Volatility of the short rate in the rational lognormal model

A recent article of Flesaker and Hughston introduces a one factor interest rate model called the rational lognormal model. This model has a lot to recommend it including guaranteed finite positive interest rates and analytic tractability. Consequently, it has received a lot of attention among practioners and academics alike. However, it turns out to have the undesirable feature of predicting that the asymptotic value of the short rate volatility is zero. This theoretical result is proved rigorously in this article. The outcome of an empirical study complementing the theoretical result is discussed at the end of the article. European call options are valued with the rational lognormal model and a comparably calibrated mean reverting Gaussian model. unsurprisingly, rational lognormal option values are considerably lower than the analogous mean reverting Gaussian option values. In other words, the volatility in the rational lognormal model declines so quickly that options are severely undervalued.     

Mergers and acquisitions as a response to the deregulation of the electric power industry: value creation or value destruction?

Many electric utilities, as a response to the deregulation of the electric power industry, adopted a strategy of acquiring other electric or gas utilities. We examine whether these merger and acquisition strategies create value for the utility shareholders and whether the strategies result in superior post-merger operating and stock-price performance relative to utilities that did not grow through acquisitions. We find little evidence that the mergers and acquisitions created long-term value for a fully diversified investor. Furthermore, the stock price and operating performance of the acquirers under performed the stock price and operating performance of a control portfolio of utilities that did not engage in merger activity.      

Petrophysical characterization and natural fracturing in an olivine-dolerite aquifer

As part of a study investigating the naturally-occurring fractures in mafic rocks, two holes were drilled 450 m apart through the Palisades dolerite sill in New York. Well-2 is 229 m deep and Well-3 was drilled to 305 m, both penetrating through the sill and into the underlying Triassic sediments of the Newark Basin. Both holes were logged with downhole geophysical tools, including the BHTV, which acoustically images fractures intersecting the well. Understanding the fracture pattern, density, and porosity in the sill is essential for identifying possible zones of active fluid flow and high permeability. Using the BHTV logs, 96 and 203 fractures were digitally mapped within the sill in Well-2 and Well-3, respectively. Most fractures appear to dip steeply (76-78°). There is a shift in fracture orientation, however, and these fractures may or may not be continuous over the short lateral distance between Well-2 and Well-3. The lithology of the sill as identified by drill chips is nevertheless continuous between the holes. Both intersect a 7 m thick olivine-rich layer about 15 m above the bottom of the sill. Several fractures identified in Well-2 have large apparent aperture (>6cm) which correspond to high porosity zones (6-14%) observed in the logs. Resistivity logs were used to compute porosity using Archie's law and match well with the neutron porosity log in Well-2. We use the relationship between porosity and fracture aperture within the sill at Well-2 to infer the porosity in Well-3. High-porosity, large-aperture zones, including the target olivine layer, are identified in both holes. Changes in the temperature gradient log indicate active fluid flow in the sill, although flow appears to be most active in the sediments. Direct field measurements of bulk permeability, hydrologic modeling of fluid flow and calibration of fracture and log porosity will be undertaken in the future.     

Temperance and economic assumptions

The preceding arguments illustrate the inability to adeguately account for the notion of temperance through mainstream contemporary economics. They also bring to light additional anomalies concerning other intangible virtues, e.g., truth, beauty, and knowledge. However, the problems associated with discounting such concepts do not negate the importance of material concerns. Just as people must crawl before they walk, so must they be able to eat before they can think. Before human beings attempt to exercise virtuous qualities in their daily lives, they must first satisfy some level of the basic needs for survival. Without realizing this necessary condition, the search for virtues, particularly temperance, is meaningless.     

Competitive auctions

We study a class of single-round, sealed-bid auctions for an item in unlimited supply, such as a digital good. We introduce the notion of competitive auctions. A competitive auction is truthful (i.e. encourages bidders to bid their true valuations) and on all inputs yields profit that is within a constant factor of the profit of the optimal single sale price. We justify the use of optimal single price profit as a benchmark for evaluating a competitive auctions profit. We exhibit several randomized competitive auctions and show that there is no symmetric deterministic competitive auction. Our results extend to bounded supply markets, for which we also give competitive auctions.     

The Impact of the European Union Insurance Directives on Insurance Company Stocks

This article examines the impact of the passage of the Second and Third Life and Non‐Life European Insurance Directives on insurance firms located in 14 European Union countries, Norway, and Switzerland. The third directives have a wealth effect on the European insurance market, while the second directives do not. The Third Life Directive resulted in a wealth increase for the European insurance market, while the Third Non‐Life Directive had a modest negative wealth effect. The wealth effects differ at both the country and firm level. The directives have differential impacts on firms depending on the firms’ characteristics and those of the market they operated in prior to the directives. Regression results indicate that the second directives have impacted firms in protected markets negatively, especially those with higher debt and higher returns on assets. At the time of the third directives, insurance firms benefited, even those in previously protected markets, indicating that firms may have positioned themselves in preparation for the liberalization of the laws.