Christophe Faugère

Designing free software samples: a game theoretic approach

We develop a vertical differentiation game-theoretic model that addresses the issue of designing free software samples (shareware) for attaining follow-on sales. When shareware can be reinstalled, cannibalization of sales of the commercial product may ensue. We analyze the optimal design of free software according to two characteristics: the evaluation period allotted for sampling (potentially renewable) and the proportion of features included in the sample. We introduce a new software classification scheme based on the characteristics of the sample that aid consumer learning. We find that the optimal combination of features and trial time greatly depends on the category of software within the classification scheme. Under alternative learning scenarios, we show that the monopolist may be better off not suppressing potential shareware reinstallation.

The Equity Premium: Consistent with GDP Growth and Portfolio Insurance

We find that the long-term equity premium is consistent with both GDP growth and portfolio insurance. We use a supply-side growth model and demonstrate that the arithmetic average stock market return and the returns on corporate assets and debt depend on GDP per capita growth. The implied equity premium matches the U.S. historical average over 1926-2001. Separately, we find that the equity premium tracks the value of a put option on the S&P 500. Our theory predicts a smaller equity premium in the future, assuming that the recent regime shifts in dividend policies, interest rates, and tax rates are permanent. Copyright 2006, The Eastern Finance Association.

The Price of Gold: A Global Required Yield Theory

A gold valuation theory based on viewing gold as a global real store of wealth shows that the real price of gold varies inversely with the stock market P/E. The price thus is a direct function of a global yield required to achieve a constant real after-tax return equal to long-term global real GDP per capita growth. Foreign exchange affects the price of gold to the extent that required yields and purchasing power parity equalizations do not take place across nations in the short run. A quarterly valuation model constructed using concurrent economic data yields prices that track real U.S. gold prices over 1979–2002 within 12% of tracking error. Prices are sometimes briefly impacted by major world events.

A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination

Stock market valuation and Treasury yield determination are consistent with the Fisher effect (1896) as generalized by Darby (1975) and Feldstein (1976). The U.S. stock market (SP 2) the stock market is indeed priced as the present value of expected dividends with the proviso that investors are expecting fast mean reversion of the SP 5) the yield spread is largely explained by the differential of long-term book value per share growth vs. near term growth, with possible yield curve inversions. Finally, 7) the Fed model is partially validated since both the S&P 500 forward earnings yield and the ten-year Treasury yield are determined by a common factor: the required yield.

Ruthless Compassion in Banking and Finance

Beyond the severe economic impact, another consequence of the 2008 financial crisis is the worldwide indignation felt toward the finance industry for its direct involvement in creating this crisis. It is now a befitting question to ask: What, if any, is the noble purpose of finance? I apply the definition of noble as used in Buddhism. I introduce the Buddhist concept of Ruthless Compassion, taught by Tibetan Master Chogyam Trungpa Rinpoche. I assert that Ruthless Compassion is a valuable quality for the job of banker or financier, as it is another tool available to reduce the costs associated with the typical asymmetry of information. A preliminary inquiry is launched into whether this concept can serve as a stepping stone for defining a new value system easily applicable in the finance industry.

Sell Discipline and Institutional Money Management

There has been next to no study in the financial literature of sell decisions. An institutional money management database covering more than 7,000 investment portfolios now facilitates examination of different sell discipline criteria with respect to risk-adjusted returns and downside risk. The evidence indicates that portfolio performance is strongly related to the choice of the sell discipline criterion, even correcting for the potential effects of investment style changes over the period investigated. In rising markets, institutional money managers are likely to benefit from using less restrictive sell discipline criteria, while in declining markets they might benefit from a more restrictive sell discipline criterion. Market conditions, that is, strongly influence the effectiveness of the various sell discipline criteria.

Characterizing Value and Growth Investing in Institutional Portfolios

Using a unique money manager database that allows managers to identify their own investment styles, we examine 4,754 non mutual fund value- and growth-oriented portfolios over the period 1999-2003. Consistent with style definitions, we find that on average, growth funds have price-earnings ratios, price-to-book ratios and earnings growth rates that are twice as large as those for value funds. We find that large and mid-cap value funds hold stocks of companies with significantly higher financial leverage than those held by growth funds. We measure style adherence relative to Russell indexes as well as the funds’ own benchmarks, and find that large cap funds tend to stay closer to their own benchmarks

The Fear Premium and Daily Comovements of the S&P 500 E/P ratio and Treasury Yields before and during the 2008 Financial Crisis: The Fear Premium and Daily Comovements

I develop a new risk measure called the Total Fear Premium that generalizes Faugere�?Van Erlach (2009) and accounts for both flight�?to�?safety and flight�?to�?liquidity behavior. This new measure helps to explain why the daily S&P 500 forward earnings yield (E/P ratio) is strongly negatively correlated with daily Treasury yields of all maturities during the 2008 financial crisis, which is a reversal from the relation that prevailed before the crisis. The Total Fear Premium “mimics�? the VIX during the financial crisis. Once the basic GARCH formulation modeling the interaction between the earnings yield and Treasury yields is augmented with the Total Fear Premium, the relation between the earnings yield and short�?term Treasury yields becomes significantly positive, in line with Famas (1975) view that short�?term yields are good proxies for expected inflation. Two by�?products of this analysis are: 1) a new risk premium measure associated with flight�?to�?liquidity and 2) a new way to measure the inflation risk premium on a daily basis.

The Fear Premium and Daily Comovements of the S&P 500 E/P Ratio and Treasury Yields Before and During the 2008 Financial Crisis

The daily S&P 500 forward earnings yield (E/P ratio) is strongly negatively correlated with daily Treasury yields of all maturities during the 2007 financial crisis, which is a reversal from the relation that prevailed before the crisis. To explain this pattern reversal, I introduce a new risk measure called the Total Fear Premium that accounts for flight-to-safety and flight-to-liquidity behavior. The Total Fear Premium “mimics” the VIX during the financial crisis. Once the basic GARCH formulation modeling the interaction between the earnings yield and Treasury yields is augmented with the Total Fear Premium, the relation between the earnings yield and short-term Treasury yields becomes significantly positive, in line with Fama’s (1975) view that short-term yields are good proxies for expected inflation. Two by-products of this analysis are: 1) a new risk premium measure associated with flight-to-liquidity and 2) a new way to measure the inflation risk premium on a daily basis.

Musings on a NanoGold Standard

NanoGold is a simple device to make the return to a gold standard possible. Money is backed by nano quantities of gold. Because of advances in digital technology, I argue here that a NanoGold particle is a viable medium of exchange provided people can measure it accurately, validate its tangibility in transactions and safely store it. The NanoGold standard will be effective if a new social convention around monetary units takes hold: one nanoparticle of gold is worth the same as the real value of one dollar today. I analyze the undesirable wealth effect due to private holding of gold flooding the economy, and the conditions to prevent it. If central banks can enforce a minting monopoly on these NanoGold particles, then paper money has true backing. Monetary policy can generate price stability while postponing the deflationary trap to an infinitely distant future. The implications for Fiscal policy are potentially far-reaching. This new currency unit endows the government with virtually unlimited resources. A logical but stunning implication of the proposal is that the costs associated with runaway government debt and Ricardian equivalence can altogether be avoided under this new standard. The fallback position cannot be worse than today’s fiat monetary system.