Abel Cadenillas - Academia.edu (original) (raw)

Papers by Abel Cadenillas

Springer eBooks, 2021

Cascading failure consists of complicated sequences of dependent failures and can cause large bla... more Cascading failure consists of complicated sequences of dependent failures and can cause large blackouts. The emerging risk analysis, simulation, and modeling of cascading blackouts are briefly surveyed, and key references are suggested.

B E Journal of Theoretical Economics, Sep 15, 2007

In this paper, we formulate a model prescribing optimal policy for cash disbursements and seasone... more In this paper, we formulate a model prescribing optimal policy for cash disbursements and seasoned equity offerings taking into account the principal-agent problems inherent in these decisions. In order to discipline managers, stockholders demand that excess free cash flow be disbursed either as cash dividends or through stock repurchases. Managers resist stockholders in this regard since they prefer to retain excess free cash flow in order to pursue personal interests and reduce the probability that the company will experience financial distress in the future. However, as a consequence of withholding cash disbursements, managers incur disutility due to the possibility that their control of the firm could be threatened by the market for corporate control. We model this situation as a stochastic impulse control problem, and succeed in finding an analytical solution. We derive several testable implications, some of which have not been fully addressed in the corporate finance literature.

We consider a financial market in which there is a single stock. An investor is free to buy and s... more We consider a financial market in which there is a single stock. An investor is free to buy and sell this stock at any time, but when he does so he pays a transaction cost and he either pays a tax in the event of a gain or receives a tax credit in the event of a loss. The investor's

Considers a stochastic control problem with linear dynamics, convex cost criterion, and convex st... more Considers a stochastic control problem with linear dynamics, convex cost criterion, and convex state constraint, in which the control enters both the drift and diffusion coefficients. These coefficients are allowed to be random, and no LP-bounds are imposed on the control. The authors obtain for this model an explicit solution for the adjoint equation, and a global stochastic maximum principle.

Interdisciplinary mathematical sciences, Apr 1, 2007

Insurance Mathematics & Economics, Sep 1, 2014

We consider an investor who wants to select her/his optimal consumption, investment and insurance... more We consider an investor who wants to select her/his optimal consumption, investment and insurance policies. Motivated by new insurance products, we allow not only the financial market but also the insurable loss to depend on the regime of the economy. The objective of the investor is to maximize her/his expected total discounted utility of consumption over an infinite time horizon. For the case of hyperbolic absolute risk aversion (HARA) utility functions, we obtain the first explicit solutions for simultaneous optimal consumption, investment, and insurance problems when there is regime switching. We determine that the optimal insurance contract is either noinsurance or deductible insurance, and calculate when it is optimal to buy insurance. The optimal policy depends strongly on the regime of the economy. Through an economic analysis, we calculate the advantage of buying insurance.

Social Science Research Network, 2005

We show that a possible explanation for the widespread use of options in compensation contracts m... more We show that a possible explanation for the widespread use of options in compensation contracts might be that they provide a way to screen executives. In particular, we consider the problem of a risk-neutral firm that tries to hire a risk-averse executive. There are several types of executives, of varying quality. Executives know their own types, but the firm only knows the probability distribution of types. Executives affect stock price dynamics through the choice of volatility, and by applying costly effort. The firm offers executives a compensation contract consisting exclusively of stock or options. We show that the optimal contract with type uncertainty requires more leverage than contracts with perfect information. Even when the optimal contract with perfect information requires stock compensation, in the case of incomplete information it might be optimal to offer options compensation to filter out bad executives.

Operations Research, Oct 1, 2015

Motivated by empirical facts, we develop a theoretical model for optimal currency government debt... more Motivated by empirical facts, we develop a theoretical model for optimal currency government debt portfolio and debt payments, which allows both government debt aversion and jumps in the exchange rates. We obtain first a realistic stochastic differential equation for public debt, and then solve explicitly the optimal currency debt problem. We show that higher debt aversion and jumps in the exchange rates lead to a lower proportion of optimal debt in foreign currencies. Furthermore, we show that for a government with extreme debt aversion it is optimal not to issue debt in foreign currencies. To the best of our knowledge, this is the first theoretical model that provides a rigorous explanation of why developing countries have reduced consistently their proportion of foreign debt in their debt portfolios.

Insurance Mathematics & Economics, Sep 1, 2014

h i g h l i g h t s • This work is motivated by the recent financial crises. • We consider an ins... more h i g h l i g h t s • This work is motivated by the recent financial crises. • We consider an insurer whose risk is modeled by a jump-diffusion process. • The insurer's risk is negatively correlated with the capital gains. • We obtain the optimal policies in explicit forms for various utility functions. • We study the impact of the market parameters on the optimal policies.

Journal of Financial Economics, Jul 1, 2004

We study the incentive effects of granting levered or unlevered stock to a risk-averse manager. T... more We study the incentive effects of granting levered or unlevered stock to a risk-averse manager. The stock is granted by risk-neutral shareholders who choose leverage and compensation level. The manager applies costly effort and selects the level of volatility, both of which affect expected return. The results are driven by the attempt of the risk-neutral shareholders to maximize the value of their claims net of the compensation package. We consider a dynamic setting and find that levered stock is optimal for high-type managers, firms with high momentum, large firms, and firms for which additional volatility only implies a modest increase in expected return.

Annals of Operations Research, Nov 16, 2015

Motivated by the current debt crisis in the world, we develop a stochastic debt control model to ... more Motivated by the current debt crisis in the world, we develop a stochastic debt control model to study the optimal government debt ceiling, or equivalently the optimal ceiling for government debt. We consider a government that wants to control its debt by imposing an upper bound or ceiling on its debt-to-GDP ratio. We assume that debt generates a cost for the country, and this cost is an increasing and convex function of debt ratio. The government can intervene to reduce its debt ratio, but there is a cost generated by this reduction. The goal of the government is to find the optimal control that minimizes the expected total cost. We obtain an explicit solution for the government debt problem, that gives an explicit formula for optimal government debt ceiling. Moreover, we derive a rule for optimal debt policy in terms of the optimal government debt ceiling. In an extension of the model, we find that countries with a strong positive link between debt and economic growth should have a high optimal debt ceiling. This paper provides the first theoretical model for the optimal government debt ceiling.

Journal of Economic Theory, Jul 1, 1999

The article pioneers the designing of a theoretical model for the optimal foreign exchange interv... more The article pioneers the designing of a theoretical model for the optimal foreign exchange intervention in Iran. The model used is a nonlinear dynamic programming model with stochastic continuous functions to solve which the Uhlig program has been used. The results indicate that determining the best volume of intervention depends on the economic objectives of policymakers, the exchange rate of the present time, and the future exchange rate expected by the monetary authorities. Due to the monopolistic condition of the government in the foreign exchange market, the volume of the foreign exchange intervention in the market depends on the level the government is trying to keep the exchange rate at the present time as well as the next period. The exchange rate in Iran is not solely determined on the basis of the market mechanisms; therefore, the determinant of the volume of intervention by the monetary authority at the present time is the level that the government attempts to keep the exchange rate at present and in the future. The present and future levels of the exchange rate depend on the government budget expenditures. This in turn depends on the government size and its reliance on foreign exchange revenues received from the sale of oil.

Mathematics, Nov 6, 2020

We study the optimal control of a government stabilization fund, which is a mechanism to save mon... more We study the optimal control of a government stabilization fund, which is a mechanism to save money during good economic times to be used in bad economic times. The objective of the fund manager is to keep the fund as close as possible to a predetermined target. Accordingly, we consider a running cost associated with the difference between the actual fiscal fund and the fund target. The fund manager exerts control over the fund by making deposits in or withdrawals from the fund. The withdrawals are used to pay public debt or to finance government programs. We obtain, for the first time in the literature, the optimal band for the government stabilization fund. Our results are of interest to practitioners. For instance, we find that the higher the volatility, the larger the size of the optimal band. In particular, each country and state should have its own optimal fund band, in contrast to the "one-size-fits-all" approach that is often used in practice.

Risks, Dec 4, 2018

We develop a government debt management model to study the optimal debt ceiling when the ability ... more We develop a government debt management model to study the optimal debt ceiling when the ability of the government to generate primary surpluses to reduce the debt ratio is limited. We succeed in finding a solution for the optimal debt ceiling. We study the conditions under which a country is not able to reduce its debt ratio to reach its optimal debt ceiling, even in the long run. In addition, this model with bounded intervention is consistent with the fact that, in reality, countries that succeed in reducing their debt ratio do not do so immediately, but over some period of time. To the best of our knowledge, this is the first theoretical model on the debt ceiling that accounts for bounded interventions.

Systems & Control Letters, Dec 1, 2002

We consider a stochastic control problem with linear dynamics with jumps, convex cost criterion, ... more We consider a stochastic control problem with linear dynamics with jumps, convex cost criterion, and convex state constraint, in which the control enters the drift, the diffusion, and the jump coefficients. We allow these coefficients to be random, and do not impose any Lp-bounds on the control.We obtain a stochastic maximum principle for this model that provides both necessary and

Finance and Stochastics, Feb 1, 1999

. We study the problem of investing in securities in order to maximize the after-tax rate of re... more . We study the problem of investing in securities in order to maximize the after-tax rate of return. We consider a single stock modeled as geometric Brownian motion along with the objective of maximizing the long-run growth rate of after-tax wealth. We show that it is optimal not only to cut short the losses, but also the profits, even though

Journal of Economic Theory, Mar 1, 2007

We consider first-best risk-sharing problems in which "the agent" can control both the drift (eff... more We consider first-best risk-sharing problems in which "the agent" can control both the drift (effort choice) and the volatility of the underlying process (project selection). In a model of delegated portfolio management, it is optimal to compensate the manager with an option-type payoff, where the functional form of the option is obtained as a solution to an ordinary differential equation. In the general case, the optimal contract is a fixed point of a functional that connects the agent's and the principal's maximization problems. We apply martingale/duality methods familiar from optimal consumptioninvestment problems.

Mathematical Finance, Apr 1, 2000

We consider the problem of a Central Bank that wants the exchange rate to be as close as possible... more We consider the problem of a Central Bank that wants the exchange rate to be as close as possible to a given target, and in order to do that uses both the interest rate level and interventions in the foreign exchange market. We model this as a mixed classical-impulse stochastic control problem, and provide for the first time a solution to that kind of problem. We give examples of solutions that allow us to perform an interesting economic analysis of the optimal strategy of the Central Bank.

Springer eBooks, 2021

Cascading failure consists of complicated sequences of dependent failures and can cause large bla... more Cascading failure consists of complicated sequences of dependent failures and can cause large blackouts. The emerging risk analysis, simulation, and modeling of cascading blackouts are briefly surveyed, and key references are suggested.

B E Journal of Theoretical Economics, Sep 15, 2007

In this paper, we formulate a model prescribing optimal policy for cash disbursements and seasone... more In this paper, we formulate a model prescribing optimal policy for cash disbursements and seasoned equity offerings taking into account the principal-agent problems inherent in these decisions. In order to discipline managers, stockholders demand that excess free cash flow be disbursed either as cash dividends or through stock repurchases. Managers resist stockholders in this regard since they prefer to retain excess free cash flow in order to pursue personal interests and reduce the probability that the company will experience financial distress in the future. However, as a consequence of withholding cash disbursements, managers incur disutility due to the possibility that their control of the firm could be threatened by the market for corporate control. We model this situation as a stochastic impulse control problem, and succeed in finding an analytical solution. We derive several testable implications, some of which have not been fully addressed in the corporate finance literature.

We consider a financial market in which there is a single stock. An investor is free to buy and s... more We consider a financial market in which there is a single stock. An investor is free to buy and sell this stock at any time, but when he does so he pays a transaction cost and he either pays a tax in the event of a gain or receives a tax credit in the event of a loss. The investor's

Considers a stochastic control problem with linear dynamics, convex cost criterion, and convex st... more Considers a stochastic control problem with linear dynamics, convex cost criterion, and convex state constraint, in which the control enters both the drift and diffusion coefficients. These coefficients are allowed to be random, and no LP-bounds are imposed on the control. The authors obtain for this model an explicit solution for the adjoint equation, and a global stochastic maximum principle.

Interdisciplinary mathematical sciences, Apr 1, 2007

Insurance Mathematics & Economics, Sep 1, 2014

We consider an investor who wants to select her/his optimal consumption, investment and insurance... more We consider an investor who wants to select her/his optimal consumption, investment and insurance policies. Motivated by new insurance products, we allow not only the financial market but also the insurable loss to depend on the regime of the economy. The objective of the investor is to maximize her/his expected total discounted utility of consumption over an infinite time horizon. For the case of hyperbolic absolute risk aversion (HARA) utility functions, we obtain the first explicit solutions for simultaneous optimal consumption, investment, and insurance problems when there is regime switching. We determine that the optimal insurance contract is either noinsurance or deductible insurance, and calculate when it is optimal to buy insurance. The optimal policy depends strongly on the regime of the economy. Through an economic analysis, we calculate the advantage of buying insurance.

Social Science Research Network, 2005

We show that a possible explanation for the widespread use of options in compensation contracts m... more We show that a possible explanation for the widespread use of options in compensation contracts might be that they provide a way to screen executives. In particular, we consider the problem of a risk-neutral firm that tries to hire a risk-averse executive. There are several types of executives, of varying quality. Executives know their own types, but the firm only knows the probability distribution of types. Executives affect stock price dynamics through the choice of volatility, and by applying costly effort. The firm offers executives a compensation contract consisting exclusively of stock or options. We show that the optimal contract with type uncertainty requires more leverage than contracts with perfect information. Even when the optimal contract with perfect information requires stock compensation, in the case of incomplete information it might be optimal to offer options compensation to filter out bad executives.

Operations Research, Oct 1, 2015

Motivated by empirical facts, we develop a theoretical model for optimal currency government debt... more Motivated by empirical facts, we develop a theoretical model for optimal currency government debt portfolio and debt payments, which allows both government debt aversion and jumps in the exchange rates. We obtain first a realistic stochastic differential equation for public debt, and then solve explicitly the optimal currency debt problem. We show that higher debt aversion and jumps in the exchange rates lead to a lower proportion of optimal debt in foreign currencies. Furthermore, we show that for a government with extreme debt aversion it is optimal not to issue debt in foreign currencies. To the best of our knowledge, this is the first theoretical model that provides a rigorous explanation of why developing countries have reduced consistently their proportion of foreign debt in their debt portfolios.

Insurance Mathematics & Economics, Sep 1, 2014

h i g h l i g h t s • This work is motivated by the recent financial crises. • We consider an ins... more h i g h l i g h t s • This work is motivated by the recent financial crises. • We consider an insurer whose risk is modeled by a jump-diffusion process. • The insurer's risk is negatively correlated with the capital gains. • We obtain the optimal policies in explicit forms for various utility functions. • We study the impact of the market parameters on the optimal policies.

Journal of Financial Economics, Jul 1, 2004

We study the incentive effects of granting levered or unlevered stock to a risk-averse manager. T... more We study the incentive effects of granting levered or unlevered stock to a risk-averse manager. The stock is granted by risk-neutral shareholders who choose leverage and compensation level. The manager applies costly effort and selects the level of volatility, both of which affect expected return. The results are driven by the attempt of the risk-neutral shareholders to maximize the value of their claims net of the compensation package. We consider a dynamic setting and find that levered stock is optimal for high-type managers, firms with high momentum, large firms, and firms for which additional volatility only implies a modest increase in expected return.

Annals of Operations Research, Nov 16, 2015

Motivated by the current debt crisis in the world, we develop a stochastic debt control model to ... more Motivated by the current debt crisis in the world, we develop a stochastic debt control model to study the optimal government debt ceiling, or equivalently the optimal ceiling for government debt. We consider a government that wants to control its debt by imposing an upper bound or ceiling on its debt-to-GDP ratio. We assume that debt generates a cost for the country, and this cost is an increasing and convex function of debt ratio. The government can intervene to reduce its debt ratio, but there is a cost generated by this reduction. The goal of the government is to find the optimal control that minimizes the expected total cost. We obtain an explicit solution for the government debt problem, that gives an explicit formula for optimal government debt ceiling. Moreover, we derive a rule for optimal debt policy in terms of the optimal government debt ceiling. In an extension of the model, we find that countries with a strong positive link between debt and economic growth should have a high optimal debt ceiling. This paper provides the first theoretical model for the optimal government debt ceiling.

Journal of Economic Theory, Jul 1, 1999

The article pioneers the designing of a theoretical model for the optimal foreign exchange interv... more The article pioneers the designing of a theoretical model for the optimal foreign exchange intervention in Iran. The model used is a nonlinear dynamic programming model with stochastic continuous functions to solve which the Uhlig program has been used. The results indicate that determining the best volume of intervention depends on the economic objectives of policymakers, the exchange rate of the present time, and the future exchange rate expected by the monetary authorities. Due to the monopolistic condition of the government in the foreign exchange market, the volume of the foreign exchange intervention in the market depends on the level the government is trying to keep the exchange rate at the present time as well as the next period. The exchange rate in Iran is not solely determined on the basis of the market mechanisms; therefore, the determinant of the volume of intervention by the monetary authority at the present time is the level that the government attempts to keep the exchange rate at present and in the future. The present and future levels of the exchange rate depend on the government budget expenditures. This in turn depends on the government size and its reliance on foreign exchange revenues received from the sale of oil.

Mathematics, Nov 6, 2020

We study the optimal control of a government stabilization fund, which is a mechanism to save mon... more We study the optimal control of a government stabilization fund, which is a mechanism to save money during good economic times to be used in bad economic times. The objective of the fund manager is to keep the fund as close as possible to a predetermined target. Accordingly, we consider a running cost associated with the difference between the actual fiscal fund and the fund target. The fund manager exerts control over the fund by making deposits in or withdrawals from the fund. The withdrawals are used to pay public debt or to finance government programs. We obtain, for the first time in the literature, the optimal band for the government stabilization fund. Our results are of interest to practitioners. For instance, we find that the higher the volatility, the larger the size of the optimal band. In particular, each country and state should have its own optimal fund band, in contrast to the "one-size-fits-all" approach that is often used in practice.

Risks, Dec 4, 2018

We develop a government debt management model to study the optimal debt ceiling when the ability ... more We develop a government debt management model to study the optimal debt ceiling when the ability of the government to generate primary surpluses to reduce the debt ratio is limited. We succeed in finding a solution for the optimal debt ceiling. We study the conditions under which a country is not able to reduce its debt ratio to reach its optimal debt ceiling, even in the long run. In addition, this model with bounded intervention is consistent with the fact that, in reality, countries that succeed in reducing their debt ratio do not do so immediately, but over some period of time. To the best of our knowledge, this is the first theoretical model on the debt ceiling that accounts for bounded interventions.

Systems & Control Letters, Dec 1, 2002

We consider a stochastic control problem with linear dynamics with jumps, convex cost criterion, ... more We consider a stochastic control problem with linear dynamics with jumps, convex cost criterion, and convex state constraint, in which the control enters the drift, the diffusion, and the jump coefficients. We allow these coefficients to be random, and do not impose any Lp-bounds on the control.We obtain a stochastic maximum principle for this model that provides both necessary and

Finance and Stochastics, Feb 1, 1999

. We study the problem of investing in securities in order to maximize the after-tax rate of re... more . We study the problem of investing in securities in order to maximize the after-tax rate of return. We consider a single stock modeled as geometric Brownian motion along with the objective of maximizing the long-run growth rate of after-tax wealth. We show that it is optimal not only to cut short the losses, but also the profits, even though

Journal of Economic Theory, Mar 1, 2007

We consider first-best risk-sharing problems in which "the agent" can control both the drift (eff... more We consider first-best risk-sharing problems in which "the agent" can control both the drift (effort choice) and the volatility of the underlying process (project selection). In a model of delegated portfolio management, it is optimal to compensate the manager with an option-type payoff, where the functional form of the option is obtained as a solution to an ordinary differential equation. In the general case, the optimal contract is a fixed point of a functional that connects the agent's and the principal's maximization problems. We apply martingale/duality methods familiar from optimal consumptioninvestment problems.

Mathematical Finance, Apr 1, 2000

We consider the problem of a Central Bank that wants the exchange rate to be as close as possible... more We consider the problem of a Central Bank that wants the exchange rate to be as close as possible to a given target, and in order to do that uses both the interest rate level and interventions in the foreign exchange market. We model this as a mixed classical-impulse stochastic control problem, and provide for the first time a solution to that kind of problem. We give examples of solutions that allow us to perform an interesting economic analysis of the optimal strategy of the Central Bank.