auditors response to political connections and cronyism in malaysia this paper extends the literature on the role of political economy in financial reporting and auditing by testing two hypotheses the first hypothesis predicts that there will be a greater increase in audit effort and audit fees for malaysian firms with political connections as a result of the asian financial crisis than for non politically connected firms because these firms have a higher risk of financial misstatements the second hypothesis predicts that the audit fees of politically connected firms will decline when capital controls are introduced by the government as a ploy to financially assist politically connected firms to rebound from the crisis and thus reduces the risk of financial misstatements the results show that there is a greater increase in audit fees for firms with political connections than for non politically connected firms as a result of the asian financial crisis however there is a decline in audit fees for politically connected firms after the capital controls are implemented

what do we know about macroeconomics that fisher and wicksell did not the answer to the question in the title is a lot in this essay i argue that the history of macroeconomics during the 20th century can be divided into three epochs

hedge fund seeding via fees for seed swaps under idiosyncratic risk we develop a dynamic valuation model of the hedge fund seeding business by solving the consumption and portfolio choice problem for a risk averse manager who launches a hedge fund through a seeding vehicle this vehicle i e fees for seed swap specifies that a strategic partner seeder provides a critical amount of capital in exchange for participation in the funds revenue our results indicate that the new swap not only solves the serious problem of widespread financing constraints for new and early stage funds esfs managers but can be highly beneficial to both the manager and the seeder if structured properly

state dependent pricing and the dynamics of money and output standard macroeconomic models of price stickiness assume that each firm leaves its price unchanged for a fixed amount of time we present an alternative model in which the pricing decision depends on the state of the economy we find a method of aggregating individual price changes that allows a simple characterization of macroeconomic variables the model produces a positive money output correlation and an empirical phillips curve in addition the impact of monetary shocks depends crucially on the current level of output which points to a natural connection between state dependent microeconomics and state dependent macroeconomics i introduction there is a long tradition in macroeconomics of attributing the real effects of nominal demand shocks to nominal price stickiness in this view if there is no change in prices when nominal demand rises then quantities must bear the burden of adjustment hence nominal price rigidity provides the friction needed for nominal demand shocks to be transmitted to the real economy standard models of this transmission mechanism such as fischer 1977 and taylor 1980 are based on the assumption that each firm leaves its price unchanged for a fixed amount of time the main reason for considering such time dependent pricing rules is their analytic tractability constraining firms to adjust their prices at prespecified times both simplifies the derivation of equilibrium strategies and allows the use of powerful time series techniques to analyze aggregate dynamics the main disadvantage of the timedependent approach is that between price adjustments firms are not allowed to respond even to extreme changes of circumstance this makes it difficult to know whether the qualitative effects of money in these models are the result of nominal rigidities per se or of the exogenously imposed pattern of price changes an alternative approach to modeling price stickiness is to allow the price setting decision to depend on the actual state of the

uma breve historia sobre a abordagem de desequilibrio na macroeconomia this paper presents a brief history of non market clearing approach emphasizing its macroeconomics developments this episode is part of keynesian reaction to neoclassical synthesis crises while friedman and lucas classical reaction is widely known disequilibrium approach became a virtually forgotten episode in the history of economic thought disequilibrium authors aimed to develop a framework sustained in analytical primitives distinct from those that became dominant after new classical methodological victory in that scheme keynesian model was no longer a special case of the classical world but actually the exact opposite that was a singular episode which should not be understood as neoclassical synthesis height or the first movements toward new keynesian economics we also discuss the causes of its failure in became the new mainstream

an asset allocation puzzle comment should the proportion of risky assets in the risky part of an investor s portfolio depend on the investor s risk aversion according to basic financial theory in particular the mutual fund separation theorem with a riskless asset the answer is no the theorem states that rational investors should divide their assets between a riskless asset and a risky mutual fund the composition of which is the same for all investors risk aversion affects only the allocation between the riskless asset and the fund however niko canner et al 1997 cmw hereafter observed that popular investment advice does not conform to this theory they reported the stocks bonds and cash allocations recommended by four advisors for conservative moderate and aggressive investors as shown in table 1 which is reproduced from cmw the advisors recommend a bond stock ratio that varies directly with risk aversion for example fidelity recommends a bond stock ratio of 1 50 for a conservative more riskaverse investor a ratio of 1 00 for a moderate less risk averse investor and a ratio of 0 46 for an aggressive still less risk averse investor the inconsistency between such advice and the separation theorem is called an asset allocation puzzle by cmw they attempted to solve the puzzle by relaxing key assumptions in the theory but finally reached a negative conclusion although we cannot rule out the possibility that popular advice is consistent with some model of rational behavior we have so far been unable to find such a model p 181 however they suggested that consideration of intertemporal trading might help resolve the puzzle in the present paper we provide theoretical support for the popular advice the two key insights are that the investor s horizon may exceed the maturity of the cash asset and that the investor rebalances the portfolio as time passes if the investor s horizon exceeds the maturity of cash which might be a money market security with maturity of one to six months then cash is not the riskless asset as is commonly assumed in the basic theory in a theory allowing portfolio rebalancing as opposed to a buy and hold framework it is not unreasonable to assume that the investor can synthesize a riskless asset a zero coupon bond maturing at the horizon using a bond fund and cash then bonds will be both in the synthetic riskless asset and in the risky mutual fund and we show that in this case the theoretical bond stock ratio varies directly with risk aversion for any hyperbolic absolute risk aversion hara investor as an example of the type of results that a specific model can produce we provide a continuous time model with closed form solutions which produces theoretical bond stock ratios similar to the popular advice the present paper is organized as follows in the next section we analyze the popular advice in terms of the theory of mutual fund separation of david cass and joseph e stiglitz 1970 we show that this theory is relevant both in static and dynamic frameworks and use it to analyze the popular advice in complete and incomplete markets in section ii we analyze the popular advice in the context of robert c merton s 1971 continuous time statement of mutualfund separation and present an illustrative model in which a crra investor makes continuous time portfolio decisions under interest rate and stock price uncertainty in section iii numerical results are compared with the popular advice section iv is a conclusion bajeux besnainou department of finance school of business and public management george washington university 2023 g street nw washington dc 20052 jordan national economic research associates 1255 23rd street nw washington dc 20037 portait cnam and essec finance chair cnam 2 rue conte paris france this research was supported by a grant from the institute for quantitative investment research we thank two anonymous referees for their comments 1 hara functions include quadratic utility which is one way of justifying mean variance preferences and constant relative risk aversion crra utility both quadratic and crra utility were considered in the cmw analysis

consumer demand and equilibrium unemployment in a working model of the customer market incentive wage economy though not conceived as a constant the natural unemployment rate was taken to be invariant to supply shocks until the late seventies and to real demand shocks until now the largely micro theoretic model here is one in a series deriving the natural rate path from general equilibrium in this model the labor market exhibits generalized real wage rigidity resulting from the use of incentive wages to combat shirking and the asset backing shares is the firms customers arising from customer market friction one finding is that increased consumer demand drives up the natural rate by driving real interest rates up

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

optimal portfolio policies with borrowing and shortsale constraints abstract we characterize optimal intertemporal portfolio policies for investors with crra utility facing either a borrowing constraint or shortsale restrictions or both the optimal constrained portfolios are identified as optimal unconstrained portfolios for a higher riskless rate or for a subset of the risky assets or for a combination of the two settings our characterization is based on duality results in cvitanic and karatzas 1992 annals of applied probability 2 767 818 for optimal portfolio investment when portfolio values are more generally constrained to a closed convex nonempty subset of r n

risk aversion in a dynamic asset allocation experiment we conduct a controlled laboratory experiment in the spirit of merton 1971 in which subjects dynamically choose their portfolio allocation between a risk free and risky asset using the optimal allocation of an investor with hyperbolic absolute risk aversion hara utility we fit the experimental choices to characterize the risk profile of our participants despite substantial heterogeneity decreasing absolute risk aversion and increasing relative risk aversion are the predominant types we also find some evidence of increased risk taking after a gain finally the session level risk attitudes show a different profile than the individual descriptions of risk attitudes

mean variance portfolio selection of cointegrated assets abstract this paper considers the continuous time mean variance portfolio selection problem in a financial market in which asset prices are cointegrated the asset price dynamics are then postulated as the diffusion limit of the corresponding discrete time error correction model of cointegrated time series the problem is completely solved in the sense that solutions of the continuous time portfolio policy and the efficient frontier are obtained as explicit and closed form formulas the analytical results are applied to pairs trading using cointegration techniques numerical examples show that identifying a cointegrated pair with a high mean reversion rate can generate significant statistical arbitrage profits once the current state of the economy sufficiently departs from the long term equilibrium we propose an index to simultaneously measure the departure level of a cointegrated pair from equilibrium and the mean reversion speed based on the mean variance paradigm an empirical example is given to illustrate the use of the theory in practice

dynamic portfolio choice with parameter uncertainty and the economic value of analysts recommendations we derive a closed form solution for the optimal portfolio of a non myopic utility maximizer who has incomplete information about the alphas or abnormal returns of risky securities we show that the hedging component induced by learning about the expected return can be a substantial part of the demand using our methodology we perform an ex ante empirical exercise which shows that the utility gains resulting from optimal allocation are substantial in general especially for long horizons and an ex post empirical exercise which shows that analysts recommendations are not very useful

optimal portfolio management with american capital guarantee abstract the aim of the paper is to investigate finite horizon portfolio strategies which maximize a utility criterion when a constraint is imposed on a terminal date european guarantee or on every intermediate date american guarantee we prove the optimality of the option based portfolio insurance method for both european and american cases when an expected crra utility function is maximized the american obpi is fully described in a black scholes environment as well as in the more general case of complete markets using the gittins index techniques developed by el karoui and karatzas 1995 optimality results are extended to general utility functions

continuous time mean variance asset allocation a time consistent strategy abstract we develop a numerical scheme for determining the optimal asset allocation strategy for time consistent continuous time mean variance optimization any type of constraint can be applied to the investment policy the optimal policies for time consistent and pre commitment strategies are compared when realistic constraints are applied the efficient frontiers for the pre commitment and time consistent strategies are similar but the optimal investment strategies are quite different

basel s value at risk capital requirement regulation an efficiency analysis abstract we analyze the optimal portfolio policies of expected utility maximizing agents under var capital requirement var cr regulation in comparison to the optimal policy under exogenously imposed var limit var l and limited expected loss lel regulations with var cr regulation the agent strategy consists of simultaneous decisions on both the portfolio var and on the implied amount of required eligible capital as a result the performance of var cr regulation depends on its design the parameter n and the agent preferences we show that an optimal var cr regulation allows the regulator on the one hand to completely eliminate the exposure to the largest losses which may jeopardize the existence of the institution and on the other hand to restrain the portfolio exposure to all other losses these results rationalize the current basel regulations however the analysis shows also that there is an optimal level of required eligible capital from the regulator standpoint counter intuitively any requirement above this optimal level is inefficient as it leads to a smaller amount of actually maintained eligible capital and thereby to a larger exposure to the most adverse states of the world unfortunately the current basel s range of required levels n 3 4 is within this inefficient range moreover with an inefficient regulation the agent might employ an inefficient reporting and disclosure procedure

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

promoting financing of cleaner production investments unep experience abstract the article provides a summary of a recently completed study by unep dtie on past investment practices in cleaner production it also provides a brief on the conclusions and recommendations of the debate that culminated at the parallel session on financing issues at the 6th international high level seminar on cp held in montreal in october 2000 the article then extracts the most relevant and topical issues from these papers and outlines the main challenges ahead as perceived in 2001

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

the role of risk aversion and intertemporal substitution in dynamic consumption portfolio choice with recursive utility abstract our objective is to understand how risk aversion and elasticity of intertemporal substitution under recursive utility affect dynamic consumption portfolio decisions for a three date model with a stochastic interest rate we obtain an analytic solution for the optimal policies we find that in general consumption and portfolio decisions depend on both risk aversion and elasticity of intertemporal substitution the size of risk aversion relative to unity determines the sign of the intertemporal hedging portfolio while elasticity of intertemporal substitution affects only its magnitude the portfolio weight is independent of elasticity of intertemporal substitution only for the case of a constant investment opportunity set

the numeraire portfolio abstract a portfolio formed from a given list of assets is defined as a numeraire portfolio for the list if a it is self financing b its value is always positive and c zero is always the best conditional forecast of the numeraire dominated rate of return of every asset on the list the numeraire portfolio exists if and only if there are no profit opportunities from trading assets on the list for a sample list of heterogeneous assets nyse size quintile portfolios corporate bonds and short term bills numeraire dominated returns are similar to market model forecast errors and as abnormal return measures clearly dominate market adjusted returns

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

efficient wage bargaining as a repeated game this paper builds a bridge between the two existing approaches for wage and employment determination in a unionized market the monopoly union model and the efficient bargaining model both fail to capture the dynamic aspects of wage bargaining when the repeated nature of the wage bargaining process is considered the equilibria are neither as inefficient as the monopoly union model predicts nor as fully efficient rather the two models can be regarded as particular cases with certain discount rates we apply our model to issues such as the endgame interpretation of the u s steel industry wage concessions and featherbedding

menu costs and the neutrality of money a model of endogenous price adjustment under money growth is presented firms follow s s pricing policies and price revisions are imperfectly synchronized in the aggregate price stickiness disappears and money is neutral the connection between firm price adjustment and relative price variability in the presence of monetary growth is also investigated the results contrast with those obtained in models with exogenous fixed timing of price adjustment

a monte carlo method for optimal portfolios this paper proposes a new simulation based approach for optimal portfolio allocation in realistic environments with complex dynamics for the state variables and large numbers of factors and assets a first illustration involves a choice between equity and cash with nonlinear interest rate and market price of risk dynamics intertemporal hedging demands significantly increase the demand for stocks and exhibit low volatility we then analyze settings where stock returns are also predicted by dividend yields and where investors have wealth dependent relative risk aversion large scale problems with many assets including the nasdaq sp500 bonds and cash are also examined the question of optimal portfolio allocation has been of long standing interest for academics and practitioners in finance while the mean variance analysis of markowitz 1952 is still commonly used among portfolio managers it has been well understood since merton 1971 that long term investors would prefer portfolios that include hedging components to protect against fluctuations in their investment opportunities prompted by the seminal papers of merton 1969 1971 and samuelson 1969 studies have explored various aspects of the dynamic portfolio problem when asset prices follow diffusion processes e g richard 1975 this literature has relied for the most part on a dynamic programming approach to the problem more recent contributions by pliska 1986 karatzas lehoczky and shreve 1987 and cox and huang 1989 have proposed an alternative resolution method based on martingale techniques in the context of this approach an optimal portfolio formula was derived by ocone and karatzas 1991 this expression involves expectations of random variables depending on j6erme b detemple is at boston university school of management and cirano rene

do supply curves slope up this paper examines the short run responses of price and quantity to exogenous demand shocks for disaggregated u s manufacturing industries using prior information on input output linkages to identify industries whose fluctuations are likely to function as approximately exogenous demand shocks for other industries i find that demand shocks induce positive covariation between price and quantity for 16 out of 26 sample industries controlling for observable cost shift variables when sample industries are pooled i estimate that a demand shock which initially raises industry output by 1 percent generates a price increase of 0 182 percent within one year i find that input output instruments detect upward sloping supply curves more readily than least squares or other commonly used demand shift instruments

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

nontraded asset valuation with portfolio constraints a binomial approach we provide a simple binomial framework to value american style derivatives subject to trading restrictions the optimal investment of liquid wealth is solved simultaneously with the early exercise decision of the nontraded derivative noshort sales constraints on the underlying asset manifest themselves in the form of an implicit dividend yield in the risk neutralized process for the underlying asset one consequence is that american call options may be optimally exercised prior to maturity even when the underlying asset pays no dividends applications to executive stock options eso are presented it is shown that the value of an eso could be substantially lower than that computed using the black scholes model we also analyze nontraded payoffs based on a price that is imperfectly correlated with the price of a traded asset the economics of asset pricing when one or more of the assets in the opportunity set are either subject to trading restrictions or entirely nontraded is a matter of great interest viewed from a practical perspective we have several important examples of such assets that are subject to trading restrictions pensions which represent perhaps the most significant of assets held by individual households are subject to trading restrictions it is typically the case that assets in pensions are not available for immediate consumption borrowing against pension assets is subject to significant direct and indirect costs by way of taxes and early withdrawal penalties human capital is another example housing investment is also illiquid and subject to significant transaction costs together pensions human capital and housing constitute a substantial part of a typical household s assets the significance of such nontraded assets for risk premia has already been noted by bewley 1982 there are other circumstances where lack of unrestricted trading plays an important role executive compensation plans usually take the this article was presented at boston university we would like to thank the editor bernard dumas and two anonymous referees for very helpful comments we also thank nalin kulatilaka and seminar participants for useful suggestions ganlin chang fei guan and carlton osakwe provided valuable research assistance j detemple acknowledges support from the social sciences and humanities research

a near rational model of the business cycle with wage and price inertia this paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects the individual loss to agents with inertial price wage behavior is second order in terms of the parameter describing the shock while the effect on real economic variables is first order thus significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses

optimal investment and consumption when allowing terminal debt we analyze a dynamic optimization problem which involves the consumption and investment of an investor with constant relative risk aversion for consumption but with a risk aversion for final wealth which does not necessarily imply that terminal wealth must always be positive we require risk aversion for terminal wealth to be positive but not monotone there is a point of maximal risk aversion at zero wealth and the investor may continue to consume when wealth is negative using dual optimization methods we can derive explicit solutions and we find that the optimal solution differs in a fundamental way from the case where risk aversion is monotone it turns out that the optimal consumption function is convex and concave at different wealth levels and that the optimal investment strategy may no longer be monotone as a function of the remaining time to invest and consume

the fundamental transformation in macroeconomics when factors enter into joint production they typically develop a degree of specificity with respect to each other it is well known that when combined with contracting difficulties specificity gives rise to a williamsonian fundamental transformation from an ex ante competitive relationship to an ex post bilateral monopoly the macroeconomic consequences of widespread specificity are far reaching specificity results in misallocation underutilization and unemployment of the economy s productive factors it hampers growth by depressing the incentives to replace what is outdated and to fully utilize the economy s resources it disrupts macroeconomic adjustment by inducing a wedge between timid creation and excessive destruction of the old system and it exacerbates downturns by elastifying the cyclical response of inelastic factors this abstract was borrowed from another version of this item

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

subsidies in carbon finance for promoting renewable energy development abstract faced with decreasing exhaustible nonrenewable resources and climate change resulting from the use of fossil energy it is urgent to accelerate the development of renewable energy but the development of renewable energy requires abundant financial support both from banks and governments this article considers bank loans to develop renewable energy and highlights the effects of government subsidies by using a microeconomic model and taking all stakeholders including the government banks and shareholders of the firm into consideration this study finds that government subsidies raise outputs and debt levels of renewable energy firms and improve shareholder value as well more importantly financial debts stimulate firms outputs but decrease the net profit per unit of debt due to the limited liability effects finally subsidy policy plays a critical role in renewable energy development because environmental efficiencies of subsidies decrease with the subsidy degree other valuable conclusions would be achieved if principal agent problem and other corporate governance factors are employed

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

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

a model of capital and crises we develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices the model is cast within a dynamic general equilibrium economy and the role for intermediation is derived endogenously based on optimal contracting considerations low intermediary capital reduces the risk bearing capacity of the marginal investor we show how this force helps to explain patterns during financial crises the model replicates the observed rise during crises in sharpe ratios conditional volatility correlation in price movements of assets held by the intermediary sector and fall in riskless interest rates

optimal risk sharing with effort and project choice we consider first best risk sharing problems in which the agent can control both the drift effort choice and the volatility of the underlying process project selection in a model of delegated portfolio management it is optimal to compensate the manager with an option type payoff where the functional form of the option is obtained as a solution to an ordinary differential equation in the general case the optimal contract is a fixed point of a functional that connects the agent s and the principal s maximization problems we apply martingale duality methods familiar from optimal consumption investment problems

general wisdom concerning the factors affecting the adoption of cleaner technologies a survey 1990 2007 abstract cleaner technologies ct have recently received much attention in diverse media and policy agendas this comes out of the clear role they play in environmental protection and sustainability and the large potential to contribute to economic growth and competitiveness the realization of both potentials depends on the level diffusion and exploitation achieved today very low this article presents a selective survey of papers that today represent the general wisdom concerning the factors affecting adoption as a primary condition to diffusion and exploitation of ct the paper helps to clarify the challenges facing diffusion modelers and policy makers when dealing with policy design assessing the levels of diffusion achieved as well as the factors affecting diffusion of a particular technology the paper ends outlining further research need in the field

on equilibrium asset price processes in this article we derive necessary and sufficient conditions that must be satisfied by equilibrium asset price processes in apure exchange economy we examine a world in which asset prices follow a diffusion process asset markets are dynamically complete all investors maximize their state independent expected utility of consumption at some future date and investors have nonrandom exogenous income we show that it is necessary and suffcient that the coefficients of an equilibrium diffusion price process satisfy a partial differential equation and a boundary condition we also examine how the dynamics of asset prices are related to the shape of the representative investor s utility function through the boundary condition for example in a constant volatility economy the expected instantaneous return of the market portfolio is mean reverting if and only if the relative risk aversion of the representative investor is decreasing in terminal wealth

precautionary savings and the permanent income hypothesis this paper derives the explicit solution of a dynamic stochastic optimal consumption problem for infinitely lived agents whose preferences exhibit in the presence of non diversifiable labour income uncertainty a constant elasticity of intertemporal substitution and constant absolute risk aversion the constancy of the elasticity of intertemporal substitution which implies that marginal utility at zero consumption is infinite guarantees that the non negativity constraint on consumption is never binding along the optimal path the assumption of constant absolute risk aversion allows an explicit computation of human wealth and provides a simple representation of the precautionary savings motive

a social capital paradox entrepreneurial dynamism in a small world clean technology cluster abstract clean tech entrepreneurs have struggled to gain investor confidence because of some particular characteristics and circumstances of the industry this research combines network and sustainable development literature in the clean tech context to support the logic of a new investment approach that may stimulate sustainable investing in clean tech theory is proposed to suggest that there may be an advantageous social capital paradox where strong ties in a cluster lead to dynamism rather than decay the clean tech industry provides a context where strong ties offer network stability in a small world cluster such that it is a value creating organizational form offering greater dynamism two related propositions are developed to support the social capital paradox they lead to a theoretical conclusion that long term integrated partner solutions where partners are also resource constrained lead to successful alliances supporting a dynamic cluster that will grow over time a practical conclusion is that investing in a connected cluster of firms might be less risky compared to investing in a new firm or even a portfolio of well diversified assets de risking clean production investments may be achievable through a small world network cluster backed security

dynamic asset allocation with mean variance preferences and a solvency constraint abstract the aim of this article is to analyze the portfolio strategies that are mean variance efficient when continuous rebalancing is allowed and a solvency constraint wealth positiveness is imposed at each point in time under very general assumptions ito processes for the security price dynamics those efficient strategies are identified as synthetic put options on the particular inefficient portfolio yielding the return with minimal second moment this general characterization allows us to derive a closed form formula for the optimal portfolio weights when the investment opportunity set is constant the optimal weights are explicit functions of the current market index the formula is then used to simulate dynamically efficient strategies for different horizons and targets and to describe the time pattern of the allocation to stocks versus bonds

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

equilibrium prices in the presence of delegated portfolio management abstract this paper analyzes the asset pricing implications of commonly used portfolio management contracts linking the compensation of fund managers to the excess return of the managed portfolio over a benchmark portfolio the contract parameters the extent of delegation and equilibrium prices are all determined endogenously within the model we consider symmetric fulcrum performance fees distort the allocation of managed portfolios in a way that induces a significant and unambiguous positive effect on the prices of the assets included in the benchmark and a negative effect on the sharpe ratios asymmetric performance fees have more complex effects on equilibrium prices and sharpe ratios with the signs of these effects fluctuating stochastically over time in response to variations in the funds excess performance

the cyclical behavior of marginal cost and price the author examines the cyclical behavior of price marginal cost margins for u s manufac turing after 1956 short run marginal cost is markedly procyclical this is primarily due to procyclical overtime payments incurred beca use employment is not perfectly flexible in most industries output price fails to respond to the cyclical movement in marginal cost so price marginal cost margins are markedly countercyclical the res ults contradict business cycle theories that explain low production i n a recession by a high real cost of producing they support theories that explain low production in a recession by the inability of firms to sell their output copyright 1987 by american economic association

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

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

keeping the keynesian faith this wide ranging discussion takes in the development of macroeconomics and the influence of ideas and events on that development the nature and causes of the great depression keynesianism lessons from the high inflation period of the 1970s the role of macroeconomic policy and the idea of the new economy

optimal consumption wealth relationships derived by consumer intertemporal profit maximisation abstract this paper proposes an artificial intertemporal consumer profit maximisation problem that is simple to solve the optimal consumption function which is consistent with intertemporal utility maximisation is then generated directly from a specification of the consumer s instantaneous profit function

dynamic asset allocation for stocks bonds and cash closed form solutions for hara optimal portfolios are obtained in a dynamic portfolio optimization model in three assets stocks bonds and cash in a vasicek type model of stochastic interest rates with correlated stock prices the hara is a buy and hold combination of a zero coupon bond with maturity matching the investor s horizon and a crra mutual fund this simple characterization facilitates insights about investor behavior over time and provides explanations on the rational use of convex versus concave investment strategies the model illuminates clearly the role of the different market parameters and relative risk aversion in portfolio strategies

equilibrium open interest abstract this paper analyses what determines an individual investor s risk sharing demand for options and aggregating across investors what the equilibrium demand for options we find that agents trade options to achieve their desired skewness specifically we find that portfolio holdings boil down to a three fund separation theorem that includes a so called skewness portfolio that agents like to attain our analysis indicates also however that the common risk sharing setup used for option demand and pricing is incompatible with a stylized fact about open interest across strikes

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

dynamic asset allocation portfolio decomposition formula and applications a new decomposition of the optimal portfolio in dynamic models with von neumann morgenstern preferences and ito prices is established the formula rests on a change of numeraire that uses pure discount bonds as units of account the dynamic hedging demand has two components the first hedge insures against fluctuations in an optimally designed bond with a maturity date matching the investor s horizon the second hedge immunizes against fluctuations in the market price of risk in the bond numeraire various applications are examined new results concerning the behavior of extremely risk averse individuals the demand for bonds and its long horizon limit and the optimal portfolio in incomplete markets are derived the author 2009 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please email journals permissions oxfordjournals org oxford university press

optimal hedging in a dynamic futures market with a nonnegativity constraint on wealth abstract this paper examines the issue of optimal hedging demands for futures contracts from an investor who cannot freely trade his portfolio of primitive assets in the context of lognormal rather than normal returns and of a constant absolute risk aversion utility function in this context the nonnegativity constraint on wealth is binding and the optimal hedging demands are not identical with those encountered in the bulk of the literature which has largely overlooked this problem negative results concerning the derivation of equilibrium in the futures markets and the computation of the open interests then follow

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

a minimum variance result in continuous trading portfolio optimization the problem of minimizing the variance of discounted wealth at the end of a fixed period is solved when the expectation of terminal wealth is constrained to a specified investment goal the results are obtained in a continuous trading framework under the assumption that the funds can be exchanged between a riskless bond and a stock whose discounted price is described by a geometric brownian motion transaction costs are ignored i e the market is frictionless and unlimited borrowing is permitted at the same rate as the return on the bond typically the optimal trading policy under the above assumptions involves a highly leveraged investment in the stock in the early stages followed by an accumulation of the bond in the later stages numerical results are provided as an illustration of the theory

on the optimality of path dependent structured funds the cost of standardization abstract this paper examines the suitability of an important class of standard financial structured products namely those whose performances are based on smoothing the return of a given risky underlying asset while providing a guarantee at maturity using various assumptions about the customers attitudes towards risk we show that such standardized products are not optimal even if the financial market volatility is constant as a by product we provide in particular the optimal portfolio value in the regret rejoice framework to go further with the notion of aversion of getting a return smaller than the risk free one using the notion of compensating variation we determine for the first time the monetary losses of providing these standardized products instead of the optimal ones to the customers we show that these monetary losses can be very significant when the volatility of the risky asset is stochastic from the operational point of view such results highly suggest to trade on the volatility index vix and or to introduce derivatives written on it when selling standardized funds in order to better meet investors needs and preferences

multiple expectational equilibria under monopolistic competition this paper shows that a monopolistically competitive economy with real investment can have multiple rational expectations equilibria one is associated with entrepreneurs optimistic expectations about future demand another with entrepreneurs pessimism it also shows that an optimistic expectational equilibrium pareto dominates a pessimistic equilibrium an investment subsidy can be beneficial both by reducing the original underinvestment distortion and by changing firms expectations from pessimistic to optimistic the most important assumption is increasing returns to scale and monopolistic competition makes increasing returns consistent with each producer s optimization

optimal contracts in a continuous time delegated portfolio management problem this article studies the contracting problem between an individual investor and a professional portfolio manager in a continuous time principal agent framework optimal contracts are obtained in closed form these contracts are of a symmetric form and suggest that a portfolio manager should receive a fixed fee a fraction of the total assets under management plus a bonus or a penalty depending upon the portfolio s excess return relative to a benchmark portfolio the appropriate benchmark portfolio is an active index that contains risky assets where the number of shares invested in each asset can vary over time rather than a passive index in which the number of shares invested in each asset remains constant over time fund managers compensation schemes in a delegated portfolio management setting have been of special interest to both academics and practitioners academic interest stems in part from the rapid growth of managed funds over the last two decades gompers and metrick 1998 report that by december 1996 mutual funds pension funds and other financial intermediaries held discretional control over more than half of the u s equity market it is thus of importance to study the impact of institutional trading on asset prices and to integrate into one model both asset pricing and delegated portfolio management compensation as advocated by brennan 1993 allen and santomero 1997 and allen 2001 it is also important to understand the relationship between a manager s trading strategies and his implicit incentives or career concerns see e g brown harlow and starks 1996 brown goetzmann and park 1997 chevalier and ellison 1999 and chen and pennacchi 2000 these concerns include internal promotion from a small to a large fund higher outside offers and the flow of money through the fund under management 1 the importance of fund manager compensation is also underscored by congressional passage in 1970 of the amendment to

small menu costs and large business cycles a macroeconomic model of monopoly i introduction the conflict between modern neoclassical and traditional keynesian theories of the business cycle centers upon the pricing mechanism in neoclassical models prices are fully flexible they represent the continuous optimization of economic agents and the continuous intersection of supply and demand in keynesian models prices are often assumed to be sticky they do not necessarily equilibrate all markets at all times one of the reasons for the resurgence of the equilibrium approach to macroeconomics has been the absence of a theoretical underpinning for this keynesian price stickiness this note shows that sticky prices can be both privately efficient and socially inefficient the business cycle results from the suboptimal adjustment of prices in response to a demand shock to the extent that policy can stabilize aggregate demand it can mitigate the social loss due to this suboptimal adjustment in some keynesian models prices are simply exogenously fixed 2 in others agents must set their prices in advance of the transaction date the act of altering a posted price is certainly costly these costs include such items as printing new catalogs and informing salesmen of the new price yet these menu costs are small and therefore generally perceived as providing only a weak foundation for these fixed price models however this inference is flawed small menu costs can cause large welfare losses the claim that price adjustment costs are small does not rebut the claim that they are central to understanding economic fluctuations

a general equilibrium model of international portfolio choice we investigate in a two country general equilibrium model whether a bias in consumption towards domestic goods will necessarily lead to a preference for domestic securities we develop a model where investors are constrained to consume only from their domestic capital stock and where it is costly to transfer capital across countries in this model investors less risk averse than an investor with log utility bias their portfolios towards domestic assets investors more risk averse than log however prefer foreign assets thus this model suggests that it is unlikely that the portfolios observed empirically can be explained by the high proportion of domestic goods in total consumption we investigate in a two country general equilbrium model whether a bias in consumption toward domestic goods will necessarily lead to a preference for domestic assets in an investor s optimal portfolio we constrain investors to consume only from their domestic capital stock and introduce a proportional cost for transferring goods from one country this cost gives rise to endogenous deviations from the law of one price lop thus the home and foreign investors do not hold identical portfolios we show that an investor s optimal portfolio is biased towards domestic equity only if she is less risk averse than an investor with log utility investors with relative risk aversion greater than one exhibit a preference for the foreign asset this is because the exchange rate derived endogenously is negatively correlated with the return on the foreign asset and therefore the translated return on the foreign stock is less risky than that on the domestic stock thus the results of this model suggest that it is unlikely that the preference for domestic assets that is observed empirically can be explained by the high proportion of domestic goods in total consumption there exists a considerable body of literature documenting the gains from international diversification grubel 1968 was the first to propose that international diversification allows investors to attain lower return variances than those achievable by diversifying domestically this proposition relies on the correlation between stock indices across countries being significantly less

optimal investment with minimum performance constraints abstract we consider the portfolio problem of an investor whose wealth is constrained to be at least as large as that generated by investment in a stochastic benchmark portfolio using standard option pricing results the optimal portfolio policy of a hara utility investor is derived explicitly this policy is shown to be equivalent at any point in time to the investor s optimal unconstrained policy when he has contracted to paying out a proportion of the value of the benchmark portfolio at the terminal date this proportion which lies between zero and one is smaller the more likely it is that the investor will strictly outperform the benchmark over the investment horizon

regulation of capital flows effects on liquidity and the role of financial reporting quality abstract capital controls as restrictions on capital flows are a tool proposed as a cure to the destabilizing market movements of the 1970s i e tobin 1978 despite the criticism that they have received edwards 1999 capital controls resurfaced during the european financial crisis and the restrictions imposed on capital flows in cyprus and greece these were the first instances of capital control implementation in the european union s history and had various effects on firms financial positions by using a sample of eu countries and distinguishing between austerity and capital controls periods we assess the effects of capital controls on the stock liquidity of firms all of the sample countries have a common financial reporting framework international financial reporting standards ifrs and some of them implemented a range of different measures from less intensive such as increases in tax rates to more intensive such as the enforcement of capital controls in their effort to stabilize their economies for the task at hand we specifically engage two accounting determinants of information asymmetry namely conditional conservatism and the level of earnings management our results show that financial reporting quality as measured by higher conditional conservatism and lower earnings management is beneficial for liquidity however during the capital controls period the relation between conditional conservatism and liquidity becomes negative and this negative relation relates to less risky firms thus the negative relation between conditional conservatism and liquidity is likely due to investors keeping more conservative firms in their portfolios as a measure against the crisis

optimal investment with s shaped utility and trading and value at risk constraints an application to defined contribution pension plan abstract in this paper we investigate an optimal investment problem under loss aversion s shaped utility and with trading and value at risk var constraints faced by a defined contribution dc pension fund manager we apply the concavification and dual control method to solve the problem and derive the closed form representation of the optimal terminal wealth in terms of a controlled dual state variable we propose a simple and effective algorithm for computing the initial dual state value the lagrange multiplier and the optimal terminal wealth theoretical and numerical results show that the var constraint can significantly impact the distribution of the optimal terminal wealth and may greatly reduce the risk of losses in bad economic states due to loss aversion

does option compensation increase managerial risk appetite this paper solves the dynamic investment problem of a risk averse manager compensated with a call option on the assets he controls under the manager s optimal policy the option ends up either deep in or deep out of the money as the asset value goes to zero volatility goes to infinity however the option compensation does not strictly lead to greater risk seeking sometimes the manager s optimal volatility is less with the option than it would be if he were trading his own account furthermore giving the manager more options causes him to reduce volatility managers with convex compensation schemes play an important role in financial markets this paper solves for the optimal dynamic investment policy for a risk averse manager paid with a call option on the assets he controls the paper focuses on how the option compensation impacts the manager s appetite for risk when he cannot hedge the option position on one hand the convexity of the option makes the manager shun payoffs that are likely to be near the money under the optimal policy the manager either significantly outperforms his benchmark or else incurs severe losses furthermore in examples of optimal trading strategies asset volatility goes to infinity as asset value goes to zero yet option compensation does not strictly lead to greater risk seeking as asset value grows large or if the evaluation date is far away the manager moderates asset risk for example if the manager has constant relative risk aversion crra asset volatility converges to the merton constant as asset value goes to infinity in some situations the manager actually chooses a lower asset volatility than he would if he were investing on his own because the leverage inherent in his option magnifies his exposure to the asset volatility in addition with all constant or decreasing absolute risk averse utility functions from the hyperbolic absolute risk averse hara class giving the manager more options causes him to reduce asset volatility in the crra case for example the manager targets a fixed volatility for his personal

non addictive habits optimal consumption portfolio policies abstract we formulate a model of preferences with non addictive habits where consumption is required to be non negative at all times but can fall below a standard of living index that aggregates past consumption we study the consumption portfolio problem taking account of the non negativity constraint on consumption and provide a constructive proof for the existence of an optimal policy on a finite time horizon 0 t we show that the consumption constraint binds up to an endogenous stopping time 0 t after which it remains slack until t a decomposition of constrained consumption involving an asian average strike capped call option is demonstrated

market timing with option implied distributions a forward looking approach we address the empirical implementation of the static asset allocation problem by developing a forward looking approach that uses information from market option prices to this end we extract constant maturity s p 500 implied distributions and transform them to the corresponding risk adjusted ones then we form optimal portfolios consisting of a risky and a risk free asset and evaluate their out of sample performance we find that the use of risk adjusted implied distributions times the market and makes the investor better off than if she uses historical returns distributions to calculate her optimal strategy the results hold under a number of evaluation metrics and utility functions and carry through even when transaction costs are taken into account not surprisingly the reported market timing ability deteriorated during the recent subprime crisis an extension of the approach to a dynamic asset allocation setting is also presented this paper was accepted by wei xiong finance