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We study a dynamic portfolio optimization problem related to convergence trading, which is an investment strategy that exploits temporary mispricing by simultaneously buying relatively underpriced assets and selling short relatively overpriced ones with the expectation that their prices converge in the future. We build on the model of Liu and Timmermann (2013) and extend it by incorporating unobservable Markov-modulated pricing errors into the price dynamics of two co-integrated assets. We characterize the optimal portfolio strategies in full and partial information settings both under the assumption of unrestricted and beta-neutral strategies. By using the innovations approach, we provide the filtering equation that is essential for solving the optimization problem under partial information. Finally, in order to illustrate the model capabilities, we provide an example with a two-state Markov chain., Comment: 25 pages, 5 figures

To assess stock market informational efficiency with minimal data snooping, we take the view of a statistician with little knowledge of finance. The statistician uses techniques such as least squares to estimate peer-implied fair values from the market values of replicating portfolios with the same accounting statements as the company being valued. Divergence of a company's peer-implied value estimate from its market value represents mispricing, motivating a convergence trade that earns risk-adjusted returns of up to 10% per year and is economically significant for both large and small cap firms. The rate of convergence decays to zero over the subsequent 34 months.

We study a dynamic portfolio optimization problem related to convergence trading, which is an investment strategy that exploits temporary mispricing by simultaneously buying relatively underpriced assets and selling short relatively overpriced ones with the expectation that their prices converge in the future. We build on the model of Liu and Timmermann (2013) and extend it by incorporating unobservable Markov-modulated pricing errors into the price dynamics of two co-integrated assets. We characterize the optimal portfolio strategies in full and partial information settings both under the assumption of unrestricted and beta-neutral strategies. By using the innovations approach, we provide the filtering equation that is essential for solving the optimization problem under partial information. Finally, in order to illustrate the model capabilities, we provide an example with a two-state Markov chain.

We study the optimal trading policy of an arbitrageur who can exploit temporary mispricing in a market with two convergent assets. We build on the model of Liu and Timmermann (2013) and include transaction costs, which impose additional limits to the implementation of such convergence trade strategy. We show that the presence of transaction costs could reveal an endogenous stop-loss concern in a certain economy, which affects the optimal policy of the arbitrageur in significant ways. Using pairs of dual-listed Chinese stock shares as samples and a pairs trading strategy based on standard deviation of the spread as benchmark, we demonstrate the efficiency of the strategy implied by our model. Several extensions of our model are also discussed.

Convergence trades exploit temporary mispricing by simultaneously buying relatively underpriced assets and selling short relatively overpriced assets. This paper studies optimal convergence trades under both recurring and nonrecurring arbitrage opportunities represented by continuing and "stopped" cointegrated price processes and considers both fixed and stochastic (Poisson) horizons. Conventional long-short delta neutral strategies are generally suboptimal and it can be optimal to simultaneously go long (or short) in two mispriced assets. Optimal portfolio holdings critically depend on whether the risky asset position is liquidated when prices converge. Our theoretical results are illustrated on pairs of Chinese bank shares traded on both the Hong Kong and China stock exchanges. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

The accession of ten new members in May 2004 means a considerable increase in income disparities in the European Union. At what speed has income converged in the past and what role have changes in trade relations and factor mobility played in this? What projections can be made for the catching-up process of the new member states? And what conclusions should be drawn for the future of EU regional policy?

Does openness contribute to convergence of countries to the US income level? Our statistical and econometric analysis concludes for an affirmative answer. Using data for 150 countries for 1970-2012 we conclude almost all cases fell in three groups of countries that experienced a significant convergence: (i) followed the Asian export model, (ii) accessed the European Union, or (iii) are rich in natural resources and had an appropriate policy. All three cases are based on openness. Institutions also play a major role. There is beta-convergence. But over the all period only 20% of the countries jumped from low to middle and from middle to high income, which shows the persistence of each group.The paper "Development Theory and Globalization, the Second Wave: A Reinterpretation" to which this Appendix II applies is available at the following URL: http://ssrn.com/abstract=2444601Appendix I for this paper are available at the following URL: http://ssrn.com/abstract=2444622

"Pairs trading" involves taking a bet that the price paths of two stocks that have historically moved together will converge again after any divergence. Consistent with the view that profits to pairs trading comes through market making, i.e., short term liquidity provision and price discovery; we find that pairs trading profits are higher when the initial divergence is due to (a) news that temporarily reduces the liquidity of one of the stocks in the pair, or (b) news that affects both stocks in the pair, and there are a priori reasons to believe that one stock reacts faster to such news. Profits are lower when the initial divergence in prices is associated with value relevant news specific to a stock in the pair. Pairs involving smaller, less liquid and more volatile stocks tend to converge faster after initial divergence. When one of the stocks in the pair is more likely to have sluggish response to common information as evidenced by less common sell side coverage and institutional holdings, the risk of a margin call due to further divergence is lower. Closing out positions that do not converge within 10 days leads to higher risk adjusted returns ignoring transactions costs when compared to holding positions for 6 months.

This paper studies the spread between the newly issued 30 year Treasury bond and the old 30 year bond. The spread follows a systematic pattern over the auction cycle: it begins high at an auction date, and converges toward zero by the next auction date. I document the profits on establishing a long old bond/ short new bond convergence trade and rolling this over every auction cycle, over a period from 6/95 to 11/99. Despite the systematic convergence, the average profits are close to zero, and profits covary with the stock market in a manner resembling a short put option position. The difference in repo market financing rates between the two bonds is an important component of the costs in carrying the position. I then ask what economic factors account for the level and time variation in the spread. Using the spread between commercial paper and T-Bills to identify changes in investor preference for liquid assets, I establish that aggregate factors affecting liquidity preference plays an important role in the variation of the bond/old-bond spread. The evidence also establishes that new bonds are imperfect substitutes for other bonds, and therefore changes in the supply of new bonds, such as in recent Treasury buybacks, will have important effects on bond market spreads.