that gain away this paper studies the wage effects of the use of alcohol and tobacco the analysis based on a recent survey in the netherlands shows that for males the use of tobacco has a negative wage effect of about 10 while the use of alcohol has a positive wage effect of about the same size the wages of females are not affected by smoking and drinking

cannabis use and its effects on health education and labor market success cannabis is the most popular illegal drug its legal status is typically justified on the grounds that cannabis use has harmful consequences empirically investigating this issue has been a fertile topic for research in recent times we provide an overview of this literature focusing on studies which seek to establish the causal effect of cannabis use on health education and labor market success we conclude that there do not appear to be serious harmful health effects of moderate cannabis use nevertheless there is evidence of reduced mental well being for heavy users who are susceptible to mental health problems while there is robust evidence that early cannabis use reduces educational attainment there remains substantial uncertainty as to whether using cannabis has adverse labor market effects

information trade and derivative securities hellwig s 1980 model is used to analyze the value of improving trading opportunities by more frequent trading in the underlying asset or by trading in a derivative asset with multiple trading sessions uninformed investors behave as rational trend followers while more informed investors follow a contrarian strategy as trading becomes continuous pareto efficiency is achieved with trading in an appropriate derivative security pareto efficiency may be achieved in only a single round of trading all derivative claims are then priced on black and scholes 1973 principles and in the absence of further supply shocks no trading will take place in subsequent trading rounds article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

currency options and the optimal hedging of contingent foreign exchange exposure foreign exchange transaction exposures over the complete range of probabilities as well the optimal forward and option hedge alternatives three utility functions are used covering a wide range of risk postures in marked contrast with the virtually universal endorsement of option hedging contingent exposures to be found in the financial management literature our results indicate that options have little if any useful role to play in the hedging of transaction exposures of any sort

does drug use lower wages this study using microdata from the 1980 and 1984 waves of the national longitudinal survey of youth examines the effects of drug use on wages and employment contrary to most previous researcher

back testing the performance of an actively managed option portfolio at the swedish stock market 1990 1999 we build an investment model based on stochastic programming in the model we buy at the ask price and sell at the bid price we apply the model to a case where we can invest in a swedish stock index call options on the index and the risk free asset by reoptimizing the portfolio on a daily basis over a ten year period it is shown that options can be used to create a portfolio that outperforms the index with ex post analysis it is furthermore shown that we can create a portfolio that dominates the index in terms of mean and variance i e at given level of risk we could have achieved a higher return using options

an econometric analysis of coca eradication policy in colombia abstract we estimate an econometric model of coca production in colombia our results indicate that coca eradication is an ineffective means of supply control as farmers compensate by cultivating the crop more extensively the evidence further suggests that incentives to produce legal substitute crops may have greater supply reducing potential than eradication

illicit drug use unemployment and occupational attainment in this paper we use data from the british crime survey bcs to examine the effect of illicit drug use on labour market outcomes we find very little evidence to support any relationship between drug use hard or soft and occupational attainment however we find compelling evidence to suggest that drug use particularly the use of opiates cocaine and crack cocaine is associated with an increased risk of unemployment regardless of age or gender

spanning and completeness in markets with contingent claims abstract we characterize financial markets that are complete or that contain portfolios which span all measurable functions of a particular asset payoffs either finite and infinite dimensional these results are then employed to describe the extent to which options trading is sufficient to complete markets to investigate the existence of efficient funds and to establish the extent of market completeness required to ensure the unanimity and irrelevance results of modern corporation finance

who uses illegal drugs gary becker and kevin murphy 1988 present a theoretical model of rational addiction that requires information on past present and future prices they do not study illegal drugs empirically in this and their related papers a major data source is the annual survey of high school seniors hss also known as monitoring the future this work is summarized in l johnston et al 1988 they find a growing use of drugs measured by monthly annual and lifetime prevalence over time and differences by region and sex cocaine use showed marked increases from 1976 though this levelled off from 1986 to 1987 they often rely on cross tabs that leaves many variables uncontrolled and the results subject to omitted variable bias j bachman et al 1984 use ordinary least squares ols regressions in which the drug use in the three years post high school is related to various characteristics such as living arrangements while an improvement over cross tabs ols applied to categorical dependent variables yields inefficient estimates see m nerlove and s press 1973 johnston et al used follow up surveys of a subsample drawn from each cohort they find the use of some drugs decline at older ages say 35 though they do not determine if the heavy users have died dropped out of the sample or have been rehabilitated the hss s initial restriction to high school seniors removes about 30 percent of the population who drop out of high school perhaps because of taking drugs studies based on the national institute of drug abuse nida sample of people 12 and older show some heavy drug use of people less than 17 years old see j d miller et al 1982 and nida 1985 richard clayton 1985 using the 1980 hss presents univariate regressions that shows the frequency of use of cocaine is positively related to lifetime marijuana use and days out of school in the past month but negatively related to high school grade point average h abelson and miller 1985 using the nida surveys covering 1974 82 show differences in the percentage using cocaine by education and race for lifetime 12 months and last month measures they find strong trends d kandel 1980 presents a recent survey of drinking and drug use among youth people in their late 30 s mature out of heroin use rather than die

alcohol and earnings does drinking yield a wage premium this paper examines the relationship between alcohol consumption and earnings for prime age males wage differentials for non moderate and heavy drinkers are estimated using a polychotomous choice model which accounts for the endogenous relationship be tween drinking and earnings we find that moderate alcohol consumption leads to increased earnings relative to abstention however heavy drinking leads to reduced earnings relative to moderate drinking heavy drinkers possess flatter age earnings profiles and attain lower returns for higher education than non and moderate drinkers these results are in contrast to previous research on substance abuse which finds no earnings drop off for heavy users

is complete hedging optimal for international bond portfolios over the 1980s however non u s investors could have lowered their international portfolios risks by taking on some currency exposure for these investors the benefits of diversification across currencies more than offset the cost of the currencies volatilities evidently the free lunch argument misses something and investors should be concerned that the missing link might change across countries or over time

integrated dynamic models for hedging international portfolio risks abstract we develop scenario based stochastic programming models for hedging the risks of international portfolios using options the models provide increasing level of integration in managing market and foreign exchange fx risks we start with a single stage model with currency options for selective hedging of fx risks while market risk is addressed through diversification we add stock options to hedge market risks and add quantos and currency options to develop an integrated model using an innovative method to price quantos on the scenario tree underpinning the stochastic program the models are extended to multi stage settings backtesting on market data over a 14 year period that includes the global financial crisis of 2008 we demonstrate the effectiveness of taking increasingly integrated views of risk management simultaneous hedging of market and fx risks using stock and currency options has the best ex post performance the differences are economically significant and statistical significance is established through rigorous hypothesis testing the models are particularly effective during the crisis test results show that two stage models outperform their single stage counterparts regardless of the hedging strategy

employment unemployment and problem drinking the misuse of alcohol is estimated to result in enormous economic costs composed largely of reduced labor market productivity however there has been debate on this issue the purpose of this paper is to help to resolve this debate by presenting sound structural estimates of the relationship between measures of problem drinking and of employment and unemployment the analysis is based on the 1988 alcohol supplement of the national health interview survey we find that for both men and women problem drinking results in reduced employment and increased unemployment

the drivers of financial globalization over the past decade emerging markets have accounted for a growing fraction of world gdp and international trade reflecting fast growth in china and india but also strong economic performance across the board and the spec tacular increase in foreign exchange reserve holdings the growing importance of sovereign wealth funds and the pattern of global imbal ances more generally suggest that these coun tries are also playing a major role in financial globalization

asset allocation with correlation a composite trade off abstract we assess the ability of minimum variance portfolio allocation strategies accounting for time varying correlation between assets to provide performance benefits relative to an equally weighted portfolio prior to transaction costs correlation based strategies emphatically outperform the equally weighted benchmark this finding is strongest for short horizon correlation forecasts and attributed to dynamic correlation as opposed to variance forecasts thus estimation error is not found to be the primary obstacle to successful portfolio optimization rather frequent rebalancing and associated transaction costs pose a significant challenge limiting portfolio turnover through short selling restrictions and greater rebalancing error tolerance results in regular outperformance of the correlation based strategies even for large transaction costs taken together these findings provide evidence of a trade off between optimal portfolio performance forecasting horizon rebalancing frequency and transaction costs