Knowledge that Transforms

In an environment where trading volume affects security prices and where prices are uncertain when trades are submitted, quasi-arbitrage is the availability of a series of trades that generate infinite expected profits with an infinite Sharpe ratio. We show that when the price impact of trades is permanent and time-independent, only linear price-impact functions rule out quasi-arbitrage and thus support viable market prices. When trades have also a temporary price impact, only the permanent price impact must be linear while the temporary one can be of a more general form. We also extend the analysis to a time-dependent framework.

This paper extends the conditional logit approach (Rasch, Andersen, Chamberlain) used in panel data models of binary variables with correlated fixed effects and strictly exogenous regressors. In a two-period two-state model, necessary and sufficient conditions on the joint distribution function of the individual-and-period specific shocks are given such that the sum of individual binary variables across time is a sufficient statistic for the individual effect. By extending a result of Chamberlain, it is shown that root-n consistent regular estimators can be constructed in panel binary models if and only if the property of sufficiency holds. In applied work, the estimation method amounts to quasi-differencing the binary variables as if they were continuous variables and transforming a panel data model into a cross-section model. Semiparametric approaches can then be readily applied.

We analyze bidding behavior in auctions when risk-averse bidders bid for an object whose value is risky. We show that, as risk increases, decreasingly risk-averse bidders will reduce their bids by more than the risk premium. Ceteris paribus, bidders will be better off bidding for a more risky object in first-price, second-price, English, and allpay auctions with affiliated private values. We then extend the results to common value settings. This 'precautionary bidding' effect arises because the expected marginal utility of income increases with risk, so bidders are reluctant to bid so highly. We show that precautionary bidding also arises in response to common values risk. This precautionary bidding behavior can make decreasingly risk-averse bidders better off when they face a 'winner's curse' than when they do not.