further results on asset pricing with incomplete information abstract this paper extends the analysis of asset pricing when information is incomplete by relaxing some of the restrictive assumptions of the gaussian model studied earlier in the literature for the information structure considered the posterior beliefs of the investor the conditional distribution of the current state given the past observations are characterized by two sets of sufficient statistics implementable in the form of a filter i the vector of conditional means and ii a set of sufficient statistics for the conditional variance covariance matrix a separation theorem is demonstrated and used to produce a closed form solution for the interest rate process when the investor s utility function is logarithmic in this context we examine the informational efficiency properties of the interest rate and analyze the stochastic shifts in the volatility of the interest rate process

stochastic equilibria existence spanning number and the no expected financial gain from trade hypothesis stochastic equilibria under uncertainty with continuous time security trading and consumption are demonstrated in a general setting a common question is whether the current price of a security is an unbiased predictor of the future price of the security plus intermediate dividends this is the hypothesis of no expected financial gains from trade the relevance of this hypothesis in multi good economies is called into question by the following demonstrated fact for each set of probability assessments there exists a corresponding equilibrium one with the original agents original equilibrium allocations and no expected financial gains from trade under the given probability assessments the spanning number of the economy is defined as the fewest number of security markets required to sustain a complete markets equilibrium in a dynamic sense made precise in the paper the spanning number is linked directly to agent primitives in particular the manner in which new information resolves uncertainty over time the spanning number is shown to be invariant under bounded changes in expectations several examples are given in which the spanning number is finite even though the number of potential states of the world is infinite

economic policy uncertainty and sovereign credit rating decisions panel quantile evidence for the eurozone we employ a panel quantile framework that quantifies the relative importance of quantitative and qualitative factors across the conditional distribution of sovereign credit ratings in the eurozone area we find that regulatory quality and competitiveness have a stronger impact for low rated countries whereas gdp per capita is a major driver of high rated countries a reduction in the current account deficit leads to a rating or outlook upgrade for low rated countries economic policy uncertainty impacts negatively on credit ratings across the conditional distribution however the impact is stronger for the lower rated countries in other words the creditworthiness of low rated countries takes a much bigger hit than that of high rated countries when european policy uncertainty is on the rise

prepayment and the valuation of mortgage backed securities this paper puts forward a valuation framework for mortgage backed securities rather than imposing an optimal value minimizing call condition we assume that at each point in time there exists a probability of prepaying this conditional probability depends upon the prevailing state of the economy to implement our valuation procedure we use maximum likelihood techniques to estimate a prepayment function in light of recent aggregate gnma prepayment experience by integrating this empirical prepayment function into our valuation framework we provide a complete model to value mortgagebacked securities given an optimal value minimizing call policy a mortgage should never be called when its market value is less than its call price similarly a mortgage should be called if it is worth more than its call price however mortgagors often call their loans when the prevailing refinancing rate exceeds the contract rate on the loan dunn and mcconnell 1981 in addition some mortgagors do not call their loans when the loan s contract rate exceeds the prevailing refinancing rate the purpose of this paper is to put forward a valuation framework for mortgagebacked securities consistent with these stylized facts associated with mortgage prepayments the mortgagor s prepayment decision is integral to our valuation framework however we do not impose an optimal value minimizing call condition to price these securities rather we assume that at each point in time there exists a probability of prepaying this conditional probability depending upon the prevailing state of the economy by integrating this prepayment function into our valuation framework we provide a complete model to value mortgage backed securities to implement our valuation procedures we estimate a prepayment function given recent gnma prepayment experience we follow green and shoven 1986 by using a proportional hazards model to estimate the influence of various explanatory variables or covariates on the mortgagor s prepayment decision distinct from green and shoven we explicitly model the effects of seasoning as well as investigating the influence of interest cost savings from refinancing in addition we also consider the effects of lagged refinancing rates heterogeneity

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

equilibrium pricing and portfolio composition in the presence of uncertain parameters abstract we analyze the effect of parameter uncertainty on equilibrium asset prices for the symmetric case when the amount of estimation risk is the same for all securities the existing literature argues that parameter uncertainty is largely irrelevant for equilibrium our results differ we find that symmetric estimation risk affects equilibrium values of relative asset prices expected returns market weights and betas

oil and the macroeconomy since world war ii all but one of the u s recessions since world war ii have been preceded typically with a lag of around three fourths of a year by a dramatic increase in the price of crude petroleum this does not mean that oil shocks caused these recessions evidence is presented however that even over the period 1948 72 this correlation is statistically significant and nonspurious supporting the proposition that oil shocks were a contributing factor in at least some of the u s recessions prior to 1972 by extension energy price increases may account for much of post opec macroeconomic performance

a nonlinear general equilibrium model of the term structure of interest rates abstract we derive and test an alternative closed form general equilibrium model of the term structure within the cox ingersoll and ross theoretical framework in which yields are nonlinear functions of the risk free rate we show that equilibrium bond prices and the risk free rate are not always inversely related and that bond risk need not be strictly increasing in maturity using hansen s generalized method of moments to obtain parameter estimates this nonlinear model outperforms the cox ingersoll and ross square root model in describing actual treasury bill yields for the 1964 1986 period

environmental policy and competitiveness the porter hypothesis and the composition of capital abstract the porter hypothesis suggests a win win situation in the sense that environmental policy improves both environment and competitiveness the suggestion received strong criticism from economists driven by the idea that if opportunities exist firms do not have to be triggered by an extra cost in this paper a model is developed which confirms this point but which also draws attention to some general mechanisms that relax the trade off considerably downsizing and modernization of firms subject to environmental policy will increase average productivity and will have positive effects on the marginal decrease of profits and environmental damage

multinational oil companies and the adoption of sustainable development a resource based and institutional theory interpretation of adoption heterogeneity sustainable development is often framed as a social issue to which corporations should pay attention because it offers both opportunities and challenges through the use of institutional theory and the resource based view of the firm we shed some light on why more than 20 years after sustainable development was first introduced we see neither the adoption of this business model as dominant nor its converse that is the total abandonment of the model as unworkable and unprofitable we focus on multinational corporations mncs because they were among the organizations first called to take action in order to illustrate the institutional pressures mncs face and their strategic response to these pressures we analysed four major oil and gas multinationals subject to similar sustainable development pressures climate change biodiversity renewable energy development and social investment we argue that normative and coercive isomorphism does not occur at the global level because sustainable development is largely a stakeholder driven rather than a broad social pressure that is host country interpretation of sustainable development pressures varies across an mnc s subsidiary network based on the analysis of the four major mncs annual reports from 2000 to 2005 we argue that mimetic isomorphism may occur but since it implies the use of complex and intangible resources mimetic processes are slow rare and discretionary

the information content in bond model residuals an empirical study on the belgian bond market abstract we estimate daily vasicek cir and spline models on belgian data and compare the trading profits that can be made on the basis of their residuals abnormal returns measured using three different benchmarks are negatively related to once and twice lagged mispricing buying underpriced bonds and especially selling overpriced bonds yields significant abnormal returns even when the trade is delayed by up to five days after observing the mispricing the traditional spline model overfits the data and is least able to detect mispricing large model residuals are more likely to be the result of model misspecification or estimation than are small or medium sized residuals

on aggregation of information in competitive markets the dynamic case abstract this article examines in the spirit of hellwig 1980 how a dynamic competitive security market aggregates and communicates information between various market participants at every instant it employs a continuous time economy consisting of a large number of heterogeneous agents who are endowed with noisy private signals about the risky asset payoff of differing precision it yields a stationary rational expectations equilibrium in which at every instant the agents use information contained in the market prices without rendering their private information redundant it shows that the market price reflects only that part of private information which is common to many signals and thus extends hellwig s single period results to a multi period model

does social performance really lead to financial performance accounting for endogeneity the empirical relationship between a firm s social performance and its financial performance is still not well established in the literature despite more than 30 years of research and more than 100 empirical studies on the issue the results are still mixed we argue that the heterogeneous results found in previous studies are not due exclusively to problems related with the measurement instruments or the samples used instead we posit that a more fundamental problem related with the endogeneity of social strategic decisions could be driving most of the empirical findings we show that using a panel data of 658 firms from 1991 to 2005 how some of the results found in previous research change and some are even reversed when endogeneity is properly taken into account

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

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

an empirical comparison of forward rate and spot rate models for valuing interest rate options our main goal is to investigate the question of which interest rate options valuation models are better suited to support the management of interest rate risk we use the german market to test seven spot and forward rate models with one and two factors for interest rate warrants for the period from 1990 to 1993 we identify a one factor forward rate model and two spot rate models with two factors that are not significantly outperformed by any of the other four models further rankings are possible if additional criteria are applied

learning and asset prices under ambiguous information we propose a new modeling framework to study the asset pricing implications of learning under ambiguity aversion in a continuous time partial information lucas economy we characterize analytically equilibrium equity returns and make the following observations first learning under ambiguity aversion implies an equilibrium discount for ambiguity if and only if relative risk aversion is below one or equivalently the elasticity of intertemporal substitution eis is above one in this case ambiguity aversion increases conditional equity premia and volatilities second equilibrium interest rates are lower irrespective of risk aversion third no time invariant relation between excess returns and conditional variances exists therefore estimated relations between excess returns and equity conditional variances are highly time varying and have an indeterminate sign fourth estimates of the eis based on standard euler equations for equity returns are strongly downward biased in a setting of learning and ambiguity aversion therefore an eis well above one can be consistent with estimates of eis well below one fifth ambiguity does not resolve asymptotically finally using realistic model parameters we show that a low risk aversion and a moderate amount of ambiguity are consistent with the equity premium the low interest rate and the excess volatility puzzles

a multifactor spot rate model for the pricing of interest rate derivatives we propose a multifactor model in which the spot rate libor follows a lognormal process with a stochastic conditional mean under the risk neutral measure in addition to the spot rate factor the second factor is related to the premium of the first futures rate over the spot libor similarly the third factor is related to the premium of the second futures rate over the first futures rate we calibrate the model to the initial term structure of futures rates and to the implied volatilities of interest rate caplets we then apply the model to price interest rate derivatives such as european and bermudan style swaptions and yieldspread options the model can be employed to price more complex interest rate derivatives such as path dependent derivatives or multi currency dependent derivatives because of its markovian property

interest rates and monetary policy uncertainty abstract this paper analyzes a model in which optimizing households are uncertain about monetary policy and learn about it over time in this model the variance of changes in nominal and ex post real interest rates increases with the variance of the household s predictive distribution over money growth a positive relation between unexpected changes in nominal interest rates and the money stock results from monetary policy uncertainty finally if money growth covaries negatively with real wealth an increase in monetary policy uncertainty increases the expected real rate of interest and decreases the nominal rate of interest

the environmentalism of the poor revisited territory and place in disconnected glocal struggles abstract in 2002 the year it was published the environmentalism of the poor was one of the first books examining in a multidisciplinary perspective three parallel environmental movements around the world eleven years later we re examine these movements the cult of wilderness the gospel of eco efficiency and the mantra of environmental justice focusing on the increased visibility of struggles representing environmental justice and the environmentalism of the poor even if they are often disconnected from an organizational standpoint glocal manifestations of resistance have emerged since the 1990s today environmental movements assert common values related to place identity and culture activists concepts such as ecological debt environmental justice environmental liabilities land grabbing environmental gentrification corporate accountability climate justice food sovereignty or economic degrowth are the keywords of the networks of the global environmental justice movement at the same time such concepts support the rural and urban movements that remake place for marginalized groups re assert traditional practices and protect territory from contamination land appropriation and real estate speculation some possibilities exist for cooperation between environmental justice and the other varieties of environmentalism here comparative research can help unravel the use of valuation languages different from green economic growth or sustainable development

paradoxes and dilemmas for stakeholder responsive firms in the extractive sector lessons from the case of shell and the ogoni this paper examines some of the paradoxes and dilemmas facing firms in the extractive sector when they attempt to take on a more stakeholder responsive orientation towards issues of environmental and social responsibility we describe the case of shell and the ogoni and attempt to draw out some of the lessons of that case for more sustainable operations in the developing world we argue that firms such as shell rio tinto and others may well exhibit increasingly stakeholder responsive behaviours at the corporate strategic level however for reasons of strategy lack of competency or institutional will this increasing level of corporate responsiveness may not be mirrored effectively in dealings between subsidiary business units and their most important direct stakeholders for example local communities and in the developing world we contrast the struggles of shell to replicate its corporate stakeholder responsiveness at the local level in nigeria with the experiences of other firms that seem to have developed managerial capabilities at a somewhat deeper level throughout the firm with consequent benefits both for stakeholders and the business

investment and hedging under a stochastic yield curve abstract this paper examines portfolio decisions involving both fixed and non fixed income securities two state variables the short term and the long term interest rates fully determine the bonds prices and partly influence the other assets prices we propose first a methodology for determining optimal portfolios in such a context and then use that methodology to solve the portfolio problem of investors whose long term bond holdings are constrained which generates undesirable interest rate risk that are hedged with futures contracts the individual futures positions which involve several hedging components and the futures market equilibrium open interest are derived and analysed

sovereign debt the assessment this article serves as an introduction to two issues of the oxford review of economic policy one entitled sovereign debt understanding bond markets during the eurozone crisis and the second sovereign debt lessons from the past reforms for the future we begin by documenting recent trends in advanced country sovereign indebtedness and reviewing events that preceded the sovereign debt crisis in the eurozone the mechanisms through which rising sovereign debt may impact bond yields economic growth and inflation are discussed and the evidence for such effects is reviewed our discussion highlights that there is no unique threshold beyond which sovereign debt exerts adverse macroeconomic effects and that in order to understand the consequences of a given debt load one must analyse its structure in terms of internal and external creditors currency denomination the time to maturity of the bonds and the legal code governing debt issuance as well as various economic and political constraints measuring the fiscal space of the sovereign we then turn our attention to episodes in which sovereign debt proves excessive and default occurs we review explanations for the protracted and inefficient nature of defaults and describe some lessons from historical studies examining default outcomes in the final part of the paper we discuss proposals for averting future debt crises including jointly issued bonds such as eurobonds contingent convertible bonds and elements of a sovereign debt restructuring mechanism in the course of our discussion we draw on each of the 11 articles included in the two issues of this journal devoted to sovereign debt copyright 2013 oxford university press

an equilibrium model of bond pricing and a test of market efficiency in two previous and related papers 3 4 the authors have reported the results of estimating a particular equilibrium model of bond pricing using quarterly data on canadian government bonds for the period 1964 to 1979 this paper reports the results of applying a similar model to the pricing of u s government bonds for the period 1958 1979 using data from the crsp government bond file the paper also extends the previous empirical analysis by evaluating the ability of the pricing model to detect underpriced and overpriced bonds the data reveal a strong relation between price prediction errors and subsequent bond returns

differential taxation and the equilibrium structure of interest rates equilibrium coupon bond pricing relationships given differential taxation are derived under uncertainty assuming that both corporate and municipal bonds were originally issued at par but are currently selling at a discount the impact of differential taxation upon the term structure and coupon structure of interest rates is investigated while the tax structure of interest rates is uniquely characterized differential taxation substantially alters the prevailing equilibrium structure of interest rates

learning about investment risk the effects of structural uncertainty on dynamic investment and consumption abstract we analyze a general equilibrium model where production shocks are unobservable and there is structural uncertainty regarding investment risk because the volatility of the production shocks is unknown higher investment generally accelerates learning on the unknown parameter but the dynamic interaction between learning and investment is complex we quantify this interaction by numerically computing equilibrium investment and consumption in a version of the model calibrated by aggregate us data we find that imperfect observability of productivity shocks by itself does not significantly affect equilibrium investment and consumption but structural uncertainty significantly impacts equilibrium investment and consumption levels

stochastic volatility option pricing this paper examines alternative methods for pricing options when the underlying security volatility is stochastic we show that when there is no correlation between innovations in security price and volatility the characteristic function of the average variance of the price process plays a pivotal role it may be used to simplify fourier option pricing techniques and to implement simple power series methods we compare these methods for the alternative mean reverting stochastic volatility models introduced by stein and stein 1991 and heston 1993 we also examine the biases in the black scholes model that are eliminated by allowing for stochastic volatility and we correct some errors in the stein and stein 1991 analysis of this issue empirical evidence on underlying asset prices and on their derivatives strongly suggests that asset price volatility is stochastic the pricing of options under this condition is therefore an important problem in this paper we study alternative option pricing methods that account for stochastic volatility we are particularly concerned with power series methods which we show to be quite accurate and easy to implement for alternative volatility specifications we point out their relation with recently proposed exact methods this permits a precise assessment of the approximation involved in the simple power series approach and of the impact of stochastic volatility on option prices following garman 1976 stochastic volatility option prices must satisfy a bivariate fundamental partial differential equation pde in the two state variables security price and volatility since volatility is not spanned by assets in the econ omy the volatility risk may not be eliminated by arbitrage methods therefore its market price explicitly enters into the pde the associated risk premium is owen graduate school of management vanderbilt university nashville tn 37203 and universita di siena facolta di scienza economiche e bancarie 53100 siena italy respectively part of this research was supported from a grant from the dean s fund and the financial markets research center at the owen school of management vanderbilt university some of this research was completed while roma was visiting the anderson graduate school of management ofthe university of california at los angeles we thank participants of the finance accounting and economics workshop at the owen school of management vanderbilt university for useful comments we appreciate the suggestions of roger huang craig lewis ron masulis and walter torous we thank joanne ball for editorial

an intertemporal general equilibrium model of asset prices this paper develops a continuous time general equilibrium model of a simple but complete economy and uses it to examine the behavior of asset prices in this model asset prices and their stochastic properties are determined endogenously one principal result is a partial differential equation which asset prices must satisfy the solution of this equation gives the equilibrium price of any asset in terms of the underlying real variables in the economy in this paper we develop a general equilibrium asset pricing model for use in applied research an important feature of the model is its integration of real and financial markets among other things the model endogenously determines the stochastic process followed by the equilibrium price of any financial asset and shows how this process depends on the underlying real variables the model is fully consistent with rational expectations and maximizing behavior on the part of all agents our framework is general enough to include many of the fundamental forces affecting asset markets yet it is tractable enough to be specialized easily to produce specific testable results furthermore the model can be extended in a number of straightforward ways consequently it is well suited to a wide variety of applications for example in a companion paper cox ingersoll and ross 7 we use the model to develop a theory of the term structure of interest rates many studies have been concerned with various aspects of asset pricing under uncertainty the most relevant to our work are the important papers on intertemporal asset pricing by merton 19 and lucas 16 working in a continuous time framework merton derives a relationship among the equilibrium expected rates of return on assets he shows that when investment opportunities are changing randomly over time this relationship will include effects which have no analogue in a static one period model lucas considers an economy with homogeneous individuals and a single consumption good which is produced by a number of processes the random output of these processes is exogenously determined and perishable assets are defined as claims to all or a part of the output of a process and the equilibrium determines the asset prices our theory draws on some elements of both of these papers like merton we formulate our model in continuous time and make full use of the analytical tractability that this affords the economic structure of our model is somewhat similar to that of lucas however we include both endogenous production and

are european sovereign bonds fairly priced the role of modelling uncertainty abstract this paper examines the extent to which large swings of sovereign yields in euro area countries during the debt crisis can be attributed to fundamentals focusing on the inherent uncertainty in bond yield models we show that the outcomes are strongly affected by modelling choices with regard to i the confidence bands for the model prediction ii the assumption whether the model coefficients are similar across countries or not iii the sample selection iv the inclusion of financial variables and v the choice of time varying coefficients these choices affect the explanatory power of macro fundamentals and the extent of mispricing

toward a new conception of the environment competitiveness relationship accepting a fixed trade off between environmental regulation and competitiveness unnecessarily raises costs and slows down environmental progress studies finding high environmental compliance costs have traditionally focused on static cost impacts ignoring any offsetting productivity benefits from innovation they typically overestimated compliance costs neglected innovation offsets and disregarded the affected industry s initial competitiveness rather than simply adding to cost properly crafted environmental standards can trigger innovation offsets allowing companies to improve their resource productivity shifting the debate from pollution control to pollution prevention was a step forward it is now necessary to make the next step and focus on resource productivity

valuation and analysis of collateralized mortgage obligations this study develops a model for the valuation of collateralized mortgage obligations cmos the model is based on a two factor model of the term structure of interest rates and embeds an empirically estimated mortgage prepayment function the model is used to analyze various cmo tranches including standard sequential pay fixed rate tranches planned amortization class pac tranches targeted amortization class tac tranches floating rate tranches interest only io and principal only po tranches z bonds and residuals the results of this analysis illustrate the sensitivity of the various tranches to differences in cmo structure changes in interest rates the characteristics of the underlying collateral and mortgage prepayments

environmental justice in the oil refinery industry a panel analysis across united states counties abstract environmental injustice due to economic inequality and its correlates and consequences has been a focus for researchers and policy makers alike over many years with much of that research focusing on race as the major determinant of inequality in this paper we extend this literature by focussing on emissions from the oil refinery industry at the community level in particular based on the use of panel data we analyse econometrically how the environmental performance of individual petroleum refineries emissions of benzene and toluene to the atmosphere associates with determinants of economic inequality at the micro level in terms of average per capita income at the level of united states counties as well as average county level unemployment rates the paper finds evidence of environmental injustice as a result of unemployment levels in areas around refineries and to a slightly lesser extent as a result of income inequality it discusses these results in a wider context referring amongst other things to the role of county level community characteristics and the potential for private firms to substitute for the intervention of public institutions if these are lacking

discretized reality and spurious profits in stochastic programming models for asset liability management in the literature on stochastic programming models for practical portfolio investment problems relatively little attention has been devoted to the question how the necessarily approximate description of the asset price uncertainty in these models influences the optimal solution in this paper we will show that it is important that asset prices in such a description are arbitrage free descriptions which have been suggested in the literature are often inconsistent with observed market prices and or use sampling to obtain a set of scenarios about the future we will show that this effectively introduces arbitrage opportunities in the optimization model for an investor who cannot exploit arbitrage opportunities directly because of market imperfections and trading restrictions we will illustrate that the presence of such arbitrage opportunities may cause substantial biases in the optimal investment strategy

information quality and long run risk asset pricing implications i study the asset pricing implications of the quality of public information about persistent productivity shocks in a general equilibrium model with kreps porteus preferences low information quality is associated with a high equity premium a low volatility of consumption growth and a low volatility of the risk free interest rate the relationship between information quality and the equity premium differs from that in endowment economies my calibration improves substantially upon the bansal yaron model in terms of the moments of the wealth consumption ratio and the return on aggregate wealth in this paper i introduce learning into a production based long run risk model learning improves the asset pricing implications of the model along three dimensions it increases the equilibrium equity premium reduces the volatility of consumption growth and reduces the volatility of the risk free interest rate i show that because of the production economy setting the relationship between information quality and the equity premium differs from that found in pure exchange economies see e g veronesi 2000 quantitatively my model improves substantially upon the bansal and yaron 2004 model in terms of its predictions about the volatility of the return on aggregate wealth and the wealth consumption ratio compared to bansal and yaron 2004 i use a lower relative risk aversion rra parameter two and a higher intertemporal elasticity of substitution ies parameter two my model generates a lower risk premium on the market portfolio 5 06 per year but does roughly as well as the bansal and yaron 2004 model according to other measures commonly used to assess the performance of consumption based asset pricing models such as the key moments of the risk free interest rate and the consumption growth rate more specifically i consider a general equilibrium model with a linear production technology and kreps porteus preferences kreps and porteus 1978 hengjie ai is at the fuqua school of business duke university this paper is based on chap

shifting endpoints in the term structure of interest rates abstract this paper links the term structure to perceptions of monetary policy long horizon forecasts of short rates required by no arbitrage term structure models are heavily influenced by the endpoints or limiting conditional forecasts of the short rate process common assumptions that the short rate is mean reverting or contains a unit root are shown to generate unrealistic yield predictions failures occur because these assumptions inadequately account for historical shifts in market perceptions of the policy target for inflation this paper links endpoint shifts to agent learning about shifts in long term policy goals shifting endpoints in short rate processes significantly improve yield predictions

optimal portfolio choice under incomplete information models of asset pricing generally assume that the variables which characterize the state of the economy are observable however the distributional properties of asset prices that are relevant for portfolio decisions are in general not observable and therefore must be estimated the estimation of expected returns is a particularly difficult problem and estimation errors are likely to be substantial in this light it is reasonable to examine whether the assumption of observability of expected returns and other relevant state variables causes significant mis specification in equilibrium models of asset prices this paper has three main objectives first to derive optimal estimators for the unobservable expected instantaneous returns using observations of past realized returns second to establish that estimation and portfolio choice can be solved in two separate steps third to analyze the impact of estimation error on investment choices the estimators of expected returns are in general not consistent i e the estimation error does not tend to disappear asymptotically the effects of the estimation error therefore cannot be ignored even if realized returns are observed continuously over an infinite time period

stochastic processes for interest rates and equilibrium bond prices default free bonds represent in essence money sold forward the investor gives dollars say to the government now in exchange for a contract which promises to pay with probability one a given number of dollars at maturity and possibly a stream of intermediate coupon payments prior to maturity only recently have financial economists begun to examine the pricing of those bonds in a portfolio context in that framework nominal liquidity premiums or risk premiums on long term default free bonds are attributable to uncertainty about taste technological and price level changes which may occur prior to maturity of the bonds and prior to each coupon payment if any to the extent that the investor is unable to diversify away that uncertainty there is a systematic risk attached to the marginal utility which he or she can derive from the use in consumption or investment of the dollar payoffs on the bonds in some term structure models the instantaneous or short term rate of interest denoted here as a function of time t by r t in nominal terms and r t in real terms can be taken as a sufficient statistic1 for the source of systematic uncertainty about the marginal utility of the proceeds to be derived from defaultfree bonds maturing beyond the next instant e g merton 1974 vasicek 1977 cox ingersoll and ross 1977 specific assumptions about tastes technology and utility functions lead to specific equilibrium stochastic processes for the instantaneous short term riskless rate and longer term bond prices which are modelled as functionally dependent upon maturity and that short term riskless rate if a closed form solution exists for the long term bond price as a function of maturity and the short term interest rate it will be conditional inter alia on the parameters of the stochastic process for that short term rate marsh 1981 proposed that the closed form solutions could be tested in terms of the restrictions implied cross sectionally on the parameters of the time series process for the returns or prices of longer term bonds each with a given term to maturity for an analogy outside the term structure literature think of the closed form solution given by black and scholes 1972 for the price of an option on a nondividend paying stock with lognormal price dynamics given the model the cross section of time series for the changes in prices for each of the several options written on the same stock are not unrestricted their dispersion is functionally linked to the same volatility parameter for the stock price thus the option model including

long and short term interest rates in a risky world abstract the paper develops and tests a general equilibrium model in which variability or risk affects the choice of portfolios our measures of variability include only the variability of unanticipated growth in monetary and non monetary aggregates and our tests use data ending with the change in federal reserve procedures in october 1979 we find that increased variability of unanticipated money growth raises demands for debt and money and reduces the demand for real capital interest rates on both short and long term debt rise by a risk premium we estimate the size of the risk premium before and after the october 1979 change and we show that the change in federal reserve procedures moved the economy to a less efficient point

undesirable facilities and property values a summary of empirical studies abstract undesirable land uses are expected to impose health or amenity risks on surrounding communities these risks are expected to be translated economically into negative effects on adjacent property values these negative effects may be present even when such uses possess offsetting advantages of proximity such as employment opportunities the purpose of this study is to summarize empirical studies completed to date that test whether undesirable land uses have observable negative effects on adjacent property values this information may be useful in assessing minimum valuations of terminating undesirable land uses such as clean up of hazardous sites or compensation necessary to ameliorate the economic impacts of new undesirable uses

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

on the impacts of oil price fluctuations on european equity markets volatility spillover and hedging effectiveness the objective of this paper is to investigate the volatility spillovers between oil and stock markets in europe as not all industries are expected to be equally affected by oil price changes we conduct our study at both the aggregate as well as sector levels empirically we make use of a recently developed var garch approach which allows for transmissions in volatilities in addition we analyze the optimal weights and hedge ratios for oil stock portfolio holdings based on our results on the whole our findings show significant volatility spillovers between oil price and sector stock returns and suggest that a better understanding of those links is crucial for portfolio management in the presence of oil price risk

an equilibrium debt option pricing model in discrete time abstract in this paper we develop a discrete time binomial model for pricing options on default free debt securities the model is a single factor or spot rate model in which an arbitrage free term structure is developed and used to price any interest rate contingent claim the model differs from other work in this area in that the model is straightforward to program and use and is not bound by a restrictive equilibrium concept such as the expectations hypothesis the paper demonstrates various properties of the model and demonstrates how information from the existing term structure can be used to parameterize the model

financial innovation and information the role of derivatives when a market for information exists we study the effects of financial innovation in a model of endogenous information acquisition we determine the conditions under which the introduction of a derivative written on an existing stock increases or decreases the incentive to purchase information we show that financial innovation produces some effects which hold across informational structures and others which differ the former coincide with the few empirical results that are robust in the literature effects on prices risk premia and volatility while the latter coincide with the ones that differ experiment by experiment effects on volume correlation between volume and volatility and market informational efficiency copyright 2002 oxford university press

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

effects of financial innovations on market volatility when beliefs are heterogeneous abstract consider a model with two logarithmic utility maximizer agents that observe aggregate consumption but disagree about its expected rate of change markets are incomplete we first show that volatility of the interest rate in an economy with additional information is higher in a complete markets economy with no additional information there are two differences in volatility with the previous the first one due to the increase in volatility of the wealth share of the individuals is always positive the second difference is the change in covariance between the components of the interest rate volatility and can be positive or negative

parameter estimation in stochastic scenario generation systems abstract scenario analysis offers an effective tool for addressing the stochastic elements in multi period financial planning models critical to any scenario generation process is the estimation of the input parameters of the underlying stochastic model for economic factors in this paper we propose a new approach for estimation known as the integrated parameter estimation ipe this approach combines the significant features of other well known estimation techniques within a non convex multiple objective optimization framework with the objective weights controlling the relative importance of the features we solve the non convex optimization problem using adaptive memory programming a variation of tabu search based on a short interest rate model using uk treasury rates from 1980 to 1995 the integrated approach compares favorably with maximum likelihood and the generalized method of moments we also evaluate performance with towers perrin s cap link scenario generation system

the environment as a luxury good or too poor to be green abstract this paper discusses the views of different authors on the relations between economic growth and environmental scarcities it lays out the common assumptions behind inglehart s postmaterialist thesis in environmental sociology krutilla s criterion for the valuation of environmental amenities hirsch s notion of the positional economy and pearce s numerical results on weak sustainability the paper shows how different views on the environmental consequences of economic growth imply at the same time different theories about environmental movements in rich countries there is an increasing demand for environmental amenities which cannot be substituted by products of the material economy and there are also environmental movements against the effluents of affluence in poor countries there are environmental movements characterized as the environmentalism of the poor

equilibrium interest rates and multiperiod bonds in a partially observable economy this paper analyzes the market for financial assets in a production and exchange economy with several realized outputs and a single unobservable source of nondiversifiable risk the paper demonstrates that for a large class of diffusion outputs and preferences optimizing consumers first estimate the realizations of the unobservable factor and then use these estimates to determine portfolio and consumption rules moreover the explicit consideration of this unobservable productivity factor affects equilibrium demands and prices the equilibrium spot rate of interest emerges as the best estimate of the unobservable factor and multiperiod default free bonds arise as the optimal hedge for the unobservable changes of the stochastic investment opportunity set this paper analyzes the market for financial assets in a production and exchange economy with several realized outputs and a single unobservable source of nondiversifiable risk the paper poses and answers three questions 1 how do consumers determine equilibrium demands and prices when their investment opportunities are unobservable 2 in equilibrium what financial assets provide an optimal hedge for the

the delivery option on forward contracts a comment livingston contends that short futures long cash traders can eliminate the potential costs of the quality option through use of a dynamic trading strategy it is proposed here that if this is possible then futures prices will never reach a stable equilibrium alternatively if livingston s argument is flawed then no risk free arbitrage opportunities are likely to be available to either short cash long futures or long cash short futures traders under such conditions futures prices will reach an equilibrium when the expected return and risk of each type position are equally attractive

corporate social responsibility in the multinational enterprise strategic and institutional approaches what is the relationship of global and local country specific corporate social responsibility csr to international organizational strategy applying the strategic logic of the bartlett and ghoshal typology to the realm of csr multinational firms should respond to pressures for integration and responsiveness from salient stakeholders however an institutional logic would suggest that multinational firms will simply replicate the existing product market organizational strategy multidomestic transnational global in their management of csr these alternative approaches are tested with a survey instrument sent to mnes operating in mexico the results of this study are consistent with the proposition that institutional pressures rather than strategic analysis of social issues and stakeholders are guiding decision making with respect to csr we develop implications for mne management and research as well as public policy

the stochastic properties of term structure movements abstract the aim of this paper is to identify a stationary statistical model for treasury bill discount changes we find that the sample variance of discount changes are non stationary over short differencing intervals but stabilize as the intervals increase to quarterly or semi annual periods this result has important implications for pricing options and for analyzing the predictive properties of forward rates we show that the stochastic process structure leads to a downward revision in estimates of forward rate predictive power

the money and bond markets in france abstract when rates of return on bonds are computed over extremely short holding periods the ex post cross sectional relationship between realized return and risk is linear it is therefore possible at any time to extrapolate the cross sectional relationship to a zero risk level and thus to determine the implied instantaneous riskless rate of interest we apply this technique to french bond price data using a rather unique data set in which prices are sampled daily we are able to compare the overnight rate implied in bond price data to the actual overnight money market rate we conclude that the two rates are significantly different which is evidence of segmentation between the two markets the institutional set up prevailing in france during the sample period explains the segmentation result

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

oil price shocks and emu sovereign yield spreads abstract this study examines for the first time the relationship among the oil price shocks and the sovereign yield spreads in the emu which is collectively the largest oil importer of the world in a time varying environment in particular we examine the time varying correlation between oil price shocks and the 10 year sovereign yield spread of core and periphery countries in the emu by employing a scalar bekk framework the main findings reveal that the correlations between sovereign yield spreads and oil price shocks are indeed time varying and are influenced by specific economic and geopolitical events that took place during the study period furthermore even though the correlation patterns are constantly low or zero prior to the great recession a change is revealed in the post 2008 period when correlations become moderate and more volatile finally we do not observe noteworthy differences in the correlation behaviour between core and periphery countries to different oil price shocks the findings of this study are particularly useful and provide valuable information to marketplace participants

credit ratings and the pricing of sovereign debt during the euro crisis this paper identifies the impact of credit rating changes on the sovereign spreads in europe and investigates the macro and financial factors that account for the time varying effects of a given credit rating change we find that changes of ratings are informative significant economically and robust even after controlling for conventional fundamentals a one unit rise in the average credit rating in a scale index of 25 ratings decreases cds spreads by about 45 basis points on average however the association between credit rating changes and spreads follows a complicated non linear pattern dependent on the level of the credit rating applying a non linear spline regression we find high sensitivity large change in spreads for a given change in ratings at the very low end of credit ratings and then a u shape pattern ratings at the moderately low end b and very high end of credit levels above a are fairly insensitive while middle ratings are quite sensitive to credit rating changes with the highest sensitivity at the bb level we also find that european countries had quite similar cds responses to credit rating changes during the pre crisis period but that large differences emerged between the now highlysensitive giips group and other european country groupings eu and euro area excluding giips and the non eu area we also find that contagion from changing the ranking of the giips on other euro countries disappears when own country credit rating changes are taken into account in contrast a decline in the credit rating in the giips area is transmitted as a decline in the cds spread of non euro eu which may be deemed as a substitute asset that increases in demand when the perceived risk of giips sovereign debt increases

multi period information markets abstract this article examines the single shot decision problem of a monopolistic information seller selling a flow of information in a dynamic framework in a generalized version of wang s 1993 economy it shows that the profit maximizing strategy of the seller is to sell his information as is but only to a fraction of traders it argues that this strategy of selling information is different from that in a static model mainly due to the very different nature of constraints faced by the information seller in a dynamic framework

valuing debt options empirical evidence abstract a two factor model using the instantaneous rate of interest and the return on a consol bond to describe the term structure of interest rates the brennan schwartz model is used to derive theoretical prices for american call and put options on us government bonds and treasury bills these model prices are then compared with market prices the theoretical model used to value the dept options also provides hedge ratios which may be used to construct zero investment portfolios which in theory are perfectly riskless several trading strategies based on these riskless portfolios are examined

environmental policy the porter hypothesis and the composition of capital effects of learning and technological progress abstract in this paper the effect of environmental policy on the composition of capital is investigated by allowing for nonlinearities it generalizes xepapadeas and de zeeuw j environ econ manage 37 1999 165 and determines scenarios in which their results do not carry over in particular we show that the way acquisition cost of investment decreases with the age of the capital stock is of crucial importance we also focus more explicitly on learning and technological progress among others we obtain that in the presence of learning implementing a stricter environmental policy with the aim to reach a certain target of emissions reduction has a stronger negative effect on industry profits which implies quite the opposite as to what is described by the porter hypothesis

consumption and equilibrium interest rates in stochastic production economies in this paper we analyze the behavior of equilibrium real interest rates in an identical consumer economy in which the preferences are represented by time additive logarithmic utility functions and production technologies are cobb douglas with stochastic constant returns to scale the following main results are established i when there is no relative price uncertainty it is shown that the equilibrium interest rate exhibits a mean reverting tendency a nontrivial steady state distribution is found to exist for the equilibrium interest rate the properties of the equilibrium interest rate are also derived and discussed ii in a multigood economy even with additive preferences across goods the equilibrium interest rates depend explicitly on relative prices the substitution possibilities in production technologies induce this result this is in contrast to the findings of richard and sundaresan 11 who show that the analytical general equilibrium term structure of interest rates formula of cox ingersoll and ross 5 is unaffected by the introduction of relative price uncertainty when the technologies are linear and hence involve no substitution furthermore we relate our results to those of cox ingersoll and ross 5 breeden 3 and richard and sundaresan 11 with special emphasis on stochastic production and realtive price uncertainty

contagion during the greek sovereign debt crisis abstract we examine the impact of news about greece and news about a greek bailout on bank stock prices in 2010 using data for 48 european banks we identify the twenty days with extreme returns on greek sovereign bonds and categorise the news events during those days into news about greece and news about the prospects of a greek bailout we find that except for greek banks news about greece does not lead to abnormal returns while news about a bailout does even for banks without any exposure to greece or other highly indebted euro countries this finding suggests that markets consider news about the bailout to be a signal of european governments willingness in general to use public funds to combat the financial crisis sovereign bond prices of portugal ireland and spain respond to both news about greece and news about a greek bailout

the term structure of interest rates in a partially observable economy this paper investigates the term structure of interest rates in a multiperiod production and exchange economy with incomplete information unable to observe their stochastic investment opportunities investors engage in dynamic bayesian inference this results in the endogenous identification of a more complex production function which generates a richer term structure resembling the one that actual market prices imply in addition this paper introduces a characteristic function of the term structure and demonstrates that in contrast with a fully observable economy the widely investigated expectations hypothesis holds true only if interest rates are nonstochastic this paper investigates the term structure of interest rates in a dynamic production and exchange economy with an unobservable productivity factor in order to estimate the unobservable stochastic investment opportunities rational investors engage in dynamic bayesian inference anticipated changes in investors quality of information about the fluctuations of the economic state variable affect equilibrium demands and prices this results in the endogenous identification of a more complex production function which induces a richer term structure term structures of interest rates in a partially observable economy resemble term structure curves that actual market prices imply this paper also introduces a characteristic function of the term structure and demonstrates that in contrast with a fully observable economy the widely investigated expectations

logarithmic preferences myopic decisions and incomplete information this paper examines a dynamic production economy with incomplete information and shows that the set of myopic preferenees those that induee myopic decisions depends on the representation of the information flow for example logarithmic preferenees are nonmyopic when some of the economic state variables are unobservable the analysis offers a broader definition of myopic behavior termed generalized myopia which is independent of the representation of the information flow allowing for any smooth concave utility function logarithmic preferenees endogenously emerge as necessary for generalized myopia in incomplete information economies and when combined with restrictions on the information structure they become sufficient i introduction this paper investigates myopic decisions and myopic preferenees in an in complete information production economy with continuous consumption and in vestment the paper interprets myopic decisions as those that do not use informa tion regarding future investment opportunities and identifies specific conditions for myopia within the model although previous research in financial economics has associated logarithmic preferenees with myopic behavior this analysis demonstrates that logarithmic preferenees necessarily induee myopic behavior only when all the economic state variables are observable based on this analysis the paper proposes a broader definition of myopia termed generalized myopia that is independent of the information flow representation the paper also provides nec essary and sufficient conditions for the existence of generalized myopia within both complete and incomplete information economies while the analysis allows for any smooth concave utility function logarithmic preferenees endogenously arise as necessary for generalized myopia in incomplete information economies and when combined with restrictions on the information structure they become sufficient

on the optimal hedge of a nontraded cash position in this paper we focus on the optimal demand for futures contracts by an investor with a logarithmic utility function who attempts to hedge a nontraded cash position when the analysis is conducted in the cash commodity price space we show that the value function associated with the bernoulli investor program is not additively separable thus suggesting that this investor hedges against shifts in the opportunity set as represented by the commodity price by establishing the equivalence between the cash formulation of the problem and the wealth formulation we are able to analyze the problem in the wealth commodity price space in this space we show the additive separability of the value function when the futures settlement price process is perfectly locally correlated with the commodity price process the demand for futures in this instance is composed of a a mean variance term and b a minimum variance component that is a classic feature of models with nontraded assets since the first best nonmyopic optimum is attained however the deviation from a mean variance demand should not be interpreted as the expression of a nonmyopic behavior but rather as an attempt to restore a first best optimum on the other hand when the correlation between the futures price and the underlying commodity price is imperfect in general the value function does not separate additively the first best solution cannot be attained and the optimal futures trading strategy involves a hedging term against shifts in the opportunity set in the classic dynamic portfolio problem the investor selects a trading strategy in risky and riskless assets so as to maximize his or her expected lifetime utility in this environment where all assets can be freely traded the logarithmic investor behaves myopically to the extent that he or she ignores shifts in the opportunity set when making current choices samuelson 271 mossin 24 hakansson 16 merton 22 in particular in models with continuous trading it turns out that the value function corresponding to the investor s program is additively separable in wealth and state variables the implication is that his or her behavior will be myopic i e that his or her demand functions for assets will be of the pure meanvariance efficiency type and in particular will not include any dynamic hedging components that are characteristic of financial markets with shifting opportunities in this paper we investigate the structure of the bernoulli investor s demand functions in the situation where one asset cannot be freely traded in the market

generalising interest rate duration with directional derivatives direction x and applications conventional or fisher weil duration is an ordinary derivative that measures the response of portfolio value to marginal parallel shifts in the term structure while other proposed measures are generally specific to particular interest rate processes in this paper we show that portfolio responses to arbitrary shifts in the term structure may be handled by the use of frechet or directional derivatives presenting a simple algorithm for the directional derivative of a fixed interest portfolio viewed as a set of cash flows for a given portfolio one can locate the most sensitive areas along the term structure by computing a function or profile direction x that gives the term structure movement to which the portfolio is most exposed immunisation techniques can be based on choosing ancillary assets that ensure that the portfolio directional derivative is zero or as close to zero as possible this generalises approaches based on factor models of the term structure the analysis is applied to both continuous and discrete time

on the consistency of the black scholes model with a general equilibrium framework we construct a simple economy with consumption only at the final date in which we endogenize the stochastic behavior of prices assumed in the black scholes model certain preferences constant proportional risk aversion and beliefs are shown to be sufficient and necessary in certain respects for the existence of such an equilibrium the analysis is then generalized to a continuous consumption framework in which we embed the merton proportional dividend model

fracking and environmental in justice in a texas city abstract shale gas development sgd via horizontal drilling and fracking is touted for economic benefits and spurned for health and environmental impacts despite sgd s socioecological salience few peer reviewed empirical studies document the distribution of positive and negative effects the city of denton texas has 280 active gas wells and over a decade of sgd here we use an environmental justice framework to analyze the distribution of sgd s costs and benefits within denton using data on mineral property values from 2002 to 2013 and gas well locations we ask who owns denton s mineral rights i e the greatest financial beneficiaries and how does this ownership pattern relate to who lives near gas wells i e those who shoulder the nuisances and health impacts our results show that denton s mineral wealth is widely distributed around the u s residents own 1 of the total value extracted and the city government is a large financial beneficiary in addition to distributional inequities our analysis demonstrates that split estate doctrine legal deference to mineral owners and sgd s uniqueness in urban centers create disparities in municipal sgd decision making processes the environmental justice issues associated with fracking in denton also provide one possible explanation for residents november 2014 vote to ban hydraulic fracturing

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

state price densities under heterogeneous beliefs the smile effect and implied risk aversion abstract it has been widely noted in the empirical literature that state price densities implicit in financial asset prices are not log normal this paper shows that this phenomenon can be caused by heterogeneity in investors beliefs it derives the state price density under heterogeneous beliefs in closed form and demonstrates that heterogeneous beliefs can give rise to multimodal state price densities consequences for the smile effect in implied option volatility and for measures of risk aversion inferred from empirical state price densities are discussed

do credit rating agencies provide valuable information in market evaluation of sovereign default risk abstract we assess the marginal information value of credit rating announcements on market pricing of sovereign risk as measured by cds spreads we demonstrate that accurate assessment of the effect of credit rating changes must be conditioned on relevant information known prior to the rating change to this end we include macroeconomic conditions and the watch or outlook status of the bond immediately prior to the rating change in our information set the empirical work employs a dynamic panel macroeconomic model with 56 countries using monthly data from january 2004 through august 2012 we find that watch outlook status plays a critical role in accurately determining the information value of credit rating changes with point estimates in some cases changing by a factor of eight cds spreads respond most strongly to credit rating changes when bonds are on stable status but also respond significantly when bonds are on outlook status the least response is found for bonds on watch status at the time of the downgrade the downgrades in these cases are largely anticipated and the information value incorporated at the time of the negative watch announcements

does sovereign risk in local and foreign currency differ abstract sovereign debt in local currency has been considered safer than in foreign currency the literature offers scant guidance as to why such a gap existed or why it has slowly and steadily diminished over the past two decades we suggest and empirically test five hypotheses we find fx reserves and original sin greater financing in local currency to consistently be robust determinants of the gaps in local and foreign currency ratings as for why the gap has declined we identify as important factors the surge in global reserves and to a lesser extent the decline of original sin

spread the news the impact of news on the european sovereign bond markets during the crisis we investigate how news affected domestic interest spreads vis a vis germany and how it propagated to other countries during the recent crisis period thereby distinguishing between the so called giips countries and other european countries we make original use of the eurointelligence newsflash to construct news variables based on the amount of news that is released on a country on a given date we find that more news on average raises the domestic interest spread of giips countries since september 2009 in addition we find that it leads to an increase in the interest spreads of other giips countries the magnitude of this effect is related to cross border bank holdings a split of news into bad and good news shows that the upward pressure on domestic and foreign interest spreads is driven by bad news we also find spillovers of bad news from giips countries onto non giips countries however the magnitude of these spillovers is substantially smaller than that to other giips countries

willingness to accept compensation for the environmental risks of oil transport on the amazon a choice modeling experiment abstract this paper looks at the question of whether subsistence level indigenous people place a value on the preservation of ecosystems independent of direct impacts of environmental change such as impacts on their production activities the economics literature generally suggests that non use values don t exist among the poor and in the informal sector of the economy we examine this issue through a choice modeling experiment a survey was conducted of rainforest communities who live on the banks of the amazon river rio solimoes in the vicinity of proposed oil and gas pipelines the data were analyzed in the choice modeling framework revealing relatively high amounts of compensation that were necessary in order to accept the potential ecosystem damages associated with oil transport even if the people were completely compensated for direct damages such as loss of access to productive resources these results suggest that environmental quality is important for its own sake a result that is very different from the implicit assumption among many economists

are mortgage lenders guilty of the housing bubble a uk perspective existing theoretical models of house prices and credit rely on continuous rationality of consumers an assumption that has been frequently questioned in recent years meanwhile empirical investigations of the relationship between prices and credit are often based on national level data which is then tested for structural breaks and asymmetric responses usually with subsamples meen 1999 argues that local markets are structurally different from one another and so the coefficients of any estimated housing market model should vary from region to region we investigate differences in the price credit relationship for 12 regions of the uk markov switching is introduced to capture asymmetric market behaviours and turning points results show that credit abundance had a large impact on house prices in greater london and nearby regions alongside a strong positive feedback effect from past house price movements this impact is even larger in greater london and the south east of england when house prices are falling which are the only instances where the credit effect is more prominent than the positive feedback effect a strong positive feedback effect from past lending activity is also present in the loan dynamics furthermore bubble probabilities extracted using a discrete kalman filter neatly capture market turning points

a model of competitive stock trading volume a model of competitive stock trading is developed in which investors are heterogeneous in their information and private investment opportunities and rationally trade for both informational and noninformational motives i examine the link between the nature of heterogeneity among investors and the behavior of trading volume and its relation to price dynamics it is found that volume is positively correlated with absolute changes in prices and dividends i show that informational trading and noninformational trading lead to different dynamic relations between trading volume and stock returns

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

expected life time utility and hedging demands in a partially observable economy this paper analyzes the expected life time utility and the hedging demands in an exchange only representative agent general equilibrium under incomplete information we derive an expression for the investor s expected life time utility and analyze his hedging demands for intertemporal changes in the stochastic unobservable growth of the endowment process and the changing quality of information regarding these changes the hedging demands consist of two components which could work in opposite directions so that a conservative consumer may end up having positive hedging demands our results are qualitatively different from those prevailing under constant growth cf brennan m j 1998 the role of learning in dynamic portfolio decisions european finance review 1 295 306 ziegler a 2003 incomplete information and heterogeneous beliefs in continuous time finance springer berlin chapter 2

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