This article extends the standard continuous time financial market model pioneered by Samuelson (1969) and Merton (1971) to allow for insider information. The paper derives necessary and sufficient conditions for arbitrage opportunities of insiders and presents optimal portfolio strategies for investors having anticipative information. We prove that if the investment horizon of an insider ends after his initial information advantage has disappeared, an insider has arbitrage opportunities if and only if the anticipative information is so informative that it contains zero-probability events given initial public information. When it ends before or when anticipative information does not contain such events we derive expressions for optimal consumption and portfolio policies and examine the effects of anticipative information on the optimal policies of an insider. Optimal insider policies are shown not to be fully revealing. Anticipative information is of no value and therefore does not affect the optimal behavior of insiders if and only if it is independent from public information. We show that arbitrage opportunities allow to replicate arbitrary consumption streams such that the insider's budget constraint is not binding. Consequently, Merton's consumption-investment problem has no solution whenever investment horizons are longer than resolution times of signals and insider information contains events whose occurrence is not believed. If the true signal is perturbed by independent noise this problem can be avoided. But since in this case investors never learn the true anticipative information we argue that this does not capture an important feature of insider information. We also show that the valuation of contingent claims measurable with respect to public information at maturity is invariant to insider information if the latter does not allow for arbitrage opportunities. In contrast contingent claims have no value for insiders with anticipative information generated by signals with continuous distribution.
{"title":"Insider Information, Arbitrage and Optimal Portfolio and Consumption Policies","authors":"M. Rindisbacher","doi":"10.2139/ssrn.302181","DOIUrl":"https://doi.org/10.2139/ssrn.302181","url":null,"abstract":"This article extends the standard continuous time financial market model pioneered by Samuelson (1969) and Merton (1971) to allow for insider information. The paper derives necessary and sufficient conditions for arbitrage opportunities of insiders and presents optimal portfolio strategies for investors having anticipative information. We prove that if the investment horizon of an insider ends after his initial information advantage has disappeared, an insider has arbitrage opportunities if and only if the anticipative information is so informative that it contains zero-probability events given initial public information. When it ends before or when anticipative information does not contain such events we derive expressions for optimal consumption and portfolio policies and examine the effects of anticipative information on the optimal policies of an insider. Optimal insider policies are shown not to be fully revealing. Anticipative information is of no value and therefore does not affect the optimal behavior of insiders if and only if it is independent from public information. We show that arbitrage opportunities allow to replicate arbitrary consumption streams such that the insider's budget constraint is not binding. Consequently, Merton's consumption-investment problem has no solution whenever investment horizons are longer than resolution times of signals and insider information contains events whose occurrence is not believed. If the true signal is perturbed by independent noise this problem can be avoided. But since in this case investors never learn the true anticipative information we argue that this does not capture an important feature of insider information. We also show that the valuation of contingent claims measurable with respect to public information at maturity is invariant to insider information if the latter does not allow for arbitrage opportunities. In contrast contingent claims have no value for insiders with anticipative information generated by signals with continuous distribution.","PeriodicalId":180189,"journal":{"name":"Boston University Questrom School of Business Research Paper Series","volume":"5 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2001-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116308617","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper provides an explanation of currency crises based on an argument that bailing out financially distressed exporting firms through a currency depreciation is ex-post optimal. Exporting firms have profitable investment opportunities, but they will not invest because high leverage causes debt overhang problems. The government can make investments feasible by not defending a fixed exchange rate and letting the currency depreciate. Currency depreciation always increases the profitability of new investments when revenues are in a foreign currency and costs are at least partially in domestic. Interestingly, foreign borrowing by exporting firms doesn't change the qualitative results: if firms' debt is denominated in foreign currency, a larger depreciation is needed to restore incentives to invest. An important feature in our model is that in general exporting firms choose to finance investments with debt instead of equity. Currency depreciation is socially optimal if risky projects have a higher expected return than safe projects and if firms are forced to rely on debt financing because of underdeveloped equity markets. Although currency depreciation is always ex-post optimal, it can be harmful ex-ante. Exporting firms know that the government will let the currency depreciate, if their risky investments have failed. This leads to excessive investment in risky projects even if more valuable safe projects are available.
{"title":"Corporate Leverage and Currency Crises","authors":"Arturo Bris, Y. Koskinen","doi":"10.2139/ssrn.217169","DOIUrl":"https://doi.org/10.2139/ssrn.217169","url":null,"abstract":"This paper provides an explanation of currency crises based on an argument that bailing out financially distressed exporting firms through a currency depreciation is ex-post optimal. Exporting firms have profitable investment opportunities, but they will not invest because high leverage causes debt overhang problems. The government can make investments feasible by not defending a fixed exchange rate and letting the currency depreciate. Currency depreciation always increases the profitability of new investments when revenues are in a foreign currency and costs are at least partially in domestic. Interestingly, foreign borrowing by exporting firms doesn't change the qualitative results: if firms' debt is denominated in foreign currency, a larger depreciation is needed to restore incentives to invest. An important feature in our model is that in general exporting firms choose to finance investments with debt instead of equity. Currency depreciation is socially optimal if risky projects have a higher expected return than safe projects and if firms are forced to rely on debt financing because of underdeveloped equity markets. Although currency depreciation is always ex-post optimal, it can be harmful ex-ante. Exporting firms know that the government will let the currency depreciate, if their risky investments have failed. This leads to excessive investment in risky projects even if more valuable safe projects are available.","PeriodicalId":180189,"journal":{"name":"Boston University Questrom School of Business Research Paper Series","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2000-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130898573","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The proliferation of alternative information sources has reduced the relevance of corporate annual reports. This paper examines economic outcomes in an oligopolistic industry as investors become better informed but financial reports convey a smaller portion of the total information. Results show that an increase in alternate sources of information, and the resulting decline in relevance of financial reports, leads to a loss in economic efficiency despite the presence of additional information. Investors benefit, but at the expense of consumers and social welfare. Investors benefit not necessarily because the amount of information in the economy increases, but because there is a change in the channels through which the same information is communicated.
{"title":"Economic Consequences of the Declining Relevance of Financial Reports","authors":"N. Sinha, John S. Watts","doi":"10.2139/SSRN.217488","DOIUrl":"https://doi.org/10.2139/SSRN.217488","url":null,"abstract":"The proliferation of alternative information sources has reduced the relevance of corporate annual reports. This paper examines economic outcomes in an oligopolistic industry as investors become better informed but financial reports convey a smaller portion of the total information. Results show that an increase in alternate sources of information, and the resulting decline in relevance of financial reports, leads to a loss in economic efficiency despite the presence of additional information. Investors benefit, but at the expense of consumers and social welfare. Investors benefit not necessarily because the amount of information in the economy increases, but because there is a change in the channels through which the same information is communicated.","PeriodicalId":180189,"journal":{"name":"Boston University Questrom School of Business Research Paper Series","volume":"17 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2000-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131569004","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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