understanding dynamic mean variance asset allocation abstract we provide a new portfolio decomposition formula that sheds light on the economics of portfolio choice for investors following the mean variance mv criterion we show that the number of components of a dynamic portfolio strategy can be reduced to two the first is preference free and hedges the risk of a discount bond maturing at the investor s horizon while the second hedges the time variation in pseudo relative risk tolerance both components entail strong horizon effects in the dynamic asset allocation as a result of time varying risk tolerance and investment opportunity sets we also provide closed form solutions for the optimal portfolio strategy in the presence of market return predictability the model parameters are estimated over the period 1963 to 2012 for the u s market we show that i intertemporal hedging can be very large ii the mv criterion hugely understates the true extent of risk aversion for high values of the risk aversion parameter and the more so the shorter the investment horizon and iii the efficient frontiers seem problematic for investment horizons shorter than one year but satisfactory for large horizons overall adopting the mv model leads to acceptable results for medium and long term investors endowed with medium or high risk tolerance but to very problematic ones otherwise

credit supply and the housing boom an increase in credit supply driven by looser lending constraints in the mortgage market is the key force behind four empirical features of the housing boom before the great recession the unpreced

multitask agency and contract choice an empirical exploration the multitask agency problem is examined empirically using contracts between private integrated oil companies and their service stations in the city of vancouver the empirical tests assess how variations in the characteristics of one task affect the choice of agent compensation scheme for another comparative statics from the model predict that higher powered incentives will be offered for gasoline sales when the secondary activity is not highly complementary with gasoline retailing where complementarity is measured by the cross price demand effect the covariation in uncertainty and the degree of effort substitutability copyright 1996 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

limited liability and incentive contracting with ex ante action choices abstract this article examines a principal agent model of financial contracting in which a risk neutral entrepreneur agent makes an unobservable ex ante effort choice while employing the investment funds of a risk neutral investor principal the key innovation is that the investment contract is subject to statutory liability limits given these liability limits two settings are considered one in which the investor payoff function is also constrained to be monotonically nondecreasing in firm profit and another in which no such monotonic contract constraint is imposed in the former case a standard debt contract is shown to emerge and a first best effort choice is not achieved in the latter setting the optimum is characterized by a live or die payoff function and a first best effort level may or may not be realized

evaluating interval forecasts a complete theory for evaluating interval forecasts has not been worked out to date most of the literature implicitly assumes homoskedastic errors even when this is clearly violated and proceed by merely testing for correct unconditional coverage consequently i set out to build a consistent framework for conditional interval forecast evaluation which is crucial when higher order moment dynamics are present the new methodology is demonstrated in an application to the exchange rate forecasting procedures advocated in risk management

conflicting tasks and moral hazard theory and experimental evidence abstract we study a multi task principal agent problem in which tasks can be in direct conflict with each other in theory it is difficult to induce a single agent to exert efforts in two conflicting tasks because effort in one task decreases the success probability of the other task we have conducted an experiment in which we find strong support for the relevance of this incentive problem in the presence of conflict subjects choose two efforts significantly less often when both tasks are assigned to a single agent than when there are two agents each in charge of one task

impact of ex ante hypothetical bias mitigation methods on attribute non attendance in choice experiments in this article we use survey data from nigeria on consumers preferences for organic products to investigate the impact of ex ante hypothetical bias mitigation methods cheap talk and honesty priming on respondents attribute non attendance we employ a framework that allows us to jointly examine the response to the stated choice component and the response to the attribute processing questions while avoiding the potential endogeneity bias and measurement error problems arising from some attribute non attendance methods our results show that the incidence of attribute non attendance varies across the treatments in general with significant difference in attribute non attendance rates between respondents exposed to the mitigation strategies honesty priming and cheap talk and the baseline group we also find that the low willingness to pay values for the honesty priming task appear to correspond with the lowest attribute non attendance rates reported for all the attributes especially price and might reflect a more realistic valuation of the attributes

habit formation and exhaustible resource risk pricing abstract this paper studies the risk pricing implications of introducing habit formation in consumption in a model that encompasses growth with nonrenewable resources and capital markets it is shown that the expected return on nonrenewable resource stocks incorporates both short run and long run risk factors the short run risk factor is associated with shocks to current surplus consumption growth the long run risk factor reflects the investor s desire to hedge against long run shocks to future surplus consumption prospects long run habit risk premium the model is tested using energy commodities index and us aggregate real per capita consumption data and the results confirm that habit enters significantly in the pricing equation by entertaining a long run time varying risk coefficient compared to results obtained with a no habit formation model time separable preferences we found that long run future prospects of surplus consumption constitute a forward looking risk factor to be taken into account in explaining the dynamics of energy prices under uncertainty

equilibrium in securities markets with heterogeneous investors and unspanned income risk abstract in a finite time horizon incomplete market continuous time setting with dividends and investor incomes governed by arithmetic brownian motions we derive closed form solutions for the equilibrium risk free rate and stock price for an economy with finitely many heterogeneous cara investors and unspanned income risk in equilibrium the sharpe ratio is the same as in an otherwise identical complete market economy whereas the risk free rate is lower and consequently the stock price is higher the reduction in the risk free rate is highest when the more risk averse investors face the largest unspanned income risk

solving consumption and portfolio choice problems the state variable decomposition method we develop a new solution method for a broad class of discrete time dynamic portfolio choice problems the method efficiently approximates conditional expectations of the value function by using i a decomposition of the state variables into a component observable by the investor and a stochastic deviation and ii a taylor expansion of the value function we illustrate the accuracy of the method in handling several realistic features of portfolio choice problems such as intermediate consumption multiple assets multiple state variables portfolio constraints non time separable preferences and nonredundantendogenous state variables we finally use the method to solve a realistic large scale life cycle portfolio choice and consumption problem with predictable expected returns and recursive preferences jel g11 g12

dynamic optimal portfolio choice in a jump diffusion model with investment constraints we consider the dynamic portfolio choice problem in a jump diffusion model where an investor may face constraints on her portfolio weights for instance no short selling constraints it is a daunting task to use standard numerical methods to solve a constrained portfolio choice problem especially when there is a large number of state variables by suitably embedding the constrained problem in an appropriate family of unconstrained ones we provide some equivalent optimality conditions for the indirect value function and optimal portfolio weights these results simplify and help to solve the constrained optimal portfolio choice problem in jump diffusion models finally we apply our theoretical results to several examples to examine the impact of no short selling and or no borrowing constraints on the performance of optimal portfolio strategies

do banks overstate their value at risk abstract this paper is the first empirical study of banks risk management systems based on non anonymous daily value at risk var and profit and loss data using actual data from the six largest canadian commercial banks we uncover evidence that banks exhibit a systematic excess of conservatism in their var estimates the data used in this paper have been extracted from the banks annual reports using an innovative matlab based data extraction method out of the 7354 trading days analyzed in this study there are only two exceptions i e days when the actual loss exceeds the disclosed var whereas the expected number of exceptions with a 99 var is 74 for each sample bank we extract from historical vars a risk overstatement coefficient ranging between 19 and 79 we attribute var overstatement to several factors including extreme cautiousness and underestimation of diversification effects when aggregating vars across business lines and or risk categories we also discuss the economic and social cost of reporting inflated vars

multitask agency problems focus and task clustering abstract this short paper discusses recent insights of multitask agency theory it considers in turn the issues of effort substitution conflicts between tasks and implicit incentives and mission it concludes by addressing the problem of optimal task clustering

monte carlo computation of optimal portfolios in complete markets we introduce a method that relies exclusively on monte carlo simulation in order to compute numerically optimal portfolio values for utility maximization problems our method is quite general and only requires complete markets and knowledge of the dynamics of the security processes it can be applied regardless of the number of factors and of whether the agent derives utility from intertemporal consumption terminal wealth or both we also perform some comparative statics analysis our comparative statics show that risk aversion has by far the greatest influence on the value of the optimal portfolio

monte carlo methods for security pricing the monte carlo approach has proved to be a valuable and flexible computational tool in modern finance this paper discusses some of the recent applications of the monte carlo method to security pricing problems with emphasis on improvements in efficiency we first review some variance reduction methods that have proved useful in finance then we describe the use of deterministic low discrepancy sequences also known as quasi monte carlo methods for the valuation of complex derivative securities we summarize some recent applications of the monte carlo method to the estimation of partial derivatives or risk sensitivities and to the valuation of american options we conclude by mentioning other applications

portfolio choice with puts evidence from variable annuities this study investigated the asset allocation behavior of individuals who select an out of the money long dated longevity put option on their investment funds the asset allocations of these people within their variable annuity subaccounts are 5 30 percent more risky than the allocations of those who do not choose this protection investors who do not choose the longevity put option follow the classic life cycle age phased reduction in equity a rudimentary model of utility maximizing behavior is suggested that justifies the increased allocation to risk as long as the investor understands the payoff structure of the longevity put and is willing and able to exercise the annuity option if and when it matures in the money

inferred vs stated attribute non attendance in choice experiments a study of doctors prescription behaviour abstract it is increasingly recognised that respondents to choice experiments employ heuristics such as attribute non attendance ana to simplify the choice tasks this paper develops an econometric model which incorporates preference heterogeneity among respondents and allows the probability of non attendance to depend on the respondents stated non attendance we find evidence that stated ana is a useful indicator of the prevalence of non attendance in the data contrary to previous papers in the literature we find that estimates of marginal rates of substitution derived from models which account for ana are similar to the standard logit estimates

on optimal portfolio choice under stochastic interest rates abstract in an economy where interest rates and stock price changes follow fairly general stochastic processes we analyze the portfolio problem of an investor endowed with a non traded cash bond position he can trade on stocks the riskless asset and a futures contract written on the bond so as to maximize the expected utility of his terminal wealth when the investment opportunity set is driven by an arbitrary number of state variables the optimal portfolio strategy is known to contain a pure preference free hedge component a speculative element and merton breeden hedging terms against the fluctuations of each and every state variable while the first two components are well identified and easy to work out the implementation of the last ones is problematic as the investor must identify all the relevant state variables and estimate their distribution characteristics using the martingale approach we show that the optimal strategy can be simplified to include in addition to the pure hedge and speculative components only two merton breeden type hedging elements however large is the number of state variables the first one is associated with interest rate risk and the second one with the risk brought about by the co movements of the spot interest rate and the market prices of risk the implementation of the optimal strategy is thus much easier as it involves estimating the characteristics of the yield curve and the market prices of risk only rather than those of numerous a priori unknown state variables moreover the investor s horizon is shown explicitly to play a crucial role in the optimal strategy design in sharp contrast with the traditional decomposition finally the role of interest rate risk in actual portfolio risk management is emphasized

who should buy long term bonds according to conventional wisdom long term bonds are appropriate for conservative long term investors this paper develops a model of optimal consumption and portfolio choice for infinite lived investors with recursive utility who face stochastic interest rates solves the model using an approximate analytical method and evaluates conventional wisdom as risk aversion increases the myopic component of risky asset demand disappears but the intertemporal hedging component does not conservative investors hold assets to hedge the risk that real interest rates will decline long term inflation indexed bonds are most suitable for this purpose but nominal bonds may also be used if inflation risk is low

incentives for helping on the job theory and evidence recent advances in incentive theory stress the multidimensional nature of agent effort and specifically cases where workers affect one anothers performance through helping efforts this article models helping efforts as determined by the compensation package and task allocation the model is tested with australian evidence on reported helping efforts within work groups the evidence consistently supports the hypothesis that helping efforts are reduced while individual efforts are increased when promotion incentives are strong piece rates and profit sharing appear to have little effect on helping efforts while task variety and helping efforts are positively correlated

early exercise decision in american options with dividends stochastic volatility and jumps using a fast numerical technique we investigate a large database of investors suboptimal nonexercise of short maturity american call options on dividend paying stocks listed on the dow jones the correct modeling of the discrete dividend is essential for a correct calculation of the early exercise boundary as confirmed by theoretical insights pricing with stochastic volatility and jumps instead of the black scholes merton benchmark cuts the amount lost by investors through suboptimal exercise by one quarter the remaining three quarters are largely unexplained by transaction fees and may be interpreted as an opportunity cost for the investors to monitor optimal exercise

the use of alternative preference elicitation methods in complex discrete choice experiments we analyse stated preference data over nursing jobs collected from two different discrete choice experiments a multi profile case best worst scaling experiment bws prompting selection of the best and worst among alternative jobs and a profile case bws wherein the respondents choose the best and worst job attributes the latter allows identification of additional utility parameters and is believed to be cognitively easier results suggest that respondents place greater value on pecuniary over non pecuniary gains in the multi profile case there is little evidence that this discrepancy is induced by the extra cognitive burden of processing several profiles at once in the multi profile case we offer thoughts on other likely mechanisms

fairness and incentives in a multi task principal agent model this paper reports on a two task principal agent experiment in which only one task is contractible the principal can either offer a piece rate contract or a voluntary bonus to the agent bonus contracts strongly outperform piece rate contracts many principals reward high effort on both tasks with substantial bonuses agents anticipate this and provide high effort on both tasks in contrast almost all agents with a piece rate contract focus on the first task and disregard the second principals understand this and predominantly offer bonus contracts this behavior contradicts the self interest theory but is consistent with theories of fairness

evolutionary portfolio selection with liquidity shocks insurance companies invest their wealth in financial markets the wealth evolution strongly depends on the success of their investment strategies but also on liquidity shocks which occur during unfavourable years when indemnities to be paid to the clients exceed collected premia an investment strategy that does not take liquidity shocks into account exposes insurance companies to the risk of bankruptcy when liquidity shocks and low investment payoffs jointly appear therefore regulatory authorities impose solvency restrictions to ensure that insurance companies are able to face their obligations with high probability this paper analyses the behaviour of insurance companies in an evolutionary framework we show that an insurance company that merely satisfies regulatory constraints will eventually vanish from the market we give a more restrictive no bankruptcy condition for the investment strategies and we characterize trading strategies that are evolutionary stable i e able to drive out any mutation

theories of behavior in principal agent relationships with hidden action abstract in a laboratory experiment we investigate behavior in a principal agent situation with moral hazard we evaluate the predictive success of two theories one is the standard agency theory which assumes that the agent will accept any contract offer that satisfies his participation constraint typically requiring zero expected utility the other is the fair offer theory suggested by keser and willinger 2000 principals principles when agents actions are hidden international journal of industrial organization 18 1 163 185 which requires that the principal provide full insurance against losses to the agent and leave him a share of at most 50 of the generated surplus the treatment variable of our experiment is the cost of effort as effort costs increase expected net surplus of a contract decreases we observe that fair offer theory generally predicts observed contract offers better than standard agency theory however the predictive success of the fair offer theory decreases while the one of standard agency theory increases with decreasing expected net surplus

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

addressing preference heterogeneity multiple scales and attribute attendance with a correlated finite mixing model of tap water choice unobserved heterogeneity of error scale in choice models is a recent extension of the better investigated issue of heterogeneity of taste intensity it is achieved by fitting choice panel data with specifications that simultaneously handle inter personal variation in scale and taste the aim is to separate differences in preference intensities across respondents from differences in the degree of consistency in choice behaviour or preference discrimination while accounting for correlation between the two another recent substantive issue in choice data analysis is attribute non attendance we develop a finite mixing model to address simultaneously the three issues above we empirically prove the concept on stated preference data related to tap water attributes in a study for industry regulation

endogenous matching and the empirical determinants of contract form empirical work on contracts typically regresses contract choice on observed principal and agent characteristics if i some of these characteristics are unobserved or partially observed and ii there are incentives whereby particular types of agents end up contracting with particular types of principals estimated coefficients on the observed characteristics may be misleading we address this endogenous matching problem using a data set on agricultural contracts between landlords and tenants in early renaissance tuscany controlling for endogenous matching has an impact on parameters of interest and tenants risk aversion appears to have influenced contract choice

a discrete choice model with endogenous attribute attendance abstract this paper develops a discrete choice model in which the decision to consider an attribute in the choice process is modelled endogenously in an application to patients choice of general practitioner it is found that the proposed model outperforms the standard logit model in terms of goodness of fit and produces substantially different estimates of willingness to pay

a monte carlo method for optimal portfolios this paper proposes a new simulation based approach for optimal portfolio allocation in realistic environments with complex dynamics for the state variables and large numbers of factors and assets a first illustration involves a choice between equity and cash with nonlinear interest rate and market price of risk dynamics intertemporal hedging demands significantly increase the demand for stocks and exhibit low volatility we then analyze settings where stock returns are also predicted by dividend yields and where investors have wealth dependent relative risk aversion large scale problems with many assets including the nasdaq sp500 bonds and cash are also examined the question of optimal portfolio allocation has been of long standing interest for academics and practitioners in finance while the mean variance analysis of markowitz 1952 is still commonly used among portfolio managers it has been well understood since merton 1971 that long term investors would prefer portfolios that include hedging components to protect against fluctuations in their investment opportunities prompted by the seminal papers of merton 1969 1971 and samuelson 1969 studies have explored various aspects of the dynamic portfolio problem when asset prices follow diffusion processes e g richard 1975 this literature has relied for the most part on a dynamic programming approach to the problem more recent contributions by pliska 1986 karatzas lehoczky and shreve 1987 and cox and huang 1989 have proposed an alternative resolution method based on martingale techniques in the context of this approach an optimal portfolio formula was derived by ocone and karatzas 1991 this expression involves expectations of random variables depending on j6erme b detemple is at boston university school of management and cirano rene

dynamic hedging and extreme asset co movements the paper investigates the portfolio allocation effects of increased asset co movements during market downturns we develop a model for the stock price process that allows for increased and asymmetric dependence between extreme return realizations we isolate the portfolio hedging demands that arise due to extreme co movements and find a substantial shift of the portfolio holdings toward the risk free asset we demonstrate that accounting for dependence between extreme events in portfolio decisions leads to significant economic gains that stem primarily from intertemporal hedging motives these findings are robust along alternative modeling assumptions of extreme co movements and conditional correlation

are choice experiments reliable evidence from the lab this study investigates whether a popular stated preference method the choice experiment ce reliably measures individuals values for a good we address this question using an induced value experiment our results indicate that ces fail to elicit payoff maximizing choices we find little evidence that increasing the salience of the choices or adding monetary incentives increase the proportion of payoff maximizing choices this questions the increasing use of ce to value non market goods for policy making

pricing and exercising american options an asymptotic expansion approach abstract this paper proposes and implements a novel asymptotic expansion approach for pricing discretely monitored american options and approximating their optimal early exercise boundaries under a generic class of multivariate derivative pricing models incorporating both stochastic volatility and levy driven jumps in asset return the price and the critical value can be expanded up to any arbitrary order around those under a simple constant volatility jump diffusion model the expansion terms are then efficiently implemented by exactly solving some backward inductions via closed form fourier transforms where a substantial extension of the hilbert transform method of feng and linetsky 2008a 2009 plays an important role the efficiency of our method is illustrated through some representative examples as applications we analyze the impacts of various model parameters on the optimal early exercise boundary compare the optimal early exercise boundaries under different models and propose a derivative proxy based method for practically exercising american options under models with stochastic volatility and jumps

portfolio choice and mortality contingent claims the general hara case abstract we solve a portfolio choice problem that includes mortality contingent claims and labor income under general hara preferences our contribution beyond existing literature is to i focus on the covariance between shocks to human capital and financial capital to ii model the utility of a family with basic needs and iii include life insurance and pension annuity claims in one unified life cycle model our solution employs a similarity reduction mapping which reduces the two dimensional hjb equation into one dimension this allows for the implementation of a quick numerical scheme and when shocks to human capital and financial capital are perfectly correlated a closed form expression is obtained as a special case

moral hazard and limited liability the real effects of contract bargaining abstract i examine the standard assumption in the moral hazard agency literature that the principal has all the bargaining power at the contract offer stage when the agent has limited liability as is often the case in practice the contract changes according to the distribution of bargaining power and consequently so does the agents effort implications of this result are examined

the asset allocation puzzle is still a puzzle abstract intertemporal hedging activity has been advocated as being the solution to the asset allocation puzzle a standing assumption made in the dynamic asset allocation literature is that one or several bonds can perfectly hedge the interest rate risk and related market price of risk in the economy in a multi asset world ceteris paribus such an assumption biases the portfolio allocation of a non myopic investor towards bonds we extend the literature to allow for an incomplete bond market when solving for the optimal portfolio choice of a rational investor it is shown that investors with a high level of risk aversion could invest more in stocks than in bonds

optimal portfolios with minimum capital requirements abstract we propose a novel approach to active risk management based on the recent basel ii regulations to obtain optimal portfolios with minimum capital requirements in order to avoid regulatory penalties due to an excessive number of value at risk var violations capital requirements are minimized subject to a given number of violations over the previous trading year capital requirements are based on the recent basel ii amendments to account for the stressed var that is the downside risk of the portfolio under extreme adverse market conditions an empirical application for two portfolios involving different types of assets and alternative stress scenarios demonstrates that the proposed approach delivers an improved balance between capital requirement levels and the number of var exceedances furthermore the risk adjusted performance of the proposed approach is superior to that of minimum var and minimum stressed var portfolios

equilibrium impact of value at risk regulation abstract we study the asset pricing implications of value at risk var regulation in incomplete continuous time economies with intermediate expenditure stochastic opportunity set and heterogeneous attitudes to risk our findings show that because of an anticipatory effect of var constraints on the optimal hedging demand the partial equilibrium incentives of var regulation can lead banks to increase their risk exposure in high volatility states in general equilibrium var constraints can produce unambiguously lower interest rates and higher equity sharpe ratios the var impact on equity volatility and equity expected returns is ambiguous

the organization and scope of agents regulating multiproduct industries abstract a mechanism design problem with two dimensional uncertainty is solved to derive the optimal policy for regulating a monopolist with private information about the marginal cost of producing two different goods the paper establishes that informational economies of scope or incentive complementarities arise when one firm produces both goods the regulator should weigh these economies against the benefits of relative performance incentives when choosing between integrated and decentralized organizations unless the marginal costs of the two products are sufficiently positively correlated the optimal ex ante policy gives control of both markets to a single firm journal of economic literature classification number s d82 l22 l51

an evaluation of bank measures for market risk before during and after the financial crisis abstract we study the performance and behavior of value at risk measures used by a number of large u s banks before during and after the financial crisis alternative benchmark var measures including garch based measures are estimated directly from the banks trading revenues to explain the bank var performance results while overly conservative in both the pre crisis and post crisis periods bank var exceedances were excessive and clustered in the crisis period this contrasted with mostly unbiased benchmark hs and garch vars in the pre crisis and post crisis periods and vastly superior garch based var performance in the crisis period with lower exceedance rates and no exceedance clustering our results document the bank vars very slow adjustment to changing market conditions and their systematic bias in all studied periods our results indicate that bank vars could be improved by the use of models with time varying volatility and built on banks knowledge of their current positions

measuring the relative productivity of multitasking to sole tasking in household production experimental evidence the standard household production model does not incorporate multitasking although time diary data reveal that individuals regularly multitask we incorporate multitasking into a household production model in which time spent in childcare can be sole tasked or multitasked with another household production activity and we present the results of an experiment designed to measure the productivity parameters of this model because utility and productivity are intertwined and difficult to disentangle in any household production model we vary the utility pay offs our experimental participants receive in order to determine how our estimated productivity parameters are affected by a change in the utility parameters our estimates of the relative multitasking productivities indicate that while a minute of sole tasked time produces more of a single commodity than a minute of multitasked time total household output increases when two outputs are produced simultaneously hence confirming the economic motivation f

the impact of off balance sheet activities on banks returns an application of the arch m to canadian data abstract this paper revisits the impact of off balance sheet obs activities on banks risk return trade off recent studies e g stiroh and rumble 2006 show that increasing obs activities does not necessarily yield straightforward diversification benefits for banks however introducing a risk premium in the standard banks returns models and resorting to an arch m procedure canadian data suggest that banks risk return trade off displays a structural break around 1997 in the second subperiod of our sample 1997 2007 we find that the noninterest income generated by obs activities no longer impacts banks returns negatively while during the first period 1988 1996 the volatility variable is not significant in any returns equations a risk premium eventually emerges pricing the risk associated to obs activities

optimal consumption and portfolio policies when asset prices follow a diffusion process abstract we consider a consumption portfolio problem in continuous time under uncertainty a martingale technique is employed to characterize optimal consumption portfolio policies when there exist nonnegativity constraints on consumption and on final wealth we also provide a way to compute and verify optimal policies our verification theorem for optimal policies involves a linear partial differential equation unlike the nonlinear partial differential equation of dynamic programming the relationship between our approach and dynamic programming is discussed we demonstrate our technique by explicitly computing optimal policies in a series of examples in particular we solve the optimal consumption portfolio problem for hyperbolic absolute risk aversion utility functions when the asset prices follow a geometric brownian motion the optimal policies in this case are no longer linear when nonnegativity constraints on consumption and on final wealth are included by these examples one can see that our approach is much easier than the dynamic programming approach

releasing the trap a method to reduce inattention bias in survey data with application to u s beer taxes this study uses discrete choice experiments to explore the efficacy of prompts targeted at reducing inattention bias upon receiving feedback inattentive respondents are given the opportunity to reanswer a so called trap question that checks for attentiveness we find that individuals who miss trap questions and do not correctly revise their responses have significantly different choice patterns as compared to individuals who correctly answer the trap question adjusting for these inattentive responses has a substantive impact on policy impacts results based on attentive participant responses indicate that a minimum beer price would have to be substantial to substantially reduce beer demand jel c83 q18 q51

an evaluation of the basle guidelines for backtesting banks internal risk management models the 1996 amendment to the baste capital accord to incorporate market risks constitutes a breakthrough in the determination of capital requirements rather than dictating these requirements through a uniform supervisory approach banks are allowed to use their own internal models for computing the capital required in order to mitigate moral hazard problems and stimulate banks to use adequate internal models the models must be subjected to a backtesting procedure if a model produces too many incorrect predictions increased capital requirements result this paper provides an evaluation of the current internal models approach in conjunction with the proposed backtesting procedure in particular using a stylized representation of the present supervisory framework we investigate whether banks are provided with the right incentives to come up with the correct internal model we find that under the current regulatory framework banks are prone to under reporting their true market risk a much stricter penalty scheme is required in order to align banks incentives with those of the supervisor we check the sensitivity of our results to changes in the length of the planning horizon portfolio risk time preferences risk attitudes and the distribution of financial returns

portfolio insurance gap risk under conditional multiples abstract the research on financial portfolio optimization has been originally developed by markowitz 1952 it has been further extended in many directions among them the portfolio insurance theory introduced by leland and rubinstein 1976 for the option based portfolio insurance obpi and perold 1986 for the constant proportion portfolio insurance method cppi the recent financial crisis has dramatically emphasized the interest of such portfolio strategies this paper examines the cppi method when the multiple is allowed to vary over time to control the risk of such portfolio management a quantile approach is introduced together with expected shortfall criteria in this framework we provide explicit upper bounds on the multiple as function of past asset returns and volatilities these values can be statistically estimated from financial data using for example arch type models we show how the multiple can be chosen in order to satisfy the guarantee condition at a given level of probability and for various financial market conditions

how do respondents process stated choice experiments attribute consideration under varying information load the popularity of stated choice sc experiments has produced many design strategies in which researchers use increasingly more complex choice settings to study choice behaviour when the amount of information to assess increases we wonder how an individual handles such information in making a choice defining the amount of information as the number of attributes associated with each choice set we investigate how this information is processed as we vary its complexity four ordered heterogeneous logit models are developed each for an sc design based on a fixed number of attributes in which the dependent variable defines the number of attributes that are ignored we find that the degree to which individuals ignore attributes is influenced by the dimensionality of the sc experiment the deviation of attribute levels from an experienced reference alternative the use of adding up attributes where feasible the number of choice sets evaluated and the personal income of the respondent the empirical evidence supports the view that individuals appear to adopt a range of coping strategies that are consistent with how they process information in real markets and that aligning choice complexity with the amount of information to process is potentially misleading relevancy is what matters copyright 2006 john wiley sons ltd

job design with sequential tasks and outcome externalities revisited we revisit job design with sequential tasks and outcome externalities from a different perspective extending schmitz 2013a when two sequential tasks need to be performed by wealth constrained agents the principal can hire only one agent or two different agents when there exists an outcome externality in terms of the fixed cost and such an externality is not too large if the two tasks are conflicting resp synergistic then it is optimal for the principal to hire two different agents resp only one agent when there exists an outcome externality regarding the marginal cost the opposite result holds

the pernicious effects of contaminated data in risk management banks hold capital to guard against unexpected surges in losses and long freezes in financial markets the minimum level of capital is set by banking regulators as a function of the banks own estimates of their risk exposures as a result a great challenge for both banks and regulators is to validate internal risk models we show that a large fraction of us and international banks uses contaminated data when testing their models in particular most banks validate their market risk model using profit and loss p l data that include fees and commissions and intraday trading revenues this practice is inconsistent with the definition of the employed market risk measure using both bank data and simulations we find that data contamination has dramatic implications for model validation and can lead to the acceptance of misspecified risk models moreover our estimates suggest that the use of contaminated data can significantly reduce market risk induced regulatory capital

attending to the reasons for attribute non attendance in choice experiments this paper focuses on behavioural reasons underlying stated attribute non attendance in choice experiments in order to identify and incorporate procedures for dealing with heterogeneous attribute processing strategies we ask respondents follow up questions regarding their reasons for ignoring attributes based on these statements we conclude that the standard way of assigning a zero impact of ignored attributes on the likelihood is inappropriate we find that some respondents act in accordance with the passive bounded rationality assumption since they ignore an attribute simply because it does not affect their utility excluding these genuine zero preferences as the standard approach essentially does might bias results other respondents claim to have ignored attributes to simplify choices however we find that these respondents have actually not completely ignored attributes we argue along the rationally adaptive behavioural model that valid preference information may indeed be elicited in these cases and we illustrate how recoding of non attendance statements conditional on stated reasons may be a more appropriate solution than the current standard way of taking stated non attendance into account

optimal consumption and investment with capital gains taxes this article characterizes optimal dynamic consumption and portfolio decisions in the presence of capital gains taxes and short sale restrictions the optimal decisions are a function of the investor s age initial portfolio holdings and tax basis our results capture the trade off between the diversification benefits and tax costs of trading over an investor s lifetime the incentive to rediversify the portfolio is inversely related to the size of the embedded gain and investor s age contrary to standard financial advice the optimal equity holding increases well into an investor s lifetime in our model due to the forgiveness of capital gains taxes at death taxes play an important role in the decision making process of individuals concerning their consumption and investment plans the taxation of returns on financial assets alters the benefits of saving for future consumption and thus affects the trade off between current consumption and investment moreover the ability of investors to defer the taxation of capital gains alters the relative valuation of stocks and bonds and thus affects the optimal portfolio composition of investors the deferral feature of capital gains taxes also affects the trade off investors face regarding taxes and diversification investors would like to maintain an optimally diversified portfolio over time

limited liability and incentive contracting with multiple projects i examine a principal agent model with multiple projects where a risk neutral manager is protected by limited liability the analysis has several interesting implications i incentive problems are shown to be a natural source of economies of scope as combining multiple projects under the management of a single manager relaxes the limited liability constraint ii as a result managers may be overloaded with work and exert inefficiently high effort and iii the analysis has implications for the optimal allocation of projects to different managers copyright 2001 by the rand corporation

principals principles when agents actions are hidden abstract we examine the behavior of subjects in a simple principal agent game with hidden action while subjects in the role of agents tend to choose the actions which maximize their expected profits subjects in the role of principals offer contracts which differ from the theoretical predictions we identify three principles of contract design 1 the agent s remuneration for the better outcome is at least as high as the remuneration for the worse outcome 2 the agent must not risk making a loss 3 the net profit of the agent should not be higher than the net profit of the principal

dynamic asset allocation portfolio decomposition formula and applications a new decomposition of the optimal portfolio in dynamic models with von neumann morgenstern preferences and ito prices is established the formula rests on a change of numeraire that uses pure discount bonds as units of account the dynamic hedging demand has two components the first hedge insures against fluctuations in an optimally designed bond with a maturity date matching the investor s horizon the second hedge immunizes against fluctuations in the market price of risk in the bond numeraire various applications are examined new results concerning the behavior of extremely risk averse individuals the demand for bonds and its long horizon limit and the optimal portfolio in incomplete markets are derived the author 2009 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please email journals permissions oxfordjournals org oxford university press

regulating complementary products a comparative institutional analysis optimal regulation subject to informational constraints is analyzed for industries for which production requires complementary inputs an issue for regulatory policy is whether supply in these industries should be bundled or unbundled bundled supply calls for regulation of an integrated industry unbundled supply has each component regulated separately a main result is that unbundling introduces into regulation an additional component of information cost that is similar to double marginalization in the monopoly pricing of complementary products unbundling may be advantageous if it allows sufficient competition in nonmonopoly services but the information cost can exceed the benefits of competition

intertemporal asset allocation a comparison of methods abstract this paper compares two recent monte carlo methods advocated for the computation of optimal portfolio rules the candidate methods are the approach based on monte carlo with malliavin derivatives mcmd proposed by detemple garcia and rindisbacher detemple et al 2003 a monte carlo method for optimal portfolios journal of finance 58 401 406 and the approach based on monte carlo with regression mcr of brandt goyal santa clara and stroud brandt et al 2003 a simulation approach to dynamic portfolio choice with an application to learning about return predictability working paper wharton school our comparisons are carried out in the context of various intertemporal portfolio choice problems with two assets a risky asset and a riskless asset and different configurations of the state variables the specifications studied include a linear model with a single state variable admitting an exact solution and a non linear model with two state variables that requires a purely numerical resolution the accuracies of the candidate methods are compared we provide in particular efficiency plots displaying the speed accuracy trade off for various selections of the relevant simulation and discretization parameters mcmd is shown to dominate in all the settings considered

on the optimality of path dependent structured funds the cost of standardization abstract this paper examines the suitability of an important class of standard financial structured products namely those whose performances are based on smoothing the return of a given risky underlying asset while providing a guarantee at maturity using various assumptions about the customers attitudes towards risk we show that such standardized products are not optimal even if the financial market volatility is constant as a by product we provide in particular the optimal portfolio value in the regret rejoice framework to go further with the notion of aversion of getting a return smaller than the risk free one using the notion of compensating variation we determine for the first time the monetary losses of providing these standardized products instead of the optimal ones to the customers we show that these monetary losses can be very significant when the volatility of the risky asset is stochastic from the operational point of view such results highly suggest to trade on the volatility index vix and or to introduce derivatives written on it when selling standardized funds in order to better meet investors needs and preferences

contingent claims analysis and life cycle finance this paper explores the application of contingent claims analysis cca to two important issues in life cycle finance investing for retirement and deciding when if ever to switch careers contingent claims analysis is a methodology that grew out of the option pricing theory of fischer black robert c merton and myron scholes they derived the option pricing model by showing that there is a self financing dynamic trading strategy that replicates the payoffs from a call option in the absence of transaction costs the law of one price and the force of arbitrage imply that the cost of the initial replicating portfolio is the price of the option that same approach applies to any derivative security or contingent contract based on traded assets for every dynamic trading strategy there exists an equivalent contingent contract in reality most investors face substantial transactions costs and cannot trade even approximately continuously as is done in the theoretical models but in a modern well developed financial system the lowest cost transactors may have marginal trading costs close to zero and can trade almost continuously thus the lowest cost producers of contingent contracts can approximate reasonably well the dynamic trading strategy and in a competitive environment

a parametric nonlinear model of term structure dynamics recent nonparametric estimation studies pioneered by ait sahalia document that the diffusion of the short rate is similar to the parametric function r superscript 1 5 estimated by chan et al whereas the drift is substantially nonlinear in the short rate these empirical properties call into question the efficacy of the existing affine term structure models and beg for alternative models which admit the observed behavior this article presents such a model our model delivers closed form solutions for bond prices and a concave relationship between the interest rate and the yields we show that in empirical analyses our model outperforms the one factor affine models in both time series as well as cross sectional tests article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

utilitarianism and fairness in portfolio positioning abstract the paper introduces the theory of optimal positioning of financial products it is illustrated in the context of long term intertemporal portfolio allocation and can be applied for example to asset allocation funds we embed this problem in location theory the portfolio is optimized within the investors risk aversion dimension for the crra utility functions we compute explicitly the distance functions for the first utilitarian criterion the average utility of the investors is maximized for the second one fairness criterion the choice of portfolio is optimized so that the average monetary loss due to the lack of customization is minimized given the distribution of investors risk aversion we provide a solution method and an algorithm to optimally position standardized portfolio along one of these two criteria

semi analytical solutions for dynamic portfolio choice in jump diffusion models and the optimal bond stock mix this paper studies the optimal portfolio selection problem in jump diffusion models where an investor has a hara utility function and there are potentially a large number of assets and state variables more specifically we incorporate jumps into both stock returns and state variables and then derive semi analytical solutions for the optimal portfolio policy up to solving a set of ordinary differential equations to greatly facilitate economic insights and empirical applications of jump diffusion models to examine the effect of jump risk on investors behavior we apply our results to the bond stock mix problem and particularly revisit the bond stock ratio puzzle in jump diffusion models our results cast new light on this puzzle that unlike pure diffusion models it cannot be rationalized by the hedging demand assumption due to the presence of jumps in stock returns

exploring group dynamics in deliberative choice experiments abstract deliberative monetary valuation has emerged as a promising alternative to conventional stated preference studies of ecosystem services it promises to give respondents a better basis for decision making by exposing them to a more diverse set of knowledge arguments and opinions through group discussion however under certain conditions small groups may fail to effectively pool the individual knowledge of their members this paper examines the impact of the initial distribution of individual preferences in discussion groups on the outcome of deliberative choice experiments drawing on a deliberative monetary valuation study of forest ecosystem services in west saxony germany it is shown that the initial preference distribution in groups influences both the diversity of arguments exchanged during group discussions and respondents consideration of the costs of environmental policies furthermore results indicate that respondents post discussion willingness to pay is affected by the initial preference distribution in groups though these changes were not statistically significant the choice certainty of respondents was found to remain largely unaffected overall the empirical findings of this study provide preliminary evidence about the need to conduct future deliberative monetary valuation studies with groups with heterogeneous initial preferences as this may provide respondents with a more complete set of decision relevant information

job design with conflicting tasks reconsidered a principal wants two sequential tasks to be performed by wealth constrained agents suppose that there is an outcome externality i e a first stage success can make second stage effort more or less effective if the tasks are conflicting the principal s profit maximizing way to induce high efforts is to hire one agent to perform both tasks so that the prospect to get a larger second stage rent after a first stage success motivates the agent to work hard in the first stage in contrast when there is an effort externality i e first stage effort reduces or increases the probability of a second stage success then the principal prefers to hire two agents whenever the tasks are conflicting

rent seeking versus productive activities in a multi task experiment incentive instruments like asset ownership and performance pay often have to strike a balance between the productive incentives and the rent seeking incentives they provide standard theory predicts that these instruments become less attractive when the effectiveness of rent seeking activities increases in contrast theories that emphasize the importance of reciprocity suggest that this relationship may go the other way around in this paper we test these predictions by means of a laboratory experiment by and large our findings confirm standard theory incentive instruments typically become less attractive when the scope for rent seeking activities increases however reciprocity motivations do seem to mitigate the adverse effects of rent seeking opportunities to a considerable extent

optimal incentives for teams much of the existing theory of incentives describes a static relationship that lasts for just one transaction this static assumption is not only unrealistic but the resulting predictions appear to be at odds with many work organizations the current paper introduces possible long term interaction among agents and studies how the design of explicit incentives and work organizations can exploit and interact with the implicit incentives generated by the repeated interaction of the agents the optimal incentive scheme is shown to display observed features of the increasingly popular teams such as the use of low powered group incentives