Customer markets and the welfare effects of monetary policy

A customer market model in which firms and customers form long-term relations is developed and integrated into the canonical New Keynesian framework. This leads to two important differences compared to the standard model. First, the purely forward-looking Phillips curve is replaced by a hybrid variant where current inflation also depends on past inflation. Second, the welfare cost of inflation is much lower, which leads to an optimal monetary policy where relatively more weight is put on output gap stabilization than previously found in the literature.     

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.     

Why the Housing Sector Leads the Whole Economy: The Importance of Collateral Constraints and News Shocks

This paper establishes a dynamic stochastic partial equilibrium model for explaining residential investment dynamics in the United States, focusing on the distinctive cyclical features of residential investment in that it leads the whole economy. This paper is different from the existing literature by adding three new features to the model: news shocks, collateral constraints and agent heterogeneity. The partial equilibrium analysis where interest rates are exogenously fixed shows that these assumptions are essential to generating the dynamic pattern in which residential investment leads consumption and GDP.     

A Continuous-Time Analysis of Optimal Restructuring of Contracts with Costly Information Disclosure

This paper studies the role of restructuring, as compared to the one of liquidation, in valuation of long-term debt contracts in a continuous-time model with costly information disclosure. In asset-pricing literature, Merton??s (J Finance 29:449?C470, 1974) contingent-claim models have been long used for valuation of corporate securities and loans. However, since they basically assume sufficiently complete security structures in markets, the literature is not necessarily suitable for examining costly-information problems. On the other hand, in corporate-finance literature, it has been well known that agency costs (i.e., conflicts of interest among agents) distort corporate capital structure under costly-information problems. However, the effect of the distortion on valuation of securities and loans has not been explicitly studied either in theory or in practice. This paper bridges such a gap between the two literatures. This paper shows that, under a costly-information problem, corporate leverage ratios are higher when restructuring is expected to be accepted in default than otherwise. The risk of a jump to liquidation increases the default probability in short term, and decreases the probability of restructuring over time.     

Stochastic CVP analysis as a gateway to decision-making under uncertainty

Although a substantial research literature on cost–volume–profit (CVP) analysis under uncertainty has accumulated since the seminal contribution of Jaedicke and Robichek [Accounting Review, 39 (1964), 917], this literature has been almost entirely ignored by authors of managerial and cost accounting textbooks. This is unfortunate because owing to the extreme simplicity of the basic deterministic CVP model, students are better able to understand the elements added by generalizing the model to an uncertainty situation. A CVP model that incorporated uncertainty would therefore provide a good entry point into the important but complicated topic of decision-making under uncertainty. This paper sets forth, analyzes and applies a CVP under uncertainty model specifically geared toward classroom instruction. It is a simpler model than many of those developed in the research literature, but it does incorporate one advanced component: an “economic” demand function relating the expected sales level to price. Price is neither a constant nor a random variable in this model but rather the firm's basic decision variable. The simplicity of the model permits analytical solutions for five “special prices”: (1) the highest price which sets breakeven probability equal to a minimum acceptable level; (2) the price which maximizes expected profits; (3) the price which maximizes a Cobb–Douglas utility function based on expected profits and breakeven probability; (4) the price which maximizes breakeven probability; and (5) the lowest price which sets breakeven probability equal to a minimum acceptable level. An example of application is presented in which the model is applied to pricing continuing education programs offered by Center for Management and Professional Development at the authors’ university.     

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.     

Heterogeneous preferences and equilibrium trading volume

The representative-agent Lucas model stresses aggregate risk and hence does not allow us to study the impact of agents’ heterogeneity on the dynamics of equilibrium trading volume. In this paper, we investigate under what conditions non-informational heterogeneity, i.e., differences in preferences and endowments, leads to nontrivial trading volume in equilibrium. We present a non-informational no-trade theorem that provides necessary and sufficient conditions for zero equilibrium trading volume in a continuous-time Lucas market model with heterogeneous agents, multiple goods, and multiple securities. We explain in detail how no-trade equilibria are related to autarky equilibria, portfolio autarky equilibria, and peculiar financial market equilibria, which play an important role in the literature on international risk sharing.     

Social Security reform: the effect of investing in equities

Several proposals have been developed to reform the Social Security System to ensure that it is fully funded. The investment of a portion of Social Security funds in equities has often been proposed as a means to avoid increasing payroll taxes. This paper develops a general equilibrium model to demonstrate that investing Social Security funds in equities will decrease the return on equities and increase interest rates on bonds, which also leads to an increase in general income taxes. Thus, investing Social Security funds in equities simply shifts a potential increase in payroll taxes to an increase in income taxes.     

Does an Agency‐Type of Audit Model Fit a Stewardship Context? Evidence from Performance Auditing in Dutch Municipalities

The degree of auditor independence is an important issue in the performance auditing literature. However, little attention has been paid to the influence of the context in which an audit body operates. This paper investigates how an audit model with a high degree of auditor independence, which is consistent with agency theory's rather formal view of relationships in organizations, functions in a context with more informal relationships, as implied by stewardship theory. Based on two case studies and a survey, the paper concludes that Dutch councilors are more satisfied with audit reports if in their municipality there is a fit between context and audit model.     

Capital budgeting,valuation and personal taxes

This paper examines the relationship between before tax and after tax valuation and uses this to examine the literature on capital budgeting and capital structure in the presence of corporate and personal taxes, a literature which features a bewildering array of valuation formulae. Some of the variation between such formulae naturally arises out of variations in underlying model assumptions; however, in several cases, it arises because there are (by no means obvious) internal inconsistencies. The potential magnitude of the errors that might arise in a capital budgeting context is then explored through sensitivity analysis.     

On the Relationship of Stewardship and Valuation—An Analytical Viewpoint

Agency theoretical literature in accounting has frequently stressed possible difficulties in pursuing stewardship and valuation usefulness simultaneously. However, recent empirical evidence has revealed a significantly positive correlation between the two objectives. These empirical findings provide support for the IASB/FASB's decision to encompass stewardship in valuation usefulness in their revised conceptual framework. The objective of our paper is to identify factors influencing the stewardship/valuation relationship by using an analytical model. In a Linear Exponential Normal (LEN) setting we focus on the characteristics of an accounting system, in particular relevance, freedom from error and freedom from bias, the latter two according to IASB/FASB being components of representational faithfulness. We show that accounting quality, comprising relevance and freedom from error, has similar effects on valuation and stewardship usefulness. However, we identify conditions under which there is no perfect mapping from stewardship to valuation. Moreover, discretion in the accounting system has different consequences for both objectives as it does not affect valuation usefulness while it entails potentially negative effects on stewardship. Thus, we raise doubts in relation to the standard‐setters' view that stewardship is automatically met by a focus on valuation usefulness.     

金融危机前后我国商业银行效率比较研究

本文运用考虑非期望产出的非径向、非角度的SBM模型对我国13家上市商业银行金融危机前后的效率进行了对比分析,结果表明,金融危机并未对我国商业银行的效率产生负面影响,相反危机后银行业整体效率有所提高,但最近一年银行效率有下降的趋势,并对产生这种现象的原因进行了初步分析。     

On the risk situation of financial conglomerates: does diversification matter?

In general, conglomeration leads to diversification of risk (the diversification benefit) and a decrease in shareholder value (the conglomerate discount). Diversification benefits in financial conglomerates are typically derived without explicitly accounting for reduced shareholder value. However, a comprehensive analysis requires competitive conditions within the conglomerate, i.e., shareholders and debt holders should receive risk-adequate returns on their investment. In this paper, we contribute to the literature on this topic by comparing the diversification effect in conglomerates with and without accounting for altered shareholder value. We derive results for a holding company, a parent-subsidiary structure, and an integrated model. In addition, we consider different types of capital and risk transfer instruments in the parent-subsidiary model, including intragroup retrocession and guarantees. We conclude that under competitive conditions, diversification does not matter to the extent frequently emphasized in the literature. The analysis contributes to the ongoing discussion on group solvency regulation and enterprise risk management, which is of relevance to insurance groups and other financial conglomerates.     

Market Transparency and the Accounting Regime

We model the interaction of financial market transparency and different accounting regimes. This paper provides a theoretical rationale for the recently proposed shift in accounting standards from historic cost accounting to marking to market. The paper shows that marking to market can provide investors with an early warning mechanism while historical cost gives management a “veil” under which they can potentially mask a firm's true economic performance. The model provides new explanations for several empirical findings and has some novel implications. We show that greater opacity in financial markets leads to more frequent and more severe crashes in asset prices (under a historic‐cost‐accounting regime). Moreover, our model indicates that historic cost accounting can make the financial market more rather than less volatile, which runs counter to conventional wisdom. The mechanism shown in the model also sheds light on the cause of many financial scandals in recent years.     

Dynamic Linkages Between the China and International Stock Markets

China has become recognized a fourth world economy and is playing a much more important role than ever before in the world economy. In this paper, we study the relationship between the China and the international main stock markets, including the stock markets in the U.S., the U.K., Japan and Hong Kong. Both long-term and short-term dynamic linkages between the China and the international main stock markets are explored by applying a Markov-Switching Vector Error Correction Model (MS-VECM), which takes into account the three regimes of depression, boom and speculation in the market. Our new findings with the data under study include: (i) There has been a significant trend of long-term co-movement between the China and the international stock markets since 1999. (ii) In short term, the stock market in China has been impacted directly or indirectly by the international main stock markets, which varies under different regimes. This impact is still weak in the depression regime, but strong in the boom regime, and, in particular, it has become very strong through the co-integration error correction in the regime of speculation. These findings are different from those documented in the literature and are potentially interesting for international investment and risk management.     

Optimal exercise strategies for corporate warrants

In this paper, we analyse the optimal exercise strategies for corporate warrants issued by levered firms. For the analysis, we distinguish between two exercise variants, namely the traditional block exercise and competitive exercise in equilibrium. We find that the optimal exercise date under the block condition can be before or after an optimal exercise in equilibrium. Surprisingly, optimal block exercise can occur even without any dividend payments in contrast to the competitive exercise. As a consequence, the asset values and the stock volatility under block exercise fundamentally deviate from those under the competitive exercise variant. Moreover, the value of a warrant in the block case and its exercise strategy do not coincide with those of a corresponding call option which contrasts with the assumption of ‘option-like’ warrant valuation.     

A skeptical appraisal of the bootstrap approach in fund performance evaluation

It has become standard practice in the fund performance evaluation literature to use the bootstrap approach to distinguish “skills” from “luck”, while its reliability has not been subject to rigorous statistical analysis. This paper reviews and critiques the bootstrap schemes used in the literature, and provides a simulation analysis of the validity and reliability of the bootstrap approach by applying it to evaluating the performance of hypothetical funds under various assumptions. We argue that this approach can be misleading, regardless of using alpha estimates or their t‐statistics. While alternative bootstrap schemes can result in improvements, they are not foolproof either. The case can be worse if the benchmark model is misspecified. It is therefore only with caution that we can use the bootstrap approach to evaluate the performance of funds and we offer some suggestions for improving it.     

我国政府投资效应的CGE模型分析——基于“刘易斯”宏观闭合框架下的模拟

以往国内利用可计算一般均衡(CGE)模型进行实证研究的文献,大多是假设中国处在资本充足、充分就业的新古典主义宏观闭合框架下,忽视了我国目前处于二元经济的客观事实。本文基于中国现阶段的基本国情,建立了一个刘易斯宏观闭合下的CGE模型,并利用该方法模拟了2008年末我国启动的政府投资(1.18万亿)对经济各个方面产生的影响。模拟结果显示:政府投资将会在未来几年之内拉动实际GDP增长1.83%、提升总消费2.1%、社会总投资9.89%、进口额2.09%、出口额2.14%,同时将带来约1805万的新增就业机会。     

COS method for option pricing under a regime-switching model with time-changed Lévy processes

We extend the regime-switching model to the rich class of time-changed Lévy processes and use the Fourier cosine expansion (COS) method to price several options under the resulting models. The extension of the COS method to price under the regime-switching model is not straightforward because it requires the evaluation of the characteristic function which is based on a matrix exponentiation which is not an easy task. For a two-state economy, we give an analytical expression for computing this matrix exponential, and for more than two states, we use the Carathéodory–Fejér approximation to find the option prices efficiently. In the new framework developed here, it is possible to allow switches not only in the model parameters as is commonly done in literature, but we can also completely switch among various popular financial models under different regimes without any additional computational cost. Calibration of the different regime-switching models with real market data shows that the best models are the regime-switching time-changed Lévy models. As expected by the error analysis, the COS method converges exponentially and thus outperforms all other numerical methods that have been proposed so far.     

The Impact of Capital Structure on Efficient Sourcing and Strategic Behavior

We model the capital structure choice of a firm that operates under imperfect competition. Extant literature demonstrates that debt commits a firm to an aggressive output stance, which is an advantage to the firm under Cournot competition. However, empirical evidence, indicates that debt is a disadvantage under imperfect competition. We reconcile the theory with the evidence by incorporating firms' relations with their suppliers, in a model of strategic firmrival interactions. Under imperfect competition and incomplete contracting, we show that although debt financing improves a firm's input sourcing efficiency it could also benefit the firm's rivals by lowering their input costs. This effect offsets the benefits due to aggressive product market strategies that result from increased debt. Under certain conditions this subsidy effect is sufficiently strong that debt is suboptimal in equilibrium and leads to an increase in rival's shareholder value.