Estimating the structural credit risk model when equity prices are contaminated by trading noises

The transformed-data maximum likelihood estimation (MLE) method for structural credit risk models developed by Duan [Duan, J.-C., 1994. Maximum likelihood estimation using price data of the derivative contract. Mathematical Finance 4, 155–167] is extended to account for the fact that observed equity prices may have been contaminated by trading noises. With the presence of trading noises, the likelihood function based on the observed equity prices can only be evaluated via some nonlinear filtering scheme. We devise a particle filtering algorithm that is practical for conducting the MLE estimation of the structural credit risk model of Merton [Merton, R.C., 1974. On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance 29, 449–470]. We implement the method on the Dow Jones 30 firms and on 100 randomly selected firms, and find that ignoring trading noises can lead to significantly over-estimating the firm’s asset volatility. The estimated magnitude of trading noise is in line with the direction that a firm’s liquidity will predict based on three common liquidity proxies. A simulation study is then conducted to ascertain the performance of the estimation method.     

Declining prices and optimality when costs follow an experience curve

There is a widely held notion that as production costs decline with experience, prices should follow more or less in parallel. Although this notion has been an important factor in estimating experience curves and in formulating corporate strategies, we show that it is generally inconsistent with published multiperiod optimal pricing models. The paper then goes on to demonstrate that this apparent conflict can be reconciled by allowing the demand process to exhibit increasing price elasticity over time. Since this demand characteristic is very plausible for innovative products, we suggest it be incorporated into optimal pricing models.     

Estimating quadratic variation when quoted prices change by a constant increment

For financial assets whose best quotes almost always change by jumping by the market’s price tick size (one cent, five cents, etc.), this paper proposes an estimator of Quadratic Variation which controls for microstructure effects. It measures the prevalence of alternations, where quotes jump back to their just-previous price. It defines a simple property called “uncorrelated alternation”, which under conditions implies that the estimator is consistent in an asymptotic limit theory, where jumps become very frequent and small. Feasible limit theory is developed, and in simulations works well.     

Income taxation when markets are incomplete

We investigate the welfare effects of proportional income taxation in a standard general equilibrium model with incomplete markets (GEI). Formally, our analysis is on the allocative effects of state-contingent income tax reforms. Tax reforms are restricted to be anonymous, publicly and truthfully announced before markets open, and they are required to result in an ex-post constrained efficient allocation. Our main result is to show that there do typically exist contingent tax reforms that are Pareto improving. These reforms, acting directly on the asset span, modify private risk-sharing opportunities. Thus, unlike most of the GEI literature, the type of policy transmission mechanism considered does not rely on second-order, relative spot price effects. Yet, the key welfare effects of our tax reforms are substantially equivalent to those induced through changes in relative spot prices, as, for example, in Geanakoplos and Polemarchakis (1986), Geanakoplos et al. (1990), or in Citanna et al. (2001). Mathematics Subject Classification (2000): 58E17, 46N10, 93B29 Journal of Economic Literature Classification: D52, H21, H24, H25     

Strategy-proof allocation when preferences are single-plateaued

Abstract. We consider private good economies with single-plateaued preferences. A solution selects for each preference profile a non-empty set of allocations. An agent strictly prefers a set of allocations to another set of allocations if and only if he strictly prefers any allocation in the first set to any in the second set according to his single-plateaued preference relation. We characterize the class of sequential-allotment solutions by essentially single-valuedness, Pareto-indifference, and coalitional stragety-proofness. These solutions are the Pareto-indifferent extensions of the solutions studied by Barberà et al. 1997. Received: 9 May 2000 / Accepted: 1 May 2001     

Optimal instruments when the disturbances are small

Single-equation instrumental variable estimators (e.g., the k-class) are frequently employed to estimate econometric equations. This paper employs Kadane's (1971) small-σ method and a squared-error matrix loss function to characterize a single-equation class of optimal instruments, $\text{A}$. $\text{A}$ is optimal (asymptotically for a small scalar multiple, σ, of the model's disturbance) in that all of its members are preferred to all non-members. From this characterization it is shown all k-class estimators and certain iterative estimators belong to $\text{A}$. However, non-iterative principal component estimators [e.g., Kloek and Mennes (1960)] are unlikely to belong to $\text{A}$. These latter instrumental variable estimators have been advocated [see Amemiya (1966) and Kloek and Mennes (1960)] for estimating ‘large’ econometric models.     

Intergenerational justice when future worlds are uncertain

Let there be a positive (exogenous) probability that, at each date, the human species will disappear. We postulate an Ethical Observer (EO) who maximizes intertemporal welfare under this uncertainty, with expected-utility preferences. Various social welfare criteria entail alternative von Neumann Morgenstern utility functions for the EO: utilitarian, Rawlsian, and an extension of the latter that corrects for the size of population. Our analysis covers, first, a cake-eating economy (without production), where the utilitarian and Rawlsian recommend the same allocation. Second, a productive economy with education and capital, where it turns out that the recommendations of the two EOs are in general different. But when the utilitarian program diverges, then we prove it is optimal for the extended Rawlsian to ignore the uncertainty concerning the possible disappearance of the human species in the future. We conclude by discussing the implications for intergenerational welfare maximization in the presence of global warming.     

Credit rationing when banks are funding constrained

Credit crunches, such as in the recent financial crisis, generally occur when banks are themselves funding constrained. We use this observation to repair the workhorse Stiglitz–Weiss model of credit rationing. Recent research has invalidated the distributional assumption on which that model is based. This paper shows that by adding the assumption that banks are capacity constrained, Stiglitz–Weiss rationing can occur again. It discusses how this finding can be related to the current policy debates on bank funding and credit provision.     

Model selection when there are multiple breaks

We consider model selection facing uncertainty over the choice of variables and the occurrence and timing of multiple location shifts. General-to-simple selection is extended by adding an impulse indicator for every observation to the set of candidate regressors: see Johansen and Nielsen (2009). We apply that approach to a fat-tailed distribution, and to processes with breaks: Monte Carlo experiments show its capability of detecting up to 20 shifts in 100 observations, while jointly selecting variables. An illustration to US real interest rates compares impulse-indicator saturation with the procedure in Bai and Perron (1998).     

Optimal law enforcement when victims are rational players

The economic analysis of crime usually views a victim as a passive party whose role is limited to suffering harm. In this paper, we extend the economic theory of law enforcement by modeling victims as an active party in criminal deterrence. First, they may take some precautions to avoid victimization. Second, they may or may not report their victimization. The lack of reporting weakens law enforcement and criminal deterrence by reducing detection rates. This suggests that victims could be encouraged to report by being paid a compensation. Nevertheless, compensating victims certainly reduces precaution. We argue that such effect never offsets the gains obtained in terms of criminal detection and apprehension. Received: December 1998 / Accepted: January 2000     

Estimating demand systems when outcomes are correlated counts

We describe and employ a Bayesian posterior simulator for fitting a high-dimensional system of ordinal or count outcome equations. The model is then applied to describe the multiple site recreation demands of individual agents, and we argue that our approach provides advantages relative to existing methods commonly applied in this area. In particular, our model flexibly adjusts to match observed frequencies in trip outcomes, permits a flexible correlation pattern among the sites visited by individuals, and the posterior simulator for fitting this model is relatively easy to implement in practice. We also describe how the posterior simulations produced from the model can be used to conduct a variety of counterfactual experiments, including predicting behavioral changes and describing welfare implications resulting from shifts in exogenous demographic and site characteristics. We illustrate our method using data from the Iowa Lakes Project by modeling the visitation patterns of individuals to a set of twenty-nine large Iowa lakes. Consistent with previous findings in the literature, we see strong evidence that own and cross-price effects on trip demand are negative and positive, respectively, that higher income increases the likelihood of visiting most sites, and that a commonly used indicator of water quality, Secchi transparency, is positively correlated with the number of trips taken. In addition, the correlation structure among the errors reveals a complex pattern in which unobserved factors affecting trip demand are generally (though not strictly) positively correlated across sites. The flexibility and richness with which we are able to characterize the demand system provides a solid platform for counterfactual analysis, where we find significant behavioral and welfare effects from changes in site availability, water quality, and travel costs.     

Bubble trouble ‐ are British house prices significantly overvalued?

The OECD last December said British house prices were overvalued by 30% or more. There has been much talk, including in a 2005 speech by Gordon Brown, of a house price bubble. This article, by Gavin Cameron, John Muellbauer and Anthony Murphy of Oxford University, finds no significant evidence for a bubble from a dynamic panel data model of British regional house prices between 1972 and 2003. The model consists of a system of inverted housing demand equations, incorporating spatial interactions and lags and relevant spatial parameter heterogeneity. The results are data consistent, with plausible long-run solutions and include a full range of explanatory variables. Novel features of the model include transaction cost effects influencing the speed of adjustment and housing market flows, as well as stocks, driving prices. Furthermore, the model allows for shifts in real and nominal interest rate effects as credit markets liberalised.     

Dividend paying assets,the unit root property,and suboptimality

We consider the stationary equilibria of one good overlapping generations (OLG) economies with a sequence of possibly incomplete asset markets and prove two results. First, we show that if some asset always pays a nonnegative dividend, then its price changes sign across states if and only if the Perron root of every agent’s matrix of intertemporal rates of substitution exceeds one. Second, we provide sufficient conditions in terms of dividends and asset prices such that, keeping asset prices fixed, a conditionally Pareto improving allocation is induced by a stationary reassignment of a single asset. When taken together the results show that when for some agent the Perron root exceeds one, the existence of an asset that pays a strictly positive dividend in every state is sufficient to induce an improvement.     

Price dynamics when there are alternatives to cash payment

Empirical evidence from the 1980s and 1990s indicates that cash use in the U.S. remains high even though there has been a proliferation of alternatives to cash. This paper examines the dynamics of inflation and asset prices in response to innovations in the efficiency of processing noncash transactions. The quantitative results suggest that inflation is more sensitive than nominal interest rates or real equity prices to innovations in the efficiency of non-cash payments processing. Thus, as alternatives to cash payment become more prominent, the volatility of real interest rates may increase.(JELE31, E41, G12) This research is supported by a Swarthmore College Faculty Research Grant and a Eugene M. Lang Faculty Fellowship.     

股市震荡调整楼市在反弹吗？

自“5·30”以来，持续一个多月的股市调整，让不少此前冲着牛市来股市赚一把的投资者失望之极。股市的小调必然导致资金的外流，最近一周以来沪深两市的交易量持续萎缩就是强有力的证据。     

Monetary policy when wages are downwardly rigid: Friedman meets Tobin

Monetary policy in an economy with both downwardly rigid wages and a transaction motive for money demand is studied using a dynamic stochastic general equilibrium model. The two key features of the model imply that both Tobin's “inflation grease” argument and Friedman's rule are operative, and so optimal inflation may be positive or negative. The Simulated Method of Moments is used to estimate the nonlinear model based on its second-order approximation. Results indicate that the Ramsey policy that maximizes social welfare involves an average inflation rate of about 0.4% per year. In the more realistic case where a central banker follows a simple targeting policy, the optimal inflation target is about 1% per year. We view this result as providing support for the low, but strictly positive, inflation targets used in many countries.     

Uniqueness of Arrow-Debreu and Arrow-Radner equilibrium when utilities are additively separable

This survey paper has three purposes: We first present in finite dimension, different approaches to the problem of uniqueness of Arrow-Debreu equilibrium when agents have additively separable utilities. We then study how, in the specific framework of a two period contingent good economy the results obtained generalize to infinite dimension. We consider economies where agents' consumption space is and agents' utilities are additively separable. Lastly, we show that in some restricted settings, some results may be used to prove uniqueness of Arrow-Radner equilibria when there are incomplete financial markets.