A computational study on general equilibrium pricing of derivative securities

This paper analyses the accuracy of replicating portfolio methods in predicting asset prices. In a two-period, general equilibrium model with incomplete financial markets and heterogeneous agents, a computational study is conducted under various distributional assumptions. The focus is on the price of a call option on an underlying risky asset. There is evidence that the value of the (approximate) replicating portfolio is a good approximation for the general equilibrium price for CRRA preferences, but not for CARA preferences. Furthermore, there is strong evidence that the introduction of the call option reduces market incompleteness, but that the price of the underlying asset is unchanged. There is, however, inconclusive evidence on the welfare effects of the option. The author thanks Dolf Talman, Andrew Somerville, an anonymous referee, and an Associate Editor for helpful comments. Research funding from the Irish Research Council for the Humanities and Social Sciences is gratefully acknowledged.     

Do accounting measurement regimes matter? A discussion of mark-to-market accounting and liquidity pricing

Using a model with banking and insurance sectors, Allen and Carletti show that marking-to-market interacts with liquidity pricing to exacerbate the likelihood of financial contagion between the two sectors. In this discussion, I lay out the main ingredients of their model and explain how they interact with liquidity pricing to generate financial contagion. I then discuss some limitations of their model and propose an interesting extension.     

An approximation pricing algorithm in an incomplete market: A differential geometric approach

The minimal distance equivalent martingale measure (EMM) defined in Goll and Rüschendorf (2001) is the arbitrage-free equilibrium pricing measure. This paper provides an algorithm to approximate its density and the fair price of any contingent claim in an incomplete market. We first approximate the infinite dimensional space of all EMMs by a finite dimensional manifold of EMMs. A Riemannian geometric structure is shown on the manifold. An optimization algorithm on the Riemannian manifold becomes the approximation pricing algorithm. The financial interpretation of the geometry is also given in terms of pricing model risk.Received: February 2004, Mathematics Subject Classification (2000): 62P05, 91B24, 91B28JEL Classification: G11, G12, G13Yuan Gao: Present address Block 617, Bukit Panjang Ring Road, 16-806,Singapore 670617. I am currently working in a major investment bank.This paper is based on parts of my doctoral dissertation Gao (2002),which isavailable upon request.Part of the research was done during my visit to HumboldtUniversity in 2002 and was partially supported by Deutsche Forschungsgemeinschaft, Sonderforschungsbereich 373. I am especially thankful to Professor Hans Föllmer for the invitation and helpful discussions.We would like to thank Professor Martin Schweizer,the associate editor and the referee for their constructive comments.     

Optimal pricing of intraday liquidity

This paper presents a general equilibrium model where intraday liquidity is needed because the timing of payments is uncertain. A necessary and sufficient condition for an equilibrium to be efficient is that the nominal intraday interest rate be zero, even when the overnight rate is strictly positive. Because a market for liquidity may not achieve efficiency, this creates a role for the central bank. I allow for the possibility of moral hazard and study policies commonly used by central banks to reduce their exposure to risk. I show collateralized lending achieves the efficient allocation, while, for certain parameters, caps cannot prevent moral hazard.     

Discrete-time option pricing with stochastic liquidity

Classical option pricing theories are usually built on the law of one price, neglecting the impact of market liquidity that may contribute to significant bid-ask spreads. Within the framework of conic finance, we develop a stochastic liquidity model, extending the discrete-time constant liquidity model of Madan (2010). With this extension, we can replicate the term and skew structures of bid-ask spreads typically observed in option markets. We show how to implement such a stochastic liquidity model within our framework using multidimensional binomial trees and we calibrate it to call and put options on the S&P 500.     

股权分置改革与流动性定价问题研究

在中国经济体制改革已取得重大成效的今天,股权分置问题成为众多经济问题的根源和制约改革进一步深化的障碍,如何在维护股东利益和保持市场稳定的基础上审慎地解决股权分置问题成为了中国面临的巨大的智慧考验。我们认为,对流动性的分析与定价是中国资本市场股权分置改革的核心问题,其意义远大于其表面上的非流通股参与流通,同时也体现在促进金融创新和估值体系重建两个方面。本文不揣浅陋,着眼于流动性的理论依据,试图探讨如何利用衍生金融工具给股票流动性定价,以此来解决对价给付问题。     

Housing policy and the progressivity of income taxation

Most countries have tax provisions and subsidies to promote homeownership. These provisions generate an asymmetry in the tax treatment of owner- and rental-occupied housing, which affects the incentives to supply tenant-occupied housing. This paper analyzes the quantitative importance of the interaction of these provisions with the progressivity of income taxation in the context of an overlapping generations model with housing and rental markets. The model replicates the key facts observed in the economy, as well as distributional patterns of ownership, house size, and landlord behavior. The model suggests that the progressivity of income taxation can amplify or mitigate the effects of the asymmetries with important implications for housing tenure, housing consumption, portfolio reallocations, and welfare that differ from those reported in the literature.     

Liquidity risk and arbitrage pricing theory

Classical theories of financial markets assume an infinitely liquid market and that all traders act as price takers. This theory is a good approximation for highly liquid stocks, although even there it does not apply well for large traders or for modelling transaction costs. We extend the classical approach by formulating a new model that takes into account illiquidities. Our approach hypothesizes a stochastic supply curve for a securitys price as a function of trade size. This leads to a new definition of a self-financing trading strategy, additional restrictions on hedging strategies, and some interesting mathematical issues.Received: 1 November 2003, Mathematics Subject Classification: 60G44, 60H05, 90A09JEL Classification: G11, G12, G13Umut Çetin: This work was performed while Dr. Çetin was at the Center for Applied Mathematics, Cornell UniversityPhilip Protter: Supported in part by NSF grant DMS-0202958 and NSA grant MDA-904-03-1-0092 The authors wish to thank M. Warachka and Kiseop Lee for helpful comments, as well as the anonymous referee and Associate Editor for numerous helpful suggestions, which have made this a much improved paper.     

Excess liquidity,bank pricing rules,and monetary policy

This paper studies the implications of excess bank liquidity for the effectiveness of monetary policy in a simple model with credit market imperfections. The demand for excess reserves is determined by precautionary factors and the opportunity cost of holding cash. It is argued that excess liquidity may impart greater stickiness to the deposit rate in response to a monetary contraction and induce an easing of collateral requirements on borrowers – which in turn may translate into a lower risk premium and lower lending rates. As a result, asymmetric bank pricing behavior under excess liquidity may hamper the ability of a contractionary monetary policy to lower inflation.     

Factor pricing in commodity futures and the role of liquidity

This paper empirically investigates the pricing factors and their associated risk premiums of commodity futures. Existing pricing factors in equity and bond markets, including market premium and term structure, are tested in commodity futures markets. Hedging pressure in commodity futures markets and momentum effects is also considered. This study combines these factors to discuss their importance in explaining commodity future returns, while the literature has studied these factors separately. One of the important pricing factors in equity and bond markets is liquidity, but its role as a pricing factor in commodity futures markets has not yet been studied. To our knowledge, this research is the first to study liquidity as a pricing factor in commodity futures. The risk premiums of two momentum factors and speculators’ hedging pressure range from 2% to 3% per month and are greater than the risk premiums of roll yield (0.8%) and liquidity (0.5%). The result of a significant liquidity premium suggests that liquidity is priced in commodity futures.     

Bank accounting conservatism and bank loan pricing

This paper studies the effects of bank accounting conservatism on the pricing of syndicated bank loans. We provide evidence that banks timelier in loss recognition charge higher spreads. We go onto consider what happens to the relationship between spreads and timeliness in loss recognition during the financial crisis. During the crisis, banks timelier in loss recognition increase their spreads to a lesser extent than banks less timely in loss recognition. These findings are broadly consistent with the argument that conditional accounting conservatism serves a governance role. The policy implication is that banks timelier in loss recognition exhibit more prudent and less pro-cyclical loan pricing behaviour.     

Asset tangibility and capital allocation

Firms comprise divisions that often differ with respect to the degree of asset tangibility. As the strength of borrowing constraints depends on the liquidation value of assets, these firms influence their debt capacity by allocating funds across divisions. We argue that a company whose capital allocation is not verifiable suffers from a dynamic inconsistency problem, as it tends to allocate resources in favor of divisions with fewer tangible assets, leading to a tight borrowing constraint. When capital allocation is verifiable, committing to invest only little there eases this constraint, although it implies a deviation from a return maximizing allocation.     

Risk measure pricing and hedging in incomplete markets

This article attempts to extend the complete market option pricing theory to incomplete markets. Instead of eliminating the risk by a perfect hedging portfolio, partial hedging will be adopted and some residual risk at expiration will be tolerated. The risk measure (or risk indifference) prices charged for buying or selling an option are associated to the capital required for dynamic hedging so that the risk exposure will not increase. The associated optimal hedging portfolio is decided by minimizing a convex measure of risk. I will give the definition of risk-efficient options and confirm that options evaluated by risk measure pricing rules are indeed risk-efficient. Relationships to utility indifference pricing and pricing by valuation and stress measures will be discussed. Examples using the shortfall risk measure and average VaR will be shown. The work of Mingxin Xu is supported by the National Science Foundation under grant SES-0518869. I would like to thank Steven Shreve for insightful comments, especially his suggestions to extend the pricing idea from using shortfall risk measure to coherent ones, and to study its relationship to utility based derivative pricing. The comments from the associate editor and the anonymous referee have reshaped the paper into its current version. The paper has benefited from discussions with Freddy Delbaen, Jan Večeř, David Heath, Dmitry Kramkov, Peter Carr, and Joel Avrin.     

Internet search intensity,liquidity and returns in emerging markets

Using a sample of listed companies in the Vietnam stock market from 2013 to 2018, this paper investigates the linkage between Internet search intenseness and stock returns and trading volume. The empirical results confirm the “price pressure hypothesis” that search intensity is positively associated with subsequent stock returns and trading volume. It also finds that the positive effects on stock returns are not temporary but remain for the long term although some reversals occur. The results show that the effects of search intensity on stock returns are higher for large stocks than for small stocks. The findings also reveal that stocks that attract more attention from the public are exposed to higher market risk. These findings have not been documented in the literature so they enrich the information on the relationship between Internet search intenseness and stock market returns, especially for emerging markets where Internet user numbers are sharply increasing.     

The reform of accounting standards and audit pricing

This paper focuses on the reform of accounting standards in China in 2007 and investigates its impact on equilibrium pricing in the audit market. We find that the concentration of the audit market and the probability of issuing modified audit opinions do not significantly change, but that audit fees increase significantly after the adoption of the new accounting standards in China. Deeper analysis suggests that (1) the implementation of the new IFRS-based Chinese Accounting Standards (CASs) has increased the market risk faced by listed firms and thus auditors’ expected audit risk, causing an increase in audit fees, and (2) the degree of the increase in audit fees is positively related to the adjusted difference between net income according to the old CAS before 2007 and the new CAS after 2007. We thus conclude that the reform has had a significant impact on audit pricing in China.     

Aggregate implications of indivisible labor, incomplete markets, and labor market frictions

We study the impact of tax and transfer programs on steady-state allocations in a model with search frictions, an operative labor supply margin, and incomplete markets. In a benchmark model that has indivisible labor and incomplete markets but no trading frictions we show that the aggregate effects of taxes are identical to those in the economy with employment lotteries, though individual employment and asset dynamics can be different. The effect of frictions on the response of aggregate hours to a permanent tax change is highly nonlinear. There is considerable scope for substitution between “voluntary” and “frictional” nonemployment in some situations.     

Spanning and efficiency in an economy with collective and individual risks

Much of the literature on incomplete markets emphasizes the study of conditions under which security market returns, either with or without derivative securities, span some exogenous set of cash flows. It is argued here that the only set of exogenous cash flows to which this literature is applicable are those that are contingent on existing assets' returns. The reason for this is that cash flows created by firms' production decisions are likely to be influenced by individual (unique) risk that is not incorporated into the market's existing information structure. The results of this article show that, if individual risk is pervasive, efficient allocation is likely to be achieved only in a large asset market which allows for the diversification of individual risk. The conditions for such diversification are derived and their implications discussed.     

Implicit pricing across residential rental submarkets

This paper examines implicit price differences of rental housing characteristics across various property types to measure whether determinants of rents are valued in the aggregate or separately. The results show that hedonic price functions are not identical across property types, which suggests that ordinary least squares is not the appropriate estimation technique when modeling the implicit prices for an aggregate rental market. Generalized least squares estimation of a random coefficient model removes the restriction of fixed parameters imposed by OLS and allows estimation of implicit prices for rental markets containing multiple property types.