equilibrium in an ambiguity averse mean variance investors market abstract in a financial market composed of n risky assets and a riskless asset where short sales are allowed and mean variance investors can be ambiguity averse i e diffident about mean return estimates where confidence is represented using ellipsoidal uncertainty sets we derive a closed form portfolio rule based on a worst case max min criterion then in a market where all investors are ambiguity averse mean variance investors with access to given mean return and variance covariance estimates we investigate conditions regarding the existence of an equilibrium price system and give an explicit formula for the equilibrium prices in addition to the usual equilibrium properties that continue to hold in our case we show that the diffidence of investors in a homogeneously diffident with bounded diffidence mean variance investors market has a deflationary effect on equilibrium prices with respect to a pure mean variance investors market in equilibrium deflationary pressure on prices may also occur if one of the investors in an ambiguity neutral market with no initial short position decides to adopt an ambiguity averse attitude we also establish a capm like property that reduces to the classical capm in case all investors are ambiguity neutral

convergence to the law of one price without trade barriers or currency fluctuations using a panel of 51 prices from 48 cities in the united states we provide an upper bound estimate of the rate of convergence to purchasing power parity we find convergence rates substantially higher than typically found in cross country data we investigate some potentially serious biases induced by i i d measurement errors in the data and find our estimates to be robust to these potential biases we also present evidence that convergence occurs faster for larger price differences finally we find that rates of convergence are slower for cities farther apart however our estimates suggest that distance alone can only account for a small portion of the much slower convergence rates across national borders

mean reversion in real exchange rates evidence and implications for forecasting abstract the stationarity of real exchange rates over the recent flexible exchange rate period is an issue that has long bedeviled researchers in international finance using a constrained multivariate framework this paper provides the strongest evidence yet that real exchange rates were mean reverting over the 1973 93 period we also investigate shifts in long run real exchange rates which may be important for the purpose of forecasting out of sample forecasting shows that the random walk model is outperformed by a mean stationary model especially at long horizons in addition there are substantial forecasting benefits from using a multivariate approach

a general mean variance approximation to expected utility for short holding periods the mean variance model is precisely consistent with the expected utility hypothesis only in the special cases of normally distributed security returns or quadratic utility functions there is little evidence however that security returns follow normal distributions see 13 for references and quadratic preferences can be shown to generate implausible results exhibiting increasing absolute risk aversion in the pratt ll arrow 1 2 sense and displaying negative marginal utility after some finite wealth level in addition hakansson 4 has shown that single period mean variance efficient portfolios can have disastrous consequences over time even when return distributions are stationary such criticisms of the mean variance approach within the von neumann morgenstern framework have prompted several writers to suggest that investors maximize the expected value of utility functions with more realistic properties while others have criticized the single period focus of the model one popular alternative utility function is the logarithmic function which exhibits decreasing absolute risk aversion and conveniently leads to myopic decision processes through time i e investors treat each period as if it were the last basing investment decisions on that period s wealth and return distributions only 8 4 other utility functions with constant relative risk aversion such as the power function also imply myopic decision rules within a multiperiod setting

employer stock and 401 k plans the sharp decline in the stock prices of several firms at which employees held a large fraction of their 401 k plan assets in company stock including enron global crossing lucent and polaroid has sparked a public policy debate about investment options in 401 k plans at many large firms particularly those with retirement saving plans that combine elements of an employee stock ownership plan esop with a traditional 401 k a substantial fraction of defined contribution retirement plan assets are held in company stock such undiversified holdings are a source of concern because they raise the volatility of the retirement wealth for employees and expose some workers to the prospect of very small retirement values holding an undiversified position in employer stock may be particularly costly because of the potential correlation between company stock returns and the value of the worker s human capital which may depend on the company s prospects this paper reviews the extent of undiversified company stock investments in 401 k plans evaluates the cost of such investments from an employee s perspective and discusses a range of policy actions that could address the excessive concentration of retirement plan assets

investor sentiment and the financial crisis a sentiment based portfolio theory perspective the article proposes a portfolio model subjected to a constraint that captures the investor s goal with maximum estimation of expected return that is affected by investor sentiment and we give a solution of the portfolio model by exploring the geometric features furthermore we discuss the relationship between investor sentiment and the financial crisis by analysing the optimal allocation the results show that when investor sentiment is low enough the investor should reject the investment this condition leads the depression financial market to prevail then the financial crisis erupts when investor sentiment is modest the financial crisis is difficult to erupt unless the decline of investor sentiment is quick and deep but there is a special status that the financial crisis is caused by other factors rather than by investor sentiment and only improving investor sentiment cannot move away from the financial crisis

collapsing exchange rate regimes and exchange rate dynamics some further examples abstract this paper extends some recent perfect foresight models of balance of payments crises and exchange rate realignments to a world of smart speculators sticky prices and restricted international capital movements the likelihood and timing of a regime collapse are shown to depend upon initial foreign reserve endowments monitary policy speeds of market adjustment and future exchange rate policy these factors are also shown to influence the dynamic behavior of the exchange rate and prices during a transitional period of floating

recent developments in international finance a guide to research abstract this is a critical evaluation of the state of the art in international finance several points of reference are selected the mundell fleming branson mfp paradigm the monetary model with purchasing power parity ppp as a long run anchor the representative agent approach and the natural real exchange rate natrex model their strengths and weaknesses are identified from both a theoretical and empirical point of view we conclude with a suggestion of what is a fruitful explanation of medium to longer run movements in the real exchange rate and the current account

models of currency crises with self fulfilling features the discomfort a government suffers from speculation against its currency determines the strategic incentives of speculators and the scope for multiple currency market equilibria after describing an illustrative model in which high unemployment may cause an exchange rate crisis with self fulfilling features the paper reviews some other self reinforcing mechanisms recent econometric evidence seems consistent with the practical importance of these mechanisms

a minimax portfolio selection strategy with equilibrium a new minimax model on optimal portfolio selection with uncertainty of both randomness and estimation in inputs is established and the corresponding optimal portfolio is derived analytically based on this result a sufficient condition for the existence and uniqueness of a nonnegative equilibrium price system under which the total demand and supply of each asset are equal is provided and an explicit formula for such a price system is obtained furthermore some properties of the equilibrium are discussed

wall street and the housing bubble we analyze whether mid level managers in securitized finance were aware of the housing bubble and a looming crisis in 2004 2006 using their personal home transaction data we find little evidence of them timing the bubble or exercising cautious behavior in purchasing homes relative to two uninformed control groups one composed of non housing equity analysts and the other of non real estate lawyers to the extent that the practice of securitization may have led to lax screening of subprime borrowers the average person in our sample did not expect it to lead to problems in the wider housing market our findings suggest the need to expand the incentives based view of the crisis to incorporate a role for distorted beliefs

portfolio optimization with mental accounts we integrate appealing features of markowitz s mean variance portfolio theory mvt 4 and shefrin and statman s behavioral portfolio theory bpt into a new mental accounting 5 ma framework features of the ma framework include an ma structure of portfolios 6 a definition of risk as the probability of failing to reach the threshold level in each mental 7 account and attitudes toward risk that vary by account we demonstrate a mathematical 8 equivalence between mvt ma and risk management using value at risk var the ag9

normality solvency and portfolio choice this paper examines whether investors with power utility functions choose mean vari ance mv efficient portfolios when returns are approximately normally distributed and there is borrowing or lending at a riskless interest rate the results show that the unlevered portfolios of power utility investors plot very closely to the mv efficient frontier how ever there are marked differences in the mix of risky assets regardless of whether the portfolios are highly concentrated or widely diversified such differences allow power investors to remain solvent even when they lever their optimal portfolios to a greater ex tent than less risk averse mv investors who risk bankruptcy it is concluded that the investment policies of power utility and mv investors with similar risk aversion measures are not as similar as is commonly believed this is particularly true for high power inves tors unless explicit solvency constraints are imposed on the mv problem and for low power investors when quadratic utility approximations are made to the power utility func tions these differences in the investment policies of power utility and mv investors lead us to question the widely accepted assertion that the assumptions of homogeneous beliefs normality a riskless asset and risk averse investors imply the simple mv capm where all investors including power utility investors hold combinations ofthe market portfolio and the riskless asset

portfolio selection with mental accounts and delegation das et al 2010 develop an elegant framework where an investor selects portfolios within mental accounts but ends up holding an aggregate portfolio on the mean variance frontier this investor directly allocates the wealth in each account among available assets in practice however investors often delegate the task of allocating wealth among assets to portfolio managers who seek to beat certain benchmarks accordingly we extend their framework to the case where the investor allocates the wealth in each account among portfolio managers our contribution is threefold first we provide an analytical characterization of the existence and composition of the optimal portfolios within accounts and the aggregate portfolio second we present conditions under which such portfolios are not on the mean variance frontier and conditions under which they are third we show that the aforementioned analytical characterization is also applicable within the framework of das et al and thus improves upon their numerical approach

purchasing power parity and unit root tests using panel data abstract this paper reports the results of unit root tests for real exchange rates using a panel framework this panel approach provides greatly improved power compared to conventional univariate time series unit root tests we obtain evidence supporting ppp over the recent flexible exchange rate period for g 6 and oecd countries we show explicitly that failure to find such evidence in previous research was due to the low power of the tests

seigniorage revenue deficits and self fulfilling currency crises abstract this paper examines potential resolutions to the conflict between a fixed exchange rate and seigniorage revenue requirement of a stylized developing economy that gives rise to a currency crisis the government has an informational advantage and can decide when it is optimal to invoke an escape clause i e to drop the peg and float speculators must guess when the crisis will happen based on their assessment of the probability of collapse and this makes pegged exchange rate equilibria unstable

on the sensitivity of mean variance efficient portfolios to changes in asset means some analytical and computational results tbis paper investigates the sensitivity of meanvariance mv efficientportfolios to changes in the means of individual assets when only a budget constraint is imposed on the investment problem the analytical results indicate that an mv efficient portfolio s weights mean and variance can be extremely sensitive to cbanges in asset means when nonnegativity constraints are also imposed on the problem the computational results confirm that a positively weigbted mv efficient portfolio s weigbts are extremely sensitive to cbanges in asset means but the portfolio s returns are not a surprisingly small increase in the mean of just one asset drives balf the securities from the portfolio yet the portfolio s expected return and standard deviation are virtually uncbanged this paper supersedes should investors hold well diversified portfolios financial support from the natural science and engineering research council of canada is gratefully acknowledged we also acknowledge the most capable assistance of ruth cornale simon ng jean marc potier and frederick shen the paper was presented at simon fraser university and the western finance association meetings in san diego we thank the participants especially stephen brown john herzog john heaney ray koopman and bruce lehmann and the editors jon ingersoll and chester spatt for

identity and the economics of organizations on plebes first day at west point called r day they strip down to their underwear their hair is cut off they are put in uniform they then must address an older cadet with the proper salute and with the statement sir new cadet doe reports to the cadet in the red sash for the first time as ordered plebes must stand and salute and repeat and stand and salute and repeat until they get it exactly right all the while being reprimanded for every tiny mistake in the summary of david lipsky 2003 pp 145 154 who spent four years tracking a company of cadets at west point on r day you surrender your old self in stages but r day is just the beginning of the training and personal re engineering that is to come so that west point graduates emerge four years later as loyal officers in the u s army lipsky shows that despite some failure this tough program is remarkably successful in creating officers with the will to lead in battle economists current picture of organizations and work incentives has no place for the west point program and the motivations it seeks to inculcate in recruits in a standard economic model an individual s preferences are fixed and utility depends only on pecuniary variables the army s aim at west point is to change cadets preferences they wish to inculcate non economic motives in the cadets so that they have the same goals as the u s army alternatively stated the goal of west point is to change the identity of the cadets so they will think of themselves above all else as officers in the u s army they will feel bad about themselves they will lose utility if they fall short of the ideals of such an officer this change in identity

evaluating the impact of inequality constraints and parameter uncertainty on optimal portfolio choice we present new analytical results for the impact of portfolio weight constraints on an investor s optimal portfolio when parameter uncertainty is taken into account while it is well known that parameter uncertainty and imposing weight constraints results in reduced certainty equivalent returns in the general case there are no analytical results in a special case commonly used in the funds management literature we derive analytical expression for the certainty equivalent loss that does not depend on the risk aversion parameter we illustrate our theoretical results using hedge fund data from the perspective of a fund of fund manager our contribution is to formalize the framework to investigate this problem as well as providing tractable analytical solutions that can be implemented using either simulated or asset manager returns

speculation and the decision to abandon a fixed exchange rate regime this paper investigates the extent to which it is possible for speculative attacks to be predictable given information on economic fundamentals a standard model of predictable attacks is extended to incorporate an optimizing monetary authority it is shown that while incorporating a forward looking monetary authority improves our understanding of many observed phenomena it also implies that the branch of the literature that places emphasis on predictable movements in fundamentals cannot generate predictable speculative attacks in addition the model provides useful insights into the viability of temporary nominal anchor policies and a theoretical foundation for an important empirical methodology

delaying the inevitable interest rate defense and balance of payments crises the classical model of balance of payments crises implicitly assumes that the central bank sits passively as international reserves dwindle in practice however central banks typically defend pegs aggressively by raising short term interest rates this paper analyzes the feasibility and optimality of raising interest rates to delay a potential bop crisis interest rate policy works through two distinct channels by raising demand for domestic interest bearing liquid assets higher interest rates tend to delay the crisis higher interest rates however increase public debt service and imply higher future inflation which tends to bring forward the crisis we show that under certain conditions it is feasible to delay the crisis but raising interest rates beyond a certain point may actually hasten the crisis a similar nonmonotonic relationship emerges between welfare and the increase in interest rates it is thus optimal to engage in some active interest rate defense but only up to a certain point i

portfolio optimization under a minimax rule this paper provides a new portfolio selection rule the objective is to minimize the maximum individual risk and we use an l function as the risk measure we provide an explicit analytical solution for the model and are thus able to plot the entire efficient frontier our selection rule is very conservative one of the features of the solution is that it does not explicitly involve the covariance of the asset returns

a half century of returns on levered and unlevered portfolios of stocks bonds and bills with and without small stocks in two earlier papers grauer and hakansson 1982 grauer and hakansson 1984 we applied the multiperiod portfolio theory of mossin 1968 hakansson 1971 1974 leland 1972 ross 1974 and huberman and ross 1983 to the construction and rebalancing of portfolios composed of u s stocks corporate bonds government bonds and a risk free asset borrowing was ruled out in the first article while margin purchases were permitted in the second the probability distributions used were naively estimated from past realized returns in ibbotson this paper applies multiperiod portfolio theory to the construction and rebalancing of portfolios composed of u s stocks corporate bonds government bonds and a risk free asset with small stocks included as a separate investment vehicle probability assessments are based on the past joint empirical distribution our principal findings are 1 small stocks while totally ignored at times entered even the most riskaverse portfolios most of the time and 2 small stocks when chosen tended to replace common stocks except in the 1970s and early 1980s when they were primarily held in lieu of the risk free asset presented at the australian graduate school of management and at macquarie university both in sydney southern methodist university duke university the university of southern california the london graduate school of business and the annual meeting of the western financo association in scottsdale arizona the authors thank the participants of these seminars especially michael brennan and ehud ronn for helpful comments financial support from the social sciences and humanities research council of canada and the financial research foundation of canada is gratefully acknowledged the authors also wish to thank changwoo lee for research assistance and are greatly indebted to frederick shen for computational assistance

collapsing exchange rate regimes another linear example abstract in the literature on speculative attacks on a fixed exchange rate it is usually assumed that the monetary authority responsible for fixing the rate reacts passively to the monetary disruption caused by the attack this assumption is grossly at odds with actual experience where the monetary base implications of the attacks are usually sterilized such sterilization means that the attack is no longer exclusively a monetary event and requires that the standard attack model be broadened to include the effects of sterilization on other markets these issues are motivated by reference to the december 1994 collapse of the mexican peso

on cross country differences in the persistence of real exchange rates abstract previous findings of long run purchasing power parity come mainly from data for industrial countries raising the issue of whether the results suffer sample selection bias and exaggerate the general relevance of parity reversion this study uncovers substantial cross country heterogeneity in the persistence of deviations from parity the results show that it is more likely rather than less likely to find parity reversion for developing countries than industrial countries although some persistence variations may partly reflect country differences in structural characteristics such as inflation experience and government spending a considerable portion of those variations seems unaccounted for

the choice of numeraire currency in panel tests of purchasing power parity we investigate the implications of the choice of numeraire currency on panel tests of purchasing power parity under the current regime of flexible exchange rates by conducting panel unit root tests with twenty one different base currencies we show that the conditions necessary for numeraire irrelevancy are not supported empirically and that the choice of numeraire currency can and does matter for ppp the evidence of ppp is stronger for european than for non european base currencies distance between the countries and volatility of the exchange rates are the most important determinants of the results

own company stock in defined contribution pension plans a takeover defense abstract if managers induce employees to hold company stock in defined contribution pension plans as a form of takeover defense then changes in state laws that enhance managerial protection should lead to a reduction in employer stock in 401 k plans delaware s mid 1990s validation of the poison pill in conjunction with a staggered board was followed by a significant decline in employee ownership within defined contribution plans for firms incorporated in delaware evidence using governance data suggests that this is due to responses of firms with staggered boards binary choice models confirm that employee ownership in defined contribution plans lowers takeover probabilities

equity home bias a review essay this paper reviews the relatively more recent literature on equity home bias the empirical finding that people overinvest in domestic stocks relative to the optimal investment portfolio implied by the modern portfolio theory it reviews six broad classes of explanation of this puzzling phenomenon 1 hedging home risks 2 barriers to foreign investments 3 information asymmetries and 4 behavioral factors the consensus is that none of the explanations can account for the full extent of the bias by itself thus the home bias should be explained by a combination of rational and behavioral factors

naive diversification strategies in defined contribution saving plans there is a worldwide trend toward defined contribution saving plans and growing interest in privatized social security plans in both environments individuals are given some responsibility to make their own asset allocation decisions raising concerns about how well they do at this task this paper investigates one aspect of the task namely diversification it is shown that some investors follow the 1 n strategy they divide their contributions evenly across the funds offered in the plan consistent with this naive notion of diversification it is found that the proportion invested in stocks depends strongly on the proportion of stock funds in the plan

intranational price convergence and price stickiness evidence from denmark we show that estimates of the half life of deviations from loop are biased when not taking into account the precision when aggregating over types of goods using a comprehensive dataset with monthly price data for 124 homogeneous products across regions in denmark over the period 1997 2010 we find a large positive aggregation bias on average we find that the half life is 8 4 months when taking the bias into account compared to 28 7 months when applying the standard method the heterogeneity in estimated half life can be explained by price stickiness distance between regions and whether the good is traded or non traded this article is protected by copyright all rights reserved

panel unit root tests of purchasing power parity for price indices abstract this paper adopts four panel unit root tests to evaluate ppp over the floating period for six different price indices results generally support ppp albeit the speeds of adjustment differ considerably between price indices and test procedures the degree of contemporaneous and serial correlation as well as heterogeneity of the series in the panel affect stationarity and the speed of mean reversion

social interaction at work abstract stock market investment decisions of individuals are positively correlated with those of coworkers sorting of unobservably similar individuals to the same workplaces is unlikely to explain this pattern as evidenced by the investment behavior of individuals who move between plants purchases made under stronger coworker purchase activity are not associated with higher returns moreover social interaction appears to drive the purchase of within industry stocks overall we find a strong influence of coworkers on investment choices but not an influence that improves the quality of investment decisions

when is it optimal to abandon a fixed exchange rate the influential krugman flood garber kfg model of balance of payment crises assumes that a fixed exchange rate is abandoned if and only if international reserves reach a critical threshold value from a positive standpoint the kfg rule is at odds with many episodes in which the central bank has plenty of international reserves at the time of abandonment we study the optimal exit policy and show that from a normative standpoint the kfg rule is generally suboptimal we consider a model in which the fixed exchange rate regime has become unsustainable due to an unexpected increase in government spending we show that when there are no exit costs it is optimal to abandon immediately when there are exit costs the optimal abandonment time is a decreasing function of the size of the fiscal shock for large fiscal shocks immediate abandonment is optimal our model is consistent with evidence suggesting that many countries exit fixed exchange rate regimes with still plenty of international reserves in the central bank s vault copyright 2008 wiley blackwell

can foreign currency deposits prop up a collapsing exchange rate regime abstract the flood and garber flood r p garber p m 1984 collapsing exchange rate regimes some linear examples journal of international economics 17 1 13 speculative attack model is extended to consider whether the authorities could forestall an exchange rate collapse by encouraging foreign currency holdings by domestic residents deposits of foreign currency could be held at home or abroad although domestic residents have a home country preference other things equal the paper considers the consequences of a required reserves policy on domestically located deposits which the authorities use to supplement official reserves to defend the exchange rate despite initial findings that suggest the life of the regime can be lengthened in this way the paper shows that such a policy does not postpone a collapse but actually hastens it

behavioral portfolio theory we develop a positive behavioral portfolio theory bpt and explore its implications for portfolio construction and security design the optimal portfolios of bpt investors resemble combinations of bonds and lottery tickets consistent with friedman and savage s 1948 observation we compare the bpt efficient frontier with the mean variance efficient frontier and show that in general the two frontiers do not coincide optimal bpt portfolios are also different from optimal capm portfolios in particular the capm twofund separation does not hold in bpt we present bpt in a single mental account version bpt sa and a multiple mental account version bpt ma bpt sa investors integrate their portfolios into a single mental account while bpt ma investors segregate their port folios into several mental accounts bpt ma portfolios resemble layered pyramids where layers are associated with aspirations we explore a two layer portfolio where the low aspiration layer is designed to avoid poverty while the high aspiration layer is designed for a shot at riches

price convergence in the european car market this article examines price convergence in the european union eu car market over the period 1995 to 2005 we find that there is a clear evidence of price convergence among the eu15 countries but not before 1999 moreover countries of the economic and monetary union emu started convergence previously to the eu15 as a whole finally exchange rate changes have significantly contributed to price dispersion over time across countries the results provide significant evidence that trade liberalization and the emu have enhanced the process of regional integration in the european automobile industry even though there is room for further measures to promote integration

portfolio selection in a data rich environment we model portfolio weights as a function of latent factors that summarize the information in a large number of economic variables this approach hereafter diffusion index approach offers the opportunity to exploit a much richer information base to improve portfolio selection we use factor analysis to estimate the space spanned by the factors this provides consistent estimates for the optimal weights as the number of economic variables and sample size go to infinity we consider an empirical application to illustrate the practical usefulness of our approach the results indicate that the diffusion index approach helps to improve the portfolio performance

impossible frontiers a key result of the capital asset pricing model capm is that the market portfolio the portfolio of all assets in which each asset s weight is proportional to its total market capitalization lies on the mean variance efficient frontier the set of portfolios having mean variance characteristics that cannot be improved upon therefore the capm cannot be consistent with efficient frontiers for which every frontier portfolio has at least one negative weight or short position we call such efficient frontiers impossible and show that impossible frontiers are difficult to avoid in particular as the number of assets n grows we prove that the probability that a generically chosen frontier is impossible tends to one at a geometric rate in fact for one natural class of distributions nearly one eighth of all assets on a frontier is expected to have negative weights for every portfolio on the frontier we also show that the expected minimum amount of short selling across frontier portfolios grows linearly with n and even when short sales are constrained to some finite level an impossible frontier remains impossible using daily and monthly u s stock returns we document the impossibility of efficient frontiers in the data

information immobility and the home bias puzzle many argue that home bias arises because home investors can predict home asset payoffs more accurately than foreigners can but why does global information access not eliminate this asymmetry we model investors endowed with a small home information advantage who choose what information to learn before they invest surprisingly even when home investors can learn what foreigners know they choose not to investors profit more from knowing information others do not know learning amplifies information asymmetry the model matches patterns of local and industry bias foreign investments portfolio outperformance and asset prices finally we propose new avenues for empirical research

gold monetization and gold discipline gold and its price have emerged as frequent topics of both academic and government debate 2 public attention focused on the gold market since gold s price began fluctuating violently in 1980 and 1981 has turned to gold as a possible means of removing some discretion inherent in the current fiat money system since lack of adherence to monetary rules can lead to problems of dynamic policy inconsistency academic economists have begun seriously to reconsider monetary standards based either on gold or on some other commodity as politically feasible methods of establishing rules 3

the home institution bias abstract we document a new investor preference we call the home institution bias whereas the home asset bias is a preference for domestic assets the home institution bias is a preference for domestic financial institutions our data come from sweden s government mandated retirement system in cross fund regressions we find that funds offered by swedish institutions received around 10 times more money than similar funds offered by foreign institutions we show that this preference for home institutions is distinct from the home asset preference is not driven by information asymmetries and is consistent with an underlying preference by individuals to deal with the familiar cross individual regressions also support a behavioral explanation because the home institution bias is strongest among financially unsophisticated and provincial investors

interactive decision system in stochastic multiobjective portfolio selection abstract some investors pursuing a high return at the relatively high risk of losing a part of their money do not always select a preferred portfolio from among the so called mean variance efficient frontier provided by markowitz 1959 portfolio selection wiley new york chue and nagasawa 1996 an investor modeling and interactive method in multiobjective portfolio selection proceedings of the pacific conference on manufacturing 96 constructed their own investor model based on an risk permission maximum return portfolio and proposed an interactive portfolio selection system for selecting a preferred portfolio from the set of candidate portfolios this paper extends the system to the case when the mean and the variance of return of securities have several scenarios with known occurrence probabilities

sensitivity analysis for mean variance portfolio problems this paper shows how to perform sensitivity analysis for mean variance mv portfolio problems using a general form of parametric quadratic programming the analysis allows an investor to examine how parametric changes in either the means or the right hand side of the constraints affect the composition mean and variance of the optimal portfolio the optimal portfolio and associated multipliers are piecewise linear functions of the changes in either the means or the right hand side of the constraints the parametric parts of the solution show the rates of substitution of securities in the optimal portfolio while the parametric parts of the multipliers show the rates at which constraints are either tightening or loosening furthermore the parametric parts of the solution and multipliers change in different intervals when constraints become active or inactive the optimal mv paths for sensitivity analyses are piecewise parabolic as in traditional mv analysis however the optimal paths may contain negatively sloping segments and are characterized by types of kinks i e points of nondifferentiability not found in mv analysis

portfolio selection with mental accounts and background risk abstract das et al 2010 develop a model where an investor divides his or her wealth among mental accounts with motives such as retirement and bequest nevertheless the investor ends up selecting portfolios within mental accounts and an aggregate portfolio that lie on the mean variance frontier importantly they assume that the investor only faces portfolio risk in practice however many individuals also face background risk accordingly our paper expands upon theirs by considering the case where the investor faces background risk our contribution is threefold first we provide an analytical characterization of the existence and composition of the optimal portfolios within accounts and the aggregate portfolio second we show that these portfolios lie away from the mean variance frontier under fairly general conditions third we find that the composition and location of such portfolios can differ notably from those of portfolios on the mean variance frontier

economics and identity this paper considers how identity a person s sense of self affects economic outcomes we incorporate the psychology and sociology of identity into an economic model of behavior in the utility function we propose identity is associated with different social categories and how people in these categories should behave we then construct a simple game theoretic model showing how identity can affect individual interactions the paper adapts these models to gender discrimination in the workplace the economics of poverty and social exclusion and the household division of labor in each case the inclusion of identity substantively changes conclusions of previous economic analysis

keynes meets markowitz the trade off between familiarity and diversification we develop a model of portfolio choice to nest the views of keynes who advocates concentration in a few familiar assets and markowitz who advocates diversification we use the concepts of ambiguity and ambiguity aversion to formalize the idea of an investor s familiarity toward assets the model shows that for any given level of expected returns the optimal portfolio depends on two quantities relative ambiguity across assets and the standard deviation of the expected return estimate for each asset if both quantities are low then the optimal portfolio consists of a mix of familiar and unfamiliar assets moreover an increase in correlation between assets causes an investor to increase concentration in familiar assets flight to familiarity alternatively if both quantities are high then the optimal portfolio contains only the familiar asset s as keynes would have advocated in the extreme case in which both quantities are very high no risky asset is held nonparticipation this paper was accepted by brad barber teck ho and terrance odean special issue editors

international portfolio selection with exchange rate risk a behavioural portfolio theory perspective abstract this paper analyzes international portfolio selection with exchange rate risk based on behavioural portfolio theory bpt we characterize the conditions under which the bpt problem with a single foreign market has an optimal solution and show that the optimal portfolio contains the traditional mean variance efficient portfolio without consideration of exchange rate risk and an uncorrelated component constructed to hedge against exchange rate risk we illustrate that the optimal portfolio must be mean variance efficient with exchange rate risk while the same is not true from the perspective of local investors unless certain conditions are satisfied we further establish that international portfolio selection in the bpt with multiple foreign markets consists of two sequential decisions investors first select the optimal bpt portfolio in each market overlooking covariances among markets and then allocate funds across markets according to a specific rule to achieve mean variance efficiency or to minimize the loss in efficiency

self fulfilling risk predictions an application to speculative attacks abstract we show that changing market beliefs about currency risk can generate a self fulfilling speculative attack on a fixed exchange rate the attack does not require a later change in policies to make it profitable we illustrate this point by introducing an endogenous risk premium into a first generation model of a speculative attack the model is further modified to take account of sterilization debt financed fiscal deficits and anticipatory price setting behavior we use the model to interpret the 1994 mexican peso crisis

a panel project on purchasing power parity mean reversion within and between countries abstract previous time series studies have shown evidence of mean reversion in real exchange rates deviations from purchasing power parity ppp appear to have half lives of approximately four years however the long samples required for statistical significance are unavailable for most currencies and are potentially inappropriate because of regime changes in this study we re examine deviations from ppp using a panel of 150 countries and 45 annual post wwii observations our panel shows strong evidence of mean reversion that is similar to that from long time series ppp deviations are eroded at a rate of approximately 15 annually i e their half life is around four years such findings can be masked in time series data but are relatively easy to find in cross sections

optimal employee ownership contracts under ambiguity aversion the aim of this paper is to compute and describe the conditions of an optimal employee ownership contract between an employer and an ambiguity averse employee we then introduce ambiguity aversion in the baseline model of aubert et al 2014 using the multiple prior preferences of gilboa and schmeidler 1989 and its extension proposed by maccheroni et al 2006 this model offers solutions that reconcile labor and financial economics and behavioral economics research findings on employee ownership the paper focuses on the most common situation where employee ownership has a positive impact on corporate performance but can also be used as an entrenchment mechanism we determine the optimal company stock contribution which corresponds to a perfect subgame nash equilibrium in the ambiguity framework using the framework of gilboa and schmeidler s 1989 we show that the optimal ownership contract is respectively increasing with respect to the lower bound of the return expectation in the case of a high level of effort and decreasing with respect to the upper bound of the return expectation in the case of a low level of effort in the framework of maccheroni et al 2006 we prove that if aversion to ambiguity is sufficiently high then we find the same behavior as in the case of no ambiguity

diversification as a public good community effects in portfolio choice within a rational general equilibrium model in which agents care only about personal consumption we consider a setting in which due to borrowing constraints individuals endowed with local resources underparticipate in financial markets as a result investors compete for local resources through their portfolio choices even with complete financial markets and no aggregate risk agents may herd into risky portfolios this yields a pareto dominated outcome as agents introduce community risk unrelated to fundamentals moreover if some agents are behaviorally biased or cannot completely diversify their holdings rational agents may choose more extreme portfolios and amplify the effect

rational and self fulfilling balance of payments crises speculative attacks on a pegged exchange rate must sometimes occur ifasset price paths are to be free of abnormal profit opportunities suchattacks are fully rational as they reflect the market s response to aregime breakdown that is inevitable the authors shows that under someexpectations about policy balance of payments crises can also be purely self fulfilling events in such cases even a permanently viableregime may collapse and the economy will possess multiple equilibriacorresponding to different subjective assessments of the probability ofa crisis the behavior of the domestic interest rate will naturally reflect the possibility of a speculative attack copyright 1986 by american economic association

inside information and the own company stock puzzle u s investors allocate 30 40 of their financial asset portfolio in the stock of the company they work for such a portfolio flies in the face of standard portfolio theory which prescribes that an investor should hold less of a financial asset that is positively correlated with her undiversified labor income nevertheless we propose a rational explanation that prescribes a long position in own company stock precisely because the own company stock is positively correlated with the investor s labor income any information the investor learns about her earnings is a partial information advantage in her own company stock when confronted with a choice of what information to acquire employees may choose to learn about their own firm learning lowers the employee s risk of holding own firm equity which raises its risk adjusted returns and makes a long position optimal jel f30 g11 d82

offering versus choice in 401 k plans equity exposure and number of funds records of over half a million participants in more than 600 401 k plans indicate that participants tend to allocate their contributions evenly across the funds they use with the tendency weakening with the number of funds used the number of funds used typically between three and four is not sensitive to the number of funds offered by the plans which ranges from 4 to 59 a participant s propensity to allocate contributions to equity funds is not very sensitive to the fraction of equity funds among offered funds the paper also comments on limitations on inferences from experiments and aggregate level data analysis how much and how to save for retirement is one of the most important financial decisions made by most people defined contribution dc pension plans such as the popular 401 k plans are important instruments of such savings by 2001 year end about 45 million american employees held 401 k plan accounts with a total of 1 75 trillion in assets holden and vanderhei 2001 an important characteristic of these plans is that the participant has responsibility over his savings among a plan s various funds how responsibly do the participants behave in particular how sensitive are participants choices to possible framing effects associated with the menu of choices they are offered to explore these questions this paper analyzes a data set recently provided by the vanguard group consisting of records of more than half a million participants in about 640 dc plans these plans offer between 4 and 59 funds in which participants can invest all plans offer at least one stock fund 635 plans

dea frontier improvement and portfolio rebalancing an application of china mutual funds on considering sustainability information disclosure abstract data envelopment analysis dea has been a widely used methodology for evaluating the relative performance of portfolios extensive work has appeared for realizing the role of dea in the aspect of assessing portfolio performance and deriving the relative rankings however the role of providing realizable benchmarks is not fully explored in the existing literatures most importantly the dea based portfolio performance evaluation methods developed in the existing literatures can hardly provide support for fund managers in pursuing sustainability performance in this paper we first propose a dea frontier improvement approach under the mean variance framework this approach provides investor with a rebalancing strategy as well as an improved dea frontier which approximates the portfolio efficient frontier better than the traditional dea model does then this approach is extended to a general return risk framework our in sample simulation results verify the effectiveness of the proposed approach for a wide range of applications in addition the out of sample tests show that the rebalancing investment strategies can achieve higher sharpe ratios and sortino ratios than those of the original ones finally we apply the proposed approach to evaluate mutual fund performance in china with the consideration of sustainability information disclosure we construct a disclosure index to indicate the extent of sustainable information disclosure of each mutual fund the results show that the proposed approach provides not only investment recommendations but also references for constructing sustainable green funds

capital asset pricing compatible with observed market value weights we show that the set of expected return vectors for which an observed portfolio is mean variance mv efficient is a two parameter family we identify ten ways to specify the time series behavior of the two parameters the result highlights a number of inconsistencies involved in mv modelling for each of the cases it permits the inference of the time series of expected return vectors as well as all the other capital asset pticing model capm variables compatible with a known covariance matrix and the observed time series of market value weights the empirical work shows that there are substantial case to case differences in the time series of mean vectors and many of them are quite different from the constant mean vector envisioned in tests of

international portfolio diversification with estimation risk international portfolio diversification has long been advocated as a way of enhancing average returns while reducing portfolio risk for the investor who considers diversifying into foreign securities this proposition however relies on the assumption that the required inputs to the classical mean variance analysis are known with certainty typically expected returns variances and covariances are simply replaced by their ex post sample values and the optimal portfolio is derived without mentioning the uncertainty inherent in these parameter values but the rational investor should take this uncertainty into account when forming expectations and probably will consider estimators that are less subject to estimation error than the classical sample mean this paper investigates alternative estimators of expected returns and their implications for the alleged gains from diversification an important observation is the crucial influence that errors in estimating expected returns have on portfolio analysis a closer examiprevious studies of international portfolio diversification have relied on ex post meanvariance analysis without considering the problem of estimation risk typically past averages are substituted for expected returns and no allowance is made for the uncertainty inherent in these parameter values first i demonstrate the shortcomings of such an approach and second i investigate another method of estimating expected returns initially proposed by stein by shrinking the sample averages toward a common mean i find that the out of sample performance of the optimal portfolio is substantially increased one of the implications of this method is that the classical conclusions vastly overestimate the possible gains in average returns instead benefits from diversification are more likely to accrue from a reduction in risk this paper draws on part of my dissertation at the university of chicago i am grateful to arnold zellner michael mussa george constantinides and especially john bilson for useful discussions and comments numerous improvements were also suggested by the referee this research received the generous financial support of the college interuniversitaire d etudes doctorales dans les sciences du management

the collapse of the fixed exchange rate regime with sticky wages and imperfect substitutability between domestic and foreign bonds abstract the paper extends the recent literature on balance of payments crises by allowing real effects to be connected with them the collapse of the fixed exchange rate regime and the dynamics associated with this regime shift are studied in addition the effects of a fiscal expansion under the fixed exchange rate regime are studied taking into account the fact that the viability of the regime is policy dependent

collapsing exchange rate regimes some linear examples abstract we construct a pair of linear examples to study the collapse time of a fixed exchange rate regime the first example is a perfect foresight continuous time model which allows calculation of the exact collapse time and the tracking of reserves the second example is a discrete time stochastic model which yields an endogenous probability distribution over the collapse time and produces a forward discount of the exchange rate

loyalty based portfolio choice i evaluate the effect of loyalty on individuals portfolio choice using a unique dataset of retirement contributions i exploit the statutory difference that in 401 k plans stand alone employees can invest directly in their division while conglomerate employees must invest in the entire firm including all unrelated divisions consistent with loyalty employees of stand alone firms invest 10 percentage points 75 more in company stock than conglomerate employees support is also found using variation in loyalty between different groups of employees across and within firms the cost to employees of loyalty is large amounting to nearly a 20 loss in retirement income

regional inflation spatial locations and the balassa samuelson effect evidence from japan we empirically analyse regional inflation using data from japan where there is no regulation to impede the free movement of labour capital goods and services across regions in particular our analysis will focus on the geographical location of regions and the productivity known as the balassa samuelson bs effect as explanations for the dynamics of regional inflation based on a spatial model which is consistent with the theoretical specification of the bs we have confirmed that while it is a relatively small country in terms of land area both spatial location and productivity are important determinants of regional inflation

searching for stationarity purchasing power parity under the current float abstract using panel data methods we investigate long run purchasing power parity by testing for unit roots in real exchange rates of industrial countries under the current float the evidence against the unit root hypothesis is stronger for larger than for smaller panels for monthly than for quarterly data and when the german mark rather than the united states dollar is used as the base currency while we find that accounting for serial correlation considerably weakens the evidence against the unit root null the results as a whole are consistent with long run purchasing power parity

the behaviour of relative prices in the european union a sectoral analysis using multivariate unit root test methods this paper investigates the purchasing power parity ppp hypothesis at the sectoral level across six european countries over the last 17 years evidence of mean reversion towards ppp is found for the relative prices of some sectors and countries mean reversion in relative prices is explained by cross country and cross sectoral characteristics such as the distance between countries nominal exchange rate volatility differences in gdp per capita non tariff barriers research and development advertising industrial concentration and tradeability of the products

speculative attacks with unpredictable or unknown foreign exchange reserves during a currency crisis speculators usually do not know the value of a central bank s foreign exchange reserves in this paper i show that modelling speculators as having imperfect knowledge of reserves enriches the predictions of the classical model of specula tive attacks with realistic lags in reserve reporting and costs to unsuccessful speculation successful speculative attacks will involve a jump depreciation unsuccessful attacks may occur attacks may occur when fundamentals are improving attacks may not be preceded by large increases in interest rates and fixed exchange rates may be abandoned with no attack and no decline in the money supply jel classification f3 1 attaques speculatives quand les reserves de devises etrangeres sont soit imprevisibles soit inconnues au cours d une crise monetaire les speculateurs ne connaissent pas normalement la valeur des reserves de devises etrangeres que la banque centrale a en main ce memoire montre qu une modelisation des speculateurs en postulant qu ils ont une connaissance imparfaite des reserves permet d enrichir les predictions du modele classique des attaques speculatives a partir d une evaluation realiste des delais dans les rapports sur la quantite de reserves et des couits d une speculation ratee on deter mine que les attaques speculatives reussies vont impliquer que se produise une deprecia tion discontinue que des attaques speculatives ratees puissent se produire que des attaques peuvent se produire quand les donnees fondamentales s ameliorent que des at taques ne peuvent pas etre precedees par de fortes augmentations des taux d interet et que des taux de change fixes peuvent etre abandonnes sans attaques et sans chute dans

whom do you trust investor advisor relationships and mutual fund flows i provide a measure for the value that investors place on trust and relationships in asset management by examining mutual fund flows around announced changes in the ownership of fund management companies i find a decline in flows of around 7 of fund assets in the year following the announcement date resulting primarily from fund outflows retail investors and investors in funds with higher expense ratios are most responsive to ownership changes providing evidence that such investors appear to place a significant value on trust and are more likely to respond to a relationship disruption by withdrawing their assets

short sales restrictions and kinks on the mean variance frontier with a short sales restriction there may be switching points along the mean variance frontier corresponding to changes in the set of assets held traditional wisdom holds that each switching point corresponds to a kink while ross has claimed that kinks never occur this paper shows that the truth lies between the two views since the efficient frontier may or may not be kinked at a switching point there is some indication that kinks are rare since a kink corresponds to a portfolio in which all assets have the same expected return

gains from international diversification 1968 85 returns on portfolios of stocks and bonds this paper applies the multi period investment model to a universe of international securities on the basis of the simple probability assessment approach our principal findings are 1 the gains from including non u s asset categories in the universe were remarkably large in some cases statistically significant especially for the highly risk averse strategies 2 the gains from removing the no leverage constraint were more substantial than they were in the absence of non u s securities and 3 there is strong evidence of market segmentation in that the optimal levels of investment in u s securities were mostly zero in the presence of the non u s asset categories

the overvaluation of purchasing power parity abstract recent panel studies of purchasing power parity have reported strong evidence of mean reversion in real exchange rates however these studies fail to control for cross sectional dependence in the data this failure has dramatic consequences raising the significance level of tests with a nominal size of 5 percent to as much as 50 percent it is shown in this paper that controlling for cross sectional dependence no evidence against the random walk null can be found in panels of up to 64 real exchange rates this finding cannot be attributed to low power as there is ample power in panels of this size to reject the unit root null