nep-cmp New Economics Papers
on Computational Economics
Issue of 2010‒10‒09
sixteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Density quantization method in the optimal portfolio choice with partial observation of stochastic volatility By Grzegorz Ha{\l}aj
  2. Export Taxes, World Prices, and Poverty in Argentina: a Dynamic CGE-Microsimulation Analysis By Martin Cicowiez; Javier Alejo; Luciano Di Gresia; Sergio Olivieri; Ana Pacheco
  3. American Options Pricing under Stochastic Volatility: Approximation of the Early Exercise Surface and Monte Carlo Simulations By Yu. A. Kuperin; P. A. Poloskov
  4. The Value of Optimization in Dynamic Ride-Sharing: a Simulation Study in Metro Atlanta By Agatz, N.A.H.; Erera, A.; Savelsbergh, M.W.P.; Wang, X.
  5. Taxation Reforms: a CGE-Microsimulation Analysis for Pakistan By Saira Ahmed; Vagar Ahmed; Ahsan Abbas
  6. How sensitive are equilibrium pricing models to real-world distortions? By Harbir Lamba
  7. Responses of the Polish economy to demand and supply shocks under alternative fiscal policy rules By Piotr Karp; Magdalena Zachłod-Jelec
  8. A reduced basis for option pricing By Rama Cont; Nicolas Lantos; Olivier Pironneau
  9. On a numerical approximation scheme for construction of the early exercise boundary for a class of nonlinear Black-Scholes equations By Daniel Sevcovic
  10. FX Smile in the Heston Model By Janek, Agnieszka; Kluge, Tino; Weron, Rafal; Wystup, Uwe
  11. The Euro overnight interbank market and ECB's liquidity management policy during tranquil and turbulent times By Nuno Cassola; Michael Huetl
  12. Wage Subsidies, Work Incentives, and the Reform of the Austrian Welfare System By Steiner, Viktor; Wakolbinger, Florian
  13. Civil War, Climate Change and Development: A Scenario Study for Sub-Saharan Africa By Devitt, Conor; Tol, Richard S. J.
  14. Endogenous Credit Constraints, Human Capital Investment and Optimal Tax Policy By Hongyan Yang
  15. Forecasting and assessing Euro area house prices through the lens of key fundamentals By Anton Nakov; Carlos Thomas
  16. Equilibrium distributions in gas-like economic models: an analytical derivation By Xavier Calbet; Jose-Luis Lopez; Ricardo Lopez-Ruiz

  1. By: Grzegorz Ha{\l}aj
    Abstract: Computational aspects of the optimal consumption and investment with the partially observed stochastic volatility of the asset prices are considered. The new quantization approach to filtering - density quantization - is introduced which reduces the original infinite dimensional state space of the problem to the finite quantization set. The density quantization is embedded into the numerical algorithm to solve the dynamic programming equation related to the portfolio optimization.
    Date: 2010–09
  2. By: Martin Cicowiez; Javier Alejo; Luciano Di Gresia; Sergio Olivieri; Ana Pacheco
    Abstract: In this paper we implement a sequential dynamic computable general equilibrium model combined with microsimulations to assess (1) the short- and long-run economic impacts of a gradual reduction in the export tax that was introduced during the economic crisis that hit Argentina at the end of 2001, and (2) the impact of a decrease in the world prices of food products, one of the country’s main export product. Our results show that the elimination of the export tax would have different long run effects depending on the fiscal instrument that is used by the government to compensate for the loss in tax revenue. On the one hand, when the government budget is equilibrated by an increased deficit, the average annual growth rate for 2008-2015 is lower than in the baseline scenario. On the other hand, when the government budget is equilibrated by an increased direct tax rate, there is a long-run positive effect on growth. In any case, the employment level is lower and the price of food items is higher. Therefore, the poverty headcount ratio increases. As expected, a reduction in the world price of food items (i.e., a worsening in Argentina’s terms of trade) would impact negatively on the country’s GDP growth rate and poverty, particularly in the rural areas.
    Keywords: Poverty, export taxes, food prices, Argentina, computable general equilibrium microsimulations
    JEL: D58 F13 I30 O54
    Date: 2010
  3. By: Yu. A. Kuperin; P. A. Poloskov
    Abstract: The aim of this study was to develop methods for evaluating the American-style option prices when the volatility of the underlying asset is described by a stochastic process. As part of this problem were developed techniques for modeling the early exercise surface of the American option. These methods of present work are compared to the complexity of modeling and computation speed. The paper presents the semi-analytic expression for the price of American options with stochastic volatility. The results of numerical computations and their calibration are also presented. The obtained results were compared with results excluding the effect of volatility smile.
    Date: 2010–09
  4. By: Agatz, N.A.H.; Erera, A.; Savelsbergh, M.W.P.; Wang, X.
    Abstract: Smartphone technology enables dynamic ride-sharing systems that bring together people with similar itineraries and time schedules to share rides on short-notice. This paper considers the problem of matching drivers and riders in this dynamic setting. We develop optimization-based approaches that aim at minimizing the total system-wide vehicle miles and individual travel costs. To assess the merits of our methods we present a simulation study based on 2008 travel demand data from metropolitan Atlanta. The simulation results indicate that the use of sophisticated optimization methods instead of simple greedy matching rules may substantially improve the performance of ride-sharing systems. Furthermore, even with relatively low participation rates, it appears that sustainable populations of dynamic ride-sharing participants may be possible even in relatively sprawling urban areas with many employment centers.
    Keywords: ride-share;dynamic;carpool;matching;passenger transportation
    Date: 2010–08–17
  5. By: Saira Ahmed; Vagar Ahmed; Ahsan Abbas
    Abstract: This paper provides an ex ante assessment of taxation reforms being considered in Pakistan, in order to widen the tax base and rationalise the rate structure of different taxes. Amongst the main proposals, those focusing on sales tax and agricultural direct taxes seem relatively more attractive. The former has the highest share in indirect taxes and is also easier to collect, while the latter is intended to bring the presently exempted agricultural incomes into the tax net. As a first step, we study the general equilibrium effects of existing taxes by removing them from the system one at a time. In the second step we study the micro-macro impacts of four policy experiments: a) increasing sales tax rate by 33 percent; b) applying a 10 percent sales tax on presently zero-rated goods; c) increasing sales tax rate by 33 percent and bringing the services sectors in the sales tax net; and d) increasing sales tax rate by 33 percent, bringing the services sectors in the sales tax net, and imposing a 5 percent flat tax on agricultural incomes. In the third step we calculate the lost revenue due to evasion and avoidance. Results from experiments indicate the tough choices for policy makers in trying to improve the currently low tax to GDP ratio in Pakistan. Almost all simulations result in a decrease in investment levels, reduced consumption, and an increase in poverty. We thus recommend a gradual approach to tax reform that can make the adjustment process less painful.
    Keywords: Taxation, Microsimulation, General Equilibrium, Poverty, Inequality, Progressivity, Redistribution
    JEL: H22 D58 C51 C81 I32
    Date: 2010
  6. By: Harbir Lamba
    Abstract: In both finance and economics, quantitative models are usually studied as isolated mathematical objects --- most often defined by very strong simplifying assumptions concerning rationality, efficiency and the existence of disequilibrium adjustment mechanisms. This raises the important question of how sensitive such models might be to real-world effects that violate the assumptions. We show how the consequences of rational behavior caused by perverse incentives, as well as various irrational tendencies identified by behavioral economists, can be systematically and consistently introduced into an agent-based model for a financial asset. This generates a class of models which, in the special case where such effects are absent, reduces to geometric Brownian motion --- the usual equilibrium pricing model. Thus we are able to numerically perturb a widely-used equilibrium pricing model market and investigate its stability. The magnitude of such perturbations in real markets can be estimated and the simulations imply that this is far outside the stability region of the equilibrium solution, which is no longer observed. Indeed the price fluctuations generated by endogenous dynamics, are in good general agreement with the excess kurtosis and heteroskedasticity of actual asset prices. The methodology is presented within the context of a financial market. However, there are close links to concepts and theories from both micro- and macro-economics including rational expectations, Soros' theory of reflexivity, and Minsky's theory of financial instability.
    Date: 2010–09
  7. By: Piotr Karp (University of Lodz and Ministry of Finance, Financial Policy, Analysis and Statistics Department); Magdalena Zachłod-Jelec (Ministry of Finance, Financial Policy, Analysis and Statistics Department)
    Abstract: Recent experiences of many countries during the crisis restored the important dilemma that fiscal policymakers face of how to alleviate the demand contraction while ensuring sustainability of public finances in the long-term.\\ In this paper we study the consequences of the demand and supply shocks for Poland under alternative policy scenarios. Using a macroeconometric model of the Polish economy, we analyse the response of the economy to shocks under several fiscal policy rules. We try to answer the questions which fiscal rule works best in terms of public finance sustainability and business cycle fluctuations stabilization while taking into account the source of shocks to the economy.\\ We found that structural balance rule and expenditure rule act counter-cyclically in the whole simulation period, but at the same time the pace at which they stabilize public debt is quite slow.
    Keywords: fiscal rules, model simulations, demand shocks, supply shocks
    JEL: E17 E37 E62 H30 H62 H63
    Date: 2010–07–30
  8. By: Rama Cont (PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII); Nicolas Lantos (LJLL - Laboratoire Jacques-Louis Lions - CNRS : UMR7598 - Université Pierre et Marie Curie - Paris VI); Olivier Pironneau (LJLL - Laboratoire Jacques-Louis Lions - CNRS : UMR7598 - Université Pierre et Marie Curie - Paris VI)
    Abstract: We introduce a reduced basis method for the efficient numerical solution of partial integro-differential equations which arise in option pricing theory. Our method uses a basis of functions constructed from a sequence of Black-Scholes solutions with different volatilities. We show that this choice of basis leads to a sparse representation of option pricing functions, yielding an approximation whose precision is exponential in the number of basis functions. A Galerkin method using this basis for solving the pricing PDE is presented. Numerical tests based on the CEV diffusion model and the Merton jump diffusion model show that the method has better numerical performance relative to commonly used finite-difference and finite-element methods. We also compare our method with a numerical Proper Orthogonal Decomposition (POD). Finally, we show that this approach may be used advantageously for the calibration of local volatility functions.
    Date: 2010–09–30
  9. By: Daniel Sevcovic
    Abstract: The purpose of this paper is to construct the early exercise boundary for a class of nonlinear Black--Scholes equations with a nonlinear volatility depending on the option price. We review a method how to transform the problem into a solution of a time depending nonlinear parabolic equation defined on a fixed domain. Results of numerical computation of the early exercise boundary for various nonlinear Black--Scholes equations are also presented.
    Date: 2010–09
  10. By: Janek, Agnieszka; Kluge, Tino; Weron, Rafal; Wystup, Uwe
    Abstract: The Heston model stands out from the class of stochastic volatility (SV) models mainly for two reasons. Firstly, the process for the volatility is non-negative and mean-reverting, which is what we observe in the markets. Secondly, there exists a fast and easily implemented semi-analytical solution for European options. In this article we adapt the original work of Heston (1993) to a foreign exchange (FX) setting. We discuss the computational aspects of using the semi-analytical formulas, performing Monte Carlo simulations, checking the Feller condition, and option pricing with FFT. In an empirical study we show that the smile of vanilla options can be reproduced by suitably calibrating three out of five model parameters.
    Keywords: Heston model; vanilla option; stochastic volatility; Monte Carlo simulation; Feller condition; option pricing with FFT
    JEL: C63 C5 G13
    Date: 2010–09
  11. By: Nuno Cassola (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Michael Huetl (University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen, Switzerland.)
    Abstract: We analyze the impact of the recent financial market crisis on the Euro Overnight Index Average (EONIA) and interbank market trading and assess the effectiveness of the ECB liquidity policy between 07/2007 - 08/2008. We extend the model of [QM06] by (i) incorporating the microstructure of the EONIA market including the ECB fine-tuning operation on the last day of the maintenance period (MP) and banks’ daily excess liquidity, (ii) giving insight into banks’ trading behavior characterized by an endogenous regime-switch and suggesting an efficient procedure to simulate the entire MP, and (iii) proposing a model for market distortion due to lending constraints which lead to a bid-ask spread for the EONIA rate. The model is calibrated by simulation fitting daily EONIA rates and aggregate liquidity measures observed between March 2004 and September 2008. Besides lending constraints we consider market segmentation and aggregate liquidity shocks as possible market distortions in the crisis period. For a calibration cross-check and for estimating the timing of the endogenous regime-switch we use panel data covering liquidity data of 82 Euro Area commercial banks for the period 03/2003 - 07/2007. With the calibrated model the ECB policy of liquidity frontloading is evaluated and compared with a reserve band system policy similar to the Bank of England’s framework. We find that liquidity frontloading is a small scale central bank intervention which is capable of stabilizing interest rates in both frictionless and distorted markets. Simulations suggest that without frontloading the EONIA would have been, on average, 23 basis points above the policy rate (target); with frontloading, the overnight rate is, on average, on target. JEL Classification: E44, E52, G21.
    Keywords: liquidity management, open market operations, simulation, microstructure.
    Date: 2010–10
  12. By: Steiner, Viktor (DIW Berlin); Wakolbinger, Florian (University of Linz)
    Abstract: We analyze the labor supply and income effects of a needs-based minimum benefit system ("Bedarfsorientierte Mindestsicherung") to be introduced in Austria by the end of this/beginning of next year. The aim of this reform is to reduce poverty as well as increasing employment rates of recipients of social assistance. On the basis of a behavioral microsimulation model we show that this new system will slightly increase incomes for the poorest households and slightly reduce labor supply due to the generous allowances for marginal employment under the current and the planned regulations of unemployment assistance. As an alternative, we analyze a reform proposal which reduces financial incentives for marginal employment not covered by social security, and rewards working longer hours by a wage subsidy. Although this alternative reform would yield modest positive labor supply effects, a relatively large number of households would suffer income losses.
    Keywords: work incentives, labor supply, social safety system, microsimulation
    JEL: H31 I38 J22
    Date: 2010–09
  13. By: Devitt, Conor; Tol, Richard S. J.
    Abstract: We construct a model of development, civil war, and climate change. There are multiple interactions. Economic growth reduces the probability of civil war and the vulnerability to climate change. Climate change increases the probability of civil war. The impacts of climate change, civil war, and civil war in the neighbouring countries reduce economic growth. The model has two potential poverty traps ? a climate-change-induced one and a civil-war-induced one ? and the two poverty traps may reinforce one another. We calibrate the model to Sub-Saharan Africa and conduct a double Monte Carlo analysis accounting for both parameter uncertainty and stochasticity. We find the following. Although we use the SRES scenarios as our baseline, and thus assume rapid economic growth in Africa and convergence of African living standards to the rest of the world, the impact of civil war and climate change (ignored in SRES) are sufficiently strong to keep a number of countries in Africa in deep poverty with a high probability. Other countries enjoy exponential growth; and some countries may either be trapped in poverty or experience rapid growth. The SRES scenarios were wrong to ignore the impact of climate change and civil war on economic development.
    Keywords: civil war/climate change/economic development/Climate change/growth/Impacts of climate change/poverty/scenarios/uncertainty
    Date: 2010–09
  14. By: Hongyan Yang (Department of Economics, University of Konstanz, Germany)
    Abstract: This paper employs a two-period life-cycle model to derive the optimal tax policy when educational investments are subject to credit constraints. Credit constraints arise from the limited commitment of debitors to repay loans and are endogenously determined by private banks under the non-default condition that individuals can-not be better off by defaulting. We show that the optimal redistributive taxation trades the welfare gain of reducing borrowing demand and of changing the credit constraints against the efficiency costs of distorting education and labor supply. In addition, we compare the optimal taxation with that when credit constraints are taken as given. If income taxation decreases (increases) the borrowing limit, taking credit constraints as given leads to a too high (low) labor tax rate. Thus, ignoring the effects of tax policy on credit constraints overestimates (underestimates) the welfare effects of income taxation. Numerical examples show that income taxation tightens the credit constraints and the optimal tax rates are lower when credit constrains are endogenized. The intuition is that redistributive taxation reduces the incentive to invest in education and to work, thus exaggerating the moral hazard problems associated with credit constraints.
    Keywords: labor taxation, human capital investment, credit constraints
    JEL: H21 I2 J2
    Date: 2010–09–30
  15. By: Anton Nakov (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Carlos Thomas (Banco de España, Alcalá, 48, 28014 Madrid, Spain.)
    Abstract: We study optimal monetary policy in a flexible state-dependent pricing framework, in which monopolistic competition and stochastic menu costs are the only distortions. We show analytically that it is optimal to commit to zero inflation in the long run. Moreover, our numerical simulations indicate that the optimal stabilization policy is "price stability". These findings represent a generalization to a state-dependent framework of the same results found for the simple Calvo model with exogenous timing of price adjustment. JEL Classification: E31.
    Keywords: optimal monetary policy, price stability, stochastic menu costs, state-dependent pricing.
    Date: 2010–10
  16. By: Xavier Calbet; Jose-Luis Lopez; Ricardo Lopez-Ruiz
    Abstract: A step by step procedure to derive analytically the exact steady state probability density function of well known kinetic wealth exchange economic models is shown. This gives as a result an integro-differential equation, which can be solved analytically in some cases and numerically in others. This technique should provide some guidance into the type of probability density functions that can be derived from particular economic agent exchange rules, or for that matter, any other kinetic model of gases with particular collision physics.
    Date: 2010–10

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