Collective fineness of stock prices and efficiency of financial markets

Recent literature exploring the efficiency properties of options has examined the conditions under which incomplete financial markets would be equivalent to the Arrow-Debreu model. A usual assumption made in establishing such an equivalence is that some security price is ‘fine’ on the state space. This assumption is relaxed. Under more realistic assumptions it is shown that any portfolio is fine and options written on it can bring about complete markets.     

Inducing liquidity in thin financial markets through combined-value trading mechanisms

Asset pricing theory hypothesizes that investors are only interested in portfolios; individual securities are evaluated only in terms of their contribution to portfolio risk and return. Yet, standard financial market design is that of parallel, unconnected markets, whereby investors cannot submit orders in one market conditional on events in others. When markets are thin, this exposes them to substantial execution risk. Fear of ending up with unbalanced portfolios after trading may even keep investors from submitting orders, further eroding liquidity and the ability of markets to equilibrate. The suggested solution is a portfolio trading mechanism referred to as combined-value trading (CVT). Investors are allowed to submit orders for packages of securities and the system matches trades and computes prices by optimally combining portfolio orders in an open book. We study the performance of the CVT mechanism experimentally and compare it to the performance of parallel, unconnected double auctions in experiments with similar parametrization and either a similar number of subjects or substantially thicker markets. We present evidence that our portfolio trading mechanism facilitates equilibration to the extent that the thicker markets do. Inspection of order submission and trade activity reveals that subjects manage to exploit the direct linkages between markets enabled by the CVT system.     

The impact of news,oil prices,and global market developments on Russian financial markets1

This paper analyses the impact of news, oil prices, and international financial market developments on daily returns on Russian bond and stock markets. First, regarding returns, energy news affects returns, while news from the war in Chechnya is not significant. Market volatility does not appear to be sensitive to either type of news. Second, a significant effect of the growth in oil prices on Russian stock returns is detected. Third, the international influence on Russian financial markets depends upon the degree of financial liberalization. The higher the degree of financial liberalization, the stronger is the impact of US stock returns on Russian financial markets. In addition, banking reform and interest rate liberalization efforts seem to dictate the globalization of Russian stock markets, while it is the progress in liberalizing securities markets and non‐bank financial institutions that matters more for the globalization of Russian bond markets.     

Information, trade and incomplete markets

The no-trade result of Milgrom and Stokey, J Econ Theory 26:17–27 (1982), states that if rational traders begin with an ex-ante Pareto optimal allocation then the arrival of information cannot generate trade. This paper allows traders to trade before and after the arrival of information. If there are enough securities to hedge against all payoff relevant risk, then the preinformation-arrival allocation is Pareto optimal and information arrival has no effect. This no-retrade result is the competitive analog of the no-trade result of (1982). However, information generically generates trade when markets are state-contingent incomplete.We thank seminar participants at Cambridge, Carnegie Mellon,Cornell, Essex, London, Maastricht, USC, and York and participants at the 2003 SITE, the 2003 SAET and the Fall 2002 Cornell–Penn State Macro Conference. We also thank Karl Shell and a referee for this journal for useful comments     

Innovation,growth and financial markets

We review some of the literature at the intersection of innovation, financial markets, and economic growth. We explore two key questions: (i) How financial markets interact with innovation; (ii) what type of quality transformations are brought about by innovation. A special emphasis is given to questions that stem from the 2008 economic and financial crisis, and to subjects further developed in the articles collected in this issue.     

Speculative trade, asset prices and investment levels

Summary. In this paper I consider a dynamically complete market model without intrinsic uncertainty. Agents' beliefs are different, but correct in the limit. Some agents are more patient than others. I show that infinitely often share prices are low and the economy stagnates. Also, infinitely often share prices are high and the economy grows. The changes from growth to stagnation and from stagnation to growth are not caused by exogenous shocks. They are caused by speculative trade among agents with different propensities to save and invest. Received: January 8, 2001; revised version: April 11, 2002 RID="*" ID="*" I thank an anonymous referee for helpful comments. I gratefully acknowledge financial support from the National Science Foundation.     

The set of sunspot equilibria in economies with incomplete financial markets: variable asset prices

Summary. I consider the set of equilibria of two-period economies with S extrinsic states of nature in the second period and I assets with linearly independent nominal payoffs. Asset prices are variable. If the number of agents is greater than (S-I), the payoff matrix is in general position and S 2I, the set of equilibrium allocations generically (in utility function space) contains a smooth manifold of dimension (S-1). Moreover, the map from states o f nature to equilibrium allocations (restricted to this manifold) is one-to-one at each equilibrium. Received: February 23, 1998; revised version: June 1, 2000     

Stochastic dominance, efficiency and separation in financial markets

A portfolio problem exhibits separation when all of its solutions can be expressed as affine combinations of a small number of mutual funds. The concept of separation is one of the cornerstones of modern portfolio theory, underlying everything from the mean-variance portfolio selection rule of [7. and 8.] and [11.] to the equilibrium pricing model of [10.], [6.] and [2.]. A great deal of effort has been put into investigating conditions which validate separation assumptions: [3.] as well as [4.] study this problem in terms of utility functions while [9.] takes a distributional approach. The purpose of this note is to show that for the distributional approach, the so-called weak and strong forms of separation are actually equivalent.     

Market crashes,speculation and learning in financial markets

A natural conjecture is that if agents’ beliefs are almost correct then equilibrium prices should be close to rational expectations prices. Sandroni (J Econ Theory 82:1–18, 1998) gives a counterexample in an economy with sunspots and complete markets. We extend Sandroni’s result by showing that the conjecture is generically true for economies with complete markets. We consider a standard General Equilibrium model with large but finite horizon and complete markets. We show that, for almost every such economy, if conditional beliefs eventually become correct along a path of events then equilibrium prices of assets traded along this path converge to rational expectations equilibria in the sup-norm. Moreover, we establish that, generically, there exist along any such path local diffeomorphisms between individual beliefs and equilibrium prices. I would like to thank C. Ewerhart and A. Kirman for their comments, as well as the seminar participants at the University of Minho, the General Equilibrium Workshop 2005 in Zurich, and the 15th Asian General Equilibrium Conference 2007 in Singapore. An anonymous referee also provided very valuable comments.     

Intraday trade in dealership markets

We develop and test a structural asymmetric information transaction model to characterize the price impact of information when markets are thin. Since orders are accepted individually, the model allows for transaction costs and brokerage fees. Equilibrium demands mixed entry strategies on the part of potentially informed traders. Estimation of the structural parameters is performed using a maximum likelihood procedure on NYSE data. The structural model is rejected primarily because the nonlinear restrictions do not allow for sufficient correlation between price movements and pricing errors. This leads to unreasonably low estimates of the probability of informed trade relative to an unrestricted alternative. The price impact of information is found to be positive and significant, but economically small. This is because although the amount of private information is substantial, the quality of the information signals is poor, particularly in the middle of the trading day. Informed agents do not trade small quantities, which suggests that their ability to divide orders is limited by transaction costs.     

Common markets and trade liberalization

Abstract.  The GATT Rounds show that trade liberalization is essentially a cooperative non‐stationary dynamic process. Therefore, the impact of Regionalism on trade liberalization possibly changes over time. I adapt the trade liberalization model of Devereux (1997) to examine how this impact varies. Common markets lead to a one‐time shock in immediate tariffs, as well as to a change in their rate of decline. I find that common markets that happen late in the trade liberalization process are more likely to lead to a decline in immediate tariffs. Common markets also increase the rate of decline of tariffs after their formation. JEL Classification: F03, F15     

Access prices,unbundling and product variety in European Internet markets

A fundamental policy in European broadband regulation is unbundled access to the local loop of the incumbent telephone company. We present comparative static results that show as the access price decreases, the retail price decreases, the variety of plans offered by Internet service providers increases and the quantity of each variety increases when a threshold condition is met. Using data from 18 European countries from 2006 to 2012, we find empirical support for these results when Internet product variety is measured by variation in download speeds.     

Global capital markets,housing prices,and partisan fiscal policies

In recent years, global imbalances have channeled the excess savings of surplus countries toward the real estate markets of deficit countries. By consequence, the deficit countries that attracted lots of foreign capital experienced large run‐ups in house prices, whereas most surplus countries that exported capital exhibited flat or slow house price growth. We first use new house price data and a novel instrumental variable design to show the causal relationship between housing prices and capital inflows, particularly through debt bonanzas. We then argue that international capital flows affect the fiscal policy preferences of both voters and political parties by way of their impact on housing prices. Where capital inflows are large and housing prices are rising, we expect voters to respond by demanding both lower taxes and less publicly‐provided social insurance because rising house prices allow homeowners to self‐insure against income loss. In contrast, declining house prices produce greater demands for social insurance, particularly among those most exposed to housing market risk. We present evidence from two cross‐national surveys that supports these claims, as well as a “before and after” analysis of the housing crash in Eastern Europe. We also show that the connection between house prices and social policy also manifests itself in government spending outcomes, mediated by partisan control.     

On volatility of prices in arbitrage-free markets

Summary This paper addresses the question of what one can learn about the dynamics of an economy from observing cross-sectional and time series variations in the volatility of prices in an arbitrage-free securities market. We introduce the notions of stochastic derivatives, marginal risk-adjusted growth rates, and marginal risk exposure in a single factor economy. We show that future variations in the state of the economy are due to two independent sources: the marginal risk-adjusted growth rate and the changes in marginal risk exposure. Using the martingale characterization of arbitrage-free prices, together with a martingale representation formula due to Haussmann (1978), we show that cross sectional variations in price volatility of assets with linear payoffs can be used to identify the sum of these two sources. Measurements of price volatility for assets with linear payoffs are not sufficient for complete identification of the independent determinants of possible future variations in the economy. However, using the volatility of prices of options on the state variable, we can identify the stochastic derivative and hence compute the price volatility of any path independent contingent claim.I am grateful to David Kreps and Kenneth Singleton for helpful conversations and to an anonymous referee for useful remarks. Financial support from Stanford Graduate School of Business Faculty Fellowship is gratefully acknowledged.     

Walrasian prices in markets with tradable rights

In this paper, we consider an exchange economy where there is an external restriction for the consumption of goods. This restriction is defined by both, a cap on consumption of certain commodities and the requirement of an amount of rights for the consumption of these commodities. The caps for consumption are imposed exogenously due to the negative effects that the consumption may produce. The consumption rights or licenses are distributed among the agents. This fact leads to the possibility of establishing license markets. These licenses do not participate in agents’ preferences, however, the individual’s budgetary constraint may be modified, leading to a reassignment of resources. Our aim is to show the existence of a Walrasian equilibrium price system linking tradable rights prices with commodity prices.     

Debt, interest rates, and integration of financial markets

It is commonly believed that higher budget deficits raise interest rates. However, these crowding out effects of increasing public debt have usually been found to be small or non-existent. One explanation is that on globalised bond markets interest rate differentials are offset due to financial integration. This paper tests crowding out, and measures the degree of integration of government bond markets, using spatial modelling techniques. Our main finding is that the crowding out effect of public debt on domestic long term interest rates is small: a 1% increase in the debt ratio pushes up domestic rates by 2 pp at most. Financial integration implies an important spillover effect via international bond markets, but only between OECD, and in particular EU, countries. The feedback effect from these markets on long term interest rates is as important as the domestic crowding out effect of higher public debt. Emerging markets are not as well integrated into international capital markets, causing a stronger crowding out effect.     

Vertical distribution, parallel trade, and price divergence in integrated markets

We develop a model of vertical pricing in which an original manufacturer sets wholesale prices in two markets that are integrated at the distributor level by parallel imports (PI). The manufacturing firm needs to set these two prices to balance three competing interests: restricting competition in the PI-recipient market, avoiding resource wastes due to actual trade, and reducing the double-markup problem in the PI-source nation. These tradeoffs imply the counterintuitive result that retail prices could diverge as a result of declining trading costs, even as the volume of PI increases. Thus, in some circumstances it may be misleading to think that permitting PI is an unambiguous force for price integration.     

Shadow prices and substitution in trade distorted economies

This paper derives simple and operational shadow pricing rules in a three-sector, three-factor general equilibrium model incorporating nontraded goods. Under the Little-Mirrlees method, if a single simple and empirically plausible condition is satisfied, the accounting ratio for land will exceed unity and those for capital and labor will lie below unity. If this condition is not satisfied or cannot be verified, it is still possible to fix some accounting ratios above or below unity just from knowledge of the signs of substitution patterns in consumption and factor intensity patterns in production. Guidelines are also derived for setting the shadow prices of nontraded goods or quota restricted imports. It is shown that the alternative, domestic price method generally yields less useful guidelines than the Little-Mirrlees method.