Knowledge that Transforms

Volume Contents Review of Finance, Volume 6, Issue 3, 2002, Pages 449–450, https://doi.org/10.1023/A:1022020828077 Published: 01 December 2002

Using asset market data, as well as theoretical relations between investors’ preferences, option-implied, risk-neutral, probability distribution functions (PDFs,) and index-implied, actual, PDFs, this paper extracts a time-series of investors’ relative risk aversion (RRA) functions. Based on results recently derived by Benninga and Mayshar (2000), these functions are used to recover the evolution of risk preferences heterogeneity. Applying non-parametric estimation on European call options written on the S & P500 index, we find that: (i) the RRA functions are decreasing; and (ii) the constructed risk preferences heterogeneity series is positively correlated in a static, as well as a dynamic, setup with a prevalent proxy for investors heterogeneity, namely, the spread between auction- and market-yields of Treasury bills.

One of the most enduring topics in financial theory is the persistence of investment risk across time. Traditional finance lacks methods for considering and hedging non-diversifiable risks. This paper is based on the general equilibrium model of Allen and Gale (1997). We extend their model in various directions: the intermediary is a firm and not a planner, financial markets are assumed to be incomplete, and the mechanism of intergenerational risk-sharing is endogenously determined. Our model allows for the analysis of optimal behavior of individuals and the intermediary together with the respective feedback processes.

This paper introduces risk-averse preferences in Chari and Jagannathan (1988). A first motivation for this extension is to give a positive role for afinancial intermediary in the economy, who offers risk-sharing contracts toliquidity seeking individuals. In this framework, both informationinduced anpure panic runs will occur. The second motivation is to complete Chari and Jagannathan's welfare analysis by comparing suspension of convertibility and deposit insurance, given their relative benefits and costs (of randomizationin meeting liquidity needs or deadweight taxation). It is shown that the choice between the two contracts depends on the level of risk aversion, the intertemporal discount factor and the attributes about the underlying technology.

This paper develops a new pricing model for American-style indexed executive stock options. We rely on a basic model framework and an indexation scheme first proposed by Johnson and Tian (2000a) in their analysis of European-style indexed options. Our derivation of the valuation formula represents an instructive example of the usefulness of the change-of-numeraire technique. In the paper's numerical section we implement the valuation formula and demonstrate that not only may the early exercise premium be significant but also that the delta of the American-style option is typically much larger than the delta of the otherwise identical (value-matched) European-style option. Vega is higher for indexed options than for conventional options but largely independent of whether the options are European- or American-style. This has important implications for the design of executive compensation contracts. We finally extend the analysis to cover the case where the option contracts are subject to delayed vesting . We show that for realistic parameter values, delayed vesting leads only to a moderate reduction in the value of the American-style indexed executive stock option.

This paper examines a multiperiod production economy where investors do not observe the realizations of productivity factors or security expected returns. Unlike previous work, which expresses the equilibrium conditions as functions of unobservable (to both real-world investors and empiricists) moments of the distributions of returns, we express the equilibrium real rate as a function of the observable sample paths of realizations of returns. We provide a framework for empirically testing this and other asset pricing models without outside-the-model econometric assumptions needed for producing the unobservable moments of returns. We construct versions of the restrictions for any time interval between observations.

This paper studies the optimal combination of debt and dividend commitments in an agency model of the firm. Financial policy is relevant because ex-post information asymmetryrequires managerial rewards to depend on the ability to meet financial commitments. If perquisite or inside information problems exist in isolation, debt-based incentives as assumed inprevious studies result endogenously. If the problems exist simultaneously, dividends can beoptimal even when they appear excessively costly as a signal and unduly lenient as a disciplining device. The reason is that the set of dynamically consistent rewards increases when debt commitments are augmented with dividend commitments, and a larger set of ex-post rewards is more valuable as ex-ante decisions become more complex.

Market discipline is an article of faith among financial economists, and the use of market discipline as a regulatory tool is gaining credibility. Effective market discipline involves two distinct components: security holders' ability to accurately assess the condition of a firm (monitoring) and their ability to cause subsequent managerial actions to reflect those assessments (influence). Substantial evidence supports the existence of market monitoring. However, the existing evidence about market influence involves relatively rare events such as management turnover. This paper seeks evidence that U.S. bank holding companies' security price changes reliably influence subsequent managerial actions. Although we identify some patterns consistent with beneficial market influences, our methodology does not provide strong evidence that stock or (especially) bond investors regularly influence managerial actions. Day-to-day market influence remains, for the moment, more a matter of faith than of empirical evidence.

Using a new database covering some 91 supervisory agencies, this paper examines how important various skilled experts are in the supervisory process and the relative usage of different kinds of such experts. We seek to explore what kind of perspective supervisors in different institutional settings may adopt: a macro-oriented perspective or a more micro-approach? The answer to this question is relevant, as there is evidence that many financial crises have been macro-induced. It is found that central banks employ more economists and fewer lawyers in their supervisory/financial stability wing than non-central bank supervisory agencies. This result would indicate that an institutional setting with direct or indirect central bank involvement is more likely to produce a macro-approach. Next, there are significant economies of scale in financial supervision, though this can be measured by several alternative variables (e.g., the relative scale of bank intermediation). Finally, there do not appear to be major economies of scope. A more complex financial system with a well-developed stock market would need both more supervisors as well as more skilled ones.