The Effects of Judicial Strength and Rule of Law on Portfolio Investment in the Developing World*

Objective. Applying existing theories relating to investment risk, this article examines the effects of judicial strength and adherence to the rule of law on portfolio investment in the developing world. We aim to demonstrate that countries with higher levels of judicial strength and rule of law are more able to attract portfolio investment because they provide greater protection of property rights and a better risk environment for investors. Methods. Using time‐series data for 79 developing countries for the period 1996–2005, we employ panel‐corrected standard errors multivariate regressions to demonstrate that higher levels of judicial strength and rule of law are associated with higher levels of portfolio investment. Results. We find that a one standard deviation increase in overall judicial strength and rule of law results in more than a 50 percent increase in portfolio investment. In separate analyses, we show that a one standard deviation increase in specific measures of judicial independence, impartial courts, and protection of property rights leads to increases in portfolio investment ranging from 27 percent to 184 percent. Conclusion. Judicial strength and adherence to the rule of law are important determinants of portfolio investment in the developing world.     

Does the Euro–Mediterranean Partnership contribute to regional integration?

The paper investigates whether Southern Mediterranean and Middle Eastern markets under the Euro–Mediterranean Partnership (Egypt, Lebanon, Morocco, Malta, and Turkey) have become more financially integrated with the European stock market over time. The findings suggest that the Turkish equity market is moderately integrated with the European market, while the other economies exhibit weak financial integration with Europe, supporting the idea that the partnership appears to have no effect on enhancing inter-market linkages for these economies. Therefore, these markets would be good destinations for international investors seeking attractive investment opportunities to diversify their equity portfolios. Structural changes in the cross-market integration do exist, which may be considered as a guide for international equity portfolio diversification over different subperiods. In addition, there is evidence of an increasing trend in conditional correlations for Egypt and Turkey, to varying degrees, over time, notably during the post global financial crisis of 2007–2008, thus revealing herding behavior during this period. Overall, investors should be wary of the variation of equity market integration over time before engaging in an investment at the level of portfolio management and diversification. Policymakers must be aware of the remoteness of the current achievements of the Euro–Mediterranean Partnership from the targets set in terms of financial development and economic growth.     

Horizon Length and Portfolio Risk

In this paper, we compare the attitude towards current risk of two expected-utility-maximizing investors who are identical except that the first investor will live longer than the second one. It is often suggested that the young investor should take more risks than the old investor. We consider as a benchmark the case of complete markets with a zero risk-free rate. We show that a necessary and sufficient condition to assure that younger is riskier is that the Arrow-Pratt index of absolute tolerance (T) be convex. If we allow for a positive risk-free rate, the necessary and sufficient condition is T convex, plus T(0) = 0. It extends the well-known result that rational investors can behave myopically if and only if the utility function exhibits constant relative risk aversion.     

Ambiguity in asset pricing and portfolio choice: a review of the literature

We survey the literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. This ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.     

Failing the Transition from Welfare to Work: Women Chronically Disconnected from Employment and Cash Welfare*

Objectives. Although employment among welfare mothers increased substantially following the 1996 welfare reform, some former welfare recipients failed to find stable employment. We review the extent to which low‐income mothers are without work and cash welfare for long periods of time and seek to understand the correlates of becoming chronically disconnected. Methods. We analyze data from a 1997–2003 panel study of single mothers who received cash welfare in an urban county in Michigan in February 1997. We develop a new measure of the extent to which former recipients are “chronically disconnected” from both employment and cash welfare and estimate regression models of the correlates of this economic outcome. Results. About 9 percent of respondents became chronically disconnected, defined as being without employment and cash welfare during at least one‐quarter of the months during the 79‐month study period. Important correlates of becoming chronically disconnected include having a physical limitation, having a learning disability, using illegal drugs or meeting the diagnostic screening criteria for alcohol dependence, and having no car or driver license. The chronically disconnected are more likely to have lost a job than to have lost welfare benefits and are more economically disadvantaged than those with regular sources of economic support. Conclusions. To reduce the number of women who fail to make a successful transition from welfare to work, more attention should be given to programs and policies that attempt to reconnect disconnected women to regular sources of economic support.     

The price of risk with incomplete knowledge on the utility function*

When a risk is exchanged, the exact value for the minimum price (positive or negative) that the purchaser (investor, or insurer) is willing to pay is given by the certainty equivalent wealth level, which in turn depends on his specific utility function. When this utility function is unknown, then only a sufficient condition on the price can ever be found. This paper provides methods for calculating such a sufficient condition, when only limited information on the utility function is known.     

Outsourcing with identical suppliers and shortest-first policy: a laboratory experiment

We study experimentally in the laboratory two 2-player games that mimic a decentralized decision-making situation in which firms repeatedly outsource production orders to multiple identical suppliers. The first game has a unique (inefficient) equilibrium in mixed strategies, while the second game has two (efficient) equilibria in pure strategies and an infinite number of (inefficient) equilibria in mixed strategies. In both games, the optimal social costs can also be obtained via dominated strategies. We find that only in the second game subjects manage to reach an efficient outcome more often when matched in fixed pairs than when randomly rematched each round. Surprisingly, this is because subjects coordinate on dominated strategies (and not an efficient pure strategy equilibrium). We show theoretically that preferences for efficiency cannot explain our experimental results. Inequality aversion, on the other hand, cannot be rejected.     

How Best to Flip-Flop if You Must: Integer Dynamic Stochastic Programming for Either-Or

Standard portfolio analysis presumes one can blend different securities continuously. When one must choose all of one portfolio or all of another, we are in stochastic digital programming: either-or, zero-or-one choice. The algorithm for doing this optimally is shown to be simpler than in real variable maximizing, a switch from the usual extra complexities of digital programming. The Bellman multi-period dynamic programming is shown, paradoxically, to make it possible for a risk-averse investor to want sometimes to embrace an unfair gamble. The superiority of within-time diversification over across-time diversification carries over to this flip-flop case.     

Cashless stores and cash users

The emergence of cashless stores has led several cities and states to ban such stores. This article investigates this policy issue by characterizing consumers who pay cash for in-person purchases and banked and unbanked consumers who do not have credit or debit cards. Using a random utility model, I simulate the effects on consumer welfare caused by a hypothetical complete transition to cashless stores. The simulations show that the burden from this transition on consumers with no credit or debit cards is seven times higher than the burden on consumers who have both cards. The conclusion lists policy options for alternatives to cash that may be needed before all brick-and-mortar stores become cashless.     

The Portfolio Choices of Hispanic Couples*

Objectives. The objective of this article is to assess the overall wealth level and portfolio choices of Hispanic families. Methods. We use Survey of Income and Program Participation (SIPP) data to first estimate the determinants of net worth. Conditioning on overall wealth levels, we then estimate a model of asset portfolios. Results. Our results reveal that Hispanic couples as a group are less wealthy than otherwise similar white couples, although there is substantial variation across Hispanic‐origin groups. Accounting for these wealth disparities, Hispanic couples hold less financial wealth, but more real estate and business equity than do white couples. Conclusions. Much of the disparity in portfolio choices of Hispanics as a group relative to whites appears to stem from the fact that they are less wealthy. At the same time, it is important to separately analyze the wealth position of distinct Hispanic‐origin groups.     

Capital markets integration and economic growth in the European Union

This paper argues that a deeper integration of capital markets in the European Union is necessary to support accelerated economic growth. Further integrated equity and bond markets will provide access to capital funding improve the allocation of capital, help mitigate market and systemic risks, and ultimately foster a counter-cyclical, sustained real economy growth. The paper provides evidence that the increases in both total portfolio equity and debt to GDP ratios in the euro area actively contribute to real GDP growth.     

THE GENERALIZED HARMONIC MEAN AND A PORTFOLIO PROBLEM WITH DEPENDENT ASSETS

McEntire (1984) proved that, for a portfolio problem with independent assets, the generalized harmonic mean plays the role of a risk-free threshold. Based upon this property, he developed a criterion for including or excluding assets in an optimal portfolio, and he proved an ordering theorem showing that an optimal portfolio always consists of positive amounts of the assets with the largest mean values. Also, some commonly used utility functions were shown to satisfy the property that the dominance of an asset over another is unaffected by the addition of other assets. In this paper we extend these results to the case where assets are dependent.     

Does gold act as a safe haven against exchange rate fluctuations? The case of Pakistan rupee

Investors often look for a refuge to avoid undesirable exposures to risk during period of extreme downturns in currency returns. We investigate daily gold and rupee exchange rates depreciation against set of currencies over the period of 1992–2015. Using wavelets at multiple time horizons; we find that gold act as a consistent short run hedge against exchange rate hence validating the exchange rate destruction hypothesis. This finding is helpful for speculators in their decision making while taking long and short positions accordingly. This finding suggests that central bank also need to keep other safe haven assets in reserves because the hedging ability of gold is only limited to short run. Further, the role of gold in providing protection against currency risks is also confirmed using quantile regression. These results assist portfolio managers and governments in formulating effectual diversification strategy for preserving investment portfolio during extreme event condition. Our results also suggest that gold has a lead relationship with exchange rate; however, this relationship switches over specific time intervals. This finding is of major concern for policy makers in determining the extent of stabilization in gold prices to bring consistency to exchange rate. Finally, the Granger coherence coefficients confirm that the strength of the causal relationship varies across over all frequencies. These conclusions have important implications for policy makers, economic analysts, portfolio managers and institutional investors.     

Portfolio Inertia and Epsilon-Contaminations

This article analyzes investors’ portfolio selection problems in a two-period dynamic model of Knightian uncertainty. We account for the existence of portfolio inertia in this two-period framework. Furthermore, by incorporating investors’ updating behavior, we analyze how observing new information in the first period will affect investors’ behavior. By this analysis, we show that observing new information in the first period will expand portfolio inertia in the second period compared with the case in which observing new information has not been gained in the first period if the degree of Knightian uncertainty is sufficiently large.     

The economics of adding and subdividing independent risks: Some comparative statics results

In this paper we address the problem of determining whether adding independent risks or subdividing them is a good substitute for insurance. Despite the fact that accepting more i.i.d. risks increases total risk, it is shown that some risk-averse decision makers can rationally reduce their demand for insurance by doing so. Similarly, a better diversified portfolio of i.i.d. risky assets can rationally be more insured, even if diversification is a risk-reduction scheme. We derive conditions sufficient to obtain unambiguous comparative statics results. Assuming that absolute risk aversion is decreasing and that the fourth derivative of the utility function is positive, we show that diversification is an exceptionally good substitute for insurance. Under the same conditions, adding independent risks to wealth reduces the demand for insurance on each unit.     

Mean utility preserving increases in risk for state dependent utility functions

This paper defines the concept of a mean utility preserving spread across states (MUPSAS) for state dependent utility functions and analyzes the behavioural impact of shifts in the probability distribution of wealth across states such that overall mean utility is preserved. The main result provides an alternative way of ranking state dependent utility functions according to their degree of risk aversion (thus extending Kami's theorem of comparative risk aversion) and establishes a link between increases in risk and risk aversion for state dependent preferences. In a portfolio problem where preferences and the rate of return of the risky venture are state dependent, we find sufficient conditions to determine the impact of a MUPSAS on the optimal share of the portfolio invested in the risky asset.

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On Hobbes’s state of nature and game theory

Hobbes’s state of nature is often analyzed in two-person two-action non-cooperative games. By definition, this literature only focuses on duels. Yet, if we consider general games, i.e., with more than two agents, analyzing Hobbes’s state of nature in terms of duel is not completely satisfactory, since it is a very specific interpretation of the war of all against all. Therefore, we propose a definition of the state of nature for games with an arbitrary number of players. We show that this definition coincides with the strategy profile considered as the state of nature in two-person games. Furthermore, we study what we call rational states of nature (that is, strategy profiles which are both states of nature and Nash equilibria). We show that in rational states of nature, the utility level of any agent is equal to his maximin payoff. We also show that rational states of nature always exist in inessential games. Finally, we prove the existence of states of nature in a class of (not necessarily inessential) symmetric games.     

Decision analysis using lottery-dependent utility

In this article we show how the lottery-dependent expected utility (LDEU) model can be used in decision analysis. The LDEU model is an extension of the classical expected utility (EU) model and yet permits preference patterns that are infeasible in the EU model. We propose a framework for constructing decision trees in a particular way that permits us to use the principle of optimality and thus the divide and conquer strategy for analyzing complex problems using the LDEU model. Our approach may be applicable to some other nonlinear utility models as well. The result is that, if desired, decision analysis can be conducted without assuming the restrictive substitution principle/independence axiom.