A model of currency crises with heterogeneous market beliefs

This paper shows that the approach followed by Tamborini (2015) in analyzing and interpreting the euro area public debt crisis, based on the role played by agents characterized by heterogeneous market beliefs, can be applied also to the case of currency crises. By doing so, rather than considering the private sector as an atomistic player endowed with perfect information, and by considering a central bank that optimizes the amount of unsterilized inflow of foreign reserves in a Mundell-Fleming type speculative attack model, allows to explain the interest rates convex non-linearity that characterized, for example, a country like Italy during the 1992–93 EMS crisis.     

Aggregation of heterogeneous beliefs

This paper is a generalization of [Calvet, L., Grandmont, J.-M., Lemaire, I., 2002. Aggregation of heterogenous beliefs and asset pricing in complete financial markets. Working paper] to a dynamic setting. We propose a method to aggregate heterogeneous individual probability beliefs, in dynamic and complete asset markets, into a single consensus probability belief. This consensus probability belief, if commonly shared by all investors, generates the same equilibrium prices as well as the same individual marginal valuation as in the original heterogeneous probability beliefs setting. As in [Calvet, L., Grandmont, J.-M., Lemaire, I., 2002. Aggregation of heterogenous beliefs and asset pricing in complete financial markets. Working paper], the construction stands on a fictitious adjustment of the market portfolio. The adjustment process reflects the aggregation bias due to the diversity of beliefs. In this setting, the construction of a representative agent is shown to be also valid.     

Decreasing downside risk aversion and background risk

In this paper, we show that risk vulnerability can be associated with the concept of downside risk aversion (DRA) and an assumption about its behavior, namely that it is decreasing in wealth. Specifically, decreasing downside risk aversion in the Arrow–Pratt and Ross senses are respectively necessary and sufficient for a zero-mean background risk to raise the aversion to other independent risks.     

How money illusions and heterogeneous beliefs affect asset prices

We develop a dynamic asset pricing model with two investors with money illusions and heterogeneous beliefs about some aspects of the economy. The model is tractable and delivers closed forms for all equilibrium quantities. The study shows that money illusion leads the nominal shock risk to generate spillover effects on the real side of the economy and affects all equilibrium quantities, even without inflation disagreement. We find that bond yields increase, but the stock price decreases, as money illusion increases. Bond yield and stock price volatilities increase with fundamental disagreement, while the latter decreases with inflation disagreement. We also discover that the stock risk premium is inverse-U shaped as inflation disagreement increases. Moreover, we find that the optimistic investor holds positions in real bonds and stocks, and shorts the nominal bond to hedge against the risk of market changes, which is in line with the pessimistic investor’s beliefs.     

Can risk aversion explain schooling attainments? Evidence from Italy

Using unique Italian panel data, in which individual differences in behavior toward risk are measured from answers to a lottery question, we investigate if (and to what extent) risk aversion can explain differences in schooling attainments. We formulate the schooling decision process as a reduced-form dynamic discrete choice, which we estimate flexibly. We analyze how grade transition from one level to the next varies with preference heterogeneity (risk aversion), parental human capital, socioeconomic variables and persistent unobserved (to the econometrician) heterogeneity. We find that differences in attitudes toward risk account for a modest portion of the probability of entering higher education.     

Stochastic equilibria of an asset pricing model with heterogeneous beliefs and random dividends

We investigate dynamical properties of a heterogeneous agent model with random dividends and further study the relationship between dynamical properties of the random model and those of the corresponding deterministic skeleton, which is obtained by setting the random dividends as their constant mean value. Based on our recent mathematical results, we prove the existence and stability of random fixed points as the perturbation intensity of random dividends is sufficiently small. Furthermore, we prove that the random fixed points converge almost surely to the corresponding fixed points of the deterministic skeleton as the perturbation intensity tends to zero. Moreover, simulations suggest similar behaviors in the case of more complicated attractors. Therefore, the corresponding deterministic skeleton is a good approximation of the random model with sufficiently small random perturbations of dividends. Given that dividends in real markets are generally very low, it is reasonable and significant to some extent to study the effects of heterogeneous agents’ behaviors on price fluctuations by the corresponding deterministic skeleton of the random model.     

Modelling conditional skewness: Heterogeneous beliefs,short sale restrictions and market declines

This paper tests the relationship among heterogeneous beliefs, short sale restrictions and time-varying conditional skewness under different market conditions. The results show that heterogeneous beliefs and short sale restrictions have negative impacts on conditional skewness during periods of market decline but have negative, positive or no impacts during periods of market growth. This evidence reconciles conflicting evidence in recent empirical studies on the relationship among heterogeneous beliefs, short sale restrictions and conditional skewness.     

Aggregate stock market behavior and investors’ low risk aversion

This paper studies whether investors’ high risk aversion can be avoided in a representative-agent model that is able to explain aggregate stock market behavior in the US financial market. We present a consumption-based asset pricing model with a representative agent who has a ‘catching up with the Joneses’ preference to show that high risk aversion can be avoided in a representative-agent model that can help explain many of the empirically observed properties of the aggregate stock market return, including the equity premium and risk-free rate puzzles, the predictability of long-horizon stock returns, and the ‘leverage effect’ in return volatility.     

Asset price dynamics with heterogeneous beliefs and local network interactions

In this paper we investigate the effects of network topologies on asset price dynamics. We introduce network communications into a simple asset pricing model with heterogeneous beliefs. The agents may switch between several belief types according to their performance. The performance information is available to the agents only locally through their own experience and the experience of other agents directly connected to them. We model the communications with four commonly considered network topologies: a fully connected network, a regular lattice, a small world, and a random graph. The results show that the network topologies influence asset price dynamics in terms of the regions of stability, amplitudes of fluctuations and statistical properties.     

Feasible sets,comparative risk aversion,and comparative uncertainty aversion in bargaining

We study feasible sets of the bargaining problem under two different assumptions: the players are subjective expected utility maximizers or the players are Choquet expected utility maximizers. For the latter case, we consider the effects on bargaining solutions when players become more risk averse and when they become more uncertainty averse.     

Implied risk aversion and pricing kernel in the FTSE 100 index

This paper studies the estimation of the pricing kernel and explains the pricing kernel puzzle found in the FTSE 100 index. We use prices of options and futures on the FTSE 100 index to derive the risk neutral density (RND). The option-implied RND is inverted by using two nonparametric methods: the implied-volatility surface interpolation method and the positive convolution approximation (PCA) method. The actual density distribution is estimated from the historical data of the FTSE 100 index by using the threshold GARCH (TGARCH) model. The results show that the RNDs derived from the two methods above are relatively negatively skewed and fat-tailed, compared to the actual probability density, that is consistent with the phenomenon of “volatility smile.” The derived risk aversion is found to be locally increasing at the center, but decreasing at both tails asymmetrically. This is the so-called pricing kernel puzzle. The simulation results based on a representative agent model with two state variables show that the pricing kernel is locally increasing with the wealth at the level of 1 and is consistent with the empirical pricing kernel in shape and magnitude.     

Optimal Two‐part Pricing under Cost Uncertainty

This paper examines the optimal two‐part pricing under cost uncertainty. We consider a risk‐averse monopolistic firm that is subject to a cost shock to its constant marginal cost of production. The firm uses two‐part pricing to sell its output to a continuum of heterogeneous consumers. We show that the global and marginal effects of risk aversion on the firm's optimal two‐part pricing are to raise the unit price and lower the fixed payment. We further show that an increase in the fixed cost of production induces the firm to raise (lower) the unit price and lower (raise) the fixed payment under decreasing (increasing) absolute risk aversion. The firm's optimal two‐part pricing is unaffected by changes in the fixed cost under constant absolute risk aversion. Finally, we show that a mean‐preserving spread increase in cost uncertainty induces the firm to raise the unit price and lower the fixed payment under either decreasing or constant absolute risk aversion. Copyright © 2011 John Wiley & Sons, Ltd.     

Explaining the Czech interbank market risk premium

This paper focuses on the development of the interbank market risk premium in the Czech Republic during the global financial crisis. We explain the significant departure of interbank interest rates from the key monetary policy rate by a combination of different factors, including liquidity risk, counterparty risk, foreign influence, interbank relations, and strategic behavior. The results suggest a relevant role of market factors and some importance of counterparty risk.     

Asset prices in an exchange economy when agents have heterogeneous homothetic recursive preferences and no risk free bond is available

We study a pure exchange economy under incomplete markets where households have heterogeneous homothetic recursive preferences and lending and borrowing are precluded. We fully characterize the properties of the efficient allocations and the equilibrium asset price. The ownership distribution dynamics reveal the emergence of a dominant agent, who after some finite time, remains the only investor that increases asset holdings until asymptotically owning the entire wealth. Investors can be ranked according to a unique parameter that aggregates agents’ preference characteristics and we show how time discount rate, attitude towards risk and intertemporal substitution contribute to capital accumulation.     

Risk aversion,public disclosure,and partially informed outsiders

In this paper, we examine the impact of public disclosure and partially informed outsiders on a risk-averse insider’s trading behavior, market efficiency, and market depth. In our model, under disclosure requirements, except for the final auction, market depth is the same at every auction. When informed outsiders are risk-neutral, in contrast to the case of a risk-averse insider with no informed outsiders, the insider is more concerned about the uncertainty about future price risk. When the number of informed outsiders increases, market liquidity improves, and the insider increases the variance of her random component to conceal her trading strategy. However, since the insider is relatively more risk-averse, she pays less attention to doing this on her own. Besides, the order flow provided by informed outsiders and randomly added by the insider injects additional liquidity into the market. When informed outsiders are risk-averse, compared to risk-neutral informed outsiders, an insider is most concerned about trading risks brought by informed outsiders at the beginning of trading. Furthermore, whether the trader is an insider or informed outsider, the more risk-averse trader has lower expected profits. Moreover, outsiders’ greater risk aversion leads to a smaller market depth.     

Portfolio constraints,differences in beliefs and bubbles

I propose an arbitrage-based theory of bubbles in economies with general portfolio constraints and differences in beliefs. I find that, in general, bubbles cannot exist unless the constraints restrict the demand for credit sufficiently to induce low interest rates. Speculation due to heterogeneous beliefs does not cause bubbles. Ruling out bubbles under asymmetric information requires stronger assumptions: the presence of some uninformed agents and mild portfolio restrictions (debt or borrowing constraints), or alternatively, the existence of some impatient and fully informed agents.     

Heterogeneous beliefs and the choice between private restructuring and formal bankruptcy

We present a theory for the puzzling issue regarding why certain firms in financial distress, prefer a costlier formal bankruptcy procedure over direct renegotiations. We show that claimholders’ heterogeneous beliefs about the results of a formal plan and about judicial discretion may lead to such a preference. The proposed model predicts which resolution would be chosen under claimholders’ beliefs about the determinants driving the outcome of a formal procedure, such as the extent to which firm value is affected by bankruptcy, the likelihood of deviation from the absolute priority rule, and the probability of the court adopting a reorganization plan.     

On compensation for risk aversion and skewness affection in wages

This paper presents extensive empirical testing of the hypothesis that greater post-schooling earnings risk requires higher expected returns. Expanding on this notion, on the basis of utility theory, we predict that workers not only care about risk but also about the skewness in the distribution of the compensation paid: workers exhibit risk aversion and skewness affection. To test these hypotheses, this paper carefully develops various measures of risk and skewness by occupational/educational classification of the worker and finds supportive evidence: for men, wages rise with occupational earnings variance and decrease with skewness, for women only the negative effect of skewness is significant.