a behavioral framework for time diversification the box of factors that we call risk is both too large and too small the box is large enough to include many sometimes conflicting measures of risk variance and semivariance probabilities of losses and their amounts but the box is too small to include factors that affect choices but fall outside the boundaries of risk frames and cognitive errors self control and regret we explore the role of these factors in time diversification the belief that time diversification reduces risk underlies the current drive to invest social security funds in stocks but is such investment prudent we discuss the role of advisors in providing prudent advice changes in the standards of prudence over time the use of time diversification in guiding investors to prudent portfolios and its use in the current debate on social security

optimal nonparametric estimation of first price auctions this paper proposes a general approach and a computationally convenient estimation procedure for the structural analysis of auctioni data considering first price sealed bid auction models within the independent private value paradigm we show that the underlying distribution of bidders private values is identified from observed bids and the number of actual bidders without any parametric assumptions using the theoiy of minimax we establish the best rate of uniform convergence at which the latent density of private values can be estimated nonparametrically from available data we then propose a two step kernel based estimator that converges at the optimal rate

expected inflation and the real rates of interest on taxable and tax exempt bonds this paper analyzes the impact of inflation on rates of return on taxable corporate bonds and tax exempt municipal bonds the paper considers a differential tax system where the tax rate depen ds on both the identity of the investor and the source of income it also consid ers the possibility that inflation may induce investors to switch from holding one asset to holding another it is demonstrated that while inflation should increase the pre personal tax real rate of interest on taxable bonds it should reduce the real rate of interest on tax exempt bonds copyright 1987 by ohio state university press

inflation tax rates and investment with endogenous financial behavior since modigliani and miller s 24 famous article there has been an extensive theoretical debate over the role of corporate financial policy in determining real investment 3 5 8 13 22 27 28 auerbach 1 and feldstein green and sheshinski 9 assume that an interior debt to total capital ratio exists at the firm level which minimizes the cost of funding investment this position can be theoretically justified if one allows for the presence of default risk with incomplete financial markets 3 bankruptcy costs 5 13 or corporate tax shield substitutes for debt 5 miller 22 on the other hand downplays the importance of capital market imperfections and argues that while in an economy with personal and corporate taxes an interior corporate sector debt ratio will exist at the firm level the choice of financial mix remains irrelevant despite the theoretical attention devoted to this topic virtually no attempts have been made to establish an empirical model for the debt ratio such a model could prove useful in explaining asset yields and real investment or more ambitiously in testing the alternative theories of financial policy determination mentioned above the lack of effort in this area is surprising since many economists apparently believe that the debt ratio is quite important in determining real capital formation and resource allocation 7 10 11 12 20 26 theory alone cannot be used to support this contention since even if one does not accept the modigliani miller reasoning and believes instead that financial policy is chosen optimally the effect of a change in financial policy on the cost of funds will be approximately to the first order zero this is a direct consequence of the envelope theorem which states that a marginal change in a choice variable leaves the objective function unchanged only an empirical study of discrete changes can determine the importance of financial policy for real investment in a recent study 25 we estimated a reduced form model of the corporate sector debt ratio the evidence in that paper supports the notion that increases in the nominal interest rate will encourage firms to increase their debt ratio due to the tax advantages of bond financing and that

time diversification under loss aversion a bootstrap analysis we examine the problem of time diversification from the viewpoint of prospect theory investors we use a block bootstrap approach to generate returns of us stocks and treasury bills for time horizons ranging from 1 year to 20 years on average value functions computed using these bootstrapped returns are mainly positive and increase monotonically with the time horizon the strategy that yields the highest average value function is the one that buys and holds an all equity portfolio for 20 years in contrast mean variance optimal portfolios are more conservative with the optimal proportion of the portfolio invested in stocks declining with time horizon our results suggest that time diversification ought to be viewed more favourably by prospect theory investors than by mean variance investors

precautionary saving and endogenous labor supply with and without intertemporal expected utility we analyze precautionary saving behavior in a framework with labor and nonlabor income risks an endogenous supply of labor and a representation of preferences that disentangles attitudes towards risk attitudes towards intertemporal substitution and ordinal preferences for consumption and leisure this preference structure allows us to disentangle and to describe in an intuitive way the different forces that determine precautionary saving in the small and in the large

risk rationality and time diversification the validity of the concept of time diversification is the subject of long running debate supporters of the concept argue that risk decreases as investment horizon increases detractors suggest that the concept is false on the face of it we argue that time diversification is consistent both theoretically and empirically with current conceptions of risk and rationality and we also note the implications of changes in investment horizon for stock market behavior

on the risk of stocks in the long run a note in a recent article in this journal zvi bodie used a simplified black scholes model to prove that the cost of insuring a long term stock portfolio against earning less than the risk free rate increases over time bodie believes that this means the risk of investing in common stocks increases over time and that the conventional wisdom of the investment community concerning time diversification is a fallacy bodie s proof relies on a constant standard deviation for common stock over all holding periods this assumption however may not be appropriate for long term stock portfolios this article is not available online

factor and spread analysis of the convertible securities market factor decomposition demonstrates that during certain time periods the convertible market has offered excess returns over a well allocated bond equity portfolio moreover because the magnitude of these returns spans a wide range of values investors can use this valuation framework as a tool for estimating the relative attractiveness of convertibles compared with their underlying equity and fixed income components analysis of yield spreads demonstrates the changing nature of valuation levels embedded in convertible securities a factor analysis of a market weighted equity index underlying convertibles shows that their equity component is well diversified across two major dimensions value versus growth and large cap versus small cap

formative experiences and portfolio choice evidence from the finnish great depression we trace the impact of formative experiences on portfolio choice plausibly exogenous variation in workers exposure to a depression allows us to identify the effects and a new estimation approach makes addressing wealth and income effects possible we find that adversely affected workers are less likely to invest in risky assets this result is robust to a number of control variables and it holds for individuals whose income employment and wealth were unaffected the effects travel through social networks individuals whose neighbors and family members experienced adverse circumstances also avoid risky investments

the impact of inflation on the aggregate debt asset ratio this paper demonstrates that contrary to the results of previous studies the impact of inflation on the aggregate debt asset ratio cannot be determined theoretically however it is shown that inflation is likely to increase this ratio when personal income tax schedules are indexed to the price level and or when leverage related costs are relatively high and the personal tax rate on income from holding common stocks is relatively low studies concerning the effect of inflation on firms capital structure conclude that inflation enhances debt financing jaffe 9 modigliani and cohn 16 and modigliani 15 argue that nominal interest payments consist in part of true interest payments and in part of a compensation for the reduction in the real value of the principal the fact that firms are allowed to deduct their entire interest expense including the portion that is a return of principal reduces their cost of debt capital gordon 6 concludes that the equilibrium debt capital ratio rises when the inflation rate rises he argues that an increase in the nominal interest rate induced by inflation increases the tax advantage of debt financing thus debt financing becomes more attractive and a rise in leverage related costs is necessary to restore equilibrium gordon asserts that the increase in leveragerelated costs is brought about by an increase in the debt equity ratio all these studies however focus primarily on the tax benefits of debt financing to the corporation and implicitly assume that each firm has a unique optimal structure which may change with inflation in contrast miller 14 in a world without inflation concludes that firms are indifferent to their capital structure and that the aggregate debt equity ratio is determined by the ratio of the wealth of investors who for tax reasons choose to hold bonds to the wealth of those who choose to hold stocks this paper explicitly incorporates tax considerations of both investors and firms into the analysis of the effect of inflation on the aggregate corporate debtasset ratio it is demonstrated that the effect of inflation on the aggregate debtasset ratio cannot be determined theoretically however inflation is likely to increase this ratio when personal income tax schedules are indexed to the price level and or when leverage related costs are relatively high and the tax on income from holding common stocks is relatively low we consider an economy in which investors are subject to a progressive tax system income from corporate bonds

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

english auctions and the stolper samuelson theorem we prove that the english auction with bidders that need not be ex ante identical and may have interdependent valuations has an efficient ex post equilibrium we establish this result for environments where it has not been previously obtained we also prove two versions of the stolper samuelson theorem one for economies with n goods and n factors and one for non square economies similar assumptions and methods underlie these seemingly unrelated results

how risk sharing may enhance efficiency of english auctions we investigate the possibility of enhancing efficiency by awarding premiums to a set of highest bidders in an english auction in a setting that extends maskin and riley 1984 econometrica 52 1473 1518 in three aspects i the seller can be risk averse ii the bidders can have heterogeneous risk preferences and iii the auction can have a binding reserve price our analysis reveals that the premium has an intricate joint effect on risk sharing and expected revenue which in general benefits risk averse bidders when the seller is more risk averse than the pivotal bidder a condition often verifiable by deduction prior to the auction the premium also benefis the seller and therefore leads to a pareto improvement of the english auction the advantage of such premium tactics is directly related to a the seller s degree of risk aversion b the reserve price c the riskiness of the object for sale d the degree of heterogeneity in risk preferences among the bidders and e the number of the potential bidders

optimal bidding in auctions from a game theory perspective abstract the game theoretic perspective in auction bidding has provided a powerful normative framework for the analysis of auctions and it has generated an impressive volume of research contributions tracing this research we review key recent advances which have greatly expanded our understanding of the operation of auctions and produced a more accurate analysis of mechanism design and optimal bidding we follow various experimental studies which have shown that the predictive power of auction theory remains in many cases limited for this reason we concentrate on research themes which enhance the applicability of auction theory leading to more realistic descriptions of bidding behaviors we identify important innovations which expand the environment of auction bidding and carry us beyond rational decision making we conclude providing directions of future research and discussing their implications

intergenerational risk sharing and risk taking of a pension fund abstract by using their financial reserves efficiently pension funds can smooth shocks on their asset returns and can thus facilitate intergenerational risk sharing in addition to the primary benefit of improved time diversification this form of risk allocation affords the additional benefit of allowing these funds to take better advantage of the equity premium which also favors the consumers in this paper our aim is twofold first we characterize the socially efficient policy rules of a collective pension plan in terms of portfolio management capital payments to retirees and dividend payments to shareholders we examine both the first best rules and the second best rules where in the latter case the fund is constrained by a solvency constraint and by a guaranteed minimum return to workers contributions second we measure the social surplus of the system compared to a situation in which each generation would save and invest in isolation for its own retirement we estimate that the certainty equivalent return of the pension saving scheme goes from 3 23 per year to 3 76 when intergenerational risk sharing is introduced one of the main results of the paper is that better intergenerational risk sharing does not reduce the risk born by each generation rather it increases the expected return to the workers contributions

portfolio choice with non expected utility in continuous time non expected utility preferences which can distinguish intertemporal substitution from attitudes towards risk are extended to continuous time the consumption savings and portfolio problem is solved for constant intertemporal elasticity of substitution and constant relative risk aversion

time diversification and estimation risk the recommendation that investors with long investment horizons tilt their portfolios toward stocks is commonplace we used a nonparametric bootstrap approach to investigate whether in a mean variance efficient portfolio the weights for u s stocks and u s t bills vary in a systematic manner with investment horizon this approach allowed us to analyze the impact of estimation risk on the optimal weights of stocks and fixed income securities the results show that an investor can gain from time diversification the weights for stocks in an efficient portfolio were significantly larger for long investment horizons than a one year horizon

equilibrium consumption and precautionary savings in a stochastically growing economy abstract the derivation of a closed form solution for consumption based on the constant elasticity utility function in the presence of stochastic labor income has proved to be intractable this paper derives a closed form equilibrium relationship between consumption and wealth one that holds along a balanced growth path in a stochastic romer endogenous growth model by employing more general recursive preferences we can disentangle the coefficient of relative risk aversion from the intertemporal elasticity of substitution the effects of key structural parameters on equilibrium consumption and its tradeoff with leisure are analyzed a significant aspect of our analysis concerns the extent to which current risk in the economy is shared between labor and capital this plays an important role in determining the impact of risk on the economy in general and on consumption in particular formal analysis is supplemented with extensive numerical simulations

guaranteeing individual accounts global aging is prompting workers and taxpayers everywhere to recognize their vulnerability to the inherent uncertainty of unfunded social security systems this has generated an international wave of social security reforms over the last two decades prompting more than 20 countries to establish individual account ia plans in the united states the idea of individual accounts has attracted recent interest with the release of the final report of the president s commission to strengthen social security csss here voluntary individual accounts were proposed as a key element of a reformed national old age system see commission to strengthen social security 2001 john f cogan and mitchell 2003 strengths of ia s include the fact that participants gain ownership in their accounts and diversify their pension investments nevertheless ia participants also must bear capital market risk recent market volatility has reminded investors of the importance of capital market fluctuations and their potential impact on retirement income in response some policymakers have suggested that guarantees be designed to help protect ia investments abroad such guarantees have been adopted in several latin american countries undergoing reform and most recently in japan and germany mitchell and kent smetters 2003 sensible public policy recommending the adoption of guarantees must identify their costs and who will pay for them in this paper we discuss how to evaluate such costs in the context of a social security reform that includes ia s along with ways to finance them

a preliminary exploration on stochastic dynamic asset allocation models under a continuous time sticky price general equilibrium this article studies asset allocation problems under endogenous macroeconomic dynamics and monetary policy rules by merging a continuous time sticky price general equilibrium model based on the ne

optimal guaranteed return portfolios and the casino effect in this paper we address the problem of determining optimal portfolios that may include options in a framework of return maximization with risk constraints relative to a benchmark as well as in terms of absolute returns the model we propose allows for deterministic constraints as well as probabilistic constraints we derive properties of optimal and feasible portfolios and present a linear programming model to solve the problem the optimal portfolios have payoff functions that reflect a gambling policy we show that optimal solutions to a large class of portfolio models that maximize expected return subject to downside risk constraints are driven by this casino effect and present tractable conditions under which it occurs in our model we propose to control the casino effect by using chance constraints using results from financial theory we formulate an lp model that maximizes expected return subject to worst case return constraints and chance constraints on achieving prespecified levels of return the results are illustrated with real life data on the s p 500 index

asymmetric english auctions abstract this paper studies equilibria of the n bidder single object english or open ascending price auction in a setting with interdependent values and asymmetric bidders maskin in h siebert ed privatization institut fur weltwirtschaften der universitat kiel kiel 1992 pp 115 136 showed that if the values satisfy a single crossing condition then the two bidder english auction has an efficient equilibrium in this paper two extensions of the single crossing condition the average crossing condition and the cyclical crossing condition are introduced the main result is that under either of these conditions the n bidder english auction has an efficient equilibrium

on the risk of stocks in the long run a resolution to the debate in response to the ongoing debate in this journal about whether the risk of investments in the stock market is increased or decreased by lengthening the investment period we show that bodie s attempt to identify market risk with the price of put options leads to a circular argument within the workings of arbitrage free option pricing models thus bodie failed to rebut the conventional view that longer investment horizons may be thought of as less risky bodie s put option prices are relevant however to determining market prices of stock investment insurance

the time diversification controversy some financial theorists reject the widely held practitioner belief in time diversification the theorists argue that given serially uncorrelated returns holding a risky asset over longer periods of time will not reduce its inherent riskiness the argument is supported by references to economic models of risk aversion such as mean variance optimization and expected utility theory mean variance optimizers however are not indifferent to investment horizon and investment horizon indifference is only a special case within expected utility theory furthermore to the extent that models reject the notion of time diversification they are inadequate because they are inconsistent with common sense measures of risk at very long horizons

misconceptions about optimal equity allocation and investment horizon our analysis and results offer some resolution to a debate that has continued for 30 years we demonstrate that in contrast to prior claims no conflict exists between the implications of economic models of choice under uncertainty and a rational investor preference for larger equity allocations at longer investment horizons using examples of expected utility of wealth and mean variance utility we show that the effect of a longer horizon on risky asset allocation is consistent with increasing or decreasing optimal equity allocations even under the assumption of constant relative risk aversion

the statistics of sharpe ratios the building blocks of the sharpe ratio expected returns and volatilities are unknown quantities that must be estimated statistically and are therefore subject to estimation error this raises the natural question how accurately are sharpe ratios measured to address this question i derive explicit expressions for the statistical distribution of the sharpe ratio using standard asymptotic theory under several sets of assumptions for the return generating process independently and identically distributed returns stationary returns and with time aggregation i show that monthly sharpe ratios cannot be annualized by multiplying by 12 except under very special circumstances and i derive the correct method of conversion in the general case of stationary returns in an illustrative empirical example of mutual funds and hedge funds i find that the annual sharpe ratio for a hedge fund can be overstated by as much as 65 percent because of the presence of serial correlation in monthly returns and once this

the nature of market growth risk and return in the model of asset appreciation advanced here the market economy and the market of asset claims on the economy are modeled as organic or exponential growth processes similar to those commonly seen in nature and the biological sciences in dempsey s organic growth model of appreciation dogma investors have a log wealth utility function within the framework the market risk premium is derived as the premium that balances supply and demand among risky and risk free assets the model indicates that the premium is less than is indicated by ex post returns observed on u s stock markets the model is consistent however with empirical observations that idiosyncratic risk and small company size are rewarded by the markets in terms of the model investors choose to allocate their portfolios long in both the risky market and the risk free asset furthermore their portfolios are independent of the investment time horizon

asset allocation in a downside risk framework 1991 asset allocation in a downside risk framework financial analysts journal vol 47 no 5 pp 28 40

as time goes by an investigation of how asset allocation varies with investor age abstract we investigate how individuals asset allocations in their portfolios vary with age considering the relationship between individual attitudes and behavior we find individuals portfolios become more risk seeking with age even taking account of asset accumulation counter to their intuition

put prices and pen participation rates at longer horizons is equity risk in the eye of the beholder two recent articles in the financial analysts journal address the question of how equity risk changes as investment horizons grow longer both use analyses based on derivatives pricing examples but draw exactly opposite conclusions we reexamine these authors arguments and find the logic of both analyses is flawed we demonstrate that the use of specialized put option prices as proxies for equity risk yields ambiguous conclusions about equity risk changes at longer investment horizons with added information about an investor s required minimum rate of return however we can specify the change in equity risk at longer horizons with these put prices

econometrics of first price auctions in this paper we propose an estimation method for the empirical study of theoretical auction models we focus on first price sealed bid and descending auctions and we adopt the private value paradigm where each bidder is assumed to have a different private value only known to him for the object that is auctioned following mcfadden 1989 and pakes and pollard 1989 our proposed method is based on simulations specifically the method relies on a simulated nonlinear least squares objective function appropriately adjusted so as to obtain consistent estimates of the parameters of interest we illustrate the proposed method by studying a market of agricultural products where descending auctions are used our analysis takes into account heterogeneity of the auctioned objects and the fact that only the winning bid is observed we estimate the parameters that characterize the distribution of the unobserved private values for each auctioned object

why do companies pay dividends this paper presents a simple model of market equilibrium to explain why firms that maximize the value of their shares pay dividends even though the funds could instead be retained and subsequently distributed to shareholders in a way that would allow them to be taxed more favorably as capital gains the two principal ingredients of our explanation are 1 the conflicting preferences of shareholders in different tax brackets and 2 the shareholders desire for portfolio diversification we show that companies will pay a positive fraction of earnings in dividends we also provide some comparative static analysis of dividend behavior with respect to tax parameters and to the conditions determining the riskiness of the securities this abstract was borrowed from another version of this item

viewscapes and flood hazard coastal housing market response to amenities and risk coastal amenities and risk are so highly correlated that separate identification within the hedonic framework is potentially challenging in this study we construct a three dimensional measure of ocean view viewscape accounting for natural topography and built obstruction that varies independent of risk classification to disentangle these spatially integrated housing characteristics a spatial autoregressive hedonic model is developed to provide consistent estimates of the willingness to pay for coastal amenities and risk our findings suggest that incorporating the gis based view measures can be successful in isolating risk factors from spatial amenities

investments with downside insurance and the issue of time diversification of two insurance policies that guarantee the same minimum rate of return on a portfolio and differ only in their time horizons which is riskier this study shows that if the minimum rate is lower than the risk free rate and if the risk is measured by the cost of insurance then the degree of risk is not a monotonic function of the policy s time horizon for every positive level of concession rate defined as the risk free rate minus the insured rate the cost of such insurance peaks at a finite time horizon this peak cost horizon is typically between 5 and 15 years the higher the concession rate or the lower the volatility of the insured portfolio the shorter this peak cost time horizon is thus although a 5 year insurance policy can be much riskier than a 1 year policy it can also be riskier than a 30 year policy

efficient portfolios when housing needs change over the life cycle abstract we address the issue of the efficiency of household portfolios in the presence of housing risk we treat housing stock as an asset and rents as a stochastic liability stream over the life cycle households can be short or long in their net housing position efficient financial portfolios are the sum of a standard markowitz portfolio and a housing risk hedge term that multiplies net housing wealth our empirical results show that net housing plays a key role in determining which household portfolios are inefficient the largest proportion of inefficient portfolios obtains among those with positive net housing who should invest more in stocks

time preference and capital asset pricing models abstract results of the theory of individual optimal consumption investment choice under uncertainty are extended to a class of intertemporally dependent preferences for consumption streams these results are then used to show that with intertemporally dependent preferences which are more realistic than the separable time additive preference structure merton s 1973 multi beta intertemporal capital asset pricing model is still valid but it can no longer be collapsed to breeden s 1979 single consumption beta model

banks firms and the relative pricing of tax exempt and taxable bonds abstract the traditional analysis of the relative pricing of tax exempt and taxable debt is a habitat theory of the term structure of interest rates in the traditional analysis the preferences of investors for particular maturities of debt lead to unique pricing relations at every point on the yield curve which are indicative of investor marginal tax brackets recent work by fama 1977 suggests that banks are potential arbitrageurs across tax exempt and taxable bond markets which force a particular equilibrium on the pricing of short term bonds miller 1977 suggests that the choice of debt or equity financing by firms in the aggregate forces a similar equilibrium on the pricing of all tax exempt and taxable bonds this paper exploits the institution of regulation q and its effects on the banking system to bring evidence to bear on the predictions of these three models

miller s equilibrium shareholder leverage clienteles and optimal capital structure the purpose of this paper is twofold first we examine the individual portfolio decisions when income from stocks and bonds is taxed at different rates second a rationale for the existence of risky debt in the presence of leverage related costs and differential personal income taxation is provided previous studies on capital structure with differential personal income taxation have ignored either the portfolio risk consideration and or the possibility of losing personal and corporate interest tax shields due to insufficient taxable earnings e g 8 2 3 14 13 6 7 1 9 19 20 21 23 in section i of this paper both the portfolio risk consideration and the possibility of losing personal and corporate interest tax shields are explicitly introduced this enables us to provide a rationale for the shareholder leverage clientele phenomenon within a mean variance framework we also demonstrate a non corner solution for the optimal corporate capital structure in a tax environment similar to that of miller s debt and taxes 14 in sections ii and iii of this paper miller s world is further modified to include risky debt and the attendant costs we re examine and synthesize recent studies on the theory of optimal capital structure which have appeared since the publication of debt and taxes e g 4 6 7 13 19 20

constrained labor supply and risk aversion abstract this paper extends previous work by showing that consumption constraints typically increase individuals risk aversion even if the illiquid good e g leisure has good substitutes calibrations indicate time use constraints may raise risk aversion considerably under many common scenarios

asymmetry in first price auctions with affiliated private values collusion and heterogeneity across firms may introduce asymmetry in bidding games a major difficulty in asymmetric auctions is that the bayesian nash equilibrium strategies are solutions of an intractable system of differential equations we propose a simple method for estimating asymmetric first price auctions with affiliated private values considering two types of bidders we show that these differential equations can be rewritten using the observed bid distribution we establish the identification of the model characterize its theoretical restrictions and propose a two step non parametric estimation procedure for estimating the private value distributions an empirical analysis of joint bidding in ocs auctions is provided copyright 2003 john wiley sons ltd

health and portfolio choices a diffidence approach the effect of health status on portfolio decisions has been extensively studied from an empirical viewpoint in this paper we propose a theoretical model of individuals choice of financial assets under bivariate utility functions depending on wealth and health our approach makes an extensive use of the diffidence theorem we establish the conditions under which the share of wealth held in risky assets falls as 1 individuals health status deteriorates and 2 individuals health status becomes risky these conditions are shown to be related to the behavior of the intensities of correlation aversion and of cross prudence as wealth increases

taxation portfolio choice and debt equity ratios a general equilibrium model this paper explores the portfolio behavior of investors differing with respect to both tax rates and risk aversion emphasizing the role of constraints on individual and firm behavior in ensuring the existence of and characterizing portfolio equilibrium under certain conditions on the securities available in the market which also are necessary for shareholders to be unanimous in supporting firm value maximization investors will be segmented by tax rate into two groups one specialized in equity and the other in debt though the relative wealths of the two groups determine the aggregate debt equity ratio each firm will be indifferent to its financial policy

identification and estimation of auction models with unobserved heterogeneity in many procurement auctions the bidders unobserved costs depend both on a common shock and on idiosyncratic private information assuming a multiplicative structure i derive sufficient conditions under which the model is identified and propose a non parametric estimation procedure that results in uniformly consistent estimators of the cost components distributions the estimation procedure is applied to data from michigan highway procurement auctions private information is estimated to account for 34 of the variation in bidders costs it is shown that accounting for unobserved auction heterogeneity has important implications for the evaluation of the distribution of rents efficiency and optimal auction design

a theory of optimal timing and selectivity abstract we solve an extended optimal portfolio problem in continuous time for any horizon where we allow the mean and variance of returns to be stochastic introduce fund flows to and from the portfolio permit differential investor preferences for dividend versus growth stocks and allow the investor to buy costly information on the random mean and variance of the portfolio to improve his portfolio choice set this model provides analytical results especially useful in understanding the expenditure on timing and selection information a mutual fund undertakes in attempting to improve performance relative to a benchmark we examine this proposition for growth and income funds long and short investment horizons and also account for fund inflows and outflows we also combine our model of costly learning with the traditional model of incomplete information to understand the interaction between costly and costless learning the approach taken is a purely theoretical one and in this regard the paper is normative in spirit we anticipate that the propositions in this paper will provide two byproducts i a framework for fund managers to think about how to allocate information expenses between timing and selection skills and ii give academics especially empirical researchers a theoretical backdrop against which to examine the mutual fund industry

labor supply flexibility and portfolio choice in a life cycle model abstract this paper examines the effect of the labor leisure choice on portfolio and consumption decisions over an individual s life cycle the model incorporates the fact that individuals may have considerable flexibility in varying their work effort including their choice of when to retire given this flexibility the individual simultaneously determines optimal levels of current consumption labor effort and an optimal financial investment strategy at each point in his life cycle we show that labor and investment choices are intimately related the ability to vary labor supply ex post induces the individual to assume greater risks in his investment portfolio ex ante

changes in implicit flood risk premiums empirical evidence from the housing market abstract hedonic valuation models have shown that sales prices can capitalize property risk factors such as flood zone properties facing lower risk sell at a premium all else being equal previous research has indicated that price differentials reflecting risk of flooding become much larger in the wake of a storm we re examine these findings for pitt county north carolina using multiple storm events within a difference in differences framework and we compare flood zone price differentials for a more recent sample of property sales prior to hurricane fran in 1996 we detect no market risk premium for the presence in a flood zone but we find significant price differentials after major flooding events amounting to a 5 7 decrease after hurricane fran and 8 8 decrease after hurricane floyd results from a separate model that examines more recent data covering a period without significant storm related flood impacts indicate a significant risk premium ranging between 6 0 and 20 2 for homes sold in the flood zone but this effect is diminishing over time essentially disappearing about 5 or 6 years after hurricane floyd the lack of a persistent effect suggests that buyers and sellers risk perceptions may change with the prevalence of hazard events and that homebuyers are unaware of flood risks and insurance requirements when bidding on properties

on the risk of stocks in the long run a familiar proposition is that investing in common stocks is less risky the longer an investor plans to hold them if this proposition were true then the cost of insuring against earning less than the risk free rate of interest should decline as the investment horizon lengthens this paper shows that the opposite is true even if stock returns are mean reverting in the long run the case for young people investing more heavily than older people in stocks cannot therefore rest solely on the long run properties of stock returns for guarantors of money fixed annuities the proposition that stocks in their portfolios are a better hedge the longer the maturity of their obligations is unambiguously wrong

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

time diversification definitions and some closed form solutions abstract we establish general conditions under which younger investors should invest a larger proportion of their wealth in risky assets than older ones in the finite horizon dynamic setting we show that such phenomenon known as time diversification can occur in the presence of human wealth guaranteed consumption or mean reverting stock returns we formalize two alternative notions of time diversification commonly confounded in the literature analytic solutions are provided for both time series and cross sectional forms of time diversification to our best knowledge this paper is the first to solve in closed form the hedging demand for a cara investor with inter temporal consumption and a finite horizon facing mean reverting expected returns our results indicate that horizon can have a significant effect on the portfolio demand of a cara investor due to inter temporal hedging

identification of standard auction models this paper presents new identification results for models of first price second price ascending english and descending dutch auctions we consider a general specification of the latent demand and information structure nesting both private values and common values models and allowing correlated types as well as ex ante asymmetry we address identification of a series of nested models and derive testable restrictions enabling discrimination between models on the basis of observed data the simplest model symmetric independent private values is nonparametrically identified even if only the transaction price from each auction is observed for richer models identification and testable restrictions may be obtained when additional information of one or more of the following types is available i the identity of the winning bidder or other bidders ii one or more bids in addition to the transaction price iii exogenous variation in the number of bidders iv bidder specific covariates while many private values pv models are nonparametrically identified and testable with commonly available data identification of common values cv models requires stringent assumptions nonetheless the pv model can be tested against the cv alternative even when neither model is identified

leverage and the value of a firm under a progressive personal income tax the relation between a firm s value and its leverage rate is investigated under a tax regime where interest is a tax deductible expense to firms where it is taxed at a progressive rate to persons and where share income is free of taxation the analysis is restricted to a one period economy with capital markets that are perfectly competitive apart from the above tax regime the equilibrium value of a firm is found to be a convex function of its leverage rate it is independent of the leverage rate only in the special case where the portfolio decisions of persons make all their marginal tax rates the same and equal to the corporate tax rate

speculation in standard auctions with resale in standard auctions resale creates a role for a speculator a bidder who is commonly known to have no use value for the good on sale we study this issue in environments with symmetric independent private value bidders for second price and english auctions the efficient value bidding equilibrium coexists with a continuum of inefficient equilibria in which the speculator wins the auction and makes positive profits first price and dutch auctions have an essentially unique equilibrium and whether or not the speculator wins the auction and distorts the final allocation depends on the number of bidders the value distribution and the discount factor speculators do not make profits in first price or dutch auctions

time diversification perspectives from option pricing theory despite repeated theoretical arguments to the contrary many investment professionals subscribe to the principle of time diversification this principle states that equity investments become less risky if held for longer periods of time we apply option pricing theory to the question of how the investment horizon affects equity risk financially engineered securities that guarantee a minimum return allow for greater equity market participation if the investor commits to a longer time horizon in other words the fair cost of insuring a minimum return in terms of foregone market participation is lower for longer horizons the lower cost of risk reduction suggests that risk itself is lower consistent with the pervasive practitioner belief in time diversification

endogenous labor leisure investment choice under time constraints we posit the opportunity cost of time required to manage risky investments including conducting research and performance monitoring as a potential explanation for the equity premium puzzle an economic agent who should allocate a limited amount of time to labor leisure and risky investment is subject to the opportunity time cost of investment activity which is foregone labor or leisure our model envisages its impact on equity premium and volatility in the presence of such a time constraint in particular with closed form solutions to the risky asset returns volatility and risk free rate in a simple equilibrium framework wherein agents have log utility the model is shown to yield excess return and volatility consistent with historical values observed in the u s stock market even with a small amount of time cost in addition the model enables us to sort out the impact of endogenous labor leisure choice on return dynamics by comparing it with the exogenous labor income case

household portfolio choice and retirement this study examines household portfolio choice through the retirement transition i show that couples significantly decrease their stock allocations after retirement whereas singles allocations remain relatively unchanged reallocations are concentrated among couples in which the wife is more risk averse than her husband husbands and wives respective retirement events are followed by opposite signed changes in stock allocations these findings are consistent with a model of collective household decision making in which spouses have heterogeneous risk preferences and suggest that dynamics in the distribution of intrahousehold bargaining power generate time varying household risk aversion

discounting inside the washington d c beltway places more weight on costs and benefits in the near term over costs and benefits in the future the choice of the discount rate is therefore critical in evaluating the merits of many public policy proposals this article focuses on how the choice of discount rate can dramatically affect policy choices these policies include whether to build a bridge whether to privatize a power marketing administration which sells electricity generated by government owned facilities such as dams how much money should be spent on early childhood education or options for reforming social security the ongoing challenge is to discount future costs or benefits in a way that matches the project s level of riskiness we begin by discussing the underlying issues in choosing an appropriate discount rate we then discuss the variety of different discount rates that are actually used by various washington policymakers and the biases they often generate

efficient gradualism in intertemporal portfolios abstract this paper examines intertemporal portfolio plans under autocorrelation in asset returns and considers whether these plans conform to the common advice that risky assets be bought gradually and then held in decreasing amounts as the investment horizon approaches given elliptical returns optimal portfolio plans with precommitment must be mean variance efficient then for arma 1 1 parameterizations with negative autocorrelation the age effect gradual diminishing of risky holdings as the horizon approaches is confirmed as is dollar cost averaging gradual entry into the risky asset for sufficiently distant horizons for a numerically analyzed alternative bivariate returns process only the age effect is confirmed

contingent valuation from dubious to hopeless abstract approximately 20 years ago peter diamond and i wrote an article for this journal analyzing contingent valuation methods at that time peter s view was that contingent valuation was hopele

economic valuation of environmental quality using property auction data a structural estimation approach this study proposes a method to economically evaluate environmental quality using property auction data our approach is consistent with microeconomic auction theory and can directly estimate the value function from the data a task that is often difficult when using conventional revealed preference methods such as the hedonic approach we use a method of simulated moments to estimate the value function which in turn is used to calculate the economic value of environmental quality changes we apply this method to data on foreclosure property auctions in tokyo in order to economically evaluate hypothetical improvements in neighborhood fire risks