Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies

In this article, we show how to analyze analytically the equilibrium policies and prices in an economy with a stochastic investment opportunity set and incomplete financial markets, when agents have power utility over both intermediate consumption and terminal wealth, and face portfolio constraints. The exact local comparative statics and approximate but analytical expression for the portfolio policy and asset prices are obtained by developing a method based on perturbation analysis to expand around the solution for an investor with log utility. We then use this method to study a general equilibrium exchange economy with multiple agents who differ in their degree of risk aversion and face borrowing constraints. We characterize explicitly the consumption and portfolio policies and also the properties of asset returns. We find that the volatility of stock returns increases with the cross-sectional dispersion of risk aversion, with the cross-sectional dispersion in portfolio holdings, and with the relaxation of the constraint on borrowing. Moreover, tightening the borrowing constraint lowers the risk-free interest rate and raises the equity premium in equilibrium.

Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility

Our objective is to identify the trading strategy that would allow an investor to take advantage of "excessive" stock price volatility and "sentiment" fluctuations. We construct a general-equilibrium model of sentiment. In it, there are two classes of agents and stock prices are excessively volatile because one class is overconfident about a public signal. As a result, this class of overconfident agents changes its expectations too often, sometimes being excessively optimistic, sometimes being excessively pessimistic. We determine and analyze the trading strategy of the rational investors who are not overconfident about the signal. We find that, because overconfident traders introduce an additional source of risk, rational investors are deterred by their presence and reduce the proportion of wealth invested into equity except when they are extremely optimistic about future growth. Moreover, their optimal portfolio strategy is based not just on a current price divergence but also on their expectation of future sentiment behavior and a prediction concerning the speed of convergence of prices. Thus, the portfolio strategy includes a protection in case there is a deviation from that prediction. We find that long maturity bonds are an essential accompaniment of equity investment, as they serve to hedge this "sentiment risk."

Efficient Intertemporal Allocations with Recursive Utility

In this article, our objective is to determine efficient allocations in economies with multiple agents having recursive utility functions. Our main result is to show that in a multiagent economy, the problem of determining efficient allocations can be characterized in terms of a single value function (that of a social planner), rather than multiple functions (one for each investor), as has been proposed thus far (Duffie, Geoffard and Skiadas (1994)). We then show how the single value function can be identified using the familiar technique of stochastic dynamic programming. We achieve these goals by first extending to a stochastic environment Geoffard's (1996) concept of variational utility and his result that variational utility is equivalent to recursive utility, and then using these results to characterize allocations in a multiagent setting.

What Can Rational Investors Do About Excessive Volatility and Sentiment Fluctuations?

Our objective is to understand the trading strategy that would allow an investor to take advantage of "excessive" stock price volatility and "sentiment" fluctuations. We construct a general equilibrium model of sentiment. In it, there are two classes of agents and stock prices are excessively volatile because one class is overconfident about a public signal. This class of irrational agents changes its expectations too often, sometimes being excessively optimistic, sometimes being excessively pessimistic. We find that because irrational traders introduce an additional source of risk, rational investors reduce the proportion of wealth invested into equity except when they are extremely optimistic about future growth. Moreover, their optimal portfolio strategy is based not just on a current price divergence but also on a prediction concerning the speed of convergence. Thus, the portfolio strategy includes a protection in case there is a deviation from that prediction. We find that long maturity bonds are an essential accompaniment of equity investment, as they serve to hedge this "sentiment risk." The answer to the question posed in the title is: "There is little that rational investors can do optimally to exploit, and hence, eliminate excessive volatility, except in the very long run."

Financial distress and the cross section of equity returns,”

Abstract In this paper, we provide a new perspective for understanding cross-sectional properties of equity returns. We explicitly introduce financial leverage in a simple equity valuation model and consider the likelihood of a firm defaulting on its debt obligations as well as potential deviations from the absolute priority rule (APR) upon the resolution of financial distress. We show that financial leverage amplifies the magnitude of the book-to-market effect and hence provide an explanation for the empirical evidence that value premia are larger among firms with a higher likelihood of financial distress. By further allowing for APR violations, our model generates two novel predictions about the cross section of equity returns: (i) the value premium (computed as the difference between expected returns on mature and growth firms), is humpshaped with respect to default probability, and (ii) firms with a higher likelihood of deviation from the APR upon financial distress generate stronger momentum profits. Both predictions are confirmed in our empirical tests. These results emphasize the unique role of financial distressand the nonlinear relationship between equity risk and firm characteristics-in understanding cross-sectional properties of equity returns. JEL Classification Codes: G12, G14, G3

Competence in Endoscopic Ultrasound and Endoscopic Retrograde Cholangiopancreatography, From Training Through Independent Practice.

BACKGROUND & AIMS: It is unclear whether participation in competency-based fellowship programs for endoscopic ultrasound (EUS) and endoscopic retrograde cholangiopancreatography (ERCP) results in high-quality care in independent practice. We measured quality indicator (QI) adherence during the first year of independent practice among physicians who completed endoscopic training with a systematic assessment of competence. METHODS: We performed a prospective multicenter cohort study of invited participants from 62 training programs. In phase 1, 24 advanced endoscopy trainees (AETs), from 20 programs, were assessed using a validated competence assessment tool. We used a comprehensive data collection and reporting system to create learning curves using cumulative sum analysis that were shared with AETs and trainers quarterly. In phase 2, participating AETs entered data into a database pertaining to every EUS and ERCP examination during their first year of independent practice, anchored by key QIs. RESULTS: By the end of training, most AETs had achieved overall technical competence (EUS 91.7%, ERCP 73.9%) and cognitive competence (EUS 91.7%, ERCP 94.1%). In phase 2 of the study, 22 AETs (91.6%) participated and completed a median of 136 EUS examinations per AET and 116 ERCP examinations per AET. Most AETs met the performance thresholds for QIs in EUS (including 94.4% diagnostic rate of adequate samples and 83.8% diagnostic yield of malignancy in pancreatic masses) and ERCP (94.9% overall cannulation rate). CONCLUSIONS: In this prospective multicenter study, we found that although competence cannot be confirmed for all AETs at the end of training, most meet QI thresholds for EUS and ERCP at the end of their first year of independent practice. This finding affirms the effectiveness of training programs. Clinicaltrials.gov ID NCT02509416

Competence in Endoscopic Ultrasound and Endoscopic Retrograde Cholangiopancreatography, From Training Through Independent Practice.

BACKGROUND & AIMS: It is unclear whether participation in competency-based fellowship programs for endoscopic ultrasound (EUS) and endoscopic retrograde cholangiopancreatography (ERCP) results in high-quality care in independent practice. We measured quality indicator (QI) adherence during the first year of independent practice among physicians who completed endoscopic training with a systematic assessment of competence. METHODS: We performed a prospective multicenter cohort study of invited participants from 62 training programs. In phase 1, 24 advanced endoscopy trainees (AETs), from 20 programs, were assessed using a validated competence assessment tool. We used a comprehensive data collection and reporting system to create learning curves using cumulative sum analysis that were shared with AETs and trainers quarterly. In phase 2, participating AETs entered data into a database pertaining to every EUS and ERCP examination during their first year of independent practice, anchored by key QIs. RESULTS: By the end of training, most AETs had achieved overall technical competence (EUS 91.7%, ERCP 73.9%) and cognitive competence (EUS 91.7%, ERCP 94.1%). In phase 2 of the study, 22 AETs (91.6%) participated and completed a median of 136 EUS examinations per AET and 116 ERCP examinations per AET. Most AETs met the performance thresholds for QIs in EUS (including 94.4% diagnostic rate of adequate samples and 83.8% diagnostic yield of malignancy in pancreatic masses) and ERCP (94.9% overall cannulation rate). CONCLUSIONS: In this prospective multicenter study, we found that although competence cannot be confirmed for all AETs at the end of training, most meet QI thresholds for EUS and ERCP at the end of their first year of independent practice. This finding affirms the effectiveness of training programs. Clinicaltrials.gov ID NCT02509416

A General Equilibrium Model of International Portfolio Choice.

The author investigates, in a two-country general equilibrium model, whether a bias in consumption towards domestic goods will necessarily lead to a preference for domestic securities. We develop a model where investors are constrained to consume only from their domestic capital stock and where it is costly to transfer capital across countries. In this model, investors less risk averse than an investor with log utility bias their portfolios towards domestic assets. Investors more risk averse than log, however, prefer foreign assets. Thus, this model suggests that it is unlikely that the portfolios observed empirically can be explained by the high proportion of domestic goods in total consumption. Copyright 1993 by American Finance Association.