For each two-player game, a linear-programming algorithm finds a component of the Nash equilibria and a subset of its perfect equilibria that are simply stable in the sense that there are nearby equilibria for each nearby game that perturbs one strategy's probability or payoff more than others. Copyright 1992 by The Econometric Society.
WE ARE MOST GRATEFUL to Glazer and Rosenthal for the attention they have paid to our work (Abreu and Matsushima (1992a, b, c)). In the process of criticizing our mechanism, they have provided an elegant exposition of it which usefully supplements our own efforts. The criticisms themselves we feel are misplaced, and based on a close reading but narrow interpretation of our results. Glazer and Rosenthal seek to show that in our mechanisms .. . the iterative removal of strictly dominated strategies is (or indeed ought to be) controversial. In terms of conventional decision theory the iterative logic is impeccable. When iterative deletion leads to a unique profile, that profile is the unique rationalizable profile, the unique Nash equilibrium, and so on. Of course, the logic of iterative dominance entails common knowledge of rationality. The theoretical coherence of this assumption has been questioned in the context of backward programming in extensive form games (see Luce and Raiffa (1957, pp. 80-81), Rosenthal (1981), Basu (1988), Reny (1992a, 1992b), Bonanno (1991), Binmore (1987a, 1987b), and Gul (1989) among others). These paradoxes of common knowledge of rationality have been highlighted in stylized examples such as the finitely repeated prisoners' dilemma and Rosenthal's centipede which in fact has been a seminal inspiration for this recent literature.2 But our mechanisms are simultaneous. There is no opportunity to demonstrate irrationality, strategic or otherwise, and therefore no scope to rationalize iteratively dominated behavior. From a decision theory perspective, the Glazer and Rosenthal critique might therefore be viewed as an elaborate revival of the (indefensible) claim that players in a one-short prisoners' dilemma will choose not to confess because they are both better off doing so than by both playing their dominant strategies. Within the standard game theory paradigm there is really nothing more to be said. Before turning to issues of bounded rationality, we note that the Glazer and Rosenthal critique is essentially premised on the existence of a countervailing focal point. But what is a focal point? The notion is notoriously vague, and we are aware of no widely accepted definition.3 This is not to deny that in very simple and particular games, certain behavior may be focal. Frequently, focalness is identified with a Pareto dominating equilibrium, and this is the point of view Glazer and Rosenthal seem to adopt.4 This is implicit in their acknowledgement that ... . when the social choice function does satisfy Pareto optimality, our objection loses much of its immediate
David Heath, Robert Jarrow, Andrew Morton, Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation, Econometrica, Vol. 60, No. 1 (Jan., 1992), pp. 77-105
ABSTRACT We estimate and compare a variety of continuous‐time models of the short‐term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short‐term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well‐known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.
ABSTRACT This paper presents evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time. I test this hypothesis by estimating the Euler equation of an optimizing model of investment. Including the effect of a debt constraint greatly improves the Euler equation's performance in comparison to the standard specification. When the sample is split on the basis of two measures of financial distress, the standard Euler equation fits well for the a priori unconstrained groups, but is rejected for the others.
ABSTRACT This paper tests two of the simplest and most popular trading rules—moving average and trading range break—by utilizing the Dow Jones Index from 1897 to 1986. Standard statistical analysis is extended through the use of bootstrap techniques. Overall, our results provide strong support for the technical strategies. The returns obtained from these strategies are not consistent with four popular null models: the random walk, the AR(1), the GARCH‐M, and the Exponential GARCH. Buy signals consistently generate higher returns than sell signals, and further, the returns following buy signals are less volatile than returns following sell signals, and further, the returns following buy signals are less volatile than returns following sell signals. Moreover, returns following sell signals are negative, which is not easily explained by any of the currently existing equilibrium models.
ABSTRACT We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s.
ABSTRACT While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks.
ABSTRACT Two easily measured variables, size and book‐to‐market equity, combine to capture the cross‐sectional variation in average stock returns associated with market β , size, leverage, book‐to‐market equity, and earnings‐price ratios. Moreover, when the tests allow for variation in β that is unrelated to size, the relation between market β and average return is flat, even when β is the only explanatory variable.