Arbitrage With Holding Costs: A Utility-Based Approach

Unit time costs, or holding costs, are incurred in many arbitrage contexts. Examples include losing the use of short sale proceeds and lending funds at below market rates in reverse repurchase agreements. This paper analyzes the investment problem of a risk averse arbitrageur who faces holding costs. The model allows prices to deviate from “fundamental” values without allowing for riskless arbitrage opportunities. After characterizing an arbitrageur's optimal strategy, the model is examined in the context of the Treasury market. The analysis reveals that holding costs are an important friction in this market and that they can significantly affect arbitrageur behavior.     

The Effects of Wealth and Income on Subjective Well‐Being and Ill‐Being*

The accepted view among psychologists and, increasingly, economists is that household income has statistically significant but only small effects on measures of subjective well‐being. Income, however, is clearly an imperfect measure of the economic circumstances of households. Using data drawn from the 2002 wave of the Household, Income and Labour Dynamics in Australia (HILDA) Survey, this paper demonstrates that wealth, which can be viewed as providing a degree of economic security, is at least as important to well‐being and ill‐being as income.     

Estimating the Correlation Structure of International Share Prices

Recently, the case for international portfolio diversification has been convincingly argued in the framework of mean-variance portfolio analysis by a number of researchers. However, virtually no empirical documentation exists concerning the best method for estimating the correlation structure of international share prices. In this paper, 12 models for estimating the international correlation matrix are presented and empirically tested relative to full historical extrapolation. The major evaluation criteria are the mean squared error and stochastic dominance based on the frequency distribution of the squared forecast errors. The results indicate that the National Mean Model strictly dominates all the others in terms of forecasting accuracy.     

Orthogonal Frontiers and Alternative Mean-Variance Efficiency Tests

This paper catalogues properties of minimum norm orthogonal portfolios: portfolios which minimize a quadratic objective function and have returns uncorrelated with those of a candidate portfolio that is not mean-variance efficient. The analysis shows that the dollar versions of these portfolios correspond to estimators of zero beta rates based on alternative statistical criteria and grouping procedures while costless orthogonal portfolios represent candidate mean-variance efficiency tests. It also develops inference procedures for zero and unit net investment portfolios of individual securities (instead of grouped portfolios) that have zero expected betas. The resulting mean-variance efficiency tests are reasonably insensitive to the underlying statistical assumptions.     

SEQUESTERING CARBON ON AGRICULTURAL LAND: SOCIAL COST AND IMPACTS ON TIMBER MARKETS

Planting trees to sequester carbon has broad political appeal. However, effects of a major tree planting program on the agricultural sector and on timber markets are unclear. This paper examines social costs of sequestering carbon in tree plantations on U.S. agricultural land and investigates harvesting's effects on timber prices and on private timber producers' welfare. The analysis links a model of the U.S. agricultural sector that includes the land base in major production areas with a model of the U.S. softwood economy. Using current data on planting, maintenance, and harvesting costs for tree plantations and carbon sequestration rates, the models estimate the price and welfare effects of alternative carbon sequestration goals. Results indicate a range of outcomes. Consumers pay higher prices for food as farmers divert land from crops to trees. However, wood products consumers gain from falling timber prices if the trees enter commercial markets. Agricultural producers and landowners gain from higher commodity prices, but private forest owners lose. Large tree planting programs imply that policymakers must compensate private commercial tree planting to prevent farmers from displacing present tree plantations.     

An Empirical Analysis of Australian Strike Activity: Estimating the Industrial Relations Effect of the First Three Years of the Prices and Incomes Accord*

Australian strike activity war relatively low in the 1983(2)-1986(1) period. Some part of this experience is attributable to changes in the macroeconomic environment and some is a consequence of improvements in industrial relations. This paper attempts to determine the role of each by estimating econometric models for the 1959(3)-1983(1) period and forecasting indicators of strike activity over the subsequent three years. We find that working days lost per unionist decreased because of macroeconomic conditions, but that these variables explain less than half of the actual decline. This suggests that, for the initial three-year period of its institution, the Accord helped deliver a favorable industrial relations environment, a situation that is not necessarily long-lasting. More generally, the results show strike activity to be pro-cyclical and influenced by profits and inflation.     

Borrower Risk under Alternative Mortgage Instruments

This paper analyzes differences in borrower risk under alternative mortgage instruments and various borrower characteristics. The traditional approach of measuring borrower risk in terms of actual delinquency and foreclosure data is rejected in favor of a model based on potential delinquency-that is, changes in the mortgage payment to income ratio. The combinations of mortgage terms and borrower characteristics that are most likely to produce a potential delinquency are isolated based on the calculation of hypothetical payment to income ratios over an eight year period.