nep-fmk New Economics Papers
on Financial Markets
Issue of 2006‒08‒12
43 papers chosen by
Carolina Valiente
London South Bank University

  1. Should the FDIC worry about the FHLB? the impact of Federal Home Loan Bank advances on the Bank Insurance Fund By Rosalind L. Bennett; Mark D. Vaughan; Timothy J. Yeager
  2. International Portfolio Diversification and Market Linkages in the presence of regime-switching volatility By Thomas Flavin; Ekaterini Panopoulou
  3. Is the Federal Home Loan Bank system good for banks? a look at evidence on membership, advances and risk By Dusan Stojanovic; Mark D. Vaughan; Timothy J. Yeager
  4. U.S. banking deregulation and self-employment: a differential impact on those in need By Yuliya Demyanyk
  5. The response of firms’ investment and financing to adverse cash flow shocks : the role of bank relationships By Catherine Fuss; Philip Vermeulen
  6. Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion By Wolfram J. Horneff; Raimond Maurer; Olivia S. Mitchell; Ivica Dus
  7. Why Do Migrants Return to Poor Countries? Evidence From Philippine Migrants%u2019 Responses to Exchange Rate Shocks By Dean Yang
  8. Sudden Stops, Financial Crises, and Original Sin in Emerging Countries: Déjà vu? By Michael D. Bordo
  9. "Banking, Finance, and Money: A Socioeconomics Approach" By L. Randall Wray
  10. Monetary Transmission Mechanism in Transition Economies: Surveying the Surveyable By Balázs Égert; Ronald MacDonald
  11. Capital Flows to Central and Eastern Europe By Philip R. Lane; Gian Maria Milesi-Ferretti
  12. Regulation of Financial Systems and Economic Growth By Alain de Serres; Shuji Kobayakawa; Torsten Sløk; Laura Vartia
  13. Financial crises and total factor productivity By Felipe Meza; Erwan Quintin
  14. Market Discipline, Information Processing, and Corporate Governance By Martin Hellwig
  15. Global Bond Portfolios and EMU By Philip R. Lane
  16. The Performance of International Equity Portfolios By Charles P. Thomas; ;
  17. Exchange Rate Changes and Inflation in Post-Crisis Asian Economies: VAR Analysis of the Exchange Rate Pass-Through By Takatoshi Ito; Kiyotaka Sato
  18. Situating Middle East and North Africa (MENA) capital markets within the emerging markets universe By Thomass Lagoardde-Segot; Brian M. Lucey
  19. Valuation and asset pricing in infinite-horizon sequential markets with portfolio constraints By K. Huang
  20. A Market-Clearing Role for Inefficiency on a Limit Order Book By Jeremy Large
  21. Rational Plunging and the Option Value of Sequential Investment The Case of Petroleum Exploration By James L. Smith; Rex Thompson
  22. What Drives the Disposition Effect? An Analysis of a Long-Standing Preference-Based Explanation By Nicholas Barberis; Wei Xiong
  23. Subsampling-Based Tests of Stock-Return Predictability By In Choi; Timothy K. Chue
  24. Consumer-finance myths and other obstacles to financial literacy By William R. Emmons
  25. How Household Portfolios Evolve After Retirement: The Effect of Aging and Health Shocks By Courtney Coile; Kevin Milligan
  26. Implementing Arrow-Debreu equilibria by trading infinitely lived securities By K. Huang; Z. Liu
  27. The price of free advice By Machiel van Dijk; MIchiel Bijlsma; Marc Pomp
  28. Household Saving and Asset Valuations in Selected Industrialised Countries By Paul Hiebert
  29. On Weak Predictor-Corrector Schemes for Jump-Diffusion Processes in Finance By Nicola Bruti-Liberati; Eckhard Platen
  30. Optimal Degree of Public Information Dissemination By Camille Cornand; Frank Heinemann
  31. "How the Maastricht Regime Fosters Divergence as Well as Fragility" By Joerg Bibow
  32. The Chicago VOC Trading System: The Consequences of Market Design for Performance By R. F. Kosobud; H.H. Stokes; C.D. Tallarico; B.L. Scott
  33. Financial reporting quality in privaty equity backed companies: the impact of ownership concentration By Beuselinck, C.; Manigart, S.
  34. Simple Market Protocols for Efficient Risk Sharing By Marco LiCalzi; Paolo Pellizzari
  35. Stock Prices and the Cost of Environmental Regulation By Joshua Linn
  36. Wealth transfers and the role of collateral when lifetimes are uncertain By Abdelkrim Seghir; Juan Pablo Torres-Martinez
  37. The U.S. Treasury yield curve: 1961 to the present By Refet S. Gurkaynak; Brian Sack; Jonathan H. Wright
  38. Are longer bankruptcies really more costly? By Daniel M. Covitz; Song Han; Beth Anne Wilson
  39. Sorting, Incentives and Risk Preferences: Evidence from a Field Experiment By Charles Bellemare; Bruce S. Shearer
  40. Forward trading and collusion in oligopoly By Matti Liski; Juan-Pablo Montero
  42. Precautionary Saving and Precautionary Wealth By Christopher D. Carroll; Miles S. Kimball
  43. Uncertainty and Investment Dynamics By Nick Bloom; John Van Reenen; Stephen Bond

  1. By: Rosalind L. Bennett; Mark D. Vaughan; Timothy J. Yeager
    Keywords: Banks and banking ; Financial institutions ; Deposit insurance
    Date: 2005
  2. By: Thomas Flavin; Ekaterini Panopoulou
    Abstract: We examine if the benefits of international portfolio diversification are robust to time-varying asset return volatility. Since diversified portfolios are subject to common cross-country shocks, we focus on the transmission mechanism of such shocks in the presence of regime-switching volatility. We find little evidence of increased market interdependence in turbulent periods. Furthermore, for the vast majority of time, we show that risk reduction is delivered for the US investor who holds foreign equity.
    Keywords: Market comovement; International portfolio diversification; Financial market crises; Regime switching.
    Date: 2006–08–02
  3. By: Dusan Stojanovic; Mark D. Vaughan; Timothy J. Yeager
    Keywords: Government-sponsored enterprises ; Federal Home Loan Bank System ; Bank liquidity
    Date: 2005
  4. By: Yuliya Demyanyk
    Keywords: Bank supervision ; Banks and banking
    Date: 2006
  5. By: Catherine Fuss (National Bank of Belgium, Research Department); Philip Vermeulen (ECB, DG Research)
    Abstract: We test whether firms with a single bank are better shielded from loss of credit and investment cuts in periods of adverse cash flow shocks than firms with multiple bank relationships. Our estimates of the cash flow sensitivity of investment show that both types of firms are equally subject to financing constraints that bind only in the event of adverse cash flow shocks. In these periods, firms incur lower cuts in investment expenditures when they can obtain extra credit. In periods of adverse cash flow shocks, the probability of obtaining extra bank debt becomes more sensitive to the size and leverage of the firm.
    Keywords: financial constraints, lending relationships, firm investment, firm financing
    JEL: D92
    Date: 2006–07
  6. By: Wolfram J. Horneff; Raimond Maurer; Olivia S. Mitchell; Ivica Dus
    Abstract: Retirees must draw down their accumulated assets in an orderly fashion so as not to exhaust their funds too soon. We derive the optimal retirement portfolio from a menu that includes payout annuities as well as an investment allocation and a withdrawal strategy, assuming risk aversion, stochastic capital markets, and uncertain lifetimes. The resulting portfolio allocation, when fixed as of retirement, is then compared to phased withdrawal strategies such a “self-annuitization” plan or the 401(k) “default” pattern encouraged under US tax law. Surprisingly, the fixed percentage approach proves appealing for retirees across a wide range of risk preferences, supporting financial planning advisors who often recommend this rule. We then permit the retiree to switch to an annuity later, which gives her the chance to invest in the capital market and “bet on death.” As risk aversion rises, annuities first crowd out bonds in retiree portfolios; at higher risk aversion still, annuities replace equities in the portfolio. Making annuitization compulsory can also lead to substantial utility losses for less risk-averse investors.
    Date: 2006–07
  7. By: Dean Yang
    Abstract: This paper distinguishes between target-earnings and life-cycle motivations for return migration by examining how Philippine migrants’ return decisions respond to major, unexpected exchange rate changes in their overseas locations (due to the Asian financial crisis). Overall, the evidence favors the life-cycle explanation: more favorable exchange rate shocks lead to fewer migrant returns. A 10% improvement in the exchange rate reduces the 12-month return rate by 1.4 percentage points. However, some migrants appear motivated by target-earnings considerations: in households with intermediate foreign earnings, favorable exchange rate shocks have the least effect on return migration, but lead to increases in household investment.
    JEL: D13 F22 J22 O12 O15
    Date: 2006–07
  8. By: Michael D. Bordo
    Abstract: The current pattern of sudden stops and financial crises in emerging markets has great resonance to events in the first era of globalization, from 1870-1913. In this paper I present descriptive statistics on capital flows, current account reversals and financial crises during the period 1870-1913 and compare them with the recent experience. I analyze the incidence of crises and measure their effects on real output losses. Furthermore, I consider the influence of openness to trade, original sin and currency mismatches on the pattern of sudden stops and financial crises. I find strikingly similar patterns across both eras of globalization. The pre-1914 sudden stops were associated with significant output losses comparable with the recent events, and their effects differed considerably depending on a country’s economic circumstances, just as they do today.
    JEL: E44 F32 N1 N20
    Date: 2006–07
  9. By: L. Randall Wray
    Abstract: This paper briefly summarizes the orthodox approach to banking, finance, and money, and then points the way toward an alternative based on socioeconomics. It argues that the alternative approach is better fitted to not only the historical record, but also sheds more light on the nature of money in modern economies. In orthodoxy, money is something that reduces transaction costs, simplifying “economic life” by lubricating the market mechanism. Indeed, this is the unifying theme in virtually all orthodox approaches to banking, finance, and money: banks, financial instruments, and even money itself originate to improve market efficiency. However, the orthodox story of money's origins is rejected by most serious scholars outside the field of economics as historically inaccurate. Further, the orthodox sequence of “commodity (gold) money” to credit and fiat money does not square with the historical record. Finally, historians and anthropologists have long disputed the notion that markets originated spontaneously from some primeval propensity, rather emphasizing the important role played by authorities in creating and organizing markets. By contrast, this paper locates the origin of money in credit and debt relations, with the money of account emphasized as the numeraire in which credits and debts are measured. Importantly, the money of account is chosen by the state, and is enforced through denominating tax liabilities in the state’s own currency. What is the significance of this? It means that the state can take advantage of its role in the monetary system to mobilize resources in the public interest, without worrying about “availability of finance.” The alternative view of money leads to quite different conclusions regarding monetary and fiscal policy, and it rejects even long-run neutrality of money. It also generates interesting insights on exchange rate regimes and international payments systems.
    Date: 2006–07
  10. By: Balázs Égert (Oesterreichische Nationalbank; EconomiX at the University of Paris X-Nanterre and William Davidson Institute.); Ronald MacDonald (University of Glasgow and CESIfo.)
    Abstract: This paper surveys recent advances in the monetary transmission mechanism (MTM). In particular, while laying out the functioning of the separate channels in the MTM, special attention is paid to exploring possible interrelations between different channels through which they may amplify or attenuate each others’ impact on prices and the real economy. We take stock of the empirical findings especially as they relate to countries in Central and Eastern Europe, and compare them to results reported for industrialised countries, especially for the euro area. We highlight potential pitfalls in the literature and assess the relative importance and potential development of the different channels.
    Keywords: Monetary transmission, transition, Central and Eastern Europe, credit channel, interest rate channel, interest rate pass-through, exchange rate channel, exchange rate pass-through, asset price channel.
    JEL: E31 E51 E58 F31 O11 P20
    Date: 2006
  11. By: Philip R. Lane; Gian Maria Milesi-Ferretti
    Abstract: We examine the evolution of the external position in CEE countries over the past decade, with a strong emphasis on the composition of the international balance sheet. We assess the extent of their international financial integration, in comparison to the advanced economies and other emerging markets, and highlight the most salient features of their external capital structure in terms of the relative importance of FDI, portfolio equity, and external debt. In addition, we briefly describe the bilateral and currency composition of their external liabilities. Finally, we explore the implications of the accumulated stock of external liabilities for future trade and current account balances.
    Date: 2006–08–02
  12. By: Alain de Serres; Shuji Kobayakawa; Torsten Sløk; Laura Vartia
    Abstract: This paper examines whether regulation that is more conducive to competitive and efficient financial systems has a significant positive impact on sectoral output and productivity growth in a sample of 25 OECD countries. More specifically, following a methodology used by Rajan and Zingales (1998), the paper tests whether industries that depend more heavily on external sources of funding tend to grow faster in countries that have more competition-friendly regulation in markets for banking services and financial instruments. The regulatory indicators are assembled from surveys conducted by the World Bank on regulations in banking and securities markets. They point to substantial variations in the stance of regulation across countries, in particular with respect to the broad rules underpinning securities market transactions. The empirical analysis indicates that financial system regulation matters for output growth both in a statistical and economic sense. <P>Réglementation des systèmes financiers et croissance économique <BR>L'objet de cette étude consiste à examiner, sur la base d'un échantillon de 25 pays de l'OCDE, dans quelle mesure une réglementation plus propice à des systèmes financiers concurrentiels et efficaces entraîne un effet positif significatif sur la croissance sectorielle. De manière plus spécifique, suivant une approche utilisée par Rajan et Zingales (1998), l'étude vérifie si les industries qui dépendent davantage des fonds externes croissent plus rapidement dans les pays dont la réglementation conduit à une concurrence plus vive sur les marchés des services bancaires et des instruments financiers. Les indicateurs de réglementation sont construits à partir d'information recueillie par la Banque Mondiale sur la réglementation dans le secteur bancaire et sur les valeurs obilières. Ils mettent en lumière des variations substantielles entre les pays, en particulier en ce qui a trait à la réglementation encadrant les transactions sur valeurs mobilières. L'analyse statistique indique que la réglementation des systèmes financiers affecte la croissance de la production de manière significative, à la fois au sens statistique et économique.
    Keywords: système financier, financial systems, external funding, financial regulation, sectoral growth, barrier to competition, investor protection, financement externe, réglementation financière, croissance sectorielle, entrave à la concurrence, protection des actionnaires
    JEL: G15 G18 G21 G28 O40
    Date: 2006–08–02
  13. By: Felipe Meza; Erwan Quintin
    Abstract: Total factor productivity (TFP) falls markedly during financial crises, as we document with recent evidence from Mexico and Asia. These falls are unusual in magnitude and present a difficult challenge for the standard small open economy neoclassical model. We show in the case of Mexico’s 1994-95 crisis that the model predicts that inputs and output should have fallen much more than they did. Using models with endogenous factor utilization, we find that capital utilization and labor hoarding can account for a large fraction of the TFP fall during the crisis. However, these models also predict that output should fall significantly more than in the data. Given the behavior of TFP, the biggest challenge may not be explaining why output falls so much following financial crises, but rather why it falls so little.
    Keywords: Financial crises - Mexico
    Date: 2005
  14. By: Martin Hellwig (Max Planck Institute for Research on Collective Goods, Kurt Schumacher-Str. 10, Bonn)
    Abstract: The paper reviews and assesses our understanding of the notion of “market discipline” in corporate governance. It questions the wholesale appeal to this notion in policy discussion, which fails to provide an account of the underlying mechanisms in terms of theory and empirical analysis. Discipline that is provided by the “market” must be compared to discipline that is provided by other institutions, e.g., intermediaries acting as “delegated monitors”. The comparative assessment depends on (i) the information technology, (ii) the role of strategic interactions, and (iii) the disciplinary mechanism itself. Concerning (i), the question is whether the benefits of multiple sources of information exceed the costs. Concerning (ii), strategic interactions concern the free-rider problem in acquiring information that benefits all financiers, as well as distributive externalities involved in exploiting an information advantage to the detriment of other financiers. Concerning (iii), the question is whether investors have explicit intervention rights or whether “discipline” results from managerial acquiescence. As for the acquisition and aggregation of information in organized markets, positive welfare effects arise only if the information is put to productive use, either through improvements in real investment and managerial incentives, or through changes in corporate control. Necessary conditions for such benefits to arise are fairly restrictive, especially if the changes that occur are based on managerial acquiescence rather than the legal intervention rights of investors. The expansion of market-based managerial incentives in the nineties had little to do with these theoretical accounts. The experience of moral hazard that has accompanied this expansion, on the side of gate-keeping institutions as well as corporate management, confirms the predictions of theory about the potential for shortfalls in market discipline and the agency costs of equity finance through the open market.
    Keywords: Market Discipline, Financial Institutions, Information Processing, Corporate Governance
    JEL: G14 G20 G30
    Date: 2006–07
  15. By: Philip R. Lane
    Abstract: We examine the bilateral composition of international bond portfolios for the euro area and the individual EMU member countries. We find considerable support for "euro area" bias: EMU member countries disproportionately invest in one another relative to other country pairs. Another striking pattern is the positive connection between trade linkages and financial linkages in explaining asymmetries across EMU member countries in terms of their outward bond investments vis-a-vis external counterparties. Our empirical results underline the impact of currency union on financial integration and support the notion that financial regionalization is the leading force underlying financial globalization.
    Date: 2006–08–02
  16. By: Charles P. Thomas; ;
    Abstract: This paper evaluates the ability of U.S. investors to allocate their foreign equity portfolios across 44 countries over a 25-year period. We find that U.S. portfolios achieved a significantly higher Sharpe ratio than foreign benchmarks, especially since 1990. We test whether this strong performance owed to trading expertise or longer-term allocation expertise. The evidence is overwhelmingly against trading expertise. While U.S. investors did abstain from momentum trading and instead sold past winners, we find no evidence that these past winners subsequently underperformed. In addition, conditional performance measures, which directly test reallocating into (out of) markets that subsequently outperformed (underperformed), suggest no significant trading expertise. In contrast, we offer strong evidence of longer-term allocation expertise: If we fix portfolio weights at the end of 1989 and do not allow reallocations, we still find superior performance in the recent period.
    Keywords: momentum, contrarian, conditional performance measures, equities, home bias
    Date: 2006–08–02
  17. By: Takatoshi Ito; Kiyotaka Sato
    Abstract: Macroeconomic consequences of a large currency depreciation among the crisis-hit Asian economies had varied from one country to another. Inflation did not soar in most Asian countries, including Thailand and Korea, after the exchange rate depreciated during the crisis. Indonesia, however, suffered very high inflation following a very large nominal depreciation of the rupiah. As a result, price competitive advantage by the rupiah depreciation was lost in the real exchange rate terms. The objective of this paper is to examine the pass-through effects of exchange rate changes on the domestic prices in the East Asian economies using a VAR analysis. Main results are as follows: (1) the degree of exchange rate pass-through to import prices was quite high in the crisis-hit economies; (2) the pass-through to CPI was generally low, with a notable exception of Indonesia: and (3) in Indonesia, both the impulse response of monetary policy variables to exchange rate shocks and that of CPI to monetary policy shocks are positive, large, and statistically significant. Thus, Indonesia’s accommodative monetary policy, coupled with the high degree of the CPI responsiveness to exchange rate changes was an important factor in the spiraling effects of domestic price inflation and sharp nominal exchange rate depreciation in the post-crisis period.
    JEL: F12 F31 F41
    Date: 2006–07
  18. By: Thomass Lagoardde-Segot; Brian M. Lucey
    Abstract: The objective of this paper is to situate the MENA area within the emerging markets universe. We first discuss the various components of market emergence and generate four bootstrapped indexes reflecting market size, market activity, market pricing and transparency. We then draw inter-regional and country-level comparisons using a probit model and a hierarchical cluster analysis. Our results suggest that in spite of intra-regional heterogeneity, the MENA region ranks favorably by comparison to Latin America and Eastern Europe. We can therefore expect greater international financial integration of the MENA region in the near future.
    Keywords: Common Agricultural Policy, World Trade Organizations, Trade Negotiations.
    Date: 2006–08–02
  19. By: K. Huang
    Abstract: We develop a theory of valuation of payoff streams in infinite-horizon sequential markets and discuss implications of this theory for equilibrium under various portfolio constraints. We study the nature of asset price bubbles in light of this theory. We show that there cannot be equilibrium price bubbles on asset in positive net supply under a transversality restriction. Our analysis extends the work by Huang and Werner [9] to stochastic settings with complete or incomplete markets.
    Keywords: Valuation, asset price bubble, portfolio constraint
    JEL: C61 D50 G10 G12
  20. By: Jeremy Large (All Souls College, University of Oxford)
    Abstract: Using a stochastic sequential game in ergodic equilibrium, this paper models limit order book trading dynamics. It deduces investor surplus and some agents' strategies from depth's stationarity, while bypassing altogether agents' intricate forecasting problems. Market inefficiency adjusts to induce equal supply and demand for liquidity over time. Consequently, at a given bid-ask spread surplus per investor is invariant to faster, more regular or more sophisticated trading, or modified queuing rules: apparent improvements are offset as inefficiency adjusts back to market-clearing levels. Moreover, investor surplus decreases with the spread. In the model, price discreteness fixes the spread at the tick size. Narrowing the tick is beneficial, but may be resisted by sell-side traders.
    Keywords: stochastic sequential game, ergodic equilibrium, market microstructure, limit order book, market depths, bid-ask spread
    JEL: C73 G14 G24
    Date: 2006–07–14
  21. By: James L. Smith; Rex Thompson
    Abstract: Any investor in assets that can be exploited sequentially faces a tradeoff between diversification and concentration. Loading a portfolio with correlated assets has the potential to inflate variance, but also creates information spillovers and real options that may augment total return and mitigate variance. The task of optimal portfolio design is therefore to strike an appropriate balance between diversification and concentration. We examine this tradeoff in the context of petroleum exploration. Using a simple model of geological dependence, we show that the value of learning options creates incentives for explorationists to plunge into dependence; i.e., to assemble portfolios of highly correlated exploration prospects. Risk-neutral and risk-averse investors are distinguished not by the plunging phenomenon, but by the threshold level of dependence that triggers such behavior. Aversion to risk does not imply aversion to dependence. Indeed the potential to plunge may be larger for risk-averse investors than for risk-neutral investors. To test the empirical validity of our theory, we examine the concentration of bids tendered in petroleum lease sales. We find that higher levels of risk aversion are associated with a revealed preference for more highly concentrated (i.e., less diversified) portfolios.
    Date: 2006–02
  22. By: Nicholas Barberis; Wei Xiong
    Abstract: One of the most striking portfolio puzzles is the “disposition effect”: the tendency of individuals to sell stocks in their portfolios that have risen in value since purchase, rather than fallen in value. Perhaps the most prominent explanation for this puzzle is based on prospect theory. Despite its prominence, this explanation has received little formal scrutiny. We take up this task, and analyze the trading behavior of investors with prospect theory preferences. We find that, at least for the simplest implementation of prospect theory, the link between these preferences and the disposition effect is not as obvious as previously thought: in some cases, prospect theory does indeed predict a disposition effect, but in others, it predicts the opposite. We provide intuition for these results, and identify the conditions under which the disposition effect holds or fails. We also discuss the implications of our results for other disposition-type effects that have been documented in settings such as the housing market, futures trading, and executive stock options.
    JEL: G11 G12
    Date: 2006–07
  23. By: In Choi; Timothy K. Chue
    Abstract: We develop subsampling-based tests of stock-return predictability and apply them to U.S. data. These tests allow for multiple predictor variables with local-to-unit roots. By contrast, previous methods that model the predictor variables as nearly integrated are only applicable to univariate predictive regressions. Simulation results demonstrate that our subsampling-based tests have desirable size and power properties. Using stock-market valuation ratios and the risk-free rate as predictors, our univariate tests show that the evidence of predictability is more concentrated in the 1926-1994 subperiod. In bivariate tests, we find support for predictability in the full sample period 1926-2004 and the 1952-2004 subperiod as well. For the subperiod 1952-2004, we also consider a number of consumption-based variables as predictors for stock returns and find that they tend to perform better than the dividend-price ratio. Among the variables we consider, the predictive power of the consumption-wealth ratio proposed by Lettau and Ludvigson (2001a, 2001b) seems to be the most robust. Among variables based on habit persistence, Campbell and Cochrane's (1999) nonlinear specication tends to outperform a more traditional, linear specification.
    Keywords: Subsampling, local-to-unit roots, predictive regression, stock-return predictability, consumption-based models
    Date: 2006–07
  24. By: William R. Emmons
    Keywords: Consumer protection ; Education - Economic aspects
    Date: 2005
  25. By: Courtney Coile; Kevin Milligan
    Abstract: In this paper, we study how the portfolios of elderly U.S. households evolve after retirement, using data from the Health and Retirement Study (HRS). In particular, we investigate the influence of aging and health shocks on a household’s ownership of various assets and on the dollar value and share of total assets held in each asset class. We find that households decrease their ownership of most asset classes as they age, with the strongest evidence for principal residences and vehicles, while increasing the share of assets held in bank accounts and CDs. Consistent with prior studies, we find that the death of a spouse is a strong predictor of selling the principal residence. However, we find that widowhood also leads households to sell vehicles, businesses, and real estate and to put money into bank accounts and CDs, and further that other health shocks have very similar impacts. Finally, we explore why health shocks affect asset holdings and find that the effect of a shock is greatly magnified when households have physical or mental impairments. This suggests that factors other than standard risk and return considerations may weigh heavily in many older households’ portfolio decisions.
    JEL: G11 J14
    Date: 2006–07
  26. By: K. Huang; Z. Liu
    Abstract: We show that Arrow-Debreu equilibria with countably additive prices in infinite-time economy under uncertainty can be implemented by trading infinitely-lived securities in complete sequential markets under two different portfolio feasibility constraints: wealth constraint, and essentially bounded portfolios. Sequential equilibria with no price bubbles implement Arrow-Debreu equilibria, while those with price bubbles implement Arrow-Debreu equilibria with transfers. Transfers are equal to the value of price bubbles on initial portfolio holdings. Price bubbles may arise in sequential equilibrium under the wealth constraint, but with essentially bounded portfolios.
    Keywords: Arrow-Debreu equilibrium, security markets equilibrium, price bubbles, transfers
  27. By: Machiel van Dijk; MIchiel Bijlsma; Marc Pomp
    Abstract: What factors determine how well consumers make their actual choices with regard to financial products? This paper empirically evaluates two different choices consumers make when buying deferred annuities. One choice concerns the type of insurance policy, the other concerns the choice of insurance provider. For both choices we will analyse what factors explain the quality of the choice made. In particular, we will investigate the role of financial advice in the decision making process. By combining Dutch consumer survey data and data on quotations by Dutch life insurance companies, we obtain the following results. First, respondents who buy their policy directly from an insurer attain a significantly better match between their risk preferences and the type of policy chosen than respondents who purchase their policy through an insurance broker. Second, respondents who buy their policy through an insurance broker obtain a significantly lower pay-out than respondents who purchased their policy directly from an insurance company. These results raise doubts about the functioning of both the market for financial advice and the market for life insurances.
    Keywords: Financial advice; life insurances; choice behaviour
    JEL: D12 G22 L84
    Date: 2006–07
  28. By: Paul Hiebert (European Central Bank)
    Abstract: Over the past decade, a fairly synchronised and steady decline in household saving rates has been witnessed in some OECD countries but not in others. In these English-speaking countries, which share many similar institutional and cultural features, declines in household or personal saving appear to have been correlated with large capital gains and rapid financial innovation. An empirical investigation based on quarterly macroeconomic data indicates that gains in the valuation of asset holdings have indeed been important as a substitute for traditional household saving (that is, personal saving as defined in the national accounts) in these countries over the last decades, and in some cases that this effect has been intensifying through time. Existing studies analysing private saving have tended to either focus on individual countries, finding the importance of wealth effects in certain cases, or a panel of OECD countries in which other common factors tend to dominate the wealth effect. In the latter case, it is possible that the lack of a significant wealth effect could be attributable to heterogeneity across countries.
    Keywords: household saving; wealth valuation; error-correction
    JEL: C22 E21
    Date: 2006–08
  29. By: Nicola Bruti-Liberati (School of Finance and Economics, University of Technology, Sydney); Eckhard Platen (School of Finance and Economics, University of Technology, Sydney)
    Abstract: Event-driven uncertainties such as corporate defaults, operational failures or central bank announcements are important elements in the modelling of financial quantities. Therefore, stochastic differential equations (SDEs) of jump-diffusion type are often used in finance. We consider in this paper weak discrete time approximations of jump-diffusion SDEs which are appropriate for problems such as derivative pricing and the evaluation of risk measures. We present regular and jump-adapted predictor-corrector schemes with first and second order of weak convergence. The regular schemes are constructed on regular time discretizations that do not include jump times, while the jump-adapted schemes are based on time discretizations that include all jump times. A numerical analysis of the accuracy of these schemes when applied to the jump-diffusion Merton model is provided.
    Keywords: weak approximations; Monte Carlo simulations; predictor-corrector schemes; jump diffusions
    JEL: G10 G13 C63
    Date: 2006–07–01
  30. By: Camille Cornand (Financial Market Group, London School of Economics and Political Sciences Houghton Street, London WC2A 2AE, United-Kingdom,; Frank Heinemann (Technische Universität Berlin, Sekretariat H 52 Strasse des 17. Juni 135, 10623 Berlin
    Abstract: Financial markets and macroeconomic environments are often characterized by positive externalities. In these environments, transparency may reduce expected welfare from an ex-ante point of view: public announcements serve as a focal point for higher-order beliefs and affect agents’ behaviour more than justified by their informational contents. Some scholars conclude that it might be better to reduce the precision of public signals or entirely withhold information. This paper shows that public information should always be provided with maximum precision, but under certain conditions not to all agents. Restricting the degree of publicity is a better-suited instrument for preventing the negative welfare effects of public announcements than restrictions on their precision are.
    Keywords: Transparency, public information, private information, coordination, strategic complementarity
    JEL: C73 D82 F31
    Date: 2006–02
  31. By: Joerg Bibow
    Abstract: This paper investigates the phenomenon of persistent macroeconomic divergence that has occurred across the eurozone in recent years. Optimal currency area theory would point toward asymmetric shocks and structural factors as the foremost candidate causes. The alternative hypothesis pursued here focuses on the working of the Maastricht regime itself, making it clear that the regime features powerful built-in destabilizers that foster divergence as well as fragility. Supposed adjustment mechanisms actually have turned out to undermine the operation of the currency union by making it less “optimal,” that is, less subject to a “one-size-fits-all” monetary policy and common nominal exchange rate, in view of the resulting business cycle desynchronization and related build-up of financial imbalances. The threats of fragility and divergence reinforce each other. Without regime reform these developments could potentially spiral out of control, threatening the long-term survival of EMU.
    Date: 2006–07
  32. By: R. F. Kosobud; H.H. Stokes; C.D. Tallarico; B.L. Scott
    Abstract: The Chicago cap-and-trade approach to regulating stationary source VOC emissions in the Chicago ozone non-attainment area is a pioneering program that could set a precedent for other urban areas troubled by high ozone concentrations. It holds out the promise of cost-effectiveness, innovation stimulation, and flexibility compared with traditional regulation. To appraise this program design and evaluate these objectives, this study analyzes four years of data since the inception of the program in 2000. The data reveal that while emissions are far below the cap, there are unexpectedly large banks, startling expirations, and low prices of tradable permits, all inconsistent with an effective market. We find that the market as designed has been constrained from reaching its objectives by the continuance and extension of an underlying layer of traditional regulation, and to a lesser extent by over-allotment of tradable permits. That is, traditional regulation and over-allotment, combined with a market design calling for a small reduction in emissions from baseline and a one-year limit on banking, explain the incongruous outcomes recorded in the market. This study explores the evolution of this particular market design and presents statistical evidence in support of the hypothesis that the performance of a cap-and-trade market is very sensitive to design features when combined with other regulatory measures. The study concludes that the market as presently designed falls far short of achieving cost effectiveness, innovation stimulation, and flexibility. The policy recommendations include that the cap be significantly tightened, perhaps in a series of steps, and the banking horizon be extended to three years or more. Such redesign should enable the cap-and-trade approach to assume its proper role in helping to achieve the new eight-hour standard for ozone concentrations.
    Date: 2004–11
  33. By: Beuselinck, C.; Manigart, S.
    Abstract: We argue and empirically show on a sample of 270 unquoted, private equity backed companies that the shareholder structure of private companies influences the quality of their accounting information. We show that companies in which private equity (PE) investors have a higher equity stake produce accounting information that is of lower quality than companies in which PE investors have a lower equity stake, controlling for company size and age. We argue that this is evidence that a large equity stake is a substitute for high earnings quality
    Date: 2006–01–15
  34. By: Marco LiCalzi; Paolo Pellizzari (Department of Applied Mathematics, University of Venice)
    Abstract: This paper studies the performance of four market protocols with egard to allocative efficiency and other performance criteria such as volume or volatility. We examine batch auctions, continuous double auctions, specialist dealerships, and a hybrid of these last two. All protocols are practically implementable because the messages that traders need to use are simple. We test the protocols by running (computerized) experiments in an environment that controls for tradersÕ behavior and rules out any informational effect. We find that all protocols generically converge to the efficient allocation in finite time. An extended comparison over other performance criteria produces no clear winner, but the presence of a specialist is associated with the best all-round performance.
    Keywords: market microstructure, allocative efficiency, comparison of market institutions, performance criteria.
    JEL: G19 D61 D44 C63
    Date: 2005–04
  35. By: Joshua Linn
    Abstract: Recent environmental regulations have used market incentives to reduce compliance costs and improve efficiency. In most cases, the Environmental Protection Agency (EPA) selects an emissions cap using the predicted costs of reducing pollution. The EPA and other economists have used a "bottom-up" approach to predict the costs of such regulations, which forecast how every affected firm will respond. It is uncertain whether firms rely on the same predictions in making their compliance decisions. This paper uses stock prices to compare the predictions of the bottom-up studies with those of the affected firms. I focus on a recent tradable permit program, the Nitrogen Oxides Budget Trading Program (NBP). Started in 2004, the NBP requires electric generators in the Midwest and East to reduce their emissions or purchase permits from other firms. I compare utilities’ stock prices with the prices that would have occurred in the absence of the new regulation. I make this comparison by exploiting variation in the location of generators owned by utilities; the control group consists of utilities without any generators in the NBP. I estimate that investors expected the program to reduce profits by about $2 billion per year (2000 dollars). Investors expected the NBP to primarily affect coal generators, which have larger baseline emission rates than other fossil fuel generators. These results agree with previous studies that used the bottom-up approach.
    Date: 2006–04
  36. By: Abdelkrim Seghir (American University of Beirut, Economics Department); Juan Pablo Torres-Martinez (Department of Economics PUC-Rio)
    Abstract: We develop a general equilibrium model of wealth transfers in the presence of uncertain lifetimes and default. Without introducing exogenous debt constraints, agents are allowed to make collateral-backed promises at any state of their life span.
    Keywords: Uncertain lifetimes, Collateralized Assets, Donations, Wills.
    JEL: D52 D91
    Date: 2006–08
  37. By: Refet S. Gurkaynak; Brian Sack; Jonathan H. Wright
    Abstract: The discount function, which determines the value of all future nominal payments, is the most basic building block of finance and is usually inferred from the Treasury yield curve. It is therefore surprising that researchers and practitioners do not have available to them a long history of high-frequency yield curve estimates. This paper fills that void by making public the Treasury yield curve estimates of the Federal Reserve Board at a daily frequency from 1961 to the present. We use a well-known and simple smoothing method that is shown to fit the data very well. The resulting estimates can be used to compute yields or forward rates for any horizon. We hope that the data, which are posted on the website and which will be updated periodically, will provide a benchmark yield curve that will be useful to applied economists.
    Date: 2006
  38. By: Daniel M. Covitz; Song Han; Beth Anne Wilson
    Abstract: We test the widely held assumption that longer restructurings are more costly. In contrast to earlier studies, we use instrumental variables to control for the endogeneity of restructuring time and creditor return. Instrumenting proves critical to our finding that creditor recovery rates increase with duration for roughly 1½ years following default, but decrease thereafter. This, and similar results using the likelihood of reentering bankruptcy, suggest that there may be an optimal time in default. Moreover, the default duration of almost half of our sample is well outside the optimal default duration implied by our estimates. We also find that creditors benefit from more experienced judges and from oversight by only one judge. The results have implications for the reform and design of bankruptcy systems.
    Date: 2006
  39. By: Charles Bellemare (Université Laval, CIRPÉE and IZA Bonn); Bruce S. Shearer (Université Laval, CIRPÉE and IZA Bonn)
    Abstract: The, often observed, positive correlation between incentive intensity and risk has been explained in two ways: the presence of transaction costs as determinants of contracts and the sorting of risk-tolerant individuals into firms using high-intensity incentive contracts. The empirical importance of sorting is perhaps best evaluated by directly measuring the risk tolerance of workers who have selected into incentive contracts under risky environments. We use experiments, conducted within a real firm, to measure the risk preferences of a sample of workers who are paid incentive contracts and face substantial daily income risk. Our experimental results indicate the presence of sorting; Workers in our sample are risktolerant. Moreover, their level of tolerance is considerably higher than levels observed for samples of individuals representing broader populations. Interestingly, the high level of risk tolerance suggests that both sorting and transaction costs are important determinants of contract choices when workers have heterogeneous preferences.
    Keywords: risk aversion, sorting, incentive contracts, field experiments
    JEL: J33 M52 C93
    Date: 2006–07
  40. By: Matti Liski; Juan-Pablo Montero
    Abstract: We consider an infinitely-repeated oligopoly in which at each period firms not only serve the spot market by either competing in prices or quantities but also have the opportunity to trade forward contracts. Contrary to the pro-competitive results of finite-horizon models, we find that the possibility of forward trading allows firms to sustain collusive profits that otherwise would not be possible. The result holds both for price and quantity competition and follows because (collusive) contracting of future sales is more effective in deterring deviations from the collusive plan than in inducing the previously identified pro-competitive effects.
    Date: 2005–03
  41. By: Kenneth W. Clements; Renee Fry
    Abstract: There is a large literature on the influence of commodity prices on the currencies of countries with a large commodity-based export sector such as Australia, New Zealand and Canada ("commodity currencies"). There is also the idea that because of pricing power, the value of currencies of certain commodity-producing countries affects commodity prices, such as metals, energy, and agricultural-based products ("currency commodities"). This paper merges these two strands of the literature to analyse the simultaneous workings of commodity and currency markets. We implement the approach by using the Kalman filter to jointly estimate the determinants of the prices of these currencies and commodities. Included in the specification is an allowance for spillovers between the two asset types. The methodology is able to determine the extent that currencies are indeed driven by commodities, or that commodities are driven by currencies, over the period 1975 to 2005.
    Date: 2006–07
  42. By: Christopher D. Carroll; Miles S. Kimball
    Abstract: This is an entry for The New Palgrave Dictionary of Economics, 2nd Ed.
    Date: 2006–01
  43. By: Nick Bloom; John Van Reenen; Stephen Bond
    Abstract: This paper shows that, with (partial) irreversibility, higher uncertainty reduces the impact effect of demand shocks on investment. Uncertainty increases real option values making firms more cautious when investing or disinvesting. This is confirmed both numerically for a model with a rich mix of adjustment costs, time-varying uncertainty, and aggregation over investment decisions and time, and also empirically for a panel of manufacturing firms. These cautionary effects of uncertainty are large – going from the lower quartile to the upper quartile of the uncertainty distribution typically halves the first year investment response to demand shocks. This implies the responsiveness of firms to any given policy stimulus may be much lower in periods of high uncertainty, such as after major shocks like OPEC I and 9/11.
    JEL: D92 E22 D8 C23
    Date: 2006–07

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