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Research

Publications

Stochastic Growth: A Duality Approach (JET, Vol. 113 (2003), p131-143.)
Abstract We re-examine the representative agent's optimal consumption and savings under uncertainty in the presence of investment constraints using martingale representation and convex analysis techniques. This framework allows quantifying explicitly precautionary savings motive that induces a higher average growth rate than in a certainty set up. We provide a closed form solution for a Cobb-Douglas economy. The effect of uncertainty on portfolio selection is analyzed. Consumption growth rate and risk free interest rate exhibit a U shape relationship. Uncertainty negatively affects expected consumption growth rate; such a result seems to be supported by empirical evidence.
JEL classification: C61, D90, O41.
Keywords: Stochastic Growth, Convex Analysis, Precautionary Savings.

 
Asset Prices in an Exchange Economy when Agents Have Heterogeneous Homothetic Recursive Preferences and No Risk Free Bond is Available  (JEDC, Vol. 35 (2011), p80-96.)
Abstract We study a pure exchange economy under incomplete markets where households have heterogeneous homothetic recursive preferences and lending and borrowing are precluded. We fully characterize the properties of the efficient allocations and the equilibrium asset price. The ownership distribution dynamics reveal the emergence of a dominant agent, who after some finite time, remains the only investor that increases asset holdings until asymptotically owning the entire wealth. Investors can be ranked according to a unique parameter that aggregates agents' preference characteristics and we show how time discount rate, attitude towards risk and intertemporal substitution contribute to capital accumulation.
JEL classification: C68, D81, G12.
Keywords: Recursive Preferences, Heterogeneous Agents, General Equilibrium, Ownership Distribution.
 
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Why Does Junior Put All His Eggs in One Basket? A Potential Rational Explanation for Holding Concentrated Portfolios, join with Stathis Tompaidis (UT Austin) and Chunyu  Yang (BI Norwegian Business School) (JFE, Vol. 109 (2013), p775-796)
Abstract Empirical studies of household portfolios show that young households, with little financial wealth, hold under-diversified portfolios that are concentrated in a small number of assets, a fact often attributed to behavioral biases. We present a potential rational alternative: we show that investors with little financial wealth, who receive labor income, rationally limit the number of assets they invest in when faced with financial constraints such as margin requirements and   restrictions on borrowing. We provide a theoretical and numerical support for our results and identify the ratio of wealth to labor income as useful control variable for household portfolio studies.
JEL classification: D81, D83, E21, G11.
Keywords: Asset Selection, Under-diversification, Labor Income, Financial Constraints, Household Portfolios.

Asset Management with Endogenous Withdrawals under a Drawdown Constraint otential(Forthcoming Quantitative Finance 2018)
Abstract Asset preservation is a major concern for foundations that are hostile to large wealth downfalls. Implications for optimal consumption and investment policies are explored in a dynamic setting where wealth is restrained from falling below a fraction of its all-time high. Risky investment regulates wealth growth and mitigates the ratchet e.ect of the constraint, and may decrease as wealth approaches its maximum. The correspondence found between habit formation over consumption and wealth ratcheting provides a rational explanation for the proliferation of capital protection oriented funds.
JEL Classification: D81, E21, G11.
Keywords: Optimum Portfolio Rules, High Water Mark, Endogenous Habit Formation, Spirit of Capitalism.

Rent-to-Own Usurers? Theory and Empirical Evidence, join with Sanjiv Jaggia (Cal Poly) and Michael Anderson (UMass, Dartmouth) (Forthcoming the Journal of Consumer Affairs, 2018)

Abstract The rent to own industry (RTO) given its emphasis on subprime or, at least, financially constrained consumers is often seen as exploitative with excessive financing costs. This paper develops a rational-expectations competitive equilibrium model to explore the pricing mechanism of a RTO agreement. The model accounts for the contract's embedded options and several bundled services. Using detailed transactional data, we infer how customers exercise these options to calibrate our model for several product categories, contractual lengths and payment periodicity. The resulting predictions provide a justification for the high financing costs observed in the marketplace.
JEL Classification: D1, G23.
Keywords:  Embedded Options; Financial Distress; Subprime Industry.

Manuscripts under Review

Intertemporal Allocations under Undiversifiable Labor Income: A Duality Approach (Invited to revise and resubmit to Mathematical Finance)
Abstract We revisit the optimal consumption-investment problem for an infinitely lived isoelastic utility agent who is unable to borrow against her non-insurable future labor income. Using duality techniques, we show that an income growth mean preserving spread lowers consumption and risk tolerance compared to the perfect market framework; equity holdings are dampened (enhanced) whenever income increases (decreases) stock demand under complete markets. Moreover, consumption is further reduced compared to the insurable income setting. Fixing total income volatility, numerical simulations implemented using a shooting method reveal a drastic drop in consumption for small wealth to income ratios as undiversifiable income risk limits hedging and the value of human capital is at its lowest.
JEL classification: D81, E21, G11.
Keywords:  Optimum Portfolio Rules, Incomplete Markets, Labor Income, Background Risk, Duality Techniques, Shooting Method.

Working Papers

Hedge Fund Fee Structure and Risk Exposure: Theory and Empirical Evidence, joined with Matias Braun (UAI)
Abstract We solve in closed form the optimal investment strategy of an infinitely lived risk neutral hedge fund manager compensated by a management fee and a high water mark (HWM) contract. The fraction of asset under management (AUM) allocated in equity is a convex increasing function of the distance to the HWM as moving away from the HWM is increasingly bad news both for management and incentive fees. This convexity effect is enhanced by the size of the incentive fee rate. The higher the management fee rate, the larger the risk exposure, as the revenue insurance effect gets magnified. Frequently beating by a small amount the HWM is optimal as it mitigates the ratchet feature of the HWM. Data seem to support the theoretical predictions of the model: returns' volatility is strongly related to distance to the HWM: being 20% underwater is associated with an increase of 192 bps in the ex-post returns' volatility. Also consistent, the time elapsed between hits and the extent to which the fund surpasses the HWM both increase with distance to the HWM. An extension shows that a fund termination threat reduces risk taking behavior as the fund drifts away from the HWM, which is consistent with our empirical findings. 
JEL Classification: G01, G11, G23.
Keywords: High Water Mark, Management Fees, Incentive Fees, Optimum Portfolio Rules, Ratchet Effect.

Debt Financing Irreversible Investment
Abstract   This paper endogenizes the cost of external funds and explores their impact on undertaking an irreversible investment. The investment strategy incorporates equilibrium feedback that result from a bargaining process between equityholders and a lender; contrary to debt issuance, tax benefits and distress costs cannot be internalized by the firm. "Bad news" are less costly for the firm that has incentives to accelerate investment whereas creditors intend to delay it; under-investment or over-investment is determined by each party relative bargaining power and the size of bankruptcy costs. Default and credit market imperfections raise the effective cost of capital, which dampens the value of waiting. The impact of assets already in place, bankruptcy costs and leverage level are also examined.
JEL classification: C78, D92, E22, G32, G33.
Keywords: Option Value, Irreversible Investment, Debt, Sequential Bargaining, Nash Bargaining.
 
 
Speculative Bubbles in a Pure Exchange Economy
Abstract We develop a complete market equilibrium model where two identical isoelastic individuals have heterogeneous expectations. We identify three ingredients for a bubble to form: (i) low risk aversion; (ii) belief dispersion and; (iii) fairly even wealth distribution. Belief disagreements lead agents to take opposite leveraged positions: high stock prices prevail when interest rates are low. The speculative premium incorporates differences of opinion in all future contingencies; for risk neutral investors it can be decomposed into a stream of European call options. Allowing for heterogeneity in preferences reveals that only one investor needs to display a low risk aversion to generate a bubble. The case of infinitely risk averse investors is also examined.
JEL Classification: D51, D84, G12.
Keywords: General Equilibrium Theory, Asset Pricing, Heterogeneous Beliefs, Leverage, Speculation.