slides II - Personal pages of the CEU

417 Pages·2014·12.08 MB·English

by  Péter Kondor

Financial Economics
Block II: Financial markets with frictions
Pe´ ter Kondor
November 25, 2014
What is missing from CBAP? Asset pricing with frictions
Part I
Overview
What is missing from CBAP? Asset pricing with frictions
Outline of Part I
What is missing from CBAP?
Asset pricing with frictions
What is missing from CBAP? Asset pricing with frictions
What is missing from Consumption Based Asset
Pricing?
• CBAP focuses on the consumption/investment decision of
a representative agent
• prices move only when marginal utility of a dollar changes
or when investment opportunity changes
What is missing from CBAP? Asset pricing with frictions
• CBAP abstracts from
• some traders have different (better?) information than
others
• many assets are held through financial sector. Managers
might have different incentives (explicit contract, impress
investors in the short term, worry about bankruptcy etc.)
• sometimes it might be hard to form the portfolio you want
• no counterparty
• no short-sale
• trading costs
• no capital/collateral for the trade
• hard to survive short-term losses
• bounded rationality
What is missing from CBAP? Asset pricing with frictions
• typically, predictions are on monthly data, over many years
(predictability, equity premium, value and size premium etc)
• arguably, good approximation on the business cycle
frequency
• over time perhaps:
• private information becomes public
• fund managers not maximizing their investors’ utility
disappear
• you find counterparties
• boundedly rational investors disappear
• probably a good approach for explanations on why
expected returns are larger in recessions, or how much
different assets should pay on average
What is missing from CBAP? Asset pricing with frictions
• also: very powerful theory
• few assumptions, rich predictions
• consistent with marcoeconomic analysis
• quantative focus gives discipline
What is missing from CBAP? Asset pricing with frictions
• Can it explain:
• the 30% loss in the capitalization of US stock market on
1987 without any apperent reason (and the subsequent
rebounce)
• that priceline.com was valued over all major U.S. airlines
together in 1999 (and lost 97% of its value in 2000)
• that in the fall of 2008, Hungarian treasuries was unsellable
for any price?
• in the period 2004-2006, virtually all risky bonds traded with
historically record low spreads (emerging market bonds,
junk-bonds, mortgage-backed assets etc)
What is missing from CBAP? Asset pricing with frictions
• that in March 2007, a fall on Chinese stock exchange
prompted a fall in virtually all risky assets around the globe
(stocks, emerging-market bonds, junk-bonds).
• effect of the fall of interconnected institutions (Lehmann,
LTCM etc)
• that the price of virtually identical assets can differ
significantly and for an extended period (Siamese-twin
stocks)
• and, above all: the the financial crisis and the following
Great Depression in 2008-2009?
What is missing from CBAP? Asset pricing with frictions
• most of the above would fall into some notion of
”liquidity-problems”. Buzz-word, many meanings
• liquidity of an asset: speed of trade, cost of trade (bid-ask
spread or other), depth
• liquidity of the market, aggregate liquidity
• liquidity of traders (institutions), funding liquidity
• many times used for any relatively short-term discrepancy
in markets
• challenge: lack of liquidity is a symptom, should be
explained and not assumed
• for this, you have to understand how trading works: have to
consider microeconomic frictions