Spanning with American options

In this paper, we investigate the existence of multiperiod American options generating dynamically complete markets. We show that if a primitive security separates states at the terminal date, then generically there exist multiperiod American options on that security generating dynamically complete markets. We also provide an example of an economy in which multiperiod American options on a primitive security generate dynamically complete markets, while multiperiod European options do not.     

Pricing rules and Arrow–Debreu ambiguous valuation

This paper considers pricing rules of single-period securities markets with finitely many states. Our main result characterizes those pricing rules C that are super-replication prices of a frictionless and arbitrage-free incomplete asset structure with a bond. This characterization relies on the equivalence between the sets of frictionless securities and securities priced by C. The former captures securities without bid-ask spreads, while the second captures the class of securities where, if some of its delivers is replaced by a higher payoff, then the resulting security is characterized by a higher value priced by C. We also analyze the special case of pricing rules associated with securities markets admitting a structure of basic assets paying one in some event and nothing otherwise. In this case, we show that the pricing rule can be characterized in terms of capacities. This Arrow–Debreu ambiguous state price can be viewed as a generalization for incomplete markets of Arrow–Debreu state price valuation. Also, some interesting cases are given by pricing rules determined by an integral w.r.t. a risk-neutral capacity. For instance, incomplete markets of Arrow securities and a bond are revealed by a Choquet integral w.r.t. a special risk-neutral capacity.     

A characterization of the distributions that imply mean—Variance utility functions

If there is a riskless asset, then the distribution of every portfolio is determined by its mean and variance if and only if the random returns are a linear transformation of a spherically distributed random vector. If there is no riskless asset, then the spherically distributed random vector is replaced by a random vector in which the last n ? 1 components are spherically distributed conditional on the first component, which has an arbitrary distribution. If the number of assets is infinite, then there must exist random variables m, v, y, where the distribution of y conditional on m and v is standard normal, such that every portfolio is distributed as some linear combination of m and vy. If there is a riskless asset, then m has zero variance. These distributions exhibit two-fund separability even if the utility function is not concave.     

Implementing Arrow-Debreu equilibria by trading infinitely-lived securities

Summary. We show that Arrow-Debreu equilibria with countably additive prices in infinite-time economy under uncertainty can be implemented by trading infinitely-lived securities in complete sequential markets under two different portfolio feasibility constraints: wealth constraint, and essentially bounded portfolios. Sequential equilibria with no price bubbles implement Arrow-Debreu equilibria, while those with price bubbles implement Arrow-Debreu equilibria with transfers. Transfers are equal to price bubbles on initial portfolio holdings. Price bubbles arise in sequential equilibrium under the wealth constraint if some securities are in zero supply or negative prices are permitted, but cannot arise with essentially bounded portfolios.Received: 19 November 2003, Revised: 24 February 2004, JEL Classification Numbers: D50, G12, E44.Correspondence to: Jan WernerWe acknowledge helpful discussions with Roko Aliprantis, Subir Chattopaydhyay, Steve LeRoy, Manuel Santos, and seminar participants at Brown University, University of Pennsylvania, NBER Workshop in General Equilibrium Theory, SITE 2000, the 2000 World Congress of the Econometric Society, and Federal Reserve Bank of Kansas City. The views expressed herein are those of the authors and do not necessarily reflect the views of Federal Reserve Bank of Kansas City or the Federal Reserve System.     

Security Innovation on Several Assets Under Asymmetric Information

The paper examines the optimal innovation of securities by an issuer who is endowed with several risky assets and private information on one of the assets. Assuming that the degree of asymmetric information between the issuer and the outside investor is large, we show that the issuer restricts the number of securities that he creates. We also show that the payoff of the security created by the issuer is not closely correlated, and is sometimes completely uncorrelated, with the payoff of the asset that is subject to the asymmetric information, depending on the hedging needs and the accuracy of information.
JEL Classification Numbers: D52, D82, G20.     

证券分析师评级报告的投资价值研究——来自香港股市的经验证据

伴随着证券市场的产生和繁荣,证券分析师队伍也日益壮大并日趋专业。以港股为例,通过跟踪经纪行数百名分析师自2003年以来对香港上市公司的评级结果,以及重点考察不同评级结果投资组合的收益率情况后,发现尽管分析师的专业判断具有显著的投资价值,并以此确定投资标的或重点研究跟踪对象具有良好的可操作性。但由于其评级结果具有较为明显的实效性,对市场的影响力也会发生变化,因此需要时刻密切注意分析师的最新评级成果并及时更新。     

Social norms and trust among strangers

We study the development of a social norm of trust and reciprocity among a group of strangers via the “contagious strategy” as defined in Kandori (1992). Over an infinite horizon, the players anonymously and randomly meet each other and play a binary trust game. In order to provide the investors with proper incentives to follow the contagious strategy, there is a sufficient condition that requires that there exists an outside option for the investors. Moreover, the investorsʼ payoff from the outside option must converge to the payoff from trust and reciprocity as the group size goes to infinity. We show that this sufficient condition is also a necessary condition to sustain any sequential equilibrium in which the trustees adopt the contagious strategy. Our results imply that a contagious equilibrium only supports trust if trust contributes almost nothing to the investorsʼ payoffs.     

Foreign equity option pricing under stochastic volatility model with double jumps

This paper considers the challenging problem advocated by Huang and Hung (2005), that is to incorporate the stochastic volatility into the foreign equity option pricing. Foreign equity options (quanto options) are contingent claims where the payoff is determined by an equity in one currency but the actual payoff is done in another currency. Huang and Hung (2005) priced foreign equity options under the Lévy processes. In Huang and Hung's paper, they considered jumps in the foreign asset prices and exchange rates and assumed the volatility as constant. However, many studies showed that constant volatility and jumps in returns are incapable of fully capturing the empirical features of equity returns or option prices. In this paper, the stochastic volatility with simultaneous jumps in prices and volatility is proposed to model foreign asset prices and exchange rates. The foreign equity option pricing formula is given by using the Fourier inverse transformation. The numerical results show that the use of stochastic volatility with simultaneous jumps in prices and volatility proposed to model foreign asset prices and exchange rates is necessary and this approach can help us to capture more accurately the foreign equity option prices.     

An analysis of the conditions for the validity of Modigliani-Miller Theorem with incomplete markets

Summary In this paper we investigate the consequences of the firms' financial decisions in the framework of a perfectly competitive general equilibrium model with incomplete markets. When markets are complete or there are no derivative securities (such as options, forwards or futures) written on the firms' shares, these decisions are irrelevant. This result reaffirms and qualifies the original claim by Modigliani and Miller. On the other hand, if markets are incomplete, we show that in the presence of any type of derivative security a change in the capital structure of a firm will modify, generically, both the real equilibrium allocation and the value of the firm. The reason is that the payoff of the derivative securities is affected in a non-linear way by changes in the firm's financial policy; thus the set of the agents' insurance opportunities is also modified.The paper is a revised version of chapter 1 of my Ph.D. dissertation at Cambridge University. I wish to thank F. H. Hahn and H. M. Polemarchakis for their encouragement and very useful discussions. I am also grateful to J. Detemple, S. E. Satchell, S. Schaefer, P. Siconolfi, R. Stapleton, M. Subrahmanyam and three anonymous referees, as well as to participants at seminars at Cambridge, Columbia, EUI, Bocconi, USC, the R.E.S. Conference in Nottingham and the 6th World Congress of the Econometric Society in Barcelona for helpful comments. The usual disclaimer applies.     

Information Revelation and Market Incompleteness

This paper introduces a theory of market incompleteness based on the information transmission role of prices and its adverse impact on the provision of insurance in financial markets. We analyse a simple security design model in which the number and payoff of securities are endogenous. Agents have rational expectations and differ in information, endowments, and attitudes toward risk. When markets are incomplete, equilibrium prices are typically partially revealing, while full relevation is attained with complete markets. The optimality of complete or incomplete markets depends on whether the adverse selection effect (the unwillingness of agents to trade risks when they are informationally disadvantaged) is stronger or weaker than the Hirshleifer effect (the impossibility of trading risks that have already been resolved), as new securities are issued and prices reveal more information. When the Hirshleifer effect dominates, an incomplete set of securities is preferred by all agents, and generates a higher volume of trade.     

Equilibria in incomplete assets economies with infinite dimensional spot markets

The paper studies the two period incomplete markets model where assets are claims on state contingent commodity bundles and there are no bounds on portfolio trading. The important results on the existence of equilibrium in this model assume that there is a finite number of commodities traded in each spot market and that preferences are given by smooth utility functions. With these assumptions an equilibrium exists outside an “exceptional” set of assets structures and initial endowments. The present paper extends these results by allowing for general infinite dimensional commodity spaces in each spot market. These include all the important commodity spaces studied in the literature on the existence of Walrasian equilibrium—in each spot market the consumption sets are the positive cone of an arbitrary locally solid Riesz space or of an ordered topological vector space with order unit or of a locally solid Riesz space with quasi-interior point. The paper establishes that even with our very general commodity spaces there exists an equilibrium for a “very” dense set of assets structures. Our approach is in the main convex analytic and the results do not require that preferences be smooth or complete or transitive. The concepts and techniques studied in this paper have important finite as well as infinite dimensional applications. This paper has benefited from the comments of Martine Quinzii, Wayne Shafer, Manuel Santos and Yeneng Sun. The research of C. D. Aliprantis is supported by the NSF Grants SES-0128039, DMS-0437210, and ACI-0325846. The research of R. Tourky is funded by the Australian Research Council Grant A00103450.     

Evidence of cross-asset contagion in U.S. markets

This study examines evidence of cross-asset contagion among REIT, money, stock, bond, and currency markets in the US from 2006 to 2012, which covers the subprime and European sovereign debt crisis. We apply the Granger causality test and a vector auto-regression to examine the change of causality structure. Our results show that contagion exists from medium-term bond markets to equity markets; REIT, money markets and short-term bond markets show little evidence of cross-asset contagion with other markets; and the currency market shows high co-movement and contagion with equity markets. Our findings provide more rewarding asset reallocating strategies for the investors who invest in both bond and equity markets before a crisis to consider reallocating their portfolio into REIT and money markets to benefit from diversification during a crisis period.     

Monopolistic security design in finance economies

Summary. The purpose of this paper is to analyze endogenous asset innovation by an entrepreneurial exchange owner in a general equilibrium model of incomplete security markets with financial transaction fees. A monopolistic market maker has the technology to introduce a new option into the economy and charge investors proportional transaction fees if they trade on the exchange. The market maker's objective is to choose the security and transaction fee that maximize revenues when opening the exchange. A computational analysis of this problem is necessary since there are no interesting models with closed-form solutions. We compute the price and welfare effects of the option introduction. Received: March 14, 2000; revised version: December 12, 2000     

Real options as a component of the market value of stocks: evidence from the Spanish Stock Market

This paper aims to examine how investors’ expectations about the value of a firm's real options are reflected in the price of its stocks. If the real-option approach is correct, then the efficient-market hypothesis predicts that stock prices will reflect the available information relative to the real options held by firms and their ability to identify, acquire, maintain and exercise them. The role of investment irreversibility, operating and financial flexibility, business and geographical diversification, and size are examined as indicators of a firm's real option strategy. The empirical analysis of a panel of 101 companies listed on the Spanish Stock Exchange during the period 1991–1997 provides evidence consistent with predictions. The market value of the real option portfolio is significantly and positively related to business diversification, asset irreversibility and operating leverage, and negatively related to size. In addition, financial leverage and geographical diversification are not significantly related to our proxies for the market value of real options. These results are robust even after controlling for industry, and alternative measures of investment flexibility and business diversification.     

Option implied beta and option return

We study the information content of option-implied betas for future equity option returns, using data on the S&P 500 index options and all of the component stock options. We find a significantly strong relation between option-implied betas and option returns cross-sectional. The paper presents evidence that call (put) option returns increase (decrease) with the option-implied betas of the underlying stock. A trading strategy of buying high (low) implied beta call (put) option portfolio and selling low (high) implied beta call (put) option portfolio generates a statistically and economically significant return. Our results are robustly persistent even after controlling for various cross-sectional effects and are not explained by the risk factors in asset pricing.     

International asset prices and portfolio choices under Bayesian learning

We calculate equilibrium asset prices and portfolio choices from a two-country OLG international asset pricing model under the assumption that investors are on a Bayesian learning path. Investors from both countries receive identical information flows, but domestic investors start off with less precise priors concerning foreign fundamentals. Learning is shown to produce first-order effects on the properties of asset prices, in the form of increased equity returns, volatility clustering, and time-varying correlations across national stock markets. Moreover, on a learning path, estimation risk generates portfolio biases similar to those observed empirically, i.e. a strong preference towards domestic securities and excessive turnover in foreign securities. These findings are robust to changes in prior beliefs, the calibration of initial information asymmetries, and the parameterization of the model. We use real GDP data for the US and Europe to calibrate the model and show that in the event of a financial liberalization during the 1970s, high excess returns, time-varying volatility, substantial home bias, and excess turnover should have been observed.     

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.     

Strategic use of futures and options by commodity processors

The impacts of input–output price relationships on end-users' demands for positions in futures and options are analyzed using a mean-variance portfolio model and applied to price risk management in the bread manufacturing industry. A production relationship was assumed between the input and resultant output, and correlation between the input and output prices were introduced into the portfolio model. The optimal hedge ratio can be either positive or negative depending upon the relationship between the input and output price standard deviation adjusted for production technology and input–output price correlation. Introduction of a call option into the portfolio (in addition to the futures) does not change the hedging demand for futures; however, the speculative component changes. The results show that the addition of input–output linear production and price correlation relationships would not justify a hedging role for options unless there is bias in the futures and/or options markets.     

Arbitrage and equilibrium with portfolio constraints

We consider a multiperiod financial exchange economy with nominal assets and restricted participation, where each agent’s portfolio choice is restricted to a closed, convex set containing zero, as in Siconolfi (Non-linear Dynamics in Economics and Social Sciences, 1989). Using an approach that dates back to Cass (CARESS Working Paper, 1984; J Math Econ 42:384–405, 2006) in the unconstrained case, we seek to isolate arbitrage-free asset prices that are also quasi-equilibrium or equilibrium asset prices. In the presence of such portfolio restrictions, we need to confine our attention to aggregate arbitrage-free asset prices, i.e., for which there is no arbitrage in the space of marketed portfolios. Our main result states that such asset prices are quasi-equilibrium prices under standard assumptions and then deduces that they are equilibrium prices under a suitable condition on the accessibility of payoffs by agents, i.e., every payoff that is attainable in the aggregate can be marketed through some agent’s portfolio set. This latter result extends previous work by Martins-da-Rocha and Triki (Working Paper, University of Paris 1, 2005).     

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