The regulations governing asset distributions from many retirement plans give participants the option to time retirement or rollovers from the plan strategically. They possess a long-lived put option, whose exercise price resets periodically to the current value of the assets in the plan. I derive a recursive closed-form valuation formula for the option and develop a numerical algorithm for implementing the result. I find that, for reasonable assumptions about volatility and life expectancy, the option's value may approach 40% of the value of the assets in the plan, financed entirely by those still contributing. This wealth transfer can, however, be easily avoided by making a simple change to the current regulations governing valuation and payout of these retirement plans.

Journal Article Rational Prepayment and the Valuation of Mortgage-Backed Securities Get access Richard Stanton Richard Stanton University of California, Berkeley Address correspondence to Richard Stanton, Haas School of Business, University of California, Berkeley, 350 Barrows Hall, Berkeley, CA 94720. Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 8, Issue 3, July 1995, Pages 677–708, https://doi.org/10.1093/rfs/8.3.677 Published: 28 May 2015

This article presents a technique for nonparametrically estimating continuous-time diffusion processes that are observed at discrete intervals. We illustrate the methodology by using daily three and six month Treasury Bill data, from January 1965 to July 1995, to estimate the drift and diffusion of the short rate, and the market price of interest rate risk. While the estimated diffusion is similar to that estimated by Chan, Karolyi, Longstaff, and Sanders (1992), there is evidence of substantial nonlinearity in the drift. This is close to zero for low and medium interest rates, but mean reversion increases sharply at higher interest rates.

This article presents a technique for nonparametrically estimating continuous‐time diffusion processes that are observed at discrete intervals. We illustrate the methodology by using daily three and six month Treasury Bill data, from January 1965 to July 1995, to estimate the drift and diffusion of the short rate, and the market price of interest rate risk. While the estimated diffusion is similar to that estimated by Chan, Karolyi, Longstaff, and Sanders (1992) , there is evidence of substantial nonlinearity in the drift. This is close to zero for low and medium interest rates, but mean reversion increases sharply at higher interest rates.

During the recent financial crisis, ABX.HE index credit default swaps (CDS) on baskets of mortgage-backed securities were a benchmark widely used by financial institutions to mark their subprime mortgage portfolios to market. However, we find that prices for the AAA ABX.HE index CDS during the crisis were inconsistent with any reasonable assumption for mortgage default rates, and that these price changes are only weakly correlated with observed changes in the credit performance of the underlying loans in the index, casting serious doubt on the suitability of these CDS as valuation benchmarks. We also find that the AAA ABX.HE index CDS price changes are related to short-sale activity for publicly traded investment banks with significant mortgage market exposure. This suggests that capital constraints, limiting the supply of mortgage-bond insurance, may be playing a role here similar to that identified by Froot (2001) in the market for catastrophe insurance. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

We develop a theoretical model of a network of intermediaries whose optimal behavior is jointly determined, leading to heterogeneous financial norms and systemic vulnerabilities. We apply the model to the network of U.S. mortgage intermediaries from 2005 to 2007, using a data set containing all private-label, fixed-rate mortgages, with loan flows defining links. Default risk was closely related to network position, evolving predictably among linked nodes, and loan quality estimated from the model was related to independent quality measures, altogether pointing to the vital importance of network effects in this market. Received April 20, 2016; editorial decision July 11, 2017 by Editor Stijn Van Nieuwerburgh.

This paper conducts a comprehensive study of the optimal exercise policy for an executive stock option and its implications for option cost, average life, and alternative valuation concepts. The paper is the first to provide analytical results for an executive with general concave utility. Wealthier or less risk-averse executives exercise later and create greater option cost. However, option cost can decline with volatility. We show when there exists a single exercise boundary, yet demonstrate the possibility of a split continuation region. We also show that, for constant relative risk averse utility, the option value does not converge to the Black and Scholes value as the correlation between the stock and the market portfolio converges to one. We compare our model's option cost with the modified Black and Scholes approximation typically used in practice and show that the approximation error can be large or small, positive or negative, depending on firm characteristics.

We show that several well-known asset pricing puzzles are largely mitigated if we endow the representative agent with an arbitrarily small minimum consumption level. This allows us to solve the model for parameter values where the standard “Lucas tree” model is not defined. For these parameters, disasters become more important, and the market risk premium therefore higher, even though consumption is less risky. Our model yields reasonable risk premia, Sharpe ratios, and discount rates; excess price volatility; and a high market price-dividend ratio. We derive closed-form solutions for all variables of interest.

This paper shows that the existence of managerial ability, combined with the labor contract prevalent in the industry, implies that the closed‐end fund discount should exhibit many of the primary features documented in the literature. We evaluate the model's ability to match the quantitative features of the data, and find that it does well, although there is some observed behavior that remains to be explained.

This paper develops a rational, liquidity-based model of closed-end funds (CEFs) that provides an economic motivation for the existence of this organizational form: They offer a means for investors to buy illiquid securities, without facing the potential costs associated with direct trading and without the externalities imposed by an open-end fund structure. Our theory predicts the patterns observed in CEF initial public offerings (IPOs) and the observed behavior of the CEF discount, which results from a trade-off between the liquidity benefits of investing in the CEF and the fees charged by the fund's managers. In particular, the model explains why IPOs occur in waves in certain sectors at a time, why funds are issued at a premium to net asset value (NAV), and why they later usually trade at a discount. We also conduct an empirical investigation, which, overall, provides more support for a liquidity-based model than for an alternative sentiment-based explanation.