We report on six large-scale 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 complete-markets model, and the Sharpe-Lintner-Mossin 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, thin-markets 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.

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 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 long-lived 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 mean-variance 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.

The huge capital inflow into hedge funds has motivated this study. Whereas the mean-variance 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) long-short 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 event-driven and relative-value hedge funds. 2. The excellent liquidity. It allows more favorable leveraging schemes for widely

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.

Under the assumption of normally distributed returns, we analyze whether the Cumulative Prospect Theory of Tversky and Kahneman (1992) is consistent with the Capital Asset Pricing Model. We find that in every financial market equilibrium the Security Market Line Theorem holds. However, under the specific functional form suggested by Tversky and Kahneman (1992) financial market equilibria do not exist. We suggest an alternative functional form that is consistent with both, the experimental results of Tversky and Kahneman and also with the existence of equilibria.

is an engagement

this dissertation. It is comfortable to stand on the shoulders of two men with giant commercial success: this gives me the idea that my theoretical work has a purpose

In this paper, we survey ideas and principles of modeling the investment decision process of economic agents. We start with the criteria of Markowitz of formulating return and risk as mean and variance, and also its extensions. We then look into other related criteria which are based on probability assumptions on future prices of securities. We also present methodologies which, instead of assuming probability distributions, rely on the best solution for the worst case scenario or in the average. A few multiple stage optimization models are discussed. Finally we give a few remarks on some interesting topics for further investigations.

This paper develops some results regarding the economic value added and real options. We use Merton’s (1987) model of capital market equilibrium with incomplete information to introduce information costs in the pricing of real assets. This model allows a new definition of the cost of capital in the presence of information uncertainty. Using the methodology in Bellalah (2001, 2002) for the pricing of real options, we extend the standard models to account for shadow costs of incomplete information.