Jim Chen's SSRN abstracts

Welcome to Jim Chen's SSRN abstracts. This is a human-friendly display of the RSS feed  for Mr. Chen's official SSRN page (http://ssrn.com/author=68651), reorganized by reverse chronological order rather than number of downloads. To receive updates as Mr. Chen posts new papers or updates old papers, please use the following form:

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REVISION: The Fragile Menagerie: Biodiversity Loss, Climate Change, and the Law, http://www.ssrn.com/abstract=2862882 (July 15, 2017)

The greatest vectors of biodiversity loss in the Anthropocene epoch are climate change, habitat destruction, invasive species, pollution, population, and overkill. Perversely enough, the legal understanding of extinction mechanisms remains frozen in time, like a cave dweller in ice. Climate change, habitat destruction, and alien invasive species should figure more prominently than overkill and the marketing of products derived from endangered species. The law, however, imposes its clearest and harshest sanctions precisely where the drivers of extinction are weakest: when humans consciously capture or kill other living things. The Endangered Species Act has been adapted to address habitat destruction on private land and to mitigate climate change. Nevertheless, the law’s lack of congruence with conservation biology impedes efforts to preserve biodiversity and mitigate climate change.
REVISION: Law on the Market? Abnormal Stock Returns and Supreme Court Decision-Making, http://www.ssrn.com/abstract=2649726 (May 16, 2017)

What happens when the Supreme Court of the United States decides a case impacting one or more publicly-traded firms? While many have observed anecdotal evidence linking decisions or oral arguments to abnormal stock returns, few have rigorously or systematically investigated the behavior of equities around Supreme Court actions. In this research, we present the first comprehensive, longitudinal study on the topic, spanning over 15 years and hundreds of cases and firms. Using both intra- and interday data around decisions and oral arguments, we evaluate the frequency and magnitude of statistically-significant abnormal return events after Supreme Court action. On a per-term basis, we find 5.3 cases and 7.8 stocks that exhibit abnormal returns after decision. In total, across the cases we examined, we find 79 out of the 211 cases (37%) exhibit an average abnormal return of 4.4% over a two-session window with an average |t|-statistic of 2.9. Finally, we observe that abnormal ...
New: Even-Keeled Moments of Doubt, http://www.ssrn.com/abstract=2967244 (May 13, 2017)

Uncertainty affects all aspects of economics. A principle this vital demands a mathematically precise definition. The distinction between risk and uncertainty, as made by Frank Knight (1921) and John Maynard Keynes (1937), invites the following definition (Anderson, Ghysels & Juergens 2009): An event is risky if its outcome is unknown but the distribution of its outcomes is known. By contrast, an event is uncertain if its outcome is unknown and the distribution of its outcomes is also unknown. In fat-tailed problems where historical evidence does not reflect the true distribution of extreme outcomes, kurtosis approximates uncertainty. This intuition arises from options pricing models where both price and volatility fluctuate stochastically (Heston 1993).
New: A Generalized Higher-Moment Capital Asset Pricing Model, with Theoretical Implications and Legal Applications, http://www.ssrn.com/abstract=2942637 (March 30, 2017)

The conventional capital asset pricing model (CAPM) has come under severe attack for its failure to reflect investor behavior. This paper describes financial decision-making under uncertainty in formal mathematical terms as a generalized higher-moment capital asset pricing model. It develops that model through the Taylor series expansion of the logarithm of expected financial returns. This mathematical expedient treats the conventional two-moment CAPM and a four-moment variant (expressed in terms of mean, variance, skewness, and kurtosis) as convenient, mentally tractable special cases of a generalized higher-moment model. This paper then explores the theoretical implications and legal applications of higher-moment asset pricing. In prospect theory, perhaps the best known expression of behavioral economics, a “fourfold pattern” of decisionmaking under uncertainty predicts risk-seeking behavior in particular circumstances. Skewness preference arises in a wide variety of economic ...
REVISION: Fables of the Reconstruction: Human Emotion and Behavioral Heuristics in Environmental Economics, http://www.ssrn.com/abstract=2705196 (February 3, 2017)

Environmental economics provides an especially rich source of insights into the impact of emotion, cognitive bias, and behavioral heuristics on risk assessment and management. In contrast with the ambivalent reception of behavioral psychology within mathematical finance, the impact of emotion and innate heuristics on environmental decision making has never been doubted. From the affect heuristic to the endowment effect and disaster psychology, environmental choices harbor the richest trove of economic departures from strict rationality.
REVISION: Legal Responses to Biodiversity Loss and Climate Change, http://www.ssrn.com/abstract=2864062 (November 13, 2016)

The greatest vectors of biodiversity loss today are climate change, habitat destruction, invasive species, pollution, population, and overkill. Climate change, habitat destruction, and alien invasive species should figure more prominently than overkill and the marketing of products derived from endangered species. The law, however, imposes its clearest, harshest sanctions precisely where the drivers of extinction are weakest: when humans consciously capture or kill other living things. More helpfully, the Endangered Species Act has been adapted to address habitat destruction on private land and to mitigate climate change.
REVISION: Baryonic Beta Dynamics: Splitting the Atom of Systematic Risk, http://www.ssrn.com/abstract=2832735 (September 19, 2016)

Despite the rise of multi-factor models emphasizing value, firm size, and momentum, beta remains the primary measure of risk in asset pricing. Designed to define systematic risk, net of idiosyncratic risk that can be neutralized through diversification, beta combines a measure of volatility with a measure of correlation. Much of the frustration with beta stems from the failure to disaggregate beta’s discrete components. Conventional beta is often treated as if it were “atomic” in the original Greek sense: uncut and indivisible. This article rehabilitates beta by splitting the atom of systematic risk. Particle physics provides a fruitful framework for evaluating discrete components of financial risk. Quantum chromodynamics (QCD) focuses on six flavors of quarks in three matched pairs: up/down, charm/strange, and top/bottom. Baryons are subatomic particles consisting of three quarks. They include protons and neutrons, which account for most of the mass of the visible ...
REVISION: Price-Level Regulation and Its Reform, http://www.ssrn.com/abstract=771226 (September 13, 2016)

Price-level, or “price-cap,” regulation offers an alluring alternative to the traditional technique of monitoring a regulated firm’s profits. Part II of this article contrasts price-level regulation with conventional cost-of-service ratemaking and with Ramsey pricing. Price-level regulation stands as a market-based, incentive-driven “third way” between traditional regulation and complete deregulation. Part III provides formal specifications of price-level regulation. Although some jurisdictions have set price caps according to operating cost and rate-of-return calculations that clearly parallel those steps in conventional ratemaking, this article will focus on price-level methodologies that combine an economy-wide measure of inflation with an x-factor reflecting total factor productivity within a regulated industry. Part IV addresses the simpler component of price-level regulation, the choice of an inflation index. Part V devotes detailed attention to the treatment of the ...
REVISION: The Promise and the Peril of Parametric Value-at-Risk (VaR) Analysis, http://www.ssrn.com/abstract=2615664 (August 22, 2016)

Leptokurtosis, or the risk lurking in “fat tails,” poses the deepest epistemic threat to economic forecasting. Parametric value-at-risk (VaR) models are extremely vulnerable to kurtosis in excess of the levels associated with a normal, Gaussian distribution. This article provides step-by-step guidance on the use of Student’s t-distribution to enhance the statistical robustness of VaR forecasts. For degrees of freedom greater than 4, Student’s t-distribution can emulate any level of kurtosis exceeding that of a Gaussian distribution. Because VaR is elicitable from historical data, observed levels of excess kurtosis can inform the proper use of Student’s t-distribution to measure value-at-risk. In addition, the calculation of parametric VaR according to the number of degrees of freedom implied by historical levels of excess kurtosis leads directly to the corresponding value of expected shortfall. Conducted in this fashion, parametric VaR not only exploits the elicitability of that ...
REVISION: Sinking, Fast and Slow: Bifurcating Beta in Financial and Behavioral Space, http://www.ssrn.com/abstract=2629541 (August 19, 2016)

Modern portfolio theory accords symmetrical treatment to all deviations from expected return, positive or negative. This assumption is vulnerable on both descriptive and behavioral grounds. Many of the predictive flaws in contemporary finance stem from mathematically elegant but empirically flawed Gaussian models. In reality, returns are skewed. The presumption that returns and volatility are symmetrical also defies human behavior. Losing hurts worse than winning feels good; investors do not react equally to upside gain and downside loss. Moreover, correlation tightening during bear markets, not offset by changes in correlation during bull markets, suggest that standard diversification strategies may erode upside returns without providing adequate protection during times of stress. This article outlines mathematical tools for calculating volatility, variance, covariance, correlation, and beta, not merely across the entire spectrum of returns, but also on either side of mean ...
REVISION: Legal Quanta: A Mathematical Romance of Many Dimensions, http://www.ssrn.com/abstract=2760182 (August 19, 2016)

Many things can be measured and expressed numerically. Nature speaks in the language of mathematics. Mathematical analysis of law is often associated with the application of established empirical techniques to ever-growing bodies of legal data. Other distinct applications of mathematics to law include machine learning, legal networks, and analytical modeling. Mathematical analysis of law ultimately follows not only the data describing the legal world as we find it, but also the own internal logic of mathematics.
REVISION: Momentary Lapses of Reason: The Psychophysics of Law and Behavior, http://www.ssrn.com/abstract=2683557 (August 19, 2016)

The conventional capital asset pricing model (CAPM) remains the preferred approach to risk management in a wide range of economic settings. At the same time, the neoclassical assumptions underlying the CAPM have come under severe attack by behavioral economics. In sharp contrast with the purely rational agents of neoclassical economics, real humans make decisions under the constraints imposed by their innate heuristics. The tension between conventional asset pricing theory and behavioral economics puts particular pressure on law. As an applied branch of social science, law purports to subject human conduct to rules that should optimize objective well-being as well as subjective satisfaction. This paper proposes a mathematically expedient method of alleviating this tension. A four-moment capital asset pricing model captures the emotional impact of odd and even moments of statistical distributions. Critically, a four-moment CAPM transcends the limits of financial models that ...
REVISION: Law on the Market? Evaluating the Securities Market Impact of Supreme Court Decisions, http://www.ssrn.com/abstract=2649726 (August 14, 2016)

Do judicial decisions affect the securities markets in discernible and perhaps predictable ways? In other words, is there “law on the market” (LOTM)? This is a question that has been raised by commentators, but answered by very few in a systematic and financially rigorous manner. Using intraday data and a multiday event window, this large scale event study seeks to determine the existence, frequency and magnitude of equity market impacts flowing from Supreme Court decisions. We demonstrate that, while certainly not present in every case, "law on the market" events are fairly common. Across all cases decided by the Supreme Court of the United States between the 1999-2013 terms, we identify 79 cases where the share price of one or more publicly traded company moved in direct response to a Supreme Court decision. In the aggregate, over fifteen years, Supreme Court decisions were responsible for more than 140 billion dollars in absolute changes in wealth. Our analysis not only ...


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