Econophysics review: I. Empirical facts

This article and the companion paper aim at reviewing recent empirical and theoretical developments usually grouped under the term Econophysics. Since the name was coined in 1995 by merging the words ‘Economics’ and ‘Physics’, this new interdisciplinary field has grown in various directions: theoretical macroeconomics (wealth distribution), microstructure of financial markets (order book modeling), econometrics of financial bubbles and crashes, etc. We discuss the interactions between Physics, Mathematics, Economics and Finance that led to the emergence of Econophysics. We then present empirical studies revealing the statistical properties of financial time series. We begin the presentation with the widely acknowledged ‘stylized facts’, which describe the returns of financial assets—fat tails, volatility clustering, autocorrelation, etc.—and recall that some of these properties are directly linked to the way ‘time’ is taken into account. We continue with the statistical properties observed on order books in financial markets. For the sake of illustrating this review, (nearly) all the stated facts are reproduced using our own high-frequency financial database. Finally, contributions to the study of correlations of assets such as random matrix theory and graph theory are presented. The companion paper will review models in Econophysics from the point of view of agent-based modeling.     

Anomalous waiting times in high-frequency financial data

In high-frequency financial data not only returns, but also waiting times between consecutive trades are random variables. Therefore, it is possible to apply continuous-time random walks (CTRWs) as phenomenological models of the high-frequency price dynamics. An empirical analysis performed on the 30 DJIA stocks shows that the waiting-time survival probability for high-frequency data is non-exponential. This fact imposes constraints on agent-based models of financial markets.     

An intelligent agent-based competitive contract process: UNIK-AGENT

The framework of agent-based commerce is proposed as the second generation of electronic commerce. Since the communication messages and solution methods of agents are significantly influenced by the contract type, we have defined the grammar of contracts first. By using this generalized contract grammar, we can express new creative contract types as well as traditional ones such as bids and auctions. The messages in agent-based commerce have adopted three layers: Agent Communication Language, Electronic Commerce, and Product Specification. For electronic commerce, the agent is regarded as an extension of expert systems with the additional capability of communication control and meta-problem solving. A prototype of the agent-based commerce development environment, UNIK-AGENT, is developed to implement the idea. The procedure of the message generation and solution method selection is illustrated with the case of a computer purchase. © 1998 John Wiley & Sons, Ltd.     

Paradox,accounting values,and intelligible regulation

Expected utility theory, which includes estimating the probabilities of uncertain future outcomes, is the classical model for rational economic decision making, and, by implication, rational valuation and financial reporting regulation. In Wittgensteinian terms it is a ‘hinge’ of the language game in which these practices are embedded. When rendered explicit, however, this ‘hinge’ appears to be formally incoherent. The exploration of this problem has consequences for all of our arguments over the epistemological underpinnings of accounting reports – whether realist, representational, constructivist, or otherwise.Arguably, there are two complementary primitive models that underlie real-world probability estimation. Taken together, they generate a version of Goodman's inductive paradox (other versions of which also arise for non-inductive empirical generalisation). This, in its turn, is related to Kripke's paradox, which arises when we try to give behavioural accounts of rule following, and so of participation in a language game.This paper explicates this type of paradox in the context of commercial decision making, and considers its consequences. The existence of paradoxes should render the system that generates them completely incoherent, but (paradoxically …) they seem to be generated by any attempt to give complete accounts of some of the normative fundamentals which underlie linguistic practice – such as truth-telling, validity and rule-following.Whether or not these paradoxes represent a serious threat to the coherence of the empirical or behavioural sciences, it might be objected that commercial decision making methods and financial regulation rarely aspire to the kind of rigour that these disciplines attempt to achieve. Part of the argument of this paper will be that the intelligibility of commercial language suggests an approach to these paradoxes which is not obvious from more traditional philosophical perspectives.The intentionality of belief renders certain belief claims by participants in a shared language game incorrigible (within the game), in the sense that they can be doubted only by doubting the seriousness or quality of participation. If certain statements about rule following and word meaning have this same quality, then there is a way of avoiding the consequences of Goodman's and Kripke's paradoxes, and of sterilising the probability estimation paradox for any playable commercial language game.     

Private-Value Auction Versus Posted-Price Selling: An Agent-Based Model Approach

An agent-based first-price private-value auction and an agent-based posted-price market are developed to compare these selling methods when buyers have private values. If the seller cannot impose a reserve price and has little uncertainty about the item's value, the seller's expected revenue is highest in the posted-price market. Otherwise, the seller is better off selling the item with the auction. Using a genetic algorithm and Monte Carlo integration solved the agent-based models quicker and provided more precise answers than solving models with particle swarm optimization and using the trapezoidal rule for numerical integration. Copyright © 2015 John Wiley & Sons, Ltd.     

The residual market factor,the APT,and mean-variance efficiency

The rapidly increasing volume of both published and unpublished work on the arbitrage pricing theory (APT) of Ross (1976) has given rise to a number of misunderstandings at the interface of theoretical and econometric work. In this article we extend the theoretical structure of our previous work (McElroy and Burmeister, 1985, 1988; Burmeister and McElroy, 1987, 1988) to provide a broad yet rigorous framework both for econometric estimation and for better economic interpretation of new empirical results. We begin with the case where allK factors are observed, and then present the second case ofK−1≡J observed APT factors and one unobserved factor, theresidual market factor introduced in McElroy and Burmeister (1985). The economic interpretations for equivalent specifications of this model are discussed, and we enumerate several immediate payoffs to these specifications. The main new results are concerned with the sometimes intricate relationships among APT models withK factors and APT models withK factors that are constrained to satisfy mean-variance efficiency restrictions. These results are not only of theoretical interest, but more importantly they provide the basis for econometric estimation and testing of nested hypotheses. These econometric issues are discussed in detail.     

Policyholder Exercise Behavior in Life Insurance: The State of Affairs

The article presents a review of structural models of policyholder behavior in life insurance. We first discuss underlying drivers of policyholder behavior in theory and survey the implications of different models. We then turn to empirical behavior and appraise how well different drivers explain observations. The key contributions lie in the synthesis and the systematic categorization of different approaches. The article should provide a foundation for future studies, and we describe some important directions for future research in the conclusion.     

Trading profitability from learning and adaptation on the Tokyo Stock Exchange

This study proposes unexamined technical trading rules, which are dynamically switching strategies among filter, moving average and trading-range breakout rules. The dynamically switching strategy is formulated based on a discrete choice theory consistent with the concept of myopic utility maximization. We utilize the transaction data of the individual stocks listed on the Nikkei 225 from September 1, 2005 to August 31, 2007. We demonstrate that switching strategies produce positive returns and their performance is better than those from the buy-and-hold and non-switching strategies over our sample periods. We also demonstrate equivalent performance for switching with different learning horizons, implying that behavioural heterogeneity of stock investors arises from the coexistence of different strategies with varying degrees of learning horizons. Our result supports several research assumptions and results on agent-based theoretical models that successfully replicate empirical features in financial markets, such as fat tails of return distributions and volatility clustering. However, upon considering the effects of data-snooping bias superior performance disappears.     

Early-warning analysis for currency crises in emerging markets: A revisit with fuzzy clustering

Currency crises, also often called balance-of-payment crises, occur when massive capital outflows force a country to devalue or float its currency. The world-wide integration of capital markets since the 1980s and 1990s has increased the degree of capital mobility, which also determined a substantial turbulence in foreign exchange markets and frequent currency crises. In this paper, we explore advanced supporting instruments for predicting currency crises, based on an empirical study of the currency crisis episodes in 23 emerging markets around the world during the second half of last century. More specifically, we investigate the usefulness of prediction models built based on the fuzzy c-means method. First we build clustering models that partition data into a certain number of overlapping natural groups. Thereafter, we classify the data clusters into early-warning clusters and tranquil clusters. We compare the performance of our models with a conventional c-means clustering model and a benchmark probit model. The results show that the proposed models achieve a similar level of out-of-sample performance as the probit model and c-means model. The fuzzy approach also introduces additional explanatory advantages into the early-warning analysis process. Copyright © 2010 John Wiley & Sons, Ltd.     

MERGER ACTIVITY AND MANAGERIAL COMPENSATION

A theoretical monopolistic economy is developed to explain relationships between merger activity and managerial compensation packages. In this economy, managers are assigned to and compensated by firms based on models established in “n” person cooperative game theory. Compensation packages offered to managers of potential acquiring firms are studied with respect to their impact on managers' willingness to initiate profitable merger bids. The model explains why overall merger returns decrease as the size of the target firm relative to the bidding firm increases. Model results are consistent with numerous other empirical findings regarding merger profit distributions.     

The effect of neglecting the slope parameters’ heterogeneity on dynamic models of corporate capital structure

We present a parsimonious representation of debt-ratio dynamics that is able to nest the Trade-Off, Pecking-Order and Market-Timing theoretical models, at the same time avoiding the poolability of the slope parameters. The inference on the heterogeneous speed of adjustment of the firm towards the target debt ratio is based on a comparison of the unit root results from both individual company and (this is a relative novelty in the case of micro-data) panel data. Results show that company behavior is largely heterogeneous with regard to the theory underlying the historical data. Our proposed methodology may be usefully employed in order to identify sub-samples of companies behaving in an homogeneous manner, and can be extended to study the empirical capital structure models with more appropriate quantitative instruments. This would avoid the arbitrary a priori selection of sub-samples and the imposition of untested poolability assumptions as commonly occurs in the empirical literature.     

VaR limits for pension funds: an evaluation

In a series of papers during the last ten years an interest rate theory with models which are driven by Lévy or more general processes has been developed. In this paper we derive explicit formulas for the correlations of interest rates as well as zero coupon bonds with different maturities. The models considered in this general setting are the forward rate (HJM), the forward process and the LIBOR model as well as the multicurrency extension of the latter. Specific subclasses of the class of generalized hyperbolic Lévy motions are studied as driving processes. Based on a data set of parametrized yield curves derived from German government bond prices we estimate correlations. In a second step the empirical correlations are used to calibrate the Lévy forward rate model. The superior performance of the Lévy driven models becomes obvious from the graphs.     

对制度变迁理论的新发展及假设前提的评述

从诺斯概括的制度变迁一般理论出发,评述这一理论最新的发展,即引入制度变迁的主观博弈过程和进化博弈过程.同时分析各种思路的假设前提,强调在解释现实的制度变迁时,应该注意假设与现实的一致性,指出与中国现实相对接近的制度变迁理论是强制性制度变迁理论.     

Asymmetric information in insurance: general testable implications

Several recent articles on empirical contract theory and insurance have tested for a positive correlation between coverage and ex post risk, as predicted by standard models of pure adverse selection or pure moral hazard. We show here that the positive correlationproperty can be extended to general setups: competitive insurance markets and cases where risk aversion is public. We test our results on a French dataset. Our tests confirm that the estimated correlation is positive; they also suggest the presence of market power.     

Financial contagion: evolutionary optimization of a multinational agent-based model

Over the past two decades, financial market crises with similar features have occurred in different regions of the world. Unstable cross-market linkages during a crisis are referred to as financial contagion. We simulate crisis transmission in the context of a model of market participants adopting various strategies; this allows testing for financial contagion under alternative scenarios. Using a minority game approach, we develop an agent-based multinational model and investigate the reasons for contagion. Although the phenomenon has been extensively investigated in the financial literature, it has not been studied through computational intelligence techniques. Our simulations shed light on parameter values and characteristics which can be exploited to detect contagion at an earlier stage, hence recognizing financial crises with the potential to destabilize cross-market linkages. In the real world, such information would be extremely valuable in developing appropriate risk management strategies. Copyright © 2009 John Wiley & Sons, Ltd.     

假冒伪劣治理的经济博弈分析

对假冒伪劣的治理是我国经济体制转轨中一个令人关切的问题.假冒伪劣商品严重威胁着消费者的健康和生命安全,已成为社会经济肌体上的毒瘤.本文通过构造博弈模型,分析了其存在根源,进而得出从多方面综合整治的对策.     

Prospect theory–based portfolio optimization: an empirical study and analysis using intelligent algorithms

The behaviourally based portfolio selection problem with investor’s loss aversion and risk aversion biases in portfolio choice under uncertainty is studied. The main results of this work are: developed heuristic approaches for the prospect theory model proposed by Kahneman and Tversky in 1979 as well as an empirical comparative analysis of this model and the index tracking model. The crucial assumption is that behavioural features of the prospect theory model provide better downside protection than traditional approaches to the portfolio selection problem. In this research the large-scale computational results for the prospect theory model have been obtained for real financial market data with up to 225 assets. Previously, as far as we are aware, only small laboratory tests (2–3 artificial assets) have been presented in the literature. In order to investigate empirically the performance of the behaviourally based model, a differential evolution algorithm and a genetic algorithm which are capable of dealing with a large universe of assets have been developed. Specific breeding and mutation, as well as normalization, have been implemented in the algorithms. A tabulated comparative analysis of the algorithms’ parameter choice is presented. The prospect theory model with the reference point being the index is compared to the index tracking model. A cardinality constraint has been implemented to the basic index tracking and the prospect theory models. The portfolio diversification benefit has been found. The aggressive behaviour in terms of returns of the prospect theory model with the reference point being the index leads to better performance of this model in a bullish market. However, it performed worse in a bearish market than the index tracking model. A tabulated comparative analysis of the performance of the two studied models is provided in this paper for in-sample and out-of-sample tests. The performance of the studied models has been tested out-of-sample in different conditions using simulation of the distribution of a growing market and simulation of the t-distribution with fat tails which characterises the dynamics of a decreasing or crisis market.     

An Insurance Market Simulation With Both Adverse and Advantageous Selection

The theory of adverse selection predicts that high‐risk individuals are more likely to buy insurance than low‐risk individuals if asymmetric information regarding individuals’ risk type is present in the market. The theory of advantageous selection predicts the opposite—a negative relationship between insurance coverage and risk type can be obtained when hidden knowledge in other dimensions (e.g., the degree of risk aversion) is present in addition to the risk type. Using the heterogeneity of insurance buyers in either risk type or risk aversion, we first introduce a classroom‐based insurance market simulation game to show that adverse selection and advantageous selection can coexist. We then explain the underlying concepts using two methods: a mathematical framework based on expected utility theory and an empirical framework based on the results of the game itself. The game is easy to implement, reinforces textbook concepts by providing students a hands‐on experience, and supplements current textbooks by bringing their content up to date with current research.     

An investigation of wholly‐owned foreign subsidiary control through transaction cost economics theory

This paper investigates the management control systems used by multinational corporation headquarters to control wholly‐owned foreign subsidiaries. Our theory development is based on transaction cost economics. First, we conduct a series of exploratory interviews, providing an insight into the context, and second, we provide empirical evidence based on cross‐sectional survey data. Our results indicate that activity traits (uncertainty, asset specificity and post hoc information impactedness) have significant implications on control choices, in particular the control archetype combinations chosen by headquarters, although not all results are consistent with theory predictions. Our findings are supported by extensive alternative testing.     

Axiomatization of residual income and generation of financial securities

This paper presents an axiomatization of residual income, also known as excess profit, and illustrates how it can univocally give rise to fixed-income or variable-income assets. In the first part it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specified theory of residual income is generated: one is the standard theory, which historically traces back to Hamilton and Marshall and is a deep-rooted notion in economic theory, finance, and accounting. Another is the systemic value added or lost-capital paradigm: first introduced by Magni, the theory is enfolded in Keynes's notion of user cost and is naturally generated by an arbitrage-theory perspective. In the second part, the paper inverts the usual analysis: instead of computing residual incomes from a pattern of cash flows, residual incomes are fixed first to derive vectors of cash flows. It is shown that variable- or fixed-income assets may be constructed on the basis of either theory starting from pre-determined growth rates for residual income. In particular, zero-coupon bonds and coupon bonds traded in a capital market are shown to be deduced as equilibrium vectors of residual-income-based assets.