Capital asset pricing in an overlapping generations model

This paper attempts to contribute to two rapidly growing branches in economic theory: asset pricing and “overlapping generations” models. The model is formulated and it is shown that equilibrium prices exist, and some of their properties are discussed. Then the model is applied to an asymmetric information environment to see if randomness in the number of informed agents could confuse the uninformed. Surprisingly, it could not.     

Partitioning uncertain workloads

We present a method for determining the ratio of the tasks when breaking any complex workload in such a way that once the outputs from all tasks are joined, their full completion takes less time and exhibit smaller variance than when running on the undivided workload. To do that, we have to infer the capabilities of the processing unit executing the divided workloads or tasks. We propose a Bayesian Inference algorithm to infer the amount of time each task takes in a way that does not require prior knowledge on the processing unit capability. We demonstrate the effectiveness of this method in two different scenarios; the optimization of a convex function and the transmission of a large computer file over the Internet. Then we show that the Bayesian inference algorithm correctly estimates the amount of time each task takes when executed in one of the processing units.     

Abstracts

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Performance maximization of actively managed funds

A growing literature suggests that, even in the absence of any ability to predict returns, holding options on the benchmarks or trading frequently can generate positive alpha. The ratio of alpha to its tracking error appraises a fund's performance. This paper derives the performance-maximizing strategy, which turns out to be a variant of a buy-write strategy, and the least upper bound on such performance enhancement. If common equity indices are used as benchmarks, the potential alpha generated from trading frequently can be substantial in magnitude, but it carries considerable risk. The statistical significance in estimated alpha is low, and the probability of a negative alpha is high. The performance enhancement from holding options can be significant - both economically and statistically - if the options' implied volatilities are higher than the volatilities of the benchmark returns. The performance-maximizing strategy derived in this paper is different from the strategies that switch portfolio exposure to the benchmarks. The exposure-switching strategies are not promising unless the switching is based on superior information.     

Preferred risk habitat of individual investors

The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks whose volatilities are commensurate with their risk aversion. The data, 1995–2000 holdings of over 20,000 clients at a large German broker, are consistent with the predictions of the hypothesis: the returns of stocks within each portfolio have remarkably similar volatilities, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk-averse customers indeed hold less volatile stocks. Greater volatility specialization is associated with lower Sharpe ratios, primarily because more specialized investors hold fewer stocks and thereby expose themselves to more unsystematic risk.     

Management fads, pedagogies, and other soft technologies

We present a model for the diffusion of management fads and other technologies which lack clear objective evidence about their merits. The choices made by non-Bayesian adopters reflect both their own evaluations and the social influence of their peers. We show, both analytically and computationally, that the dynamics lead to outcomes that appear to be deterministic in spite of being governed by a stochastic process. In other words, when the objective evidence about a technology is weak, the evolution of this process quickly settles down to a fraction of adopters that is not predetermined. When the objective evidence is strong, the proportion of adopters is determined by the quality of the evidence and the adopters’ competence.     

Optimal Liquidity Trading

A liquidity trader wishes to trade a fixed number of shares within a certain time horizon and to minimize the mean and variance of the costs of trading. Explicit formulas for the optimal trading strategies show that risk-averse liquidity traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility or liquidity increases. In the presence of transaction fees, traders want to trade less often when either price volatility or liquidity goes up or when the speed of price reversion declines. In the multi-asset case, price effects across assets have a substantial impact on trading behavior.We are grateful to Prajit Dutta and Larry Glosten for numerous conversations and comments and to Marc Lipson for help with the Plexus data. Comments and suggestions of the referee and the editor, Josef Zechner, helped us improve the paper. We also thank the participants of the Chicago Board of Trade 13th Annual European Futures Research Symposium 2000 and the participants of the EFA Annual Meetings 2001.     

Pioneers for Profit: St. Petersburg Entrepreneurs in Services

Russian private entrepreneurs in services are truly pioneering,because many services— especially trade, financial services,and most business and consumer services—are poorly developed.This article uses 1992 and 1993 survey data from St. Petersburgto assess the characteristics of these entrepreneurs, theirfirms, and the markets in which they deal. Evaluation of thefirms' performance establishes how well they are doing and providesinsight into the determinants of success. Their performancewas surprisingly good and can be attributed to several factors,including the existence of a substantial gap between the desiredand the actual levels of many services and the high level ofeducation and motivation of the entrepreneurs themselves. Policypriorities are to achieve macroeconomic stability, a transparentlegal framework and simplified regulations, a well-designedtax code, further privatization of real estate, and better accessto finance. Direct assistance programs would be useful in providinginformation, counseling, and financing to small and medium-sizefirms.     

Additional cautionary notes about the Pearson's correlation coefficient

In this paper we draw attention to two usually-neglected problems with the use of the Pearson's correlation coefficient for ordinal scores. We refer to the questions of substantial differences between the marginal distributions of the two variables to be correlated, and the number of ties on each one of the distributions or on both. Finally, we propose a correction factor for the Pearson's correlation coefficient when the number of ties is large. Some empirical examples are given in order to demonstrate these points.