The pricing kernel puzzle in forward looking data

The pricing kernel puzzle concerns the locally increasing empirical pricing kernel, which is inconsistent with a risk-averse representative investor in a single period, single state variable setting. Some recent papers worry that the puzzle is caused simply by the mismatch of backward looking subjective and forward looking risk-neutral distributions of index returns. By using a novel test and forward looking information only, we generally confirm the existence of a u-shaped pricing kernel puzzle in the S&P 500 options data. The evidence is weaker for tests against an alternative with a risk-neutral investor and for longer horizons.     

Voluntary disclosure of information when firms are uncertain of investor response

A firm may prefer not to disclose its private information if it is uncertain of investor response. In the setting under consideration, a firm needs to acquire capital from an investor. The investor can choose to invest in the firm, the risk free asset or in some alternative risky investment opportunity. It is shown that in a partial disclosure equilibrium, the firm discloses average information and withholds bad and good information. Disclosure of average information arises to attract the investor's capital away from the risk free asset.     

The information content of option-implied information for volatility forecasting with investor sentiment

This study explores the effect of investor sentiment on the volatility forecasting power of option-implied information. We find that the risk-neutral skewness has the explanatory power regarding future volatility only during high sentiment periods. Furthermore, the implied volatility has varying volatility forecasting ability depending on the level of investor sentiment. Our findings suggest that the effectiveness of volatility forecasting models based on option-implied information varies over time with the level of investor sentiment. We confirm the important role of investor sentiment in volatility forecasting models exploiting option-implied information with strong evidence from in-sample and out-of-sample analyses. We also present improvements in the accuracy of volatility forecasts from volatility forecasting models derived by incorporating investor sentiment in these models.     

Predictability and Transaction Costs: The Impact on Rebalancing Rules and Behavior

Recent papers show that predictability calibrated to U.S. data has a large effect on the rebalancing behavior of a multiperiod investor. We find that this continues to be true in the presence of realistic transaction costs. In particular, predictability causes the no-trade region for the risky-asset holding to become state dependent and, on average, wider and higher. Predictability also motivates the investor to spend considerably more on rebalancing and to rebalance more often. In other results, we find that introducing costly liquidation of the risky asset for consumption lowers the average allocation to the risky asset, though only marginally early in life. Our experiments also vary the nature of the return predictability and introduce return heteroskedasticity.     

Foreign institutional investors,information asymmetries,and asset valuation in emerging markets

This study investigates the effects of information asymmetries and asset valuation model differences (investor heterogeneity) between foreign and domestic investors on their distinct portfolio holdings in an emerging market setting. I argue that information asymmetry and investor heterogeneity views significantly interact in explaining the different asset allocation decisions of foreign and domestic investors. Employing a large dataset from Turkey, the findings suggest that both information asymmetry and investor heterogeneity view play a key role in explaining the investment decisions of different investor groups. Specifically, different from domestic investors, foreign investors are more likely to invest in firms with a higher global market performance which supports the investor heterogeneity view. However, this relationship only holds for firms with high information asymmetries. The difference in valuation models between foreign and domestic investors converge when asymmetric information problems between these investor groups weaken. This study contributes to the international finance literature by providing a new explanation of why foreign and domestic investors invest in different assets.     

On the Optimality of Portfolio Insurance

This paper examines the optimality of an insurance strategy in which an investor buys a risky asset and a put on that asset. The put's striking price serves as the insurance level. In complete markets, it is highly unlikely that an investor would utilize such a strategy. However, in some types of less complete markets, an investor may wish to purchase a put on the risky asset. Given only a risky asset, a put, and noncontinuous trading, an investor would purchase a put as a way of introducing a risk-free asset into the portfolio. If, in addition, there is a risk-free asset and the investor's utility function displays constant proportional risk-aversion, then the investor would buy the risk-free asset directly and not buy a put. In sum, only under the most incomplete markets would an investor find an insurance strategy optimal.     

The Role of Learning in Dynamic Portfolio Decisions

This paper analyzes the effect of uncertainty about the mean return on the risky asset on the portfolio decisions of an investor who has a long investment horizon. Building on the earlier work of Detemple (1986), Dothan and Feldman (1986), and Gennotte (1986), it is shown that the possibility of future learning about the mean return on the risky asset induces the investor to take a larger or smaller position in the risky asset than she would if there were no learning, the direction of the effect depending on whether the investor is more or less risk tolerant than the logarithmic investor whose portfolio decisions are unaffected by the possibility of future learning. Numerical calculations show that uncertainty about the mean return on the market portfolio has a significant effect on the portfolio decision of an investor with a 20 year horizon if her assessment of the market risk premium is based solely on the Ibbotson and Sinquefield (1995) data.     

Dynamic nonmyopic portfolio behavior

The dynamic nonmyopic portfolio behavior of an investor whotrades a risk-free and risky asset is derived for all HARA utilityfunctions and a stochastic risk premium. Conditions are foundfor when the investor holds more or less than the myopic amountof the risky assets; hedges against or speculates the risk-premiumuncertainty; is long or short on the risky asset; and holdsmore or less of the risky asset at longer horizons. The analyticalsolutions derived take multiple mathematical forms and includeextreme cases in which investors with long but finite horizonscan attain nirvana.     

Recovering the probability density function of asset prices using garch as diffusion approximations

This paper uses Garch models to estimate the objective and risk-neutral density functions of financial asset prices and by comparing their shapes, recover detailed information on economic agents' attitudes toward risk. It differs from recent papers investigating analogous issues because it uses Nelson's result that Garch schemes are approximations of the kind of differential equations typically employed in finance to describe the evolution of asset prices. This feature of Garch schemes usually has been overshadowed by their well-known role as simple econometric tools providing reliable estimates of unobserved conditional variances. We show instead that the diffusion approximation property of Garch gives good results and can be extended to situations with (i) non-standard distributions for the innovations of a conditional mean equation of asset price changes and (ii) volatility concepts different from the variance. The objective PDF of the asset price is recovered from the estimation of a nonlinear Garch fitted to the historical path of the asset price. The risk-neutral PDF is extracted from cross-sections of bond option prices, after introducing a volatility risk premium function. The direct comparison of the shapes of the two PDF_s reveals the price attached by economic agents to the different states of nature. Applications are carried out with regard to the futures written on the Italian 10-year bond.     

Implied Binomial Trees

This article develops a new method for inferring risk-neutral probabilities (or state-contingent prices) from the simultaneously observed prices of European options. These probabilities are then used to infer a unique fully specified recombining binomial tree that is consistent with these probabilities (and, hence, consistent with all the observed option prices). A simple backwards recursive procedure solves for the entire tree. From the standpoint of the standard binomial option pricing model, which implies a limiting risk-neutral lognormal distribution for the underlying asset, the approach here provides the natural (and probably the simplest) way to generalize to arbitrary ending risk-neutral probability distributions.     

Option Prices and the Underlying Asset's Return Distribution

This work examines the relation between option prices and the true, as opposed to risk-neutral, distribution of the underlying asset. If the underlying asset follows a diffusion with an instantaneous expected return at least as large as the instantaneous risk-free rate, observed option prices can be used to place bounds on the moments of the true distribution. An illustration of the paper's results is provided by the analysis of the information concerning the mean and standard deviation of market returns contained in the prices of S&P 100 Index Options.     

投资者关注与市场反应——来自中国证券交易所交易公开信息的自然实验

涨停的股票能否被交易公开信息披露取决于收益率排名中的随机因素,与股票的基本面特征无关。本文利用这一机制设计自然实验检验了投资者关注对股价的影响。实证结果显示交易公开信息披露使股票受到投资者更多的关注,增加了小额资金的净流入,减少了大额资金的净流入和股价的短期收益率,抑制了股价短期波动率,同时降低了股价在长期发生反转的可能性。频繁登上交易公开信息的知名营业部买入的股票受到更多关注,相应的市场反应也更加显著。进一步的研究表明监管性信息披露引发的投资者关注通过降低市场信息不对称抑制了股价反转。     

Robustness and Pricing with Uncertain Growth

We study how decision-makers' concerns about robustness affectprices and quantities in a stochastic growth model. In the modeleconomy, growth rates in technology are altered by infrequentlarge shocks and continuous small shocks. An investor observesmovements in the technology level but cannot perfectly distinguishtheir sources. Instead the investor solves a signal extractionproblem. We depart from most of the macroeconomics and financeliterature by presuming that the investor treats the specificationof technology evolution as an approximation. To promote a decisionrule that is robust to model misspecification, an investor actsas if a malevolent player threatens to perturb the actual data-generatingprocess relative to his approximating model. We study how aconcern about robustness alters asset prices. We show that thedynamic evolution of the risk-return trade-off is dominatedby movements in the growth-state probabilities and that theevolution of the dividend-price ratio is driven primarily bythe capital-technology ratio.     

International stock market cointegration under the risk-neutral measure

This paper investigates international cointegration and financial integration among equity market indexes using index option data, providing an ex-ante analysis through investor anticipations. Daily time series of risk-neutral variance, skewness, and kurtosis are constructed for five major indexes for three sub-periods between 2003 and 2013. Fractionally cointegrated VAR models are estimated at the international level, accounting for persistence in risk-neutral moments. Our results show that there exist international equilibria in risk-neutral moments defined by several cointegrating vectors. During the 2007–2009 global crisis period, these equilibria are characterized by an increase in persistence and in the speeds of adjustment. Moreover, for risk-neutral variance and skewness, all markets are included in the equilibria and none are weakly exogenous. Outside the global crisis period, the cointegration relationship is more fragmented, especially for higher-order moments. In particular, crash and tail risks are segmented during the European debt crisis.     

Information Collection and IPO Underpricing

This study provides new evidence that IPO underpricing is economic rents paid for investor to gather costly information. Subrahmanyam and Titman (1999) report that diverse investor information, once aggregated in the public market, could provide a more informative stock price and accurate feedback to firm’s investment decision. I investigate the hypothesis that IPO underpricing as economic rents could be higher, when investor information is diverse. In support of this hypothesis, I find a positive and significant correlation between the extent of underpricing and the information diversity measure proposed by Barron et al. (1998). There is a positive and significant correlation between this information diversity measure and an IPO firm’s subsequent (absolute) change in capital and R&D expenditures. In addition, firms with high information diversity measure and change in subsequent investment exhibit a better subsequent return performance than firms with low diversity and change in investment. This is consistent with the proposition that investor information serves as useful feedback for managers in the IPO market.JEL Classification: G32     

Optimal Hedging and Valuation of Nontraded Assets

This paper examines a number of valuation problems faced by an expected-utility-maximizing investor who, over a given time horizon, is constrained to hold an asset which cannot be replicated by dynamic trading and which therefore does not have a unique no-arbitrage price. We first derive the private valuation which the investor assigns to the nontradedasset in order to determine his optimal investment in the traded assets. We thereby show that, as part of this portfolio, the investor hedges the private valuation process of the nontraded asset, rather than its market price process. We also study the price at which the investor would be willing to sell the nontraded asset if he were subsequently prohibited from trading in it, as well as the amount the investor would be willing to pay to removethe trading restriction. All three values are shown to depend in an intuitive manner on the investor's risk aversion, the residual risk of the nontraded asset unhedged by the traded assets, the difference between the constrained holding and optimal unconstrained holding of the asset and the length of the time horizon over which the asset cannot be traded.     

The Role of Learning in Dynamic Portfolio Decisions

This paper analyzes the effect of uncertainty about the meanreturn on the risky asset on the portfolio decisions of an investorwho has a long investment horizon. Building on the earlier workof Detemple (1986), Dothan and Feldman (1986), and Gennotte(1986), it is shown that the possibility of future learningabout the mean return on the risky asset induces the investorto take a larger or smaller position in the risky asset thanshe would if there were no learning, the direction of the effectdepending on whether the investor is more or less risk tolerantthan the logarithmic investor whose portfolio decisions areunaffected by the possibility of future learning. Numericalcalculations show that uncertainty about the mean return onthe market portfolio has a significant effect on the portfoliodecision of an investor with a 20 year horizon if her assessmentof the market risk premium is based solely on the Ibbotson andSinquefield (1995) data.     

Market making, prices, and quantity limits

This article develops a model of spread and depth setting underasymmetric information where the equilibrium depth is proportionallymore sensitive than the spread to changes in the degree of informationasymmetry. The analysis uses a one-period model in which a risk-neutral,monopolistic market maker faces a price-sensitive liquiditytrader and a better informed trader who is alternatively riskneutral and risk averse. The equilibrium depth can take valuesranging from 0 to infinity, depending on the information asymmetry,the asset volatility, and the strength of the liquidity demand,while the spread remains positive and finite.     

Can Miracles Lead to Crises? The Role of Optimism in Emerging Markets Crises

Emerging market financial crises are abrupt and dramatic usually occurring after a precrisis bonanza. This paper develops an equilibrium asset pricing model with informational frictions in which crisis itself is a  consequence  of the investor optimism in the period preceding the crisis. If preceded by a sequence of positive signals, a small, negative noise shock can trigger a downward adjustment in investors' beliefs, asset prices, and consumption. The magnitude of this downward adjustment  increases  with the level of optimism attained prior to the negative signal. Moreover, with informational frictions, asset prices display persistent effects in response to transitory shocks.     

Recovering Probability Distributions from Option Prices

This article derives underlying asset risk-neutral probability distributions of European options on the S&P 500 index. Nonparametric methods are used to choose probabilities that minimize an objective function subject to requiring that the probabilities are consistent with observed option and underlying asset prices. Alternative optimization specifications produce approximately the same implied distributions. A new and fast optimization technique for estimating probability distributions based on maximizing the smoothness of the resulting distribution is proposed. Since the crash, the risk-neutral probability of a three (four) standard deviation decline in the index (about ?36 percent (?46 percent) over a year) is about 10 (100) times more likely than under the assumption of lognormality.