performance attribution using an apt with prespecified macrofactors and time varying risk premia and betas this paper assesses the selection and timing abilities of 130 equity mutual funds using a conditional apt model with specified macrofactors and time varying risk premia and betas for all fund categories based on investment objectives a significant proportion of the funds exhibits negative abnormal asset selection performance based on the unconditional jensen 1968 alpha and a reduced proportion of the funds in each category attempts to time the realizations of the macrofactors including those captured by the residual market factor the average selection performance of the mutual funds improves and the proportion of funds attempting to time macrofactor realizations declines when measured using the asset selection and factor timing models with time varying risk premia and betas

measuring the pricing error of the arbitrage pricing theory this article provides an exact bayesian frame work for analyzing the arbitrage pricing the ory apt based on the gibbs sampler we show how to obtain the exact posterior distributions for functions of interest in the factor model in particular we propose a measure of the apt pricing deviations and obtain its exact posterior distribution using monthly portfolio returns grouped by industry and market capitalization we find that there is little improvement in reduc ing the pricing errors by including more factors beyond the first one as an important extension of the asset pricing model of sharpe 1964 and lintner 196 5 ross 1976 1977 derived the arbitrage pricing theory apt which addresses a fundamental problem in finance to char acterize the expected return on a security the apt implies that the expected return is approximately a

risk and return in an equilibrium apt application of a new test methodology abstract we use an asymptotic principal components technique to estimate the pervasive factors influencing asset returns and to test the restrictions imposed by static and intertemporal equilibrium versions of the arbitrage pricing theory apt on a multivariate regression model the empirical techniques allow for fairly arbitrary time variation in risk premiums we find that the apt provides a better description of the expected returns on assets than the capital asset pricing model capm however some statistically reliable mispricing of assets by the apt remains

sequential tests of the arbitrage pricing theory a comparison of principal components and maximum likelihood factors we examine the cross sectional pricing equation of the apt using the elements of eigenvectors and the maximum likelihood factor loadings of the covariance matrix of returns as measures of risk the results indicate that for data assumed stationary over twenty years the first vector is a surprisingly good measure of risk when compared with either a one or a five factor model or a five vector model we conclude that in some circumstances principal components analysis may be preferred to factor analysis

on the number of factors in the arbitrage pricing model recent theory has demonstrated that the arbitrage pricing model with k factors critically depends on whether k eigenvalues dominate the covariance matrix of returns as the number of securities grows large the purpose of this paper is to test whether sample covariance matrices can be characterized as having k large eigenvalues using all available data on the 1983 crsp tapes we compute sample covariance matrices of returns in sequentially larger portfolios of securities analyzing their eigenvalues we find evidence that one eigenvalue dominates the covariance matrix indicating that a one factor model may describe security pricing we also find that for values of k larger than one there is no obvious way to choose the number of factors nevertheless we find that while only the first eigenvalue dominates the matrix the first five eigenvalues are growing more distinct arbitrage pricing theory apt as originally developed by ross 22 23 is built on the twin assumptions of no arbitrage opportunities in the capital market and a linear relationship between actual returns and k common factors the principal hypothesis of the model is that expected returns should be linearly related to the weights of the common factors in the assumed linear process in every test of the model the focus has been to use factor analysis to extract k factors from sample covariance matrices and then to test the hypothesis by regressing returns or average returns against the factor loadings of the common factors most previous tests have either assumed that the number of factors is equal to some predetermined number or have estimated k simultaneously with estimation of the factor loadings thus existing tests of the apt are joint tests of the apt pricing result and an assumed or estimated number of factors the question of how many factors are important has not been addressed separately from the pricing tests because the apt pricing result is the significant prediction of a theory which has little to say about the value of k nevertheless crosssection linear models have been a central part of financial economics and it is clearly important to know at least the approximate number of factors which will be significant in such regressions particularly given the computational difficulties of large scale factor analysis furthermore dhrymes friend and gultekin 6 report that the number of factors needed for standard chi squared tests increases university at buffalo suny i am in debt to donald bosshardt gary chamberlain thomas ho richard roll lemma senbet mark zmijewski and the participants in finance workshops at the universities of michigan wisconsin and buffalo for their extensive comments nevertheless i am solely responsible for what remains this paper would not have been started without the unselfish cooperation of jay leavitt director of academic computing university at buffalo suny who designed the eigenvalue algorithm which i used i am also grateful for partial financial support and lavish computer funds from the school of management and for the expert programming assistance provided by ravi shukla

using generalized method of moments to test mean variance efficiency this paper develops tests of unconditional mean variance efflciency under weak distributional assumptions using a generalized method of moments framework these tests are potentially more robust than commonly employed tests which rely on the assumption that asset returns are normally distributed and temporarily i i d using returns for size based portfolios from 1926 to 1988 we show that the conclusion concerning the mean variance effilciency of market indexes can be sensitive to the test considered the application of multivariate statistical techniques in financial economics has become common practice in recent years much of the development has been in the area of testing asset pricing models the assumption that asset returns follow a time invariant multivariate normal distribution permits tests of restrictions on model parameters in a pooled time series cross section framework these tests can be interpreted as tests of the mean variance efficiency of a portfolio or combination of portfolios gibbons 1982 jobson and korkie 1982 stambaugh 1982 shanken 1985 1987 kandel and stambaugh 1987 mackinlay 1987 and gibbons ross and shanken 1989 are examples of work presenting multivariate tests of the capital asset pricing model connor and korajczyk 1988 and lehmann and modest 1988 present multivariate tests of the arbitrage pricing model breeden gibbons and litzenberger 1989 present multivariate tests of the consumption based capm although these papers assume the normality of asset returns little analysis has been conducted to understand the sensitivity of the inferences to violations of this assumption 2 3

the principal agent relationship with an informed principal ii common values in many circumstances a principal may have relevant private information when she proposes a contract to an agent we analyze such a principal agent relationship as a noncooperative game the principal proposes a contract which is accepted or rejected by the agent who for most of our analysis has no private information the contract is executed if accepted otherwise the reservation allocation takes effect this allocation may be determined by a pre existing contract which the principal by her proposal is attempting to renegotiate or it may simply be the no trade point in this paper we assume that the principal s information directly affects the agent s payoff before solving the game we discuss pareto efficiency with asymmetric information we define an incentive compatible allocation to be weakly interim efficient wie if there exists no alternative incentive compatible allocation that both parties prefer for all possible beliefs that the agent might have about the principal s private information type we show that any wie allocation is interim efficient ie for some beliefs the rothschild stiglitz wilson rsw allocation relative to the reservation allocation l is the allocation that maximizes the payoff of each type of principal within the class of incentive compatible allocations that guarantee the agent at least the utility he gets from a irrespective of his beliefs about the principal s type the equilibrium set of the contract proposal game consists of the allocations that weakly pareto dominate the rsw allocation thus there is a unique equilibrium outcome if and only if the latter is ie and the equilibrium outcome is the rsw allocation itself after characterizing the equilibrium allocations we study those that are renegotiation proof when either the principal or the agent leads the renegotiation we then compare our contract proposal game which is a signaling model with its screening counterpart we conclude by extending our results to the case in which the agent as well as the principal has private information under the assumption of quasi linear preferences

multivariate tests of the zero beta capm abstract a cross sectional regression test csrt of the capm is developed and its connection to the hotelling t2 test of multivariate statistical analysis is explored algebraic relations between the csrt the likehood ratio test and the langrange multiplier test are derived and a useful small sample bound on the distribution function of the csrt is obtained an application of the csrt suggests that the crsp equally weighted index is inefficient but that the inefficiency is not explained by a firm size effect from february to december

can a well fitted equilibrium asset pricing model produce mean reversion in recent papers cecchetti et al 1990 and kandel and stambaugh 1990 showed that negative serial correlation in long horizon returns was consistent with an equilibrium model of asset pricing in this paper we show that their results rely on misspecified markov switching models for the endowment process once the proper markov specification is chosen for the endowment process the model does not produce mean reversion of the magnitude detected in the data furthermore the small amount of mean reversion produced by the model is due only to small sample bias we also show that this model is unable to predict negative excess returns contrary to empirical evidence

the efficiency of competitive equilibria in insurance markets with asymmetric information abstract this paper addresses the relationship between competitive equilibria and efficient allocations in an insurance market with asymmetric information using the definition of second best efficiency proposed by harris and townsend 1981 for environments characterized by informational assmmetry the efficiency properties of several proposed market equilibria are examined we find an analogue to the first optimality theorem a miyazaki wilson equilibrium always results in a second best allocation

health insurance without single crossing why healthy people have high coverage standard insurance models predict that people with high risks have high insurance coverage it is empirically documented that people with high income have lower health risks and are better insured we show that income differences between risk types lead to a violation of single crossing in an insurance model where people choose treatment intensity we analyse different market structures and show the following if insurers have market power the violation of single crossing caused by income differences and endogenous treatment choice can explain the empirically observed outcome our results do not rely on differences in risk aversion between types

some results in the theory of arbitrage pricing this paper derives a stronger version of huberman s recent preference free pricing theorem this pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals from a linear factor model it must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not the factor model has uncorrelated residuals this result provides the intuition for the role of residual risk in the pricing model and eliminates some classes of arbitrage opportunities still present under huberman s bound some applications to empirical tests and performance measurement are also discussed the arbitrage pricing theory is one of several financial pricing models which attempts to explain the cross sectional variation in expected returns on assets in certain respects it is similar to the capital asset pricing model but there are both substantive and subtle differences one of the key advantages of the apt is that it derives a simple linear pricing relation approximating that in the capm without some of the latter s objectionable assumptions perhaps the key disadvantage of the apt is that it provides no clues as to what might be important factors nor as to how to interpret the factor premiums which appear in the pricing equation this paper serves several purposes after reviewing the linear factor model formulation in section i it derives in section ii a stronger version of huberman s 9 recent preference free pricing theorem this pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals this relation must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not a linear factor model with uncorrelated residuals is the appropriate returns generating mechanism section iii specializes this result by eliminating the effects of residual covariances and compares the results here to those of previous apt models when applied to the standard linear factor model with uncorrelated residuals this new pricing bound eliminates arbitrage opportunities which remain under huberman s bound this result also provides for the first time the intuition for the role of residual risk in the approximate pricing relation section v provides an interpretation of the factor premiums and gives a valid asset pricing model interpretation to the apt which is consistent with merton s

exact arbitrage pricing and the minimum variance frontier the author examines the relationship between the arbitrage pricing theory of ross and mean variance analysis in particular conditions are derived on the vector of the factor risk premia that are equivalent to the existence of a strictly positively weighted portfolio on the minimum variance frontier also a sufficient condition is given under which the existence of a positive minimum variance portfolio of all the assets in the economy will imply the existence of a positive minimum variance portfolio on a subset this means that rejection of the hypothesis of the existence of a positive minimum variance portfolio on a subset satisfying this condition implies rejection for the whole set a growing body of literature explores the relationship between the arbitrage pricing theory apt of ross 13 14 and the mean variance model among the early work in this direction were the papers of chamberlain and rothschild 2 and chamberlain 1 these papers examine a sequence of economies and characterize the relationship in the limit between the mean and portfolio cost functionals and the minimum variance frontier chamberlain 1 also gives a condition under which exact arbitrage pricing will hold dybvig 4 and grinblatt and titman 7 examine equilibrium models in an apt context for a finite economy they derive sharp bounds on the deviation from exact arbitrage pricing recent papers by huberman kandel and stambaugh 9 and grinblatt and titman 8 explore the relationship between the apt and the mean variance model by studying portfolios that can be used as proxies for the factors and examining the relationship these portfolios bear to the minimum variance frontier these two papers also deal with equilibrium models in spite of the number and variety of equilibrium apt models the question of the pricing of factor risk in equilibrium remains largely unexplored this paper makes some progress in addressing that issue by looking at a given equilibrium restriction and studying the constraints it imposes on the vector of factor premia itself the most familiar equilibrium restriction we might study is the central implication of the capital asset pricing model capm that the market portfolio is efficient in particular no portfolio with the same expected return as the market portfolio has a smaller variance the restriction we actually study is weaker than

nonlinear dynamics in financial markets evidence and implications daily asset returns exhibit two key statistical properties price changes are not autocorrelated but the absolute values of changes are strongly autocorrelated nonlinear processes can generate this type of behavior linear processes cannot additively nonlinear processes are consistent with the view that expected returns are time varying although much effort has been applied to modeling expected returns there has been little evidence to support the view that time varying expected returns can account for the strong nonlinearity in the observed returns data multiplicatively nonlinear models are consistent with the view that expected volatilities are time varying evidence from price changes as well as options implied volatilities show that volatility is time varying and mean reverting in fact multiplicatively nonlinear models have been able to explain a great deal of the nonlinearity in asset returns thus future volatility can be forecast even though the direction of price changes is difficult

on multivariate tests of the capm abstract this paper evaluates the power of multivariate tests of the capital asset pricing model the results indicate that when employing an unspecified alternative hypothesis the ability of the tests to distinguish between the capm and other pricing models is poor an upper bound is derived for the distance the alternative distribution of the test statistic can be from the null distribution when the deviations from the capm are due to missing factors this upper bound explains the low power of the tests

stable factors in security returns identification using cross validation recent papers in financial research focus on identifying a stable factor structure for security returns the likelihood ratio test typically is used to determine the number of factors from exploratory factor analysis models in this article we consider the use of cross validation to identify a stable factor structure in security returns when applied to actual stock return data cross validation identifies a smaller number of stable factors than the likelihood ratio test in groups of 30 60 randomly selected securities cross validation suggests one dominant factor whereas the likelihood ratio test identifies from four to six factors furthermore when groups are designed to highlight industry or size effects the discovery of more than one dominant factor is problematic even if there are multiple economic factors generating stock returns they may be difficult to disentangle if the underlying factors tend to be correlated

a note on the geometry of shanken s csr t2 test for mean variance efficiency abstract shanken 1985 derives a test for the zero beta capital asset pricing model capm which as he points out is equivalent to a test of the mean variance efficiency of the market portfolio this note illustrates the geometry of shanken s test in the mean variance space

exchange rate exposure and industry characteristics evidence from canada japan and the usa abstract this paper examines industry level exchange rate exposures for canada japan and the usa measuring exposure by adding the change in the exchange rate to the domestic market model of industry portfolio returns some industries in all three countries display significant exposures moreover for each country the exchange rate is important for explaining industry returns at the economy wide level to explore whether exchange rate exposures are systematically linked to the activities of the industries we model exposure as a function of industry characteristics for all three countries the relation between exposure and industry characteristics is broadly consistent with economic theory jel f3

rational expectations and the aggregation of diverse information in laboratory security markets the idea that markets might aggregate and disseminate information and also resolve conflicts is central to the literature on decentralization hurwicz 1972 and rational expectations lucas 1972 we report on three series of experiments all of which were predicted to have performed identically by the theory of rational expectations in two of the three series one in which participants trade a complete set of arrow debreu securities and a second in which all participants have identical preferences double auction trading leads to efficient aggregation of diverse information and rational expectations equilibrium failure of the third series to exhibit such convergence demonstrates the importance of market institutions and trading instruments in achievement of equilibrium

the existence of equilibrium in discontinuous economic games ii applications in part i of this study we established two existence theorems for mixed strategy equilibrium in games with discontinuous payoff functions see theorems 4 4 and 5 5 in dasgupta and maskin 1986 hereafter d m 1986 in this second part we use the second of these two theorems to prove the existence of mixed strategy equilibrium in some wellknown discontinuous economic games that fail to have pure strategy equilibria the models we analyse are the bertrand edgeworth example of price setting duopolists with capacity constraints see section 2 2 price competition among firms producing differentiated products hotelling 1929 and d aspremont gabszewicz and thisse 1979 see section 2 3 spatial competition eaton and lipsey 1975 and shaked 1975 see section 3 and models of market dependent information rothschild and stiglitz 1976 and wilson 1977 section 4 the paper concludes section 5 with a classification of these models

comparative measures of performance for u s based international equity mutual funds abstract this paper compares an international two index model to an international arbitrage pricing theory iapt two factor model to evaluate the performance of 37 u s based international mutual funds over the 1985 1993 period results from the index model confirm prior research that international funds perform as well as the market proxy in contrast the iapt model implies superior investment performance by the international funds moreover the two models produce different relative performance rankings intertemporal comparisons of the models indicate that the multifactor iapt model better reflects the international equity return generating process

market equilibrium with hidden knowledge and self selection the problem of the existence of a competitive equilibrium in models with hidden knowledge and self knowledge has been discussed previously by m rothschild and j e stiglitz 1976 c a wilson 1977 and j g riley 1979 recent analyses of such models by i cho and d kreps 1986 and riley argue for a particular outcome the pareto dominant separating zero profit one the authors prove the existence of such an outcome under very general conditions and generalizing the reactive equilibrium concept introduced by riley they prove this outcome is the unique reactive equilibrium copyright 1987 by the econometric society

integration or segmentation of the canadian stock market evidence based on the apt the domestic and international arbitrage pricing theories are modified to encom pass the hypotheses that the canadian and global north american equity markets are com pletely or partly integrated segmented the exchange rate determination literature is used to identify potentially priced binational factors and the sensitivities and factor prices are es timated using non linear sur the two equity markets are only partly integrated segmented canadian stock returns are influenced by the pure domestic components of the term structure and lagged industrial production and by the pure international components of the differential

nonlinear dynamical model of regime switching between conventions and business cycles abstract we introduce and study a non equilibrium continuous time dynamical model of the price of a single asset traded by a population of heterogeneous interacting agents in the presence of uncertainty and regulatory constraints the model takes into account i the price formation delay between decision and investment by the second order nature of the dynamical equations ii the linear and nonlinear mean reversal or their contrarian in the form of speculative price trading iii market friction iv uncertainty in the fundamental value that controls the amplitude of mispricing v nonlinear speculative momentum effects and vi market regulations that may limit large mispricing drifts we find markets with coexisting equilibrium conventions and business cycles that depend on a the relative strength of value investing versus momentum investing b the level of uncertainty on the fundamental value and c the degree of market regulation the stochastic dynamics is characterized by nonlinear geometric random walk like processes with spontaneous regime shifts between different conventions or business cycles this model provides a natural dynamical framework to model regime shifts between different market phases that may result from the interplay between the effects i vi

the likelihood ratio test statistic of mean variance efficiency without a riskless asset abstract the question whether a given porfolio is mean variance efficient is a basic problem of investment analysis mean variance efficiency is also the basis of the capital asset pricing model this paper presents the explicit form of the likelihood ratio test of the hypothesis that a given portfolio or a particular market index is ex ante mean variance efficient in the case where there is no riskless asset geometric relations are illustrated to provide intuition about the constrained maximum likelihood estimators and the test statistic and two simple economic interpretations of the test are given

a new approach to testing asset pricing models the bilinear paradigm we propose a new approach to estimating and testing asset pricing models in the context of a bilinear paradigm introduced by kruskal 18 this approach is both simple and at the same time quite general as an illustration we apply it to the special case of the arbitrage pricing model where the number of factors is pre specified the data appear to be generally in conflict with a five or seven factor representation of the model used by roll and ross 30 when we consider the number of replications of our test and the large number of observations on which it is performed the frequency with which we reject the three factor apm does not lead us to conclude that this model is unrepresentative of security returns further the rejection of the five and seven factor versions is to be expected if the three factor version is correct the paradigm gives insight into the appropriate specification of the model and suggests that there may be a small number of economy wide factors that affect security returns tests of asset pricing models on the basis of observed stock market data have represented a staple of the financial economics literature of the past twenty years the early work is reviewed in the famous paper by jensen 12 and papers by fama and macbeth 6 rosenberg and marathe 31 and roll and ross 30 there has been a great deal of confusion regarding what testable propositions are implied by these models see discussion in roll 29 in this paper we show that at a minimum all asset pricing models yet proposed imply a simple easily testable hypothesis which we refer to as the bilinear hypothesis while specific models may imply further testable propositions if the bilinear hypothesis is rejected the model is inconsistent with the data and should be rejected our test exploits the fact that the economic content of any equilibrium asset pricing model can be expressed in the form of a potentially refutable constraint on the set of parameters of the process generating security returns this constraint specifies that given a set of security specific characteristics there exists a linear relationship common across securities relating expected returns to these

a critical reexamination of the empirical evidence on the arbitrage pricing theory this paper demonstrates that the roll and ross rr and other previously published tests of the apt are subject to several basic limitations there is a general nonequivalence of factor analyzing small groups of securities and factor analyzing a group of securities sufficiently large for the apt model to hold it is found that as one increases the number of securities the number of factors determined increases this increase in the number of factors with larger groups of securities cannot readily be explained by a distinction between priced and nonpriced risk factors as it is impermissible to carry out tests on whether a given risk factor is priced using factor analytic procedures the apt model as exposited by ross 17 18 and extended by huberman 9 has provided the basis of an extensive literature as for example brown and weinstein 1 chen 3 hughes 10 ingersoll 11 jobson 12 reinganum 15 roll and ross rr 16 and shanken 17 to mention but a few it has also been treated in a more general context by chamberlain and rothschild 2 our purpose here is not to comment on this collection of papers many of which are unpublished but to reexamine the evidence presented by rr and point out major pitfalls involved in the empirical methodology employed by them and others who have followed their lead rr claim that on theoretical and more importantly on empirical grounds arbitrage pricing theory apt is an attractive alternative to the capital asset pricing model capm the apt it is argued requires less stringent and presumably more plausible assumptions is more readily testable since it does not require the measurement of the market portfolio and may be better able to explain the anomalies found in the application of the capm to asset returns the acceptability of the apt like that of the capm or any other theory ultimately depends on its ability to explain the relevant empirical evidence our subsequent discussion will show that many of the prqblems associated with the capm are also present in the apt context and that its ability to explain the relevant empirical evidence is not markedly superior moreover it raises questions not only about the rr and related empirical investigations of the apt but also about the testability of that theory in the present state of the art a major part of the problem results from the necessity to break down the universe being analyzed through the apt model this is forced upon the investigator by the fact

a game theoretic foundation of competitive equilibria with adverse selection equilibria with adverse selection we construct a fully specified extensive form game that captures competitive markets with adverse selection in particular it allows firms to offer any finite set of contracts so that cross subsidization is not ruled out moreover firms can withdraw from the market after initial contract offers have been observed we show that a subgame perfect equilibrium always exists and that in fact when withdrawal is costless the set of subgame perfect equilibrium outcomes may correspond to the entire set of feasible contracts we then focus on robust equilibria that exist both when withdrawal costs are zero and when they are arbitrarily small but strictly positive we show that the miyazaki wilson contracts are the unique robust equilibrium outcome of our game this outcome is always constrained efficient and involves cross subsidization from low to high risk agents that is increasing in the share of low risks in the population under weak conditions on risk preferences

neutrally optimal mechanism under adverse selection the canonical insurance problem abstract this paper revisits the problem of adverse selection in the insurance market of rothschild and stiglitz 1976 we extend the three stage game in hellwig 1987 by allowing firms to endogenously choose whether or not to pre commit on their contractual offers menus we show how this mechanism can deliver the miyazaki wilson spence allocation as the unique perfect bayesian equilibrium this allocation is the unique incentive efficient and individually rational maximizer of the utility of the most profitable type in fact given that the informed player has only two types it is the unique core allocation and thus the unique neutral optimum in the sense of myerson 1983

potential performance and tests of portfolio efficiency abstract the potential performance of an asset set may be obtained by choosing the portfolio proportions to maximize the sharpe 1966 performance measure if a portfolio has a sharpe measure equivalent to the potential performance of the underlying set of assets then it is efficient multivariate statistical procedures for comparing potential performance and testing portfolio efficiency are developed and then evaluated using simulations two likelihood ratio statistics are then used to compare stock and bond indices against sets of 20 and 40 portfolios the procedures are also compared to the gibbons 1982 methodology for testing financial models

a comparison of single and multifactor portfolio performance methodologies a comparison of single and multifactor portfolio performance methodologies using value line and size ranked portfolios indicates that although both methodologies provide unbi ased estimates of portfolio performance there are systematic differences in the power of the two methodologies the predictive power of the multifactor methodology is superior for well diversified portfolios but inferior for less diversified portfolios

efficient competitive equilibria with adverse selection do walrasian markets function orderly in the presence of adverse selection in particular is their outcome efficient when exclusive contracts are enforceable this paper addresses these questions in the context of a rothschild stiglitz insurance economy we identify an externality associated with the presence of adverse selection as a special form of consumption externality consequently we show that competitive equilibria always exist but are not typically incentive efficient however as markets for pollution rights can internalize environmental externalities markets for consumption rights can be designed to internalize the consumption externality due to adverse selection with such markets competitive equilibria exist and incentive constrained versions of the first and second welfare theorems hold

an example of non existence of riley equilibrium in markets with adverse selection abstract rothschild and stiglitz 1976 proposed a model of a competitive market with adverse selection and showed that a pure strategy nash equilibrium may not exist among the solutions proposed to deal with this problem a particularly influential one is the notion of riley or reactive equilibrium riley 1979 we give an example that shows that a riley equilibrium may not exist if consumers are not ordered

derived factors in event studies abstract we examine the utility of the statistical factor model of the process generating stock returns in the context of event studies for a variety of estimation procedures and experimental designs we find limited value added relative to the use of a simple market model we would attribute this finding to misspecification of the statistical factor analysis model and suspect that there exist more robust procedures for estimating the factor structure of stock returns

multivariate proxies and asset pricing relations abstract a framework is developed in which inferences can be made about the validity of an equilibrium asset pricing relation even though the central aggregate in this relation is unobservable a multivariate proxy for the true market portfolio consisting of an equal weighted stock index and a long term government bond index is employed in an investigation of the sharpe lintner capm the empirical evidence suggests that we can reject the joint hypothesis that a capm is valid and b multiple correlation between the true market portfolio and proxy assets exceeds 0 7 connections to the equilibrium factor pricing literature are also explored

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

the number of factors in security returns both factor analysis of security returns and the analysis of eigenvalues seem to indicate that a market factor explains the major part of security returns we find that such evidence is consistent with an economy where there are in fact k equally important priced factors eigenvalue analysis in the context of such an economy will lead an investigator to the false inference that the one important factor is the return on an equally weighted market index this paper examines a particular exact k factor economy where each of the k factors is priced and contributes equally on average to the variance of returns we show analytically that for such an economy the approximate factor solution identifies the first factor as the return on an equally weighted market index and would lead to the inference that the remaining h 1 factors are not priced using a cross section regression technology our particular model is consistent with existing empirical work that has studied the number of factors in security markets these results suggest an important caveat to the interpretation of approximate factor solutions in an apt or multibeta pricing context one might also infer a capm bias in tests of the apt using the factor analysis technology on a more positive note the results suggest a simple rotation of the factor analysis solution that will lead to more powerful tests of the asset pricing relations to motivate this study consider the fact that the single factor market model suggested by markowitz 1959 and developed by sharpe 1963 remains one of the most popular empirical models of the return generating process the widespread acceptance of this model owes much to the work of king 1966 through a seven factor analysis of return data he concludes that one factor explains a large percentage of the variance of stock prices a factor on which each security tends to weight positively he interpreted this result to mean that there exists a basic market factor in operation which has a major effect on all securities this work supported the development of empirical research into the capital asset pricing model the model has been extensively applied in the event study context

incentive efficient price systems in large insurance economies with adverse selection we decentralize incentive efficient allocations in large adverse selection economies by introducing a competitive market for mechanisms that is for menus of contracts facing a budget constraint informed individuals purchase lottery tickets to enter mechanisms whereas firms sell tickets and supply slots at mechanisms at given prices beyond optimization market clearing and rational expectations an equilibrium requires that firms cannot favorably change or cut prices an equilibrium exists and is incentive efficient an equilibrium can be computed as the solution to a programming problem that selects the incentive efficient outcome preferred by the highest type within an appropriately defined set for two types economies this is the only equilibrium outcome

some empirical tests of the theory of arbitrage pricing we estimate the parameters of ross s arbitrage pricing theory apt using daily return data during the 1963 78 period we compare the evidence on the apt and the capital asset pricing model capm as implemented by market indices and find that the apt performs well the theory is further supported in that estimated expected returns depend on estimated factor loadings and variables such as own variance and firm size do not contribute additional explanatory power to that of the factor loadings

uncertain lifetimes and the welfare enhancing properties of annuity markets and social security this paper explores the implications of social security programs and annuity markets through which agents who are characterized by different distributions of length of lifetime share deathrelated risks when annuity markets operate a non discriminatory social security program affects only the intragenerational allocation of resources in the absence of private information regarding individual survival probabilities such a program will lead to a non optimal intragenerational allocation of resources however the presence of adverse selection considerations gives rise to a pareto improving role for a mandatory non discriminatory social security program

insurance self control and contract flexibility we study a competitive insurance market in which some consumers have too optimistic expectations regarding their future use of preventive measures when contracts are long term and inflexible such naive consumers would increase the costs of insurance for low risk consumers the competitive insurance market therefore offers flexible contracts that allow for switching between different tariffs sophisticated consumers choose a partial insurance tariff and remain low risks naive consumers choose the same tariff but later switch to full insurance and become high risks if there are sufficiently many naive consumers they pay a transfer to sophisticated consumers so that high risks subsidize low risks in contrast there are no such transfers when contracts are short term the model generates novel implications for the time frame of insurance contracts and insurance requirements

pareto optima and competitive equilibria with adverse selection and moral hazard this paper explores the extent to which standard general equilibrium analysis of pareto optima and of competitive equilibria can be applied to environments with moral hazard and adverse selection problems allowing for lotteries contracts with random components we first establish that an adverse selection insurance economy a moral hazard insurance economy a signaling economy and a private information labor market economy are all special cases of a simple general structure we then show that techniques for characterizing pareto optimal contracts as solutions to concave programming problems are useful and nice and appear to be broadly applicable allowing for lotteries we show how to characterize the optimal allocations for the adverse selection insurance and labor market economies we then show that standard existence and optimality theorems for competitive equilibria apply in the linear space containing lotteries if agents with characteristics which are distinct and privately observed at the time of initial trading enter the economy wide resource constraints in a homogeneous way other kinds of diversity are not critical for economies with moral hazard which satisfy the homogeneity condition competitive contract markets single out a subset of the optima and thus can be consistent with apparent unemployment and with a random allocation of labor supplied though all households are averse to risk the adverse selection insurance and signaling economies however do not satisfy the homogeneity condition and are difficult to decentralize efficiently with a price system

on the impact of infrequent trading on the apt systematic risk components evidence from a thin security market abstract the purpose of this note is to analyze the effects of infrequent trading on the apt systematic risk components using finnish data infrequent trading is reported to influence especially the first systematic risk component produced by factor analysis on stock returns

additional evidence on integration in the canadian stock market this paper reexamines the integration of the canadian and u s stock markets in the 1977 86 period that is relatively free from capital controls the study employs both the capm and the apt frameworks under both models the evidence is consistent with segmentation in the 1977 81 subperiod but supports integration in the 1982 86 subperiod using the apt framework we also find that the canadian stocks interlisted on the u s exchanges and nasdaq are priced in an integrated market and segmentation is predominant for the non interlisted canadian stocks in a study using an international capm framework jorion and schwartz 1986 find strong evidence of segmentation in the pricing of canadian stocks relative to a north american market comprising the canadian and u s stock markets the rejection of integration holds for canadian stocks that are interlisted on the u s stock exchanges and nasdaq as well as for domestic canadian stocks that are listed only on the canadian stock exchanges their results are surprising since the canadian and u s economies are highly integrated and the structure and regulation of security markets in the two countries are similar as well the canadian stocks interlisted on the u s stock exchanges list under the same regulation as the domestic u s stocks thus ex ante we would expect the canadian and u s stock markets to be integrated especially for the interlisted stocks 1 this study reexamines the integration in the canadian market employing both the capm and the apt frameworks since tests of market integration are joint tests of a specified model and market integration a relevant question is whether the two models produce different inferences pertaining to the integration issue in addition we explore this issue in a period that is

signalling to experts we study competitive equilibria in a signalling economy with heterogeneously informed buyers in terms of the classic spence 1973 the quarterly journal of economics 87 355 374 model of job market signalling firms have access to direct but imperfect information about worker types in addition to observing their education firms can be ranked according to the quality of their information i e their expertise in equilibrium some high type workers forgo signalling and are hired by better informed firms which make positive profits workers education decisions and firms use of their expertise are strategic complements allowing for multiple equilibria that can be pareto ranked we characterize wage dispersion and the extent of signalling as a function of the distribution of expertise among firms our model can also be applied to a variety of other signalling problems including securitization corporate financial structure insurance markets or dividend policy

explaining the single factor bias of arbitrage pricing models in finite samples abstract this paper shows that in finite samples it is not possible to distinguish all the latent factors from the idiosyncratic noise and that this leads to a bias towards the identification of a single factor it provides an approximation to this bias and the corresponding sampling distribution

a unified beta pricing theory abstract this paper derives ross s mutual fund separation theory and a new equilibrium version of ross s arbitrage pricing theory as special cases of a general theory the paper also reveals that the two theories are identical in their predictions of asset prices and portfolio returns the capital asset pricing model a restricted case of the mutual fund separation theory receives special treatment

a monte carlo investigation of the accuracy of multivariate capm tests abstract in a multivariate regression model relating individual returns to the market return capm implies non linear restrictions on the parameters several asymptotically valid tests of these restrictions have been suggested the existing monte carlo evidence shows that some of these tests are unreliable for reasonable sample sizes but does not indicate well which tests are reliable this paper reports the results of an extensive monte carlo experiment shanken s csr test and jobson and korkie s corrected likelihood ratio test are quite accurate in all cases we consider

nash equilibrium in competitive insurance i formalize a rather stylized insurance market with adverse selection as a standard duopoly i formally specify demand functions and profits and prove that a nash equilibrium in pure strategies exists if and only if the well known rothschild stiglitz allocation is efficient

a note on the behavior of stock returns around ex dates of stock distributions stock returns after the ex split date is significantly higher than the presplit volatility the increase in the standard deviation of daily returns is of the order of twenty eight to thirty five percent and persists for as long as a full year after the ex date even more interesting is their finding that there is no permanent change in the variance of returns at the announcement date they investigate several potential explanations for this aberration but are unable to find a satisfactory answer grinblatt masulis and titman 6 henceforth gmt examine the behavior of expected returns around announcement dates and exdates for stock distributions exceeding ten percent classifying stock distributions as either stock dividends split factors of twenty five percent or less or stock splits they conclude that return behavior differs across these two types of distributions with stock dividends exhibiting larger abnormal returns than splits this is interpreted by them as evidence in favor of the retained earnings hypothesis the dissimilar accounting treatment of these two types of stock distributions affects retained earnings in different ways and hence splits are not simply large stock dividends this paper extends the work of op to all types of stock distributions in section i postsplit variance is shown to be different from the presplit variance for small stock splits and stock dividends while small splits display an increase in volatility like large splits stock dividends are associated with a decrease in the volatility of returns this evidence also supports gmt s conclusions that stock splits and stock dividends are different types of events section ii investigates the volatility of returns for reverse splits and demonstrates that postsplit volatility decreases for these events this evidence is complementary to woolridge and chambers 9 findings that reverse splits are also associated with negative abnormal returns at their announcement and ex dates section iii concludes the paper

competitive pooling rothschild stiglitz reconsidered we build a model of competitive pooling which incorporates adverse selection and signaling into general equilibrium pools are characterized by their quantity limits on contributions households signal their reliability by choosing which pool to join in equilibrium pools with lower quantity limits sell for a higher price even though each household s deliveries are the same at all pools the rothschild stiglitz model of insurance is included as a special case we show that by recasting their hybrid oligopolistic competitive story in our perfectly competitive framework their separating equilibrium always exists even when they say it does not and is unique

data frequency and the number of factors in stock returns abstract determining the number of factors that explain stock returns plays an important role in empirical tests of the arbitrage pricing theory this paper examines the sensitivity of the number of factors to different data frequencies using daily weekly and monthly returns the empirical results are consistent with the null hypothesis that the number of factors is the same for different data frequencies once daily returns are adjusted for nonsynchronous trading the evidence also identifies only one or two factors

competitive insurance markets under adverse selection and capacity constraints abstract ever since the seminal work by rothschild and stiglitz q j econom 90 1976 629 on competitive insurance markets under adverse selection the problem of non existence of equilibrium in pure strategies has received much attention in the literature we extend the original analysis by considering firms which face capacity constraints which might be due to limited capital we show that under mild assumptions an equilibrium exists where every consumer obtains his appropriate rothschild stiglitz contract

constrained efficient equilibria in selection markets with continuous types abstract we prove the existence of the constrained efficient miyazaki 1977 wilson 1977 spence 1978 equilibrium in competitive markets with adverse selection when the distribution of unobservable types is continuous our existence proof applies under extremely general assumptions about individual preferences when we restrict preferences to have the widely used in the selection markets literature quasilinear form we characterize the properties of this equilibrium by developing a simple and computationally efficient numerical method for constructing it applying this method we show in a natural setting how one would compute the equilibrium allocation potentially facilitating empirical work using the mws equilibrium we illustrate this empirical application in the context of policy interventions and show that the welfare implications of a coverage mandate critically hinge on whether the market implements a constrained efficient allocation like the mws equilibrium or a constrained inefficient allocation like in azevedo and gottlieb 2017

non discriminating renegotiation in a competitive insurance market abstract a variant of the rothschild stiglitz model of a competitive insurance market is considered where each uninformed firm is allowed to renegotiate the contracts that its customers initially sign subject to the restriction that renegotiated contracts be offered to all the firm s customers such non discriminating renegotiation is shown to weaken the profitability of cream skimming to the extent that there exists a unique equilibrium outcome this outcome is that of miyazaki and spence i e the incentive compatible pair of zero profit contracts if efficient and the incentive compatible zero profit pair of contracts maximizing low risk utility otherwise

mean reversion in equilibrium asset prices this paper demonstrates that negative serial correlation in long horizon stock returns is consistent with an equilibrium model of asset pricing when investors display only a moderate desire to smooth their consumption commonly used measures of mean reversion in stock prices calculated from historical returns data nearly always lie within a 60 percent confidence interval of the median of the monte carlo distributions implied by the authors equilibrium model from this evidence the authors conclude that the degree of serial correlation in the data could plausibly have been generated by their model copyright 1990 by american economic association

a critical reexamination of the empirical evidence on the arbitrage pricing theory a reply the paper by dhrymes friend and gultekin dfg in this issue criticizes empirical work on the arbitrage pricing theory apt conducted by ourselves rr 3 and by a number of others we are honored that such eminent professors as dfg have taken an interest in our work unfortunately the dfg paper contains analysis which might foster misconceptions in the casual reader our purpose here is to present a brief nontechnical comment we are confident that those who are inclined to study the dfg paper in detail will be able to discern its merit for themselves the introductory section and the concluding section viii of dfg stress three points first that the method of rr has major pitfalls and is seriously flawed second that individual factors should not be tested for their pricing influence and third that more than three to five factors can be found by increasing the size of the group analyzed we will comment on the reasonableness of the second and third point in some detail the first is a value judgment and as such cannot be disputed on logical grounds we would be the last to object to a reasoned opinion judiciously drawn by dispassionate and unbiased scholars but of course we do not agree with the particular opinion expressed by dfg in sections i and ii dfg repeat the standard development of the apt and make much of the argument that the apt as a null hypothesis in a statistical test is independent of any rotation of the factors they stress their view that the only meaningful tests are those of whether any factors are priced rather than those which test whether some of them are priced and others are not rr raise and analyze precisely this same point 1 and in fact our awareness of this issue led us to conduct f tests of the joint significance of all factor prices see our tables iv and vi despite the rotation problem tests of individual factor pricing have meaning since the factors are extracted in the order of their importance in explaining the covariance matrix of returns it is not only perfectly valid it is also interesting to ascertain if they each have an influence upon pricing the number of statistically significant estimated priced factors can be different than the number of true factors because of chance rotation in the

multivariate tests of asset pricing the comparative power of alternative statistics this paper examines estimation issues associated with multivariate tests of asset pricing two issues are considered 1 the constraint that the sample size n must be less than the time series t and 2 the relative effect on power of using the multivariate statistic versus a univariate counterpart we find that an alternative statistic that allows for large n does not dominate the usual portfolio tests more notably we find that the power of a simple diagonal statistic usually dominates the multivariate statistic for cases considered inthis study

the impact of the return interval on common factors in stock returns evidence from a thin security market abstract the purpose of this paper is to analyze the effect of the return interval on common factors estimated in finnish stock returns firstly common factors are identified by factor analysis using daily weekly and monthly return intervals the similarity of these factors is then studied applying transformation analysis it is discovered that the factors produced by alternative return intervals significantly differ from each other an exception is the first factor representing the market index of securities

competitive markets without commitment in the presence of a time inconsistency problem with agency contracts we show that competitive markets can implement allocations that pareto dominate those achieved by a benevolent government and they induce more effort we analyze a model with moral hazard and a two sided lack of commitment after agents have chosen their work firms can modify contracts and agents can switch firms if the ex post market outcome satisfies a weak notion of competitiveness and sufficiently separates individuals it is pareto superior to a government s allocation with a complete breakdown of incentives moreover competitive markets without commitment implement more effort in equilibrium under general conditions

a walrasian theory of markets with adverse selection the paper describes a walrasian theory of markets with adverse selection and shows how refinements of equilibrium can be used to characterize uniquely the equilibrium outcome equilibrium exists under standard conditions it is shown that under certain conditions a stable set exists and is contained in a connected set of equilibria for generic models there exists a stable outcome that is all the equilibria in the stable set have the same outcome these ideas are applied to markets with one sided and two sided uncertainty under standard monotonicity conditions it is shown that the stable outcome is separating and implies a particular pattern of matches of buyers and sellers

constrained efficiency with adverse selection and directed search abstract this paper studies constrained efficiency in guerrieri et al s 2010 model of adverse selection and directed search buyers post contracts and sellers with private information about their type direct their search toward their preferred contract buyers and sellers then match bilaterally and trade if the guerrieri shimer wright equilibrium fails to achieve the first best then the planner subject to the frictions of the environment achieves strictly higher welfare than the equilibrium i e the equilibrium is not ex ante constrained efficient under certain conditions the planner achieves an allocation that even pareto dominates the equilibrium i e the equilibrium is not interim constrained efficient under other conditions the planner can completely undo the effects of adverse selection and achieves the first best cross subsidization is the key to these results

international diversification through closed end country funds abstract the primary objectives of this paper are to assess the potential of closed end country funds cecfs as vehicles for achieving international diversification at home and to examine the effect of the closed end status of these funds on their investment characteristics the main findings are first cecfs exhibit significant exposure to the u s market factor and act more like u s securities than do their underlying assets second despite these characteristics cecfs retain significant exposure to their local home market factors and provide u s investors with substantial diversification benefits emerging market funds such as brazil mexico and taiwan receive large weights in optimal international portfolios comprised of cecfs implying that these funds can play a unique role in spanning the opportunity set for u s investors third performance evaluations indicate that our sample cecfs generally did not offer significant overseas alphas fourth fund value and net asset value are found to be co integrated for the majority of cecfs from north america and europe but not for those representing the asian emerging markets

team production in competitive labor markets with adverse selection abstract team production is a frequent feature of modern organizations combined with team incentives team production can create externalities among workers since their utility upon accepting a contract depends on their team s performance and therefore on their colleagues productivity we study the effects of such externalities in a competitive labor market if workers have private information on their productivity we find that in any competitive equilibrium there must be pareto efficient separation of workers according to their productivity we further find that externalities facilitate equilibrium existence where under a particular condition on workers indifference curves even arbitrarily small externalities guarantee equilibrium existence