Contributions published at Financial Economics (Thorsten Hens)

We show that for international economies with two countries, in which agents have additively separable utility functions, the existence of sunspot equilibria is equivalent to the occurrence of the transfer paradox. This equivalence enables us to provide some new insights on the relation of the existence of sunspot equilibria and the multiplicity of spot market equilibria.

We suggest a simple asset market model in which we analyze competitive and strategic behavior simultaneously. If two-fund separation is found to hold across periods for competitive behavior, it also holds for strategic behavior. In this case the relative prices of the assets do not depend on whether the agents behave strategically or competitively. The agents acting strategically will however invest less in the common mutual fund. Constant relative risk aversion and the absence of aggregate risk are shown to be two alternative sufficient conditions for two-period fund separation. By including derivatives in our model, further strategic aspects arise. In this case the strategic behavior is found to differ from the competitive behavior even for utility functions leading to two-fund separation.

We consider economies with additively separable utility functions and give conditions for the two-agents case under which the existencenof sunspot equilibria is equivalent to the occurrence of the transfer paradox.nThis equivalence enables us to show that sunspots cannot matter if the initial economy has a unique spot market equilibrium and there are only twoncommodities or if the economy has a unique equilibrium for all distributions of endowments induced by asset trade. For more than two agents the equivalence breaks and we give an example for sunspot equilibria even though theneconomy has a unique equilibrium for all distributions of endowments inducednby asset trade.

This paper tests the effect of a matching mechanism on donations in a controlled fieldnexperiment. We match the donations of students at the University of Zurich who, each semester, have to decide whether they wish to contribute to two Social Funds. Our results support thenhypothesis that a matching mechanism increases contributions to a public good. However, the effect depends on the extent to which the contributions are matched. Whereas a 25 percentnincrease of a donation does not increase the willingness to contribute, a 50 percent increase does have an effect. In addition, people need to be socially inclined to react to the matching mechanism. The field experiment provides some evidence suggesting that the matching mechanism crowds-out the intrinsic motivation of giving.

Der Beitrag von Thorsten Hens und Klaus Reiner Schenk-Hoppé liefert eine quantitative Analyse der evolutionären Dynamik von Finanzmärkten. Die evolutionäre Finanzmarkttheorie beruht auf einer konsequenten Weiterentwicklung des in letzter Zeit entstandenen verhaltenswissenschaftlich orientierten Ansatzes, der die traditionelle Finanzmarkttheorie ergänzt. Hens und Schenk-Hoppé stellen ein evolutionäres Simulationsmodell vor, bei dem der Aktienmarkt als heterogene Population von häufig interagierenden Portfolio-Strategien im Wettbewerb um Marktkapital verstanden wird. Dabei wenden sie eine an Darwinschen Ideen orientierte Theorie der Portfolio-Selektion auf Aktien des Dow Jones Industrial Average an. Sie analysieren die Vermögensdynamik zwischen unterschiedlichen Portfolio-Strategien in einem Aktienmarktmodell mit tatsächlich gezahlten Dividenden. Die evolutionäre stabile Portfolio-Strategie, deren Budgetanteile proportional zu den erwarteten relativen Dividenden der Aktien sind, erzielt dabei langfristig das höchste Anlagevermögen imWettbewerb mit anderen Strategien. Und sie ist zudem die einzige Strategie mit dieser Eigenschaft.

There is an extensive literature claiming that it is often di*cultnto make use of arbitrage opportunities in *nancial markets. Thisnpaper provides a new reason why existing arbitrage opportunitiesnmight not be seized. We consider a world with short-lived securities,nno short-selling constraints and no transaction costs. We show thatnto exploit all existing arbitrage opportunities, traders should paynattention to all *nancial markets simultaneously. It gives a generalnresult stating that failure to do so will leave some arbitrage oppor-ntunies unexploited with probability one.

Based on an experimental analysis of a simple monetary economy we argue that a monetarynsystem is more stable than one would expect from individual rationality. We show thatnpositive reciprocity stabilizes the monetary system, provided every participant considers thenfeedbacks of his choice to the stationary equilibrium. If however the participants do not playnstationary strategies and some participants notoriously refuse to accept money then due tonnegative reciprocity their behavior will eventually induce a break down of the monetarynsystem.

This paper shows that a stock market is evolutionary stable if andnonly if stocks are evaluated by expected relative dividends. Any othernmarket can be invaded by portfolio rules that will gain market wealthnand hence change the valuation. In the model the valuation of assetsnis given by the wealth average of the portfolio rules in the market. Thenwealth dynamics is modelled as a random dynamical system. Necessary and sufficient conditions are derived for the evolutionary stabilitynof portfolio rules when (relative) dividend payoffs form a stationarynMarkov process. These local stability conditions lead to a unique evolutionary stable strategy according to which assets are evaluated bynexpected relative dividends.

We suggest a simple asset market model in which we analyze competitive and strategic behaviornsimultaneously. If for competitive behavior two-fund separation holds across periods then itnalso holds for strategic behavior. In this case the relative prices of the assets do not dependnon whether agents behave strategically or competitively. Those agents acting strategically willnhowever invest less in the common mutual fund. Constant relative risk aversion and absencenof aggregate risk are shown to be two alternative sufficient conditions for two-period fundnseparation. With derivatives further strategic aspects arise and strategic behavior is distinctnfrom competitive behavior even for those utility functions leading to two-fund separation.

Markowitz and Sharpe won the Nobel Prize in Economics more than a decade ago for thendevelopment of Mean-Variance analysis and the Capital Asset Pricing Model (CAPM). In the yearn2002, Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. Cannthese two apparently contradictory paradigms coexist?nIn deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU)nmaximization following the approach proposed by Markowitz, normal distributions and risknaversion. Kahneman & Tversky suggest Prospect Theory (PT) and Cumulative Prospect Theoryn(CPT) as an alternative paradigm to EU theory. They show that investors distort probabilities,nmake decisions based on change of wealth, exhibit loss aversion and maximize the expectation ofnan S-shaped value function which contains a risk-seeking segment. Employing change of wealthnrather than total wealth contradicts EU theory. The subjective distortion of probabilities violatesnthe CAPM assumptions of normality and homogeneous expectations, and the S-shaped valuenfunction violates the risk aversion assumption. We prove in this paper that although CPT (and PT)nis in conflict to EUT, and violates some of the CAPM's underlying assumptions, the securitynmarket line theorem (SMLT) of the CAPM is intact in the CPT framework.

Under the assumption of normally distributed returns, we analyzenwhether the Cumulative Prospect Theory of Tversky and Kahneman (1992)nis consistent with the Capital Asset Pricing Model. We find that in everynfinancial market equilibrium the Security Market Line Theorem holds.nHowever, under the specific functional form suggested by Tversky andnKahneman (1992) financial market equilibria do not exist. We suggest annalternative functional form that is consistent with both, the experimentalnresults of Tversky and Kahneman and also with the existence of equilibria.

Tobin (1958) has argued that in the face of potential capital losses on bonds it is nreasonable to hold cash as a means to transfer wealth over time. It is shown that this assertion cannot be sustained taking into account the evolution of wealth of cash holders versus non cash holders. Cash holders will be driven out of the market in the long run by traders who only use a (risky) long-lived asset to transfer wealth.

In this paper we analyze the long‐run dynamics of the market selection process among simple trading strategies in an incomplete asset market with endogenous prices. We identify a unique surviving financial trading strategy. Investors following this strategy asymptotically gather total market wealth. This result generalizes findings by Blume and Easlcy (1992) to any complete or incomplete asset market.

This paper presents an application of evolutionary portfolio theory to stocks listed in the Swiss Market Index (SMI). We study numerically the long-run outcome of the competition of rebalancing rules for market shares in a stock market with actual dividends taken from firms listed in the SMI. Returns are endogenous because prices are determined by supply and demand stemming from the rebalancing rules. Our simulations show that in competition with rebalancing rules derived from Mean-Variance Optimization, Maximum Growth Theory and Behavioral Finance, the evolutionary portfolio rule discovered in Hens and Schenk-Hoppé (2001) will eventually hold total market wealth. According to this simple rule the portfolio weights should be proportional to the expected relative dividends of the assets.

In the standard ‘capital asset pricing model’ (CAPM) with a riskless asset we give a sufficient condition for uniqueness. This condition is a joint restriction on the agents’ endowments and their preferences which is compatible with non-increasing absolute risk aversion and which is in particular satisfied with constant absolute risk aversion. Moreover, in the CAPM without a riskless asset we give an example for multiple equilibria even though all agents have constant absolute risk aversion.