Financial Engineering

We develop a structural demand model that endogenously captures the effect of out-of-stocks on customer choice by simulating a time-varying set of available alternatives. Our estimation method uses store-level data on sales and partial information on product availability. Our model allows for flexible substitution patterns, which are based on utility maximization principles and can accommodate categorical and continuous product characteristics.

We study the structure of optimal wedges and capital taxes in a dynamic Mirrlees economy with endogenous distribution of skills. Human capital is a private, stochastic state variable that drives the skill process of each individual. Building on the findings of the labor literature, we construct a tractable life-cycle model of human capital evolution with risky investment and stochastic depreciation.

In this article, we discuss how to generate upper bounds for American or Bermudan securities by Monte Carlo methods. These techniques provide a useful supplement to strategies that provide lower bound estimates (e.g. eqf13-006 and eqf13-025), allowing one to both generate valid confidence intervals for the true option price and to test the accuracy to any proposed approximation to the optimal exercise strategy.

This paper examines the so far unexplored relationship between short selling and news. It starts with a theoretical analysis of short selling's potentially beneficial and harmful effects, a brief history of its regulation and a review of the existing empirical literature. The study that follows uses daily NYSE short sale trading data representing a total of 2.3 million firm days and a measure negativity of firm news based on a content analysis of the Dow Jones Newswires.

We develop a model of hedge fund returns, which reflect the contractual relationships between a hedge fund, its investors and its prime brokers. These relationships are modeled as short option positions held by the hedge fund, wherein the "funding option" reflects the short option position with prime brokers and the "redemption option" reflects the short option position with the investors. Given an alpha producing human capital, the hedge fund's ability to deploy leverage is shown to be sharply constrained by the presence of these short options.

In October 2003, leading Dutch supermarket chain Albert Heijn slashed prices up to 30% on more than 1,000 items to counter a loss in market share caused by consumer perception of high prices. AH continued the strategy for the ensuing three years, forcing competing supermarkets to match the markdowns or risk customer defections. Game theory adherents and analysts questioned the strategy, noting price wars often jeopardize profits of both individual companies and their industries.

Motivated by applications in financial services, we consider a seller who offers prices sequentially to a stream of potential customers, observing either success or failure in each sales attempt. The parameters of the underlying demand model are initially unknown, so each price decision involves a trade-off between learning and earning. Attention is restricted to the simplest kind of model uncertainty, where one of two demand models is known to apply, and we focus initially on performance of the myopic Bayesian policy (MBP), variants of which are commonly used in practice.

We develop a two sector general equilibrium model with capital accumulation and convex adjustment costs. We use the model to study capital asset pricing and reallocation, as well as optimal consumption and investment decisions. With two sectors, the consumer balances diversification against the potential productivity and efficiency gains of investing more heavily in one sector. The general framework nests and extends standard equilibrium macro-asset pricing models.

This article provides a comprehensive analysis of a new and increasingly important phenomenon: the simultaneous holding of both equity and debt claims of the same company by non-commercial banking institutions ("dual holders"). The presence of dual holders offers a unique opportunity to assess the existence and magnitude of shareholder-creditor conflicts. We find that syndicated loans with dual holder participation have loan yield spreads that are 18–32 bps lower than those without. The difference remains economically significant after controlling for the selection effect.