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Essays on mathematical finance

Vichos, Georgios (2019) Essays on mathematical finance. PhD thesis, London School of Economics and Political Science.

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The first part of this thesis deals with the consideration of thin incomplete financial markets, where traders with heterogeneous preferences and risk exposures have motive to behave strategically regarding the demand schedules they submit, thereby impacting prices and allocations. We argue that traders relatively more exposed to market risk tend to submit more elastic demand functions. Noncompetitive equilibrium prices and allocations result as an outcome of a game among traders. General sufficient conditions for existence and uniqueness of such equilibrium are provided, with an extensive analysis of two-trader transactions. Even though strategic behaviour causes inefficient social allocations, traders with sufficiently high risk tolerance and/or large initial exposure to market risk obtain more utility gain in the noncompetitive equilibrium, when compared to the competitive one. The second part of this thesis considers a continuum of potential investors allocating funds in two consecutive periods between a manager and a market index. The manager’s alpha, defined as her ability to generate idiosyncratic returns, is her private information and is either high or low. In each period, the manager receives a private signal on the potential performance of her alpha, and she also obtains some public news on the market’s condition. The investors observe her decision to either follow a market neutral strategy, or an index tracking one. It is shown that the latter always results in a loss of reputation, which is also reflected on the fund’s flows. This loss is smaller in bull markets, when investors expect more managers to use high beta strategies. As a result, a manager’s performance in bull markets is less informative about her ability than in bear markets, because a high beta strategy does not rely on it. We empirically verify that flows of funds that follow high beta strategies are less responsive to the fund’s performance than those that follow market neutral strategies.

Item Type: Thesis (PhD)
Additional Information: © 2019 Georgios Vichos
Library of Congress subject classification: H Social Sciences > HG Finance
Sets: Departments > Statistics
Supervisor: Kardaras, Konstantinos

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