Asset Pricing with Heterogeneous Agents, Incomplete Markets and Trading Constraints

The consumption capital asset pricing model is the standard economic model used to capture stock market behavior. However, empirical tests have pointed out to its inability to account quantitatively for the high average rate of return and volatility of stocks over time for plausible parameter values. Recent research has suggested that the consumption of stockholders is more strongly correlated with the performance of the stock market than the consumption of non-stockholders. We model two types of agents, non-stockholders with standard preferences and stock holders with preferences that incorporate elements of the prospect theory developed by Kahneman and Tversky (1979). In addition to consumption, stockholders consider fluctuations in their financial wealth explicitly when making decisions. Data from the Panel Study of Income Dynamics are used to calibrate the labor income processes of the two types of agents. Each agent faces idiosyncratic shocks to his labor income as well as aggregate shocks to the per-share dividend but markets are incomplete and agents cannot hedge consumption risks completely. In addition, consumers face both borrowing and short-sale constraints. Our results show that in equilibrium, agents hold different portfolios. Our model is able to generate a time-varying risk premium of about 5.5% while maintaining a low risk free rate, thus suggesting a plausible explanation for the equity premium puzzle reported by Mehra and Prescott (1985).

Game Theoretic Bidding Strategies for Auctions in Green Electricity Markets

Electricity markets in the United States presently employ an auction mechanism to determine the dispatch of power generation units. In this market design, generators submit bid prices to a regulation agency for review, and the regulator conducts an auction selection in such a way that satisfies electricity demand. Most regulators currently use an auction selection method that minimizes total offer costs ["bid cost minimization" (BCM)] to determine electric dispatch. However, recent literature has shown that this method may not minimize consumer payments, and it has been shown that an alternative selection method that directly minimizes total consumer payments ["payment cost minimization" (PCM)] may benefit social welfare in the long term. The objective of this project is to further investigate the long term benefit of PCM implementation and determine whether it can provide lower costs to consumers. The two auction selection methods are expressed as linear constraint programs and are implemented in an optimization software package. Methodology for game theoretic bidding simulation is developed using EMCAS, a real-time market simulator. Results of a 30-day simulation showed that PCM reduced energy costs for consumers by 12%. However, this result will be cross-checked in the future with two other methods of bid simulation as proposed in this paper.

Strategic Behavior in Day-Ahead and Real-Time Markets for Electricity: Offer Cost or Payment Cost Minimization?

This study compares the procurement cost-minimizing and productive efficiency performance of the auction mechanism used by independent system operators (ISOs) in wholesale electricity auction markets in the U.S. with that of a proposed alternative. The current practice allocates energy contracts as if the auction featured a discriminatory final payment method when, in fact, the markets are uniform price auctions. The proposed alternative explicitly accounts for the market clearing price during the allocation phase. We find that the proposed alternative largely outperforms the current practice on the basis of procurement costs in the context of simple auction markets featuring both day-ahead and real-time auctions and that the procurement cost advantage of the alternative is complete when we simulate the effects of increased competition. We also find that a trade-off between the objectives of procurement cost minimization and productive efficiency emerges in our simple auction markets and persists in the face of increased competition.

Schools and Housing Markets: An Examination of School Segregation and Performance in Connecticut

This paper examines the relationship between house price levels, school performance, and the racial and ethnic composition of Connecticut school districts between 1995 and 2000. A panel of Connecticut school districts over both time and labor market areas is used to estimate a simultaneous equations model describing the determinants of these variables. Specifically, school district changes in price level, school performance, and racial and ethnic compositions depend upon each other, labor market wide changes in these variables, and the deviation of each school district from the overall metropolitan area. The specification is based on the differencing of dependent variables, as opposed to the use of level or fixed effects models and lagging level variables beyond the period over which change is considered; as a result the model is robust to persistence in the sample. Identification of the simultaneous system arises from the presence of multiple labor market areas in the sample, and the assumption that labor market changes in a variable due not directly influence the allocation of households across towns within a labor market area. We find that towns in labor markets that experience an inflow of minority households have greater increases in percent minority if those towns already ahve a substantial minoritypopulation. We find evidence that this sorting proces is reflected in housing price changes in the low priced segment of the housing market, not in the middle and upper segments.

Preference Structure and Random Paths to Stability in Matching Markets

This paper examines how preference correlation and intercorrelation combine to influence the length of a decentralized matching market's path to stability. In simulated experiments, marriage markets with various preference specifications begin at an arbitrary matching of couples and proceed toward stability via the random mechanism proposed by Roth and Vande Vate (1990). The results of these experiments reveal that fundamental preference characteristics are critical in predicting how long the market will take to reach a stable matching. In particular, intercorrelation and correlation are shown to have an exponential impact on the number of blocking pairs that must be randomly satisfied before stability is attained. The magnitude of the impact is dramatically different, however, depending on whether preferences are positively or negatively intercorrelated.

Geographic Deregulation and Commercial Bank Performance in US State Banking Markets

This paper examines the effects of geographical deregulation on commercial bank performance across states. We reach some general conclusions. First, the process of deregulation on an intrastate and interstate basis generally improves bank profitability and performance. Second, the macroeconomic variables -- the unemployment rate and real personal income per capita -- and the average interest rate affect bank performance as much, or more, than the process of deregulation. Finally, while deregulation toward full interstate banking and branching may produce more efficient banks and a healthier banking system, we find mixed results on this issue.

Interbank Markets under Currency Boards

This paper analyzes interbank markets under currency boards. Under such an environment, problematic endogeneity issues common to other monetary regimes do not arise. Using daily data from the interbank markets in Bulgaria and Lithuania we show, that contrary to the existing literature, overnight interest rates tend to decrease towards the end of the reserve holding period. Empirical results are supported by a finite horizon heterogeneous agents model showing that interest rates tend to decrease in the case of excess aggregate reserves in the banking system. Results contrast with Quir'os and Mendiz'abal (2006) who find that interest rates should be increasing regardless of the outstanding aggregate liquidity in the market. We also show that responsiveness of banks to interest rate changes diminishes as the end of reserve holding period approaches. Under certain circumstances this could lead to multiple equilibria with increasing or decreasing interest rates.

Determinants and Effects of Maturity Mismatches in Emerging Markets: Evidence from Bank Level Data

Despite the extensive work on currency mismatches, research on the determinants and effects of maturity mismatches is scarce. In this paper I show that emerging market maturity mismatches are negatively affected by capital inflows and price volatilities. Furthermore, I find that banks with low maturity mismatches are more profitable during crisis periods but less profitable otherwise. The later result implies that banks face a tradeoff between higher returns and risk, hence channeling short term capital into long term loans is caused by cronyism and implicit guarantees rather than the depth of the financial market. The positive relationship between maturity mismatches and price volatility, on the other hand, shows that the banks of countries with high exchange rate and interest rate volatilities can not, or choose not to hedge themselves. These results follow from a panel regression on a data set I constructed by merging bank level data with aggregate data. This is advantageous over traditional studies which focus only on aggregate data.

Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets

This paper shows that countries characterized by a financial accelerator mechanism may reverse the usual finding of the literature -- flexible exchange rate regimes do a worse job of insulating open economies from external shocks. I obtain this result with a calibrated small open economy model that endogenizes foreign interest rates by linking them to the banking sector's foreign currency leverage. This relationship renders exchange rate policy more important compared to the usual exogeneity assumption. I find empirical support for this prediction using the Local Projections method. Finally, 2nd order approximation to the model finds larger welfare losses under flexible regimes.

Efficiency in Deregulated Electricity Markets: Offer Cost Minimization vs. Payment Cost Minimization Auction

This study of the wholesale electricity market compares the efficiency performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed mechanism. The analysis highlights the importance of considering strategic behavior when comparing different institutional systems. We find that in concentrated markets, neither auction mechanism can guarantee an efficient allocation. The advantage of the current mechanism increases with increased price competition if market demand is perfectly inelastic. However, if market demand has some responsiveness to price, the superiority of the current auction with respect to efficiency is not that obvious. We present a case where the proposed auction outperforms the current mechanism on efficiency even if all offers reflect true production costs. We also find that a market designer might face a choice problem with a tradeoff between lower electricity cost and production efficiency. Some implications for social welfare are discussed as well.

Equity Markets, the Money Market, and Long-Run Monetary Neutrality

This paper outlines a process for teaching long-run neutrality of money, drawing an analogy between equity markets and the money market. The key points in the discussion include the following: (1) What is the price of money? (2) Why does the long-run demand for money trace out a rectangular hyperbola? (3) Why does the slow adjustment of goods and service prices to changes in the stock of money lead to a different short-run demand for money? and (4) Why does a successful currency reform generate similar short-run movements in the price of money as movements in equity share prices after a change in the supply of shares? I have used this approach successfully for over 30 years at all levels, wherever I need to discuss the money market in a macroeconomic model.

Simple-Offer vs. Complex-Offer Auctions in Deregulated Electricity Markets

In my recent experimental research of wholesale electricity auctions, I discovered that the complex structure of the offers leaves a lot of room for strategic behavior, which consequently leads to anti- competitive and inefficient outcomes in the market. A specific feature of these complex-offer auctions is that the sellers submit not only the quantities and the minimum prices at which they are willing to sell, but also the start-up fees that are designed to reimburse the fixed start-up costs of the generation plants. In this paper, using the experimental method I compare the performance of two complex-offer auctions (COAs) against the performance of a simple-offer auction (SOA), in which the sellers have to recover all their generation costs --- fixed and variable ---through a uniform market-clearing price. I find that the SOA significantly reduces consumer prices and lowers price volatility. It mitigates anti-competitive effects that are present in the COAs and achieves allocative efficiency more quickly.

Discrimination in Metropolitan Housing Markets Phase II: Asians and Pacific Islanders

This report documents the results of a an 11-city paired testing study by the Department of Housing and Urban Development of housing discrimination against Asian- Americans and Pacific Islanders. The study shows that one out of every five Asians and Pacific Islanders attempting to buy or rent a home are discriminated against, a rate similar to that of African Americans and Hispanics.

Discrimination in Metropolitan Housing Markets: National Results from Phase 1 of the Housing Discrimination Study (HDS)

The Housing Discrimination Study 2000 (HDS 2000) is the third nationwide effort sponsored by HUD to measure the amount of discrimination faced by minority home seekers. This report provides national estimates of discrimination faced by African Americans and Hispanics in 2000 as they searched for housing in the sales and rental markets. It also provides an accurate measure of how housing discrimination has changed since 1989. The report shows large decreases between 1989 and 2000 in the level of discrimination experienced by Hispanics and African Americans seeking to a buy a home. There are, however, worrisome upward trends of discrimination in the areas of geographic steering in home sales for African Americans and the amount of help agents provide to Hispanics with obtaining financing. There has also been a modest decrease in discrimination toward African Americans seeking to rent a unit. This downward trend, however, has not been seen for Hispanic renters. Hispanic renters now are more likely to experience discrimination in their housing search than do African American renters.