Financial Market Equilibrium Research Articles

Data Factor and Financial Market Equilibrium

ABSTRACT In this paper, we develop a novel asset pricing model in which data factor is incorporated into the fundamental value to explore its impact on financial market equilibrium. It is shown that high precision of data can attenuate the fundamental risk and increase the trading intensity, thus enhancing price informativeness and liquidity along with reducing the cost of capital. Furthermore, we discover that there is a positive relationship between real investment efficiency and the correlation coefficient of data factor with productivity. Our results emphasize the important role of data factor in stock pricing and real investment, as well as reveal the internal impact mechanism of data factor on equilibrium properties, which complement the existing empirical evidences and have significant implications on data application.

Political Preferences and Financial Market Equilibrium

Political Preferences and Financial Market Equilibrium

Delegated Activism, Risk Sharing, and Financial Market Equilibrium

Delegated Activism, Risk Sharing, and Financial Market Equilibrium

The more myopic, the more chaos? How the degree of traders’ short-termism affects the financial market equilibrium

We investigate the impact of the extent of investors’ short-termism on the market equilibrium in a dynamic rational expectations model. We show that multiple equilibria always arise irrespective of the degree of traders’ myopia, and that short-termism alone may not be the cause of equilibrium multiplicity, but it does significantly affect the market quality of all equilibria. The liquidity, price efficiency and expected trading volume under the high trading intensity equilibrium (HTIE) are higher than those under the low trading intensity equilibrium (LTIE) no matter how myopic the informed traders are. As the extent of investors’ short-termism increases, the difference between the HTIE and LTIE becomes larger. Interestingly, an increase in the degree of investors’ myopia in the market on the one hand mitigates the instability of the unstable equilibrium --- the HTIE (upon market perturbations a higher degree of investors’ myopia slows down the deviation from the original equilibrium under an HTIE), but on the other hand also dampens the stability of the stable equilibrium --- the LTIE (upon market perturbations a higher degree of investors’ myopia slows down the converging process to the original equilibrium under an LTIE).

Gold Prices as a Mechanism of Control and Equilibrium in Financial Markets

Gold Prices as a Mechanism of Control and Equilibrium in Financial Markets

Public debt and the world financial market

World public debt has increased by 30% of world GDP between 2007 and 2017. During the same period, the real interest rate on public debt has fallen by roughly 200 basis points, whereas it should have increased by 100 basis points according to previous estimates. This reveals that demand for public debt has increased faster than supply. Where does the increase in savings come from? To answer this question, we construct the world financial market equilibrium to identify the country and agents across countries who increased their saving rate. Using the equality between the sum of private and public saving and investment at the world level, we observed four key phenomena. First, the world investment rate has been slightly increasing during the period, with an impressive shift of investment in China. The investment rate of China was 6% of world GDP in 2007. This jumps to 12% in 2017. Second, during the 2007-2017 period, the world experienced an impressive reduction of global imbalances. The Chinese saving rate increased less than Chinese investment, and the US saving rate increased more than US investment. Third, the increase in the world saving rate came from highly indebted countries before 2007, mostly from the US and southern Europe. The increase in the current accounts of Italy, Spain and Greece (from a negative territory) is the order of magnitude of the increase in the US current account. Fourth, there is no clear relationship between the household saving rate and national government borrowing, thus not confirming the Ricardian equivalence view. Finally, it seems that the factors generating a high net saving rate in China are temporary, whereas the deleveraging of US and southern Europe may be long-lasting. As a consequence, one can expect low interest rates for a long period of time.

Modelling Alpha in a CAPM with Heterogenous Beliefs

The alpha is one of the most used terms in finance. Yet, the alpha is mystical since it has no theory. It is, for example, in contradiction to the standard CAPM with homogenous beliefs. The purpose of this paper is to show that the alpha naturally arises in a financial market equilibrium when the CAPM is extended to heterogenous beliefs. We show that the hunt for alpha-opportunities is a zero-sum game and that alpha-opportunities erode with the assets under management. Moreover, it is shown that a positive alpha is not necessarily a good criterion for the choice between active and passive investment. Finally, we argue that the standard CAPM with homogenous beliefs can be seen as the long run outcome of our model when investors' expectations are linked to the trading success.

Financial Market Equilibrium When Information is Asymmetric and Stock Ownership is a Consumption Good

We analyze a model with information asymmetry where owning certain types of stock confers direct utility, in addition to impacting wealth. Phenomena such as a value effect, negative expected profits from trading, and volume premia arise naturally in this setting. In contrast to the more traditional wealth effects of financial assets, expected stock prices deviate from expected fundamentals even when assets are in zero net supply. We predict that this deviation will be more prevalent if a larger proportion of agents directly derive extreme utility or disutility from holding stock. We also show that asset prices may non-linearly react to signals about fundamentals, leading to booms and busts, and crashes and recoveries, if agents derive greater utility from stocks with high past fundamentals.

Performance of American and Russian joint stock companies on financial market. A microstructure perspective

This paper compares the periods before and after the Ukrainian crisis of 2014 from the perspective of market microstructure. The hypothesis is that the crisis influenced the fragile Russian financial market equilibrium. As financial markets adapt to the new equilibrium, the paper studies the effects of the crisis and the imposition of economic sanctions on Russia in terms of volatility, duration, prices and volume for selected joint stock companies listed on the U.S. and the Russian stock markets. Results reveal that the Moscow Stock exchange lacks an appropriate transmission mechanism from informed investors to the rest of the market.

Adjustable- or Fixed-Rate Mortgage? Optimal Mortgage Choice with Idiosyncratic Income Risk

This paper identifies the optimal mortgage choice of homeowners, who are subject to counter-cyclical income volatility and idiosyncratic income risk. Interest rates are found in the market equilibrium of investors with similar income risk exposures, leading to pro-cyclical equilibrium interest rates. As adjustable-rate mortgages provide a hedge against systematic income risk for homeowners, the key determinant of the optimal mortgage choice is the correlation of income with the business cycle: Homeowners with highly (low) correlated income choose an ARM (FRM). The cutoff-level for the correlation of income is decreasing in the homeowner's risk aversion. That is, the more risk-averse homeowners are more likely to choose an adjustable-rate mortgage compared to less risk-averse homeowners. The mortgage choices of homeowners have an impact on the financial market equilibrium. Equilibrium interest rates become less volatile and the market price of income volatility risk increases for larger shares of adjustable-rate mortgages. In the financial market and mortgage choice equilibrium, all markets clear and no homeowner finds it optimal to switch mortgage type.

James Tobin and Modern Monetary Theory

This paper examines the relationship of the monetary economics of James Tobin to modern monetary theory, which has diverged in many ways from the directions taken by Tobin and his associates (for example, moving away from multi-asset models of financial market equilibrium and from monetary models of long-run economic growth) but which has also built upon aspects of his work (e.g. the use of simulation and calibration in his work on inter-temporal consumption decisions). Particular attention will be paid to Tobin’s unpublished series of three Gaston Eyskens Lectures at Leuven on Neo-Keynesian Monetary Theory: A Restatement and Defense, and the paper draws on my forthcoming volume on Tobin for Palgrave Macmillan’s series on Great Thinkers in Economics.

Financial market equilibria with heterogeneous agents: CAPM and market segmentation

We consider a single-period financial market model with normally distributed returns and heterogeneous agents. Specifically, some investors are classical expected utility maximizers whereas some others follow cumulative prospect theory. Using well-known functional forms for the preferences, we analytically prove that a Security Market Line Theorem holds. This implies that capital asset pricing model is a necessary (though not sufficient) requirement in equilibria with positive prices. We prove that equilibria may not exist and we give explicit sufficient conditions for an equilibrium to exist. To circumvent the complexity arising from the interaction of heterogeneous agents, we propose a segmented-market equilibrium model where segmentation is endogenously determined.

Concentrated Equilibrium and Intraday Patterns in Financial Markets

We introduce endogenous participation of market makers into a Kyle-type model with long-lived asymmetric information. In our model with plausible parameter values, the trading volume and price volatility show a U-shaped intraday pattern, often observed in actual financial markets. It will be shown that the pattern is caused not only by the trading behaviour of liquidity traders but also by that of market makers. Our findings shed new light on the stylized fact of the trade concentration at the opening and closing periods.

Concentrated Equilibrium and Intraday Patterns in Financial Markets

We introduce endogenous participation of market makers into a Kyle-type model with long-lived asymmetric information. The main result is that under a plausible parameter setting, the trading volume and price volatility show a U-shape with respect to time, meaning that the market trading concentrates at opening and closing sessions. Our model effectively provides a theoretical explanation on the stylized fact that trading concentration occurs at the opening and closing periods in financial markets.

Intermédiation financière, croissance et effet de seuil

Résumé Cet article aborde sur un plan théorique le lien entre finance et croissance dans le cas d’une économie en voie de développement. Nous mettons au jour trois aspects ayant trait au développement économique. Tout d’abord, nous montrons le rôle central de l’entrepreneur dans l’accumulation du capital et ce, quel que soit le type de système financier envisagé. Le second point revient sur l’effet déterminant de l’intermédiation financière. En optimisant l’épargne des déposants, la banque finance un montant d’investissement important et garantit ainsi un équilibre de long terme relativement élevé. Le troisième point porte sur l’existence d’équilibres multiples avec un effet de seuil qui peut piéger la croissance dans une trappe de sous-développement. Nous montrons que l’intermédiation financière opérée par la banque est toujours plus performante que les marchés financiers pour réduire le niveau du seuil, d’une part, et garantir un équilibre de long terme relativement élevé, d’autre part.

Financial market equilibria with cumulative prospect theory

The paper first shows that financial market equilibria need not to exist if agents possess cumulative prospect theory preferences with piecewise-power value functions. This is due to the boundary behavior of the cumulative prospect theory value function, which might cause an infinite short-selling problem. But even when a non-negativity constraint on final wealth is added, non-existence can occur due to the non-convexity of CPT preferences, which might cause discontinuities in the agents’ demand functions. This latter observation also implies that concavification arguments which has been used in portfolio allocation problems with CPT preferences do not apply to our general equilibrium setting with finite many agents. Existence of equilibria is established when non-negativity constraints on final wealth are imposed and there is a continuum of agents in the market. However, if the original prospect theory is used instead of cumulative prospect theory, then other discontinuity problems can cause non-existence of market equilibria even in this case.

Threshold Effect, Financial Intermediation and Macroeconomic Performance

This paper analyzes the theoretical finance-growth nexus in the case of developing countries. Using the Neoclassical growth framework, our contribution is threefold. First, we show that entrepreneurship is a growth-enhancing factor in both financial intermediary equilibrium and financial market equilibrium. Second, we show that agent’s saving is a main determinant of the optimal proportion of long-term investment and hence, we characterize the traditional role of bank as financial intermediary (deposits and investments). Third, our model is characterized by the existence of multiple steady states equilibrium with the threshold effect of capital stock, as development trap problem, which impedes the economy to reach the higher long-run steady state equilibrium. We show that financial intermediary is better than financial market in order to reduce threshold effect, and to ensure the existence and uniqueness of a higher long-run steady state equilibrium of capital stock by promoting long-term investment.

Existence of Equilibrium in Financial Markets: Hart’s Securities Exchange Model with Consumption in the First Period

Hart has established necessary and sufficient conditions for the existence of equilibrium in an economy consisting of two time periods in which agents trade assets whose returns depend on an uncertain state of nature. Hammond has enounced an equivalent condition from an alternative approach to Hart's model. In both cases, it is assumed that agents maximize the expected value of their utility in the second period, when the asset returns are paid. In this paper, Hart's model is modified in such a way that agents also value consumption in the first period and the implications of this modication on the conditions proposed by these authors are analyzed.

Liquid Capital and Market Liquidity

This article considers how the supply of liquid capital affects the liquidity of asset markets. The article views the former notion as a technological property of real investments and the latter as an endogenous property of financial market equilibrium, and describes a channel by which the two are linked. When agents hold more wealth in technologically liquid investments, a marginal adjustment to portfolio holdings alters discount rates less, causing a smaller price impact. Thus, even without intermediaries or frictions, the stock of transformable capital may be a crucial determinant of the resilience of financial markets.

Financial Market Equilibria with Cumulative Prospect Theory

The paper first shows that financial market equilibria need not to exist if agents possess cumulative prospect theory preferences with piecewise-power value functions. This is due to the boundary behavior of the cumulative prospect theory value function, which might cause an infinite short-selling problem. But even when a nonnegativity constraint on final wealth is added, non-existence can occur due to the non-convexity of CPT preferences, which might cause discontinuities in the agents' demand functions. This latter observation also implies that concavification arguments which has been used in portfolio allocation problems with CPT preferences do not apply to our general equilibrium setting with finite many agents. Existence of equilibria is established when non-negativity constraints on final wealth are imposed and there is a continuum of agents in the market. However, if the original prospect theory is used instead of cumulative prospect theory, then other discontinuity problems can cause non-existence of market equilibria even in this case.