VALUATION OF CONTINUOUSLY MONITORED DOUBLE BARRIER OPTIONS AND RELATED SECURITIES

In this paper, we apply Carr's randomization approximation and the operator form of the Wiener‐Hopf method to double barrier options in continuous time. Each step in the resulting backward induction algorithm is solved using a simple iterative procedure that reduces the problem of pricing options with two barriers to pricing a sequence of certain perpetual contingent claims with first‐touch single barrier features. This procedure admits a clear financial interpretation that can be formulated in the language of embedded options. Our approach results in a fast and accurate pricing method that can be used in a rather wide class of Lévy‐driven models including Variance Gamma processes, Normal Inverse Gaussian processes, KoBoL processes, CGMY model, and Kuznetsov's β ‐class. Our method can be applied to double barrier options with arbitrary bounded terminal payoff functions, which, in particular, allows us to price knock‐out double barrier put/call options as well as double‐no‐touch options.     

The role of taxes in corporate research and development spending

This study replicates prior research regarding research and development (R&D) spending by sampling R&D spending for a cross‐section of firms in non‐service related industries. Compustat data for 231 firms from 1992 to 1998 are used to test whether the US Federal tax credit for R&D meaningfully influenced R&D spending of the sampled firms. Firms' (1) effective rate of R&D tax credit, (2) rate of decay in R&D capital for firms' primary industry affiliation, (3) financial cost of capital, and (4) marginal tax rate are used to compute firms' user‐cost of capital for in‐house R&D. Results show that firms that were eligible for the tax credit spent more on R&D than non‐eligible firms as the user‐cost of in‐house R&D increased. These results add further evidence regarding the role of the tax credit in stimulating R&D activity and suggest that a tax credit for incremental research can be used to boost private‐sector R&D spending.     

American and European options in multi-factor jump-diffusion models,near expiry

We derive a general formula for the time decay θ for out-of-the-money European options on stocks and bonds at expiry, in terms of the density of jumps F(x,dy) and the payoff g ₊: −θ(x)=∫ g(x+y)₊ F(x,dy). Explicit formulas are derived for the standard put and call options, exchange options in stochastic volatility and local volatility models, and options on bonds in ATSMs. Using these formulas, we show that in the presence of jumps, the limit of the no-exercise region for the American option with the payoff (−g)₊ as time to expiry τ tends to 0 may be larger than in the pure Gaussian case. In particular, for many families of non-Gaussian processes used in empirical studies of financial markets, the early exercise boundary for the American put without dividends is separated from the strike price by a nonvanishing margin on the interval [0,T), where T is the maturity date.      

Dictators and oligarchs: A dynamic theory of contested property rights

In an economy with weak economic and political institutions, the major institutional choices are made strategically by oligarchs and dictators. The conventional wisdom presumes that as rent-seeking is harmful for oligarchs themselves, institutions such as property rights will emerge spontaneously. We explicitly model a dynamic game between the oligarchs and a dictator who can contain rent-seeking. The oligarchs choose either a weak dictator (who can be overthrown by an individual oligarch) or a strong dictator (who can only be replaced via a consensus of oligarchs). In equilibrium, no dictator can commit to both: (i) protecting the oligarchs' property rights from the other oligarchs and (ii) not expropriating oligarchs himself. We show that a weak dictator does not limit rent-seeking. A strong dictator does reduce rent-seeking but also expropriates individual oligarchs. We show that even though eliminating rent-seeking is Pareto optimal, weak dictators do get appointed in equilibrium and rent-seeking continues. This outcome is especially likely when economic environment is highly volatile.     

Probabilistic Population Projections for India with Explicit Consideration of the Education-Fertility Link

Among the different sources of uncertainty in population forecasting, uncertain changes in the structure of heterogeneous populations have received little attention so far, although they can have significant impacts. Here we focus on the effect of changes in the educational composition of the population on the overall fertility of the population in the presence of strong fertility differentials by education. With data from India we show that alternative paths of future female enrolment in education result in significantly different total fertility rates (TFR) for the country over the coming decades, even assuming identical fertility trends within each education group. These results from multi-state population projections by education are then translated into a fully probabilistic population projection for India in which the results of alternative education scenarios are assumed to expand the uncertainty range of the future TFR in the total population.
This first attempt to endogenize structural change with respect to education—which is the greatest measurable source of fertility heterogeneity in Asia—has resulted from a larger exercise of the Asian MetaCentre for Population and Sustainable Development Analysis to collect empirical information, scientific arguments as well as informed opinions about likely future population trends in Asia from a large number of population experts in the region. In this process, future changes in the educational composition of the population have been identified as a key driver of future fertility.
The actual probabilistic population projections for India show that with high certainty, the Indian population will continue to grow to about 1.3 billion over the next quarter of a century. After that the uncertainty will get much wider, ranging from a continued strong increase to the beginning of a population decline in India.     

Financial Recovery and Structural Changes in the Economy

How significant is the Soviet Union's financial crisis? Sergei Vasil'ev, of the Institute of Finance and Economics in Leningrad, argues that the financial crisis is the key to future developments in the Soviet economy and that heavy industry can be expected to suffer as the budget deficit is brought into balance.     

Individually rational, budget-balanced mechanisms and allocation of surplus

We investigate the issue of implementation via individually rational ex-post budget-balanced Bayesian mechanisms. We show that all decision rules generating a nonnegative expected social surplus are implementable via such mechanisms if and only if the probability distribution of the agents’ type profiles satisfies two conditions: the well-known condition of Crémer and McLean [1988. Full extraction of the surplus in Bayesian and dominant strategy auctions, Econometrica 56, 1247–1257] and the Identifiability condition introduced in this paper. We also show that these conditions are necessary for ex-post efficiency to be attainable with budget balance and individual rationality, and that the expected social surplus in these mechanisms can be distributed in any desirable way. Lastly, we demonstrate that, like Crémer–McLean condition, the Identifiability condition is generic if there are at least three agents.     

An ascending double auction

We show why the failure of the affiliation assumption prevents the double auction from achieving efficient outcomes when values are interdependent. This motivates the study of an ascending price version of the double auction. It is shown that when there is a sufficiently large, but still finite, number of sellers, this mechanism has an approximate perfect Bayesian equilibrium in which traders continue bidding if and only if their true estimates of the ‘value’ of the object being traded exceed the current price. This equilibrium is ex post efficient and has a rational expectations property in the sense that along the equilibrium path traders appear to have made the best possible trades conditional on information revealed by the trading process. We thank two anonymous referees and Dan Kovenock, the Editor, whose detailed comments and suggestions have allowed us to substantially improve the paper. We also thank seminar participants at University of Toronto, University of Wisconsin-Madison, Summer 2003 North American Meetings of the Econometric Society, 2004 NSF Decentralization Conference for their comments.     

City size and fund performance

The literature predicts that the average skill level and productivity are higher in larger cities. Prior studies use workers’ wage or education differentials to indirectly link city size and output. This article relates city size and productivity directly, using performance data of U.S. equity mutual funds. On average, funds in financial centers perform better than other funds in terms of both gross and risk-adjusted returns, but this difference is driven only by more experienced managers. Among funds in financial centers there is strong evidence of a positive relation between performance and manager experience in a given city, especially among New York funds. More importantly, we observe performance improvements of the same manager at the same fund in financial centers but not elsewhere. Our tests provide novel evidence of knowledge spillovers and learning in cities.