Utility valuation of multi-name credit derivatives and application to CDOs

We study the impact of risk-aversion on the valuation of credit derivatives. Using the technology of utility-indifference pricing in intensity-based models of default risk, we analyse resulting yield spreads in multi-name credit derivatives, particularly CDOs. We study first the idealized problem with constant intensities where solutions are essentially explicit. We also give the large portfolio asymptotics for this problem. We then analyse the case where the firms have stochastic default intensities driven by a common factor, which can be viewed as another extreme from the independent case. This involves the numerical solution of a system of reaction-diffusion PDEs. We observe that the nonlinearity of the utility-indifference valuation mechanism enhances the effective correlation between the times of the credit events of the various firms leading to non-trivial senior tranche spreads, as often seen from market data.     

A note on internal and external reference in efficiency wage models

According to Bewley, a workers’ morale depends on being treated fairly within firms. This implies that the internal comparison of the own wage with wages paid to other workers within the firm affects individual effort determination. By contrast, the standard efficiency wage models only consider a comparison of the own wage with external income opportunities as the only determinant for individual effort. We provide a simple efficiency wage framework in which both the internal and external perspectives can affect individual effort determination. Our framework suggests that the internal reference is essential for the existence of real wage rigidity while the external reference ensures an upward-sloping wage-setting curve.      

Financial Modeling in a Fast Mean-Reverting Stochastic Volatility Environment

We present a derivative pricing and estimation methodology for a class of stochastic volatility models that exploits the observed 'bursty' or persistent nature of stock price volatility. Empirical analysis of high-frequency S&P 500 index data confirms that volatility reverts slowly to its mean in comparison to the tick-by- tick fluctuations of the index value, but it is fast mean- reverting when looked at over the time scale of a derivative contract (many months). This motivates an asymptotic analysis of the partial differential equation satisfied by derivative prices, utilizing the distinction between these time scales. The analysis yields pricing and implied volatility formulas, and the latter provides a simple procedure to 'fit the skew' from European index option prices. The theory identifies the important group parameters that are needed for the derivative pricing and hedging problem for European-style securities, namely the average volatility and the slope and intercept of the implied volatility line, plotted as a function of the log- moneyness-to-maturity-ratio. The results considerably simplify the estimation procedure. The remaining parameters, including the growth rate of the underlying, the correlation between asset price and volatility shocks, the rate of mean-reversion of the volatility and the market price of volatility risk are not needed for the asymptotic pricing formulas for European derivatives, and we derive the formula for a knock-out barrier option as an example. The extension to American and path-dependent contingent claims is the subject of future work. This revised version was published online in August 2006 with corrections to the Cover Date.     

A Critical Review of the Costs of Advertising: a Transformative Consumer Research Perspective

This critical literature review incorporates a transformative consumer research (TCR) perspective in highlighting selected transgressions in corporate social responsibility that touch on (1) wealth consolidation, (2) environmental degradation, (3) commodification, (4) semiotic contamination, and (5) an erosion of accountability. It argues for a participatory approach among stakeholders in sustaining marketing research and assessing consumer policy that is both ethical and critical for academic marketers and practitioners alike. Transformative consumer researchers work to ensure that advertisements, messaging, and integrated marketing communications play a key role in promoting honesty and transparency. At the same time, transformative consumer research recognizes that advertising often masks the underlying costs incurred by society in general, and consumers in particular. TCR practices presently exist, and examples are presented to highlight these practices in consumer policy.     

Welfare criteria for tax reforms: Efficiency aspects

This paper provides unexpected support to Nash's view of how bargaining determines the social choice. We first present a spatial model of electoral competition with probabilistic voting and a very close relation between voters' preferences and their choice probabilities. The outcome of the electoral competition game is then shown to be precisely the social alternative that maximizes a Nash-type social welfare function (theorem 1). This electoral outcome is also interpreted as a unanimity likelihood maximum (corollary 1). Within our framework, existence and uniqueness of such an outcome are guaranteed (corollaries 2 and 3).     

RISK DIFFERENCES AND FINANCIAL REPORTING

Financial leverage as reported by a consolidated financial statement may differ substantially from leverage for the parent company. To assess the financial risk for the parent (not the consolidated entity), employing consolidated data is hazardous; the problem is magnified by the fact that virtually all firms report only consolidated data. Consolidated leverage almost always equals or exceeds parent leverage for a wholly owned subsidiary, and many firms reporting only consolidated data have betas significantly greater than otherwise comparable firms that report both consolidated and parent company information.     

Corporate transparency, cream-skimming and FDI

We develop a simple information-based model of Foreign direct investment (FDI) flows. On the one hand, the relative abundance of “intangible” capital in specialized industries in the source countries, which presumably generates expertise in screening investment projects in the host countries, enhances FDI flows. On the other hand, host-country relative corporate-transparency diminishes the value of this expertise, thereby reducing the flow of FDI. The model also demonstrates that the gains for the host country from FDI [over foreign portfolio investment (FPI)] are reflected in a more efficient size of the stock of domestic capital and its allocation across firms. These gains are shown to depend crucially (and positively) on the degree of competition among FDI investors. We provide also some evidence on the effects of corporate transparency indicators, such as accounting standards, on bilateral FDI flows from a panel of 24 OECD countries over the period of 1981-1998.