The Substitutability of Equities and Consumer Durable Goods: A Portfolio-Choice Approach

Using the analytical approach made famous by Chetty [4] and quarterly data covering the period from 1963.4 through 1991.3, we estimate elasticities of substitution between common stocks and residential housing and between stocks and government bonds, Treasury bills, money, the sum of savings and time deposits, and corporatep aper.3W e also test whethert hese elasticities changed following the 1987 stock market crash. We find that there is virtually no substitutabilityb etween stocks and other financial assets. Moreover, we find no evidence that asset holders are willing to substitute between stocks and housing. This last finding contradicts Runkle\u27s suggestion that as stock returns decline, consumers may move into housing, or other durable goods. In fact, it appears that individuals consider equities to be a requirement in their portfolio, and are not willing to use other assets as substitutes. We also find that, with one exception, the stock market crash of 1987 did not have a significant impact on the substitutabilityb etween common stocks and the othera ssets. The only exception is that, following the crash, stocks and Treasury bills actually became complements

Elasticity theory of structuring

Financial derivatives have often been criticized as casino-style betting instruments. It turns out that many naive ways of making them are indeed equivalent to gambling. Fortunately, this inadvertent effect can be understood and prevented. We present a theory of product design which achieves that.Comment: 16 pages, 3 figure

Portfolio Choice for HARA Investors: When Does 1/γ (not) Work?

In the continuous time-Merton-model the instantaneous stock proportions are inversely proportional to the investorâs local relative risk aversion γ. This paper analyses the conditions under which a HARA-investor can use this 1/γ-rule to approximate her optimal portfolio in a finite time setting without material effects on the certainty equivalent of the portfolio payoff. The approximation is of high quality if approximate arbitrage opportunities do not exist and if the investorâs relative risk aversion is higher than that used for deriving the approximation portfolio. Otherwise, the approximation quality may be bad.HARA-utility, portfolio choice, certainty equivalent, approximated choice

Multivariate Utility Maximization with Proportional Transaction Costs.

We present an optimal investment theorem for a currency exchange model with random and possibly discontinuous proportional transaction costs. The investor’s preferences are represented by a multivariate utility function, allowing for simultaneous consumption of any prescribed selection of the currencies at a given terminal date. We prove the existence of an optimal portfolio process under the assumption of asymptotic satiability of the value function. Sufficient conditions for asymptotic satiability of the value function include reasonable asymptotic elasticity of the utility function, or a growth condition on its dual function. We show that the portfolio optimization problem can be reformulated in terms of maximization of a terminal liquidation utility function, and that both problems have a common optimizer.Duality Theory; Lagrange Duality; Multivariate Utility Function; Asymptotic Satiability; Optimal Portfolio; Transaction Costs; Foreign Exchange Market;

EXAMINING PRICE PATHS OF A PORTFOLIO OF AGRO-BIOTECHNOLOGY SEEDS: THE EFFECTS OF COMPETITION AND FARMERS' RESPONSE

Biotechnology techniques have played an important role in meeting farmer's needs in the seed industry given the changes in customer's preferences. This paper analytically evaluates the time paths of pricing a portfolio of seeds, which simultaneously encourages seed adoption and maximizes a firm's returns within a competitive environment while considering shorter product life cycles. Using a dynamic programming (DP) approach, the results indicate that the single pricing model and the portfolio pricing model are materially affected by the firm's initial market share, the farmer's attitude towards seed attributes, and the firm competitiveness within the industry. Farmer's acceptance of a seed variety will have an impact on seed price or actions from the seed firm even though farmers are theoretically and empirically considered as price takers in the input markets.Financial Economics, Research and Development/Tech Change/Emerging Technologies,

Market Power in Mixed Hydro-Thermal Electric Systems

This paper shows that, unlike what has been found in other papers, a hydro reservoir is an effective tool to exercise market power. Its appealing as a tool is enhanced by the fact that there is no need to constrain total hydro production - a practice too easy to detect -; it suffices to distort the intertemporal allocation of hydro production over time. A hydro-producer may increase his profits by exploiting differences in price elasticity of demand across periods, allocating too little supply to less elastic periods and too much to more elastic periods. Differences in price elasticity across periods may result from the combination of a fluctuating market demand and capacity or transmission constraints that bind intermitently. This hydro scheduling decision is only available to hydro producers as thermal generators are not able to "store electric power" and decide when to sell it. It is also shown that total hydro production is not a sufficient indicator of market power being exercised as hydro producers may exercise market power even when all the water available in the\reservoir is used. The real indicator of market power being exercised is the hydro scheduling strategy usedUtilities; Market Power; Scheduling of Hydro-Reservoirs.

A Monte Carlo method for exponential hedging of contingent claims

Utility based methods provide a very general theoretically consistent approach to pricing and hedging of securities in incomplete financial markets. Solving problems in the utility based framework typically involves dynamic programming, which in practise can be difficult to implement. This article presents a Monte Carlo approach to optimal portfolio problems for which the dynamic programming is based on the exponential utility function U(x)=-exp(-x). The algorithm, inspired by the Longstaff-Schwartz approach to pricing American options by Monte Carlo simulation, involves learning the optimal portfolio selection strategy on simulated Monte Carlo data. It shares with the LS framework intuitivity, simplicity and flexibility.Comment: 38 pages, 5 figure

ALM practices, multiple uncertainty and monopolistic behavior: A microeconomic study of banking decisions

We study the decisions that a monopolistic bank takes to achieve risk management and profit objectives. The bank faces liquidity and solvency risks because loans may not be repaid and because unexpected deposit withdrawals may occur. The Asset-Liability-Management (ALM) banking model shows that compromise solutions are necessary to deal with the tradeoffs between liquidity management and profitability. It also shows that asset management practices increase profits. Moreover it shows that liability management practices and market power support profitability. Finally, the model confirms that banks should undertake long-term risky investments when depositors trust the viability of the asset transformation process.Banking; ALM; multiple uncertainty; monopolistic behavior

A Model of Housing in the Presence of Adjustment Costs: A Structural Interpretation of Habit Persistence

The paper generalizes the Grossman and Laroque (1990) model of optimal consumption and portfolio allocation in the context in which a durable good (or house) subject to adjustment costs is both an argument of the utility function and a component of wealth. Because the Grossman and Laroque model abstracts completely from nondurable consumption, their analysis cannot address either a) the potential spillover effects of the adjustment costs of the durable good on the dynamics of nondurable consumption, or b) the implications for portfolio allocation of housing risk arising from variation in the relative price of housing. By introducing an endogenously determined but infrequently adjusted state variable, the housing model generates many of the implications of the habit persistence model, such as smooth nondurable consumption, state-dependent risk aversion, and a small elasticity of intertemporal substitution despite moderate risk aversion. Using a specification of the utility function which nests both the housing model and habit persistence, the Euler equation for nondurable consumption is estimated with household level data on food consumption and housing from the PSID. The habit persistence model (without housing effects) can be decisively rejected, while the housing model (without habit effects) is not rejected.