New Economics Papers
on Financial Markets
Issue of 2007‒10‒06
two papers chosen by

  1. Wall Street and Silicon Valley: A Delicate Interaction By George-Marios Angeletos; Guido Lorenzoni; Alessandro Pavan
  2. Optimal Portfolio Liquidation for CARA Investors By Schied, Alexander; Schöneborn, Torsten

  1. By: George-Marios Angeletos; Guido Lorenzoni; Alessandro Pavan
    Abstract: Financial markets look at data on aggregate investment for clues about underlying profitability. At the same time, firms' investment depends on expected equity prices. This generates a two-way feedback between financial market prices and investment. In this paper we study the positive and normative implications of this interaction during episodes of intense technological change, when information about new investment opportunities is highly dispersed. Because high aggregate investment is "good news" for profitability, asset prices increase with aggregate investment. Because firms' incentives to invest in turn increase with asset prices, an endogenous complementarity emerges in investment decisions -- a complementarity that is due purely to informational reasons. We show that this complementarity dampens the impact of fundamentals (shifts in underlying profitability) and amplifies the impact of noise (correlated errors in individual assessments of profitability). We next show that these effects are symptoms of inefficiency: equilibrium investment reacts too little to fundamentals and too much to noise. We finally discuss policies that improve efficiency without requiring any informational advantage on the government's side.
    JEL: E2 G1 G3
    Date: 2007–10
  2. By: Schied, Alexander; Schöneborn, Torsten
    Abstract: We consider the finite-time optimal portfolio liquidation problem for a von Neumann-Morgenstern investor with constant absolute risk aversion (CARA). As underlying market impact model, we use the continuous-time liquidity model of Almgren and Chriss (2000). We show that the expected utility of sales revenues, taken over a large class of adapted strategies, is maximized by a deterministic strategy, which is explicitly given in terms of an analytic formula. The proof relies on the observation that the corresponding value function solves a degenerate Hamilton-Jacobi-Bellman equation with singular initial condition.
    Keywords: Liquidity; illiquid markets; optimal liquidation strategies; dynamic trading strategies; algorithmic trading; utility maximization
    JEL: G24 G20 G10
    Date: 2007–09–27

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