Complete Markets Strikes Back: Revisiting Risk Sharing Tests under Discount Rate Heterogeneity

Recent risk sharing tests strongly reject the hypothesis of complete markets, because in the data: (1) the individual consumption comoves with income and (2) the consumption dispersion increases over the life cycle. In this paper, I revisit the implications of these risk sharing tests in the context of a complete market model with discount rate heterogeneity, which is extended to introduce the individual choices of effort in education. I .nd that a complete market model with discount rate heterogeneity can pass both types of the risk sharing tests. The endogenous positive correlation between income growth rate and patience makes the individual consumption comove with income, even if the markets are complete. I also show that this model is quantitatively admissible to account for both the observed comovement of consumption and income and the increase of consumption dispersion over the life cycle.

A Simple Characterization of Dynamic Completeness in Continuous Time

This paper investigates dynamic completeness of financial markets in which the underlying risk process is a multi-dimensional Brownian motion and the risky securities dividends geometric Brownian motions. A sufficient condition, that the instantaneous dispersion matrix of the relative dividends is non-degenerate, was established recently in the literature for single-commodity, pure-exchange economies with many heterogenous agents, under the assumption that the intermediate flows of all dividends, utilities, and endowments are analytic functions. For the current setting, a different mathematical argument in which analyticity is not needed shows that a slightly weaker condition suffices for general pricing kernels. That is, dynamic completeness obtains irrespectively of preferences, endowments, and other structural elements (such as whether or not the budget constraints include only pure exchange, whether or not the time horizon is finite with lump-sum dividends available on the terminal date, etc.)

Debt and deficit fluctuations and the structure of bond markets

We analyse the implications of optimal taxation for the stochastic behaviour of debt. We show that when a government pursues an optimal fiscal policy under complete markets, the value of debt has the same or less persistence than other variables in the economy and it declines in response to shocks that cause the deficit to increase. By contrast, under incomplete markets debt shows more persistence than other variables and it increases in response to shocks that cause a higher deficit. Data for US government debt reveals diametrically opposite results from those of complete markets and is much more supportive of bond market incompleteness.

Insurance with frequent trading: A dynamic analysis of efficient insurance markets

This paper extends existing insurance results on the type of insurance contracts needed for insurance market efficiency toa dynamic setting. It introduces continuosly open markets that allow for more efficient asset allocation. It alsoeliminates the role of preferences and endowments in the classification of risks, which is done primarily in terms of the actuarial properties of the underlying riskprocess. The paper further extends insurability to include correlated and catstrophic events. Under these very general conditions the paper defines a condition that determines whether a small number of standard insurance contracts (together with aggregate assets) suffice to complete markets or one needs to introduce such assets as mutual insurance.

Fiscal multipliers in an incomplete markets economy

This paper studies the behavior of fiscal multipliers in two different economic environments: complete markets and incomplete markets. Based on steady state analysis, output multipliers are found within a range between 0.49 and 0.66, when the markets are complete. Under incomplete markets, output multiplier was found in an interval between 0.75 and 0.94. These results indicates that the market structure, which reflects the degree of risk sharing and the intensity of the precautionary motive faced by individuals, plays a key role in determining the fiscal multipliers. In the second part of the paper, was performed an exercise to analyze the dynamic response of macroeconomic aggregates to an exogenous and unexpected rise in government spending financed by lump-sum taxes. In this case, impact output multipliers varies in a range between 0.64 and 0.68, under complete markets, and within 1.05 and 1.20 when markets are incomplete. The results found under incomplete markets are very close to that found on related literature which usually uses an econometric approach or calibrated/estimated New Keynesian models. These results shows that taking into account the deficiencies in the insurance mechanisms can be an interesting way to reconcile theoretical models with the results found on related current literature, without the need of ad-hoc assumptions relative to price stickness.

El valor razonable como concepto vinculado a la pertinencia del valor. Fair value as a concept related to value relevance.

IDENTIFICACIÓN Y CARACTERIZACIÓN DEL PROBLEMA - HIPÓTESIS Según la NIC 39, el valor razonable es la cantidad por la que puede ser intercambiado un activo o cancelado un pasivo entre un comprador y un vendedor interesados y debidamente informados, en condiciones de independencia mutua. La definición del FASB (SFAC 7) es muy similar, y define el valor razonable como el monto mediante el que un activo podría ser enajenado en una transacción entre partes independientes, dispuestas a realizar la operación en situaciones diferentes a la de una liquidación o a la de una venta forzada. Puede apreciarse que esta definición de valor razonable es limitada porque, a excepción de escenarios que se correspondan con mercados perfectos y completos, el concepto puede abarcar valores de entrada, valores de salida y valores en uso, los cuales pueden ser muy diferentes (Beaver, 1987). El valor de entrada es el valor de adquisición o de reemplazo, el valor de salida es el precio al cual un activo puede ser vendido o liquidado, y el valor en uso es el valor incremental de una empresa atribuible a un activo (se correspondería con el valor presente mencionado anteriormente). Dado que el IASB y la FASB se ocupan de la valuación de activos que una empresa posee, y no de activos que serán adquiridos en un futuro, su definición de valor razonable debería ser interpretada desde la perspectiva del vendedor. Por lo tanto, el concepto de valor razonable que manejan el IASB y la FASB se asemeja a un valor de salida, tal como lo propusieron Chambers y Stirling hace bastantes años atrás.Planteado esto, lo que tratará de dilucidar este proyecto de investigación es si este concepto de valor razonable es realmente novedoso o es una simple regresión a los valores corrientes de salida defendidos por los autores de la década del setenta. OBJETIVOS GENERALES Y ESPECÍFICOS General Analizar si el concepto “valor razonable” tal como es definido por la normativa actual se corresponde con una definición novedosa o es una adaptación/modificación/regresión de conceptos ya existentes (valores corrientes de salida). Específicos Revisar la literatura específica desde el punto de vista de la teoría contable y las normas de las que dispone la profesión referidas a los siguientes aspectos: a) Valores corrientes b) Valor razonable MATERIALES Y MÉTODOS El análisis que se llevará a cabo comprenderá dos aspectos. El primero consiste en la revisión de la doctrina contable. Para ello se analizará bibliografía significativa y trabajos de eventos académicos relacionados con el valor razonable. En segundo término se revisará la normativa profesional a nivel nacional e internacional. Después de concluido con los pasos anteriores se analizará la novedad del concepto valor razonable y su semejanza con el valor corriente de salida planteado por los autores de la década del setenta. IMPORTANCIA DEL PROYECTO – IMPACTO Se pretende revisar si el concepto valor razonable planteado por la normativa actual resulta realmente novedoso o es una adaptación de viejos conceptos planteados en la década del setenta del siglo pasado. El proyecto resulta importante porque es un tema no desarrollado en la literatura, ni planteado en congresos. Se estima lograr material de publicación y presentación en eventos académicos. According to the NIC 39, fair value is the quantity for the one that can be exchanged an asset or cancelled a liability between a buyer and a seller interested and due informed, in conditions of mutual independence. The definition of the FASB (SFAC 7) is very similar, and defines fair value as the amount by means of which an assets might be alienated in a transaction between independent parts, ready to realize the operation in situations different from that of a liquidation or to that of a forced sale. This definition of reasonable value is limited because, with the exception of scenes that fit with perfect and complete markets, the concept can include values of entry, values of exit and values in use, which can be very different (Beaver, 1987). The value of entry is the value of acquisition or of replacement, the value of exit is the price to which an asset can be sold or liquidated, and the value in use is the incremental value of a company attributable to an asset. Provided that the IASB and the FASB deal with the appraisal of assets that a company possesses, and not of assets that will be acquired in a future, this definition of fair value should be interpreted from the perspective of the seller. Therefore, the concept of reasonable value that they handle the IASB and the FASB is alike a value of exit, as Chambers and Stirling proposed it enough years ago behind. We will review if the concept of "fair value" is really new or if it is an adaptation of old concepts.

In Search of a theory of debt management

A growing literature integrates theories of debt management into models of optimal fiscal policy. One promising theory argues that the composition of government debt should be chosen so that fluctuations in the market value of debt offset changes in expected future deficits. This complete market approach to debt management is valid even when the government only issues non-contingent bonds. A number of authors conclude from this approach that governments should issue long term debt and invest in short term assets. We argue that the conclusions of this approach are too fragile to serve as a basis for policy recommendations. This is because bonds at different maturities have highly correlated returns, causing the determination of the optimal portfolio to be ill-conditioned. To make this point concrete we examine the implications of this approach to debt management in various models, both analytically and using numerical methods calibrated to the US economy. We find the complete market approach recommends asset positions which are huge multiples of GDP. Introducing persistent shocks or capital accumulation only worsens this problem. Increasing the volatility of interest rates through habits partly reduces the size of these simulations we find no presumption that governments should issue long term debt ? policy recommendations can be easily reversed through small perturbations in the specification of shocks or small variations in the maturity of bonds issued. We further extend the literature by removing the assumption that governments every period costlessly repurchase all outstanding debt. This exacerbates the size of the required positions, worsens their volatility and in some cases produces instability in debt holdings. We conclude that it is very difficult to insulate fiscal policy from shocks by using the complete markets approach to debt management. Given the limited variability of the yield curve using maturities is a poor way to substitute for state contingent debt. The result is the positions recommended by this approach conflict with a number of features that we believe are important in making bond markets incomplete e.g allowing for transaction costs, liquidity effects, etc.. Until these features are all fully incorporated we remain in search of a theory of debt management capable of providing robust policy insights.

Endogenous policy leads to inefficient risk sharing

We analyze risk sharing and fiscal spending in a two-region model withcomplete markets. Fiscal policy determines tax rates for each state ofnature. When fiscal policy is decentralized, it can be used to affect prices of securities. To manipulate prices to their beneffit, regionschoose pro-cyclical fiscal spending. This leads to incomplete risk sharing,despite the existence of complete markets and the absence of aggregaterisk. When a fiscal union centralizes fiscal policy, securities pricescan no longer be manipulated and complete risk sharing ensues. If regionsare homogeneous, median income residents of both regions prefer the fiscalunion. If they are heterogeneous, the median resident of the rich regionprefers the decentralized setting.

Asset pricing with idiosyncratic risk and overlapping generations

A number of existing studies have concluded that risk sharing allocations supported by competitive, incomplete markets equilibria are quantitatively close to first-best. Equilibrium asset prices in these models have been difficult to distinguish from those associated with a complete markets model, the counterfactual features of which have been widely documented. This paper asks if life cycle considerations, in conjunction with persistent idiosyncratic shocks which become more volatile during aggregate downturns, can reconcile the quantitative properties of the competitive asset pricing framework with those of observed asset returns. We begin by arguing that data from the Panel Study on Income Dynamics support the plausibility of such a shock process. Our estimates suggest a high degree of persistence as well as a substantial increase in idiosyncratic conditional volatility coincident with periods of low growth in U.S. GNP. When these factors are incorporated in a stationary overlapping generations framework, the implications for the returns on risky assets are substantial. Plausible parameterizations of our economy are able to generate Sharpe ratios which match those observed in U.S. data. Our economy cannot, however, account for the level of variability of stock returns, owing in large part to the specification of its production technology.

Insurance with frequent trading

This paper looks at the dynamic management of risk in an economy with discrete time consumption and endowments and continuous trading. I study how agents in such an economy deal with all the risk in the economy and attain their Pareto optimal allocations by trading in a few natural securities: private insurance contracts and a common set of derivatives on the aggregate endowment. The parsimonious nature ofthe implied securities needed for Pareto optimality suggests that insuch contexts complete markets is a very reasonable assumption.

Option pricing in market models driven by telegraph processes with jumps

Esta tesis está dividida en dos partes: en la primera parte se presentan y estudian los procesos telegráficos, los procesos de Poisson con compensador telegráfico y los procesos telegráficos con saltos. El estudio presentado en esta primera parte incluye el cálculo de las distribuciones de cada proceso, las medias y varianzas, así como las funciones generadoras de momentos entre otras propiedades. Utilizando estas propiedades en la segunda parte se estudian los modelos de valoración de opciones basados en procesos telegráficos con saltos. En esta parte se da una descripción de cómo calcular las medidas neutrales al riesgo, se encuentra la condición de no arbitraje en este tipo de modelos y por último se calcula el precio de las opciones Europeas de compra y venta.

Bubbles, collateral and monetary equilibrium

Consider an economy where infinite-lived agents trade assets collateralized by durable goods. We obtain results that rule out bubbles when the additional endowments of durable goods are uniformly bounded away from zero, regardless of whether the asset’s net supply is positive or zero. However, bubbles may occur, even for state-price processes that generate finite present value of aggregate wealth. First, under complete markets, if the net supply is being endogenously reduced to zero as a result of collateral repossession. Secondly, under incomplete markets, for a persistent positive net supply, under the general conditions guaranteeing existence of equilibrium. Examples of monetary equilibria are provided.

Asset pricing when risk sharing is limited by default: a theoretical framework

We study the asset pricing implications of an endowment economy when agents can default on contracts that would leave them otherwise worse off. We specialize and extend the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993) to make it comparable to standard studies of asset pricillg. We completely charactize efficient allocations for several special cases. We illtroduce a competitive equilibrium with complete markets alld with elldogellous solvency constraints. These solvellcy constraints are such as to prevent default -at the cost of reduced risk sharing. We show a version of the classical welfare theorems for this equilibrium definition. We characterize the pricing kernel, alld compare it with the one for economies without participation constraints : interest rates are lower and risk premia can be bigger depending on the covariance of the idiosyncratic and aggregate shocks. Quantitative examples show that for reasonable parameter values the relevant marginal rates of substitution fali within the Hansen-Jagannathan bounds.

The role of consumer's risk aversion on price rigidity

This paper aims at contributing to the research agenda on the sources of price stickiness, showing that the adoption of nominal price rigidity may be an optimal firms' reaction to the consumers' behavior, even if firms have no adjustment costs. With regular broadly accepted assumptions on economic agents behavior, we show that firms' competition can lead to the adoption of sticky prices as an (sub-game perfect) equilibrium strategy. We introduce the concept of a consumption centers model economy in which there are several complete markets. Moreover, we weaken some traditional assumptions used in standard monetary policy models, by assuming that households have imperfect information about the ineflicient time-varying cost shocks faced by the firms, e.g. the ones regarding to inefficient equilibrium output leveIs under fiexible prices. Moreover, the timing of events are assumed in such a way that, at every period, consumers have access to the actual prices prevailing in the market only after choosing a particular consumption center. Since such choices under uncertainty may decrease the expected utilities of risk averse consumers, competitive firms adopt some degree of price stickiness in order to minimize the price uncertainty and fi attract more customers fi.'