Essays on Incomplete Information in Financial Markets
(2005) In Lund Economic Studies no. 124.- Abstract
- This thesis consists of three essays on incomplete information in financial markets, two of which are theoretical, and one that is mainly of an empirical nature. All three essays concern parameter uncertainty, and they employ a continuous-time framework.
The first essay, "The Effect of Information Quality on Optimal Portfolio Choice," analyzes the portfolio choices made by three types of agents, having access to different information sets. These three types of agents correspond to executives, stockbrokers and small investors, and we call them "fully informed agents," "insiders," and "outsiders," respectively. The fully informed agents are assumed to know the true dynamics of the economy, while the insiders and outsiders... (More) - This thesis consists of three essays on incomplete information in financial markets, two of which are theoretical, and one that is mainly of an empirical nature. All three essays concern parameter uncertainty, and they employ a continuous-time framework.
The first essay, "The Effect of Information Quality on Optimal Portfolio Choice," analyzes the portfolio choices made by three types of agents, having access to different information sets. These three types of agents correspond to executives, stockbrokers and small investors, and we call them "fully informed agents," "insiders," and "outsiders," respectively. The fully informed agents are assumed to know the true dynamics of the economy, while the insiders and outsiders have to learn it from the realizations of different signals. While the outsiders only use the realizations of the stock returns in their learning, the insiders also have access to a private signal. The contributions of the first essay are threefold. First of all, we derive an explicit closed-form solution to the insider's problem. Second, we provide a comparative static analysis of the agents' solutions. The third contribution is a calibration to US data where we make a comparison of the best estimates as well as the optimal portfolios across the three types of agents.
The second essay, "Expected Life-Time Utility and Hedging Demands in a Partially Observable Economy," analyzes the expected life-time utility and the individual agents' hedging demands in a Lucas (1978) economy, in which the dividend drift term is unknown and mean-reverting. An expression for the partially informed agent's expected life-time utility is derived, and his hedging demand is analyzed. It is shown that the hedging demand consists of two components. In the case of a negative correlation between the true drift term and the dividend growth rate, the two hedging components work in opposite directions, and, assuming a positive equity premium, a conservative investor may end up having a positive hedging demand. Interestingly, this is in contrast to the findings in Brennan (1998), who analyzes optimal portfolio choice when agents learn about a constant drift term in the stock return.
In the third essay, "Can An 'Estimation Factor' Help Explain Cross-Sectional Returns?," it is first shown in a theoretical model that the expected excess return on any asset depends on its covariance not only with the market portfolio, but also with changes in the representative agent's estimate. Then, this model is tested in a GMM framework, and compared to the three-factor Fama-French model. We find some evidence suggesting that the estimation factor (the representative agent's best estimate of the drift in aggregate dividend growth) is priced. Further, a conditional version of our model is found to perform on a par with a conditional version of the Fama-French model, and the static version of our model is found to perform on a par with the static version of the Fama-French model. We demonstrate that the impact of the estimation factor is statistically and economically significant. (Less) - Abstract (Swedish)
- Popular Abstract in Swedish
Avhandlingen består av tre essäer som behandlar effekterna av inkomplett information i de finansiella marknaderna. Av dessa essäer är två teoretiska och en är huvudsakligen empirisk. Samtliga essäer undersöker effekterna av parameterosäkerhet, och de använder sig av kontinuerliga modeller.
Den första essän, "The Effect of Information Quality on Optimal Portfolio Choice", analyserar portföljvalen hos tre typer av agenter, som har tillgång till olika informationsmängder. Dessa tre typer av agenter motsvarar företagsledare, börsmäklare respektive småsparare, och i essän kallar vi dem "fullständigt informerade agenter" ("fully informed agents"), "insiders" och "outsiders". De... (More) - Popular Abstract in Swedish
Avhandlingen består av tre essäer som behandlar effekterna av inkomplett information i de finansiella marknaderna. Av dessa essäer är två teoretiska och en är huvudsakligen empirisk. Samtliga essäer undersöker effekterna av parameterosäkerhet, och de använder sig av kontinuerliga modeller.
Den första essän, "The Effect of Information Quality on Optimal Portfolio Choice", analyserar portföljvalen hos tre typer av agenter, som har tillgång till olika informationsmängder. Dessa tre typer av agenter motsvarar företagsledare, börsmäklare respektive småsparare, och i essän kallar vi dem "fullständigt informerade agenter" ("fully informed agents"), "insiders" och "outsiders". De fullständigt informerade agenterna antas känna till ekonomins sanna dynamik, medan insiders och outsiders måste lära sig denna från realiseringarna av olika signaler. Medan "outsiders" enbart använder realiserade aktiekurser i sitt lärande, så har "insiders" även tillgång till en privat signal. Denna essäs bidrag till litteraturen är tre. Det första bidraget är en explicit lösning av insiderns portföljvalsproblem i sluten form. Det andra bidraget är en komparativ analys av de olika agenternas lösningar. Det tredje bidraget är en kalibrering av modellen till amerikanska data, där vi gör en jämförelse av såväl agenternas skattningar som deras optimala portföljer.
Den andra essän, "Expected Life-Time Utility and Hedging Demands in a Partially Observable Economy", analyserar en representativ agents förväntade nytta över livet och den individuelle agentens hedgnings-efterfrågan i en Lucas-ekonomi, i vilken den totala utdelningens driftterm är okänd och återvänder till ett visst medelvärde. Ett uttryck för den delvis informerade agenten härleds, och hans hedgnings-efterfråga analyseras. Vi visar att hedgnings-efterfrågan består av två komponenter. I det fall då det finns en negativ korrelation mellan den sanna drifttermen och förändringen i utdelningen, så kommer de två hedgnings-komponenterna att verka i motsatta riktningar och om vi antar en positiv riskpremie, så kan en konservativ agent ha en positiv hedgnings-efterfrågan. Detta resultat kontrasterar resultaten i Brennan (1998), som analyserar optimalt portföljval i det fall då agenterna lär sig om en konstant driftterm i aktieavkastningarna.
I den tredje essän, "Can An 'Estimation Factor' Help Explain Cross-Sectional Returns?", visar vi först i en teoretisk modell att riskpremien på en godtycklig tillgång inte bara beror på dess kovarians med marknadsportföljen, utan även på dess kovarians med förändringar i den representativa agentens skattningar. Sedan testas denna modell med hjälp av en metod som heter GMM (Generalized Method of Moments), och modellen jämförs med Fama-Frenchs trefaktorsmodell. Vi finner vissa tecken som tyder på att den s k estimeringsfaktorn (den representative agentens bästa skattning av driften i den totala utdelningstillväxten) är prissatt. En betingad version av vår modell visar sig vara lika bra (i termer av prissättningsfel) som en betingad version av Fama-Frenchs modell, och en statisk version av vår modell visar sig också vara lika bra som en statisk version av Fama-Frenchs modell. Våra resultat visar att estimeringsfaktorns inverkan är statistiskt och ekonomiskt signifikant. (Less)
Please use this url to cite or link to this publication:
https://lup.lub.lu.se/record/544106
- author
- Lundtofte, Frederik LU
- supervisor
- opponent
-
- Professor Feldman, David, University of New South Wales, Australia
- organization
- publishing date
- 2005
- type
- Thesis
- publication status
- published
- subject
- keywords
- ekonomiska system, ekonomisk politik, Financial science, Finansiering, ekonomisk teori, economic policy, Nationalekonomi, ekonometri, Economics, econometrics, economic theory, factor pricing models, hedging demands, estimation risk, partial information, learning, economic systems
- in
- Lund Economic Studies
- volume
- no. 124
- pages
- 128 pages
- publisher
- Department of Economics, Lund University
- defense location
- Sal EC3:210, Holger Crafoords Ekonomicentrum i Lund
- defense date
- 2005-01-14 10:15:00
- ISSN
- 0460-0029
- language
- English
- LU publication?
- yes
- id
- 43743e99-9ef8-41c6-9502-8a8d9bff1c84 (old id 544106)
- date added to LUP
- 2016-04-01 15:52:26
- date last changed
- 2019-05-21 16:51:27
@phdthesis{43743e99-9ef8-41c6-9502-8a8d9bff1c84,
abstract = {{This thesis consists of three essays on incomplete information in financial markets, two of which are theoretical, and one that is mainly of an empirical nature. All three essays concern parameter uncertainty, and they employ a continuous-time framework.<br/><br>
<br/><br>
The first essay, "The Effect of Information Quality on Optimal Portfolio Choice," analyzes the portfolio choices made by three types of agents, having access to different information sets. These three types of agents correspond to executives, stockbrokers and small investors, and we call them "fully informed agents," "insiders," and "outsiders," respectively. The fully informed agents are assumed to know the true dynamics of the economy, while the insiders and outsiders have to learn it from the realizations of different signals. While the outsiders only use the realizations of the stock returns in their learning, the insiders also have access to a private signal. The contributions of the first essay are threefold. First of all, we derive an explicit closed-form solution to the insider's problem. Second, we provide a comparative static analysis of the agents' solutions. The third contribution is a calibration to US data where we make a comparison of the best estimates as well as the optimal portfolios across the three types of agents.<br/><br>
<br/><br>
The second essay, "Expected Life-Time Utility and Hedging Demands in a Partially Observable Economy," analyzes the expected life-time utility and the individual agents' hedging demands in a Lucas (1978) economy, in which the dividend drift term is unknown and mean-reverting. An expression for the partially informed agent's expected life-time utility is derived, and his hedging demand is analyzed. It is shown that the hedging demand consists of two components. In the case of a negative correlation between the true drift term and the dividend growth rate, the two hedging components work in opposite directions, and, assuming a positive equity premium, a conservative investor may end up having a positive hedging demand. Interestingly, this is in contrast to the findings in Brennan (1998), who analyzes optimal portfolio choice when agents learn about a constant drift term in the stock return.<br/><br>
<br/><br>
In the third essay, "Can An 'Estimation Factor' Help Explain Cross-Sectional Returns?," it is first shown in a theoretical model that the expected excess return on any asset depends on its covariance not only with the market portfolio, but also with changes in the representative agent's estimate. Then, this model is tested in a GMM framework, and compared to the three-factor Fama-French model. We find some evidence suggesting that the estimation factor (the representative agent's best estimate of the drift in aggregate dividend growth) is priced. Further, a conditional version of our model is found to perform on a par with a conditional version of the Fama-French model, and the static version of our model is found to perform on a par with the static version of the Fama-French model. We demonstrate that the impact of the estimation factor is statistically and economically significant.}},
author = {{Lundtofte, Frederik}},
issn = {{0460-0029}},
keywords = {{ekonomiska system; ekonomisk politik; Financial science; Finansiering; ekonomisk teori; economic policy; Nationalekonomi; ekonometri; Economics; econometrics; economic theory; factor pricing models; hedging demands; estimation risk; partial information; learning; economic systems}},
language = {{eng}},
publisher = {{Department of Economics, Lund University}},
school = {{Lund University}},
series = {{Lund Economic Studies}},
title = {{Essays on Incomplete Information in Financial Markets}},
volume = {{no. 124}},
year = {{2005}},
}