Working Paper Abstracts – 1983
In this paper it is shown that an exhaustible resource owner’s supply response to the offer of an indexed bond depends on the correlation between the relative price of the resource and the price to which the bond contract is indexed. The indexed bond encourages current extraction only if this correlation is weak; a strong (positive or negative) correlation implies that the availability of the indexed bond discourages current production. This result is then explained in terms of two distinct and sometimes competing insurance effects generated by the indexed bond offer.
Previous estimates of a “size effect” based on daily returns data are biased. Arithmetic averaging of daily returns implies a strategy of daily-rebalancing, but deviations of quoted closing prices from the prices at which rebalancing would actually occur impart an upward bias to computed returns. Returns computed for buy-and-hold portfolios largely avoid the bias induced by closing prices. Based on a buy-and-hold portfolio strategy, the full-year size effect is half as large as previously reported, and all of the size effect is due to the month of January.
The Theil-Barbosa framework of “rational random behavior” in the theory of consumer demand involves a decision-maker who minimizes the sum of a loss functional u and the cost of information c(I). The definition of information I is that used in the information theory literature associated with Shannon, Wiener, Kullback, and Leibler. The present paper shows such a framework is appropriate for modelling the behavior of traders in speculative markets who announce bid-ask prices at which they are willing to trade. Traders will announce prices which will be drawn from a probability distribution, the selection of which is a function of the loss functional u and the cost of information. The lognormal distribution is derived as a special case. It is shown that the variance of such distributions depends on the marginal cost of information, but that the kurtosis depends on the shape of the loss functional. When the loss functional is less convex than a quadratic, distributions will be leptokurtic.
This paper derives exact pricing equations for American and European puts and calls on foreign exchange and discusses hedging strategy. Because every call option on foreign currency is simultaneously a put option on the domestic currency, an equivalence relation exists that allows the immediate derivation of put equations from the corresponding call formulas. The call and put pricing formulas are unlike the Black-Scholes equations for stock options in that there are two relevant interest rates, interest rates are stochastic, and boundary constraints differ. In addition, both American call and put options have values larger than their European counterparts.
Previous estimates of a “size effect” based on daily returns data are biased. Several properties of quoted closing prices impart an upward bias to computed returns on individual stocks. Returns computed for buy-and-hold portfolios largely avoid the bias induced by closing prices. Based on such buy-and-hold returns, the full-year size effect is half as large as previously reported, and all of the full-year effect is, on average, due to the month of January.
This study examines empirically stock market seasonality in major industrialized countries. Evidence is provided that there are strong seasonalities in the stock market return distributions in most of the capital markets around the world. The seasonality, when it exists, appears to be caused by the disproportionately large January returns in most countries and April returns in the UK. With the exception of Australia, these months also coincide with the turn of the tax year.
Empirical tests are reported for Ross’ arbitrage pricing theory using monthly data for U.S. Treasury securities during the 1960-1979 period. We find that mean returns on bond portfolios are linearly related to at least two factor loadings. Multivariate test results, however, are not consistent with the APT. Our sample data in the U.S. Treasury securities market are also not consistent with either version of the CAPM. One-month-ahead forecasts of excess returns using factor-generating models are compared with corresponding naive predictions or predictions using the “market model” with various market portfolios.
In a sequential general equilibrium with a single representative risk–averse consumer, stationary uncertainty, a one-period lag between investment and production, and concave production functions, we show that the forward price of a one-period real default-free bond one period hence is less than the expected price of the bond, if markets are locally complete and utility is state-independent. Thus the real term structure premium is always positive. This result is consistent with the “Liquidity hypothesis.” However it is not based on any assumptions about the nature of risk or on time-dependent consumption preferences. The term structure is positive because long-term bonds turn out to be a poor wealth hedge, because of the way consumers allocate consumption and investment over time.
The results hold for real interest rates in complete markets, with whatever pattern of (possibly time-dependent) discount factors the consumer has. In incomplete markets the results will also hold, as long as the utility function exhibits either constant or increasing absolute risk aversion. The nominal term structure is also explored for a class of money demand specifications. The value and sign of the term structure premium critically depend on changes in the supply of money. Thus the nominal term structure premium may be negative even if the real term structure premium is positive.