Non-arbitrage asset pricing has been an avenue of unending interest to financial academics and pr... more Non-arbitrage asset pricing has been an avenue of unending interest to financial academics and practitioners alike. With increased capital outflow being permitted by developing economies, investors now have easy access to securities issued by foreign firms. The issue investigated in this research is concerned with the persistent presence of arbitrage opportunities between depository receipts and domestic stocks of Indian firms during the recent financial crisis. Instead of being priced in parity with one another during the crisis, ADRs of Indian firms were overpriced by as much as 70% for months on end. This thesis investigates the reasons giving rise to this premium by analyzing causes like benefits from diversification and liquidity.
California for comments. The views expressed herein are those of the author(s) and do not necessa... more California for comments. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
Dynamic trading of long-dated securities exposes investors to resale price risk due to uncertaint... more Dynamic trading of long-dated securities exposes investors to resale price risk due to uncertainty about the future asset demands of their trading counter-parties. This paper specifically models trading and asset pricing when investors are asymmetrically informed about each other's preferences. Through a process we call demand discovery, trading reveals private information about counter-parties' preferences and, hence, about the preference-component in future prices. Demand discovery leads to endogenous joint dynamics in prices, trading volume, price volatility, and expected returns. As a result, trading volume and market liquidity are forward-looking proxies for preference risk in future prices. Demand discovery provides an alternative explanation to transaction costs for the empirical relationship between market liquidity and future returns. Stocks and bonds are claims on streams of cash flows that continue long after the typical holding horizons of most investors. The large volume of observed trading-with annual turnover of roughly 100 percent on the NYSE 1-suggests that marginal investors expect to re-trade over time as part of dynamic trading strategies. Consequently, investors' valuations of long-dated assets depend, not only on their own preferences for cash flows that they will personally receive, but also on their beliefs about the prices trading counter-parties will offer for the underlying cash flows in future trades. We argue, in particular, that investors are asymmetrically informed about each other's future state-contingent asset demands and that they learn through the trading process itself about the dynamics of their counter-parties' asset demands. This learning process-which we call demand discovery-leads to endogenous co-movement in volume, prices, risk, expected returns, and aggregate market liquidity. A large literature, starting with Campbell and Shiller [1988], documents both cash flow and discount rate randomness in asset prices. We further decompose discount rate risk into two parts: The impact of random future events (e.g., production shocks) on investors' future asset demands and randomness due to uncertainty about investors' actual future demand functions. In particular, if investors do not know how other investors will respond to future events, we call this preference risk. Possible sources of preference risk include endowment shocks (Constantinides and Duffie [1996]), uncertain habits (Campbell and Cochrane [1999]), stochastic risk aversion (Campbell, Grossman, and Wang [1993] and Gordon and St-Amour [2000]), the size of the pool of investors (Smith [1993]), funding and capital adequacy constraints, and uncertain subjective discount rates. Our analysis takes the existence of stochastic preferences as its starting point and then models the learning problem when investors do not know each others' preferences. Personal preferences are unlikely to be common knowledge. As preferences change randomly over time, investors are likely to learn their own preferences before these become known to others. Even when investors know their own future preferences in advance, this information might not be shared in full by others. In other words, investors' preferences may appear random to others, even if not to themselves. Both intuitions are consistent with the premise that investors know more about their own preferences than they do about other investors' preferences.
This paper investigates how noisy evaluation of worker skills affects human capital investments a... more This paper investigates how noisy evaluation of worker skills affects human capital investments and hiring. Individuals distort investments toward skills that most managers can evaluate. Dynamically, when workers become managers, managerial expertise can become increasingly skewed over time, raising investment distortions and reducing output. If firms select managerial expertise strategically, efficient investments can be retrieved when (a) identifying whether workers' skills matter more than distinguishing among skilled workers, and (b) initial investment distortions are small. Otherwise, such strategic design worsens long-run outcomes. Finally, we determine when short-run affirmative action policies are effective.
Separating signalling equilibria of financial markets with anonymous insiders are investi gated. ... more Separating signalling equilibria of financial markets with anonymous insiders are investi gated. Definitions of separating signalling equilibria are extended to allow for the noise that provides anonymity. The role of noise in equilibrium existence results is clarified. In particular, the result of Glosten and Madhavan, that noise is necessary for dealer markets to remain open, is qualified. The separating signalling equilibrium is written as the solution to a central planner's problem. Besides facilitating computation. this formulation highlights: (i) the critical nature of incentive compatibility constraints. (ii) the welfare aspects. The former causes many equilibrium price-quantity schedules to be non-linear and non-differentiable. Au analysis of the latter leads to the coudusiuu thal Pareto-efficient outcomes can be approximated by a repeated version of an insider game.
We develop a dynamic model of democratic politics in which both potential office holders and the ... more We develop a dynamic model of democratic politics in which both potential office holders and the electorate have heterogeneous ideologies. Voters have incomplete information about candidate ideologies, so they must use information from previous positions taken in office to make informed re-election decisions. We characterize the effects of term limits on the evolution over time of the ideological positions taken by office holders and derive the implications for voter choice and welfare. Contributions of our paper include:. We detail how pork provision by more senior incumbents interacts with term limits to affect electoral outcomes. Pork provision-transfers of resources from districts with junior legislators to districts with more senior legislators-induces voters to be more forgiving of extreme location by incumbents, especially incumbents in small or poor districts. Pork provision can explain why reelection probabilities in Congress exceed those for governors.-Term limits reduce voter welfare when all that matters are the ideological positions taken by the office holder.-Term limits may be advantageous when senior incumbents can extract benefits for their constituencies at the expense of districts with more junior representatives. Large or rich districts especially value term limits when there is substantial pork provision.. We characterize the welfare of all voters, not just the median voter.
We use the founding of the Federal Reserve to identify the effects of a lender of last resort. We... more We use the founding of the Federal Reserve to identify the effects of a lender of last resort. We examine stock return and interest rate volatility during September and October, when markets were vulnerable because of financial stringency from the harvest. Stock volatility fell by 40% and interest rate volatility by more than 70% following the monetary regime change. The drop is insignificant if major panic years are omitted from the analysis, however. Because business cycle downturns occurred in the same year as financial crises, our results suggest that the existence of the Federal Reserve reduced liquidity risk.
Non-arbitrage asset pricing has been an avenue of unending interest to financial academics and pr... more Non-arbitrage asset pricing has been an avenue of unending interest to financial academics and practitioners alike. With increased capital outflow being permitted by developing economies, investors now have easy access to securities issued by foreign firms. The issue investigated in this research is concerned with the persistent presence of arbitrage opportunities between depository receipts and domestic stocks of Indian firms during the recent financial crisis. Instead of being priced in parity with one another during the crisis, ADRs of Indian firms were overpriced by as much as 70% for months on end. This thesis investigates the reasons giving rise to this premium by analyzing causes like benefits from diversification and liquidity.
California for comments. The views expressed herein are those of the author(s) and do not necessa... more California for comments. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
Dynamic trading of long-dated securities exposes investors to resale price risk due to uncertaint... more Dynamic trading of long-dated securities exposes investors to resale price risk due to uncertainty about the future asset demands of their trading counter-parties. This paper specifically models trading and asset pricing when investors are asymmetrically informed about each other's preferences. Through a process we call demand discovery, trading reveals private information about counter-parties' preferences and, hence, about the preference-component in future prices. Demand discovery leads to endogenous joint dynamics in prices, trading volume, price volatility, and expected returns. As a result, trading volume and market liquidity are forward-looking proxies for preference risk in future prices. Demand discovery provides an alternative explanation to transaction costs for the empirical relationship between market liquidity and future returns. Stocks and bonds are claims on streams of cash flows that continue long after the typical holding horizons of most investors. The large volume of observed trading-with annual turnover of roughly 100 percent on the NYSE 1-suggests that marginal investors expect to re-trade over time as part of dynamic trading strategies. Consequently, investors' valuations of long-dated assets depend, not only on their own preferences for cash flows that they will personally receive, but also on their beliefs about the prices trading counter-parties will offer for the underlying cash flows in future trades. We argue, in particular, that investors are asymmetrically informed about each other's future state-contingent asset demands and that they learn through the trading process itself about the dynamics of their counter-parties' asset demands. This learning process-which we call demand discovery-leads to endogenous co-movement in volume, prices, risk, expected returns, and aggregate market liquidity. A large literature, starting with Campbell and Shiller [1988], documents both cash flow and discount rate randomness in asset prices. We further decompose discount rate risk into two parts: The impact of random future events (e.g., production shocks) on investors' future asset demands and randomness due to uncertainty about investors' actual future demand functions. In particular, if investors do not know how other investors will respond to future events, we call this preference risk. Possible sources of preference risk include endowment shocks (Constantinides and Duffie [1996]), uncertain habits (Campbell and Cochrane [1999]), stochastic risk aversion (Campbell, Grossman, and Wang [1993] and Gordon and St-Amour [2000]), the size of the pool of investors (Smith [1993]), funding and capital adequacy constraints, and uncertain subjective discount rates. Our analysis takes the existence of stochastic preferences as its starting point and then models the learning problem when investors do not know each others' preferences. Personal preferences are unlikely to be common knowledge. As preferences change randomly over time, investors are likely to learn their own preferences before these become known to others. Even when investors know their own future preferences in advance, this information might not be shared in full by others. In other words, investors' preferences may appear random to others, even if not to themselves. Both intuitions are consistent with the premise that investors know more about their own preferences than they do about other investors' preferences.
This paper investigates how noisy evaluation of worker skills affects human capital investments a... more This paper investigates how noisy evaluation of worker skills affects human capital investments and hiring. Individuals distort investments toward skills that most managers can evaluate. Dynamically, when workers become managers, managerial expertise can become increasingly skewed over time, raising investment distortions and reducing output. If firms select managerial expertise strategically, efficient investments can be retrieved when (a) identifying whether workers' skills matter more than distinguishing among skilled workers, and (b) initial investment distortions are small. Otherwise, such strategic design worsens long-run outcomes. Finally, we determine when short-run affirmative action policies are effective.
Separating signalling equilibria of financial markets with anonymous insiders are investi gated. ... more Separating signalling equilibria of financial markets with anonymous insiders are investi gated. Definitions of separating signalling equilibria are extended to allow for the noise that provides anonymity. The role of noise in equilibrium existence results is clarified. In particular, the result of Glosten and Madhavan, that noise is necessary for dealer markets to remain open, is qualified. The separating signalling equilibrium is written as the solution to a central planner's problem. Besides facilitating computation. this formulation highlights: (i) the critical nature of incentive compatibility constraints. (ii) the welfare aspects. The former causes many equilibrium price-quantity schedules to be non-linear and non-differentiable. Au analysis of the latter leads to the coudusiuu thal Pareto-efficient outcomes can be approximated by a repeated version of an insider game.
We develop a dynamic model of democratic politics in which both potential office holders and the ... more We develop a dynamic model of democratic politics in which both potential office holders and the electorate have heterogeneous ideologies. Voters have incomplete information about candidate ideologies, so they must use information from previous positions taken in office to make informed re-election decisions. We characterize the effects of term limits on the evolution over time of the ideological positions taken by office holders and derive the implications for voter choice and welfare. Contributions of our paper include:. We detail how pork provision by more senior incumbents interacts with term limits to affect electoral outcomes. Pork provision-transfers of resources from districts with junior legislators to districts with more senior legislators-induces voters to be more forgiving of extreme location by incumbents, especially incumbents in small or poor districts. Pork provision can explain why reelection probabilities in Congress exceed those for governors.-Term limits reduce voter welfare when all that matters are the ideological positions taken by the office holder.-Term limits may be advantageous when senior incumbents can extract benefits for their constituencies at the expense of districts with more junior representatives. Large or rich districts especially value term limits when there is substantial pork provision.. We characterize the welfare of all voters, not just the median voter.
We use the founding of the Federal Reserve to identify the effects of a lender of last resort. We... more We use the founding of the Federal Reserve to identify the effects of a lender of last resort. We examine stock return and interest rate volatility during September and October, when markets were vulnerable because of financial stringency from the harvest. Stock volatility fell by 40% and interest rate volatility by more than 70% following the monetary regime change. The drop is insignificant if major panic years are omitted from the analysis, however. Because business cycle downturns occurred in the same year as financial crises, our results suggest that the existence of the Federal Reserve reduced liquidity risk.
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