Covariance Risk, Mispricing, and the Cross Section of Security Returns

This paper offers a multisecurity model in which prices reflect both covariance risk and misperceptions of firms' prospects, and in which arbitrageurs trade to profit from mispricing. We derive a pricing relationship in which expected returns are linearly related to both risk and mispricing variables. The model thereby implies a multivariate relation between expected return, beta, and variables that proxy for mispricing of idiosyncratic components of value tends to be arbitraged away but systematic mispricing is not. The theory is consistent with several empirical findings regarding the cross-section of equity returns, including: the observed ability of fundamental/price ratios to forecast aggregate and cross-sectional returns, and of market value but not non-market size measures to forecast returns cross-sectionally; and the ability in some studies of fundamental/price ratios and market value to dominate traditional measures of security risk. The model also offers several untested empirical implications for the cross-section of expected returns and for the relation of volume to subsequent volatility.

Maximizing Welfare in Social Networks under a Utility Driven Influence Diffusion Model

Motivated by applications such as viral marketing, the problem of influence maximization (IM) has been extensively studied in the literature. The goal is to select a small number of users to adopt an item such that it results in a large cascade of adoptions by others. Existing works have three key limitations. (1) They do not account for economic considerations of a user in buying/adopting items. (2) Most studies on multiple items focus on competition, with complementary items receiving limited attention. (3) For the network owner, maximizing social welfare is important to ensure customer loyalty, which is not addressed in prior work in the IM literature. In this paper, we address all three limitations and propose a novel model called UIC that combines utility-driven item adoption with influence propagation over networks. Focusing on the mutually complementary setting, we formulate the problem of social welfare maximization in this novel setting. We show that while the objective function is neither submodular nor supermodular, surprisingly a simple greedy allocation algorithm achieves a factor of $(1-1/e-\epsilon)$ of the optimum expected social welfare. We develop \textsf{bundleGRD}, a scalable version of this approximation algorithm, and demonstrate, with comprehensive experiments on real and synthetic datasets, that it significantly outperforms all baselines.Comment: 33 page

Neo-Aristotelian Naturalism and the Evolutionary Objection: Rethinking the Relevance of Empirical Science

Neo-Aristotelian metaethical naturalism is a modern attempt at naturalizing ethics using ideas from Aristotle’s teleological metaphysics. Proponents of this view argue that moral virtue in human beings is an instance of natural goodness, a kind of goodness supposedly also found in the realm of non-human living things. Many critics question whether neo-Aristotelian naturalism is tenable in light of modern evolutionary biology. Two influential lines of objection have appealed to an evolutionary understanding of human nature and natural teleology to argue against this view. In this paper, I offer a reconstruction of these two seemingly different lines of objection as raising instances of the same dilemma, giving neo-Aristotelians a choice between contradicting our considered moral judgment and abandoning metaethical naturalism. I argue that resolving the dilemma requires showing a particular kind of continuity between the norms of moral virtue and norms that are necessary for understanding non-human living things. I also argue that in order to show such a continuity, neo-Aristotelians need to revise the relationship they adopt with empirical science and acknowledge that the latter is relevant to assessing their central commitments regarding living things. Finally, I argue that to move this debate forward, both neo-Aristotelians and their critics should pay attention to recent work on the concept of organism in evolutionary and developmental biology

Best-shot versus weakest-link in political lobbying: an application of group all-pay auction

We analyze a group political lobbying all-pay auction with a group specific public good prize, in which one group follows a weakest-link and the other group follows a best-shot impact function. We completely characterize all semi-symmetric equilibria. There are two types of equilibria: (1) each player in the best-shot group puts mass at the upper bound of the support, whereas each player in the other group puts mass at the lower bound of the support; (2) players in the best-shot group put masses at both the lower and the upper bounds, while the other group randomizes without a mass point. An earlier and longer version of this study was circulated under the title “The Group All-pay Auction with Heterogeneous Impact Functions.” We appreciate the comments of an Associate Editor and two anonymous referees, Kyung Hwan Baik, Walter Enders, Matt Van Essen, Paan Jindapon, David Malueg, Paul Pecorino, Seth Streitmatter, Ted Turocy, the participants at the 2015 conference of ‘Contest: Theory and Evidence’ at the University of East Anglia, and the seminar participants at the University of Alabama and Korea University. Iryna Topolyan gratefully acknowledges the support from the Charles Phelps Taft Research Center. Any remaining errors are our own

A kinetic equation for economic value estimation with irrationality and herding

A kinetic inhomogeneous Boltzmann-type equation is proposed to model the dynamics of the number of agents in a large market depending on the estimated value of an asset and the rationality of the agents. The interaction rules take into account the interplay of the agents with sources of public information, herding phenomena, and irrationality of the individuals. In the formal grazing collision limit, a nonlinear nonlocal Fokker-Planck equation with anisotropic (or incomplete) diffusion is derived. The existence of global-in-time weak solutions to the Fokker-Planck initial-boundary-value problem is proved. Numerical experiments for the Boltzmann equation highlight the importance of the reliability of public information in the formation of bubbles and crashes. The use of Bollinger bands in the simulations shows how herding may lead to strong trends with low volatility of the asset prices, but eventually also to abrupt corrections

Valuation of Government Policies and Projects

Governments play a central role in the allocation of capital and risk in the economy. Evaluating the cost to taxpayers of government investments requires an assumption about the government’s cost of capital. Governments often take their borrowing rate to be their cost of capital, which implicitly treats the market risk associated with their activities as having no cost to taxpayers. This article reviews the theoretical and practical rationale for treating market risk as a cost to governments, presents an interpretive review of the growing literature that applies the concepts and tools of modern finance to evaluating the costs of government policies and projects and suggests directions for future research. Examples considered include deposit insurance, Fannie Mae and Freddie Mac, the Federal Reserve’s emergency lending facilities, student loans, real infrastructure investments, and public pension plans

Analogy making and the structure of implied volatility skew

An analogy based option pricing model is put forward. If option prices are determined in accordance with the analogy model, and the Black Scholes model is used to back-out implied volatility, then the implied volatility skew arises, which flattens as time to expiry increases. The analogy based stochastic volatility and the analogy based jump diffusion models are also put forward. The analogy based stochastic volatility model generates the skew even when there is no correlation between the stock price and volatility processes, whereas, the analogy based jump diffusion model does not require asymmetric jumps for generating the skew

Rationale Marktübertreibungen im Zusammenhang der aktuellen Finanzmarktkrise

Der Untersuchungsgegenstand der Arbeit ist die Darstellung der wichtigsten Anlegermotive bei Marktübertreibungen. Es wird dabei auf Konzepte der verhaltensorientierten Kapitalmarktforschung zurückgegriffen. Basierend auf den gewonnenen Erkenntnissen werden Lösungsansätze zur Vermeidung von Marktübertreibungen abgeleitet. Untersuchungen, beispielsweise durch Bikhchandani und Sharma (2000), haben gezeigt, dass Herdenverhalten eine wichtige Rolle bei der Erklärung von Preisübertreibungen spielt. Dabei kann es rational sein, sich konform zur Masse der Marktteilnehmer zu verhalten. Neben dem Konzept des Herdenverhaltens kann Konservatismus unter Marktteilnehmern zur Bestätigung vorherrschender Trends beitragen. Heuristiken werden angewandt, um komplexe Sachverhalte zu vereinfachen. Insbesondere die Repräsentativitätsheuristik kann zu einer Verstärkung bestehender Preisübertreibungen führen. Die Autoren sind der Ansicht, dass vor allem eine Verbesserung der Informationsbasis zur Reduzierung von Fehleinschätzungen durch Marktteilnehmer beitragen kann. Sowohl die Verfügbarkeit als auch die Qualität der Informationen spielen dabei eine Rolle. Ein weiterer Lösungsansatz betrifft die Risikoeinstellung und Kreditvergabe der Banken. In Boomphasen sollte das Risiko eines Crashs berücksichtigt werden.The paper deals with the motives of people to invest in overvalued markets. We resort to the concepts of behavioural finance to describe the most important factors. Based on these findings we deduct measures to avoid misjudgement of markets participants. As Bikhchandani and Sharma (2000) show, the concept of herd behaviour plays a decisive role in explaining exuberance in markets. There are incentives for investors, money managers and analysts to imitate other's actions. Furthermore, conservatism as well as heuristics like representativeness may also lead to a confirmation of prevailing trends. Another driver of misjudgement is the usage of heuristics like representativeness. The authors consider that the provision of information may substantially contribute to the reduction of misjudgement and exuberance in markets. Both availability and quality of information are important. Another approach aims at the regulation of bank lending, which should be limited particularly during a booming economy

Manager- und transaktionsspezifische Determinanten der Performance von Arbitrage CLOs

Der vorliegende Beitrag untersucht die Determinanten der Performance europäischer Arbitrage Collateralized Loan Obligations für das Jahr 2009. Der Fokus liegt dabei auf der Bedeutung der performanceabhängigen Vergütung des CLO-Managers, den Eigenschaften des CLO-Managers und der Transaktionscharakteristika als mögliche Einflussfaktoren der Rating Performance. Es wird gezeigt, dass Transaktionen, bei denen dem CLO-Manager eine Incentive Management Fee gewährt wird, mit einer höheren Wahrscheinlichkeit herabgestuft werden als Transaktionen ohne Incentive Fee. Dieser Befund bestätigt die Hypothese, dass durch die Incentive Fee Risikoanreize für CLO-Manager geschaffen werden. Des Weiteren wird ein positiver Zusammenhang zwischen der Erfahrung bzw. der Größe eines CLO-Managers und der Rating Performance festgestellt. Der Einfluss des Managers auf die Performance einer CLO-Transaktion wird auch an den weiteren in der Studie herangezogenen managerspezifischen Charakteristika wie Typ und Unternehmenssitz bestätigt. Für die Transaktionscharakteristika wird hingegen im betrachteten Untersuchungszeitraum kein signifikanter Einfluss auf die Rating Performance nachgewiesen