Systems GMM estimates of the Feldstein–Horioka puzzle for the OECD countries and tests for structural breaks

A systems GMM estimation method is used to estimate the Feldstein–Horioka equation from 1960 to 2007 with a panel of 13 OECD countries. It is found that the Feldstein–Horioka puzzle exists in a weaker form with a much reduced saving retention coefficient. The Bretton Woods agreement in particular seems to have weakened the Feldstein–Horioka puzzle by significantly improving international capital mobility. In comparison the Maastricht agreement seems to have improved capital mobility only by a small magnitude. The Blundell and Bond systems GMM method and structural break tests of Mancini-Griffoli and Pauwels are used in this paper.     

An approximate distribution of delta-hedging errors in a jump-diffusion model with discrete trading and transaction costs

We introduce a jump-diffusion model for asset returns with jumps drawn from a mixture of normal distributions and show that this model adequately fits the historical data of the S&P500 index. We consider a delta-hedging strategy (DHS) for vanilla options under the diffusion model (DM) and the proposed jump-diffusion model (JDM), assuming discrete trading intervals and transaction costs, and derive an approximation for the probability density function (PDF) of the profit-and-loss (P&L) of the DHS under both models. We find that, under the log-normal model of Black–Scholes–Merton, the actual PDF of the P&L can be well approximated by the chi-squared distribution with specific parameters. We derive an approximation for the P&L volatility in the DM and JDM. We show that, under both DM and JDM, the expected loss due to transaction costs is inversely proportional to the square root of the hedging frequency. We apply mean–variance analysis to find the optimal hedging frequency given the hedger's risk tolerance. Since under the JDM it is impossible to reduce the P&L volatility by increasing the hedging frequency, we consider an alternative hedging strategy, following which the P&L volatility can be reduced by increasing the hedging frequency.     

On improving the least squares Monte Carlo option valuation method

This paper studies various possible approaches to improving the least squares Monte Carlo option valuation method. We test different regression algorithms and suggest a variation to estimating the option continuation value, which can reduce the execution time of the algorithm by one third. We test the choice of varying polynomial families with different number of basis functions. We compare several variance reduction techniques, and find that using low discrepancy sequences can improve the accuracy up to four times. We also extend our analysis to compound and mutually exclusive options. For the latter, we propose an improved algorithm which is faster and more accurate.     

The Underinvestment and Overinvestment Hypotheses: an Analysis Using Panel Data

We study the relationship between firm value and investment to test the underinvestment and overinvestment hypotheses. The results obtained, using panel data methodology as the estimation method, indicate that the abovementioned relation is quadratic, which implies that there exists an optimal level of investment. As a consequence, firms that invest less than the optimal level suffer from an underinvestment problem, while those investing more than the optimum suffer from overinvestment. The quadratic relation is maintained when firms are classified depending on their investment opportunities, the optimum being in accordance with the quality of investment opportunities.     

Capital budgeting and delegation

As part of our ongoing research into capital budgeting processes as responses to decentralized information and incentive problems, we focus in this paper on when a level of a managerial hierarchy will delegate the allocation of capital across projects and time to the level below it. In our model, delegation is a way to save on costly investigation of proposed projects. Therefore, it is more extensive the larger are the costs of such investigations. This delegation takes advantage of the fact that the lower-level manager's preferences are assumed to be similar (though not identical) to those of the higher level.     

Instability in cointegration regressions: a brief review with an application to money demand in Portugal

This study addresses some modelling questions related to the possibility of structural change in models with nonstationary variables. Focusing on cointegration issues, some methodological aspects are discussed, attempting to integrate coherently the several steps of the modelling strategy. These range from unit root to cointegration testing and to testing for instability in the cointegration vector. An empirical example with Portuguese data tries to illustrate the usefulness of this approach, where a simple money demand function is estimated using an error-correction model (ECM). If a break is explicitly allowed in the cointegration vector the forecasting performance of the ECM improves.