On the term structure of Interbank interest rates: Jump-diffusion processes and option pricing

In this paper we study the dynamic behavior of the term structureof Interbank interest rates and the pricing of options on interest ratesensitive securities. We posit a generalized single factor model withjumps to take into account external influences in the market. Daily datais used to test for jump effects. Qualitative examination of the linkagebetween Monetary Authorities' interventions and jumps are studied. Pricingresults suggests a systematic underpricing in bonds and call options ifthe jumps component is not included. However, the pricing of put optionson bonds presents indeterminacies.

Fair pricing of deposit insurance. Is it possible? Yes. Is it desirable? No

This note elaborates on a recent article by Chan, Greenbaum and Thakor(1992) who contend that fairly priced deposit insurance is incompatiblewithfree competition in the banking sector, in the presence of adverseselection.We show here that at soon as one introduces a real economic motivationfromprivate banks to manage the deposits from the public, then fairly priceddeposit insurance becomes possible. However, we also show that sucha fairlypriced insurance is never desirable, precisely because of adverseselection.We compute the characteristics of the optimal premium schedule, whichtradesoff between the cost of adverse selection and the cost of ``unfaircompetition ''.

Solving non-linear stochastic models by parameterizing expectations: An application to asset pricing with production

A new algorithm called the parameterized expectations approach(PEA) for solving dynamic stochastic models under rational expectationsis developed and its advantages and disadvantages are discussed. Thisalgorithm can, in principle, approximate the true equilibrium arbitrarilywell. Also, this algorithm works from the Euler equations, so that theequilibrium does not have to be cast in the form of a planner's problem.Monte--Carlo integration and the absence of grids on the state variables,cause the computation costs not to go up exponentially when the numberof state variables or the exogenous shocks in the economy increase. \\As an application we analyze an asset pricing model with endogenousproduction. We analyze its implications for time dependence of volatilityof stock returns and the term structure of interest rates. We argue thatthis model can generate hump--shaped term structures.

Option pricing under stochastic volatility and stochastic interest rate in the Spanish case

Among the underlying assumptions of the Black-Scholes option pricingmodel, those of a fixed volatility of the underlying asset and of aconstantshort-term riskless interest rate, cause the largest empirical biases. Onlyrecently has attention been paid to the simultaneous effects of thestochasticnature of both variables on the pricing of options. This paper has tried toestimate the effects of a stochastic volatility and a stochastic interestrate inthe Spanish option market. A discrete approach was used. Symmetricand asymmetricGARCH models were tried. The presence of in-the-mean and seasonalityeffectswas allowed. The stochastic processes of the MIBOR90, a Spanishshort-terminterest rate, from March 19, 1990 to May 31, 1994 and of the volatilityofthe returns of the most important Spanish stock index (IBEX-35) fromOctober1, 1987 to January 20, 1994, were estimated. These estimators wereused onpricing Call options on the stock index, from November 30, 1993 to May30, 1994.Hull-White and Amin-Ng pricing formulas were used. These prices werecomparedwith actual prices and with those derived from the Black-Scholesformula,trying to detect the biases reported previously in the literature. Whereasthe conditional variance of the MIBOR90 interest rate seemed to be freeofARCH effects, an asymmetric GARCH with in-the-mean and seasonalityeffectsand some evidence of persistence in variance (IEGARCH(1,2)-M-S) wasfoundto be the model that best represent the behavior of the stochasticvolatilityof the IBEX-35 stock returns. All the biases reported previously in theliterature were found. All the formulas overpriced the options inNear-the-Moneycase and underpriced the options otherwise. Furthermore, in most optiontrading, Black-Scholes overpriced the options and, because of thetime-to-maturityeffect, implied volatility computed from the Black-Scholes formula,underestimatedthe actual volatility.

A unifying approach to the empirical evaluation of asset pricing models

Two main approaches are commonly used to empirically evaluate linear factor pricingmodels: regression and SDF methods, with centred and uncentred versions of the latter.We show that unlike standard two-step or iterated GMM procedures, single-step estimatorssuch as continuously updated GMM yield numerically identical values for prices of risk,pricing errors, Jensen s alphas and overidentifying restrictions tests irrespective of the modelvalidity. Therefore, there is arguably a single approach regardless of the factors being tradedor not, or the use of excess or gross returns. We illustrate our results by revisiting Lustigand Verdelhan s (2007) empirical analysis of currency returns.

Competitive location and pricing on networks

In this paper we consider a location and pricing model for a retail firm that wants to enter a spatial market where a competitor firm is already operating as a monopoly with several outlets. The entering firms seeks to determine the optimal uniform mill price and its servers' locations that maximizes profits given the reaction in price of the competitor firm to its entrance. A tabu search procedure is presentedto solve the model together with computational experience.

On equilibria in duopolies with finite strategy spaces

We will call a game a reachable (pure strategy) equilibria game if startingfrom any strategy by any player, by a sequence of best-response moves weare able to reach a (pure strategy) equilibrium. We give a characterizationof all finite strategy space duopolies with reachable equilibria. Wedescribe some applications of the sufficient conditions of the characterization.

Valuation bubbles and sequential bubbles

Price bubbles in an Arrow-Debreu valuation equilibrium in infinite-timeeconomy are a manifestation of lack of countable additivity of valuationof assets. In contrast, known examples of price bubbles in sequentialequilibrium in infinite time cannot be attributed to the lack of countableadditivity of valuation. In this paper we develop a theory of valuation ofassets in sequential markets (with no uncertainty) and study the nature ofprice bubbles in light of this theory. We consider an operator, calledpayoff pricing functional, that maps a sequence of payoffs to the minimumcost of an asset holding strategy that generates it. We show that thepayoff pricing functional is linear and countably additive on the set ofpositive payoffs if and only if there is no Ponzi scheme, and providedthat there is no restriction on long positions in the assets. In the knownexamples of equilibrium price bubbles in sequential markets valuation islinear and countably additive. The presence of a price bubble indicatesthat the asset's dividends can be purchased in sequential markers at acost lower than the asset's price. We also present examples of equilibriumprice bubbles in which valuation is nonlinear but not countably additive.

A generalization of Hull and White formula and applications to option pricing approximation

By means of Malliavin Calculus we see that the classical Hull and White formulafor option pricing can be extended to the case where the noise driving thevolatility process is correlated with the noise driving the stock prices. Thisextension will allow us to construct option pricing approximation formulas.Numerical examples are presented.

On the relevance of modeling volatility for pricing purposes

This paper presents a two-factor (Vasicek-CIR) model of the term structure of interest rates and develops its pricing and empirical properties. We assume that default free discount bond prices are determined by the time to maturity and two factors, the long-term interest rate and the spread. Assuming a certain process for both factors, a general bond pricing equation is derived and a closed-form expression for bond prices is obtained. Empirical evidence of the model's performance in comparisson with a double Vasicek model is presented. The main conclusion is that the modeling of the volatility in the long-term rate process can help (in a large amount) to fit the observed data can improve - in a reasonable quantity - the prediction of the future movements in the medium- and long-term interest rates. However, for shorter maturities, it is shown that the pricing errors are, basically, negligible and it is not so clear which is the best model to be used.

The determinants of pricing in pharmaceuticals: Are U.S. prices really higher than those of Canada?

This paper studies price determination in pharmaceutical markets using data for 25 countries, six years and a comprehensive list of products from the MIDAS IMS database. We show that market power and the quality of the product has a significantly positive impact of prices. The nationality of the producer appears to have a small and often insignificant impact on prices, which suggests that countries which regulates prices have relatively little power to do it in a way that advances narrow national interest. We produce a theoretical explanation for this phenomenon based on the fact that low negotiated prices in a country would have a knock-on effect in other markets, and is thus strongly resisted by producers.Another key finding is that the U.S. has prices that are not significantly higher than those of countries with similar income levels. This, together with the former observation on the effect of the nationality of producers casts doubt on the ability of countries to pursue "free-riding" regulation.

Strategy communication and measurement systems

Organizations often face the challenge of communicating their strategiesto local decision makers. The difficulty presents itself in finding away to measure performance wich meaningfully conveys how to implement theorganization's strategy at local levels. I show that organizations solvethis communication problem by combining performance measures in such away that performance gains come closest to mimicking value-added asdefined by the organization's strategy. I further show how organizationsrebalance performance measures in response to changes in their strategies.Applications to the design of performance metrics, gaming, and divisionalperformance evaluation are considered. The paper also suggests severalempirical ways to evaluate the practical importance of the communicationrole of measurement systems.

Keeping up with the Joneses: An international asset pricing model

We derive an international asset pricing model that assumes local investorshave preferences of the type "keeping up with the Joneses." In aninternational setting investors compare their current wealth with that oftheir peers who live in the same country. In the process of inferring thecountry's average wealth, investors incorporate information from the domesticmarket portfolio. In equilibrium, this gives rise to a multifactor CAPMwhere, together with the world market price of risk, there existscountry-speciffic prices of risk associated with deviations from thecountry's average wealth level. The model performs signifficantly better, interms of explaining cross-section of returns, than the international CAPM.Moreover, the results are robust, both for conditional and unconditionaltests, to the inclusion of currency risk, macroeconomic sources of risk andthe Fama and French HML factor.