optimal ngo financing of a resource management certification scheme the development of voluntary certification schemes in areas as diverse as fish coffee and forestry offer the promise of environmental improvements without the requirement of governmental regulation and intervention in many cases however the costs to landholders of making the transition are too large for them to do so at the same time the large intermediaries appear to have little economic incentive to introduce certification because the market does not adequately value the environmental benefits instead ngos and other aid and development agencies who would like to see small producers benefit from the change in production practices have typically stepped in to provide financial support for certification this paper shows how voluntary price discrimination in the form of donations by the consumers that most highly value certification can be used to finance a switch to environmentally sustainable practices and thus address a market failure this analysis shows that an ngo s optimal intervention depends on the size of its budget the elasticity of supply of the product and the elasticity of participation by producers ngos with smaller budgets rely more heavily on lump sum transfers to the intermediary and less heavily on volume and participation dependent subsidies volume and participation dependent subsidies are inversely related to the elasticity of supply and the elasticity of participation in a standard lerner relationship

political risk and the expectations hypothesis abstract this paper develops and empirically supports using 3 and 6 month interest rates a theory that political risk can explain the shifting term premia found in u s data we find that incorporating these political regime shifts yield results that support the expectations hypothesis

interest rate volatility and the term structure a two factor general equilibrium model we develop a two factor general equilibrium model of the term structure the factors are the short term interest rate and the volatility of the short term interest rate we derive closed form expressions for discount bonds and study the properties of the term structure implied by the model the dependence of yields on volatility allows the model to capture many observed properties of the term structure we also derive closed form expressions for discount bond options we use hansen s generalized method of moments framework to test the cross sectional restrictions imposed by the model the tests support the two factor model there are essentially two approaches to the modeling of the term structure of interest rates in continuous time the equilibrium approach pioneered by

rate of return regulation and two part tariffs in choosing a two part tariff a monopoly subject to rate of return regulation will rely more on demand elasticities and less on marginal costs than would a welfare maximizing firm the rate of return regulated firm also will reduce its access fee or its marginal usage fee more depending on whether adding consumers or increasing output requires marginally the most capital in the typical case these effects will favor declining block rate structures which helps to explain their widespread use by rate of return regulated firms

on arbitrage free pricing of interest rate contingent claims unlike most interest rate claim models the ho lee model utilizes full information on the current term structure unfortunately the model has a major deficiency in that negative interest rates can occur this article modifies the model such that interest rates are well behaved

multivariate term structure models with level and heteroskedasticity effects abstract the paper introduces and estimates a multivariate level garch model for the long rate and the term structure spread where the conditional volatility is proportional to the th power of the variable itself level effects and the conditional covariance matrix evolves according to a multivariate garch process heteroskedasticity effects the long rate variance exhibits heteroskedasticity effects and level effects in accordance with the square root model the spread variance exhibits heteroskedasticity effects but no level effects the level garch model is preferred above the garch model and the level model garch effects are more important than level effects the results are robust to the maturity of the interest rates

a dynamic programming approach for pricing options embedded in bonds abstract we propose a dynamic programming dp approach for pricing options embedded in bonds the focus being on call and put options with advance notice an efficient procedure is developed for the cases where the interest rate process follows the vasicek cox ingersoll ross cir or generalized vasicek models our dp methodology uses the exact joint distribution of the interest rate and integrated interest rate at a future date conditional on the current value of the interest rate we provide numerical illustrations for the vasicek and cir models comparing our dp method with finite difference methods our procedure compares quite favorably in terms of both efficiency and accuracy an important advantage of the our dp approach is that it can be applied to more general models calibrated to capture the term structure of interest rates e g the generalized vasicek model

the merits of dual pricing of russian natural gas our analysis reveals that from russia s perspective there is no economic rationale to unify the price of natural gas it sells domestically and in europe we argue that pipelines allow gazprom to segment the russian market from the european including turkey market and that russia has market power in the european market if russia were to fail to exploit this market power in its european market by selling its natural gas to europe at only full long run marginal cost plus transportation costs russia would lose between 5 billion and 7 5 billion per year almost two per cent of its gdp if instead russia were to raise its domestic prices to the prices it charges in europe russian industry would incur very large investment adjustment and unemployment costs in the short run adjustment costs that cannot be justified on the basis of comparative advantage we estimate that the efficient world price would be achieved if gazprom were to employ its optimal two part tariff the optimal two part tariff would double gazprom s annual profits in europe but it involves significant long term risks for gazprom of lost market share

the pricing of options on default free bonds recent developments in the finance literature dealing with the valuation of contingent claims have been triggered by black and scholes 2 with their valuation of european options on corporate stocks the type of valuation model derived by black and scholes is attractive because it is independent of preferences this independence is possible due to the fact that the contingent claims are usually assumed to be contingent on traded assets or traded state variables for example a european call option is a claim contingent on the value of the corresponding stock to maintain the independence of the claim from preferences however some variables have to be discarded and considered as constants for example the rate of interest which is not a traded state variable is considered a constant in most of the literature see black and scholes 2 merton 11 and ingersoll 9 though this approximation might not cause important discrepancies in the case of corporate liabilities and options on corporate liabilities the effect of such an approximation on the value of default free bonds and options on default free bonds is more important since these liabilities depend only on the rate of interest

bond price dynamics and options this paper provides a closed form preference free means of valuing a european call option written on a default free pure discount bond investors may not agree upon a theory of the term structure but they will necessarily agree on equilibrium option values further these equilibrium option values may be obtained without recourse to numerical approximation default free pure discount bond prices were posited to follow a non standardized transformed brownian bridge process this specification implicitly incorporates the terminal constraint that the price of a default free pure discount bond equal its face value at maturity contingent claim valuation necessarily involves consideration of terminal constraints on the value of financial securities the brownian bridge specification permits an appropriate means of incorporating a number of such constraints therefore while this paper has considered only the application of the brownian bridge process to the valuation of debt options the introduction of this process may provide for many further financial applications

time dependent variance and the pricing of bond options in this paper we develop a model for valuing debt options that takes into account the changing characteristics of the underlying bond by assuming that the standard deviation of return is proportional to the bond s duration the resulting model uses the bond price as the single state variable and thus preserves much of the simplicity and robustness of the black scholes approach the paper provides comparisons between option prices computed using this model and those using the black scholes and brennan and schwartz models the last decade has seen a dramatic increase in the volatility of bond markets leading to a growing interest in financial instruments that can be used to hedge this risk thus in the u s canada and the u k there has been a proliferation of new interest rate dependent securities such as bond futures options on bonds options on bond futures swap agreements and bonds with option features such as callability putability retractability and so forth with the development of these markets the problems of valuation and the derivation of the hedging strategies have become subjects of increasing importance to both practitioners and academics several valuation methods have been suggested in the literature but so far no consensus has emerged as to the best solution to these problems the simplest approach to the valuation of debt options and probably the most widely used in practice is the black scholes model 3 this method originally developed for the valuation of stock options assumes that the variance of the rate of return on the underlying security is constant while this assumption is plausible for common stocks it is clearly unreasonable for bonds with a finite maturity the distinctive feature of the problem of debt option valuation is that the characteristics of the underlying asset change over time because the price is constrained to converge to the face value of the bond at maturity a second drawback of the black scholes approach is that it assumes a constant short term interest rate an assumption that is clearly inconsistent with stochastic returns on bonds in spite of these problems the black scholes model has been frequently used in practice to value debt options because of its overwhelming simplicity in comparison with other available methods

nonlinear pricing and price cap regulation abstract this paper analyzes profit maximizing nonlinear pricing by a firm that is subject to price cap regulation two forms of regulatory constraint are considered i a cap on the firm s average revenue and ii a constraint that the firm must continue to offer each consumer the option of buying at the uniform price optimal nonlinear price schedules in these regimes are shown to have simple characterizations that are related to the nonlinear tariffs that an unregulated monopolist would charge of the regulatory regimes the firm prefers the average revenue constraint to the option constraint and likes uniform pricing least consumers in aggregate prefer the option regime to uniform pricing and like the average revenue constraint least but there are also distributional effects between consumers although the optional tariff regime pareto dominates uniform pricing it is ambiguous whether welfare is higher under uniform pricing or under the average revenue regime an example is used to illustrate the nature of the ambiguity

on alternative interest rate processes abstract in this paper alternative interest rate processes are estimated for denmark germany sweden and the uk using the generalized method of moments gmm in line with the study by chan karolyi longstaff and sanders 1992 on us data there seems to be a positive relation between interest rate level and volatility for some countries in contrast to their study it is found that mean reversion plays an important role for the specification of the interest rate dynamics the results seem to be robust to the use of different moment conditions and simulations of the estimated models reveal that they are fairly able to capture non fitted moments as well in addition there is evidence of a structural change in the danish interest rate process in august 1985 which may be due to a change in monetary policy the small sample properties of the gmm estimators are also studied through simulations

modeling the stochastic behavior of short term interest rates pricing implications for discount bonds abstract this paper models the stochastic behavior of short term interest rates and determines the correct specification of the drift and diffusion functions of the spot rate process a wide variety of one factor diffusion and two factor stochastic volatility models is compared in terms of their ability to capture the dynamics of interest rate volatility the empirical evidence on the one three and six month eurodollar deposit rates indicates that a new class of models with stochastic volatility is better than the single factor diffusion models in forecasting the future volatility of interest rate changes the paper extends the one factor bdt term structure model to a two factor setting and presents the pricing implications for discount bonds monte carlo simulation results for the implied yields of three and six month zero coupon bonds imply that incorporating the so called level and garch effects in volatility improves the pricing performance of the interest rate models

one factor interest rate models and the valuation of interest rate derivative securities this paper compares different approaches to developing arbitrage free models of the term structure it presents a numerical procedure that can be used to construct a wide range of one factor models of the short rate that are both markov and consistent with the initial term structure of interest rates

rate of return regulation and product variety abstract this paper examines the effect of rate of regulation on a monopolist that faces a market of observationally identical but heterogeneous consumers under plausible technological conditions rate of return regulation increases the quality offered to any consumer and expands the variety of products it offers some consumers receive a quality that is greater than the socially optimal quality rate of return regulation unambiguously increases consumers surplus if the allowed rate of return is close to the monopoly rate of return social welfare increases as well

the effect of regulation on nonuniform electricity price schedules in the united states abstract an empirical examination of factors that influence a public utility s choice regarding the degree of nonuniformity in its price schedules is reported in this paper in particular the results support the sherman visscher theory that tighter rate of return regulation encourages a monopolist to adopt more rapidly declining rate structures some types of regulatory authority have flatter rate structures than others suggesting that the rate of return induced distortion may be countered by direct regulatory oversight somewhat surprisingly scale economics influence rate structures only weakly casting doubt on the traditional claim that average price declines because of decreasing average cost

the equity and efficiency of two part tariffs in u s natural gas markets abstractresidential natural gas customers in the united states face volumetric charges that average about 30 percent more than the marginal cost of gas this inefficient departure from marginal cost pricing allows gas utilities to cover their fixed infrastructure and operating costs proposals for recovering these costs instead through fixed monthly fees are often opposed because of a widespread belief that current rate schedules have desirable distributional consequences using nationally representative household level data we show that the correlation between household income and natural gas consumption is indeed positive but surprisingly weak so current rate schedules are only mildly progressive in part we argue that this is because poor households tend to have larger families and less energy efficient homes we calculate bill impacts under a variety of scenarios and show that even a modest energy assistance program would more than offset the distributional impact of tariff rebalancing for most low

pricing behavior of the budget constrained public enterprise abstract by assuming that a budget constrained multiproduct public enterprise chooses prices with the goal of maximizing its budget its revenue or its output specific pricing rules can be derived rather than overstating demand elasticities and then pricing like a monopolist as a budget constrained welfare maximizing firm would do the enterprise pursuing one of these alternative goals is shown to understate marginal cost and then price like a monopolist non optimal price discrimination and even cross subsidization may result the outcome tends to be more perverse when statutory entry barriers protect some markets of the enterprise in its pricing the u s postal service has shown some of the signs of such other than welfare maximizing pricing behavior

quality option profits switching option profits and variation margin costs an evaluation of their size and impact on treasury bond futures prices this paper provides empirical evidenee that the quality option in f bond futures is much less valuable than previously indicated in addition a dynamic trading strategy involving multiple switches of the cash bonds held in a long cash versus short futures position is shown to produce substantially greater profits than the single exercise of the quality op tion these findings suggest that the optimal management of long cash short futures positions is likely to involve dynamic trading strategies while passive strategies appear more appropriate for short cash long futures positions it is also shown that required variation margin payments are frequently large and may impact the profitability and risk of such positions to a greater extent than either of these options further evidenee is given indicating that observed t bond futures prices reflect an imputed value for the options and risks inherent in such positions

regulatory preferences and two part tariffs the case of electricity the purpose of this paper is to develop and demonstrate a method for deriving and testing regulatory preferences within and across customer classes and to assess the impact of these preferences on price structures and regulatory effectiveness in the electric utility industry the method extends a technique described in both nelson and ross for uncovering interclass preferences in a uniform price framework 24 33 34 by employing a two part tariff framework the extension enables the derivation of both interclass and intraclass preferences intraclass preferences can be derived in a two part tariff framework because regulators can discriminate not only between customer classes as with uniform prices but also within a customer class two part tariffs are also introduced because actual price structures in the electric utility industry are better approximated by two part tariffs than by uniform prices models of optimal two part tariffs particularly those of schmalensee and sherman and visscher are extended to allow regulatory preferences to vary across and within heterogeneous customer classes 36 37 13 27 11 25 19 18 22 2 these variable preferences are incorporated into a weighted social surplus function which regulators are assumed to maximize given this model of regulatory behavior preference weights can be derived for the electric utility industry with information on the markups of both per unit prices over marginal costs of kwh output and fixed charges over the marginal costs of customer connection and on output and connection demand elasticities

the valuation of options on coupon bonds abstract we derive simple closed form expressions for european options on coupon bonds using the general equilibrium term structure framework of cox ingersoll and ross the properties of these options are very different from those implied by the black scholes model for example bond call and put values can move in the same direction as the value of the underlying bond changes this has important implications for hedging interest rate risk with bond options furthermore bond option values can be decreasing functions of interest rate volatility as well as their time to expiration we also examine the properties of american bond options

welfare effects of price discrimination by a regulated monopolist should a multiproduct monopolist whose average price is capped by regulation be allowed to engage in third degree price discrimination if the cap applies to a price index with weights proportional to demands at uniform prices then price discrimination benefits consumers as well as the firm but if perhaps more realistically it is the firm s average revenue that is capped then consumers prefer uniform pricing in this case total output is higher when discrimination is allowed which increases welfare but marginal utilities differ across markets which is inefficient and the overall effect is ambiguous a small amount of discrimination is desirable however it is better not to allow price discrimination if the price cap is close to the level of marginal cost the consequences of tightening the price cap when discrimination is allowed are also examined

pricing interest rate derivatives a general approach the relationship between affine stochastic processes and bond pricing equations in exponential term structure models has been well established we connect this result to the pricing of interest rate derivatives if the term structure model is exponential affine then there is a linkage between the bond pricing solution and the prices of many widely traded interest rate derivative securities our results apply to m factor processes with n diffusions and l jump processes the pricing solutions require at most a single numerical integral making the model easy to implement we discuss many options that yield solutions using the methods of the article

pricing interest rate derivative securities this article shows that the one state variableinterest rate models of vasicek 1977 and cox ingersoll and ross 1985b can be extended sothat they are consistent with both the current termstructure of interest rates and either the currentvolatilities of all spot interest rates or the currentvolatilities of all forward interest rates theextended vasicek model is shown to be very tracta ble analytically the article compares option pricesobtained using the extended vasicek model withthose obtained using a number of other models