The relevance of primary dealers for public bond issues

We analyze the role of different kinds of primary and secondary market interventions for the government's goal to maximize its revenues from public bond issuances. Some of these interventions can be thought of as characteristics of a "primary dealer system". After all, we see that a primary dealer system with a restricted number of participants may be useful in case of only restricted competition among sufficiently heterogeneous market makers. We further show that minimum secondary market turnover requirements for primary dealers with respect to bond sales seem to be in general more adequate than the definition of maximum bid-ask-spreads or minimum turnover requirements with respect to bond purchases. Moreover, official price management operations are not able to completely substitute for a system of primary dealers. Finally it should be noted that there is in general no reason for monetary compensations to primary dealers since they already possess some privileges with respect to public bond auction

Portfolio selection with growth optimization and downside protection

This paper applies growth optimization with downside protection as a portfolio selection technique. The model is based on power-log utility functions that combine portfolio growth maximization with the behavioural tenets of prospect theory. We use three assets (a farm return index, a stock market index, and a Treasury bond index) to illustrate how effective this technique is compared to the standard model of growth maximization.portfolio management, growth optimization, Financial Economics, D92,

Continuous-Time Markowitz's Model with Transaction Costs

A continuous-time Markowitz's mean-variance portfolio selection problem is studied in a market with one stock, one bond, and proportional transaction costs. This is a singular stochastic control problem,inherently in a finite time horizon. With a series of transformations, the problem is turned into a so-called double obstacle problem, a well studied problem in physics and partial differential equation literature, featuring two time-varying free boundaries. The two boundaries, which define the buy, sell, and no-trade regions, are proved to be smooth in time. This in turn characterizes the optimal strategy, via a Skorokhod problem, as one that tries to keep a certain adjusted bond-stock position within the no-trade region. Several features of the optimal strategy are revealed that are remarkably different from its no-transaction-cost counterpart. It is shown that there exists a critical length in time, which is dependent on the stock excess return as well as the transaction fees but independent of the investment target and the stock volatility, so that an expected terminal return may not be achievable if the planning horizon is shorter than that critical length (while in the absence of transaction costs any expected return can be reached in an arbitrary period of time). It is further demonstrated that anyone following the optimal strategy should not buy the stock beyond the point when the time to maturity is shorter than the aforementioned critical length. Moreover, the investor would be less likely to buy the stock and more likely to sell the stock when the maturity date is getting closer. These features, while consistent with the widely accepted investment wisdom, suggest that the planning horizon is an integral part of the investment opportunities.Comment: 30 pages, 1 figur

Finite Horizon Portfolio Selection

We study the problem of maximising expected utility of terminal wealth over a nite horizon, with one risky and one riskless asset available, and with trades in the risky asset subject to proportional transaction costs. In a discrete time setting, using a utility function with hyperbolic risk aversion, we prove that the optimal trading strategy is characterised by a function of time (t), which represents the ratio of wealth held in the risky asset to that held in the riskless asset. There is a time varying no transaction region with boundaries b(t) < s(t), such that the portfo- lio is only rebalanced when (t) is outside this region. The results are consistent with similar studies of the in nite horizon problem with in- termediate consumption, where the no transaction region has a similar, but time independent, characterisation. We solve the problem numerically and compute the boundaries of the no transaction region for typical model parameters. We show how the results can be used to implement option pricing models with transaction costs based on utility maximisation over a nite horizo

“Stock PIKs”- Taking a firm by its tails

Payment-in-kind bonds (PIKs) make interest payments in the form of an issue of additional bonds rather than cash. This research provides a rationale for the recent PIK issuance by firms with low credit ratings. PIKs offer a financially constrained firm in need of restructuring both an immediate automatic stay and a prepackaged bankruptcy procedure, features that make PIKs better than alternative debt instruments. In many instances PIKs are structured to facilitate a contingent transfer of control to PIK holders, and provide an avenue of obtaining equity in the firm whether the firm value is high or low in the future. The barbell strategy of acquisition that involves a deal with the equity holders (if the firm prospects improve), and a deal with the debt holders (if the firm defaults) dominates the cost of acquisition before the firm defaults, or after the firm goes bankrupt.Monetary Policy, Stock Market, Economic Development

Equilibrium Corporate Finance

We study a general equilibrium model with production where financial markets are incomplete. At a competitive equilibrium firms take their production and financial decisions so as to maximize their value. We show that shareholders unanimously support value maximization. Furthermore, competitive equilibria are constrained Pareto efficient. Finally the Modigliani-Miller theorem typically does not hold and the firms’ corporate financing structure is determined at equilibrium. Such results extend to the case where informational asymmetries are present and contribute to determine the firms’ capital structure.capital structure, competitive equilibria, incomplete markets, asymmetric information

Optimal consumption and investment with bounded downside risk measures for logarithmic utility functions

We investigate optimal consumption problems for a Black-Scholes market under uniform restrictions on Value-at-Risk and Expected Shortfall for logarithmic utility functions. We find the solutions in terms of a dynamic strategy in explicit form, which can be compared and interpreted. This paper continues our previous work, where we solved similar problems for power utility functions

Contingent Claims Valuation of Corporate Liabilities: Theory and Empirical Tests

Although the Contingent Claims Analysis model has become the premier theory of how value is allocated among claimants on firms,its empirical validity remains an open question. In addition to being of academic interest, a test of the model would have significant practical implications. If it can be established that the model predicts actual market prices, then the model can be used to price new and untraded claims, to infer firm values from prices of traded claims like equity and to price covenants separately. In this paper evidence is presented on how well a model which makes the usual assumptions in the literature does in predicting market prices for claims in standard capital structures. The results suggest that the usual assumption list requires modification before it can serve as a basis for valuing corporate claims.