Research articles for the 2019-05-12

Applications of a New Self-Financing Equation
Rene Carmona,Kevin Webster

The goal of this note is to illustrate the impact of a self-financing condition recently introduced by the authors. We present the analyses of two specific applications usually considered in more traditional models in financial mathematics. They include hedging European options with limit orders and the optimal behavior of market makers.

Data-based Automatic Discretization of Nonparametric Distributions
Alexis Akira Toda

Although using non-Gaussian distributions in economic models has become increasingly popular, currently there is no systematic way for calibrating a discrete distribution from the data without imposing parametric assumptions. This paper proposes a simple nonparametric calibration method based on the Golub-Welsch algorithm for Gaussian quadrature. Application to an optimal portfolio problem suggests that assuming Gaussian instead of nonparametric shocks leads to up to 17% overweighting in the stock portfolio because the investor underestimates the probability of crashes.

Demand and Welfare Analysis in Discrete Choice Models with Social Interactions
Debopam Bhattacharya,Pascaline Dupas,Shin Kanaya

Many real-life settings of consumer-choice involve social interactions, causing targeted policies to have spillover-effects. This paper develops novel empirical tools for analyzing demand and welfare-effects of policy-interventions in binary choice settings with social interactions. Examples include subsidies for health-product adoption and vouchers for attending a high-achieving school. We establish the connection between econometrics of large games and Brock-Durlauf-type interaction models, under both I.I.D. and spatially correlated unobservables. We develop new convergence results for associated beliefs and estimates of preference-parameters under increasing-domain spatial asymptotics. Next, we show that even with fully parametric specifications and unique equilibrium, choice data, that are sufficient for counterfactual demand-prediction under interactions, are insufficient for welfare-calculations. This is because distinct underlying mechanisms producing the same interaction coefficient can imply different welfare-effects and deadweight-loss from a policy-intervention. Standard index-restrictions imply distribution-free bounds on welfare. We illustrate our results using experimental data on mosquito-net adoption in rural Kenya.

Empirical bias and efficiency of alpha-auctions: experimental evidence
Alexander L. Brown,Rodrigo A. Velez

We experimentally evaluate the comparative performance of the winner-bid, average-bid, and loser-bid auctions for the dissolution of a partnership. The recently introduced empirical equilibrium analysis of Velez and Brown (2019) reveals that as long as behavior satisfies weak payoff monotonicity, winner-bid and loser-bid auctions necessarily exhibit a form of bias when empirical distributions of play approximate best responses. We find support for both weak payoff monotonicity and the form of bias predicted by the theory for these two auctions. Consistently with the theory, the average-bid auction does not exhibit this form of bias. It has lower efficiency that the winner-bid auction, however.

Forecasting the Impact of Connected and Automated Vehicles on Energy Use A Microeconomic Study of Induced Travel and Energy Rebound
Morteza Taiebat,Samuel Stolper,Ming Xu

Connected and automated vehicles (CAVs) are expected to yield significant improvements in safety, energy efficiency, and time utilization. However, their net effect on energy and environmental outcomes is unclear. Higher fuel economy reduces the energy required per mile of travel, but it also reduces the fuel cost of travel, incentivizing more travel and causing an energy "rebound effect." Moreover, CAVs are predicted to vastly reduce the time cost of travel, inducing further increases in travel and energy use. In this paper, we forecast the induced travel and rebound from CAVs using data on existing travel behavior. We develop a microeconomic model of vehicle miles traveled (VMT) choice under income and time constraints; then we use it to estimate elasticities of VMT demand with respect to fuel and time costs, with fuel cost data from the 2017 United States National Household Travel Survey (NHTS) and wage-derived predictions of travel time cost. Our central estimate of the combined price elasticity of VMT demand is -0.4, which differs substantially from previous estimates. We also find evidence that wealthier households have more elastic demand, and that households at all income levels are more sensitive to time costs than to fuel costs. We use our estimated elasticities to simulate VMT and energy use impacts of full, private CAV adoption under a range of possible changes to the fuel and time costs of travel. We forecast a 2-47% increase in travel demand for an average household. Our results indicate that backfire - i.e., a net rise in energy use - is a possibility, especially in higher income groups. This presents a stiff challenge to policy goals for reductions in not only energy use but also traffic congestion and local and global air pollution, as CAV use increases.

Intermediated Implementation
Anqi Li,Yiqing Xing

We examine problems of "intermediated implementation," in which a single principal can only regulate limited aspects of the consumption bundles traded between intermediaries and agents with hidden characteristics. An example is sales, whereby retailers compete through offering consumption bundles to customers with hidden tastes, whereas a manufacturer with a potentially different goal than retailers' is limited to regulating the sold goods but not the charged prices by legal barriers. We study how the principal can implement through intermediaries any social choice rule that is incentive compatible and individually rational for agents. We demonstrate the effectiveness of per-unit fee schedule and distribution regulation, which hinges on whether intermediaries have private or interdependent values. We give further applications to healthcare regulation and income redistribution.

Pricing without martingale measure
Julien Baptiste,Laurence Carassus,Emmanuel Lépinette

For several decades, the no-arbitrage (NA) condition and the martingale measures have played a major role in the financial asset's pricing theory. We propose a new approach for estimating the super-replication cost based on convex duality instead of martingale measures duality: Our prices will be expressed using Fenchel conjugate and bi-conjugate. The super-hedging problem leads endogenously to a weak condition of NA called Absence of Immediate Profit (AIP). We propose several characterizations of AIP and study the relation with the classical notions of no-arbitrage. We also give some promising numerical illustrations.

Theory of Cryptocurrency Interest Rates
Dorje C. Brody,Lane P. Hughston,Bernhard K. Meister

A term structure model in which the short rate is zero is developed as a candidate for a theory of cryptocurrency interest rates. The price processes of crypto discount bonds are worked out, along with expressions for the instantaneous forward rates and the prices of interest-rate derivatives. The model admits functional degrees of freedom that can be calibrated to the initial yield curve and other market data. Our analysis suggests that strict local martingales can be used for modelling the pricing kernels associated with virtual currencies based on distributed ledger technologies.