Speculative Motive Research Articles

Assessing Welfare in Models with Heterogeneous Beliefs

In models with heterogeneous beliefs, we cannot analyze policy interventions using standard methods of welfare economics. We develop a novel way of assessing welfare in such models, building on risk sharing rather than the Pareto property as the concept of efficiency. Differences of opinion engender speculative motives that frustrate risk sharing and encourage self-destructive betting. In particular, unregulated competitive equilibria in the presence of belief heterogeneity cause excessive risk-taking and insufficient risk sharing in terms of social welfare. Our analysis calls for strict regulations of fi nancial markets cursed by belief divergences, such as the controversial naked credit default swaps.

Nonprofit Cash Holdings

This study examines the determinants and implications of nonprofit cash holdings. Based on agency theory and traditional literature of cash holdings, the author develop and test a number of predictions about nonprofit cash holdings. Several important findings can be highlighted. Nonprofit cash holdings do not seem to be detrimental to nonprofits; in fact, their levels can be explained with traditional precautionary and speculative motives. Additionally, governance and managerial proxies indicate that nonprofit cash holdings may not be a function of agency problems. Consistent with a harmless interpretation of cash holdings, nonprofits with higher excess cash tend to invest more in land, buildings, and equipment than those that hold less cash. Finally, donors do not penalize organizations that hold high levels of cash.

Speculating on Home Improvements

We develop a speculation-based theory of home improvements. Housing services are produced from a mix of land and structures. Homeowners optimistic about future prices for these services speculate by making improvements, which we model as them increasing their structures holding fi xed their land. The recoup value (the di fference between the resale value of improvements and construction costs) is simultaneously increasing in home price appreciation and falls with construction cost growth. This prediction stands in contrast to a consumption-cum-fi nancial constraints motive in which rising home prices loosen fi nancial constraints and lead to lower recoup values. We provide evidence consistent with a speculative motive using data on the costs and recoup values of remodeling projects across U.S. cities.

Understanding Euro Area Money Demand

We revisit the usefulness of long–run money demand equations for the European Central Bank (ECB). First, we address the issue of their instability by performing a model evaluation exercise among different specifications using a recent time–varying cointegration test. A stable relation for euro area M3 is not rejected by data only when accounting for both a speculative motive, represented by domestic and foreign price–earnings ratios, and a precautionary motive, measured by changes in unemployment. Second, relying on this result, we estimate and identify a novel stable specification for money demand which allows us to derive policy implications for the ECB. Excess liquidity matters for both financial and price stability, being more relevant for the former. In particular, M3 overhang is a leading indicator of stock market busts. Finally, we show that our model fits the anomalous behavior of M3 in the Great Financial Crisis.

Peaks, Spikes, and Barrels: Modeling Sharp Movements in Oil Prices

Global oil markets were roiled by sharp price swings in 2008, and economists are still divided over the reasons for the unusual volatility. Those emphasizing fundamentals point to inelastic supply and demand curves, others view the phenomenon mostly as a result of financial investors flocking into commodity markets. This paper attempts to infer the strength of these competing hypotheses, using a simultaneous equation model that enables us to undertake a separate analysis of supply and demand factors. The model broadly captures both the surge and subsequent fall in prices, with a particularly strong impact of demand factors. The model captures a strong effect of a measure for global liquidity but does not find support for a speculative motive.

Peaks, Spikes, and Barrels: Modeling Sharp Movements in Oil Prices

Global oil markets were roiled by sharp price swings in 2008, and economists are still divided over the reasons for the unusual volatility. Those emphasizing fundamentals point to inelastic supply and demand curves, others view the phenomenon mostly as a result of financial investors flocking into commodity markets. This paper attempts to infer the strength of these competing hypotheses, using a simultaneous equation model that enables us to undertake a separate analysis of supply and demand factors. The model broadly captures both the surge and subsequent fall in prices, with a particularly strong impact of demand factors. The model captures a strong effect of a measure for global liquidity but does not find support for a speculative motive.

Warrant Pricing During the Financial Crisis

This study analyzes the pricing of warrants written on the Swiss Market Index (SMI) during the financial crisis. Of particular interest is how changes in warrant pricing errors, i.e. the difference in the pricing between bank-issued options and their exchange-traded counterparts, may be related to an increased awareness of issuer risk, as well as to a general sell-off of risk assets, predominantly by retail investors in the warrants market with speculative motives vs. larger, institutional investors in the traditional options market, in the wake of the market turbulences in fall 2008. We extend prior literature by studying how warrant pricing errors change over time and by analyzing a comprehensive set of factors that drive warrant overpricing to determine whether there is evidence for a decrease due to a credit risk effect. Using an event study approach, we investigate how the pricing of warrants has changed in the event window compared to the estimation period. We find that the pricing errors have in fact decreased significantly during the period of interest suggesting that warrant prices have not properly accounted for the inherent credit risk. Specifically, average abnormal pricing errors and cumulative average abnormal pricing errors across issuers and different strikes are statistically and economically significant in the event window which strongly supports the thesis of a repricing of credit risk. To validate these implications we perform regression analyses that account both for a structural break and the unit root properties of the variables and conclude that there has been a significant change in the relationship of pricing errors and credit risk post September. Also, we find that part of the decrease can be related to a sell-off of warrants by predominantly individual investors with speculative motives, while larger, institutional and more hedging-oriented clients in the options market show less activity, as evidenced by a strong increase in traded warrant contracts and a positive relationship of pricing errors to the broader Swiss equity market. Our cointegration analysis allows for a consistent estimation of the long-run relationship of pricing errors and a number of factors by properly accounting for the short-run dynamics. Overall, our results suggest that going forward pricing errors should react stronger to changes in credit risk while warrants will remain more volatile than options in general due to institutional differences and differing clientele of the two markets.

Snowball Effect of a CDS Market

Exponential growth of credit default swaps market and the resulting pile of CDS contracts of notional value of $62 trillion by the end of 2007 as well as the OTC nature of the contracts are widely believed to be one of the main causes of the current crisis and its depth, because large volumes of CDS contracts create huge counterparty risks. Facing this critique, recently the financial industry was forced to settle a large portion of the outstanding contracts (albeit not all), and centralized clearing houses for CDS transactions have been created. In the paper, we construct a stylized model of a CDS market with two types of agents, which shows that if the beliefs are asymmetric and a negligibly small fixed transaction cost is present, then, following fluctuations of beliefs, the agents will find it optimal to either buy or sell new CDS contracts but not to cancel outstanding ones. As a result, the volume of CDS contracts increases endogenously and fast once the contracts at time 0 have been issued, even if no additional speculative motives are presumed. As a solution for this snowball problem in the CDS market, we suggest to modify CDS contracts in the same way as the forward contracts were modified and futures were created.

A Microfoundation for Keynes' Speculative Motive and the Liquidity Trap

A Microfoundation for Keynes' Speculative Motive and the Liquidity Trap

Irrational Exuberance in the U.S. Housing Market: Were Evangelicals Left Behind?

The recent housing bust has reignited interest in psychological theories of speculative excess (Shiller, 2007). I investigate this issue by identifying a segment of the U.S. population - evangelical protestants - that may be less prone to speculative motives, and uncover a significant negative relationship between their population share and house price volatility. Evangelicals' focus on Biblical prophecy could account for this difference, since it may enable them to interpret otherwise negative events as containing positive news, dampening the response of house prices to shocks. I provide evidence for this channel using a popular internet measure of prophetic activity and a 9/11 event study. I also analyze survey data covering religious beliefs and asset holding, and find that 'end times' beliefs are associated with a one-third decline in net worth, consistent with these beliefs providing a form of psychic insurance (Scheve and Stasavage, 2006a and 2006b) that reduces asset demand.

Irrational Exuberance in the U.S. Housing Market: Were Evangelicals Left Behind?

The recent housing bust has reignited interest in psychological theories of speculative excess (Shiller, 2007). I investigate this issue by identifying a segment of the U.S. population-evangelical protestants-that may be less prone to speculative motives, and uncover a significant negative relationship between their population share and house price volatility. Evangelicals' focus on Biblical prophecy could account for this difference, since it may enable them to interpret otherwise negative events as containing positive news, dampening the response of house prices to shocks. I provide evidence for this channel using a popular internet measure of prophetic activity and a 9/11 event study. I also analyze survey data covering religious beliefs and asset holding, and find that 'end times' beliefs are associated with a one-third decline in net worth, consistent with these beliefs providing a form of psychic insurance (Scheve and Stasavage, 2006a and 2006b) that reduces asset demand.

Managerial Career Concerns and Risk Management

AbstractWe present a dynamic model of corporate risk management and managerial career concerns. We show that managers with low (high) initial reputation have high (low) career concerns about keeping their jobs and receiving all future income. These managers are more likely to speculate (hedge) early in their careers. In the later stage of their careers when managers have less career concerns, there is no speculative motive for self interested managers. On the other hand, highly reputable managers have minimal career concerns and they engage in neither hedging nor speculation early in their careers, but they may choose to hedge after poor early performance.

Corporate risk management and speculative motives

We develop a simple framework for analyzing corporate risk management decisions when managers have a directional prediction on future price levels. The optimal hedging strategy with “a view” retains a partial exposure and requires rebalancing. This can help explain the active trading behaviour of some managers, the large cross sectional and time series variation in hedge ratios and the prevalence of partial hedging. In addition to providing a simple account of the stylized facts, the model generates new testable implications for corporate hedging policy. We parameterize and estimate the model using foreign exchange hedging data from a large multinational corporation and find support for the model’s predictions. ∗Finance Area, Kenan-Flagler Business School, University of North Carolina at Chapel Hill, Campus Box 3490, McColl Building Chapel Hill, NC 27599-3490 (Brown). Finance Area Group, Richard Ivey School of Business, University of Western Ontario, London, ON, Canada N6A 3K7 (Khokher). We would like to thank Andres Almazan, Murray Carlson, Sheridan Titman, Klaus Toft and workshop participants at the University of Texas at Austin, the University of Western Ontario, and the University of North Carolina at Chapel Hill for their comments. All errors are our sole responsibility.

A dynamic lot sizing problem with multiple customers: customer-specific shipping and backlogging costs

This paper considers a dynamic lot sizing problem faced by a producer who supplies a single product to multiple customers. Characterized by their backorder costs as well as shipping costs, a customer with a high backorder cost has a greater need for the product than a customer with a low backorder cost. We show that the general problem with time-varying customer-dependent backlogging and shipping costs is NP-hard in the strong sense. We then develop an efficient dynamic programming algorithm for an important instance of the problem when there is no speculative motive for backlogging. We also establish forecast horizon results for the case of stationary production and shipping costs, which help the decision maker determine a proper forecast horizon in a rolling-horizon planning process.

Dynamic lot‐sizing model with production time windows

AbstractWe consider a dynamic lot‐sizing model with production time windows where each of n demands has earliest and latest production due dates and it must be satisfied during the given time window. For the case of nonspeculative cost structure, an O(nlogn) time procedure is developed and it is shown to run in O(n) when demands come in the order of latest production due dates. When the cost structure is somewhat general fixed plus linear that allows speculative motive, an optimal procedure with O(T4) is proposed where T is the length of a planning horizon. Finally, for the most general concave production cost structure, an optimal procedure with O(T5) is designed. © 2007 Wiley Periodicals, Inc. Naval Research Logistics, 2007

Polynomial Algorithms for Single-Item Lot-Sizing Models With Bounded Inventory and Backlogging or Outsourcing

This paper addresses a real-life single-item dynamic lot sizing problem arising in a refinery for crude oil procurement. It can be considered as a lot sizing problem with bounded inventory. We consider two managerial policies. With one policy, a part of the demand of a period can be backlogged and with the other, a part of the demand of a period can be outsourced. We define actuated inventory bounds and show that any bounded inventory lot sizing model can be transformed into an equivalent model with actuated inventory bounds. The concept of actuated inventory bounds significantly contributes to the complexity reduction. In the studied models, the production capacity can be assumed to be unlimited and the production cost functions to be linear but with fixed charges. The results can be easily extended to piecewise linear concave production cost functions. The goal is to minimize the total cost of production, inventory holding and backlogging, or outsourcing. We show that the backlogging model can be solved in O(T <sup xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink">2</sup> ) time with general concave inventory holding and backlogging cost functions where T is the number of periods in the planning horizon. The complexity is reduced to O(T) when the inventory/backlogging cost functions are linear and there is no speculative motives to hold either inventory or backlogging. When the outsourcing levels are unbounded, we show that the outsourcing model can be transformed into an inventory/backlogging model. As a consequence, the problem can be solved in O(T <sup xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink">2</sup> ) time, if the outsourcing cost functions are linear with fixed charges even if the inventory holding cost functions are general concave functions. When the outsourcing level of a period is bounded from above by the demand of the period, which is the case in many application areas, we show that the outsourcing model can be solved in O(T <sup xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink">2 </sup> logT) time if the inventory holding and the outsourcing cost functions are linear. Note to Practitioners-This paper considers dynamic lot-sizing models with bounded inventory and outsourcing or backlogging decisions. Based on the forecasted requirements of a given item for each period of the planning horizon, the problem consists of determining the quantity to be produced inhouse or to be ordered from a supplier and the quantity to be outsourced in each period to minimize a total cost over the considered planning horizon, composed of the production or purchasing cost, inventory holding cost, and the backlogging cost or the outsourcing cost. These problems initially come from real-life crude oil procurement and often arise in many companies. In this paper, we consider two models. In one model, backlogging is allowed with a backlogging penalty while there is no possibility of outsourcing. In the other model, all of the customer requirements are satisfied in time (i.e., without backlogging) but outsourcing is possible. For each model, we develop an algorithm to find an optimal solution. The computation time of these algorithms can be bounded by a one or two degree polynom of the number of periods in the planning horizon, which means that the computation time required to find an optimal solution is very short

Joint Production and Pricing Decisions with Setup Costs and Capacity Constraints

We consider the problem of setting prices and choosing production quantities for a single product over a finite horizon for a capacity-constrained manufacturer facing price-sensitive demands. There is a fixed cost per production run and a variable cost per unit produced, both of which may vary by period. We characterize properties of the optimal solution, considering cases with constant and time-varying capacity, and with and without speculative motive for holding inventory. We show that, counter to intuition, optimal prices may increase as the capacity increases, even when capacity is constant over the horizon. We also show that increases in capacity do not always exhibit diminishing marginal returns. Our procedure produces solutions with much higher profits than can be obtained from a sophisticated sequential procedure in which a well-informed and optimum-seeking marketing department makes pricing decisions and the manufacturing department seeks to satisfy the resulting demands at minimum cost. Our results also suggest that firms with seasonal demand and tight capacity constraints should be more aggressive in setting prices to manage their demands than what is typically done in practice. Finally, we discuss how a decision maker can use our procedure as an aid in solving multiproduct versions of the problem.

Dynamic lot-sizing model with demand time windows and speculative cost structure

We consider a deterministic lot-sizing problem with demand time windows, where speculative motive is allowed. Utilizing an untraditional decomposition principle, we provide an optimal algorithm that runs in O ( nT 3 ) time, where n is the number of demands and T is the length of the planning horizon.

Analisis Kinerja Kontrak Berjangka Komoditi pada Tokyo Grain Exchange – Jepang

Futures contract is one of derivative instruments in which its value depends on underlying asset’s price fluctuation in the future. At the beginning, the futures contracts were traded with hedging motive, but now they are traded with speculative motive also. As an agricultural nation, finally, Indonesia has a commodity futures exchange (BBJ) by the end of 2000. Low volume of transactions and less futures alternative on BBJ made Tokyo Grain Exchange (TGE) as the object of this research. The statistical test concluded: The average rate of return of futures portfolio model is greater than average of forex trading of USD, and the risk of futures portfolio model is greater than forex trading of USD.

Speculative Trading and Stock Prices: Evidence from Chinese A-B Share Premia

The market dynamics of technology stocks in the late nineties has stimulated a growing body of theories that analyze the joint effects of short-sales constraints and heterogeneous beliefs on stock prices and trading volume. This paper examines implications of these theories using a unique data sample from China, a market with stringent short-sales constraints and perfectly segmented dual-class shares. The identical rights of the dual-class shares allow us to control for stock fundamentals. We find that trading caused by investors' speculative motive can help explain a significant fraction of the price difference between the dual-class shares.