Finance Papers

Asset pricing techniques, widely used in corporations, banks, and stock and bond markets, have undergone radical changes over the last 20 years

Modern theories of portfolio choice and savings behavior have provided the basis for the innovation of these models, and Wharton’s Finance Department has remained at the forefront of these developments.

The Finance Department has four areas of specialization:

  • Banking and Financial Institutions, which entails the overall economic context affecting a firm’s investments
  • Corporate Finance, concentrating on the financing and investment activities of an organization
  • Financial Instruments and Portfolio Management, which examines financial instruments and their market behavior
  • International Finance, exploring the impact of such issues as foreign currency options and exchange rates parity on the multinational corporation

 

Wharton Faculty Research

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  • Publication
    Strategic Bidding of Offer Curves: An Agent-Based Approach to Exploring Supply Curve Equilibria
    (2013-08-16) Kimbrough, Steven. O; Murphy, Frederric H
    We model a market in which suppliers bid step-function offer curves using agent-based modeling. Our model is an abstraction of electricity markets where step-function offer curves are given to an independent system operator that manages the auctions in electricity markets. Positing an elementary and computationally accessible learning model, Probe and Adjust, we present analytic results that characterize both the behavior of the learning model and the properties of step-function equilibria. Thus, we have developed a framework for validating agent-based models prior to using them in situations that are too complicated to be analyzed using traditional economic theory. In addition, we demonstrate computationally that, by using alternative policies, even simple agents can achieve monopoly rewards for themselves by pursuing more industry-oriented strategies. This raises the issue of how participants in oligopolistic markets actually behave.
  • Publication
    The Effects of Government Intervention on the Market for Corporate Terrorism Insurance
    (2011-12-01) Michel-Kerjan, Erwann; Raschky, Paul A
    Nine OECD countries presently have national terrorism insurance programs based on some type of public–private risk sharing. While such arrangements have helped provide the necessary insurance capacity in the post-September 11, 2001 era, little is known about the effect of such governmental intervention on terrorism insurance markets. This paper focuses on the United States, where the Terrorism Risk Insurance Act of 2002 (TRIA) provides insurers with no cost federal reinsurance up to an industry-wide loss of $100 billion. We present an empirical analysis to compare how insurers' diversification behavior varies between property coverage (no governmental intervention) and terrorism coverage (with government intervention). We find evidence that insurers in the U.S. are much less diversified for terrorism coverage than they are for property lines of coverage. We interpret these findings as tentative evidence for moral hazard caused by the governmental intervention under TRIA. Research highlights ► We study the effect of TRIA on insurers’ diversification behavior for terrorism lines in the United States. ► Policy-level demand and supply data for terrorism and property coverage are compiled from a unique database of hundreds of commercial firms. ► Government intervention indeed reduces insurer’s portfolio diversification. ► Government intervention also reduces effect of liquidity concerns in supply decision.
  • Publication
    Understanding College Application Decisions Why College Sports Success Matters
    (2014-01-01) Pope, Devin G; Pope, Jaren C
    Using a unique, national data set that indicates where students choose to send their SAT scores, the authors find that college sports success has a large impact on student application decisions. For example, a school that has a stellar year in basketball or football on average receives up to 10% more SAT scores. Certain demographic groups (males, Blacks, out-of-state students, and students who played sports in high school) are more likely to be influenced by sports success than their counterparts. The authors explore the reasons why students might be influenced by these sporting events and present evidence that attention/accessibility helps explain these findings.
  • Publication
    Investment and Sales: Some Empirical Evidence
    (1988) Abel, Andrew B; Blanchard, Olivier J
    This paper attempts to give a structural interpretation to the distributed lag of sales on investment at the two-digit level in US manufacturing. It first presents a simple model which captures the various sources of lags and their respective implications. It then estimates the model, using both data on investment and sales as well as direct evidence on the sources of lags. The spirit of the paper is exploratory ; the model is used mainly as a vehicle to construct, present and interpret the data. We find that the following model can roughly generate the distributed lag structure found in the data. Firms face delivery lags of 3 quarters. They also face adjustment costs, which lead them to take into account expected future sales, with discount factor -9 when constructing the desired capital stock, and to close about 5% of the gap between actual and desired capital per quarter. They pay for orders at a constant rate between the time of order and that of delivery. The model is however not very successful in explaining differences in dynamics across sectors.
  • Publication
    Do Political Parties Matter? Evidence from U.S. Cities
    (2009-02-01) Ferreira, Fernando V; Gyourko, Joseph
    Are cities as politically polarized as states and countries? “No” is the answer from our regression discontinuity design analysis, which shows that whether the mayor is a Democrat or a Republican does not affect the size of city government, the allocation of local public spending, or crime rates. However, there is a substantial incumbent effect for mayors. We investigate three mechanisms that could account for the striking lack of partisan impact at the local level, and find the most support for Tiebout competition among localities within metropolitan areas.
  • Publication
    A Non-Linear Macroeconomic Term Structure Model
    (2013-10-05) Richard, Scott F
    This model uses three implicit states (Core CPI, the unemployment rate, and the quarterly growth rate of non-farm payrolls) which follow a multivariate continuous-time Ornstein-Uhlenbeck (OU) process. The instantaneous risk-free rate (Fed Funds) is set using a policy rule (following Black (1995)) which is affine in the implicit states with a lower bound at one basis point. The policy rule is fixed throughout the sample period from November, 1985 through March, 2013. While the policy rule is fixed throughout the sample, the economy responds differently when Fed Funds are stuck at their minimum (the Zero Period) than it does when the Fed can use Fed Funds more effectively to influence the economy (the Normal Period). The implicit state OU processes have different coefficients, both physical and risk neutral, in the two response periods. While market participants may know the implicit states, an econometrician must estimate from them market and macroeconomic data. I estimate the implicit states and the OU processes parameters by maximizing the joint conditional likelihood that the implicit states are close to the government states estimates; that the model accurately determines the yield curve; and that the actual one-month returns are forecasted by the model. The data are monthly estimates of the state variables published by the government, month-end zero coupon yield curves with maturities from 2 to 30 years published by the Fed, and one month returns for the benchmark 2, 10, and 30 year Treasury zeros calculated from the month-end yield curves from November, 1985 through March, 2013. Over the entire sample the root mean square error (RMSE) in fitting yield curves is only 4.6 basis points. I find conditional yield curve responses to changes in the state variables, which are significantly different from the unconditional factors. The model is tested out-of-sample by fitting Treasury Inflation Protected Securities. I find ample profit opportunities.
  • Publication
    Sticky Leverage
    (2016-12-12) Gomes, Joao F; Jermann, Urban J; Schmid, Lukas
    We develop a tractable general equilibrium model that captures the interplay between nominal long-term corporate debt, inflation, and real aggregates. We show that unanticipated inflation changes the real burden of debt and, more significantly, leads to a debt overhang that distorts future investment and production decisions. For these effects to be both large and very persistent, it is essential that debt maturity exceeds one period. We also show that interest rate rules can help stabilize our economy.
  • Publication
    Asymmetric Information and Intermediation Chains
    (2016-09-01) Glode, Vincent; Opp, Christian C
    We propose a parsimonious model of bilateral trade under asymmetric information to shed light on the prevalence of intermediation chains that stand between buyers and sellers in many decentralized markets. Our model features a classic problem in economics where an agent uses his market power to inefficiently screen a privately informed counterparty. Paradoxically, involving moderately informed intermediaries also endowed with market power can improve trade efficiency. Long intermediation chains in which each trader's information set is similar to those of his direct counterparties limit traders' incentives to post prices that reduce trade volume and jeopardize gains to trade.
  • Publication
    Heterogeneity in Neighborhood-Level Price Growth in the United States, 1993–2009
    (2012-05-01) Ferreira, Fernando V; Gyourko, Joseph
    Examination of detailed geographical information on U.S. housing transactions from 1993 to 2009 find much heterogeneity at the neighborhood level in when the recent boom began, how big the initial jumps in price growth were, how long the booms lasted, and what types of neighborhoods boomed first. There is less neighborhood-level heterogeneity in when the bust began and in aggregate price appreciation during the boom. This heterogeneity suggests that there was no one dominant cause of the boom. We also comment on how very local data may help understand the role of contagion, among other housing market phenomena.
  • Publication
    On the Timing and Pricing of Dividends
    (2012-06-01) Binsbergen, Jules H. van; Brandt, Michael W; Koijen, Ralph
    We present evidence on the term structure of the equity premium. We recover prices of dividend strips, which are short-term assets that pay dividends on the stock index every period up to period T and nothing thereafter. It is short-term relative to the index because the index pays dividends in perpetuity. We find that expected returns, Sharpe ratios, and volatilities on short-term assets are higher than on the index, while their CAPM betas are below one. Short-term assets are more volatile than their realizations, leading to excess volatility and return predictability. Our findings are inconsistent with many leading theories.