Valuing American-style options under the CEV model: an integral representation based method

Review of Derivatives Research - This article derives a new integral representation of the early exercise boundary for valuing American-style options under the constant elasticity of variance (CEV)...     

Interpreting Value at Risk (VaR) forecasts

Value at Risk (VaR) forecasts have been increasingly accepted globally by both risk managers and regulators as a tool to identify and control exposure to financial market risk. However, modern portfolios are characterized by a constantly changing composition of security holdings that reflect portfolio managers’ strategies, expected prices, and net cash flows into the portfolio. As a result of these factors, portfolio returns are time-varying mixtures of distributions which are unlikely to be well approximated by conventional methods.     

The Greenspan years: an analysis of the magnitude and speed of the equity market response to FOMC announcements

We examine the impact of monetary policy on the S&P 500 using intraday data. The analysis shows an economically and statistically significant relationship between S&P 500 intraday returns and changes in the Fed funds target rate. The significance and magnitude of the response is dependent on whether the change was expected or unexpected. An expected change in the Fed funds target rate has no impact on prices in the broad equity market; however, an unexpected change of 25 basis points in the Fed funds target rate results in an approximate 48 basis points decline in the broad equity market’s return. The speed of these market reactions is rapid with the equity market reaching a new equilibrium within 15 minutes.

The Use and Abuse of Environmental Knowledge: A Bloomington School Interpretation of the Canadian Fisheries Act of 1868

This paper will focus on the ambitious plan for regulation embodied in the Dominion Fisheries Act of 1868, a law passed by the Canadian federal parliament in its very first year of existence. The 1868 law was intended to bring the nation's fisheries firmly under the control of officials employed by the new federal government. The paper argues that 1868 law, which was designed to address what would today be called Tragedy of the Commons problems, was a product of the hubris identified by Hayek as "the fatal conceit." The centralized and bureaucratic approach to governing fisheries represented by the 1868 Fisheries Act did not work well because the knowledge that would have been required for successful management of fisheries was highly dispersed. Drawing on Hayek and the Bloomington School, this paper argues that the experience of Canada's fisheries sector in the generation after 1868 illustrates the problems with centralized management Common-Pool Resources. In the 1890s, the centralized approach represented by the Fisheries Act of 1868 was replaced by a more flexible and decentralized system Hayek's theory of knowledge would suggest the reversal of centralization over environmental policy in the 1890s was a positive development that helped Canadians to reconcile the goals of economic development and the protection of the environment. The Hayekian paradigm suggests that control over environmental policy should be devolved downwards to the levels of government closest to resource users.     

How Significant Is Sub‐Saharan Africa's Demographic Dividend for Its Future Growth and Poverty Reduction?

Sub‐Saharan Africa will be undergoing substantial demographic changes over the next 15 years with the rising working‐age share of its population. The opportunity of African countries to convert these changes into demographic dividends for growth and poverty reduction will depend on several factors. The outlook will likely be good if African countries can continue the gains already made under better institutions and policies, particularly those affecting the productivity of labor, such as educational outcomes. If African countries can continue to build on the hard‐won development gains, the demographic dividend could account for 11–15% of gross domestic product (GDP) volume growth by 2030, while accounting for 40–60 million fewer poor in 2030. The gains can become more substantial with better educational outcomes that allow African countries to catch up to other developing countries. If the skill share of Africa's labor supply doubles because of improvements in educational attainment, from 25 to about 50% between 2011 and 2030, then the demographic dividends can expand the regional economy additionally by 22% by 2030 relative to the base case and reduce poverty by an additional 51 million people.     

Risk sharing and transition costs in the reform of pension systems in Europe

Unfunded pay-as-you-go state pension schemes are financially unsustainable in Europe as elsewhere. Proponents of reform argue that, by switching to a fully funded scheme that takes advantage of the high return on assets such as equities, the solvency of the state scheme could be restored at little or no financial burden to current taxpayers. We show that this is mistaken for two reasons.
First, making the transition is itself costly. Unless this cost is substantially financed by debt, it will fall on current generations, who are therefore likely to oppose the reform. Second, potentially higher returns are accompanied by significantly higher risk, which we quantify. We explain how an insurance scheme could be designed to mitigate both risk and moral hazard.     

Why do forecasters disagree? Lessons from the term structure of cross-sectional dispersion

Key sources of disagreement among economic forecasters are identified by using data on cross-sectional dispersion in forecasters’ long- and short-run predictions of macroeconomic variables. Dispersion among forecasters is highest at long horizons where private information is of limited value and lower at short forecast horizons. Moreover, differences in views persist through time. Such differences in opinion cannot be explained by differences in information sets; our results indicate they stem from heterogeneity in priors or models. Differences in opinion move countercyclically, with heterogeneity being strongest during recessions where forecasters appear to place greater weight on their prior beliefs.     

Profiting from innovations: the role of new game strategies in the case of Lipitor of the US pharmaceutical industry

In exploring why innovators often do not profit from their innovations, researchers concentrate on innovators versus imitators and the extent to which owners of complementary assets capture profits from innovations. The literature provides scant attention to factors that sap profits from innovations. This paper argues that an innovator's positioning vis‐à‐vis customers, suppliers, complementors, and other co‐opetitors plays a critical role in the innovator's profitability. The article explores how an innovator can use new game strategies to better positioning, thus capturing rents from innovations and enabling further innovations in the future. The study examines the case of Lipitor, one of the world's best‐selling drug, to illustrate how positioning can play in a firm's ability to profit from its innovations.     

Ad valorem versus unit taxes: monopolistic competition, heterogeneous firms, and intra-industry reallocations

Real-world industries are composed from heterogeneous firms and substantial intra-industry reallocations take place, i.e. high productivity firms squeeze out low productivity firms. Previous tax-tool comparisons have not included these central forces of industry structure. This paper examines a general equilibrium monopolistic competition model with heterogeneous firms and intra-industry reallocations. We show that the welfare superiority of ad valorem over unit taxes under imperfect competition is not only preserved but amplified. The additional difference between the tools arises because unit taxes distort relative prices, which in turn reduces average industry productivity through reallocations (the survival and increased market share of lower productivity firms). Importantly, numerical solutions of the model reveal that the relative welfare loss from using the unit tax increases dramatically in the degree of firm heterogeneity.