Giora Harpaz

Project Valuation With Time-Varying Cash Flows: A Bayesian Approach

This article investigates the valuation of a project when the distributions of cash flows vary over time. The decision maker is assumed to be a Bayesian decision maker under uncertainty. Using the dynamic programming principle of backward induction and assuming that the capital asset pricing model is valid in each time period, we derive the projects valuation formulas and systematic risks, and investigate their characteristics. Our valuation formulas embed a Bayesian learning effect and differ from the traditional textbook capital budgeting formulas.

Exchange Mergers and Electronic Trading

Organized commodities and securities exchanges are national exchanges where securities, options, and futures contracts are traded by exchange members for their own accounts and for the accounts of their clients. A wave of mergers between organized exchanges has taken place during the last decade. These mergers result from synergistic effects, tax gains, reduced capital requirements, product diversification, geographical diversification, and advances in electronic trading technology. Technology advancements facilitate mergers by reducing transaction costs, increasing market liquidity, and enhancing transparency and competition. The objective of this article is twofold: 1) to review the recent merger trends and joint ventures among major exchanges around the world, and 2) to describe the associated innovations in electronic trading that incentivized exchange mergers. John Thain took charge of the NYSE in 2003 and led it through several major technological and organizational changes. NASDAQ hastily followed suit in developing its increasingly global and multi-asset-class trading platform. Subsequently, the organized commodities exchanges in the United States started consolidating and modernizing. Thus, Wall Street and many overseas exchanges were driven into the electronic trading era, which set the stage for a series of breath-taking advances. By 2008 investors could select from a menu of alternative trading systems (ATSs) that offered different but competitive financial services. It is exciting to watch these competitors strive to surpass each other as the race to excel moves ahead relentlessly.

Pricing Securities With Exchange-Imposed Price Limits Via Risk Neutral Valuation

Asian and European financial markets impose daily price fluctuation limits on individual securities. In the US several futures exchanges are regulated by price fluctuation limits as well. The price limits in most exchanges are set daily, and they are usually based on a percentage change from the previous days closing price. We show that the future cash flows of a security subject to price limit regulation resemble that of a distinctive contingent claim. Assuming that the security price follows a lognormal distribution, we use the risk-neutral valuation relation (RNVR) developed by [4] to derive the security valuation, in the presence of price fluctuation limits. The characteristics of the pricing formula are examined analytically and numerically.

SECURITY MARKETS WITH PRICE LIMITS: A BAYESIAN APPROACH

Several financial markets impose daily price limits on individual securities. Once a price limit is triggered, investors observe either the limit floor or ceiling, but cannot know with certainty what the true equilibrium price would have been in the absence of such limits. The price limits in most exchanges are typically based on a percentage change from the previous days closing price, and can be expressed as return limits. We develop a Bayesian forecasting model in the presence of return limits, assuming that security returns are governed by identically and independently shifted-exponential random variables with an unknown parameter. The unique features of our Bayesian model are the derivations of the posterior and predictive densities. Several numerical predictions are generated and depicted graphically. Our main theoretical result with policy implications is that when return-limit regulations are tightened, the price-discovery process is impeded and investors welfare is reduced.

The non-optimality of the over-the-counter options dividend protection

Abstract Although no such adjustments are made in exchange listed options, options in the over-the-counter (OTC) market are adjusted for cash dividends by reducing their striking prices by the amount of the cash dividend on each ex-dividend date. We prove that if a call is either out-, at- or in-the-money (just before the ex-dividend dates), the OTC-dividend-protection procedure generates a sure loss to the call buyer, but it tends to be correct if a call is very-deep-in-the-money.

Fair Actuarial Values For Deductible Insurance Policies In The Presence Of Parameter Uncertainty

This paper derives the multi-period fair actuarial values for six deductible insurance policies offered in todays insurance markets. The loss in any given period is generated by the Weibull distribution with a known shape parameter but an unknown scale parameter. The insurer is assumed to be a Bayesian decision maker, in the sense that he/she learns sequentially about the unknown scale parameter by observing the realizations of the filed claims. It is shown that the insurers underlying predictive loss distributions belong to the Burr family, and the multi-period actuarially fair policy value can be derived. With a proper loading, an insurance premium can be quoted. Our major contribution is the analytical derivations of the fair actuarial values for deductible insurance policies in the presence of parameter uncertainty and Bayesian learning.