Waterloo economics series | 2008

Abstracts of working papers

#08-001 -- Mikal Skuterud

Perinatal family labour supply historical trends and the modern experience (PDF)

Abstract

The predominant perspective on perinatal family labour supply in the theoretical and empirical economics literature is that careers and children are simultaneous choices, so conditioning on the prenatal career ambitions of individuals, and particularly women, the event of a birth has little or no effect on labour market behaviour. There are, of course, many reasons to believe that this "all-or-nothing" view, rooted in assumptions of perfect foresight, overlooks significant labour market effects of children and that due to various trends, including rising correlation in husband-wife earnings, these effects may becoming increasingly important. Using historical Canadian Census data and rich longitudinal microdata, I use nonparametric techniques to identify discontinuities in employment probabilities, hours of work and wage outcomes of parents, and particularly dual-career couples, in the months just before and after a first birth. The evidence indicates that although the vast majority of new mothers and fathers who were employed prior to birth, maintain that employment, a non-trivial percentage of women (roughly 20%) appear to give up employment entirely after a birth and roughly half of them will not have returned to work 5 years later. More importantly, the percentage that drop out of the labour force is increasing and has been for at least the past two decades. This decrease is particularly evident among more educated and older women. Further, among new mothers and fathers who maintain their employment through the perinatal period, there is evidence of other types of labour supply adjustments including significant decreases (mothers) and increases (fathers) in both usual monthly hours of work and hourly wages. There is also evidence of increased probabilities of job changing in the year just before and after the birth for fathers, but not for mothers. Together these findings provide a much richer perspective on how today's dual-career families balance work and child rearing. In terms of its policy relevance, the findings emphasize the importance of measures that support parents in balancing work and family time, as opposed to measures that are focused on enabling parents, and particularly women, to maintain uninterrupted careers while raising children.

#08-002 -- M.C. Insley and T.S. Wirjanto

Contrasting two approaches in real options valuation contingent claims versus dynamic programming (PDF)

Abstract

This paper compares two well-known approaches for valuing a risky investment using real options theory: contingent claims (CC) with risk neutral valuation and dynamic programming (DP) using a constant risk adjusted discount rate. Both approaches have been used in valuing forest assets. A proof is presented which shows that, except under certain restrictive assumptions; DP using a constant discount rate and CC will not yield the same answers for investment value. A few special cases are considered for which CC and DP with a constant discount rate are consistent with each other. An optimal tree harvesting example is presented to illustrate that the values obtained using the two approaches can differ when we depart from these special cases to a more realistic scenario. Further, the implied risk adjusted discount rate calculated from CC is found to vary with the stochastic state variable and stand age. We conclude that for real options problems the CC approach should be used.

Keywords

Optimal tree harvesting, real options, contingent claims, dynamic programming

Running title

Contingent claims theory and dynamic programming

#08-003 -- Shan Chen and Margaret Insley

Regime switching in stochastic models of commodity prices: an application to an optimal tree harvesting problem (PDF)

Abstract

This paper investigates a regime switching model of stochastic lumber prices in the context of an optimal tree harvesting problem. Using lumber derivatives prices, two lumber price models are calibrated: a regime switching model and a single regime model. In the regime switching model, the lumber price can be in one of two regimes in which different mean reverting price processes prevail. An optimal tree harvesting problem is specified in terms of a linear complementarity problem which is solved using a fully implicit finite difference, fully-coupled, numerical approach. The land value and critical harvesting prices are found to be significantly different depending on which price model is used. The regime switching model shows promise as a parsimonious model of timber prices that can be incorporated into forestry investment problems.

Keywords

Optimal tree harvesting, regime switching, calibration, lumber derivatives prices, fully implicit finite difference approach

Running title

Regime switching prices and optimal tree harvesting

Paper updated July 2010 (PDF)

#08-004 -- Matthew Doyle and Jacob Wong (The University of Adelaide)

Wage posting without full commitment (PDF)

Abstract

Wage posting models of job search typically assume that firms can commit to paying workers the posted wage. This paper investigates the consequences of relaxing this assumption. Under "downward" commitment firms can commit only to paying at least their advertised wage. We show that wage posting is always an equilibrium, although in special cases other equilibria can exist. Surprisingly, the wage posting equilibrium in our economy is identical to the equilibrium when firms can commit to paying exactly their posted wage. When firms cannot even commit to paying at least their advertised wage, equilibrium exhibits job auctions with wage dispersion which generally are not constrained  efficient.

#08-005 -- Margaret Insley and M. Lei

Hedges and trees: incorporating fire risk into optimal decisions in forestry using a no-arbitrage approach

Abstract

This paper investigates the impact of including the risk of fire in an optimal tree harvesting model at the stand level, assuming timber prices follow a mean reverting stochastic process. The relevant partial differential equation is derived under different assumptions about hedging the risk of fire. The assumption that fire risk is fully diversifiable is contrasted with the assumption that it can be hedged with another asset. It is conjectured that the risk-neutral probability of fire exceeds the historical probability of fire, which will affect forest land valuation. An empirical example is presented for two different silvicultural regimes.
 

Keywords

Fire risk, forest value, hedging, jumps, no-arbitrage, optimal harvesting, Poisson process, real options

#08-006 -- Dinghai Xu and John Knight (University of Western Ontario)

Continuous empirical characteristic function estimation of mixtures of normal parameters (PDF)

Abstract

This paper develops an efficient method for estimating the discrete mix- tures of normal family based on the continuous empirical characteristic function (CECF). An iterated estimation procedure based on the closed form objective distance function is proposed to improve the estimation efficiency. The results from the Monte Carlo simulation reveal that the CECF estimator produces good finite sample properties. In particular, it outperforms the discrete type of methods when the maximum likelihood estimation fails to converge. An empirical example is provided for illustrative purposes.

Journal of Economic Literature (JEL) classification

C13; C15; C16

Keywords

Empirical characteristic function; mixtures of normal

#08-007 -- Dinghai Xu, John Knight (University of Western Ontario), and Tony S. Wirjanto

Asymmetric stochastic conditional duration model a mixture of normals approach (PDF)

Abstract

This paper extends the stochastic conditional duration model by imposing mixtures of bivariate normal distributions on the innovations of the observation and latent equations of the duration process. This extension allows the model not only to capture the asymmetric behavior of the expected duration but also to easily accommodate a richer dependence structure between the two innovations. In addition, it proposes a novel estimation methodology based on the empirical characteristic function. A set of Monte Carlo experiments as well as empirical applications based on the IBM and Boeing transaction data are provided to assess and illustrate the performance of the proposed model and the estimation method. One main empirical finding in this paper is that there is a significantly positive "leverage effect" under both the contemporaneous and lagged inter-temporal de pendence structures for the IBM and Boeing duration data.

Keywords

Stochastic conditional duration model; leverage effect; discrete mixtures of normal; empirical characteristic function

#08-008 -- Dinghai Xu and Tony S. Wirjanto

An empirical characteristic function approach to VaR under a mixture of normal distribution with time-varying volatility (PDF)

Abstract

This paper considers Value at Risk measures constructed under a discrete mixture of normal distribution on the innovations with time-varying volatility, or Mixed Normal-Generalized AutoRegressive Conditional Heteroskedasticity (MN-GARCH), model. We adopt an approach based on the continuous empirical characteristic function to estimate the parameters of the model using several daily foreign exchange rates' return data. This approach has several advantages as a method for estimating the MN-GARCH model. In particular, under certain weighting measures, a closed form objective distance function for estimation is obtained. This reduces the computational burden considerably. In addition, the characteristic function, unlike its likelihood function counterpart, is always uniformly bounded over parameter space due to the Fourier transformation. To evaluate the VaR estimates obtained from alternative specifications, we construct several measures, such as the number of violations, the average size of violations, the sum square of violations and the expected size of violations. Based on these measures, we find that the VaR measures obtained from the MN-GARCH model outperform those obtained from other competing models.

Keywords

Value at risk; mixture of normals; GARCH; characteristic function

#08-009 -- Cathy Ning and Tony S. Wirjanto

Extreme return-volume dependence in East-Asian stock markets: a copula approach

Abstract

A copula approach is adopted to examine the extreme return-volume relationship in six emerging East-Asian equity markets. The empirical results indicate that the return-volume dependence is significant and asymmetric at extremes for all six East-Asian markets. In particular extremely high returns (large gains) tend to be associated with extremely large trading volumes, but only marginal (extremely small) returns tend to be related to either large or small volumes.

JEL classification

C14, C51, G12

Keywords

Return-volume dependence; extreme returns, copulas; tail dependence

#08-010 -- Dingan Feng (York University), Peter X.-K. Song, and Tony S. Wirjanto

Time-deformation modeling of stock returns directed by duration processes (PDF)

Abstract

This paper presents a new class of time-deformation (or stochastic volatility) models for stock returns sampled in transaction time and directed by a generalized duration process. Stochastic volatility in this model is driven by an observed duration process and a latent autoregressive process. Parameter estimation in the model is carried out by using the method of simulated moments (MSM) due to its analytical feasibility and numerical stability for the proposed model. Simulations are conducted to validate the choices of the moments used in the formulation of the MSM. Both the simulation and empirical results obtained in this paper indicate that this approach works well for the proposed model. The main empirical findings for the IBM transaction return data can be summarized as follows: (i) the return distribution conditional on the duration process is not Gaussian, even though the duration process itself can marginally function as a directing process; (ii) the return process is highly leveraged; (iii) a longer trade duration tends to be associated with a higher return volatility; and (iv) the proposed model is capable of reproducing return whose marginal density function is close to that of the empirical return.
 

JEL classification

G10, C51, C32

Keywords

Duration process; ergodicity; method of simulated moments; return process; stationarity

#08-011 -- Youngsoo Choi (Hankuk University of Foreign Studies, Korea) and Tony S. Wirjanto

A simple model of the nominal term structure of interest rates (PDF)

Abstract

This paper presents a simple two-factor model of nominal term structure of interest rates, in which the log-price kernel has an autoregressive drift process and a nonlinear GARCH volatility process. With these two state-variable processes, closed-form solutions are derived for zero-coupon bond prices as well as yield to maturity for a given time to maturity.

#08-012 -- Jean Abraham (University of Minnesota) and Stéphanie Lluis

Compensating differentials and fringe benefits evidence from the medical expenditure panel survey 1997-2004 (PDF)

Abstract

In this paper, we revisited the question of the existence of a tradeoff between wages and health insurance by extending previous work in the following way: 1) we exploit richer information on health insurance in terms of whether the worker holds health insurance or whether it is offered at the firm but he/she does not hold it, 2) we analyze possible combinations of health insurance with other fringe benefits (retirement, sick leave and paid vacation), 3) we include information on workers health (self-reported) as a determinants of workers wage and mobility decision, and 4) we use an econometric framework and GMM estimations which allow us to treat the issues of endogenous choice of benefits and mobility into benefits sectors encountered in the literature and estimate the extent of worker selection into jobs with/without benefits based on unobserved individual-specific traits, skills and health status.

#08-013 -- Alan Huang, Yao Tian and Tony S. Wirjanto

Re-examining accounting conservatism: the importance of adjusting for firm heterogeneity

Abstract

Prior studies have documented the extent of accounting conservatism (in the form of the asymmetric response of accountings earnings to  news) and its increase over time. However, many of these studies implicitly assume that unobserved firm-specific characteristics (known as firm heterogeneity or firm-specific fixed effects) are homogenous and, thus, unimportant to earnings determination. In this paper, we show that this assumption is over-restrictive, and there are significant cross-sectional differences (firm heterogeneity) in earnings. We find that, after accounting for firm-specific fixed effects in the earnings determination, [i] the level of accounting conservatism is smaller in magnitude than previously documented, and [ii] there is no clear pattern of increasing conservatism over time. Our results stand in stark contrast to much of the findings in the literature and raise the awareness among researchers of the importance of accounting for firm-specific heterogeneity in  examining earnings-returns relations.

Keywords

Accounting conservatism; earnings asymmetry; firm-specific fixed effects

#08-014 -- Jee Hae Lim, Theophanis C. Stratopoulos (University of New Hampshire) and Tony S. Wirjanto

IT Innovation Persistence and State Dependence: An Empirical Investigation

Abstract

In this study we examine the persistence of a firm's ability to differentiate itself from its peers and stand out in a crowd of competitors through IT innovation. By using cross-sectional data set of large US firms from 1997-2004, our empirical evidence shows that prior IT innovation experience is an important determinant of current IT innovation capability even after we account for firm heterogeneity factors such as financial performance (halo effect), size, and industry. This evidence supports our proposition that there is a structural true state (path) dependence in the sense that prior IT innovation experience constrains future IT innovation choices and outputs. Therefore, the IT innovation capability is heterogeneously distributed and not easy to imitate.

Keywords

IT innovation persistence, IT capabilities, true state dependence