On the equivalence of the static and dynamic asset allocation problems

A classic dynamic asset allocation problem optimizes the expected final-time utility of wealth, for an individual who can invest in a risky stock and a risk-free bond, trading continuously in time. Recently, several authors considered the corresponding static asset allocation problem in which the individual cannot trade but can invest in options as well as the underlying. The optimal static strategy can never do better than the optimal dynamic one. Surprisingly, however, for some market models the two approaches are equivalent. When this happens the static strategy is clearly preferable, since it avoids any impact of market frictions. This paper examines the question: when, exactly, are the static and dynamic approaches equivalent? We give an easily tested necessary and sufficient condition, and many non-trivial examples. Our analysis assumes that the stock follows a scalar diffusion process, and uses the completeness of the resulting market model. A simple special case is when the drift and volatility depend only on time; then the two approaches are equivalent precisely if (μ (t)? r)/σ²(t) is constant. This is not the Sharpe ratio or the market price of risk, but rather a nondimensional ratio of excess return to squared volatility that arises naturally in portfolio optimization problems.     

International evidence on misspecification of the standard money demand equation

This paper tests the proposition that the interest rate in the standard money demand equation acts as a proxy for the expected change in interest rates. If this is true, the interest elasticity in the standard equation will depend on the expectations process for interest rates. Using cross-country data, we find that there does exist a relationship between the observed interest elasticity in the standard equation and the predictability of future interest rates from current interest rates.     

Local and global identification and strong consistency in time series models

We define local and global identification with respect to a sequence of criterion functions and show how global identification is related to a proof of strong consistency. We also show that local identification of the parameters is needed to ensure that common estimation procedures are well defined. We illustrate the results by an application to the simultaneous ARMAX model. Finally, we motivate and generalize a local identification result for dynamic, simultaneous equations models given by Hatanaka (1976).     

The aftermath of reunification

This article traces the evolution of the East German wage structure throughout the transition period 1992–2001. Wage dispersion has generally been rising. This increase occurred predominantly in the lower part of the wage distribution for women and in the upper part for men. Moreover, the sectoral transition affected female workers to a much larger extent than their male counterparts. A sequential decomposition analysis using quantile regressions reveals that changes in industry‐specific remuneration schemes contributed strongly to the rise in wage inequality in the lower part of the distribution for women, whereas changes in the industry composition alone would have led to a polarization of wages. In contrast, for men, changes in individual characteristics are the single most important factor contributing to the increasing wage dispersion. These gender differences are attributed to employment segregation across industries present right after German reunification.     

On Professor Kohn and Expected Utility: Correction and Clarification-Rejoinder

Professor Horowitz correctly identifies the limitation of my assuming separable utility functions to derive a marginal condition for efficiency under uncertainty. Correction this limitation, he provides a simple but powerful condition that encompasses the nonseparable as well as the separable case. This condition replaces the dubious Equation (14) derived in Kohn (1999). In a departure from von Neumann-Morgenstern theory, for cases in which the decisions of a risk-averse community are compared with those it would make were it risk-neutral, it is proposed here that the same utility function holds for risk-neutrality as for risk-aversion, but that the stochastic quantities be replaced by their expected value in the former. [Q25]     

Generalized smooth finite mixtures

We propose a general class of models and a unified Bayesian inference methodology for flexibly estimating the density of a response variable conditional on a possibly high-dimensional set of covariates. Our model is a finite mixture of component models with covariate-dependent mixing weights. The component densities can belong to any parametric family, with each model parameter being a deterministic function of covariates through a link function. Our MCMC methodology allows for Bayesian variable selection among the covariates in the mixture components and in the mixing weights. The model’s parameterization and variable selection prior are chosen to prevent overfitting. We use simulated and real data sets to illustrate the methodology.     

The exchange paradigm: Where to now?

This essay restates the main conclusions of “Value and Exchange,” discusses three possible directions of research that flow from it, and evaluates their likely impact on the economics profession. The three directions are (1) the application of the distinction between value paradigm and exchange paradigm to the elucidation of the history of economic thought, (2) formal theorizing within the framework of the exchange paradigm, and (3) empirical work informed by the insights of the exchange paradigm.      

Avoidance Costs and the Entry-exit Condition on Polluting Firms

When marginal environmental damages increase with emissions, it is said to be a problem for entry and exit that the marginal firm pays more in Pigouvian taxes than the actual damages it causes. Accordingly it is sometimes assumed that over the range of an individual firm's emissions, marginal environmental damages are approximately constant. When avoidance costs are added to environmental damages, however, the inequality may be reversed so that the assumption of constant marginal damages may aggravate rather than eliminate the alleged problem.