by Christina Atanasova & Gilles Chemla (Cahier de la Chaire n°31)

This paper provides new evidence that familiarity bias affects the portfolios ofinstitutional investors. Using a sample of large US defined-benefit pension plans for the period1992 to 2002, we show that the corporate focus of the sponsoring firm has an impact on theinvestment policy of the pension plan. Pension plans sponsored by firms with a high proportionof foreign sales are more likely to invest in international assets, plans sponsored by firms thatare active in research and development are more likely to invest in private equity, and planswith sponsors that have more fixed assets are more likely to invest in real estate andmortgages. Comparing to existing explanations of why plans tilt their portfolios towards thesponsor’s focus, familiarity bias is the most compelling one. The worse performance of pensionplans with such portfolio allocation bias is consistent with pension managers being overconfidentabout familiar assets.

Keywords: Institutional investment, defined benefit pension plans, familiarity bias

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By D. Crisan, K. Manolarakis & N. Touzi (Cahier de la Chaire n°30)

We propose a generic framework for the analysis of Monte Carlo simulation schemes of backward SDEs. The general results are used to re-visit the convergence of the algorithm suggested by Bouchard and Touzi (2004). By keeping the higher order terms in the expansion of the Skorohod integrals resulting from the Malliavin integration by parts in Bouchard and Touzi (2004), we introduce a variant of the latter algorithm which allows for a significant reduction of the numerical complexity. We prove the convergence of this improved Malliavin based algorithm, and derive a bound on the induced error. In particular, we show that the price to pay for our simplification is to use a more accurate localizing function.

Keywords: BSDEs, Weak approximations, Monte Carlo methods, Malliavin calculus

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By Bruno Bouchard, Romuald Elie & Nizar Touzi (Cahier de la Chaire n°29)

We consider the problem of finding the minimal initial data of a controlled process which
guarantees to reach a controlled target with a given probability of success or, more generally,
with a given level of expected loss. By suitably increasing the state space and the controls,
we show that this problem can be converted into a stochastic target problem, i.e. nd the
minimal initial data of a controlled process which guarantees to reach a controlled target with
probability one. Unlike the existing literature on stochastic target problems, our increased
controls are valued in an unbounded set. In this paper, we provide a new derivation of the
dynamic programming equation for general stochastic target problems with unbounded controls,
together with the appropriate boundary conditions. These results are applied to the problem
of quantile hedging in nancial mathematics, and are shown to recover the explicit solution of
Follmer and Leukert.

Keywords: Stochastic target problem, discontinuous viscosity solutions, quantile hedging

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By Gilles Chemla & Christopher A. Hennessy (Cahier de la Chaire n°28)

Privately informed owners securitizing assets signal positive information by retaining sufficient interest. Signaling provides social bene…fits, allowing uninformed investors to insure without fearing adverse selection. Instead of signaling, owners of high value assets may prefer a pooling equilibrium in which they securitize more of the asset, relying on speculators to gather information and bring prices closer to fundamentals. This induces suboptimal risk sharing, since uninformed investors face adverse selection. We analyze privately optimal securitization and the choice between signaling and reliance on speculative markets. In the model, prices are set competitively, with an endogenously informed speculator trading against uninformed hedgers placing rational orders. If a structuring exists providing sufficient speculator gains, her effort is high, mispricing is low, and all/most of the asset is securitized in a pooling equilibrium. Here risky debt and levered equity are optimal, with optimal face value trading off higher unit profi…ts for the speculator against lower hedging demand. Hedgers imperfectly insure, buying only the concave claim, the only source of speculator pro…ts. If risk-aversion is low and/or endowment shocks are small, hedging demand is low, leading to low speculator effort. Here high types sell only safe debt in a separating equilibrium with perfect risk sharing. The owner’s incentive to choose the separating equilibrium is weak when risk-aversion is high and/or endowment shocks are large, precisely when efficient risk sharing has high social value.

Keywords: securitization, debt, equity, speculator, hedging demand, separating equilibrium, pooling equilibrium

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By Ivar Ekeland (Cahier de la Chaire n°27)

According to the Stern Report on climate change, the course of the next fifty years is set: present policies will impact only in the very long term, fifty to two hundred years from now. There is no market for interest rates, so far into the future, and economists must find other ways to set interest rates in a coherent way. This paper reviews some of the methods which have been used. We start with the classical Ramsey model of economic growth, which remains a central reference in the current debate, and we study the determinants of the interest rate in that framework. We then adapt the model (and the results) to take into account various concerns, namely (a) the existence of the environment as a distinct, non-producible good, (b) uncertainty on the parameters or on the model (c) intergenerational equity.

Keywords: Climate change, Long-term policy-making, Interest rates, Growth models.

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by Laure Durand-Viel & Bertrand Villeneuve (Cahier de la Chaire n°26)

This article analyzes the impact of incomplete contracts’ length on investment in a bilateral relationship. The seller has the power to set the contract terms whereas the buyer decides on the investment level, which acts as a cap on future demand. Two-part tariffs succeed at implementing the optimal investment and consumption even if commitment is limited, and the contract’s duration is irrelevant. Interestingly, this efficient solution is rendered possible by subsidies on consumption during the contract. In other terms, duration matters hugely for the contract details (the timing of transfers), not for its performance. Under certain circumstances that we discuss, linear pricing may have to be used, which leads to suboptimal investment. We show that longer contracts are less efficient, meaning that a degree of completeness (pricing width) may be strictly complementary to another one (contract length). The buyer’s surplus increases with respect to the contract duration, whereas the seller loses more in profit than the social surplus decreases. A longer contract actually protects expropriable investors rather than investment itself.

Keywords: Long-term Contracts, Incomplete Contracting, Infrastructure Investment.

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by Nazim Regnard and Jean-Michel Zakoïan (Cahier de la Chaire n°25)

A novel GARCH(1,1) model, with coefficients function of the realizations of an exogenous process, is considered for the volatility of daily gas prices. A distinctive feature of the model is that it produces non-stationary solutions. The probability properties, and the convergence and asymptotic normality of the Quasi-Maximum Likelihood Estimator (QMLE) have been derived by Regnard and Zakoian (2009). The prediction properties of the model are considered. We derive a strongly consistent estimator of the asymptotic variance of the QMLE. An application to daily gas spot prices from the Zeebruge market is presented. Apart from conditional heteroskedasticity, an empirical finding is the existence of distinct volatility regimes depending on the temperature level.

Keywords: GARCH, Nonstationary models, Periodic models, Quasi-maximum likelihood estimation, Time-varying coefficients.

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by René Aïd, Luciano Campi, Adrien Nguyen Huu and Nizar Touzi (Cahier de la Chaire n°24)

The objective of this paper is to present a model for electricity spot prices and the corresponding forward contracts, which relies on the underlying market of fuels, thus avoiding the electricity nonstorability restriction. The structural aspect of our model comes from the fact that the electricity spot prices depend on the dynamics of the electricity demand at the maturity T, and on the random available capacity of each production means. Our model explains, in a stylized fact, how the prices of dierent fuels together with the demand combine to produce electricity prices. This modeling methodology allows one to transfer to electricity prices the risk-neutral probabilities of the market of fuels and under the hypothesis of independence between demand and outages on one hand, and prices of fuels on the other hand, it provides a regression-type relation between electricity forward prices and forward prices of fuels. Moreover, the model produces, by nature, the well-known peaks observed on electricity market data. In our model, spikes occur when the producer has to switch from one technology to the lowest cost available one. Numerical tests performed on a very crude approximation of the French electricity market using only two fuels (gas and oil) provide an illustration of the potential interest of this model.

Keywords: energy markets, electricity prices, fuel prices, risk-neutral probability, no-arbitrage pricing, forward contract

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by Olivier Guéant (Cahier de la Chaire n°23)

This general readership article proposes an approach to evaluate what an economically and socially acceptable cost can be in the context of policies that aim at improving the environment. We stress the difficulty of considering a pre-determined utility function and propose an unusual methodology which is based on considering a distribution on the space of utility functions. One of our outcomes is a microeconomic foundation of the precautionary principle: the simple fact of hesitating between several utility functions invites to use the most environment-friendly one.

Keywords: Precautionary principle, Long term discount rate, Ecological discount rate, Sustainable development

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by Delphine Lautier (Cahier de la Chaire n°22)

This article explains the role of the convenience yield in the relationships linking spot and futures prices in commodity derivatives markets. First, this variable restores the non arbitrage relationship between the prices of the underlying asset and the derivative instrument. Second, it allows establishing connections between commodities and other assets. Third, it explains why firms store at an apparent loss. The convenience is however a controversial concept. Indeed, the absence of direct evidence for this quantity signifies, first that it is necessary to address the issue of estimating it and second, that it can be accused of being an ad hoc construction. Moreover, in spite of an early interest for this concept, there is no real consensus on its definition. This article aims at gathering all the reasonable explanations which were proposed trough time in the literature.

Keywords: Convenience yield, Arbitrage, Commodity, Inventory, Non storable commodities

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