Fundamental Investment Analysis

Many economic decisions can be described as an option exercise or optimal stopping problem under uncertainty. Motivated by experimental evidence such as the Ellsberg Paradox, we follow Knight (1921) and distinguish risk from uncertainty. To afford this distinction, we adopt the multiple-priors utility model. We show that the impact of ambiguity on the option exercise decision depends on the relative degrees of ambiguity about continuation payoffs and termination payoffs. Consequently, ambiguity may accelerate or delay option exercise.

Accounting for Value teaches investors and analysts how to handle accounting in evaluating equity investments. The book's novel approach shows that valuation and accounting are much the same: valuation is actually a matter of accounting for value.

During 2008 and 2009, the insurance industry experienced unprecedented volatility. The large swings in insurers' market valuations, and the significant role that financial reporting played in the uncertainty surrounding insurance companies during that period, highlight the importance of understanding insurers' financial information and its implications for the risk and value of insurance companies.

We argue that a fundamental reason for the short-term perspective of corporate executives is the short-term orientation of shareholders themselves and the financial markets that drive the performance benchmarks of CEOs. Although some shareholders are prepared to take a more long-term view they are generally not rewarded for their loyalty to the company.

This article studies optimal mortgage design in a continuous-time setting with volatile and privately observable income, costly foreclosure, and a stochastic market interest rate. We show that the features of the optimal mortgage are consistent with an option adjustable-rate mortgage (option ARM). Under the optimal contract, the borrower is given discretion of how much to repay until his balance reaches a certain limit. The default rates and interest rate payment on the mortgage correlate positively with the market interest rate.

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.

One measure of the health of the Social Security system is the difference between the market value of the trust fund and the present value of benefits accrued to date. How should present values be computed for this calculation in light of future uncertainties? We think it is important to use market value. Since claims on accrued benefits are not currently traded in financial markets, we cannot directly observe a market value. In this paper, we use a model to estimate what the market price for these claims would be if they were traded.

If an investor wants to form a portfolio of risky assets and can exert effort to collect information on the future value of these assets before he invests, which assets should he learn about? The best assets to acquire information about are ones the investor expects to hold. But the assets the investor holds depend on the information he observes. We build a framework to solve jointly for investment and information choices, with general preferences and information cost functions.

The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks whose volatilities are commensurate with their risk aversion. The data, 1995-2000 holdings of over 20,000 clients at a large German broker, are consistent with the predictions of the hypothesis: the portfolios contain highly similar stocks in terms of volatility, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk averse customers indeed hold and trade into less volatile stocks.