Search

We introduce the concept of risk entanglement in a preference-free setting to jointly explain the exchange rate volatility, cyclicality, and currency risk premia in the data. Risk entanglement specifies a subset of incomplete market models, in which nondiffusive or nonlog-normal shocks to exchange rates are not fully spanned by asset returns. When risks are entangled, there exist multiple pricing-consistent exchange rates, but none of them are equal to the ratio of the stochastic discount factors (SDFs) or their projections. Decoupling the exchange rate from the SDFs allows us to address key FX market patterns that are puzzling in international finance.

This paper proposes a new methodology for the assessment of quality and benchmarking of antiquarian bookshops. The methodology reflects current trends in this specific market, where, in particular, the most influential factor is the Internet, which changed the structure of this market from a locally oligopolistic structure closer to the perfect competition model. However, though the Internet allowed for the competition in prices, there are several further aspects determining the quality of a bookshop. In our AHP-based methodology, we combine both the traditional bookshop-specific criteria (such as opening hours) with those measuring the new features resulting from the public open-access database of all books in stock. We present a case study of antiquarian bookshops in Prague, Czech Republic. The case study illustrates not only the insight into the structure of this market, but also demonstrates that the methodology is useful in the management of bookshops, enabling a bookshop to determine its market position among competitors. The main findings support the hypothesis that quality web services are essential as the pricing policy, which distinguishes the market from its previous locally oligopolistic phase. We also confirm the results of the case study by a robustness analysis showing that the possible subjectivity of experts plays a minor role since we would need large changes in weights of criteria to alter the resulting ranking.

Crises and tail events have asymmetric effects across borders, raising the value of arrangements improving insurance of macroeconomic risk. Using a two-country DSGE model, we provide an analytical and quantitative analysis of the channels through which countries gain from sharing (tail) risk. Riskier countries gain in smoother consumption but lose in relative wealth and average consumption. Safer countries benefit from higher wealth and better average terms of trade. Calibrated using the empirical distribution of moments of GDP-growth across countries, the model suggests non-negligible quantitative effects. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation.

The green finance policy is an important embodiment of the basic national policy of environmental protection in the financial system, and also an important guarantee for company to achieve green development. Based on the heterogeneous interest pursuit of the central state, local provinces and industrial companies, the article builds an evolutionary model of three game partners, analyzes the strategic choice of the stakeholders in the implementation process of the green finance policies, and simulates the dynamical track of evolution stability strategies of three partners. The results show that the management from the central state is very important to the implementation of the policy, and the supervision cost and punishment will also affect the final stability strategy; the policy incentive from the central state can effectively promote the enthusiasm of the local provinces to implement the green finance policies, but the implementation cost will seriously affect the willingness of the local government to help industrial companies; under the joint supervision effect of the central state, the local government’s policy incentives and the complete market mechanism, industrial companies will enhance their willingness to participate in green finance policies.

This paper investigates the effect of model uncertainty on the performance of commodity-based portfolios. We consider a constant relative risk aversion (CRRA) utility maximizer investor in a complete market, with independent ambiguity-aversion levels for the three factors explaining the term structure of future prices, namely, spot prices, convenience yield (CY) and interest rates (IRs), as proposed in the seminal work of Schwartz (J Finance 52(3): 923–973, 1997). This generic investor is interested in the speculative component of the investment rather than possessing/consuming the physical commodity. We obtain closed-form solutions for optimal investments, optimal perturbations (alternative model) and value functions in line with the robust portfolio setting of Maenhout (Rev Financial Stud 17(4): 951–983, 2004). Our main focus is on the effect of convenience yield’s uncertainty on the optimal analysis. We estimate the model by applying a combination of maximum likelihood estimation (MLE) and Kalman Filter (KF) techniques, to two commodities: West Texas Intermediate (WTI) and copper future prices. The analysis demonstrates that uncertainty on the CY factor could be the largest contributor to the under-performance of a commodities portfolio, with wealth equivalent losses (WELs) in the ranges of 33% to 88% (WTI), and 7% to 31% (copper). Moreover, small variations, of up 25%, on CY’s covariance parameters could lead to a WEL of up to 40% (WTI, lesser volatility of CY).

We consider portfolio optimization under a preference model in a single-period, complete market. This preference model includes Yaari’s dual theory of choice and quantile maximization as special cases. We characterize when the optimal solution exists and derive the optimal solution in closed form when it exists. The optimal portfolio yields an in-the-money payoff when the market is good and zero payoff otherwise. Finally, we extend our portfolio optimization problem by imposing a dependence structure with a given benchmark payoff.

This paper investigates how continuous-time trading renders complete a financial market in which the underlying risk process is a Brownian motion. A sufficient condition, that the instantaneous dispersion matrix of the relative dividends is non-degenerate, has been established in the literature for single-commodity, pure-exchange economies with many heterogenous agents where the securities’ dividends as well as the agents’ utilities and endowments include flows during the trading horizon which are analytic functions. In sharp contrast, the present analysis is based upon a different mathematical argument that assumes neither analyticity nor a particular underlying economic environment. The novelty of our approach lies in deriving closed-form expressions for the dispersion coefficients of the securities’ prices. To this end, we assume only that the pricing kernels and dividends satisfy standard growth and smoothness restrictions (mild enough to allow even for options). In this sense, our sufficiency conditions apply irrespectively of preferences, endowments or other structural elements (for instance, whether or not the budget constraints include only pure exchange).

Purpose This paper aims to investigate possibility of statistical detection of market completeness for continuous time diffusion stock market models. Design/methodology/approach The paper uses theory of forecasting to find criteria of predictability of market parameters such as volatilities and the appreciation rates. Findings It is known that the market completeness is not a robust property: small random deviations of the coefficients convert a complete market model into an incomplete one. The paper shows that market incompleteness is also non-robust: for any incomplete market from a wide class of models, there exists a complete market model with arbitrarily close paths of the stock prices and the market parameters. Originality/value The paper results lead to a counterintuitive conclusion that the incomplete markets are indistinguishable in the terms of the market statistics.

In this paper, we study optimal investment, consumption and portfolio choice in a framework where the pension planner member (PPM) embarks on an investment policy to cover up for some certain life targets. The aim of the pension plan manager is to maximize the expectation of total wealth at the time of retirement. The investment return process comprises of risk free asset and two risky assets, and the PPM benefit lies in a complete market that is constrained by the inflation rate. Explicit solutions for constant absolute risk aversion utility functions are obtained and optimal strategies are derived by applying by dynamic programming on the Hamilton-Jacobi-Bellman (HJB) equations. Our numerical results show various effects of some economic parameters on the optimal strategies. The inflation price market risk governs the amount invested in both stock and bond, at the same time varying the premium ratio (η), causes effects on the investment returns. We also investigated the effects of the correlation coefficient (ρ) when set high on consumption rate and income rate. Finally a sensitivity analysis is graphically presented.

The problem of expected utility maximization with stochastic dominance constraints in complete markets is studied. In the quantile formulation, i.e., changing the decision variable of the problem f...

This study proposes a possible explanation for demand for derivatives that have kinks, such as plain vanilla options, using a market equilibrium model. In our setting, there is one risky asset and one ambiguous additive background risk, and a complete market exists for the risky asset. Under this environment, the optimal payoff function for an ambiguity-averse investor who has an exponential utility function exhibits kinks.

We investigate competitive equilibria in a special type of incomplete markets, referred to as a comonotone market, where agents can only trade such that their risk allocation is comonotonic. The comonotone market is motivated by the no-sabotage condition. For instance, in a standard insurance market, the allocation of risk among the insured, the insurer and the reinsurers is assumed to be comonotonic a priori to the risk-exchange. Two popular classes of preferences in risk management and behavioral economics, dual utilities (DU) and rank-dependent expected utilities (RDU), are used to formulate agents’ objectives. We present various results on properties and characterization of competitive equilibria in this framework, and in particular their relation to complete markets. For DU-comonotone markets, we find the equilibrium in closed form and for RDU-comonotone markets, we find the equilibrium in closed form in special cases. The fundamental theorems of welfare economics are established in both the DU and RDU markets. We further propose an algorithm to numerically obtain competitive equilibria based on discretization, which works for both the DU-comonotone market and the RDU-comonotone market. Although the comonotone and complete markets are closely related, many of our findings are intriguing and in sharp contrast to results in the literature on complete markets in terms of existence, uniqueness, and closed-form solutions of the equilibria, and comonotonicity of the pricing kernel.

In this paper, we study optimal retirement in a two-dimensional incomplete market caused by borrowing constraints and forced unemployment risk. We show that the two aspects jointly affect an individual’s optimal consumption, investment, and retirement strategies. In contrast to the complete market case, the endogenously determined wealth threshold for retirement is significantly affected by the two-dimensional market incompleteness, resulting in a lower wealth threshold. We also discuss a possible unemployment insurance scheme for the borrowing-constrained individual to respond to the shocks of forced unemployment.

Utility-indifference approach is a useful approach to be adopted for pricing financial derivatives in an incomplete market and is an ongoing hot research topic in quantitative finance. One interesting question associated with this approach is whether or not it renders to the same option prices, degenerately, when the market becomes infinitesimally close to a complete market. The answer for such a question has been provided for European-style options as there is a well-documented theoretical proof in Davis et al. (1993). However, a theoretical proof for the case of pricing American-style options is unavailable at this stage and the answer for this question must be at least numerically confirmed before it can be comfortably used to price American-style options in incomplete markets. The contribution of this paper is to provide such a numerical verification.

In production economies with incomplete markets, shareholders disagree about the objective of the firm. We show that a weak financial intermediary, who is unable to complete markets, can offer just enough spanning to resolve this disagreement. The intermediary is limited to offering one customized contract per consumer. Knowledge of demand functions is sufficient for offering the right contracts. Once agreement among shareholders is reached, productive efficiency is restored, which in turn permits a Pareto efficient market outcome. This result shows that the first welfare theorem does not depend on complete spanning, but merely on institutions that provide the right span. However, this cannot be said about the second welfare theorem: For some wealth distributions, equilibria with transfers fail to exist due to nonconvexities caused by market incompleteness.