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74
Basic Principles of Asset Pricing Theory: Evidence from LargeScale Experimental Financial Markets
, 1999
"... We report on six largescale financial markets experiments that were designed to test two of the most basic propositions of modern asset pricing theory, namely, that the interaction between risk averse agents in a competitive market leads to equilibration, and that, in equilibrium, risk premia are ..."
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Cited by 34 (21 self)
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We report on six largescale financial markets experiments that were designed to test two of the most basic propositions of modern asset pricing theory, namely, that the interaction between risk averse agents in a competitive market leads to equilibration, and that, in equilibrium, risk premia are solely determined by covariance with aggregate risk. We designed the experiments within the framework suggested by two theoretical models, namely, Arrow and Debreu’s completemarkets model, and the SharpeLintnerMossin Capital Asset Pricing Model (CAPM). This framework enabled us to measure how far our markets were from equilibrium at any point in time, thereby allowing us to gauge the success of the models. The distance measures do not require knowledge of the (uncontrollable) level and dispersion of risk aversion among subjects, and adjust for the impact of progressive trading on the eventual equilibrium. Unlike in our earlier, thinmarkets experiments, we discovered swift convergence towards equilibrium prices of Arrow and Debreu’s model or the CAPM. This discovery is significant, because subjects always lacked the information to deliberately set asset prices using either model. Sometimes, however, the equilibrium was not found to be robust, with markets readily veering away, apparently as a result of deviations of subjective beliefs from objective probabilities. Still, we find evidence that this did not destroy the tendency for markets to equilibrate as predicted by the theory. In each experiment, we formally test and reject the hypothesis that prices are a random walk, in favor of stochastic convergence towards CAPM and Arrow Debreu equilibrium.
The Paradox Of Asset Pricing
, 2001
"... Modern finance has generated a set of formal models of the workings of financial markets that certainly excel in terms of mathematical elegance. But abstract beauty and logical appeal do not guarantee scientific validity. The illustrious late Richard Feynman, professor of physics at Caltech, made th ..."
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Cited by 18 (2 self)
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Modern finance has generated a set of formal models of the workings of financial markets that certainly excel in terms of mathematical elegance. But abstract beauty and logical appeal do not guarantee scientific validity. The illustrious late Richard Feynman, professor of physics at Caltech, made the same observation when he discussed the derivation of the law of gravitational potential energy from the "axiom" of conservation of energy. (See the above quote.) Fortunately for physicists, there is ample evidence that the law of gravitational potential energy is correct (to a certain degree). In contrast, there appears to be surprisingly little scientific support for even the most widely used financial model, namely, the CAPM. One can sympathize with E. Fama and K. French when they have recently begun to promote a pricing model that is based entirely on statistical regularities, even if it begs the question why it is more successful. To put this di#erently, asset pricing is paradoxical
The Evolution of Portfolio Rules and the Capital Asset Pricing Model
, 1998
"... The aim of this paper is to test the performance of the standard version of CAPM in an evolutionary framework. We imagine a heterogeneous population of longlived agents who invest their wealth according to dierent portfolio rules and we ask what is the fate of those who happen to behave as prescrib ..."
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Cited by 9 (3 self)
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The aim of this paper is to test the performance of the standard version of CAPM in an evolutionary framework. We imagine a heterogeneous population of longlived agents who invest their wealth according to dierent portfolio rules and we ask what is the fate of those who happen to behave as prescribed by CAPM. In a complete securities market with aggregate uncertainty, we prove that traders who either believe in CAPM and use it as a rule of thumb, or are endowed with genuine meanvariance preferences, under some very weak conditions, vanish in the long run. We show that a sucient condition to drive CAPM or mean variance traders wealth shares to zero is that an investor endowed with a logarithmic utility function enters the market. We nally check the robustness of our results allowing for dierent kinds of heterogeneity among traders.
An Equilibrium Model of Asset Pricing and Moral Hazard
 Review of Financial Studies
, 2005
"... paper represents a major extension of a section in Chapter 2 of my Ph.D. dissertation submitted to the University of California at Berkeley, where a twoasset equilibrium was developed. I am very grateful to Navneet Arora ..."
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Cited by 9 (1 self)
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paper represents a major extension of a section in Chapter 2 of my Ph.D. dissertation submitted to the University of California at Berkeley, where a twoasset equilibrium was developed. I am very grateful to Navneet Arora
The Behavioural Economics of Climate Change
, 2008
"... This paper attempts to bring some central insights from behavioural economics into the economics of climate change. In particular, it discusses (i) implications of prospect theory, the equity premium puzzle and time inconsistent preferences in the choice of discount rate used in climate change cost ..."
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Cited by 5 (0 self)
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This paper attempts to bring some central insights from behavioural economics into the economics of climate change. In particular, it discusses (i) implications of prospect theory, the equity premium puzzle and time inconsistent preferences in the choice of discount rate used in climate change cost assessments, and (ii) the implications of various kinds of social preferences for the outcome of climate negotiations. Several reasons are presented for why it appears advisable to choose a substantially lower social discount rate than the average return on investments. It also seems likely that taking social preferences into account increases the possibilities of obtaining international agreements, compared to the standard model. However, there are also effects going in the opposite direction, and the importance of sanctions is emphasised.
Videoondemand systems
 in Handbook of Internet and Multimedia Systems and Applications
, 1998
"... ..."
2003) : “Two Paradigms and Nobel Prizes in Economics: a Contradiction or Coexistence?”, NCCRFinrisk Working Paper No
"... Markowitz and Sharpe won the Nobel Prize in Economics for the development of MeanVariance (MV) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected uti ..."
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Cited by 4 (3 self)
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Markowitz and Sharpe won the Nobel Prize in Economics for the development of MeanVariance (MV) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU) maximization in the face of risk aversion. Kahneman and Tversky suggest Prospect Theory (PT) as an alternative paradigm to EU theory. They show that investors distort probabilities, make decisions based on change of wealth, exhibit loss aversion and maximize the expectation of an Sshaped value function, which contains a riskseeking segment. Can these two apparently contradictory paradigms coexist? We show in this paper that although CPT (and PT) is in conflict to EUT, and violates some of the CAPM’s underlying assumptions, the Security Market Line Theorem (SMLT) of the CAPM is intact in the CPT framework. Therefore, the CAPM is intact also in CPT framework.
Home bias and International Capital Asset Pricing Model with Human Capital
 Journal of Multinational Financial Management
, 2001
"... University, Laval University and University of Ottawa for their comments and suggestions. I thank the C.E.R.A.G. U.M.R. 5820 C.N.R.S., University of Grenoble, and the C.R.É.F.A. at Laval University for providing data and financial assistance. I remain responsible for errors. We develop an Internatio ..."
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Cited by 4 (0 self)
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University, Laval University and University of Ottawa for their comments and suggestions. I thank the C.E.R.A.G. U.M.R. 5820 C.N.R.S., University of Grenoble, and the C.R.É.F.A. at Laval University for providing data and financial assistance. I remain responsible for errors. We develop an International Capital Asset Pricing Model in continuous time including human capital. Optimal portfolio choice and asset valuation are analyzed. We show that optimal portfolio consists of three funds; the logarithmic portfolio, the hedge portfolio against inflation and the portfolio combined with returns on human capital (income). We test this model and underline its contribution to the explanation of home bias observed in
Quantitative Selection of LongShort Hedge Funds
 FAME and HEC Lausanne, Working Paper
, 2003
"... The huge capital inflow into hedge funds has motivated this study. Whereas the meanvariance community likes the diversification benefits provided by hedge funds, "searching for alpha " (Ineichen, 2002) is the major force behind their increasing popularity. The second component of the return, the ex ..."
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Cited by 3 (0 self)
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The huge capital inflow into hedge funds has motivated this study. Whereas the meanvariance community likes the diversification benefits provided by hedge funds, "searching for alpha " (Ineichen, 2002) is the major force behind their increasing popularity. The second component of the return, the exposure to market beta, is cheaply available by investing in traditional asset classes, such as the index funds. In this paper we focus on a specific point for hedge fund investments: the selection of hedged equity funds, which cover (a) longshort equity, (b) dedicated short bias as well as (c) equity market neutral. This style has the largest market share in the hedge fund sector. We concentrate our investigations on hedged equity funds for the following reasons: 1. The huge capacity. Insomuch as the investment universe is the whole equity market the considered funds are not expected to suffer decreasing returns with increased number of investors in the market, as it is anticipated for eventdriven and relativevalue hedge funds. 2. The excellent liquidity. It allows more favorable leveraging schemes for widely
Incomplete Information Equilibria: Separation Theorems and Other Myth
, 2004
"... The incomplete information financial economic equilibrium (IIE) literature has been growing at a growing rate since its inception in the early nineteen eighties. This paper highlights, clarifies, and examines issues and concepts essential to this equilibrium. These include: the number of state var ..."
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Cited by 3 (0 self)
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The incomplete information financial economic equilibrium (IIE) literature has been growing at a growing rate since its inception in the early nineteen eighties. This paper highlights, clarifies, and examines issues and concepts essential to this equilibrium. These include: the number of state variables, irrelevance of separation theorems, unobservable productivity processes that lead to complete information, relative level of variances and deterministic IIE, IIE and incomplete markets, the (im)persistence of heterogeneous beliefs, and the relation of IIE to the model uncertainty/ambiguity approach. Understanding concepts under IIE facilitates understanding these concepts under complete information equilibria, a special case of IIE.