prices and investment with collateral and default abstract this paper uses the framework of an olg economy with three period lived agents in which a durable good serves as collateral for loans to study the effect of an unanticipated income shock when the economy is in a steady state equilibrium we focus on the consequence of default on loans when the value of the collateral falls below the value of the debt it secures we analyze the impulse response functions of the price and production of the durable good and show that there is an asymmetry between the response of the price and investment of the durable good to a positive and a negative income shock arising from default on the collateralized loans we show that this asymmetry can be seen in the data on housing prices and construction and is attributable to the default on mortgages in periods of decreasing prices which acts as a turbo mechanism magnifying the decline in investment

asset pricing in multiperiod securities markets the intertemporal models developed in this paper have been stimulated by the capital asset pricing model capm of sharpe and lintner and the role of factor structure in ross arbitrage pricing theory apt suppose that some one dimensional stochastic process s provides a sufficient statistic for aggregate consumption then a heuristic dynamic programming argument shows that s market wealth and the wealth derivative of the value function for any agent are all locally perfectly correlated it follows from merton s work that there is a linear relationship between the local mean return on a security and the local covariance of that return with the return on the market portfolio the formal development uses martingale representation and martingale projection to obtain an intertemporal capm the history of a scalar brownian motion plays the role of a sufficient statistic we motivate the assumption of a sufficient statistic for aggregate consumption by considering a countable set of securities whose payoffs have an approximate factor structure where the factor components are in the information set generated by an n dimensional brownian motion and the idiosyncratic components are weakly correlated the approximate factor structure on the security payoffs implies that the rates of return have locally an approximate factor structure the role of the market portfolio can now be played by a set of n well diversified portfolios

risk and return in an equilibrium apt application of a new test methodology abstract we use an asymptotic principal components technique to estimate the pervasive factors influencing asset returns and to test the restrictions imposed by static and intertemporal equilibrium versions of the arbitrage pricing theory apt on a multivariate regression model the empirical techniques allow for fairly arbitrary time variation in risk premiums we find that the apt provides a better description of the expected returns on assets than the capital asset pricing model capm however some statistically reliable mispricing of assets by the apt remains

rewarding risk taking or skill the case of private equity fund managers abstract we examine whether typical private equity fund compensation contracts reward excessive risk taking rather than managerial skill our analysis is based on a novel model of investment value cash flows and fee dynamics of private equity funds given the embedded option like fee components our results demonstrate that fund managers indeed have an incentive for excessive risk taking when only fee income from the current fund is considered however when managers also consider potential compensation from follow on funds their risk taking incentives depend on their individual skill levels and skilled managers will have an incentive to reduce fund risk we also show that managers must generate substantial abnormal returns in order to compensate investors for the given fee components

political bias and war we examine the incentives for countries to go to war as they depend on the comparison between how much their pivotal decision makers have at risk and how much they stand to gain from a war how this ratio compares to the country at large is what we term political bias if there is no political bias then there are always payments that one country would like to make to the other that will avoid a war in the presence of commitment or enforceability of peace treaties if there is a bias on the part of one or both countries then war can result and in some cases cannot be prevented by any transfer payments we examine how war technology and relative wealth levels interact with political bias in determining whether countries make transfers go to war and form alliances our results shed some new light on the uneven contender paradox and the interpretation of the democratic peace

option listing and stock returns abstract this article examines the effect of option introductions on the underlying stocks in addition to the price increase and volatility decrease that take place when new options are listed we obtain and explain the following new empirical results i an increase in the value of the market around the listing dates of new options ii an increase in the value of an industry index which excludes the optioned stocks iii the dissipation of the price and volatility effects in recent periods and iv the existence of an announcement effect in one subperiod of our sample and its dissipation in recent periods

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

a bottom up approach to the risk adjusted performance of the buyout fund market we use the burgiss dataset to study private equity buyout fund performance our findings on performance before risk adjustments are consistent with those in the literature and indicate significant outperformance of buyout fund investments using a bottom up approach we identify the systematic risks of underlying companies in buyout funds to inform an appropriate risk adjusted benchmark which we determine to be a levered size and sector adjusted public index after making these risk adjustments we find no significant outperformance of buyout fund investments versus the public market equivalent on a dollar weighted basis we contend that even without significant risk adjusted outperformance buyout funds can play a valuable role in institutional investors portfolios

linear tests for decreasing absolute risk aversion stochastic dominance we develop and implement linear formulations of convex stochastic dominance relations based on decreasing absolute risk aversion dara for discrete and polyhedral choice sets our approach is based on a piecewise exponential representation of utility and a local linear approximation to the exponentiation of log marginal utility an empirical application to historical stock market data suggests that a passive stock market portfolio is dara stochastic dominance inefficient relative to concentrated portfolios of small cap stocks the mean variance rule and nth order stochastic dominance rules substantially underestimate the degree of market portfolio inefficiency because they do not penalize the unfavorable skewness of diversified portfolios in violation of dara this paper was accepted by james smith decision analysis

cross border venture capital investments the impact of foreignness on returns against the background of the growing internationalization of venture capital vc investing this is the first global comparison of the returns generated by individual domestic and cross border deals we examine investments worldwide during 1971 2009 and find that cross border investments significantly underperform compared with equivalent domestic investments returns are negatively affected by geographic distances cultural disparities and institutional differences between the home and host countries returns on cross border and domestic deals also decline after the late 1990s international portfolio diversification and the saturation of domestic markets may explain why vc investors make cross border investments despite poor expected returns

mean variance theory in complete markets two paradigms in the pricing of risky assets are the complete markets model of arrow and debreu and mean variance pricing as embodied in the capital asset pricing model capm the former is primarily of theoretical interest in fact prior to the recent work of banz and miller 1978 and breeden and litzenberger 1978 there was little thought or hope of practical applications on the other hand the hegemony of the capm is due mostly to its apparent ease of applicability and to a lesser extent its empirical justification in a competitive market with no taxes transactions costs or institutional constraints on portfolio holdings the allocation of the available assets will be pareto optimal the end of period distribution of wealth or the consumption goods however will typically be pareto optimal only when there is available an arrow debreu security for each contingency since by definition a pareto superior reallocation is weakly preferred by all investors a complete set of arrow debreu markets should naturally arise provided they are not too costly to establish the complete markets model of arrow and debreu and the meanvariance capital asset pricing model capm are two paradigms of risky asset markets this paper provides an integration of these two theories we prove that the standard meanvariance separation theorem obtains in a complete market only if all investors have quadratic utility in addition the familiar capm pricing relation can hold for all assets in a complete market only if arbitrage opportunities exist on the positive side we show that the validity of this relation for the primary assets in a complete market is unaffected by the distribution of returns on the created financial assets

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

the state preference approach to general equilibrium in corporate finance abstract this paper attempts to implement the state preference approach in a multiperiod exchange economy the procedure is relevant for a further investigation of various important issues in corporate finance such as the results of modigliani and miller and the integration of the state preference and the mean variance approach to asset pricing

currency prices terms of trade and interest rates a general equilibrium asset pricing cash in advance approach currency prices terms of trade and interest rates a general equilibrium asset pricing cash in advance approach

an empirical investigation of international asset pricing we investigate several asset pricing models in an international setting we use data on a large number of assets traded in the united states japan the united kingdom and france the models together with the hypothesis of capital market integration imply testable restrictions on multivariate regressions relating asset returns to various benchmark portfolios we find that multifactor models tend to outperform single index models in both domestic and international forms especially in their ability to explain seasonality in asset returns we also find that the behavior of the models is affected by changes in the regulatory environment in international markets

arbitrage asset pricing under exchange risk this paper extends the arbitrage pricing theory to an international setting specifying a linear factor return generating model in local currency terms the author shows that the usual risk diversification rule in the arbitrage pricing theory does not yield a riskless portfolio unless currency fluctuations obey the same factor model as asset returns the author then considers an arbitrage portfolio whose exchange risk is hedged by foreign riskless bonds under the resulting no arbitrage conditions the expected returns are not on the same hyperplane unlike the closed economy arbitrage pricing theory unless they are adjusted by the cost of exchange risk hedging copyright 1991 by american finance association

entrepreneurial finance and innovation an introduction and agenda for future research the increasingly large role played by financial intermediaries such as venture capitalists and angels in nurturing entrepreneurial firms and in promoting product market innovation has led to great research interest in the area of entrepreneurial finance and innovation this paper introduces the special issue of the review of financial studies dedicated to entrepreneurial finance and innovation and highlights some of the promising topics for future research in this area the special issue combines papers presented at the june 2010 entrepreneurial finance and innovation efic conference which was jointly sponsored by the kauffman foundation and the review of financial studies with other related papers

collateral requirements and asset prices many assets derive their value not only from future cash flows but also from their ability to serve as collateral in this article we investigate this collateral premium and its impact on asset returns in an infinite horizon general equilibrium model with heterogeneous agents we document that borrowing against collateral substantially increases the return volatility of long lived assets moreover otherwise identical assets with different degrees of collateralizability exhibit substantially different return dynamics because their prices contain a sizable collateral premium that varies over time this premium can be positive even for assets that never pay dividends

the time variation of risk and return in the foreign exchange and stock markets this paper attempts to determine whether the fluctuations of conditional first and second moments which are observed for many assets are consistent with the sharpelintner mossin capital asset pricing model we test the mean variance model under several different assumptions about the time variation of conditional second moments of returns using weekly data from july 1974 to december 1986 that include returns on a portfolio composed of dollar deutsche mark sterling and swiss franc assets together with the u s stock market the results indicate that estimated conditional variances cannot explain the observed time variation of risk premia rates of return on international financial assets are characterized by statistical properties that are quite common to all financial markets they are highly volatile and largely unpredictable these properties make it very difficult to extract statistically reliable estimates of systematic exchange rate and assetprice movements and are at the root of the generally poor empirical performance of international asset pricing models nevertheless two important results have been uncovered by empirical researchers and can be considered a fair characterization of the data a expected returns on foreign assets vary over time cumby and obstfeld 1981 and the numerous articles that followed recently surveyed by frankel and meese 1987 b the volatility of returns of foreign assets also changes over time cumby and obstfeld 1984 hodrick and srivastava 1984 and hsieh 1988 among others as giovannini and jorion 1987 suggest the

risk uncertainty and exchange rates this paper is motivated by two facts failure of log linear empirical exchange rate models of the 1970 s and the observed variability of risk premiums in the forward market rational maximizing models predict that changes in conditional variances of monetary policies government spendings and income growths affect risk premiums and induce conditional volatility of exchange rates i examine theoretically how changes in these exogenous conditional variances affect the level of the current exchange rate and attempt to quantify the extent that this channel explains exchange rate volatility using autoregressive conditional heteroscedastic models

inefficient dynamic portfolio strategies or how to throw away a million dollars in the stock market a number of portfolio strategies followed by practitioners are dominated because they are incompletely diversified over time the payoff distribution pricing model is used to compute the cost of following undiversified strategies simple numerical examples illustrate the technique and computer generated examples provide realistic estimates of the cost of some typical policies using reasonable parameter values the cost can be substantial and should not be ignored by practitioners a section on generalizations shows how to extend the analysis to term structure models and other general models of returns this abstract was borrowed from another version of this item

post listing performance and private sector regulation the experience of london s alternative investment market abstract we investigate the experience of companies listing and raising capital on the aim which is privately regulated and relies on nominated advisors who compete for listings and provide regulatory oversight aim firms underperform newly listed firms on traditionally regulated exchanges based on post listing returns and failure rates comparable to firms listing on the unregulated us pink sheets and exhibit abnormally high pre listing accruals and post listing reversals high quality auditors and nomads partially mitigate underperformance suggesting that aim firms have limited ability to bond through more stringent oversight underperformance is particularly pronounced for firms with higher proportions of retail investors

on the size distribution of macroeconomic disasters confidence interval of 2 to 4 the results are robust to uncertainty about the values of the disaster probability and the equity premium and can accommodate seemingly paradoxical situations in which the equity premium may appear to be infinite

differential information and performance measurement using a security market line an uninformed observer using the tools of mean variance and security market line analysis to measure the performance of a portfolio manager who has superior information is unlikely to be able to make any reliable inferences while some positive results of a very limited nature are possible e g when there is a riskless asset or when information is restricted to be security specific in general anything is possible in particular a manager with superior information can appear to the observer to be below or above the security market line and inside or outside of the mean variance efficient frontier and any combination of these is possible mean variance theory predicts that if we plot expected returns against beta coefficients all securities plot on a single line known as the security market line sml since fpi the beta coefficient for security i is interpreted as a measure of the riskiness of security i the market line is a graphical representation of the linear relationship between risk and return what are we to make of deviations from the sml i e of securities or managed portfolios that do not plot on such a line if we can retain our intuitive interpretation of fj as the riskiness of asset i and the market line as the appropriate expected return needed to reward agents taking on various degrees of risk then vertical deviations from the market line represent abnormal returns that differ from what is merited this paper and the companion piece dybvig and ross 10 explore in detail the validity of this intuition and the question of what sml deviations really measure the companion piece analyzes sml deviations caused by the choice of an inefficient market or reference portfolio in this paper we analyze sml deviations caused by superior performance based on superior information the intuitive explanation of deviations from the sml has motivated many

legal expenditure as a rent seeking game legal expenditures at a civil trial constitute an interesting type of rent seeking contest in civil litigation there is a natural interaction between the objective merits of the case and the outcome of the contest institutions such as fee shifting do not generally have a counterpart in other rent seeking contests the endogenous decision to participate in the rent seeking contest corresponds to the decision by the plaintiff to bring a case and the decision by the defendant to defend it the desirability of fee shifting is very sensitive to the value of the parameter which describes the legal technology

a nonlinear factor analysis of s p 500 index option returns growing evidence suggests that extraordinary average returns may be obtained by trading equity index options and that at least part of this abnormal performance is attributable to volatility and jump risk premia this paper asks whether such priced risk factors are alone sufficient to explain these average returns to provide an answer in as general as possible a setting i estimate a flexible class of nonlinear models using all s p 500 index futures options traded between 1986 and 2000 the results show that priced factors contribute to these expected returns but are insufficient to explain their magnitudes particularly for short term out of the money puts in a recent paper c oval and shumway 2001 examine the returns on deltahedged option positions focusing on the at the money straddle and find average returns close to minus 3 per week since over short time horizons these positions are approximately invariant to movements in the underlying index coval and shumway argue that their capm betas should be near zero and their expected returns close to the risk free rate they conclude that large deviations from the capm are the norm which they suggest is evidence that some other systematic factor such as stochastic volatility might be priced by the market similar conclusions are made by jackwerth 2000 who finds risk adjusted profitability from selling puts and by bakshi and kapadia 2003 who find that the volatility risk premium contributes significantly to higher prices for calls and puts buraschi and jackwerth 2001 concur suggesting that more than one priced risk factor is necessary to explain option prices a less direct set of evidence is the now standard observation that the black scholes implied volatilities of equity index options are upward biased predictors of future realized volatility numerous studies such as fleming ostdiek and whaley 1995 and christensen and prabhala 1998 document that implied volatilities of short term at the money equity index options are on average several percentage points higher than the volatilities realized over the option s

temporal aggregation and the continuous time capital asset pricing model we examine how the empirical implications of the capital asset pricing model capm are affected by the length of the period over which returns are measured we show that the continuous time capm becomes a multifactor model when the asset pricing relation is aggregated temporally we use hansen s generalized method of moments gmm approach to test the continuous time capm at an unconditional level using size portfolio returns the results indicate that the continuous time capm cannot be rejected in contrast the discrete time capm is easily rejected by the tests these results have a number of important implications for the interpretation of tests of the capm which have appeared in the literature few results in finance are as familiar or as widely used as the linear relation between expected returns and market betas implied by the capital asset pricing model capm however because both the discrete and continuous time versions of the capm lead to this linear relation 1 the literature often fails to distinguish between their respective empirical implications for example discrete and continuous time models are frequently used interchangeably to motivate empirical tests that use discretely observed return data 2 this paper examines how the empirical implications of the capm are affected by the length of the period over which returns are measured 3 we show that if this period differs from the implicit time frame of the model then the familiar linear capm relation need not hold for the observed returns for example the capm can imply a multifactor expression for expected returns when the asset pricing relation is properly aggregated this aspect has many important implications for applied work as well as the interpretation of empirical tests of the capm that have appeared in the literature we illustrate the importance of the temporal aggregation issue by deriving the

generalized methods of moments we provide a brief overview of applications of generalized method of moments in finance the models examined in the empirical finance literature especially in the asset pricing area often imply moment conditions that can be used in a straight forward way to estimate the model parameters without making strong assumptions regarding the stochastic properties of variables observed by the econometrician typically the number of moment conditions available to the econometrician would exceed the number of model parameters this gives rise to overidentifying restrictions that can be used to test the validity of the model specifications these advantages have led to the widespread use of the generalized method of moments in the empirical finance literature

seminonparametric estimation of conditionally constrained heterogeneous processes asset pricing applications the overidentifying restrictions of the intertemporal capital asset pricing model are usually rejected when tested using data on consumption growth and asset returns particu larly when additively separable constant relative risk utility is attributed to the representa tive agent this article investigates the extent to which specification error can explain these rejections the empirical strategy is limited information maximum likelihood in conjunc tion with seminonparametric expanding parameter space representations for both the law of motion and utility we find that consumption growth and asset returns display conditional heterogeneity but this fact does not account for rejection of the overidentifying restrictions as might be anticipated from the work of hansen singleton and others using generalized method of moments methods we also find that expansion of the parameter space in the direction of nonseparable utility causes the overidentifying restrictions to be accepted our estimation strategy provides information on the manner in which the restrictions distort the law of motion in particular imposition of additively separable constant relative risk aversion utility causes the conditional variance of consumption growth to be overpredicted the conditional covariance of asset returns with consumption growth to be overpredicted and an equity premium imposition of nonseparable seminon parametric utility causes distortion in these same directions though the distortions are much smaller which is consistent with the outcomes of the tests of the restrictions

pricing capital assets in an international setting an introduction this paper shows how differences across countries of 1 inflation rates 2 consumption baskets of investors and 3 investment opportunity sets of investors matter when one applies capital asset pricing models in an international setting in particular the fact that countries differ is shown to affect the portfolio held by investors the equilibrium expected returns of risky assets and the financial policies of firms

measuring welfare effects of unbundling financial innovations the case of collateralized mortgage obligations abstract the proposition that market extending financial innovations enhance welfare has strong theoretical support however quantification of these welfare benefits has previously been unavailable in this paper we demonstrate that such quantification is possible for market extending innovations that unbundle an existing asset by selling its cash flows in two or more parts we apply this approach to a prominent recent example of an unbundling innovation collateralized mortgage obligations and find the benefits to have been substantial

a general equilibrium analysis of option and stock market interactions the traditional pricing methodology in finance values derivative securities as redundant assets that have no impact on equilibrium prices and allocations this paper demonstrates that when the market is incomplete primary and derivative asset markets generically interact the valuation of derivative and primary security prices depend on the contractual characteristics of the derivative assets available in a version of the mossin mean variance model the authors analyze an equilibrium in which a call option derivative asset is traded and the equilibrium stock price primary asset increases when the options market is opened copyright 1991 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

private equity performance what do we know we study the performance of nearly 1400 u s buyout and venture capital funds using a new dataset from burgiss we find better buyout fund performance than has previously been documented performance consistently has exceeded that of public markets outperformance versus the s p 500 averages 20 to 27 over a fund s life and more than 3 annually venture capital funds outperformed public equities in the 1990s but underperformed in the 2000s our conclusions are robust to various indices and risk controls performance in cambridge associates and preqin is qualitatively similar to that in burgiss but is lower in thomson venture economics

gain loss and asset pricing we develop an approach to asset pricing in incomplete markets that bridges the gap between the two fundamental approaches in finance model based pricing and pricing by no arbitrage we strengthen the absence of arbtrage assumption by precluding investment opportunities whose attractiveness to a benchmark investor exceeds a specified threshold in our framework the attractiveness of an investment opportunity is measured by the gain loss ratio we show that a restriction on the maximum gain loss ratio is equivalent to a restriction on the ratio of the maximum to minimum values of the pricing kernel by limiting the maximum gainloss ratio we can restrict the admissible set of pricing kernels which in turn allows us to restrict the set of prices that can be assigned to assets we illustrate our methodology by computing price bounds for call options in a black scholes economy without intermediate trading when we vary the maximum permitted gainloss ratio these bounds can range from the exact prices implie

factor pricing in a finite economy abstract prior theoretical derivations of the arbitrage pricing theory apt bound an aggregate measure of the deviation of mean asset returns from that predicted by a linear pricing equation it is conceivable given this bound that some assets might be badly mispriced by the model in this paper a more intuitive derivation of the factor pricing equation is presented which describes the deviation on an asset by asset basis the deviation is shown to be small for assets in a realistic finite economy and is arbitrarily close to zero for those assets with arbitrarily small size relative to aggregate wealth it follows that the linear pricing equation provides a good approximation for the mean returns of all traded assets

stock prices and volume the authors undertake a comprehensive investigation of price and volume co movement using daily new york stock exchange data from 1928 to 1987 they adjust the data to take into account well known calendar effects and long run trends to describe the process they use a seminonparametric estimate of the joint density of current price change and volume conditional on past price changes and volume four empirical regularities are found 1 positive correlation between conditional volatility and volume 2 large price movements are followed by high volume 3 conditioning on lagged volume substantially attenuates the leverage effect and 4 after conditioning on lagged volume there is a positive risk return relation article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

a new approach to international arbitrage pricing this paper uses a nonlinear arbitrage pricing model a conditional linear model and an unconditional linear model to price international equities bonds and forward currency contracts unlike linear models the nonlinear arbitrage pricing model requires no restrictions on the payoff space allowing it to price payoffs of options forward contracts and other derivative securities only the nonlinear arbitragepricing model does an adequate job of explaining the time series behavior of a cross section of international returns the idea that a few relevant state variables explain expected returns is the main driving force of the seminal papers of merton 1973 and ross 1976 these seminal ideas have been extended to the pricing of international assets by ikeda 1991 ross and walsh 1983 solnik 1974 1983 and stulz 1981 among others the key implication of these arbitrage pricing models is that only risks related to these factors state variables are relevant in determining asset prices testable implications of these international asset pricing models have been derived either by placing restrictions on the payoff structure i e payoffs are linear in factors as in ikeda 1991 ross and walsh 1983 and solnik 1983 or on the joint distributions of the payoffs and state variables as in constantinides 1989 these restrictions lead to the testable implication that expected asset returns are linear in the conditional covariances with the factor payoffs in what follows we refer to these models as linear arbitrage models or linear models

multivariate proxies and asset pricing relations abstract a framework is developed in which inferences can be made about the validity of an equilibrium asset pricing relation even though the central aggregate in this relation is unobservable a multivariate proxy for the true market portfolio consisting of an equal weighted stock index and a long term government bond index is employed in an investigation of the sharpe lintner capm the empirical evidence suggests that we can reject the joint hypothesis that a capm is valid and b multiple correlation between the true market portfolio and proxy assets exceeds 0 7 connections to the equilibrium factor pricing literature are also explored

do private equity returns result from wealth transfers and short termism evidence from a comprehensive sample of large buyouts we test whether the well documented high returns of private equity sponsors result from wealth transfers from other financial claimants and counterparties and from a focus on short term profits at the expense of long term value debt investors who finance buyouts as well as buyers of private equity portfolio companies represent the two potential sources of wealth transfers however we find that on average public companies benefit when they buy financial sponsors portfolio companies experiencing positive abnormal returns upon the announcement of the acquisition and long run posttransaction abnormal returns indistinguishable from zero we further find that large portfolio company payouts to private equity on average have no relation to future portfolio company distress suggesting that debt investors are not suffering systematic wealth losses either however we find some evidence of wealth transfers from both strategic buyers and debt investors in some special situations finally we find that portf

dynamic equilibrium with two stocks heterogeneous investors and portfolio constraints we study dynamic equilibrium in a lucas economy with two stocks two heterogeneous constant relative risk aversion investors and portfolio constraints we focus on margin and leverage constraints which restrict access to credit we find a positive relationship between the amount of leverage in the economy and magnitudes of stock return correlations and volatilities tighter constraints generate rich patterns in correlations and volatilities make them less countercyclical increase risk premia proportionally to assets margins and increase prices of low margin assets more than prices of high margin assets we derive closed form solutions for the unconstrained case and the case of leverage constraints

the economics of private equity funds this article analyzes the economics of the private equity industry using a novel model and dataset we obtain data from a large investor in private equity funds with detailed records on 238 funds raised between 1993 and 2006 we build a model to estimate the expected revenue to managers as a function of their investor contracts and we test how this estimated revenue varies across the characteristics of our sample funds among our sample funds about two thirds of expected revenue comes from fixed revenue components that are not sensitive to performance we find sharp differences between venture capital vc and buyout bo funds bo managers build on their prior experience by increasing the size of their funds faster than vc managers do this leads to significantly higher revenue per partner and per professional in later bo funds the results suggest that the bo business is more scalable than the vc business and that past success has a differential impact on the terms of their future funds jel g10 g20 g24

rationalist explanations for war realist and other scholars commonly hold that rationally led states can and sometimes do fight when no peaceful bargains exist that both would prefer to war against this view i show that under very broad conditions there will exist negotiated settlements that genuinely rational states would mutually prefer to a risky and costly fight popular rationalist and realist explanations for war fail either to address or to explain adequately what would prevent leaders from locating a less costly bargain essentially just two mechanisms can resolve this puzzle on strictly rationalist terms the first turns on the fact that states have both private information about capabilities and resolve and the incentive to misrepresent it the second turns on the fact that in specific strategic contexts states may be unable credibly to commit to uphold a mutually preferable bargain historical examples suggest that both mechanisms are empirically plausible

were japanese stock prices too high abstract this paper asks whether market fundamentals can explain the recent run up and decline of japanese equity values and price earnings ratios accounting differences explain about half of the long run disparity between u s and japanese p e s for example if japanese firms used u s accounting rules the japanese p e ratio would have been 32 6 not 53 7 in 1989 accounting differences cannot however explain the doubling of this ratio in 1986 nor its decline in 1990 similarly we are unable to isolate changes in required stock returns or growth expectations that are large enough to explain recent japanese stock price movements

a characterization of the coskewness cokurtosis pricing model the coskewness cokurtosis pricing model is equivalent to absence of any positive alpha return for which the residual risk has positive coskewness and negative cokurtosis with the market this parallels the capm and also the fundamental theorem of asset pricing

margin requirements volatility and the transitory component of stock prices official margin requirements in the u s stock market were established in october 1934 to limit the amount of credit available for the purpose of buying stocks since then higher or rising margin requirements are associated with lower stock price volatility lower excess volatility and smaller deviations of stock prices from their fundamental values the results hold throughout the post 1934 period and are not very sensitive to the exclusion of the turbulent depression years from the sample thus margin requirements seem to be an effective policy tool in curbing destabilizing speculation jel 313 520 federal regulation of securities margins was mandated by congress in the securities exchange act of 1934 the stock market experience of the late 1920s led congress to the conclusion that credit financed speculation in the stock market might create excessive market volatility through a pyramidingdepyramiding process congress reasoned that the imposition of margin requirements could constrain the amount of borrowing and prevent excessive market volatility and subsequently gave the federal reserve jurisdiction over the level of margin requirements since 1934 the federal reserve

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

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

intermediary asset pricing abstract we model the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary intermediaries face an equity capital constraint risk premia r

a note on the welfare consequences of new option markets this note extends existing results on the conditions under which the opening of option markets permits a pareto improvement in welfare specifically conditions supplementary to those set forth in dybvig and ingersoll 4 and hakansson 5 are identified these results thus expand the universe of known cases in which trading in options has no negative welfare consequences welfare effects arise from changes in investors choice sets the opening of option markets can affect the choice sets of investors in two ways1 first by augmenting the existing financial market structure and second by altering the equilibrium relative prices of assets in general the two are not separable thus welfare effects should be considered within the context of an equilibrium model2 hakansson examines the nature of redistributive effects in an equilibrium model where investors utilities are arbitrary he identifies necessary and sufficient conditions for there to be no redistributive welfare effects following the opening of option markets for this result either the endowment in the richer market structure must be the equilibrium allocation in the original structure his theorem 6 or the two equilibria must share a common implicit state contingentclaim price vector theorem 7 in the model set forth below the conditions of theorem 6 are not satisfied and the conditions of theorem 7 are satisfied trivially dybvig and ingersoll examine the effect on capm equilibrium relative prices of the addition of an option market section iii they examine two cases in the first equilibrium relative prices are not affected when investors have homogeneous quadratic utilities in the second with heterogeneous utilities the capm pricing relationships break down in the model presented here equilibrium pricing relationships are preserved even though there is heterogeneity among investors

hot hands in mutual funds short run persistence of relative performance 1974 1988 the relative performance of no load growth oriented mutual funds persists in the near term with the strongest evidence for a one year evaluation horizon portfolios of recent poor performers do significantly worse than standard benchmarks those of recent top performers do better though not significantly so the difference in risk adjusted performance between the top and bottom octile portfolios is six to eight percent per year these results are not attributable to known anomalies or survivorship bias investigations with a different previously used data set and with some post 1988 data confirm the finding of persistence

a general equilibrium model of changing risk premia theory and tests keywords asset pricing theory reference sfi pb article 1989 001doi 10 1093 rfs 2 4 467 record created on 2008 03 12 modified on 2017 05 12

a unified beta pricing theory abstract this paper derives ross s mutual fund separation theory and a new equilibrium version of ross s arbitrage pricing theory as special cases of a general theory the paper also reveals that the two theories are identical in their predictions of asset prices and portfolio returns the capital asset pricing model a restricted case of the mutual fund separation theory receives special treatment

give peace a chance the effect of ownership and asymmetric information on peace abstract we study the possibility of peace when two countries fight a war over the ownership of a resource war is always the outcome of the game played by rational countries under complete or asymmetric information when there is no pre established distribution of the resource among countries when there is such a distribution of the resource under complete information peace is feasible for some initial distributions of the resource whereas under asymmetric information there are two classes of equilibria peaceful equilibria in which peace has a positive probability and aggressive equilibria which assign probability one to war surprisingly a little asymmetric information may yield war

mediation and peace this article applies mechanism design to the study of international conflict resolution standard mechanisms in which an arbitrator can enforce her decisions are usually not feasible because disputants are sovereign entities nevertheless we find that this limitation is inconsequential despite only being capable of making unenforceable recommendations mediators can be equally effective as arbitrators by using recommendation strategies that do not reveal that one player is weak to a strong opponent a mediator can effectively circumvent the unenforceability constraint this is because these strategies make the strong player agree to recommendations that yield the same payoff as arbitration in expectation this result relies on the capability of mediators to collect confidential information from the disputants before making their recommendations simple protocols of unmediated communication cannot achieve the same level of ex ante welfare as they preclude confidentiality

can the shadow of the future harm cooperation abstract it is generally thought that in long term relationships high valuations of the future are conducive to cooperation in an intertemporal model of conflict however we demonstrate the possibility of the opposite effect a longer shadow of the future may harm cooperation in particular we show that the degree of inefficiency is positively related to i the agents valuation of the future ii potential growth rates in resources iii the size of initial resource endowments and iv the effectiveness of conflict

the arbitrage pricing theory and supershares in a single period model with options on the market portfolio linear factor pricing holds if and only if the variance of the market conditional on the factors is zero there is no need for factors other than nonlinear functions of the market for accurate linear pricing of all payoff patterns the factors must be rotationally equivalent to hakansson s supershares in a multiperiod model a similar set of results holds but with consumption replacing the market payoff the methodology of the empirical arbitrage pricing theory literature is not consistent with either the single period model or the multiperiod model linear factor models have been used extensively to analyze security returns predominantly by researchers working with the arbitrage pricing theory apt paradigm 1 a coherent theoretical framework is of course crucial to give direction and interpretation to empirical work as well as to guide applications this paper presents some new basic theoretical results on factor models and security pricing in a single period model with market index options even though the sharpe lintner capm may not hold the market portfolio plays such a central role in pricing that the following condition is necessary and sufficient for a vector of factors to give linear pricing the variance of the market return conditional on the factors must be zero that is the factors must determine the market furthermore there is no need for factors other than potentially nonlinear functions of the market return nonmarket risk in a factor can be eliminated with virtually no loss of linear pricing accuracy in order to get linear pricing of all assets in a complete market the factors must be rotationally equivalent to hakansson s 1977 1978 supershares in an intertemporal model a similar set of results holds with consumption replacing the market return as the pivotal variable for pricing all securities these results are used to highlight some limitations of the existing theoretical apt literature as an interpretive foundation for apt empirical work it is argued that the empirical work is consequently somewhat misdirected so recommendations for redirection are made at the end of the paper section i discusses single period apt models and introduces a completemarkets model six theorems are derived which indicate that the potential role

the public market equivalent and private equity performance the authors show that the public market equivalent approach is equivalent to assessing the performance of private equity pe investments using rubinstein s dynamic version of the capm they developed two insights 1 one need not compute betas of pe investments and any changes in pe cash flow betas due to changes in financial leverage operating leverage or the nature of the business are automatically taken into account 2 the public market index used in evaluations should be the one that best approximates the wealth portfolio of the investor considering the pe investment opportunity

guns butter and openness on the relationship between security and trade sovereign states arm to defend real or hypothetical interests presumably because they cannot engage in complete long term contracting that would prevent such arming international trade therefore takes place within an essentially anarchic context and we can expect trade regimes and security policies to be related indeed many embargoes sanctions and various other forms of trade restrictions that have been used throughout history and continue to be used today can be considered extensions of security policies whereas some security policies can be attributed to trade policy the relationship between trade and security however has been barely explored within economics we could fairly characterize the prevailing view within the discipline as the classical liberal view according to which the expansion of international trade does not just increase the welfare of the trading partners but can also patch up any differences they might have over other contentious issues solomon polachek 1980 represents a rare articulation of this widely held perspective more boldly it could be argued that the expansion of trade always alleviates conflict by forcing the adoption of measures that manage conflict nevertheless one does not need to dig much into history to show that while trade and economic interdependence can contribute to the peaceful resolution of disputes they are not sufficient by themselves to guarantee the absence of war and the reduction of arming many observers before world war i for example considered that the hitherto unprecedented expansion of trade and interdependence between britain and germany made war unthinkable and impossible yet war occurred and with much ferocity and destruction furthermore as donald kagan 1995 pp 373 80 has argued the british policy of appeasement toward germany during the 1930 s was based on similar arguments about the use of economic caltots to avoid war what can inter

skill and luck in private equity performance we evaluate the performance of private equity pe funds using a variance decomposition model to separate skill from luck we find a large amount of long term persistence and skilled pe firms outperform by 7 to 8 annually but this performance is noisy with a large amount of luck so top quartile performance does not necessarily imply top quartile skills making it difficult for investors lps to identify skilled pe firms buyout bo firms show the largest skill differences implying the greatest long term persistence venture capital vc performance is the most noisy making good vc firms hardest to identify and implying the smallest amount of investable persistence

margin based asset pricing and deviations from the law of one price in a model with heterogeneous risk aversion agents facing margin constraints we show how securities required returns increase in both their betas and their margin requirements negative shocks to fundamentals make margin constraints bind lowering risk free rates and raising sharpe ratios of risky securities especially for high margin securities such a funding liquidity crisis gives rise to bases that is price gaps between securities with identical cash flows but different margins in the time series bases depend on the shadow cost of capital which can be captured through the interest rate spread between collateralized and uncollateralized loans and in the cross section they depend on relative margins we test the model empirically using the credit default swap bond bases and other deviations from the law of one price and use it to evaluate central banks lending facilities jel g01 g12 g13 e44 e50 the paramount role of funding constraints becomes particularly salient during liquidity crises with the one that started in 2007 being an excellent case in point banks unable to fund their operations closed down and the funding problems spread to other investors such as hedge funds that relied on bank funding therefore traditional liquidity providers became forced sellers interest rate spreads increased dramatically treasury rates dropped sharply and central banks stretched their balance sheets to facilitate funding these funding problems had significant asset pricing effects the most extreme example being the failure of the law of one price loop securities with nearly

how much would you pay to resolve long run risk abstract though risk aversion and the elasticity of intertemporal substitution have been the subjects of careful scrutiny the long run risks literature as well as the broader literature using recursive utility to address asset pricing puzzles has ignored the full implications of their parameter specifications recursive utility implies that the temporal resolution of risk matters and a quantitative assessment thereof should be part of the calibration process this paper gives a sense of the magnitudes of implied timing premia its objective is to inject temporal resolution of risk into the discussion of the quantitative properties of long run risks and related models jel d81 g11 g12

an explicit bound on individual assets deviations from apt pricing in a finite economy abstract ross s arbitrage pricing theory apt is a tractible and reasonable alternative to the mean variance model nonetheless understanding of the theory has been obscured by the complexity of the sequence economy models used for motivation by contrast we give a simple and direct derivation of the apt in a finite economy using an explicit bound on the deviations from apt prices across assets a coarse calculation shows that theoretical deviations from apt pricing are negligible in our economy

returns of claims on the upside and the viability of u shaped pricing kernels abstract when the pricing kernel is u shaped then expected returns of claims with payout on the upside are negative for strikes beyond a threshold determined by the slope of the u shaped kernel in its increasing region and have negative partial derivative with respect to strike in the increasing region of the kernel using returns of i s p 500 index calls ii calls on major international equity indexes iii digital calls iv upside variance contracts and v a theoretical construct that we denote as kernel call we find broad support for the implications of u shaped pricing kernels a possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and short selling

conflict war and redistribution this article analyzes the circumstances under which conflict leads to the outbreak of war using a formal model which incorporates both the redistribution of resources as an alternative to war and imperfect information countries act as rational agents concerned with both consumption and the public bad of a war in the first period both countries can either consume or build arms whereas in the second period there can be either the threat or the use of force to reallocate resources if both countries are fully informed then there will be no war but rather a voluntary redistribution of resources in a situation of asymmetric information however in which one country is fully informed and the other is not a war can occur if the uninformed country uses a separating equilibrium strategy precommitting itself to a positive probability of war in order to prevent bluffing by the informed country

necessary conditions for the capm abstract the general restrictions on all economic primitives i e a endowments b preferences and c asset return distributions that yield the capm under the expected utility paradigm are provided these results are then used to derive the class of restrictions on preferences and the distribution of asset returns alone that provides the capm we also show that the conditions that provide the capm and derived preferences over mean and variance are equivalent consequently this paper also resolves the question of when mean variance maximization is consistent with expected utility maximization journal of economic literatureclassification numbers g12 g11 d50

animal spirits margin requirements and stock price volatility a simple overlapping generations model is used to characterize the effects of initial margin requirements on the volatility of risky asset prices investors are assumed to exhibit heterogeneous preferences for risk bearing the distribution of which evolves stochastically across generations this framework is used to show that imposing a binding initial margin requirement may either increase or decrease stock price volatility depending upon the microeconomic structure behind fluctuations in economy wide average risk bearing propensity the ambiguous effect on volatility similarly arises when the source of heterogeneity is noise trader beliefs beyond their prudential functions the effects of initial margin requirements on securities markets are not well understood many have argued based upon empirical findings that the level of margin requirements has no discernable impact on stock price behavior nevertheless the view that high margin requirements dampen speculative excesses and reduce excess price volatility remains popular the simultaneous existence of such views highlights the uncertainty surrounding this issue in fact there exists no rigorously articulated theory of the interaction between initial margin requirements and stock prices and their returns characteristics in this paper we construct a simple dynamic model useful for characterizing the effects of initial margin requirements on security prices and returns to analyze the impact of margins we introduce investor heterogeneity into an otherwise simplified overlapping generations olg economy 2 the olg models are constructed so that each generation displays heterogeneous preferences or beliefs the distribution of which evolves stochastically across generations in each of two heterogeneous taste models we consider there are two types of agents one of which is more risk tolerant than the other in one model the

stationary equilibria in asset pricing models with incomplete markets and collateral we consider an infinite horizon exchange economy with incomplete markets and collateral constraints as in the two period model of geanakoplos and zame 2002 households can default on their liabilities at any time and financial securities are only traded if the promises associated with these securities are backed by collateral we examine an economy with a single perishable consumption good where the only collateral available consists of productive assets in this model competitive equilibria always exist and we show that under the assumption that all exogenous variables follow a markov chain there also exist stationary equilibria these equilibria can be characterized by a mapping from the exogenous shock and the current distribution of financial wealth to prices and portfolio choices we develop an algorithm to approximate this mapping numerically and discuss ways to implement the algorithm in practice a computational example demonstrates the performance of the algorithm and shows some quantitative features of equilibria in a model with collateral and default

rent seeking with asymmetric valuations this paper analyzes tullock s rent seeking game with asymmetric valuations for a variable range of the returns to scale parameter a necessary and sufficient condition for a unique pure strategy nash equilibrium is established equilibrium effort and expected profits are determined and subjected to comparative statics analysis increasing the underdog s valuation induces both players to increase their efforts increasing the favorite s valuation increases his effort but decreases the effort of the underdog expected profits increase with a player s valuation but decreases with the valuation of the competitor the impact of the returns to scale parameter is also analyzed

investment risk allocation and the venture capital exit market evidence from early stage investing abstract this study provides evidence on how venture capitalists vcs allocations of capital to riskier investments as measured by the proportion of early versus late stage investment in an industry are linked to exit market conditions prior research has primarily focused on how vcs adjust aggregate investment to public equity market conditions we develop a more inclusive measure of exit market conditions that accounts for recent secular changes that have affected the industry return structure specifically the sharp rise in the number of failures and m a relative to ipo exits we show that the dollars gained relative to dollars lost in recent exits and failures are significantly positively related to vcs allocations to early stage companies over the period 1990 2008 the changes in allocations are large enough to have an effect on the availability of funding for early stage companies in sum our evidence shows that exit market conditions have a significant and economically meaningful influence on vcs allocations to riskier investments

the asymmetric relation between initial margin requirements and stock market volatility across bull and bear markets higher initial margin requirements are associated with lower subsequent stock market volatility during normal and bull periods but show no relationship during bear periods higher margins are also negatively related to the conditional mean of stock returns apparently because they reduce systemic risk we conclude that a prudential rule for setting margins or other regulatory restrictions is to lower them in sharply declining markets in order to enhance liquidity and avoid a depyramiding effect in stock prices but subsequently raise them and keep them at the higher level in order to prevent a future pyramiding effect copyright 2002 oxford university press

margin regulation and volatility an infinite horizon asset pricing model with heterogeneous agents and collateral constraints can explain why adjustments in stock market margins under us regulation t had an economically insignificant impact on market volatility in the model raising the margin requirement for one asset class may barely affect its volatility if investors have access to another unregulated class of collateralizable assets through spillovers however the volatility of the other asset class may substantially decrease a very strong dampening effect on all assets return volatilities can be achieved by a countercyclical regulation of all markets

some results in the capm with nontraded endowments the paper establishes a positive security market line in the capm with nontraded endowments the effects of a market structure change on the security market line are analyzed when the equilibrium allocation is affected by the change