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40
The Determinants of Credit Spread Changes
, 2001
"... Using dealer’s quotes and transactions prices on straight industrial bonds, we investigate the determinants of credit spread changes. Variables that should in theory determine credit spread changes have rather limited explanatory power. Further, the residuals from this regression are highly crossco ..."
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Cited by 364 (2 self)
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Using dealer’s quotes and transactions prices on straight industrial bonds, we investigate the determinants of credit spread changes. Variables that should in theory determine credit spread changes have rather limited explanatory power. Further, the residuals from this regression are highly crosscorrelated, and principal components analysis implies they are mostly driven by a single common factor. Although we consider several macroeconomic and financial variables as candidate proxies, we cannot explain this common systematic component. Our results suggest that monthly credit spread changes are principally driven by local supply0 demand shocks that are independent of both creditrisk factors and standard proxies for liquidity.
A Model of Intertemporal Asset Prices Under Asymmetric Information
, 1993
"... This paper presents a dynamic assetpricing model under asymmetric information. Investors have different information concerning the future growth rate of dividends. They rationally extract information from prices as well as dividends and maximize their expected utility. The model has a closedform s ..."
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Cited by 155 (10 self)
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This paper presents a dynamic assetpricing model under asymmetric information. Investors have different information concerning the future growth rate of dividends. They rationally extract information from prices as well as dividends and maximize their expected utility. The model has a closedform solution to the rational expectations equilibrium. We find that existence of uninformed investors increases the risk premium. Supply shocks can affect the risk premium only under asymmetric information. Information asymmetry among investors can increase price volatility and negative autocorrelation in returns. Lessinformed investors may rztionally behave like price chasers.
Portfolio and consumption decisions under meanreverting returns: An exact solution for complete markets
 Journal of Financial and Quantitative Analysis 37, 63–91. The Journal of Finance Wachter, Jessica A
, 2003
"... This paper solves, in closed form, the optimal portfolio choice problem for an investor with utility over consumption under meanreverting returns. Previous solutions either require approximations, numerical methods, or the assumption that the investor does not consume over his lifetime. This paper ..."
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Cited by 114 (7 self)
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This paper solves, in closed form, the optimal portfolio choice problem for an investor with utility over consumption under meanreverting returns. Previous solutions either require approximations, numerical methods, or the assumption that the investor does not consume over his lifetime. This paper breaks the impasse by assuming that markets are complete. The solution leads to a new understanding of hedging demand and of the behavior of the approximate loglinear solution. The portfolio allocation takes the form of a weighted average and is shown to be analogous to duration for coupon bonds. Through this analogy, the notion of investment horizon is extended to that of an investor who consumes at multiple points in time.
The Term Structures of Equity and Interest Rates
, 2007
"... This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks conv ..."
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Cited by 33 (5 self)
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This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks convey information about how the representative investor values cash flows of different maturities. We model how the representative investor perceives risks of these cash flows by specifying a parsimonious stochastic discount factor for the economy. Shocks to dividend growth, the real interest rate, and expected inflation are priced, but shocks to the price of risk are not. Given reasonable assumptions for dividends and inflation, we show that the model can simultaneously account for the behavior of aggregate stock returns, an upwardsloping yield curve, the failure of the expectations hypothesis and the poor performance of the capital asset pricing model.
A general formula for valuing defaultable securities
 Econometrica
, 2004
"... Previous research has shown that under a suitable nojump condition, the price of a defaultable security is equal to its riskneutral expected discounted cash flows if a modified discount rate is introduced to account for the possibility of default. Below, we generalize this result by demonstrating ..."
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Cited by 28 (1 self)
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Previous research has shown that under a suitable nojump condition, the price of a defaultable security is equal to its riskneutral expected discounted cash flows if a modified discount rate is introduced to account for the possibility of default. Below, we generalize this result by demonstrating that one can always value defaultable claims using expected riskadjusted discounting provided that the expectation is taken under a slightly modified probability measure. This new probability measure puts zero probability on paths where default occurs prior to the maturity, and is thus only absolutely continuous with respect to the riskneutral probability measure. After establishing the general result and discussing its relation with the existing literature, we investigate several examples for which the nojump condition fails. Each example illustrates the power of our general formula by providing simple analytic solutions for the prices of defaultable securities.
A general methodology to price and hedge derivatives in incomplete markets, I.J.T.A.F. [to be submitted
"... We introduce and discuss a general criterion for the derivative pricing in the general situation of incomplete markets, we refer to it as the No Almost Sure Arbitrage Principle. This approach is based on the theory of optimal strategy in repeated multiplicative games originally introduced by Kelly. ..."
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Cited by 9 (4 self)
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We introduce and discuss a general criterion for the derivative pricing in the general situation of incomplete markets, we refer to it as the No Almost Sure Arbitrage Principle. This approach is based on the theory of optimal strategy in repeated multiplicative games originally introduced by Kelly. As particular cases we obtain the CoxRossRubinstein and BlackScholes in the complete markets case and the Schweizer and BouchaudSornette as a quadratic approximation of our prescription. Technical and numerical aspects for the practical option pricing, as large deviation theory approximation and Monte Carlo computation are discussed in detail. 1.
2012 “From dissonance to resonance: Cognitive interdependence in quantitative finance
 Economy and Society
"... This study explores the elusive social dimension of quantitative finance. We conducted three years of observations in the derivatives trading room of a major investment bank. We found that traders use models to translate stock prices into estimates of what their rivals think. Traders use these estim ..."
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Cited by 6 (2 self)
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This study explores the elusive social dimension of quantitative finance. We conducted three years of observations in the derivatives trading room of a major investment bank. We found that traders use models to translate stock prices into estimates of what their rivals think. Traders use these estimates to look out for possible errors in their own models. We found that this practice, reflexive modeling, enhances returns by turning prices into a vehicle for distributed cognition. But it also induces a dangerous form of cognitive interdependence: when enough traders overlook a key issue, their positions give misplaced reassurance to those traders that think similarly, disrupting their reflexive processes. In cases lacking diversity, dissonance thus gives way to resonance. Our analysis demonstrates how practices born in caution can lead to overconfidence and collective failure. We contribute to economic sociology by developing a sociotechnical account that grapples with the new forms of sociality introduced by financial models – dissembedded yet entangled; anonymous yet collective; impersonal yet, nevertheless, emphatically social.
Consumption Commitments: A Foundation for ReferenceDependent Preferences and Habit Formation
, 2010
"... We build a theory of referencedependent preferences based on adjustment costs in consumption. The main contribution of the theory is that it endogenizes the evolution of the reference point. The reference point generated by our model exhibits several features exogenously assumed in existing theorie ..."
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Cited by 4 (0 self)
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We build a theory of referencedependent preferences based on adjustment costs in consumption. The main contribution of the theory is that it endogenizes the evolution of the reference point. The reference point generated by our model exhibits several features exogenously assumed in existing theories: it (1) re‡ects recent expectations, (2) depends on past consumption levels, and (3) diminishes in importance when agents experience large shocks. When the ratio of idiosyncratic to aggregate risk is large, the model is approximately equivalent to standard habit formation speci…cations in which the reference point is a weighted average of past consumption. We illustrate the implications of endogenizing the reference point using three applications: aggregate consumption dynamics, changes in policy parameters, and the welfare cost of shocks. In each application, our model of endogenous reference points con…rms certain intuitions from existing theories but yields some starkly di¤erent predictions. For example, reducing idiosyncratic risk can raise the welfare cost of aggregate shocks by making reference points more persistent.
Market structure, security prices and informational efficiency
 MACROECONOMIC DYNAMICS
, 1997
"... We consider an economy with an incomplete securities market and heterogeneously informed investors. Each investor trades in the market to hedge the risk to his endowment and to speculate on future security payoffs using his private information. We examine the efficiency of the securities market in a ..."
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Cited by 4 (1 self)
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We consider an economy with an incomplete securities market and heterogeneously informed investors. Each investor trades in the market to hedge the risk to his endowment and to speculate on future security payoffs using his private information. We examine the efficiency of the securities market in allocating risk and transmitting information under different market structures, as defined by the set of securities traded in the market. We show that the introduction of derivative securities can decrease the market’s efficiency in revealing information on security payoffs, and increase the equity premium and price volatility in the market.