real options agency conflicts and optimal capital structure abstract we examine the impact of a stockholder bondholder conflict over the timing of the exercise of an investment option on firm value and corporate financial policy we find that an equity maximizing firm exercises the option too early relative to a value maximizing strategy and we show how this problem can be characterized as one of overinvestment in risky investment projects equityholders incentive to overinvest significantly decreases firm value and optimal leverage and significantly increases the credit spread of risky debt numerical solutions illustrate how the agency cost of overinvestment and its effect on corporate financial policy vary with firm and project characteristics

oil prices and the stock prices of alternative energy companies energy security issues coupled with increased concern over the natural environment are driving factors behind oil price movements while it is widely accepted that rising oil prices are good for the financial performance of alternative energy companies there has been relatively little statistical work done to measure just how sensitive the financial performance of alternative energy companies are to changes in oil prices in this paper a four variable vector autoregression model is developed and estimated in order to investigate the empirical relationship between alternative energy stock prices technology stock prices oil prices and interest rates our results show technology stock prices and oil prices each individually granger cause the stock prices of alternative energy companies simulation results show that a shock to technology stock prices has a larger impact on alternative energy stock prices than does a shock to oil prices these results should be of use to investors managers and policy makers

micro estimates of public spending demand functions and tests of the tiebout and median voter hypotheses responses to questions given to a random sample of michigan households are used to estimate public spending demand functions while income and price elasticities are similar to those obtained from aggregate data positive income elasticities appear to arise because public services are distributed in a prorich manner a relatively small variance in spending demands among urban and suburban communities in metropolitan areas with substantial public service variety suggests that the tiebout mechanism works this interpretation is supported by the fact that actual spending conforms substantially to desired levels in urban areas but less so in rural areas with little public sector choice

leveraged investments and agency conflicts when cash flows are mean reverting we analyse the effect of mean reverting cash flows on the costs of shareholder bondholder conflicts arising from partially debt financed investments in a partial equilibrium setting we find that such agency costs are significantly lower under mean reverting mr dynamics when compared to the ubiquitous geometric brownian motion gbm the difference is attributed to the stationarity of the mr process in addition through the application of a novel agency cost decomposition we show that for a larger speed of mean reversion agency costs are driven mainly by suboptimal timing decisions as opposed to suboptimal financing decisions in contrast under the standard gbm assumption the agency costs are driven mainly by suboptimal financing decisions for large growth rates and by suboptimal timing decisions for smaller or negative growth rates

congestion function specification and the publicness of local public goods abstract this paper is about the measurement of congestion within the median voter demand framework the model of congestion traditionally used in the literature and four others are compared and tested in a median voter framework the results show that a more flexible functional form which imposes fewer a priori restrictions on the data does at least as good a job of explaining variations in local government expenditures furthermore it is shown that measured publicness of local public goods depends entirely on the a priori restrictions imposed on the congestion function

the lognormal diffusion is hardly an equilibrium price process for exhaustible resources abstract in a model of a competitive spot market for an exhaustible resource under demand uncertainty it is shown that the lognormal diffusion the geometrical brownian motion can hardly be an equilibrium price process under the reasonable assumptions that suppliers choose the time to extract and deposits have different costs each supplier will start extraction when price first exceeds a boundary which depends on that supplier s costs but no new extraction will start during periods when the price is lower than the previously recorded high it is highly unlikely that aggregate demand responds to prices in the same way as supply

valuing flexibility the case of an integrated gasification combined cycle power plant abstract in this paper we analyze the choice between two technologies for producing electricity in particular the firm has to decide whether and when to invest either in a natural gas combined cycle ngcc power plant or in an integrated gasification combined cycle igcc power plant which may burn either coal or natural gas instead of assuming that fuel prices follow standard geometric brownian motions here they are assumed to show mean reversion specifically to follow an inhomogeneous geometric brownian motion first we consider the opportunity to invest in a ngcc power plant we derive the optimal investment rule as a function of natural gas price and the remaining life of the right to invest in addition the analytical solution for a perpetual option to invest is obtained then we turn to the igcc power plant we analyse the valuation of an operating plant when there are switching costs between modes of operation and the choice of the best operation mode this serves as an input to evaluate the option to invest in this plant finally we derive the value of an opportunity to invest either in a ngcc or igcc power plant i e to choose between an inflexible and a flexible technology respectively depending on the opportunity s time to maturity we derive the pairs of coal and gas prices for which it is optimal to invest in ngcc in igcc or simply not to invest numerical computations involve the use of one and two dimensional binomial lattices that support a mean reverting process for coal and gas prices basic parameter values are taken from an actual igcc power plant currently in operation sensitivity of some results with respect to the underlying stochastic process for fuel price is also checked

a model of capital structure when earnings are mean reverting a multiperiod model of optimal capital structure is developed under the assumption that earnings follow an autoregressive process firm value and leverage vary through time and at each date the firm achieves an optimal debt level that is a function of the full state contingent debt policy the reversion parameter of the earnings series is shown to be positively related to various measures of variability and negatively related to leverage if earnings processes are not homogeneous across firms then standard earnings risk measures in capital structure studies do not adequately represent crosssectional differences in variability in firm value

leverage decision and manager compensation with choice of effort and volatility abstract we study the incentive effects of granting levered or unlevered stock to a risk averse manager the stock is granted by risk neutral shareholders who choose leverage and compensation level the manager applies costly effort and selects the level of volatility both of which affect expected return the results are driven by the attempt of the risk neutral shareholders to maximize the value of their claims net of the compensation package we consider a dynamic setting and find that levered stock is optimal for high type managers firms with high momentum large firms and firms for which additional volatility only implies a modest increase in expected return

commodity betas with mean reverting output prices abstract this paper provides a theoretical derivation of commodity beta stock price sensitivity to commodity price using a contingent claim model the model incorporates operating leverage financial leverage costly financial distress and mean reverting commodity prices and highlights the important role played by the speed of reversion of the commodity price it is used to identify theoretically the main determinants of commodity beta commodity beta is predicted to be an increasing function of the operating and financial leverage of the firm and a decreasing function of the company s tax rate and the level volatility and speed of reversion of the commodity price empirical tests with a sample of gold mining firms provide support for these predictions particularly the new implications of the model the effect of the commodity price s speed of reversion and the company s tax rate

how big is the debt overhang problem abstract i re examine the debt overhang problem where the flexible investment level rather than the irreversible decision whether or not to operate is used to measure the underinvestment caused by debt financing i measure a large overhang cost with long term debt or short term debt as is standard underinvestment with long term debt is more severe when investment opportunities are poor and is mitigated as opportunities improve in contrast underinvestment with short term debt remains significant even when investment opportunities are good firms lever up as opportunities improve to take advantage of tax shields so that equity claimants still face the incentive to underinvest

local versus central wage bargaining with endogenous investments investment behavior may depend on whether wage bargaining takes place centrally or locally at the firm level the outcome of the wage bargain will in turn depend on previous investments ignoring other differences between the two bargaining regimes endogenous investments imply that wages are lower and profits higher under local wage bargaining than under central bargaining this does not necessarily imply that employment is highest under local bargaining since investments may differ in the two cases with a nash bargaining solution however reasonable assumptions imply that employment is highest under local wage bargaining

the effect of mean reversion on investment under uncertainty abstract mean reverting processes are appropriate for most real option investment models yet geometric brownian motion gbm processes are generally used for tractability hassett and metcalf j econom dyn control 19 1995 1471 1488 argue that using a gbm process is justified because mean reversion has two opposing effects it brings the investment trigger closer and also reduces the conditional volatility thereby lowering the likelihood of reaching the trigger and the overall effect on investment should be negligible for most reasonable parameter values this paper extends the hassett and metcalf model by incorporating a third factor the effect of mean reversion on systematic risk the main result is that mean reversion in general does have a significant impact on investment moreover this effect could be either positive or negative depending on various factors such as project duration cost of investing interest rate etc thus it is generally inappropriate to use the gbm process to approximate a mean reverting process

the optimal supply of public goods in collective choice the aim of this paper is to provide an appropriate method to estimate the elasticity of demand that is to be used to calculate the benefit share which is used for calculating the benefit burden ratio for median voters and to investigate whether the present tax system leads to an efficient level of public sector output in addition the redistribution effects of the current tax system will also be discussed the degree of bias when the environmental factor was not included in the production function is also considered

investment under alternative return assumptions comparing random walks and mean reversion abstract many recent theoretical papers have come under attack for modeling prices as geometric brownian motion this process can diverge over time implying that firms facing this price process can earn infinite profits we explore the significance of this attack and contrast investment under geometric brownian motion with investment assuming mean reversion while analytically more complex mean reversion in many cases is a more plausible assumption allowing for supply responses to increasing prices we show that cumulative investment is generally unaffected by the use of a mean reversion process rather than geometric brownian motion and provide an explanation for this result

on endogenous competitive business cycles the belief that the long run equilibrium of a competitive monetary economy that does not experience any exogeneous shocks whether originating from the external environment or from policy should be modelled as a state that is stationary or perhaps growing at a constant rate seems to be deeply rooted in the mind of some economists

option valuation of claims on real assets the case of offshore petroleum leases this paper extends financial option theory by developing a methodology for the valuation of claims on a real asset an offshore petroleum lease several theoretical and practical problems not present in applying option pricing theory to financial assets are addressed most importantly we show the necessity of combining option pricing techniques with a model of equilibrium in the market for the underlying asset petroleum reserves the advantages of this approach over conventional discounted cash flow techniques are emphasized the methodological development provides important insights for both company behavior and government policy promising empirical results are reported

a note on the publicness of local goods evidence from new york state municipalities for more than a decade now the non publicness of goods provided by local governments has been an accepted result in the median voter demand literature mcmillan wilson and arthur 1981 found that publicness was exhausted in ontario towns of more than 10 000 inhabitants but that there were still unexploited economies to collective provision in smaller towns using the original bergstrom and goodman 1973 model and new york state data i find that there is even less evidence of publicness in small towns than in large ones my results call into question the mcmillan wilson and arthur hypothesis une note sur le degre de materialite publique d usage des biens locaux le cas des municipalites de b etat de new york depuis plus d une decennie l un des resultats de la litterature specialisee analysant le comportement de demande du voteur median a ete que les biens fournis par les gouvernements locaux n etaient pas des biens publics mcmillan wilson et arthur 1981 ont montre que le degre de materialite publique d usage etait limite dans le cas des villes de plus de 10 000 habitants en ontario mais qu il existait des economies inexploitees emanant de la fourniture publique dans le cas des plus petites villes a partir du modele de bergstrom et goodman 1973 et de donnees pour l etat de new york l auteur en arrive a la conclusion qu il y a encore moins de materialite publique d usage dans les petites villes que dans les grandes ces resultats remettent en question l hypothese mcmillan wilson et arthur in contrast to the strict samuelsonian dichotomy of pure public and pure private goods the tiebout 1956 and buchanan 1965 models plot goods along a continuum of congestability goods provided by local governments or collectively purveyed and consumed in clubs are described as lying somewhere between the two polar cases the median voter demand model as developed by borcherding and deacon i would like to thank wallace oates william oakland suk kang and an anonymous referee for helpful comments on earlier drafts of this paper they are of course exonerated from association with such errors as may still remain canadian journal of economics revue canadienne d economique xix no 3 august aout 1986 printed in canada imprime au canada 0008 4085 86 568 573 1 50 canadian economics association this content downloaded from 157 55 39 102 on mon 03 oct 2016 05 08 06 utc all use subject to http about jstor org terms publicness of local goods 569 1972 and bergstrom and goodman 1973 incorporates this hypothesis observed levels of local public expenditures are said to reflect the preference of the median voter however the empirical models also include a congestion function intended to reflect the effect of collective consumption on individual enjoyment the function used in the literature is of the form

monopolistic competition and the effects of aggregate demand how important is monopolistic competition to an understanding of the effects of aggregate demand on output we ask the question at three levels can monopolistic competition by itself explain why aggregate demand movements affect output can it together with other imperfections generate effects of aggregate demand in a way that perfect competition cannot if so can it give an accurate account of the response of the economy to aggregate demand movements the answers are no yes and yes

a bargaining model with incomplete information about time preferences etude d un jeu de negociation strategique sequentiel avec information incomplete caracterisation d une classe d equilibres sequentiels appeles equilibres sequentiels de negociation et demonstration de l unicite de cet equilibre

the trade off model with mean reverting earnings theory and empirical tests the trade off theory of capital structure predicts a positive relationship between earnings and leverage contradictory to well established empirical evidence since corporate earnings are known to be mean reverting we reformulate the trade off model with mean reverting earnings we show that with mean reverting earnings there should be a negative relationship between optimal leverage and the current earnings level the model also illustrates the importance of the earnings reversion parameter in the determination of capital structure the major implications of the model are supported by empirical tests carried out with a sample of firms in the s p 500 index

the flypaper effect and other anomalies abstract i develop a model in which income both in its own right and as a proxy for other socioeconomic characteristics is an input in the production function for local public services the most obvious example is education though there are other applications as well the comparative statics results from this model yield the following results 1 the observed flypaper effect the tendency for local government to spend a higher fraction of unrestricted grants than income of residents may be due at least in part to the fact that own income but not grants is a substitute for purchased inputs in the technology hence the propensity to spend on purchased inputs out of own income is lower than out of grants 2 the income elasticity of demand for public sector output may be higher than the observed income elasticity of demand for purchased inputs 3 equalization of educational opportunity via wealth neutrality as suggested by feldstein requires major changes in education finance once we recognice the distinction between purchased inputs and output

disentangling the demand function from the production function for local public services the case of public safety abstract in this paper we develop a theoretical framework and an econometric model which allow us to separate the effect of income and other socioeconomic variables on the demand for publicly provided goods from their effect on the price of those goods we apply our approach in a study of expenditures for police protection in a cross section of 73 u s cities and counties our results suggest that studies of public expenditures which fail to incorporate community characteristics in production and cost functions can yield very misleading results

the impact of congestion on local public good production abstract this paper models local public goods production where allocation of the publicly provided input occurs simultaneously with production of the final service output the framework models local public goods as developed in club theory where congestion is an increasing function of population central to identification of the model is that the quantities of the input police are differentiated from the produced output safety estimation is across neighborhoods within a single city the results show there is a very low elasticity of congestion on average but safety in some neighborhoods in more congested than private goods

mean reversion in equilibrium asset prices evidence from the futures term structure we use the term structure of futures prices to test whether investors anticipate mean reversion in spot asset prices the empirical results indicate mean reversion in each market we examine for agricultural commodities and crude oil the magnitude of the estimated mean reversion is large for example point estimates indicate that 44 percent of a typical spot oil price shock is expected to be reversed over the subsequent eight months for metals the degree of mean reversion is substantially less but still statistically significant we detect only weak evidence of mean reversion in financial asset prices in this study we provide evidence of mean reversion in the prices of several real and financial assets rather than examining evidence of ex post reversion using time series of asset prices we use price data from futures contracts with varying delivery horizons to test whether investors expect asset prices to revert this approach offers two advantages first since futures prices are readily available for many markets our procedure can be implemented for many assets including those for which reliable spot price data is elusive second there is little ambiguity as to the source of any mean reversion detected using our method subject only to the maintained assumption that the no arbitrage cost of carry condition holds our test detects mean reversion that is expected to occur in equilibrium but has no power to detect mean reversion resulting from noise or inefficiencies our methodology focuses on relations between price levels and the slope of the futures term structure defined as the change across delivery dates in the futures prices observed on a given trading date an inverse relation between prices and the futures term slope constitutes evidence that investors expect mean reversion in spot prices to illustrate initially assume there are no

general properties of option prices when the underlying price process is a one dimensional diffusion as well as in certain restricted stochastic volatility settings a contingent claim s delta is bounded by the infimum and supremum of its delta at maturity further if the claim s payoff is convex concave the claim s price is a convex concave function of the underlying asset s value however when volatility is less specialized or when the underlying process is discontinuous or non markovian a call s price can be a decreasing concave function of the underlying price over some range increasing with the passage of time and decreasing in the level of interest rates much of the financial options literature derives precise option prices when the underlying asset price process is completely specified since it is empirically difficult to ascertain what the true underlying process is another part of that literature is concerned with deriving general properties of option prices when the underlying price process is not fully specified but instead is assumed to belong to some general class of stochastic processes merton 1973 cox and ross 1976 jagannathan 1984 in particular in the absence of arbitrage opportunities and assuming that the risk neutralized stock price follows a proportional stochastic process a risk neutral return distribution independent of price merton 1973 and jagannathan 1984 show that a call option s price is an increasing convex function of the stock price cox and ross 1976

book rate of return and prediction of earnings changes an empirical investigation over the years there has developed a fairly substantial body of research on the time series of earnings as a whole this literature concludes that changes in annual accounting earnings are unpredictable that is earnings follow a random walk 1 based on this result some inferences of economic substance policy have been claimed 2 in this paper we reconsider empirical issues which at least to some extent have been obscured by this conclusion we argue that the above result is only true in a limited sense since a modest enlargement of the predictive information set should allow for a rejection of the hypothesis that earnings changes are

the empirical analysis of fiscal illusion this paper examines the empirical analysis of the five main hypotheses subsumed under the generic term fiscal illusion after placing these hypotheses within a common theoretical framework the paper attempts to evaluate empirical research into the revenue complexity hypothesis the revenue elasticity hypothesis the flypaper effect renter illusion and debt illusion

a real options approach to the valuation of a forestry investment abstract the theory of real options is used to model the optimal tree harvesting decision the value of the option to harvest is estimated using a dynamic programming approach and a general numerical solution technique suitable for any type of stochastic process for prices the conditions under which the optimal harvest time is independent of price are examined in addition the impact of assuming future lumber prices are mean reverting is considered it is found that option value and optimal cutting time are significantly different under the mean reversion assumption compared to geometric brownian motion

a specification test for choosing the right public good price this article compares statistically three popular public good price definitions the bias of parameter estimates under the wrong definition is derived and calculated one definition is found to be clearly inferior whereas bias estimates indicate little difference between the two remaining definitions public good demand elasticities and their variances are calculated to demonstrate the importance of choosing the right price definition

institutions and short run macroeconomic performance abstract this paper reviews the growing interest in institutions it argues that the explanation for this interest is a fresh awareness of how institutions affect economic performance this connection arises because many economic interaction take the form of one or other of three classic games prisoners dilemma coordination and chicken and the outcome in these games and hence performance of the economy is influenced by the institutional context of these interactions the paper provides a detailed illustration of this argument with a survey of the literature which relates unemployment performances to the institutions of wage setting in oecd countries