Many Universities offer professional analysis of all sorts of subject matter. Below are those that I believe are of merit. I do not always agree with them- but one has to address what is coming out at the college level.
2009
4/29: "Risk Shifting and Mutual Fund
Performance" 
Mutual funds change their risk levels significantly over time. This paper investigates the performance consequences of risk shifting, as well as the economic motivations and the mechanisms of risk shifting. Using a holdings-based measure of risk shifting, we find that funds that increase risk perform worse than funds that keep stable risk levels over time. In addition, funds that expect higher benefits from risk shifting are more likely to increase risk and perform particularly poorly after increasing risk. Our results are consistent with the notion that agency problems, rather than the ability to take advantage of changing investment opportunities, are the likely motivation behind risk shifting behavior.
4/29: "Gender Differences in Risk Behaviour: Does
Nurture Matter?"
Women and men may differ in their propensity to choose a risky outcome because of innate preferences or because pressure to conform to gender-stereotypes encourages girls and boys to modify their innate preferences. Single-sex environments are likely to modify students' risk-taking preferences in economically important ways. To test this, we designed a controlled experiment in which subjects were given an opportunity to choose a risky outcome - a real-stakes gamble with a higher expected monetary value than the alternative outcome with a certain payoff - and in which the sensitivity of observed risk choices to environmental factors could be explored. The results of our real-stakes gamble show that gender differences in preferences for risk-taking are indeed sensitive to whether the girl attends a single-sex or coed school. Girls from single-sex schools are as likely to choose the real-stakes gamble as much as boys from either coed or single sex schools, and more likely than coed girls. Moreover, gender differences in preferences for risk-taking are sensitive to the gender mix of the experimental group, with girls being more likely to choose risky outcomes when assigned to all-girl groups. This suggests that observed gender differences in behaviour under uncertainty found in previous studies might reflect social learning rather than inherent gender traits.
:"Have You Heard the News? How Real-Life
Expectations React to Publicity" 
As evidence is accumulating that subjective expectations influence behavior and that these expectations are sometimes biased, it becomes policy-relevant to know how to influence individuals' expectations. Information in the media is likely to affect how people picture the future. This paper studies the role of public information dissemination, or publicity, in a real-life expectations formation process. For this purpose, an exceptional Dutch dataset on monthly expectations regarding the future eligibility age for old age social security is analyzed. On average, the publicity reaction in eligibility age expectations is small but the differences among subgroups are considerable. I find that higher educated and high income groups hardly adapt their expectations to relevant publicity. On the contrary, those who do not often read a newspaper have a relatively high publicity reaction. A potential explanation for this latter finding is that these groups have low quality initial expectations. If this is true, publicity thus particularly benefits the initially worse informed groups.
Equities are subject to much wider price swings than previously understood, according to a recent paper co-authored by Wharton finance and economics professor Robert Stambaugh. The research adds a new perspective to the work of Wharton finance professor Jeremy J. Siegel, author of the book Stocks for the Long Run, which says stock returns more than offset risks if you stay with the market through its ups and downs. In a recent interview with Knowledge@Wharton, the professors described their views about the market's long-term behavior.
http://knowledge.wharton.upenn.edu/article/2229.cfm
| By: | Martin Jones (University of Dundee) |
| URL: | http://d.repec.org/n?u=RePEc:sti:wpaper:031/2009&r=cbe |
| Keynes's theory of probability has been studied intensively in the past few years with much discussion of its relevance to modern economics. This paper examines Keynes's ideas in light of criticisms made by other authors and comes to the conclusion that Keynes's views on rationality are critically flawed. However, it is asserted that this actually allows more freedom for investigation when it is combined with insights from behavioural economics and gives examples where this could be fruitful. One of the side-effects of this is that there is a narrowing of the gap between Keynesian and mainstream behavioural views on decision-making. | |
-
Date: 2008-02 By: Antonio Guarino (University College London)
Marco Cipriani (George Washington University)URL: http://d.repec.org/n?u=RePEc:wef:wpaper:0047&r=cbe We study herd behavior in a laboratory fnancial market with financial market professionals. An important novelty of the experi- mental design is the use of a strategy-like method. This allows us to detect herd behavior directly by observing subjects?decisions for all realizations of their private signal. In the paper, we compare two treatments - one in which the price adjusts to the order ?ow in such a way that herding should never occur, and one in which the presence of event uncertainty makes herding possible. In the first treatment, traders herd seldom, in accordance with both the theory and previous experimental evidence on student subjects. A proportion of traders, however, engage in contrarianism, something not accounted for by the theory. In the second treatment, on the one hand, the proportion of herding decisions increases, but not as much as the theory would suggest; on the other hand, contrarianism disappears altogether. In both treatments, in contrast with what theory predicts, subjects sometimes prefer to abstain from trading, which affects the process of price discovery negatively. -
Date: 2009-04 By: Thomas Lux URL: http://d.repec.org/n?u=RePEc:kie:kieliw:1514&r=cbe We use weekly survey data on short-term and medium-term sentiment of German investors to estimate the parameters of a stochastic model of opinion dynamics. The bivariate nature of our data set also allows us to explore the interaction between the two hypothesized opinion formation processes, while consideration of the simultaneous weekly changes of the stock index DAX enables us to study the influence of sentiment on returns within a behavioral model of boundedly rational traders. Technically, we extend the maximum likelihood framework for parameter estimation in agent-based models introduced by Lux (2009a) by generalizing it to bivariate and trivariate settings. As it turns out, short-term sentiment is governed by strong social interaction with abrupt changes of direction while medium-term sentiment is a slowly moving process with more moderate social interaction. The trivariate model can potentially predict stock returns out-of-sample on the base of medium-run sentiment at least if an apparently spurious influence from short-run sentiment is discarded Keywords: Opinion formation, social interaction, investor sentiment
5/18:
-
Date: 2008-02 By: Antonio Guarino (University College London)
Marco Cipriani (George Washington University)URL: http://d.repec.org/n?u=RePEc:wef:wpaper:0047&r=cbe We study herd behavior in a laboratory fnancial market with financial market professionals. An important novelty of the experi- mental design is the use of a strategy-like method. This allows us to detect herd behavior directly by observing subjects?decisions for all realizations of their private signal. In the paper, we compare two treatments - one in which the price adjusts to the order ?ow in such a way that herding should never occur, and one in which the presence of event uncertainty makes herding possible. In the first treatment, traders herd seldom, in accordance with both the theory and previous experimental evidence on student subjects. A proportion of traders, however, engage in contrarianism, something not accounted for by the theory. In the second treatment, on the one hand, the proportion of herding decisions increases, but not as much as the theory would suggest; on the other hand, contrarianism disappears altogether. In both treatments, in contrast with what theory predicts, subjects sometimes prefer to abstain from trading, which affects the process of price discovery negatively. -
Date: 2009-04 By: Thomas Lux URL: http://d.repec.org/n?u=RePEc:kie:kieliw:1514&r=cbe We use weekly survey data on short-term and medium-term sentiment of German investors to estimate the parameters of a stochastic model of opinion dynamics. The bivariate nature of our data set also allows us to explore the interaction between the two hypothesized opinion formation processes, while consideration of the simultaneous weekly changes of the stock index DAX enables us to study the influence of sentiment on returns within a behavioral model of boundedly rational traders. Technically, we extend the maximum likelihood framework for parameter estimation in agent-based models introduced by Lux (2009a) by generalizing it to bivariate and trivariate settings. As it turns out, short-term sentiment is governed by strong social interaction with abrupt changes of direction while medium-term sentiment is a slowly moving process with more moderate social interaction. The trivariate model can potentially predict stock returns out-of-sample on the base of medium-run sentiment at least if an apparently spurious influence from short-run sentiment is discarded Keywords: Opinion formation, social interaction, investor sentiment
5/5:
| By: | Martin Jones (University of Dundee) |
| URL: | http://d.repec.org/n?u=RePEc:sti:wpaper:031/2009&r=cbe |
| Keynes's theory of probability has been studied intensively in the past few years with much discussion of its relevance to modern economics. This paper examines Keynes's ideas in light of criticisms made by other authors and comes to the conclusion that Keynes's views on rationality are critically flawed. However, it is asserted that this actually allows more freedom for investigation when it is combined with insights from behavioural economics and gives examples where this could be fruitful. One of the side-effects of this is that there is a narrowing of the gap between Keynesian and mainstream behavioural views on decision-making. | |
5/3:"Have You Heard the News? How Real-Life
Expectations React to Publicity"
As evidence is accumulating that subjective expectations influence behavior and that these expectations are sometimes biased, it becomes policy-relevant to know how to influence individuals' expectations. Information in the media is likely to affect how people picture the future. This paper studies the role of public information dissemination, or publicity, in a real-life expectations formation process. For this purpose, an exceptional Dutch dataset on monthly expectations regarding the future eligibility age for old age social security is analyzed. On average, the publicity reaction in eligibility age expectations is small but the differences among subgroups are considerable. I find that higher educated and high income groups hardly adapt their expectations to relevant publicity. On the contrary, those who do not often read a newspaper have a relatively high publicity reaction. A potential explanation for this latter finding is that these groups have low quality initial expectations. If this is true, publicity thus particularly benefits the initially worse informed groups.
|
The Securities and Exchange Commission has shut down
two Beverly Hills hedge funds that allegedly used a web of lies to
raise $38 million from 20 investors.
|
4/29: "Risk Shifting and Mutual Fund
Performance"
Mutual funds change their risk levels significantly over time. This paper investigates the performance consequences of risk shifting, as well as the economic motivations and the mechanisms of risk shifting. Using a holdings-based measure of risk shifting, we find that funds that increase risk perform worse than funds that keep stable risk levels over time. In addition, funds that expect higher benefits from risk shifting are more likely to increase risk and perform particularly poorly after increasing risk. Our results are consistent with the notion that agency problems, rather than the ability to take advantage of changing investment opportunities, are the likely motivation behind risk shifting behavior.
4/29: "Gender Differences in Risk Behaviour: Does
Nurture Matter?"
Women and men may differ in their propensity to choose a risky outcome because of innate preferences or because pressure to conform to gender-stereotypes encourages girls and boys to modify their innate preferences. Single-sex environments are likely to modify students' risk-taking preferences in economically important ways. To test this, we designed a controlled experiment in which subjects were given an opportunity to choose a risky outcome - a real-stakes gamble with a higher expected monetary value than the alternative outcome with a certain payoff - and in which the sensitivity of observed risk choices to environmental factors could be explored. The results of our real-stakes gamble show that gender differences in preferences for risk-taking are indeed sensitive to whether the girl attends a single-sex or coed school. Girls from single-sex schools are as likely to choose the real-stakes gamble as much as boys from either coed or single sex schools, and more likely than coed girls. Moreover, gender differences in preferences for risk-taking are sensitive to the gender mix of the experimental group, with girls being more likely to choose risky outcomes when assigned to all-girl groups. This suggests that observed gender differences in behaviour under uncertainty found in previous studies might reflect social learning rather than inherent gender traits.
4/27: The beta parameter as a measure of an asset’s risk plays a central role in finance. Estimated betas and their predictions are used in asset pricing, cash flow valuation, risk management, making investment decisions or simply as a risk factor in models with more than one factor. Because of their central role in portfolio theory, betas have been the object of enormous research interest. The traditional setting is one where beta risk is assumed to be constant. In this framework, betas can be estimated as the slope coefficient in a simple regression model fitted by ordinary least squares. However, empirical evidence in numerous studies suggest that betas are not constant over time.
:Risk
measures and their applications
in asset management
|
Date: |
2008-08-21 |
|
By: |
Birbil,
S.I. |
|
URL: |
|
|
Several
approaches exist to model decision making under risk, where risk can be
broadly defined as the effect of variability of random outcomes. One of
the main approaches in the practice of decision making under risk uses
mean-risk models; one such well-known is the classical Markowitz model,
where variance is used as risk measure. Along this line, we consider a
portfolio selection problem, where the asset returns have an elliptical
distribution. We mainly focus on portfolio optimization models
constructing portfolios with minimal risk, provided that a prescribed
expected return level is attained. In particular, we model the risk by
using Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR). After
reviewing the main properties of VaR and CVaR, we present short proofs
to some of the well-known results. Finally, we describe a
computationally efficient solution algorithm and present numerical
results. |
|
4/30:
Why Stock-price
Volatility Should Never Be a Surprise, Even in the Long Run
Equities
are subject to much wider price swings than previously understood,
according to a recent paper co-authored by Wharton finance and
economics professor Robert Stambaugh. The research adds a new
perspective to the work of Wharton finance professor Jeremy J. Siegel,
author of the book Stocks for the Long Run, which
says stock returns more than offset risks if you stay with the market
through its ups and downs. In a recent interview with
Knowledge@Wharton, the professors described their views about the
market's long-term behavior.
http://knowledge.wharton.upenn.edu/article/2229.cfm
4/20
| Date: | 2009-04 |
| By: | Jennifer Huang Clemens Sialm Hanjiang Zhang |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14903&r=rmg |
| Mutual funds change their risk levels significantly over time. This paper investigates the performance consequences of risk shifting, as well as the economic motivations and the mechanisms of risk shifting. Using a holdings-based measure of risk shifting, we find that funds that increase risk perform worse than funds that keep stable risk levels over time. In addition, funds that expect higher benefits from risk shifting are more likely to increase risk and perform particularly poorly after increasing risk. Our results are consistent with the notion that agency problems, rather than the ability to take advantage of changing investment opportunities, are the likely motivation behind risk shifting behavior. | |
4/15: How Do Emotions Influence Saving Behavior?
IB#9-8
Introduction
Employers have moved away from traditional defined benefit pension plans to defined contribution plans such as 401(k)s. As a result, many individuals are now required to make their own retirement saving and investment decisions, which has raised concerns about their ability and desire to handle these decisions. Since investment choices have major implications for future financial welfare, it is important to understand how individuals make these decisions and to identify potential ways to improve the decision-making process.
Researchers have explored various factors affecting retirement saving, such as income, age, job tenure, self-control failure, financial literacy and trust. No prior research, however, has looked at the effects of emotions on retirement savings. This Issue in Brief examines how two different emotions – hope and hopefulness – affect 401(k) participation and asset allocation. The first section defines the terms. The second section describes the structure of a recent field experiment. The third section summarizes the results, which reveal that having high hope (i.e. yearning) – for a secure retirement leads to different investment behaviors than having high hopefulness (i.e. perceived likelihood). Furthermore, threats to hope and threats to hopefulness are found to have different effects on 401(k) participation and investment decisions.
4/15: How does simplified disclosure affect individuals' mutual fund choices?
| Date: | 2009-04 |
| By: | John Beshears James J. Choi David Laibson Brigitte C. Madrian |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14859&r=cbe |
| We use an experiment to estimate the effect of the SEC’s Summary Prospectus, which simplifies mutual fund disclosure. Our subjects chose an equity portfolio and a bond portfolio. Subjects received either statutory prospectuses or Summary Prospectuses. We find no evidence that the Summary Prospectus affects portfolio choices. Our experiment sheds new light on the scope of investor confusion about sales loads. Even with a one-month investment horizon, subjects do not avoid loads. Subjects are either confused about loads, overlook them, or believe their chosen portfolio has an annualized log return that is 24 percentage points higher than the load-minimizing portfolio. | |
Juat reading teh abstract and you have an excellent idea why so much money was lost. Some journalists say that investors already know what risk is- JOKE! This is a sad commentary overall about not just the issue of reading a mutual fund prospectus but about literacy overall.
4/14:
| Date: | 2009-04-06 |
| By: | Ojo, Marianne |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:14503&r=rmg |
| Amongst other things, this paper aims to address complexities and challenges faced by regulators in identifying and assessing risk, problems arising from different perceptions of risk, and solutions aimed at countering problems of risk regulation. It will approach these issues through an assessment of explanations put forward to justify the growing importance of risks, well known risk theories such as cultural theory, risk society theory and governmentality theory. In addressing the problems posed as a result of the difficulty in quantifying risks, it will consider a means whereby risks can be quantified reasonably without the consequential effects which result from the dual nature of risk that is, risks emanating from the management of institutional risks. Current attempts by the European Union to regulate risks will also be discussed. This discussion will be facilitated through a consideration of recent developments in the EU which are aimed at addressing risks posed by hedge funds. The results obtained from a consultation process on hedge funds, and which will be discussed in the concluding section of this paper, reveal whether the systemic relevance of hedge funds and prime brokerage regulation need to be reviewed. Questions also addressed during the consultation process, which include whether indirect prudential regulation is inadequate to shield the financial system from hedge funds’ failure and whether prudential authorities have necessary tools to monitor exposures of the core financial system to hedge funds, will also be discussed. | |
4/8:
|
IMF To Warn On Spiraling Toxic Debt: Report |
|
TOKYO (Reuters) - Toxic debts racked up by banks and insurers could spiral to $4 trillion, new forecasts from the International Monetary Fund are set to suggest, British daily The Times reported on its website without citing sources. The IMF said in January that it expected the deterioration in U.S.-originated assets to reach $2.2 trillion by the end of next year. But it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21, the newspaper reported. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia, |
4/7: Chronicle of
Higher Education - The
universities engaged in the most ambitious fund-raising campaigns have
seen
collections drop 32 percent over the past year as economic volatility
prompts
donors to postpone or rethink gifts. The dozen universities
conducting
billion-dollar campaigns raised $2.71-billion from February 2008
through
January 2009, compared with nearly $4-billion for the previous 12
months. Cornell
University suffered the biggest drop, with donations falling 55 percent.
|
Date: |
2009 |
|
By: |
Claar,
Victor V |
|
URL: |
|
|
Our
paper empirically considers two general hypotheses related to the
literature of behavioral economics. First, we test the null hypothesis
that individuals behave, on average, in a manner more consistent with
the rational expectations hypothesis than with the idea of self-control
in the face of hyperbolic discounting in their saving decisions.
Second, along a variety of dimensions, we examine whether individuals
exhibit Herbert Simon’s notion that the goal formation of
individuals will differ depending upon their relative levels of
experience and knowledge. Perhaps there are significant differences
among groups in their saving decisions that depend upon their apparent
levels of intelligence, education, and knowledge. Finally, using a
variety of individual-specific control variables, we test for
robustness of the results. |
|
|
Keywords: |
Consumer
Economics; Empirical Analysis; Life Cycle Models and Saving |
3/16:
|
Date: |
2009-02-15 |
|
By: |
Maria
Grazia Romano (University of Salerno and CSEF) |
|
URL: |
|
|
The
article studies the impact of transaction costs on the trading strategy
of informed institutional investors in a sequential trading market
where traders can choose to transact a large or a small amount of the
stock. The analysis shows that high transaction costs may induce
informed investors to herd. Moreover, for low levels of transaction
costs, informed investors trade both the large and the small quantity
of the asset. Finally, if transaction costs are very low and the market
width is large enough, informed traders prefer to separate from small
liquidity traders. |
|
3/11: "Securitization, Transparency and Liquidity"
MARCO PAGANO, University
of Naples Federico II - Department of Economics, Centre for Economic
Policy
Research (CEPR), European Corporate Governance Institute (ECGI)
Email:
mrpagano@tin.it
PAOLO F. VOLPIN, London
Business School, Centre for Economic
Policy Research (CEPR), European Corporate Governance Institute (ECGI)
Email:
pvolpin@london.edu
We present a model in
which issuers of structured
bonds choose coarse and opaque ratings to enhance the liquidity of
their
primary market, at the cost of reducing secondary market liquidity or
even
causing it to freeze. The degree of transparency is inefficiently low
if the
social value of secondary market liquidity exceeds its private value.
We
analyze various types of public intervention - requiring transparency
for
rating agencies, providing liquidity to distressed banks or supporting
secondary market prices - and find that their welfare implications are
quite
different. Finally, transparency is greater if issuers restrain the
issue size,
or tranche it so as to sell the more information-sensitive tranche to
sophisticated investors only.
3/10:
|
Date: |
2009-03 |
|
By: |
Novarese,
Marco |
|
URL: |
|
|
According
to a wide literature persons are not able to evaluate their own skills
and knowledge, but the discussion on the nature, extension and
determinants of this phenomenon is still open. This paper aims at
proposing new empirical evidence on overconfidence and its
determinants, trying to find out the possible effect of past
performance on present optimism. I test my students' calibration and
confidence in predicting their future results, comparing their
expectations and real grades. My analysis allows showing the existence
of overconfidence, its reduction in two following tests, and its non
linear relation with students' capacities. Besides, I focus my
attention on the effect of the grade my students got at the end of high
school. This is used a proxy of their past experience and habit to get
good or bad grades. Past success determined overconfidence. This idea
is connected to the literature on heuristics and rule based perception. |
|
3/3
- Stock-Market Crashes and Depressions
|
Date: |
2009-02 |
|
By: |
Robert
J. Barro |
|
URL: |
|
|
Long-term
data for 25 countries up to 2006 reveal 195 stock-market crashes
(multi-year real returns of -25% or less) and 84 depressions
(multi-year macroeconomic declines of 10% or more), with 58 of the
cases matched by timing. The United States has two of the matched
events - the Great Depression 1929-33 and the post-WWI years 1917-21,
likely driven by the Great Influenza Epidemic. 45% of the matched cases
are associated with war, and the two world wars are prominent.
Conditional on a stock-market crash, the probability of a minor
depression (macroeconomic decline of at least 10%) is 30% and of a
major depression (at least 25%) is 11%. In a non-war environment, these
probabilities are lower but still substantial - 20% for a minor
depression and 3% for a major depression. Thus, the stock-market
crashes of 2008-09 in the United States and other countries provide
ample reason for concern about depression. In reverse, the probability
of a stock-market crash is 69%, conditional on a depression of 10% or
more, and 91% for 25% or more. Thus, the largest depressions are
particularly likely to be accompanied by stock-market crashes, and this
finding applies equally to non-war and war events. We allow for
flexible timing between stock-market crashes and depressions for the 58
matched cases to compute the covariance between stock returns and an
asset-pricing factor, which depends on the proportionate decline of
consumption during a depression. If we assume a coefficient of relative
risk aversion around 3.5, this covariance is large enough to account in
a familiar looking asset-pricing formula for the observed average
(levered) equity premium of 7% per year. This finding complements
previous analyses that were based on the probability and size
distribution of macroeconomic disasters but did not consider explicitly
the covariance between macroeconomic declines and stock returns. |
|
|
JEL: |
E01
E21 E23 E44 G12 |
|
Date: |
2009-01 |
|
By: |
Zingales,
Luigi |
|
URL: |
|
|
The
U.S. system of security law was designed more than 70 years ago to
regain investors’ trust after a major financial crisis. Today
we face a similar problem. But while in the 1930s the prevailing
perception was that investors had been defrauded by offerings of
dubious quality securities, in the new millennium, investors’
perception is that they have been defrauded by managers who are not
accountable to anyone. For this reason, I propose a series of reforms
that center around corporate governance, while shifting the focus from
the protection of unsophisticated investors in the purchasing of new
securities issues to the investment in mutual funds, pension funds, and
other forms of asset management. |
|
|
Keywords: |
coorporate
goverance; security regulation |
|
JEL: |
G18
G38 K22 |
|
Date: |
2009-01 |
|
By: |
Pástor,
Luboš |
|
URL: |
|
|
We
survey the recent literature on learning in financial markets. Our main
theme is that many financial market phenomena that appear puzzling at
first sight are easier to understand once we recognize that parameters
in financial models are uncertain and subject to learning. We discuss
phenomena related to the volatility and predictability of asset
returns, stock price bubbles, portfolio choice, mutual fund flows,
trading volume, and firm profitability, among others. |
|
3/3:Why do
risk premia vary over time? A theoretical investigation under habit
formation
|
Date: |
2009-02-16 |
|
By: |
De
Paoli, Bianca (Bank of England) |
|
URL: |
|
|
Empirical
evidence suggests that risk premia are higher at business cycle troughs
than they are at peaks. Existing asset pricing theories ascribe moves
in risk premia to changes in volatility or risk aversion. Nevertheless,
in a simple general equilibrium model, risk premia can be procyclical
even though the volatility of consumption is constant and despite a
countercyclically varying risk aversion coefficient. We show that
agents' expectations about future prospects also influence premium
dynamics. In order to generate countercyclically varying premia, as
found in the data, one requires a combination of hump-shaped
consumption dynamics or highly persistent shocks and habits. Our
results, thus, suggest that factors which help match activity data may
also help along the asset pricing dimension. |
|
3/3: Stock-Market
Crashes and Depressions
|
Date: |
2009-02 |
|
By: |
Robert
J. Barro |
|
URL: |
|
|
Long-term
data for 25 countries up to 2006 reveal 195 stock-market crashes
(multi-year real returns of -25% or less) and 84 depressions
(multi-year macroeconomic declines of 10% or more), with 58 of the
cases matched by timing. The United States has two of the matched
events - the Great Depression 1929-33 and the post-WWI years 1917-21,
likely driven by the Great Influenza Epidemic. 45% of the matched cases
are associated with war, and the two world wars are prominent.
Conditional on a stock-market crash, the probability of a minor
depression (macroeconomic decline of at least 10%) is 30% and of a
major depression (at least 25%) is 11%. In a non-war environment, these
probabilities are lower but still substantial - 20% for a minor
depression and 3% for a major depression. Thus, the stock-market
crashes of 2008-09 in the United States and other countries provide
ample reason for concern about depression. In reverse, the probability
of a stock-market crash is 69%, conditional on a depression of 10% or
more, and 91% for 25% or more. Thus, the largest depressions are
particularly likely to be accompanied by stock-market crashes, and this
finding applies equally to non-war and war events. We allow for
flexible timing between stock-market crashes and depressions for the 58
matched cases to compute the covariance between stock returns and an
asset-pricing factor, which depends on the proportionate decline of
consumption during a depression. If we assume a coefficient of relative
risk aversion around 3.5, this covariance is large enough to account in
a familiar looking asset-pricing formula for the observed average
(levered) equity premium of 7% per year. This finding complements
previous analyses that were based on the probability and size
distribution of macroeconomic disasters but did not consider explicitly
the covariance between macroeconomic declines and stock returns. |
|
3/2: Sorting
out Downside Beta
|
Date: |
2009-02-18 |
|
By: |
Post,
G.T. |
|
URL: |
|
|
Downside
risk, when properly defined and estimated, helps to explain the
cross-section of US stock returns. Sorting stocks by a proper estimate
of downside market beta leads to a substantially larger cross-sectional
spread in average returns than sorting on regular market beta. This
result arises despite the fact that downside beta is based on fewer
return observations and therefore is more difficult to estimate and
predict. The explanatory power of downside risk remains after
controlling for other stock characteristics, including firm-level size,
value and momentum. |
|
3/2: Cognitive
Dissonance as a Means of Reducing Hypothetical Bias
|
Date: |
2009-02-23 |
|
By: |
Alfnes,
Frode |
|
URL: |
|
|
Hypothetical
bias is a persistent problem in stated preference studies. We propose
and test a method for reducing hypothetical bias based on the cognitive
dissonance literature in social psychology. A central element of this
literature is that people prefer not to take inconsistent stands and
will change their attitudes and behavior to make them consistent. We
find that participants in a stated preference willingness-to-pay study,
when told that a nonhypothetical study of similar goods would follow,
state significantly lower willingness to pay than participants not so
informed. In other words, participants adjust their stated willingness
to pay to avoid cognitive dissonance from taking inconsistent stands on
their willingness to pay for the good being offered. |
|
3/1: "The Adequacy of Economic Resources in
Retirement"
Michigan Retirement Research Center
Research Paper No. 2008-184
MICHAEL D. HURD, The
RAND Corporation, SUNY at Stony Brook
University, College of Arts and Science, Department of Economics,
National
Bureau of Economic Research (NBER)
Email:
mhurd@RAND.ORG
SUSANN ROHWEDDER, The
RAND Corporation
Email:
Susannr@rand.org
The most common
metric for assessing the adequacy
of economic preparation for retirement is the income replacement rate,
the
ratio of income after retirement to income before retirement. However
both
economic theory and common sense say that someone is adequately
prepared if she
is able to maintain her level of economic well-being, which is not the
same as
maintaining her level of income or some fixed proportion of income.
Economic
well-being is typically measured by consumption, which is the measure
we use.
We define and estimate measures of economic preparation for retirement
based on
a complete inventory of economic resources, particularly wealth, which
we
compare with optimal consumption paths. We find that a substantial
majority of
those just past the usual retirement age are adequately prepared for
retirement
in that they will be able to finance a path of consumption that begins
at their
current level of consumption and then follows an age-pattern similar to
that of
current retirees. This is not true, however, for all groups in the
population.
In particular, almost half of singles who lack a high school education
are
likely to be forced to reduce consumption. Couples are much better
prepared
than singles. But because of taxes a substantial number of married
college
graduates will have to reduce consumption.
3/1: "Retirement Wealth Across Cohorts: The
Role of Earnings
Inequality and Pension Changes"
Michigan Retirement Research Center
Research Paper No. 2008-186
ANN HUFF STEVENS, University
of California, Davis
- Department of Economics, National Bureau of Economic Research (NBER)
Email:
annstevens@ucdavis.edu
Changes in labor
markets over the past 30 years
suggest upcoming changes in the distribution of wealth at retirement.
Baby boom
cohorts have spent the majority of their prime earnings years in a
labor market
with increased earnings inequality. This paper investigates how changes
in
lifetime earnings distributions affect the distribution of retirement
wealth
among cohorts retiring over the next decade. I use data from the Health
and
Retirement Study from 1992 to 2004 to estimate the relationship between
lifetime earnings, pre-retirement private wealth and Social Security
wealth. I
show that changes in the lower half of the male earnings distribution
explain a
substantial portion of changes in the distribution of pre-retirement
wealth.
Growth in women's earnings across the cohorts do not offset these
declines in
wealth associated with male earnings. When pensions are added to the
measure of
wealth, the role of earnings is even larger, reflecting a strong
correlation
between changes in earnings across these cohorts and changes in the
values of
their employer-provided pensions. These pension changes do not appear
to
operate via changes in pension structures (defined benefit versus
defined
contribution). The present value of wealth from future Social Security
benefits, in contrast, grows in real terms throughout most of the
distribution.
At the bottom of the male distribution of Social Security wealth,
reductions in
lifetime earnings limit this growth in real benefits, while at the top
of the
distribution earnings growth amplifies expected growth in Social
Security
wealth.
3/1: Are Stocks Really Less Volatile in the Long
Run?"
Conventional wisdom
views stocks as less volatile
over long horizons than over short horizons due to mean reversion
induced by
return predictability. In contrast, we find stocks are substantially
more
volatile over long horizons from an investor's perspective. This
perspective
recognizes that parameters are uncertain, even with two centuries of
data, and
that observable predictors imperfectly deliver the conditional expected
return.
We decompose return variance into five components, which include mean
reversion
and various uncertainties faced by the investor. Although mean
reversion makes
a strong negative contribution to long-horizon variance, it is more
than offset
by the other components. Using a predictive system, we estimate
annualized
30-year variance to be nearly 1.5 times the 1-year variance.
We find that stocks
are actually more volatile
over long horizons. At a 30-year horizon, for
example, we find return variance per year to be 21 to 53 percent higher
than
the variance at a
1-year horizon. This conclusion stems from the fact that we assess
variance
from the perspective
of investors who condition on available information but realize their
knowledge
is limited in two
key respects. First, even after observing 206 years of data
(1802–2007),
investors do not know the
values of the parameters that govern the processes generating returns
and
observable “predictors”
used to forecast returns. Second, investors recognize that, even if
those
parameter values were
known, the predictors could deliver only an imperfect proxy for the
conditional
expected return.
Of the four
components contributing positively,
the one making the largest contribution at
the 30-year horizon reflects uncertainty about future expected returns.
This
component (iii) is
often neglected in discussions of how return predictability affects
long-horizon return variance.
Such discussions typically highlight mean reversion, but mean
reversion—and predictability more
generally—require variance in the conditional expected
return, which we
denote by t . That
variance makes the future values of t uncertain, especially in the more
distant
future periods,
thereby contributing to the overall uncertainty about future returns.
The
greater the degree of
predictability, the larger is the variance of t and thus the greater is
the
relative contribution of
uncertainty about future expected returns to long-horizon return
variance.
We split the
1802–2007 sample in half and
estimate the
predictive variances separately at the ends of both subperiods. In the
first
subperiod, the predictive
variance per period rises monotonically with the horizon, under the
benchmark
priors. In the
second subperiod, the predictive variance exhibits a U-shape with
respect to
the horizon: it initially
decreases, reaching its minimum at the horizon of 7 years, but it
increases
afterwards, rising above
the 1-year variance at the horizon of 18 years. That is, the negative
effect of
mean reversion
prevails at short horizons, but the combined positive effects of
estimation
risk and uncertainty
about current and future t ’s prevail at long horizons. For
both
subperiods, the 30-year predictive
variance exceeds the 1-year variance across all prior specifications.
stocks less appealing to long-horizon investors than conventional wisdom would suggest. This
finding does not necessarily imply that long-horizon investors should hold less stock than short horizon
investors. Stock volatility is only one key ingredient in a problem that no doubt involves
other considerations of first-order importance, such as human capital and bond volatility, that are
beyond the scope of this study.19 Investigating asset-allocation decisions while allowing the higher
long-run stock volatility to enter the problem offers an interesting direction for future research.
2/26: "Financial Literacy and Planning: Implications
for Retirement
Wellbeing"
Michigan Retirement Research Center
Research Paper No. WP
2005-108
2/24: “An
Experimental Investigation of Why Individuals Conform,”
by Basit
Zafar
Social interdependence is believed to play an important role in how
people make
individual choices. This paper presents a simple model constructed on
the
premise that people are motivated by their own payoff as well as by how
their
actions compare with those of other people in their reference group.
The author
shows that conformity of actions may arise either from learning about
the norm
(social learning), or from adhering to the norm because of
image-related
concerns (social influence). To disentangle the two empirically, Zafar
uses the
fact that image-related concerns can be present only if actions are
publicly
observable. The model predictions are tested in a “charitable
contribution” experiment in which the actions and identities
of the
subjects are unmasked in a controlled and systematic way. Both social
learning
and social influence seem to play an important role in the
subjects’
choices. In addition, individuals gain utility simply by making the
same choice
as the reference group (social comparison) and change their
contributions in
the direction of the social norm even when their identities are hidden.
Once the
identities and contribution distributions of group members are
revealed,
individuals conform to the modal choice of the group. Moreover, the
author
finds that social ties (defined as subjects knowing one another from
outside
the experimental environment) affect the role of social influence. In
particular, a low-contribution norm evolves that causes individuals to
contribute less in the presence of people they know.
2/24: Experimental
tests on consumption, savings and pensions
|
Date: |
2008-12-23 |
|
By: |
Enrique
Fatás (LINEX, University of Valencia.) |
|
URL: |
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|
As
part of the current debate on the reform of pension systems, this
article examines the potential effects on consumption behaviour of
implementing a lump-sum payment in a public pension system. This work
explores an experimental investigation into retirement consumption
behaviour with two central features: first, there exists a decreasing
probability of surviving; second, there are two sequences of income,
one when individual works and another when she is retired. The results
show how subjects seem to plan their consumption and saving choices
conditionated by both the long horizon with no incomes and the lump-sum
payment. This yields, in the majority of periods, a surprising
over-saving behaviour. |
|
2/24: Gender
Differences in Risk Aversion and Ambiguity Aversion
|
Date: |
2009-01 |
|
By: |
Borghans,
Lex (Maastricht University) |
|
URL: |
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|
This
paper demonstrates gender differences in risk aversion and ambiguity
aversion. It also contributes to a growing literature relating economic
preference parameters to psychological measures by asking whether
variations in preference parameters among persons, and in particular
across genders, can be accounted for by differences in personality
traits and traits of cognition. Women are more risk averse than men.
Over an initial range, women require no further compensation for the
introduction of ambiguity but men do. At greater levels of ambiguity,
women have the same marginal distaste for increased ambiguity as men.
Psychological variables account for some of the interpersonal variation
in risk aversion. They explain none of the differences in ambiguity. |
|
|
Date: |
2009-02-10 |
|
By: |
Chollete,
Lorán (Dept. of Finance and Management Science, Norwegian
School of Economics and Business Administration) |
|
URL: |
|
|
What
drives extreme economic events? Motivated by recent theory, and events
in US subprime markets, we begin to open the black box of extremes.
Specifically, we extend standard economic analysis of extreme risk,
allowing for dynamics and endogeneity. We explain how endogenous
extremes may arise in an economy of individuals who engage in resource
transfers. Our model suggests that susceptibility to extremes depends
on differences in marginal substitution rates. Using over a century of
daily stock price data, we construct empirical probabilities of
extremes, and document interesting dynamic behavior. We find evidence
that extremes are endogenous. This latter finding raises the
possibility that control of extremes is a public good, and that extreme
events may be an important market failure for regulators and central
banks to correct. |
|
2/19: What Does the
Yield Curve Tell Us About Exchange Rate Predictability?
|
Date: |
2009 |
|
By: |
Yu-chin
Chen |
|
URL: |
|
|
This
paper uses information contained in the cross-country yield curves to
test the asset-pricing approach to exchange rate determination, which
models the nominal exchange rate as the discounted present value of its
expected future fundamentals. Research on the term structure of
interest rates has long argued that the yield curve contains
information about future economic activity such as GDP growth and
inflation. Bringing this lesson to the international context, we
extract the Nelson-Siegel (1987) factors of relative level, slope, and
curvature from cross-country yield differences to proxy expected
movements in future exchange rate fundamentals. Using monthly data
between 1985-2005 for the United Kingdom, Canada, Japan and the US, we
show that the
yield curve factors indeed can explain and predict bilateral exchange
rate movements and excess currency returns one month to two years
ahead. Out-of- sample analysis also shows the yield curve factors to
outperform a random walk in forecasting short-term exchange rate
returns. |
|
|
Keywords: |
Exchange
Rate Forecasting, Term Structure of Interest Rates, Uncovered Interest,
Parity |
2/16: The first
global financial crisis of the 21st century: Introduction
|
Date: |
2008-07 |
|
By: |
Reinhart,
Carmen |
|
URL: |
|
|
Global
financial markets are showing strains on a scale and scope not
witnessed in the past three-quarters of a century. What started with
elevated losses on U.S.-subprime mortgages has spread beyond the
borders of the United States and the confines of the mortgage market.
Many risk spreads have ballooned, liquidity in some market segments has
dried up, and large complex financial institutions have admitted
significant losses. Bank runs are no longer the subject exclusively of
history.These events have challenged policymakers, and the responses
have varied across region. The European Central Bank has injected
reserves in unprecedented volumes. The Bank of England participated in
the bail-out and, ultimately, the nationalization of a depository,
Northern Rock. The U.S. Federal Reserve has introduced a variety of new
facilities and extended its support beyond the depository sector. These
events have also challenged economists to explain why the crisis
developed, how it is unfolding, and what can be done. This volume
compiles contributions by leading economists in VoxEU over the past
year that attempt to answer these questions. We have grouped these
contributions into three sections corresponding to those three critical
questions. |
|
2/16:Forecasting
a Large Dimensional Covariance Matrix of a Portfolio of Different Asset
Classes
|
Date: |
2009-01 |
|
By: |
Lillie
Lam (Research Department, Hong Kong Monetary Authority) |
|
URL: |
|
|
In
portfolio and risk management, estimating and forecasting the
volatilities and correlations of asset returns plays an important role.
Recently, interest in the estimation of the covariance matrix of large
dimensional portfolios has increased. Using a portfolio of 63 assets
covering stocks, bonds and currencies, this paper aims to examine and
compare the predictive power of different popular methods adopted by i)
market practitioners (such as the sample covariance, the 250-day moving
average, and the exponentially weighted moving average); ii) some
sophisticated estimators recently developed in the academic literature
(such as the orthogonal GARCH model and the Dynamic Conditional
Correlation model); and iii) their combinations. Based on five
different criteria, we show that a combined forecast of the 250-day
moving average, the exponentially weighted moving average and the
orthogonal GARCH model consistently outperforms the other methods in
predicting the covariance matrix for both one-quarter and one-year
ahead horizons. |
|
2/16:
|
Date: |
2009-01-21 |
|
By: |
Palmroos,
Peter (Bank of Finland Research) |
|
URL: |
|
|
This
paper demonstrates how the observed correlation between probability of
default and loss given default depends on the fact that defaults in
which collateral provides 100% recovery are not observed. Creditors see
only the defaults of mortgagors who suffer from a fall in collateral
value to less than the remaining loan principal. Consequently, the
default data available to creditors amounts to a mere truncated sample
from the underlying population of defaults. Correlation estimates based
on such truncated samples are biased and differ substantially from
estimates derived from representative non-truncated samples. Moreover,
the observed correlation between default probability and loss given
default is sensitive to the truncation point, which may explain the
differences in correlation estimates found in the literature. This may
also explain why correlation estimates seem to be specific to cycle
phase. |
|
|
Date: |
2008-10 |
|
By: |
Stulz,
Rene M. (Ohio State U and ECGI) |
|
URL: |
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|
A
large loss is not evidence of a risk management failure because a large
loss can happen even if risk management is flawless. I provide a
typology of risk management failures and show how various types of risk
management failures occur. Because of the limitations of past data in
assessing the probability and the implications of a financial crisis, I
conclude that financial institutions should use scenarios for credible
financial crisis threats even if they perceive the probability of such
events to be extremely small. |
|
In a typical firm,
the role of risk management is
first to assess the risks faced by the firm, communicate these risks to
those
who make risk-taking decisions for the firm, and finally manage and
monitor
those risks to make sure that the firm only bears the risks its
management and
board of directors want it to bear. In general, a firm will specify a
risk
measure that it focuses on together with additional risk metrics. When
that
risk measure exceeds the firm’s tolerance for risk, risk is
reduced.
Alternatively, when the risk measure is too low for the
firm’s risk
tolerance, the firm increases its risk. Because firms are generally
more
concerned about unexpected losses, a frequently used risk measure is
Value-at-Risk or VaR, a measure of downside risk. VaR is the maximum
loss at a
given confidence level over a given period of time. Hence, if the 95%
confidence level is used and a firm has a one-day VaR of $150 million,
the firm
has a 5% chance of making a loss in excess of $150 million over the
next day if
the VaR is correctly estimated. This measure might be estimated daily
or over
longer periods of time.
EFM- VAR is a
statistical formula relied on by
many firms. It uses standard numbers for risk. My point is this as
defined by
Mandelbrot. "The professors who live by the bell curve adopted it for
mathematical convenience, not realism. It asserts that when you measure
the
world, the numbers that result hover around the mediocre; big
departures from
the mean are so rare that their effect is negligible. This focus on
averages
works well with everyday physical variables such as height and weight,
but not
when it comes to finance. One can disregard the odds of a person's
being miles
tall or tons heavy, but similarly excessive observations can never be
ruled out
in economic life. The German mark's move from four per dollar to four
trillion
per dollar after World War I should have taught economists to beware
the bell
curve.
. The economic world
is driven primarily by random
jumps. Yet the common tools of finance were designed for random walks
in which
the market always moves in baby steps. Despite increasing empirical
evidence
that concentration and jumps better characterize market reality, the
reliance
on the random walk, the bell-shaped curve, and their spawn of alphas
and betas
is accelerating, widening a tragic gap between reality and the standard
tools
of financial measurement.
To blow up an
academic dogma, empirical
observations do not suffice. A better theory is needed, and one exists:
the
fractal theory of risk, ruin, and return. In this approach,
concentration and
random jumps are not belated fudges but the point of departure
In market terms, a
power-law distribution implies
that the likelihood of a daily or weekly drop exceeding 20% can be
predicted
from the frequency of drops exceeding 10%, and that the same ratio
applies to a
10% vs. a 5% drop. In bell-curve finance, the chance of big drops is
vanishingly small and is thus ignored. The 1987 stock market crash was,
according to such models, something that could happen only once in
several
billion billion years. In power-law finance, big drops—while
certainly
less likely than small ones—remain a real and calculable
possibility.
Another aspect of the
real world tackled by
fractal finance is that markets keep the memory of past moves,
particularly of
volatile days, and act according to such memory. Volatility breeds
volatility;
it comes in clusters and lumps. This is not an impossibly difficult or
obscure
framework for understanding markets. In fact, it accords better with
intuition
and observed reality than the bell-curve finance that still dominates
the
discourse of both academics and many market players.
2/9: "Real Effects of the Subprime Mortgage Crisis:
Is it a Demand
or a Finance Shock?"
We develop a
methodology to study how the subprime
crisis spills over to the real economy. Does it manifest itself
primarily
through reducing consumer demand or through tightening liquidity
constraint on
non-financial firms? Since most non-financial firms have much larger
cash
holding than before, they appear unlikely to face significant liquidity
constraint. We propose a methodology to estimate these two channels of
spillovers. We first propose an index of a firm's sensitivity to
consumer
demand, based on its response to the 9/11 shock in 2001. We then
construct a
separate firm-level index on financial constraint based on Whited and
Wu
(2006). We find that both channels are at work, but a tightened
liquidity squeeze
is economically more important than a reduced consumer spending in
explaining
cross firm differences in stock price declines.
|
Date: |
2009-01-04 |
|
By: |
Rowthorn,
Robert E. |
|
URL: |
|
|
Gratuitous
cooperation (in favour of non-relatives and without repeated
interaction) eludes traditional evolutionary explanations. In this
paper we survey the various theories of cooperative behaviour, and we
describe our own effort to integrate these theories into a
self-contained framework. Our main conclusions are as follows. First:
altruistic punishment, conformism and gratuitous cooperation co-evolve,
and group selection is a necessary ingredient for the co-evolution to
take place. Second: people do not cooperate by mistake, as most
theories imply; on the contrary, people knowingly sacrifice themselves
for others. Third: in cooperative dilemmas conformism is an expression
of preference, not a learning rule. Fourth, group-mutations (e.g., the
rare emergence of a charismatic leader that brings order to the group)
are necessary to sustain cooperation in the long run. |
|
1/26: The Aftermath
of Financial Crises
|
Date: |
2009-01 |
|
By: |
Carmen
M. Reinhart |
|
URL: |
|
|
This
paper examines the depth and duration of the slump that invariably
follows severe financial crises, which tend to be protracted affairs.
We find that asset market collapses are deep and prolonged. On a
peak-to-trough basis, real housing price declines average 35 percent
stretched out over six years, while equity price collapses average 55
percent over a downturn of about three and a half years. Not
surprisingly, banking crises are associated with profound declines in
output and employment. The unemployment rate rises an average of 7
percentage points over the down phase of the cycle, which lasts on
average over four years. Output falls an average of over 9 percent,
although the duration of the downturn is considerably shorter than for
unemployment. The real value of government debt tends to explode,
rising an average of 86 percent in the major
post–World War II episodes. The main
cause of debt explosions is usually not the widely cited costs of
bailing out and recapitalizing the banking system. The collapse in tax
revenues in the wake of deep and prolonged economic contractions is a
critical factor in explaining the large budget deficits and increases
in debt that follow the crisis. Our estimates of the rise in government
debt are likely to be conservative, as these do not include increases
in government guarantees, which also expand briskly during these
episodes. |
|
1/26: Stages of the
2007/2008 Global Financial Crisis: Is There a Wandering Asset-Price
Bubble?
|
Date: |
2008-12-10 |
|
By: |
Orlowski,
Lucjan T |
|
URL: |
|
|
This
study identifies five distinctive stages of the current global
financial crisis: the meltdown of the subprime mortgage market;
spillovers into broader credit market; the liquidity crisis epitomized
by the fallout of Northern Rock, Bear Stearns and Lehman Brothers with
counterparty risk effects on other financial institutions; the
commodity price bubble, and the ultimate demise of investment banking
in the U.S. The study argues that the severity of the crisis is
influenced strongly by changeable allocations of global savings coupled
with excessive credit creation, which lead to over-pricing of varied
types of assets. The study calls such process a “wandering
asset-price bubble”. Unstable allocations elevate market,
credit and liquidity risks. Monetary policy responses aimed at
stabilizing financial markets are proposed. |
|
1/26:Learning in
Financial Markets
|
Date: |
2009-01 |
|
By: |
Ľuboš
Pástor |
|
URL: |
|
|
We
survey the recent literature on learning in financial markets. Our main
theme is that many financial market phenomena that appear puzzling at
first sight are easier to understand once we recognize that parameters
in financial models are uncertain and subject to learning. We discuss
phenomena related to the volatility and predictability of asset
returns, stock price bubbles, portfolio choice, mutual fund flows,
trading volume, and firm profitability, among others. |
|
|
Date: |
2009-01 |
|
By: |
Junichiro
Ishida (Osaka School of International Public Policy (OSIPP),Osaka
University) |
|
URL: |
|
|
An
effective leader must have a clear vision and a strong will to stand by
it, even in turbulent times. At the same time, though, it is also
equally important to be open-minded and flexible enough to respond
objectively to new information without being prejudiced by prior
information. This paper illustrates how these seemingly contradictory
qualifications are related and determined in a model of intrapersonal
conflicts. We consider a decision maker who is capable of deceiving
herself and manipulating information in some particular way to
construct a rosy view of the world. There is a cost of doing so,
however, because a distorted belief leads to a distorted action which
is in general less efficient. This tradeoff creates a tension within
herself and constrains the extent of information manipulation, thereby
allowing us to identify the determinants of vision and flexibility.
Among other things, we show that vision and flexibility are
substitutes, and their respective levels depend crucially on attributes
such as self-confidence level and fragility as well as the strength of
willpower. |
|
1/19: The
Spread of the Credit Crisis: View from a Stock Correlation Network
|
Date: |
2008-12-02 |
|
By: |
Smith,
Reginald |
|
URL: |
|
|
The
credit crisis roiling the world's financial markets will likely take
years and entire careers to fully understand and analyze. A short
empirical investigation of the current trends, however, demonstrates
that the losses in certain markets, in this case the US equity markets,
follow a cascade or epidemic flow like model along the correlations of
various stocks. A few images and explanation here will suffice to show
the phenomenon. Also, whether the idea of "epidemic" or a "cascade" is
a metaphor or model for this crisis will be discussed. Animations of
the spread of the crisis are available at
http://reggiesmithsci.googlepages.com/creditcrisis |
|
1/13: Skill,
Luck, Overconfidence, and Risk Taking
|
Date: |
2008-12 |
|
By: |
Natalia
Karelaia |
|
URL: |
|
|
In
most naturally occurring situations, success depends on both skill and
chance. We compare experimental market entry decisions where payoffs
depend on skill alone and combinations of skill and luck. We find more
risk taking with skill and luck as opposed to skill alone, particularly
for males, and little overconfidence. Our data support an explanation
based on differential attitudes toward luck by those whose
self-assessed skills are low and high. Making luck more important
induces greater optimism for the former, while the latter maintain a
belief that high levels of skill are sufficient to overcome the
vagaries of chance. |
|
1/6/09:
"Behavioral Biases and Mutual Fund Clienteles"
We predict that
investors with relatively strong
behavioral biases are more likely to display poor decisions and poor
performance concerning mutual funds. Such investors are more likely to
put a
larger proportion of their wealth into individual stocks, rather than
mutual
funds. But when these investors do select mutual funds, they are more
likely to
pick the “wrong” funds, or use funds
inappropriately. They will
tend to select higherexpense mutual funds rather than index funds, and
rebalance their mutual fund holdings more frequently than other
investors. When
combined with the higher fees associated with funds that target these
investors, they will experience relatively poor performance.
2008
|
Date: |
2008-12 |
|
By: |
Yakov
Ben-Haim |
|
URL: |
|
|
In
situations of relative calm and certainty, policy makers have
confidence in the mechanisms at work and feel capable of attaining
precise and ambitious results. As the environment becomes less and less
certain, policy makers are confronted with the fact that there is a
trade-off between the quality of a certain outcome and the confidence
(robustness) with which it can be attained. Added to that, in the
presence of Knightian uncertainty, confidence itself can no longer be
represented in probabilistic terms (because probabilities are unknown). We adopt the technique of Info-Gap Robust
Satisficing to first define confidence under Knightian uncertainty, and
second quantify the trade-off between quality and robustness
explicitly.We apply this to a standard monetary policy example and
provide Central Banks with a framework to rank policies in a way that
will allow them to pick the one that either maximizes confidence given
an acceptable level of performance, or alternatively, optimizes
performance for a given level of confidence |
|
12/23:
|
Date: |
2008 |
|
By: |
Frank
M. Fossen |
|
URL: |
|
|
The
empirical finding that entrepreneurs tend to invest a large share of
their wealth in their own firms despite comparably low returns and high
risk has become known as the private equity premium puzzle. This paper
provides evidence supporting the hypothesis that lower risk aversion of
entrepreneurs, and not necessarily credit constraints, may explain this
puzzle. The analysis is based on a large, representative panel data set
for Germany, which provides information on asset portfolios and
experimentally validated risk attitudes. The results show that both the
ownership probability and the conditional portfolio share of private
business equity significantly increase with higher risk tolerance. |
|
|
Keywords: |
Entrepreneurship,
Private Equity, Investment, Risk Aversion |
|
JEL: |
G11
G32 L26 J23 D81 |
|
Date: |
2008-12 |
|
By: |
George
M. Constantinides |
|
URL: |
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Widespread
violations of stochastic dominance by one-month S&P 500 index
call options over 1986-2006 imply that a trader can improve expected
utility by engaging in a zero-net-cost trade net of transaction costs
and bid-ask spread. Although pre-crash option prices conform to the
Black-Scholes-Merton model reasonably well, they are incorrectly priced
if the distribution of the index return is estimated from time-series
data. Substantial violations by post-crash OTM calls contradict the
notion that the problem primarily lies with the left-hand tail of the
index return distribution and that the smile is too steep. The decrease
in violations over the post-crash period 1988-1995 is followed by a
substantial increase over 1997-2006 which may be due to the lower
quality of the data but, in any case, does not provide evidence that
the options market is becoming more rational over time. |
|
12/22: Say
what???
|
Date: |
2008-12 |
|
By: |
Cara
Marshall (Department of Economics, Queens College of the City
University of New York) |
|
URL: |
|
|
This
paper revisits the roots of modern portfolio theory and the recognition
that a stock’s (or a stock portfolio’s) risk can be
decomposed into a systematic component and an unsystematic component,
and, further, that only the former should contribute to expected
return. However, instead of isolating the systematic component of risk
by recasting the risk in terms of a stock’s beta coefficient,
I choose to decompose the standard deviation, or variance if one
prefers the original risk measure, directly into its systematic and
unsystematic components allowing one to focus on systematic risk and
yet remain in the mean/standard deviation (or mean/variance) space.
When the standard deviation of return is decomposed into its systematic
and unsystematic components, an “adjusted CML” can
be derived and it is easily shown that this adjusted CML is equivalent
to Sharpe’s SML. This alternative way of looking at
systematic and unsystematic risk offers easily accessible insights into
the very nature of risk. This has a number of interesting implications
including, but not limited to, reducing the computational complexities
in calculating the relevant portion of a portfolio’s
volatility, facilitating sophisticated dispersion trades, estimating
risk-adjusted returns, and improving risk-adjusted performance
measurement. This paper is, in part, pedagogical and, in part, an
introduction to an alternative way of measuring systematic and
unsystematic risk. |
|
12/2/ 08: Interesting
|
Date: |
2008-12 |
|
By: |
Charles
R. Hulten |
|
URL: |
|
|
"What
is a company really worth?" is a question asked repeatedly during the
recent financial crisis. Attention has been focused on short-term
valuation issues, like the "mark-to-market" controversy. Sorting out
these issues is complicated by the fact that the market puts a value on
shareholder equity that is consistently more than twice the reported
book value of a company. Numerous observers have pointed to the absence
of most intangible assets from financial statements as an important
source of this puzzle. We use Compustat financial data for 617
R&D intensive firms to test this possibility. We find that
conventional book value alone explains only 31 percent of the market
capitalization of these firms in 2006, and that this increases to 75
percent when our estimates of intangible capital are included. The
debt-equity ratio also falls from 1.46 to 0.61. These findings suggest
that financial reports tend to substantially understate the long-run
intrinsic value of corporate America. |
|
12/3:
It's all about risk-
|
Date: |
2008-10-26 |
|
By: |
C-René
Dominique |
|
URL: |
http://d.repec.org/n?u=RePEc:eei:rpaper:eeri_rp_2008_17&r=cbe |
|
Greed
and the unethical behavior of financial institutions obviously played a
part in the collapse of the world capital market in 2008. But, this
paper argues that the main culprits are the neo-liberal ideology
(requiring ever smaller gov-ernments and privatization) and the flawed
theories of risk assessment. It also finds that given the fact that
market economies are fractal structures, the objective assessment and /
or the quantification of risks is not even possible. It concludes with
some recommendations as to how to avoid future collapses. |
|
12/3: I am 7'6"
|
Date: |
2008-05 |
|
By: |
Anne
Case (Princeton University) |
|
URL: |
|
|
We
use nine waves of the British Household Panel Survey (BHPS) to
investigate the large labor market height premium observed in the BHPS,
where each inch of height is associated with a 1.5 percent increase in
wages, for both men and women. We find that half of the premium can be
explained by the association between height and educational attainment
among BHPS participants. Of the remaining premium, half can be
explained by taller individuals selecting into higher status
occupations and industries. These effects are consistent with our
earlier findings that taller individuals on average have greater
cognitive function, which manifests in greater educational attainment,
and better labor market opportunities. |
|
11/23: "Dynamic Mean-Variance Asset Allocation"
multi-period
problems, and yet not much is known
about their dynamically optimal policies. We provide a fully analytical
characterization of the optimal dynamic mean-variance portfolios within
a
general incomplete-market economy, and recover a simple structure that
also
inherits several conventional properties of static models. We also
identify a
probability measure that incorporates intertemporal hedging demands and
facilitates much tractability in the explicit computation of
portfolios. We
solve the problem by explicitly recognizing the time-inconsistency of
the
mean-variance criterion and deriving a recursive representation for it,
which
makes dynamic programming applicable. We further show that our
time-consistent
solution is generically different from the pre-commitment solutions in
the
extant literature, which maximize the mean-variance criterion at an
initial
date and which the investor commits to follow despite incentives to
deviate. We
illustrate the usefulness of our analysis by explicitly computing
dynamic
mean-variance portfolios under various stochastic investment
opportunities in a
straightforward way, which does not involve solving a
Hamilton-Jacobi-Bellman
differential equation. A calibration exercise shows that the
mean-variance
hedging demands may comprise a significant fraction of the investor's
total
risky asset demand.
11/20:
|
Date: |
2008-10-01 |
|
By: |
Xue-Zhong
He (School of Finance and Economics, University of Technology, Sydney) |
|
URL: |
|
|
As
the main building blocks of the modern finance theory, homogeneity and
rational expectation have faced difficulty in explaining many market
anomalies, stylized factors, and market inefficiency in empirical
studies. As a result, heterogeneity and bounded rationality have been
used as an alterative paradigm of asset price dynamics and this
paradigm has been widely recognized recently in both academic and
financial market practitioners. Within the framework of Chiarella,
Dieci and He (2006a, 2006b) on mean-variance analysis under
heterogeneous beliefs in terms of either the payoffs or returns of the
risky assets, this paper examines the effect of the heterogeneity. We
first demonstrate that, in market equilibrium, the standard one fund
theorem under homogeneous belief does not held under heterogeneous
belief in general, however, the optimal portfolios of investors are
very close to the market efficient frontier. By imposing certain
distribution assumption on the heterogeneous beliefs, we then use Monte
Carlo simulations to show that certain heterogeneity among investors
can improve the Sharpe and Treynor ratios of the portfolios and
investors can benefit from the diversity in investors? beliefs. We also
show that non-normality of market equilibrium return distributions is
an outcome of the market aggregation of individual investors who make
rational decisions based on their beliefs. Our results explain the
empirical funding that that managed funds under-perform the market
index on average and show that heterogeneity can improve the market
efficiency. |
|
11/16:
|
Date: |
2008-06-06 |
|
By: |
Antonio
Guarino |
|
URL: |
|
|
We
study herd behavior in a laboratory financial market with financial
market professionals. We compare two treatments, one in which the price
adjusts to the order flow so that herding should never occur, and one
in which event uncertainty makes herding possible. In the first
treatment, subjects herd seldom, in accordance with both the theory and
previous experimental evidence on student subjects. A proportion of
subjects, however, engage in contrarianism, something not accounted for
by the theory. In the second treatment, the proportion of herding
decisions increases, but not as much as theory suggests; moreover,
contrarianism disappears altogether. |
|
|
Keywords: |
Capital
markets , Price controls , Economic models , Data analysis , |
|
Date: |
2008-10-29 |
|
By: |
Maroš
Servátka (University of Canterbury) |
|
URL: |
|
|
This
paper reports on an experiment studying the effectiveness of two types
of mechanisms for promoting trust: pecuniary and non-pecuniary as well
as their mutual interaction. Our data provide evidence that both
mechanisms significantly enhance trust in comparison to the standard
investment game. However, we find that the pecuniary mechanism performs
significantly worse than the non-pecuniary one. Our results also point
to the fact that pecuniary mechanism, which depends on monetary
incentives, can be counterproductive when combined with mechanism which
relies primarily on psychological incentives. |
|
"The Risk of Divorce and Household Saving
Behavior"
We analyze the impact
of an increase in the risk
of divorce on the saving behaviour of married couples. From a
theoretical
perspective, the expected sign of the effect is ambiguous. We take
advantage of
the legalization of divorce in Ireland in 1996 as an exogenous increase
in the
likelihood of marital dissolution. We analyze the saving behaviour over
time of
couples who were married before the law was passed. We propose a
difference-in-differences approach where we use as comparison groups
either
married couples in other European countries (not affected by the law
change),
or Irish families who did not experience a significant increase in the
expected
risk of divorce (such as very religious families, or single
individuals). Our
results suggest that the increase in the risk of divorce brought about
by the
law was followed by an increase in the propensity to save of married
couples,
consistent with a rise in precautionary savings interpretation. An
increase in
the risk of marital dissolution of about 40 percent led to a 7 to 13
percent
rise in the proportion of married couples reporting positive savings.