analytical solution for an investment problem under uncertainties with shocks abstract we derive the optimal investment decision in a project where both demand and investment cost are stochastic processes eventually subject to shocks we extend the approach used in dixit and pindyck 1994 to deal with two sources of uncertainty and we assume that the underlying processes are jump diffusion processes assuming certain conditions on the parameters we are able to derive a closed expression for the value of the firm finally we present comparative statics for the investment threshold with respect to the relevant parameters

bounded price variation and rational expectations in endogenous switching model of the u s corn market a model that includes bounded price variation and rational expectations by producers is estimated for the u s corn market the resulting model specification is highly nonlinear though since the probability of market equilibrium must be determined endogenously unlike previous research the cross equation restrictions implied by the rational expectations hypothesis are incorporated in the bounded prices model by using fair and taylor s 1983 procedure for obtaining maximum likelihood estimates of nonlinear rational expectations models the resulting model is compared against a standard equilibrium model with naive expectations the results show the bounded prices model is a superior specification copyright 1989 by mit press

modeling and monitoring risk acceptability in markets the case of the credit default swap market abstract minimal discounted distorted expectations across a range of stress levels are employed to model risk acceptability in markets interactions between discounting and stress levels used in measure changes are accommodated by lowering discount rates for the higher stress levels acceptability parameters represent a maximal and minimal discount rate a maximal stress level and the speed of rate reduction in response to stress an explicit model relating credit default swap cds prices to default probabilities is formulated with a view to making the default risk market acceptable data on cds prices and default probabilities for the six major us banks obtained from the risk management institute of the national university of singapore is employed to estimate parameters defining acceptability and the movements in market implied recovery rates we observe that the financial crisis saw an increase in the maximal discount rate and its spread over the minimal rate along with an increase in the maximal stress level being demanded for acceptability and a stable pattern for the speed of rate adjustment through the period the maximal rate rate spread and stress levels have come down but with periods in the interim where they have peaked as they did in the crisis recovery rates have oscillated and they did fall substantially but have recovered towards 40 percent near the end of the period

performance evaluation of optimized portfolio insurance strategies abstract we use s p 500 index return data for the time period 1985 2013 to evaluate the performance of portfolio insurance strategies we shed light on the question if the performance of a constant proportion portfolio insurance cppi strategy can be improved by means of a time varying multiplier which depends on the estimated future volatility neglecting any inter temporal hedging demand the theoretical foundation of the strategies is given by maximizing the expected utility of a hara investor in a diffusion model setup if the risk premium is assumed to be proportional to the variance the optimal strategy is a cppi strategy otherwise the multiple is time varying ppi it turns out that even time varying multiple strategies based on a rolling window of historical volatility estimates give a significant improvement of cppi strategies the out performance is robust w r t alternative performance measures and is also true for proportional transaction costs and adequate trigger trading

dynamic asset allocation with event risk major events often trigger abrupt changes in stock prices and volatility we study the implications of jumps in prices and volatility on investment strategies using the event risk framework of duffie pan and singleton 2000 we provide analytical solutions to the optimal portfolio problem event risk dramatically affects the optimal strategy an investor facing event risk is less willing to take leveraged or short positions the investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends both dynamic and buy and hold strategies jumps in prices and volatility both have important effects

jumps cojumps and macro announcements we use recently proposed tests to extract jumps and cojumps from three types of assets stock index futures bond futures and exchange rates we then characterize the dynamics of these discontinuities and informally relate them to us macroeconomic releases before using limited dependent variable models to formally model how news surprises explain co jumps nonfarm payroll and federal funds target announcements are the most important news across asset classes trade balance shocks are important for foreign exchange jumps we relate the size frequency and timing of jumps across asset classes to the likely sources of shocks and the relation of asset prices to fundamentals in the respective classes

a reinterpretation of the optimal demand for risky assets in fund separation theorems in a continuous time portfolio selection model with n risky assets and k state variables driving their risk and return parameters we derive simple expressions for the allocation to each asset in the k 1 risky funds of the k 2 fund separation theorem we show that the allocation to any given risky asset in each fund can be written in terms of the parameters of a regression of the excess returns of this asset on those of the n 1 remaining assets we also use these parameters to provide quantitative measures of the increase in sharpe ratio of the speculative demand or in the maximum correlation of each hedging demand with respect to the corresponding risk factor associated with the introduction of a new asset in the investment universe finally we show that in a multiperiod setting an asset is spanned by others if and only if it improves neither the maximum sharpe ratio of the speculative demand nor the maximum correlations of the hedging demands with the risk factors this paper was accepted

imports and the supply of winter tomatoes an application of rational expectations a model of the florida tomato industry is formulated under the hypothesis that growers make production decisions as rational economic agents this assumption implies that anticipated mexican tomato imports as well as other economic variables are taken into account when the planting decision is made maximum likelihood estimation methods are used to solve the simultaneous equations model and the implications of the model s reduced form are analyzed the empirical findings are consistent with the rational expectations hypothesis that producers respond to market information in its entirety when making acreage decisions key vwords expectations imports mexico rational expectations supply response tomatoes florida produces about 90 of u s tomatoes harvested for fresh use during the november to mid june season since the cuban trade embargo of february 1962 mexico has become the major foreign supplier of fresh winter tomatoes the total fresh winter tomato market in the united states has been almost equally shared by florida and mexico in recent years the rivalry for this market reached the point in 1978 that florida growers charged that mexican producers were dumping their product on the u s market schmitz firch hillman many florida growers suggest that unless mexican tomato imports are limited the florida tomato industry will effectively disappear primary attention in this paper is focused on domestic tomato acreage allocations in light of the mexican influence on the winter tomato market the paper does not attempt to evaluate the welfare effects of mexican imports on the florida tomato industry in addition to the emphasis on acreage response the domestic quantity and price effects are also considered most efforts to explain acreage devoted to agricultural crops have utilized some variant of a cobweb model because the ultimate price of the crop cannot be ascertained until the completion of the production cycle nevertheless if the supply and demand framework is truly representative of the way the market works an alternative to lagged price for representing the anticipated price for the crop is the price prediction of the supply and demand model itself thus acreage would be dependent on the expected price of the crop and expected price would result from the solution of the supply and demand model for price on the basis of information available at planting time the underlying hypothesis is that producers are acting in accordance with the information available to them at planting time and in a way represented by the interaction in the supply and demand model viewed in this way planted acreage decisions would be based on such factors as anticipated mexican imports and their attendant effect on the price of tomatoes one distinction between this and the traditional cobweb framework is that in the latter case lagged imports may influence planted acreage via their effect on lagged prices but any impact expected imports might have on current price is ignored in the acreage

tail risk and robust portfolio decisions this paper formulates a portfolio choice problem in a multiasset incomplete market characterized by ambiguous jumps and arbitrary tail assumptions we derive the optimal portfolio in closed form th

dynamic optimal portfolio choice in a jump diffusion model with investment constraints we consider the dynamic portfolio choice problem in a jump diffusion model where an investor may face constraints on her portfolio weights for instance no short selling constraints it is a daunting task to use standard numerical methods to solve a constrained portfolio choice problem especially when there is a large number of state variables by suitably embedding the constrained problem in an appropriate family of unconstrained ones we provide some equivalent optimality conditions for the indirect value function and optimal portfolio weights these results simplify and help to solve the constrained optimal portfolio choice problem in jump diffusion models finally we apply our theoretical results to several examples to examine the impact of no short selling and or no borrowing constraints on the performance of optimal portfolio strategies

decomposition of optimal portfolio weight in a jump diffusion model and its applications this article solves the portfolio choice problem in a multi asset jump diffusion model we decompose the optimal portfolio weight into components that correspond to a collection of fictitious economies one of which is a standard diffusion economy and the others of which are pure jump economies we derive a semi closed form solution for the optimal portfolio weight and investigate its properties with or without ambiguity aversion we find that an investor may not reduce her investment in risky assets when facing more frequent jumps as suggested by a single asset jump diffusion model moreover an investor who is extremely cautious about her estimates of higher moments of asset returns may still hold risky assets contrary to the prediction of a pure diffusion model with ambiguity aversion to the first moment

partial information about contagion risk self exciting processes and portfolio optimization abstract this paper compares two classes of models that allow for additional channels of correlation between asset returns regime switching models with jumps and models with contagious jumps both classes of models involve a hidden markov chain that captures good and bad economic states the distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously we show that in this framework the filtered loss intensities have dynamics similar to self exciting processes besides we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering

robust consumption and portfolio policies when asset prices can jump abstract we study the consumption portfolio allocation problem in continuous time when asset prices follow levy processes and the investor is concerned about potential model misspecification we derive optimal consumption and portfolio policies that are robust to uncertainty about the hard to estimate drift rate jump intensity and jump size parameters we also provide a semi closed form formula for the detection error probability and compare various portfolio holding strategies including robust and non robust policies our quantitative analysis shows that ignoring uncertainty leads to significant wealth loss for the investor

measuring country event risk compensation on brics international portfolio management the brics nations brazil russia india and china have a strong relative economic growth pattern in the world among economic powers the allure of globalization has made the analysis and assessment of national critical component of international portfolio management in recent years we construct the model from comparing the relative sd of stock return whereby higher sds are generally associated with more risk this relative sd forms a principle component in the change of the weights on the international portfolio choice the result shows that event jump risk not only makes the investor s allocation more conservative overall but also it can be compensated on brics event risk

who should buy long term bonds according to conventional wisdom long term bonds are appropriate for conservative long term investors this paper develops a model of optimal consumption and portfolio choice for infinite lived investors with recursive utility who face stochastic interest rates solves the model using an approximate analytical method and evaluates conventional wisdom as risk aversion increases the myopic component of risky asset demand disappears but the intertemporal hedging component does not conservative investors hold assets to hedge the risk that real interest rates will decline long term inflation indexed bonds are most suitable for this purpose but nominal bonds may also be used if inflation risk is low

exploring the regional implications of interstate quarantine policies in western australia abstract as a signatory of the world trade organization agreement australia has a responsibility to ensure the behaviour of its internal markets for food and food related products abide by the same rules and regulations as international trade this has generated a need to demonstrate the validity of any measures that restrict competition to avoid disputes and or retaliatory actions by other signatories this paper explores a spatial economic evaluation technique that can be used to examine the welfare implications of quarantine policies for regionalised industries and demonstrates practical application of this technique using two case studies of interstate trade within australia

a rational expectations model for the poultry sector in greece poultry meat production became systematic and business oriented from 1960 onwards especially during the period 1965 75 meat production showed a marked rise being increased nearly fivefold as a result of this increase in production greece has reached self sufficiency levels covering about 20 of total meat production compared to 7 in the early 1960s so far very little work has been done in analysing the rational expectations hypothesis in the context of a market model in this paper an attempt is made to examine the rational expectations hypothesis for the poultry meat sector within the framework of a simultaneous equations model that describes the factors affecting demand and supply as well as the link between farmers prices and consumers prices moreover in this study a rational expectations mechanism is integrated into the model and the hypothesis is tested it may be noted that poultry is a characteristic case of the operation of free market forces the structural equations of the model are e

high frequency trading and extreme price movements abstract are endogenous liquidity providers elps reliable in times of market stress we examine the activity of a common elp type high frequency traders hfts around extreme price movements epms we find that on average hfts provide liquidity during epms by absorbing imbalances created by non high frequency traders nhfts yet hft liquidity provision is limited to epms in single stocks when several stocks experience simultaneous epms hft liquidity demand dominates their supply there is little evidence of hfts causing epms

the reality of stock market jumps diversification abstract we propose a non parametric procedure for estimating systemic co jumps and independent idiosyncratic jumps for 35 stock markets and study news associated with these jumps as reported in factiva and bloomberg from 1988 to 2014 our results suggest that it is important to distinguish between systemic co jumps and idiosyncratic jumps we find both types of jumps have important implications for home bias investors while idiosyncratic jumps have economically significant impact on portfolio weights for emerging markets our news analysis suggests systemic jumps are typically caused by currency crises sectoral failure liquidity issues and deteriorating economic climate while idiosyncratic jumps are usually caused by political unrest currency instability and large firm effects on small economies in fact many of the idiosyncratic jumps share the same origin although different stock markets experienced the impact differently at different times

evolutionary portfolio selection with liquidity shocks insurance companies invest their wealth in financial markets the wealth evolution strongly depends on the success of their investment strategies but also on liquidity shocks which occur during unfavourable years when indemnities to be paid to the clients exceed collected premia an investment strategy that does not take liquidity shocks into account exposes insurance companies to the risk of bankruptcy when liquidity shocks and low investment payoffs jointly appear therefore regulatory authorities impose solvency restrictions to ensure that insurance companies are able to face their obligations with high probability this paper analyses the behaviour of insurance companies in an evolutionary framework we show that an insurance company that merely satisfies regulatory constraints will eventually vanish from the market we give a more restrictive no bankruptcy condition for the investment strategies and we characterize trading strategies that are evolutionary stable i e able to drive out any mutation

risk behavior and rational expectations in the u s broiler market this study examines the empirical implications of extending the rational expectations hypothesis reh to include price uncertainty a general estimation framework that incorporates both the restrictions on structural parameters and the variance covariance terms is developed garch time series processes are used to generate time varying expectations of both the means and the variances of exogenous variables the empirical application is with a quarterly model of the u s broiler industry the results indicate that the rational expectation of price variance is an important determinant of broiler supply a formal test indicates that the restrictions implied by the reh cannot be rejected

information expected utility and portfolio choice we study the consumption investment problem of an agent with a constant relative risk aversion preference function who possesses noisy information about the future prospects of a stock we also solve for the value of information to the agent in closed form we find that information can significantly alter consumption and asset allocation decisions for reasonable parameter ranges information increases consumption in the vicinity of 25 information can shift the portfolio weight on a stock from 0 to around 70 thus de pending on the stock beta the weight on the market portfolio can be considerably reduced with information causing the appearance of underdiversification the model indicates that stock holdings of informed agents are positively related to wealth unrelated to systematic risk and negatively related to idiosyncratic uncertainty we also show that the dollar value of information to the agent depends linearly on his wealth and decreases with both the propensity to intermediate consumption and risk aversion

dynamic equilibrium in markets for perennial crops a dynamic equilibrium model for perennial crop markets is formulated price expectations are formed according to perfect foresight and both the age composition of the crop and the optimal rotation are determined endogenously the model is applied to the california alfalfa market the calculated long run equilibrium acreage is quite close to average acreage over the base period the results also exhibit cyclical fluctuations in acreage with a six percent coefficient of variation thus cyclical behavior can arise from technical characteristics of the production process as well as from imperfectly formed expectations or random exogenous shocks

on the stochastic properties of carbon futures prices pricing carbon is a central concern in environmental economics due to the worldwide importance of emissions trading schemes to regulate pollution this paper documents the presence of small and large jumps in the stochastic process of the co 2 futures price the large jumps have a discrete origin i e they can arise from various demand factors or institutional decisions on the tradable permits market contrary to the existing literature we show that the stochastic process of carbon futures prices does not contain a continuous component brownian motion the results are derived by using high frequency data in the activity signature function framework todorov and tauchen in j econom 154 125 138 2010 todorov and tauchen in j bus econ stat 29 356 371 2011 the implication is that the carbon futures price should be modeled as an appropriately sampled centered levy or poisson process the pure jump behavior of the carbon price might be explained by the lower volume of trades on this allowance market compared to other highly liquid financial markets

agricultural export dumping the case of mexican winter vegetables in the u s market this paper examines the 1978 agricultural dumping charge brought by florida winter vegetable producers against mexican growers it discusses fair value in the context of three antidumping criteria prices at home and abroad selling below cost of production and third market test the u s department of commerce found in favor of the mexican producers by using the third market test a test which leads to ambiguous results it is the authors contention that the law should be changed so that future cases can be decided on a normal business practice concept accounting for production and costing decisions unique to highly perishable products

u s mexican trade in winter vegetables and illegal immigration this paper presents an integrated approach to u s mexican trade in a labor intensive commodity fresh winter tomatoes and illegal immigration of agricultural labor a seven equation econometric model is developed that includes excess demand u s import and supply mexican export equations for fresh winter tomatoes u s demand and mexican supply equations for apprehensible individuals intercountry price and wage relationship equations and a u s border patrol apprehension effort equation the empirical results indicate that both u s and mexico economic conditions affect the number of apprehended illegal mexican aliens the results also indicate that immigration and trade policies affect apprehensions

modeling time series information into option prices an empirical evaluation of statistical projection and garch option pricing model abstract this paper compares the empirical performances of statistical projection models with those of the black scholes adapted to account for skew and the garch option pricing models empirical analysis on s p500 index options shows that the out of sample pricing and projected trading performances of the semi parametric and nonparametric projection models are substantially better than more traditional models results further indicate that econometric models based on nonlinear projections of observable inputs perform better than models based on ols projections consistent with the notion that the true unobservable option pricing model is inherently a nonlinear function of its inputs the econometric option models presented in this paper should prove useful and complement mainstream mathematical modeling methods in both research and practice

optimal filtering of jump diffusions extracting latent states from asset prices this paper provides an optimal filtering methodology in discretely observed continuoustime jump diffusion models although the filtering problem has received little attention it is useful for estimating latent states forecasting volatility and returns computing model diagnostics such as likelihood ratios and parameter estimation our approach combines time discretization schemes with monte carlo methods it is quite general applying in nonlinear and multivariate jump diffusion models and models with nonanalytic observation equations we provide a detailed analysis of the filter s performance and analyze four applications disentangling jumps from stochastic volatility forecasting volatility comparing models via likelihood ratios and filtering using option prices and returns jel c11 c13 c15 c51 c52 g11 g12 g17 this paper develops a filtering approach for learning about unobserved shocks and states from discretely observed prices generated by continuous time jumpdiffusion models the optimal filtering problem which has received little attention is the natural companion to the parameter estimation problem as filters allow researchers to analyze and use their models for practical applications 1 despite its usefulness there is currently no general method for solving the filtering problem in continuous time models

an explicit multi factor credit default swap pricing model with correlated factors with the recent significant growth in the single name credit default swap cds market has come the need for accurate and computationally efficient models to value these in struments while the model developed by duffie pan and singleton 2000 can be used the solution is numerical solving a series of ordinary differential equations rather than explicit in this paper we provide an explicit solution to the valuation of a credit default swap when the interest rate and the hazard rate are correlated by using the change of measure approach and solving a bivariate riccati equation cds transaction data for the period 2 15 2000 through 4 8 2003 for 60 firms are used to test both the goodness of fit of the model and provide estimates of the influence of economic variables in the market for credit risky bonds

dynamic hedging and extreme asset co movements the paper investigates the portfolio allocation effects of increased asset co movements during market downturns we develop a model for the stock price process that allows for increased and asymmetric dependence between extreme return realizations we isolate the portfolio hedging demands that arise due to extreme co movements and find a substantial shift of the portfolio holdings toward the risk free asset we demonstrate that accounting for dependence between extreme events in portfolio decisions leads to significant economic gains that stem primarily from intertemporal hedging motives these findings are robust along alternative modeling assumptions of extreme co movements and conditional correlation

who determines mexican trade policy using a political economy approach the authors analyze the pattern of protection in mexico s manufacturing sector during the period of trade policy reforms 1985 89 when mexico experienced significant trade liberalization and an important inflow of foreign direct investment they take into account the potential effect of foreign direct investment on endogenous tariff formation it turns out that the data support this analytic approach in which the formulation of trade policy reflects political support and in which the presence of foreign direct investment in the sector strongly affects the pattern of tariff protection before and after reform in mexican manufacturing especially sectors with heavy foreign direct investment received greater protection in import competing sectors although the move toward greater openness was associated with a reduction in the influence of industrial and foreign investor lobbying

modeling expectations of bounded prices an application to the market for corn the presence of farm programs should directly affect the expectations of producers this paper analyzes the formation of price expectations when price supports constitute an effective lower bound on the distribution of the expectations we first investigate what the expected price would be if the usual rational expectations formula is used this leads to a relationship that is not estimable we suggest two alternatives one based on a tobit approximation and the other based on a perfect prediction of when the support is going to be effective using a simplified model of the u s corn market the methodology is demonstrated and compared to an alternative method of using futures prices as the expectation of harvest price the analysis of supply response for the major u s field crops is made difficult due to government intervention in these markets this intervention has been characterized by the use of price supports acreage diversion storage incentives etc during the last thirty years many studies have analyzed producer behavior in the presence of governmental involvement such studies have typically been concerned with modeling the effect of supports and diversions in an ex post sense rather than with how producers used the knowledge of farm programs to form their expectations if producers are rational economic agents their expectations of harvest prices should be conditioned both by free market forces and the type and degree of governmental intervention in the market of course farm programs have varied in nature and extent during the past thirty years and it is doubtful that any structural model could capture their complexities in this paper we attempt to introduce rational expectations in a simplified model of the u s corn market in essence we focus on the formation of price expectations when price supports constitute an effective lower bound on the distribution of the expectations we proceed by developing a theoretical model that connects the rational expectations model with a model of bounded price variation it is shown that one representation that may characterize the corn market is a triangular structural system with endogenous switching a full information maximum likelihood estimator is proposed for the system next an empirical model is specified and estimated the model is evaluated in comparison to an augmented model that contains a futures price so that some inferences may be made concerning the rational expectations model s success in summarizing relevant market information expectations under bounded prices consider a market that may be represented by a simple supply and demand system q a pt a2w el supply function pt b qt b2xt e2t demand function 1 where p and q represent market price and quantity w and x represent supply and demand shifters and p represents the rational expectation of product price at the time production decisions are made note that this system has a familiar recursive structure when the expected price variable is specified in terms of one or more lagged prices when the restricted reduced form of the structural system is solved for in terms of the expected price and this expression is used to replace pj wallis 1980 then models similar to those of goodwin and sheifrin 1982 and shonkwiler and emerson 1982

pricing and hedging in incomplete markets abstract we present a new approach for positioning pricing and hedging in incomplete markets that bridges standard arbitrage pricing and expected utility maximization our approach for determining whether an investor should undertake a particular position involves specifying a set of probability measures and associated floors which expected payoffs must exceed in order for the investor to consider the hedged and financed investment to be acceptable by assuming that the liquid assets are priced so that each portfolio of assets has negative expected return under at least one measure we derive a counterpart to the first fundamental theorem of asset pricing we also derive a counterpart to the second fundamental theorem which leads to unique derivative security pricing and hedging even though markets are incomplete for products that are not spanned by the liquid assets of the economy we show how our methodology provides more realistic bid ask spreads

systemic risk and international portfolio choice returns on international equities are characterized by jumps moreover these jumps tend to occur at the same time across countries leading to systemic risk we capture these stylized facts using a multivariate system ofjump diffusion processes where the arrival of jumps is simultaneous across assets we then determine an investor s optimal portfolio for this model of returns systemic risk has two effects one it reduces the gains from diversification and two it penalizes investors for holding levered positions we find that the loss resulting from diminished diversification is small while that from holding very highly levered positions is large returns on international equities are characterized by jumps 1 moreover these jumps tend to occur at the same time across countries implying that conditional correlations between international equity returns tend to be higher in periods of high market volatility or following large downside moves 2 our objective in

optimal portfolio allocation with volatility and co jump risk that markowitz would like abstract we study a continuous time optimal portfolio allocation problem with volatility and co jump risk allowing prices variances and covariances to jump simultaneously differently from the traditional approach we deviate from affine models by specifying a flexible wishart jump diffusion for the co precision the inverse of the covariance matrix the optimal portfolio weights that solve the dynamic programming problem are genuinely dynamic and proportional to the instantaneous co precision reconciling optimal dynamic allocation with the static markowitz type economic intuition an application to the optimal allocation problem across hedge fund investment styles illustrates the importance of having jumps in volatility associated with jumps in price

the equilibrium allocation of diffusive and jump risks with heterogeneous agents abstract we study a two agent pure exchange equilibrium subject to both nondiversifiable diffusive and jump risks agents can trade in a financial market consisting of a stock market a money market and an insurance market for jump risk heterogeneity is introduced through different levels of relative risk aversion in the framework of standard expected utility we find the surprising result that the less risk averse agent purchases insurance contracts against jump risk from the more risk averse agent this equilibrium allocation is linked to the non linear wealth sharing rule in such an economy and preserves the wealth effects studied by dumas rev financ stud 2 1989 157 in the case of pure diffusive risk since the benchmark economy with homogeneous agents generates no excess uncertainty in the stock market we study the effect on excess volatility and excess jump size solely due to different levels of relative risk aversion we observe 3 excess uncertainty in jump sizes for a reasonable specification of economic fundamentals

downside loss aversion and portfolio management downside loss averse preferences have seen a resurgence in the portfolio management literature this is due to the increasing use of derivatives in managing equity portfolios and the increased use of quantitative techniques for bond portfolio management we employ the lower partial moment as a risk measure for downside loss aversion and compare mean variance m v and mean lower partial moment m lpm optimal portfolios under nonnormal asset return distributions when asset returns are nearly normally distributed there is little difference between the optimal m v and m lpm portfolios when asset returns are nonnormal with large left tails we document significant differences in m v and m lpm optimal portfolios this observation is consistent with industry usage of m v theory for equity portfolios but not for fixed income portfolios

consuming durable goods when stock markets jump a strategic asset allocation approach in this paper we show the impact of considering jumps in the return process of risky assets when deciding how to invest and consume throughout time agents derive their utilities from consumption over time we consider an agent that invests in the financial market and in durable and perishable consumption goods assuming that there are costs for transacting the durable good we show that an agent who does not consider the possibility of jumps will make suboptimal decisions not only regarding the fraction of wealth invested in the stock market but also with respect to the timing for trading on the durable good furthermore we also show that jumps cause a non obvious asymmetric impact on the thresholds that lead the consumer to trade the durable good even when the jump distribution is symmetric

optimal portfolios when variances and covariances can jump abstract we analyze the optimal portfolio choice in a multi asset wishart model in which return variances and correlations are stochastic and subject to jump risk the optimal portfolio is characterized by the positions in stock diffusion risk variance covariance diffusion risk and jump risk we find that including jumps in the second moments changes the optimal positions and particularly variance covariance hedging demands significantly erroneously omitting these jumps gives rise to substantial model risk furthermore variance covariance jump risk can have a significant impact on potential utility gains when the market is completed by adding derivatives as a robustness check we compare our results to those obtained for other parametrizations of wishart models from the literature as well as to various single asset models

robustness of stable volatility strategies abstract the paper analyzes the robustness of stable volatility strategies i e strategies in which the portfolio weight of the stock is inversely proportional to its local volatility these strategies are optimal for a crra investor if the stock follows a diffusion process the expected excess return is proportional to its volatility and the hedging demand is zero we assess the performance of stable volatility strategies when these restrictive assumptions do not hold in particular when the risk premium is not proportional to volatility and when the stock price is subject to jumps we find that stable volatility strategies are indeed robust or close to robust under a maxmin decision rule in addition to our theoretical results we perform a simulation analysis to evaluate strategies that scale the portfolio weight by the volatility variance or a constant portfolio weight and also analyze the strategies using empirical excess returns both analyses confirm the robustness of stable volatility strategies

tails fears and risk premia we show that the compensation for rare events accounts for a large fraction of the average equity and variance risk premia exploiting the special structure of the jump tails and the pricing thereof we identify and estimate a new investor fears index the index reveals large time varying compensation for fears of disasters our empirical investigations involve new extreme value theory approximations and high frequency intraday data for estimating the expected jump tails under the statistical probability measure and short maturity out of the money options and new model free implied variation measures for estimating the corresponding risk neutral expectations

correlation risk and optimal portfolio choice we develop a new framework for multivariate intertemporal portfolio choice that allows us to derive optimal portfolio implications for economies in which the de gree of correlation across industries countries or asset classes is stochastic optimal portfolios include distinct hedging components against both stochastic volatility and correlation risk we find that the hedging demand is typically larger than in univari ate models and it includes an economically significant covariance hedging compo nent which tends to increase with the persistence of variance covariance shocks the strength of leverage effects the dimension of the investment opportunity set and the presence of portfolio constraints this paper develops a new multivariate modeling framework for intertempo ral portfolio choice under a stochastic variance covariance matrix we consider an incomplete market economy in which stochastic volatilities and stochastic correlations follow a multivariate diffusion process in this setting volatili ties and correlations are conditionally correlated with returns and optimal portfolio strategies include distinct hedging components against volatility and correlation risk we solve the optimal portfolio problem and provide simple closed form solutions that allow us to study the volatility and covariance hedg ing demands in realistic asset allocation settings we document the importance of modeling the multivariate nature of second moments especially in the con text of optimal asset allocation and find that the optimal hedging demand can be significantly different from the one implied by more common models with constant correlations or single factor stochastic volatility an important thread within the asset pricing literature has documented the characteristics of the time variation in the covariance matrix of asset

regime shifts in a dynamic term structure model of u s treasury bond yields this article develops and empirically implements an arbitrage free dynamic term structure model with priced factor and regime shift risks the risk factors are assumed to follow a discrete time gaussian process and regime shifts are governed by a discrete time markov process with state dependent transition probabilities this model gives closed form solutions for zero coupon bond prices an analytic representation of the likelihood function for bond yields and a natural decomposition of expected excess returns to components corresponding to regime shift and factor risks using monthly data on u s treasury zero coupon bond yields we show a critical role of priced state dependent regime shift risks in capturing the time variations in expected excess returns and document notable differences in the behaviors of the factor risk component of the expected returns across high and low volatility regimes additionally the state dependence of the regime switching probabilities is shown to capture an interesting asymmetry in the cyclical behavior of interest rates the shapes of the term structure of volatility of bond yield changes are also very different across regimes with the well known hump being largely a low volatility regime phenomenon jel g12 this article develops and empirically implements an arbitrage free dynamic term structure model dtsm with priced factor and regimeshift risks the risk factors are assumed to follow a discrete time gaussian process and regime shifts are governed by a discrete time markov process with state dependent transition probabilities agents are assumed to know both the current state of the economy and the regime they are currently in this leads to regime dependent risk neutral pricing and an equilibrium term structure that reflects the risks of both changes in the state and shifts in regimes

portfolio choice with illiquid assets we present a model of optimal allocation to liquid and illiquid assets where illiquidity risk results from the restriction that an asset cannot be traded for intervals of uncertain duration illiquidity risk leads to increased and state dependent risk aversion and reduces the allocation to both liquid and illiquid risky assets uncertainty about the length of the illiquidity interval as opposed to a deterministic nontrading interval is a primary determinant of the cost of illiquidity we allow market liquidity to vary from normal periods when all assets are fully liquid to illiquidity crises when some assets can only be traded infrequently the possibility of a liquidity crisis leads to limited arbitrage in normal times investors are willing to forgo 2 of their wealth to hedge against illiquidity crises occurring once every 10 years this paper was accepted by itay goldstein finance

a pure jump transaction level price model yielding cointegration we propose a new transaction level bivariate log price model that yields fractional or standard cointegration the model provides a link between market microstructure and lower frequency observations the two ingredients of our model are a long memory stochastic duration process for the waiting times k between trades and a pair of stationary noise processes ek and k which determine the jump sizes in the pure jump log price process our model includes feedback between the disturbances of the two log price series at the transaction level which induces standard or fractional cointegration for any fixed sampling interval t we prove that the cointegrating parameter can be consistently estimated by the ordinary least squares estimator and we obtain a lower bound on the rate of convergence we propose transaction level method of moments estimators of the other parameters in our model and discuss the consistency of these estimators

jump spillovers in energy futures markets implications for diversification benefits abstract in this paper we investigate jump spillover effects of five energy petroleum futures and their implications for diversification benefits in order to identify the latent historical jumps for each of these energy futures we use a bayesian mcmc approach to estimate a jump diffusion model for each we examine the simultaneous jump intensities of pairs of energy futures and the probabilities that jumps in crude oil and natural gas cause jumps or usually large returns in other energy futures in all cases we find significant evidence that the diffusion jump process is a better characterization for energy futures prices we further find that jump spillovers significantly reduce the diversification benefits of an energy futures portfolio in a tranquil rather than crisis period

a multimarket bounded price variation model under rational expectations corn and soybeans in the united states the bounded prices model under rational expectations is extended to a multimarket setting because the resulting rational expectations model is highly nonlinear fair and taylor s iterative procedure is employed in conjunction with the multimarket framework to obtain maximum likelihood estimates of a supply demand model for corn and soybeans the estimated model is then used to simulate the market equilibrium effects associated with removing price support and acreage set aside programs over the sample period among other things the results reveal that acreage set asides have dominated the induced supply effects of price support programs for corn

a jump model for fads in asset prices under asymmetric information abstract this paper addresses how asymmetric information fads and levy jumps in the price of an asset affect the optimal portfolio strategies and maximum expected utilities of two distinct classes of rational investors in a financial market we obtain the investors optimal portfolios and maximum expected logarithmic utilities and show that the optimal portfolio of each investor is more or less than its merton optimal our approximation results suggest that jumps reduce the excess asymptotic utility of the informed investor relative to that of uninformed investor and hence jump risk could be helpful for market efficiency as an indirect reducer of information asymmetry our study also suggests that investors should pay more attention to the overall variance of the asset pricing process when jumps exist in fads models moreover if there are very little or too much fads then the informed investor has no utility advantage in the long run

earning the right premium on the right factor in portfolio planning abstract the optimal portfolio as well as the utility from trading stocks and derivatives depends on the risk factors and on their market prices of risk we analyze this dependence for a crra investor in models with stochastic volatility jumps in the stock price and jumps in volatility we find that the compartment of the total variance into diffusion risk and jump risk has a small impact on the utility in an incomplete market only in contrast the decomposition of the equity risk premium into a diffusion component and a jump risk component and the compartment of the latter into its various elements has a huge impact on the utility in a complete market the more extreme the market prices of risk i e the more they deviate from their equilibrium values the larger the utility of the investor additionally we show that the structure of the optimal exposures to jump risk crucially depends on which elements of jump risk are priced

semi analytical solutions for dynamic portfolio choice in jump diffusion models and the optimal bond stock mix this paper studies the optimal portfolio selection problem in jump diffusion models where an investor has a hara utility function and there are potentially a large number of assets and state variables more specifically we incorporate jumps into both stock returns and state variables and then derive semi analytical solutions for the optimal portfolio policy up to solving a set of ordinary differential equations to greatly facilitate economic insights and empirical applications of jump diffusion models to examine the effect of jump risk on investors behavior we apply our results to the bond stock mix problem and particularly revisit the bond stock ratio puzzle in jump diffusion models our results cast new light on this puzzle that unlike pure diffusion models it cannot be rationalized by the hedging demand assumption due to the presence of jumps in stock returns

how important is intertemporal risk for asset allocation how important is merton s intertemporal risk for asset allocation decisions to address this question we jointly estimate and test a conditional asset pricing model which includes long term interest rate risk as a potentially priced factor for four broad classes of assets large stocks small stocks long term treasury bonds and corporate bonds we find that the premium for long bond risk is the main component of the risk premiums of treasury bond and corporate bond portfolios while it represents a small fraction of total risk premiums for equities our results suggest that investors perceive stocks and especially small stocks as hedges against variations in the investment opportunity set since these four asset classes represent some of the most important for investors we proceed to use our estimates to compute the optimal asset allocations for investors who optimize with or without taking into account the intertemporal risk we provide a set of measures to investigate the importance of this risk we find that at average market volatility levels investors can earn annual premiums between 3 6 during expansions and 5 8 during recessions for bearing intertemporal risk alone these results underscore the importance of explicitly considering intertemporal risk in asset allocation decisions especially during down markets and business recessions

a discontinuous mispricing model under asymmetric information we study a discontinuous mispricing model of a risky asset under asymmetric information where jumps in the asset price and mispricing are modelled by levy processes by contracting the filtration of the informed investor we obtain optimal portfolios and maximum expected utilities for the informed and uninformed investors we also discuss their asymptotic properties which can be estimated using the instantaneous centralized moments of return we find that optimal and asymptotic utilities are increased due to jumps in mispricing for the uninformed investor but the informed investor still has excess utility provided there is not too little or too much mispricing

jumps in financial markets a new nonparametric test and jump dynamics this paper introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intra day level we demonstrate that the likelihood of misclassiflcation of jumps becomes negligible when we use high frequency returns using our test we examine jump dynamics and their distributions in the u s equity markets the results show that individual stock jumps are associated with prescheduled earnings announcements and other company speciflc news events additionally s p 500 index jumps are associated with general market news announcements this suggests difierent pricing models for individual equity options versus index op

ambiguity and nonparticipation the role of regulation we investigate the implications of ambiguity aversion for performance and regulation of markets in our model agents decision making may incorporate both risk and ambiguity and we demonstrate that nonparticipation arises from the rational decision by some traders to avoid ambiguity in equilibrium these participation decisions affect the equilibrium risk premium and distort market performance when viewed from the perspective of traditional asset pricing models we demonstrate how regulation particularly regulation of unlikely events can moderate the effects of ambiguity thereby increasing participation and generating welfare gains our analysis demonstrates how legal systems affect participation in financial markets through their influence on ambiguity the author 2009 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oxfordjournals org oxford university press

portfolio choice under transitory price impact abstract we consider a portfolio optimization problem for a short term investor who faces an illiquid stock market the illiquidity of this market results from a transitory price impact that is captured by the transaction costs that are convex in the number of shares traded by an investor the linear component in these costs defines a no trading zone while the nonlinear component does not allow trading the stock at an arbitrary rate the portfolio choice problem is solved when the stock path is continuous and when the stock may crash we find that an economy could be in states where the conditional liquidity premium is of the same order of magnitude as the historical risk premium of the stock market if the illiquid stock undergoes crashes then in many states an investor demands a premium for crashes that is much higher than that in the liquid market finally we study the shape of the no trading zone when the nonlinearity in the transitory price impact is strong or moderate we find that this shape is significantly different from that when the transitory price impact is linear

optimal portfolios when volatility can jump abstract we consider an asset allocation problem in a continuous time model with stochastic volatility and jumps in both the asset price and its volatility first we derive the optimal portfolio for an investor with constant relative risk aversion the demand for jump risk includes a hedging component which is not present in models without volatility jumps we further show that the introduction of derivative contracts can have substantial economic value we also analyze the distribution of terminal wealth for an investor who uses the wrong model either by ignoring volatility jumps or by falsely including such jumps or who is subject to estimation risk whenever a model different from the true one is used the terminal wealth distribution exhibits fatter tails and in some cases significant default risk