engineering robust instruments for gmm estimation of panel data regression models with errors in variables a note econometricians have long recognized the need to account in some way for measurement errors specification errors and endogeneity to ensure that the ordinary least squares estimator is consistent this article introduces a new generalized method of moments estimator that relies on robust instruments to estimate panel data regression models containing errors in variables we show how this gmm approach can be generalized for the panel data framework using higher moments and cumulants as instruments the new instruments engineered for greater robustness are proposed to tackle the pervasive problem of weak instruments

a note on merton s optimum consumption and portfolio rules in a continuous time model in the paper optimum consumption and portfolio rules in a continuous time model by r c merton j econ theory 3 1971 373 413 solutions obtained in cases when marginal utility at zero consumption is finite are not feasible while they do satisfy the hamilton jacobi bellman equations they do not represent appropriate value functions because the boundary behavior near zero wealth is not satisfactorily dealt with in this note we specify the boundary behavior and characterize optimal solutions journal of economic literature classification numbers 022 213

fair demographic risk sharing in defined contribution pension systems in this article we formulate and solve the optimal design problem of a defined contribution public pension fund in a highly stylized but still rather general non stationary framework we adopt the viewpoint of a benevolent social planner who aims at treating in a fair manner the successive overlapping generations participating to such a long term mandatory system using the approach of el karoui and jeanblanc 1998 for the optimal consumption and portfolio choice problem with random income in a complete market we exhibit a solution to our intertemporal stochastic control problem where each generation receives a fair lumpsum retirement benefit it is proportional to the contributions she has paid during her active worklife and follows a fixed common rule although her pension value itself may depend on variables only observable at her retirement time we next relax the assumption that the collective pension system is mandatory and investigate the performance of individual investment plans in the market comparing the outcomes of both alternatives we derive a condition under which the collective fund can be expected to overperform the individual plan in the special case of a stationary economy such a possibility has been pointed out by gollier 2008 in fact this effect results from the possibility for the collective fund to borrow today against contributions of future generations which allows to implement riskier strategies and may improve its performance

optimal portfolio choice for long horizon investors with nontradable labor income this paper examines how risky labor income and retirement affect optimal portfolio choice with idiosyncratic labor income risk the optimal allocation to stocks is unambiguously larger for employed investors than for retired investors consistent with the typical recommendations of investment advisors increasing idiosyncratic labor income risk raises investors willingness to save and reduces their stock portfolio allocation towards the level of retired investors positive correlation between labor income and stock returns has a further negative effect and can actually reduce stockholdings below the level of retired investors financial advisors typically recommend that their customers invest more in stocks than in safe assets when they are working and to shift their investments towards safe assets when they retire jagannathan and kocherlakota 1996 malkiel 1996 by contrast the standard academic models of portfolio choice merton 1969 1971 samuelson 1969 show that retirement is irrelevant for portfolio decisions if investment opportunities are constant and human capital is tradable in this case the fraction of wealth optimally invested in risky assets should be constant over the lifetime of an individual recent research building on the pioneering work by merton 1971 shows that time varying investment opportunities result in portfolio rules with an intertemporal hedging component whose magnitude depends on the investment horizon of the investor kim and omberg 1996 balduzzi and lynch 1997 brennan schwartz and lagnado 1997 brandt 1999 campbell and viceira 1999 2001 barberis 2000 with time variation in investment opportunities retirement and death play an instrumental role as events that exogenously fix the individual s investment horizon more importantly retirement also marks the time at which individuals stop working and thereafter must live off their lifetime savings and possibly transfers from this perspective retirement matters for portfolio choice

cumulant instrument estimators for hedge fund return models with errors in variables we revisit the factors incorporated in asset pricing models following the recent developments in financial markets i e the rise of shadow banking and the change in the transmission channel of monetary policy we propose two versions of the fung and hsieh 2004 hedge fund return model especially an augmented market model which accounts for the new dynamics of financial markets and the procyclicality of hedge fund returns we run these models with an innovative hausman procedure tackling the measurement errors embedded in the models factor loadings our empirical method also allows for confronting the drawbacks of the instruments used to estimate hedge fund asset pricing models

an isomorphism between asset pricing models with and without linear habit formation we show an isomorphism between optimal portfolio selection or competitive equilibrium models with utilities incorporating linear habit formation and corresponding models without habit formation the isomorphism can be used to mechanically transform known solutions not involving habit formation to corresponding solutions with habit formation for example the constantinides 1990 and ingersoll 1992 solutions are mechanically obtained from the familiar merton solutions for the additive utility case without recourse to a bellman equation or first order conditions more generally recent solutions to portfolio selection problems with recursive utility and a stochastic investment opportunity set are readily transformed to novel solutions of corresponding problems with utility that combines recursivity with habit formation the methodology also applies in the context of hindy huang kreps 1992 preferences where our isomorphism shows that the solution obtained by hindy and huang 1993 can be mechanically transformed to dybvig s 1995 solution to the optimal consumption investment problem with consumption ratcheting this article presents a general method for solving asset pricing or portfolio selection models involving linear habit formation of the type studied by sundaresan 1989 constantinides 1990 detemple and zapatero 1991 ingersoll 1992 chapman 1998 and others the basic idea we pursue is that linear habit formation can be thought of as a redefinition of what constitutes consumption to include not only the current consumption rate but also a fictitious possibly negative consumption rate derived from past actual consumption by pricing out this fictitious consumption rate correctly the economy with linear habit formation can be mechanically transformed to an equivalent economy without habit formation this analysis simplifies and unifies existing results but also generates novel solutions for example together with the results of schroder and skiadas 1997 1999 our method produces optimal lifetime consumption and portfolio policies with preferences that combine recursive utility with habit formation under a stochastic

incentive properties for ordinal mechanisms we study three incentive properties for ordinal mechanisms i strategy proofness which requires that no agent gain by misrepresenting his preferences ii adjacent strategy proofness which requires that no agent gain by switching the rankings of two adjacent alternatives and iii mistake monotonicity which requires that the welfare of each agent weakly decrease as he reports increasingly bigger mistakes each of these properties has three versions depending on whether preferences over sure alternatives are extended to preferences over lotteries by the stochastic dominance downward lexicographic or upward lexicographic extension we identify conditions on the preference domain that guarantee the equivalence of these properties the universal domain and the domains of single dipped and single peaked preferences satisfy our conditions

retirement saving with contribution payments and labor income as a benchmark for investments abstract in this paper we study the retirement saving problem from the point of view of a plan sponsor who makes contribution payments for the future retirement of an employee the plan sponsor considers the employee s labor income as investment benchmark in order to ensure the continuation of consumption habits after retirement we demonstrate that the demand for risky assets increases at low wealth levels due to the contribution payments we quantify the demand for hedging against changes in wage growth and find that it is relatively small we show that downside risk measures increase risk taking at both low and high levels of wealth

continuous time methods in finance a review and an assessment i survey and assess the development of continuous time methods in finance during the last 30 years the subperiod 1969 to 1980 saw a dizzying pace of development with seminal ideas in derivatives securities pricing term structure theory asset pricing and optimal consumption and portfolio choices during the period 1981 to 1999 the theory has been extended and modified to better explain empirical regularities in various subfields of finance this latter subperiod has seen significant progress in econometric theory computational and estimation methods to test and implement continuous time models capital market frictions and bargaining issues are being increasingly incorporated in continuous time theory the roots of modern continuous time methods in finance can be traced back to the seminal contributions of merton 1969 1971 1973b in the late 1960s and early 1970s merton 1969 pioneered the use of continuous time modeling in financial economics by formulating the intertemporal consumption and portfolio choice problem of an investor in a stochastic dynamic programming setting merton 1973b also showed how such a framework can be used to develop equilibrium asset pricing implications thereby significantly extending the asset pricing theory to richer dynamic settings and expanding the scope of applications of continuous time methods to study problems in financial economics 1 within a span of about 30 years from the publication of merton s inf luential papers continuous time methods have become an integral part of financial economics indeed in certain core areas in finance such as e g asset pricing derivatives valuation term structure theory and portfolio selection continuoustime methods have proved to be the most attractive way to conduct research and gain economic intuition the continuous time approach in these areas has produced models with a rich variety of testable implications the econometric theory for testing continuous time models has made rapid strides in the last decade and has thus kept pace with the impressive progress on the theoretical front one hopes that the actual empirical investigations and estimation using the new procedures will follow suit soon

when are local incentive constraints sufficient we study the question of whether local incentive constraints are sufficient to imply full incentive compatibility in a variety of mechanism design settings allowing for probabilistic mechanisms we give a unified approach that covers both continuous and discrete type spaces on many common preference domains including any convex domain of cardinal or ordinal preferences single peaked ordinal preferences and successive single crossing ordinal preferences local incentive compatibility suitably defined implies full incentive compatibility on domains of cardinal preferences that satisfy a strong nonconvexity condition local incentive compatibility is not sufficient our sufficiency results hold for dominant strategy and bayesian nash solution concepts and allow for some interdependence in preferences

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

valuation optimal asset allocation and retirement incentives of pension plans we provide a framework in which we link the valuation and asset allocation policies of defined benefits plans with the lifetime marginal productivity schedule of the worker and the pension plan formula in turn we examine the retirement policies that are implied by the primitives of the model and the value of pension obligations our model provides an explicit valuation formula for a stylized defined benefits plan the optimal asset allocation policies consist of the replicating portfolio of the pension liabilities and the growth optimum portfolio independent of the pension liabilities we show that the worker will retire when the ratio of pension benefits to current wages reaches a critical value which depends on the parameters of the pension plan and the discount rate using numerical techniques we analyze the feedback effect of retirement policies on the valuation of plans and on the asset allocation decisions article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

a hybrid simulation optimisation scenario model for asset liability management abstract in this paper we desciibe a decision support model to sustain management of pension funds in the strategic planning of the available asset and liability policy instruments a main characteristic of the approach is that the relevant risk drivers are modelled by scenarios rather than by probability distributions we will describe the scenario generation methodology and how the scenarios are used by pension fund managers to simulate and improve asset liability strategies until a strategy is identified which is agreed upon by all who carry responsibility for the pension fund and her sponsors and trustees next we will describe how this process of managerial learning can be improved by a hybrid simulation optimisation method which applies concepts from the field of non linear global optimisation to determine the asset allocations which determine efficient frontiers of contribution rates and downside insolvency risks we will conclude by showing that the application of the developed models to a particular pension fund leads to the annulment of the infeasibility of the current asset liability policy on the one hand and to a reduction of the expected yearly contributions of us 100 million on the other

scenario generation and stochastic programming models for asset liability management in this paper we develop and test scenario generation methods for asset liability management models we propose a multi stage stochastic programming model for a dutch pension fund both randomly sampled event trees and event trees fitting the mean and the covariance of the return distribution are used for generating the coefficients of the stochastic program in order to investigate the performance of the model and the scenario generation procedures we conduct rolling horizon simulations the average cost and the risk of the stochastic programming policy are compared to the results of a simple fixed mix model we compare the average switching behavior of the optimal investment policies our results show that the performance of the multi stage stochastic program could be improved drastically by choosing an appropriate scenario generation method

an intertemporal general equilibrium asset pricing model the case of diffusion information this paper provides sufficient conditions for the equilibrium price system and a vector of exogenously specified state variable processes to form a diffusion process in a pure exchange economy the conditions involve smoothness of agents utility functions and certain nice properties of the aggregate endowment process and the dividend processes of traded assets in place of the dynamic programming a martingale representation technique is utilized to characterize equilibrium portfolio policies this technique is useful even when there does not exist a finite dimensional markov structure in the economy and thus the markovian stochastic dynamic programming is not applicable a gents are shown to hold certain hedging mutual funds and the riskless asset in contrast to earlier results the market portfolio does not have a special role in hedging since the markets are dynamically complete when there exists a finite dimensional markov system in the economy the dimension of the hedging demand identified through the markovian dynamic programming may be much larger than that identified by the martingale method copyright 1987 by the econometric society

hedging in incomplete markets with hara utility in the context of merton s original problem of optimal consumption and portfolio choice in continuous time this paper solves an extension in which the investor is endowed with a stochastic income that cannot be replicated by trading the available securities the problem is treated by demonstrating using analytic and in particular viscosity solutions techniques that the value function of the stochastic control problem is a smooth solution of the associated hamilton jacobi bellman hjb equation the optimal policy is shown to exist and given in a feedback form from the optimality conditions in the hjb equation at zero wealth a fixed fraction of income is consumed for large wealth the original merton policy is approached we also give a sufficient condition for wealth under the optimal policy to remain strictly positive

dynamic asset allocation in a mean variance framework the aim of this article is to analyze the portfolio strategies that are mean variance efficient when continuous rebalancing is allowed between the current date 0 and the horizon t under very general assumptions when a zero coupon bond of maturity t exists the dynamic efficient frontier is a straight line the slope of which is explicitly characterized every dynamic mean variance efficient strategy can be viewed as buy and hold combinations of two funds the zero coupon bond of maturity t and a continuously rebalanced portfolio an appropriate dynamic strategy defining the latter is explicitly derived for two particular price processes and comparisons of the efficient frontiers static versus dynamic are provided in these cases

two trees with heterogeneous beliefs spillover effect of disagreement in a model where investors disagree about the fundamentals of two stocks the state price density depends on investor disagreements for both stocks especially the larger stock this implies that disagreement among investors in a large firm has a spillover effect on the pricing of other stocks owned by these investors the pricing effects of investor disagreements crucially depend on the average belief biases empirical findings support the novel model prediction of a disagreement spillover effect and help reconcile some mixed evidence in the literature

solidarity in preference aggregation improving on a status quo abstract working in the arrowian framework we search for preference aggregation rules with desirable solidarity properties in a fixed population setting we formulate two versions of the solidarity axiom welfare dominance under preference replacement although the stronger proves incompatible with efficiency the combination of efficiency and our second version leads to an important class of rules which improve upon a status quo order these rules are also strategy proof which reveals a further connection between solidarity and incentive properties allowing the population to vary we again characterize the status quo rules by efficiency and a different solidarity axiom population monotonicity this extends a similar characterization of a subclass of these rules by bossert and sprumont 2014

stochastic pension funding when the benefit and the risky asset follow jump diffusion processes we study the asset allocation of defined benefit pension plans of the type designed and sponsored by firms with the aim of providing a lifetime pension to the employees at the age of retirement benefits are stochastic combining poisson jumps with brownian uncertainty the sponsor dynamically forms portfolios where the risky asset is also subjected to poisson jumps and brownian uncertainty possibly correlated with the evolution of benefits the objective is to assure future benefits while controlling the contribution made to the fund reserves the problem is solved analytically using dynamic programming techniques

consumption and portfolio choice under internal multiplicative habit formation this paper explores the optimal consumption and investment behavior of an individual who derives utility from the ratio between his consumption and an endogenous habit we obtain closed form policies under general utility functionals and stochastic investment opportunities by developing a nontrivial linearization to the budget constraint this enables us to explicitly characterize how habit formation affects the marginal propensity to consume and optimal stock bond investments we also show that in a setting that combines habit formation with epstein zin utility consumption no longer grows at unrealistically high rates at high ages and investments in risky assets decrease

consumption and portfolio policies with incomplete markets and short sale constraints the infinite dimensional case abstract we employ a martingale approach to study a dynamic consumption portfolio problem in continuous time with incomplete markets and short sale constraints we introduce a notion of minimax local martingale and transform the dynamic problem into a static problem of maximizing expected utility over the consumption bundles that satisfy a single budget constraint formed using that measure we establish the existence of and characterize the minimax local measure provide sufficient conditions for the dynamic consumption portfolio problem to have a solution and relate the optimal policies to the solution of quasi linear partial differential equation

capital asset pricing models revisited evidence from errors in variables abstract this paper revisits an instrumental variable technique to minimize the errors in variables problem in capital asset pricing models our results show that dagenais and dagenais dagenais m g dagenais d l 1997 higher moment estimators for linear regression models with errors in the variables journal of econometrics 76 193 221 estimator based on higher moments is well suited to correct for the bias induced by measurement errors in both the capm and the three factor model of fama and french fama e f french k r 1997 industry costs of equity journal of financial economics 43 153 193