Money-based underlying inflation measure for Russia: a structural dynamic factor model approach

We estimate a dynamic factor model for the cross section of monetary and price indicators. We extract the common part of the dataset’s fluctuations and decompose it into structural shocks. We argue that one of the shocks identified has empirical properties (in terms of impulse response functions) that are fully in line with the theoretically expected relationship between money growth and inflation, confirming that the process identified has the capacity for economic interpretation. Based on this finding, we decompose recent inflationary developments in Russia into those that are associated with changes in monetary stance and other shorter-lived shocks.     

PERIODIC SEQUENCES OF ARBITRAGE: A TALE OF FOUR CURRENCIES

This paper investigates arbitrage chains involving four currencies and four foreign exchange trader‐arbitrageurs. In contrast with the three‐currency case, we find that arbitrage operations when four currencies are present may appear periodic in nature, and not involve smooth convergence to a ‘balanced’ ensemble of exchange rates in which the law of one price holds. The goal of this article is to understand some interesting features of sequences of arbitrage operations, features which might well be relevant in other contexts in finance and economics.     

Reconciling sustainability, systems theory and discounting

Most definitions of sustainability imply that a system is to be maintained at a certain level, held within certain limits, into the indefinite future. Sustainability denies run-away growth, but it also avoids any decline or destruction. This sustainability path is hard to reconcile with the renewal cycle that can be observed in many natural systems developing according to their intrinsic mechanisms and in social systems responding to internal and external pressures. Systems are parts of hierarchies where systems of higher levels are made up of subsystems from lower levels. Renewal in components is an important factor of adaptation and evolution. If a system is sustained for too long, it borrows from the sustainability of a supersystem and rests upon lack of sustainability in subsystems. Therefore by sustaining certain systems beyond their renewal cycle, we decrease the sustainability of larger, higher-level systems. For example, Schumpeter's theory of creative destruction posits that in a capitalist economy, the collapse and renewal of firms and industries is necessary to sustain the vitality of the larger economic system. However, if the capitalist economic system relies on endless growth, then sustaining it for too long will inevitably borrow from the sustainability of the global ecosystem. This could prove catastrophic for humans and other species. To reconcile sustainability with hierarchy theory, we must decide which hierarchical level in a system we want to sustain indefinitely, and accept that lower level subsystems must have shorter life spans. In economic analysis, inter-temporal discount rates essentially tell us how long we should care about sustaining any given system. Economists distinguish between discount rates for individuals based on personal time preference, lower discount rates for firms based on the opportunity cost of capital, and even lower discount rates for society. For issues affecting even higher-level systems, such as global climate change, many economists question the suitability of discounting future values at all. We argue that to reconcile sustainability with inter-temporal discounting, discount rates should be determined by the hierarchical level of the system being analyzed.     

Computing the finite-time expected discounted penalty function for a family of Lévy risk processes

Ever since the first introduction of the expected discounted penalty function (EDPF), it has been widely acknowledged that it contains information that is relevant from a risk management perspective. Expressions for the EDPF are now available for a wide range of models, in particular for a general class of Lévy risk processes. Yet, in order to capitalize on this potential for applications, these expressions must be computationally tractable enough as to allow for the evaluation of associated risk measures such as Value at Risk (VaR) or Conditional Value at Risk (CVaR). Most of the models studied so far offer few interesting examples for which computation of the associated EDPF can be carried out to the last instances where evaluation of risk measures is possible. Another drawback of existing examples is that the expressions are available for an infinite-time horizon EDPF only. Yet, realistic applications would require the computation of an EDPF over a finite-time horizon. In this paper we address these two issues by studying examples of risk processes for which numerical evaluation of the EDPF can be readily implemented. These examples are based on the recently introduced meromorphic processes, including the beta and theta families of Lévy processes, whose construction is tailor-made for computational ease. We provide expressions for the EDPF associated with these processes and we discuss in detail how a finite-time horizon EDPF can be computed for these families. We also provide numerical examples for different choices of parameters in order to illustrate how ruin-based risk measures can be computed for these families of Lévy risk processes.     

Analysis of the SRISK measure and its application to the Canadian banking and insurance industries

In this paper, we analyse, modify, and apply one of the most widely used measures of systemic risk, SRISK, developed by Brownlees and Engle (in Rev Financ Stud 30:48–79, 2016). The measure is defined as the expected capital shortfall of a firm conditional on a prolonged market decline. We argue that segregated funds, also known as separate accounts in the US, should be excluded from actuarial liabilities when SRISK is calculated for insurance companies. We also demonstrate the importance of careful analysis of accounting standards when specifying the prudential capital ratio used in SRISK methodology. Based on the proposed adjustments to SRISK, we assess the systemic risk of the Canadian banking and insurance industries. It is shown that in its current implementation, the SRISK methodology substantially overestimates the systemic risk of Canadian insurance companies.     

Subjective probability assessments of the incidence of unethical behavior: the importance of scenario–respondent fit

Largely due to the difficulty of observing behavior, empirical business ethics research relies heavily on the scenario methodology. While not disputing the usefulness of the technique, this paper highlights the importance of a careful assessment of the fit between the context of the situation described in the scenario and the knowledge and experience of the respondents. Based on a study of online auctions, we provide evidence that even respondents who have direct knowledge of the situation portrayed in the scenario may develop significantly different assessments of the level of unethical behavior. Further, those assessments may be conditioned in different ways by the same moderating variables. We conclude that care should be exercised when recruiting respondents to choose only those who can be expected to understand the scenario in its true context and that separate analyses should be conducted for groups of respondents who have different perspectives within that context.     

Leverage and Mortgage Foreclosures

In this paper, we deduce the default and prepayment characteristics of mortgages by examining the actual behaviors of a large set of conforming fixed rate mortgages tracked over time. Employing reduced form pricing techniques, we are then able to fully value such mortgages, and so determine the cost as well as the probability of default for any particular mortgage. The analysis reveals the levels of foreclosures that can be expected when loans are leveraged at the high loan–to–value ratios characteristic of recent years.     

Pricing American options under stochastic volatility and stochastic interest rates

We introduce a new analytical approach to price American options. Using an explicit and intuitive proxy for the exercise rule, we derive tractable pricing formulas using a short-maturity asymptotic expansion. Depending on model parameters, this method can accurately price options with time-to-maturity up to several years. The main advantage of our approach over existing methods lies in its straightforward extension to models with stochastic volatility and stochastic interest rates. We exploit this advantage by providing an analysis of the impact of volatility mean-reversion, volatility of volatility, and correlations on the American put price.     

An optimal auction for capacity constrained bidders: a network perspective

This paper examines the problem of a seller with limited supply selling to a group of agents whose private information is two-dimensional. Each agent has a constant marginal value for the good up to some capacity, thereafter it is zero. Both the marginal value and the capacity are private information. We describe the revenue maximizing Bayesian incentive compatible auction for this environment. A novel feature of the analysis is an interpretation of an optimal auction design problem in terms of a linear program that is an instance of a parametric shortest path problem on a lattice. We thank the referees for a number of useful suggestions that have been incorporated into the paper. Mallesh Pai suggested the argument given in Lemma 1. The research was supported in part by the NSF grant ITR IIS-0121678.     

Capturing hedge fund risk factor exposures: Hedge fund return replication with ETFs

We develop a new factor selection methodology of spanning the space of hedge fund risk factors with all available exchange traded funds (ETFs). We demonstrate the efficacy of the methodology with out-of-sample individual hedge fund return replication by ETF clone portfolios. This is consistent with our interpretation of ETF returns as proxies to risk factors driving hedge fund returns. We further consider portfolios of “cloneable” and “noncloneable” hedge funds, defined as top and bottom in-sample R² matches, and demonstrate that our ETF clone portfolios slightly outperform cloneable hedge funds out of sample.