Pareto Equilibria with coherent measures of risk

In this paper, we provide a definition of Pareto equilibrium in terms of risk measures, and present necessary and sufficient conditions for equilibrium in a market with finitely many traders (whom we call "banks") who trade with each other in a financial market. Each bank has a preference relation on random payoffs which is monotonic, complete, transitive, convex, and continuous; we show that this, together with the current position of the bank, leads to a family of valuation measures for the bank. We show that a market is in Pareto equilibrium if and only if there exists a (possibly signed) measure that, for each bank, agrees with a positive convex combination of all valuation measures used by that bank on securities traded by that bank.     

Duration of sovereign debt renegotiation

In the period since 1990, sovereign debt renegotiations take an average of five years for bank loans but only one year for bonds. We provide an explanation for this finding by highlighting one key difference between bank loans and bonds: bank loans are rarely traded, while bonds are heavily traded on the secondary market. In our theory, the secondary market plays a crucial information revelation role in shortening renegotiations. Consider a dynamic bargaining game with incomplete information between a government and creditors. The creditors' reservation value is private information, and the government knows only its distribution. Delays in reaching agreements arise in equilibrium because the government uses costly delays to screen the creditors' reservation value. When the creditors trade on the secondary market, the market price conveys information about their reservation value, which lessens the information friction and reduces the renegotiation duration. We find that the secondary market tends to increase the renegotiation payoff of the government but decrease that of the creditors while increasing the total payoff. We then embed these renegotiation outcomes in a simple sovereign debt model to analyze the ex ante welfare implications. The secondary market has the potential to increase the government ex ante welfare when the information friction is severe.     

Market efficiency across securities exchanges

Considerable empirical evidence has been presented in the literature of finance in recent years addressed to the question of the informational efficiency of the American capital market. The present paper adds to that evidence. In particular, securities traded off the NYSE—on the American Stock Exchange, on regional exchanges, and over the counter—are found to exhibit return characteristics that imply rather more frequent price departures from equilibrium than for their NYSE-listed counterparts. The data consist of the actual investment experiences of a large sample of individual investors with securities traded in the various locales.     

Asymmetric information in commodity futures markets: Theory and empirical evidence

This article examines the theoretical and empirical implications of asymmetric information in commodity futures markets. In particular, it formulates and tests a theoretical model that recognizes two distinct categories of traders: hedgers, who participate in both spot and futures markets, and speculators, who participate only in the futures market. Speculators are assumed to possess differential information about the realized values of selected random variables. Multiperiod futures market equilibria are derived under competitive conditions, and the ability of futures markets to forecast changes in equilibrium spot market prices are examined. The key variable is shown to be the randomness and informational asymmetry in the aggregate supply by participating hedgers in the spot market, whose absence turns out to be the major determinant of the revelation of informational asymmetry. Moreover, under the assumption of independence of error forecasts for prices and spot market supplies, it is shown that futures market equilibrium ends up with linear expressions for prices and futures contract volumes. These linear expressions are then used to develop empirically testable models. The main empirical implications in these models revolve around the role of the basis as a predictor of future spot price changes. The paper provides an empirical investigation of these implications, using three commodities traded on the Winnipeg Commodity Exchange (WCE). © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:803–825, 1998     

A MODEL‐FREE VERSION OF THE FUNDAMENTAL THEOREM OF ASSET PRICING AND THE SUPER‐REPLICATION THEOREM

We propose a Fundamental Theorem of Asset Pricing and a Super‐Replication Theorem in a model‐independent framework. We prove these theorems in the setting of finite, discrete time and a market consisting of a risky asset S as well as options written on this risky asset. As a technical condition, we assume the existence of a traded option with a superlinearly growing payoff‐function, e.g., a power option. This condition is not needed when sufficiently many vanilla options maturing at the horizon T are traded in the market.     

A GENERAL EQUILIBRIUM MODEL OF A MULTIFIRM MORAL‐HAZARD ECONOMY WITH FINANCIAL MARKETS

We present a general equilibrium model of a moral‐hazard economy with many firms and financial markets, where stocks and bonds are traded. Contrary to the principal‐agent literature, we argue that optimal contracting in an infinite economy is not about a tradeoff between risk sharing and incentives, but it is all about incentives. Even when the economy is finite, optimal contracts do not depend on principals’ risk aversion, but on market prices of risks. We also show that optimal contracting does not require relative performance evaluation, that the second best risk‐free interest rate is lower than that of the first best, and that the second‐best equity premium can be higher or lower than that of the first best. Moral hazard can contribute to the resolution of the risk‐free rate puzzle. Its potential to explain the equity premium puzzle is examined.     

Pricing of New Securities in an Incomplete Market: the Catch 22 of No-Arbitrage Pricing

There are two distinctly different approaches to the valuation of a new security in an incomplete market. The first approach takes the prices of the existing securities as fixed and uses no-arbitrage arguments to derive the set of equivalent martingale measures that are consistent with the initial prices of the traded securities. The price of the new security is then obtained by appealing to certain criteria or on the basis of some preference assumption. The second method prices the new security within a general equilibrium framework. This paper clarifies the distinction between the two approaches and provides a simple proof that the introduction of the new security will typically change the prices of all the existing securities. We are left with the paradox that a genuinely new derivative security is not redundant, but the dominant pricing paradigm in derivative security pricing is the no-arbitrage approach, which requires the redundancy of the security. Given the widespread practice of using the no-arbitrage approach to price (or bound the price of) a new security, we also comment on some justifications for this approach.     

Equilibrium pricing of contingent claims in tradable permit markets

We advance a model of the tradable permit market and derive a pricing formula for contingent claims traded in the market in a general equilibrium framework. It is shown that prices of such contingent claims exhibit significantly different properties from those in the ordinary financial markets. In particular, if the social cost function kinks at some level of abatement, the forward price, as well as the spot price, can be subject to the so‐called price spike. However, this price‐spike phenomenon can be weakened if a system of banking and borrowing is properly introduced. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:559–589, 2010     

运用基差交易规避国际贸易风险

随着国际衍生品市场的发展,国际上很多大宗商品的买卖都利用国外发达的衍生品市场规避风险,中国企业在利用衍生品市场规避风险方面还缺乏足够的认识和知识水平,企业运用基差交易在国际贸易中规避风险很有必要。     

UTILITY MAXIMIZATION IN A LARGE MARKET

We study the problem of expected utility maximization in a large market, i.e., a market with countably many traded assets. Assuming that agents have von Neumann–Morgenstern preferences with stochastic utility function and that consumption occurs according to a stochastic clock, we obtain the “usual” conclusions of the utility maximization theory. We also give a characterization of the value function in a large market in terms of a sequence of value functions in finite‐dimensional models.     

Appreciating the Renminbi

International pressure to revalue China’s currency stems in part from the expectation that rapid economic growth should be associated with an underlying real exchange rate appreciation. This hinges on the Balassa–Samuelson hypothesis, which sees growth as stemming from improvements in traded sector productivity and associated rises in wages and non‐traded prices. Yet, despite extraordinary growth after the mid‐1990s China’s real exchange rate showed no tendency to appreciate until after 2004. We use a dynamic general equilibrium model to simulate the economy and show that, during this period, trade reforms and a rising national saving rate were offsetting forces in the presence of elastic labour supply. We then examine the possible determinants of the striking transition to real appreciation thereafter, noting mounting evidence that an improved rural term of trade has tightened China’s labour market. We show that should the Chinese government bow to international pressure by appreciating the renminbi either via an extraordinary monetary contraction or via export disincentives, the consequences would be harmful for both Chinese and global interests.     

The effect of exchange rate uncertainty on the prices and volume of international trade

By specifying a model of differential risk-bearing by import demand and export supply sides of the market for traded goods, the theoretical impact of exchange risk on both equilibrium prices and quantities is analyzed. For several empirical cases of 1965–1975 U.S. and German trade it is found that exchange rate uncertainty has had a significant impact on prices but no significant effect on the volume of trade. These price effects support previous survey results on the currency denomination of export contracts, namely that with the exception of some U.S. imports, most trade is largely denominated in the exporter's currency.     

Closing large open economy models

A large class of international business cycle models admits multiple locally isolated deterministic steady states, if the elasticity of substitution between traded goods is sufficiently low. I explore the conditions under which such multiplicity occurs and characterize the dynamic properties in the neighborhood of each steady state. Models with standard incomplete markets, portfolio costs, a debt-elastic interest rate, or an overlapping generations framework allow for multiple steady states, if the model features multiple steady states under financial autarchy. If the excess demand for the foreign traded good is increasing in the good's own price in a given steady state, the equilibrium dynamics around this steady state are unbounded. Otherwise, the dynamics are bounded and unique. By contrast, with Uzawa-type preferences, the steady state is always unique and the associated equilibrium dynamics are always bounded and unique. The same results obtain under complete markets.     

Arbitrage,cointegration, and the joint dynamics of prices across discrete commodity futures auctions

Underlying the search for arbitrage opportunities across commodity futures markets that differ in market structure is the idea that the futures prices for similar commodities that are traded on different exchanges adjusted for differences in currency, delivery time (if any), location, and market structure are equal. This article examines price linkages in competing discrete commodity futures auction markets. We find no evidence of cointegration of futures prices of similar commodities traded on two contemporaneous discrete auction futures exchanges in Asia. We also find no evidence of arbitrage activities across these two Asian exchanges, though this does not preclude arbitrage activities with North American continuous auction markets. This lack of cointegration may be due to nonstationarities in the trading cost component. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 799–815, 1999     

An empirical examination of the pricing of exchange‐traded barrier options

Actively traded barrier options were introduced on the Australian Stock Exchange in 1998. This market provides a unique laboratory in which to empirically examine their pricing. This is particularly so given that, for a number of these options, otherwise identical standard European options were simultaneously traded. As a result, the pricing of barrier options may be compared both with their theoretical valuations and with the pricing of otherwise identical European options. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:1049–1064, 2004     

Exchange rate versus inflation targeting: a theory of output fluctuations in traded and non-traded sectors

This paper develops a basic model for output fluctuations in traded and non-traded sectors under two alternative monetary policy regimes; exchange rate targeting (or monetary union) and inflation targeting. The conventional wisdom from one-sector models says that inflation targeting gives better output stabilization than exchange rate targeting when demand shocks occur, but the opposite when supply shocks occur. In a model with a traded and a non-traded sector, we show that the conventional wisdom holds for the non-traded sector. However, for the traded sector, we show that inflation targeting destabilizes output compared with exchange rate targeting when both supply and demand shocks occur. The only shocks where inflation targeting provides the better output stability for the traded sector are shocks to world market prices. The two-sector structure introduces new mechanisms that may turn around earlier results for aggregate production. For instance, a demand shock may induce higher aggregate output fluctuations with inflation targeting than with exchange rate targeting. Furthermore, a positive demand shock may prove to be contractionary under inflation targeting.     

EQUILIBRIUM STATE PRICES IN A STOCHASTIC VOLATILITY MODEL1

In a stochastic volatility model, the no-free-lunch assumption does not induce a unique arbitrage price because of market incompleteness. In this paper, we consider a contingent claim on the primitive asset, traded in zero net supply. Given a system of Arrow-Debreu state prices, we provide necessary and sufficient conditions for consistency with an intertemporal additive equilibrium model that we fully characterize. We show that the risk premia corresponding to the minimal martingale of Föllmer and Schweizer (1991) are consistent with logarithmic preferences, while the Hull and White model (1987) (volatility risk premium independent of the asset price) is consistent with a class of utility functions including constant relative risk aversion (CRRA) ones.     

Electronic Call Market for Commodity Transactions: Design of Computer-Mediated Order Matching System

Commodity exchanges provide potential market structures for electronic trading because commodity products have relatively simple and well-standardized product attributes. Most existing electronic trading systems are introduced for financial exchanges, where qualities of traded products (such as stocks and bonds) are homogeneous, thus taking into account only bid and offer prices for computer-mediated order matching. However, a single commodity market, such as the cotton or grain market, is made up of many heterogeneous goods that are similar to each other but have different product qualities and contract terms. In addition to the price, commodity traders have other pertinent preference ranges over product attributes and delivery conditions. We delineate an electronic call market system for commodity trading, which optimizes the realization of traders' utilities over extended product attributes beyond the price. The electronic call market not only maximizes the total surplus of market participants based on bid and ask prices but also satisfies their qualitative preferences over other attributes, which are difficult to include in the quantitative prices. The trading mechanism of the electronic call market integrates an economic auction model with a social choice model to produce a Pareto-improved transaction. Market simulations are conducted to validate the performance of the proposed electronic call market. The order matching system of the electronic call market is implemented using constraint logic programming.     

Back to the future: Futures margins in a future credit default swap index futures market

The introduction of exchange‐traded credit default swap (CDS) index futures is eminent and this development in the credit market is the subject of this article. A theoretically appealing and practically implementable approach to computing accurate futures margins based on extreme value theory is suggested. The approach is then exemplified with a study of the increasingly popular iTraxx Europe CDS index market. Although this market is not organized through an exchange and is not a futures market, the empirical results together with an arbitrage argument nonetheless suggest margin levels in a future exchange‐traded CDS index futures market computed using extreme value theory to be superior to those computed using the traditional normal distribution or the actual historical distribution. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:85–104, 2007