João Correia-da-Silva

Is stochastic volatility relevant for dynamic portfolio choice under ambiguity

Literature on dynamic portfolio choice has been finding that volatility risk has low impact on portfolio choice. For example, using long-run US data, Chacko and Viceira [2005. “Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets.” The Review of Financial Studies 18 (4): 1369–1402] found that intertemporal hedging demand (required by investors for protection against adverse changes in volatility) is empirically small even for highly risk-averse investors. We want to assess if this continues to be true in the presence of ambiguity. Adopting robust control and perturbation theory techniques, we study the problem of a long-horizon investor with recursive preferences that faces ambiguity about the stochastic processes that generate the investment opportunity set. We find that ambiguity impacts portfolio choice, with the relevant channel being the return process. Ambiguity about the volatility process is only relevant if, through a specific correlation structure, it also induces ambiguity about the return process. Using the same long-run US data, we find that ambiguity about the return process may be empirically relevant, much more than ambiguity about the volatility process. Anyway, intertemporal hedging demand is still very low: investors are essentially focused on the short-term risk–return characteristics of the risky asset.

Nesting Vertical and Horizontal Differentiation in Two-Sided Markets

We develop a model that is a synthesis of the two-sided markets duopoly model of Armstrong (2006) with the nested vertical and horizontal di erentiation model of Gabszewicz and Wauthy (2012), which consists of a linear city with di erent consumer densities on the left and on the right side of the city. In equilibrium, the high-quality platform sells at a higher price and captures a greater market share than the low-quality platform, despite the indiff erent consumer being closer to the high-quality platform. The di fference between market shares is lower than socially optimal, because of the inter-group externality and because the high-quality platform sells at a higher price. We conclude that a perturbation that introduces a negligible di erence between the consumer density on the left and on the right side of the city may disrupt the existence of equilibrium in the model of Armstrong (2006). Finally, we show that inter-group externalities make it easier to deter an inferior-quality entrant and make it easier for a superior-quality entrant to conquer the market.

How Should Cartels React to Entry Triggered by Demand Growth

Abstract We study the sustainability of collusion with optimal penal codes in markets where demand growth triggers the entry of a new firm. In contrast to grim trigger strategies, optimal penal codes make collusion easier to sustain before entry than after. This conclusion is robust to changes in the number of entrants and to the consideration of price-setting instead of quantity-setting. A comparison is given between different reactions of the incumbents to entry in terms of sustainability of collusion, incumbents’ profits, entrant’s profits, consumer surplus and social welfare. One of our findings is that the incumbent firms may prefer competition to collusion.

Multidimensional screening with complementary activities: Regulating a monopolist with unknown cost and unknown preference for empire building

We study the optimal regulation of a monopolist when intrinsic efficiency (intrinsic cost) and empire building tendency (marginal utility of output) are private information, but actual cost (the difference between intrinsic cost and effort level) is observable. This is a problem of multidimensional screening with complementary activities. Results are not only driven by the prior probabilities of the four possible types, but also by the relative magnitude of the uncertainty along the two dimensions of private information. If the marginal utility of output varies much more (less) across managers than the intrinsic marginal cost, there is empire building (efficiency) dominance. In that case, an inefficient empire builder produces more (less) and at lower (higher) marginal cost than an efficient money-seeker. It is only when variabilities are similar that there may be the natural ranking of activities (empire builders produce more, while efficient managers produce at a lower cost).

USING COST OBSERVATION TO REGULATE A MANAGER WHO HAS A PREFERENCE FOR EMPIRE-BUILDING ?

We study regulation of a manager who has a preference for empire-building (high output), in the presence of moral hazard (unobservable effort) and adverse selection (unobservable productivity). We find that the optimal contract is linear in cost, being composed by a fixed payment plus a partial cost reimbursement. The preference for higher output reduces the managers tendency to announce that his or her productivity is low, allowing a more powered incentive scheme (a lower fraction of the cost is reimbursed), which alleviates the problem of moral hazard.