New Economics Papers
on Financial Markets
Issue of 2006‒09‒03
forty-six papers chosen by
Carolina Valiente

  1. Heterogeneity in lending and sectoral growth : evidence from German bank-level data By Buch, Claudia M.; Schertler, Andrea; von Westernhagen, Natalja
  2. Exchange market pressure and the credibility of Macau's currency Board By Macedo, Jorge Braga de; Braz, José; Pereira, Luis brites; Nunes, Luis C.
  3. The Impact of News Releases on Trade Durations in Stocks -Empirical Evidence from Sweden By Simonsen, Ola
  5. Two-Sided Matching and Spread Determinants in the Loan Market By Jiawei Chen
  6. The behaviour of the real exchange rate: evidence from regression quantiles. By Kleopatra Nikolaou
  7. International Exchange Rate Systems - Where do we Stand? By Horst Siebert
  8. Sovereign debt restructuring : the Judge, the vultures and creditor rights By Miller, Marcus; Thomas, Dania
  9. The Equity Premium Implied by Production By Urban Jermann
  10. Understanding International Portfolio Diversification and Turnover Rates By Amir Amadi; Paul Bergin
  11. Financial Intermediation, Moral Hazard, And Pareto Inferior Trade By Hansen, Bodil Olai; Keiding, Hans
  12. Globalization and Risk Sharing By Jaume Ventura; Fernando A. Broner
  13. Do Birds of a Feather Flock Together? Speculator Herding in the World Oil Market By Robert Weiner
  14. Financial Globalization: A Reappraisal By M. Ayhan Kose; Eswar Prasad; Kenneth S. Rogoff; Shang-Jin Wei
  15. Taxation and systematic risk under decreasing returns to scale By Lund, Diderik
  16. Optimal Debt Contracts when Credit Managers are (Perhaps) Corruptible By Ingela Alger
  17. High powered Incentives and Fraudulent Behavior: Stock based versus Stock Option based Compensation By R. Andergassen
  18. Declining valuations and equilibrium bidding in central bank refinancing operations. By Christian Ewerhart; Nuno Cassola; Natacha Valla
  19. Quantifying Equilibrium Network Externalities in the ACH Banking Industry By Daniel A. Ackerberg; Gautam Gowrisankaran
  20. The euro as invoicing currency in international trade. By Annette Kamps
  21. Does the Open Limit Order Book Reveal Information About Short-run Stock Price Movements? By Hellström, Jörgen; Simonsen, Ola
  22. How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages By Areendam Chanda; Laura Alfaro; Sebnem Kalemli-Ozcan; Selin Sayek
  23. High Bids and Broke Winners By Zheng, Charles
  24. Current account composition and sustainability of external debt (I) By G. Rossini; P. Zanghieri
  25. Conventional and Unconventional Approaches to Exchange Rate Modeling and Assessment By Menzie D. Chinn; Ron Alquist
  26. Irreversible Investment, Real Options, and Competition: Evidence from Real Estate Development By Laarni Bulan; Christopher J. Mayer; C. Tsuriel Somerville
  27. `Coaching´ Small Biotech Companies into Success: The Value-adding Function of VC By Terttu Luukkonen; Mari Maunula
  28. Macroeconomic implications of demographic developments in the euro area By Angela Maddaloni; Alberto Musso; Philipp Rother; Melanie Ward-Warmedinger; Thomas Westermann
  29. How To Avoid Awarding a Valuable Asset By Sam Bucovetsky; Amihai Glazer
  30. Prospect Theory and the Law of Small Numbers in the Evaluation of Asset Prices By B. Luppi
  31. Value Added Tax Treatment of Financial Services: A Developing Country Perspective By Pierre-Pascal Gendron
  32. Revisiting the Revolving Door: Capital Flight from Southeast Asia By Edsel L. Beja, Jr.
  33. Valuation, leverage and the cost of capital in the case of depreciable assets By Lund, Diderik
  34. Why it Matters Who Runs the IMF and the World Bank-Updated October 2003 By Nancy Birdsall
  35. Research Strategies in Science-based Start-ups - Effects on performance in Danish and Swedish biotechnology By Finn Valentin; Henrich Dahlgren; Rasmus Lund Jensen
  36. A suggestion for simplifying the theory of asset prices By R. Cesari; C. D'Adda
  37. Optimal Monetary Policy with Collateralized Household Debt and Borrowing Constraints By Tommaso Monacelli
  38. Can Capital Income Taxes Survive? And Should They? By Peter Birch Sørensen
  39. Contracting for an Innovation under Bilateral Asymmetric Information By Martimort, D.; Poudou, J.-C.; Sand-Zantman, W.
  40. Price Competition over Boundedly Rational Agents By B. Luppi
  41. Failing Firm Defense with Entry Deterrence By A. Fedele; M. Tognoni
  42. Imperfect Transparency and Shifts in the Central Bank's Output Gap Target By Niklas J. Westelius
  43. The Incentive to Declare Taxes and Tax Revenue: The Lottery Receipt Experiment in China By Junmin Wan
  44. Optimal Search Auctions By Cremer, Jaques; Spiegel, Yossi; Zheng, Charles
  45. Optimal Search Auctions with Correlated Bidder Types By Cremer, Jacques; Spiegel, Yossi; Zheng, Charles
  46. Horizontal Mergers with Scale Economies By D. Dragone; L. Lambertini; A. Mantovani

  1. By: Buch, Claudia M.; Schertler, Andrea; von Westernhagen, Natalja
    Abstract: This paper studies the sectoral and geographical dimensions of the response of bank lending to sectoral growth. We use several bank-level datasets provided by the Deutsche Bundesbank for the 1996-2002 period. Our results show that bank heterogeneity affects how lending responds to domestic sectoral growth. We document that banks’ total lending to German firms reacts procyclically to domestic sectoral growth, while lending exceeding a threshold of €1.5 million to German and foreign firms does not. Moreover, we find that the response of lending depends on bank characteristics such as the banking groups, the banks’ asset size, and the degree of sectoral portfolio concentration. We find that total domestic lending by savings banks and credit cooperatives (including their regional institutions), smaller banks, and banks whose portfolios are heavily concentrated in specific sectors responds positively and, in relevant cases, more strongly to domestic sectoral growth.
    Keywords: bank lending, heterogeneity, sectoral growth
    JEL: F3 G21
    Date: 2006
  2. By: Macedo, Jorge Braga de; Braz, José; Pereira, Luis brites; Nunes, Luis C.
    Abstract: In this study, we assess the credibility of the currency board arrangement (CBA) of the Macau Special Administrative Region by studying the relationship between exchange market pressure (EMP) and the anchors of a rule-based CBA, namely, interest rate arbitrage, exchange rate arbitrage and economic discipline. A pure CBA signals its credibility by allowing the first two anchors to function automatically and by pursuing sound fiscal policies. The analysis’ results suggest that Macau’s CBA has been characterised by a state of low volatility since late 1992, with the brief exception of the East Asian financial crisis period. The paper’s main finding is that fiscal fundamentals seem to have a more pronounced role in reducing EMP’s variability during periods of low volatility whilst interest rate arbitrage is more important in periods of high volatility. We conclude that Macau’s CBA is credible at present as reflected in the low frequency of observed EMP, in the narrowing of Macau’s interest rate differential vis-à-vis U.S. interest rates and in Macau’s substantial fiscal reserves.
    Date: 2006
  3. By: Simonsen, Ola (Department of Economics, Umeå University)
    Abstract: This paper studies the impact of news announcements on trade durations in stocks on the Stockholm Stock Exchange. The news are categorized into four groups and the impact on the time between transactions is studied. Times before, during and after the news release are considered. Econometrically, the impact is studied within an autoregressive conditional duration model using intradaily data for six stocks.The empirical results reveal that news reduces the duration lengths before, during and after news releases as expected by the theoretical litterature on durations and information flow.
    Keywords: Finance; transaction data; intraday; market microstructure; ACD
    JEL: C12 C32 C41 G14
    Date: 2006–08–24
  4. By: Simonsen, Ola (Department of Economics, Umeå University)
    Abstract: This thesis comprises four papers concerning trade durations and limit order book information. Paper [1], [2] and [4] study trader durations, e.g., the time between stock transactions in intra-day data. Paper [3] focus on the information content in the limit order book concerning future price movements in stock transaction data. <p> Paper [1] considers conditional duration models in which durations are in continuous time but measured in grouped or discretized form. This feature of recorded durations in combination with a frequently traded stock is expected to negatively influence the performance of conventional estimators for intraday duration models. A few estimators that account for the discreteness are discussed and compared in a Monte Carlo experiment. An EM-algorithm accounting for the discrete data performs better than those which do not. Empirically, the incorporation of level variables for past trading is rejected in favour of change variables. This enables an interpretation in terms of news effects. No evidence of asymmetric responses to news about prices and spreads is found. <p> Paper [2] considers an extension of the univariate autoregressive conditional duration model to which durations from a second stock are added. The model is empirically used to study duration dependence in four traded stocks, Nordea, Föreningssparbanken, Handelsbanken and SEB A on the Stockholm Stock Exchange. The stocks are all active in the banking sector. It is found that including durations from a second stock may add explanatory power to the univariate model. We also find that spread changes have significant effect for all series. <p> Paper [3] empirically tests whether an open limit order book contains information about future short-run stock price movements. To account for the discrete nature of price changes, the integer-valued autoregressive model of order one is utilized. A model transformation has an advantage over conventional count data approaches since it handles negative integer-valued price changes. The empirical results reveal that measures capturing offered quantities of a share at the best bid- and ask-price reveal more information about future short-run price movements than measures capturing the quantities offered at prices below and above. Imbalance and changes in offered quantities at prices below and above the best bid- and askprice do, however, have a small and significant effect on future price changes. The results also indicate that the value of order book information is short-term. <p> Paper [4] This paper studies the impact of news announcements on trade durations in stocks on the Stockholm Stock Exchange. The news are categorized into four groups and the impact on the time between transactions is studied. Times before, during and after the news release are considered. Econometrically, the impact is studied within an autoregressive conditional duration model using intradaily data for six stocks. The empirical results reveal that news reduces the duration lengths before, during and after news releases as expected by the theoretical litterature on durations and information flow.
    Keywords: Finance; Maximum likelihood; Estimation; ACD; News; Multivariate; Intraday; Market microstructure; Granger causality; Time series; INAR; Stock price; Open limit order book
    JEL: C12 C22 C25 C32 C41 C51 G12 G14
    Date: 2006–08–24
  5. By: Jiawei Chen (Department of Economics, University of California-Irvine)
    Abstract: Empirical work on bank loans typically regresses loan spreads (markups of loan interest rates over a benchmark rate) on observed characteristics of banks, firms, and loans. The estimation is problematic when some of these characteristics are only partially observed and the matching of banks and firms is endogenously determined because they prefer partners that have higher quality. We study the U.S. bank loan market with a two-sided matching model to control for the endogenous matching, and obtain Bayesian inference using a Gibbs sampling algorithm with data augmentation. We find evidence of positive assortative matching of sizes, explained by similar relationships between quality and size on both sides of the market. Banks' risk and firms' risk are important factors in their quality. Controlling for the endogenous matching has a strong impact on estimated coefficients in the loan spread equation.
    Keywords: Two-sided matching, Loan spread, Bayesian inference, Gibbs sampling with data augmentation
    JEL: C11 C78 G21 L11
    Date: 2006–08
  6. By: Kleopatra Nikolaou (Warwick Business School, Finance Group, Univeristy of Warwick, Coventry, CV32 7AL, United Kingdom.)
    Abstract: We test for mean reversion in real exchange rates using a recently developed unit root test for non-normal processes based on quantile autoregression inference in semi-parametric and non-parametric settings. The quantile regression approach allows us to directly capture the impact of different magnitudes of shocks that hit the real exchange rate, conditional on its past history, and can detect asymmetric, dynamic adjustment of the real exchange rate towards its long run equilibrium. Our results suggest that large shocks tend to induce strong mean reverting tendencies in the exchange rate, with half lives less than one year in the extreme quantiles. Mean reversion is faster when large shocks originate at points of large real exchange rate deviations from the long run equilibrium. However, in the absence of shocks no mean reversion is observed. Finally, we report asymmetries in the dynamic adjustment of the RER. JEL Classification: F31.
    Keywords: Real exchange rate,purchasing power parity, quantile regression.
    Date: 2006–08
  7. By: Horst Siebert
    Abstract: This paper analyzes institutional arrangements for exchange rate systems and reviews what we know. It looks at the foreign exchange market, different balance of payment situations in which countries find themselves and the necessary exchange rate adjustments. It studies the options that are available to countries in choosing their exchange rate system (type of nominal anchor, nominal anchor versus real target and the degree of sovereignty to be given up) and reviews the historical experience for multilateral options. The actual system is a fragile low-inflation central bank dominated arrangement. Options for the future rest on quite a few idealistic ideas. In addition to choosing the exchange rate system, adopting the right exchange rate is also addressed.
    Keywords: Exchange rate systems, Balance of payments situations, External and internal equilibrium, Choosing the exchange rate system, Unilateral and multilateral arrangements, Options for the future, Universal money
    JEL: E E5 E42 E58 E61 F31 F32 F33
    Date: 2006–08
  8. By: Miller, Marcus (Department of Economics, CEPR and CSGR, University of Warwick); Thomas, Dania (CSGR, University of Warwick)
    Abstract: What role did the US courts play in the Argentine debt swap of 2005? What implications does this have for the future of creditor rights in sovereign bond markets? The judge in the Argentine case has, it appears, deftly exploited creditor heterogeneity – between holdouts seeking capital gains and institutional investors wanting a settlement – to promote a swap with a supermajority of creditors. Our analysis of Argentine debt litigation reveals a ‘judge-mediated’ sovereign debt restructuring, which resolves the key issues of Transition and Aggregation - two of the tasks envisaged for the IMF’s still-born Sovereign Debt Restructuring Mechanism. For the future, we discuss how judge-mediated sovereign debt restructuring (together with creditor committees) could complement the alternative promoted by the US Treasury, namely collective action clauses in sovereign bond contracts
    Keywords: Sovereign debt crises ; debt restructuring ; holdout creditors ; collective action clauses
    JEL: F34 K41 K49
    Date: 2006
  9. By: Urban Jermann
    Abstract: This paper studies the determinants of the equity premium as implied by producers’ first-order conditions. A closed form expression is presented for the Sharpe ratio at steady-state as a function of investment volatility and adjustment cost curvature. Calibrated to the U.S. postwar economy, the model can generate a sizeable equity premium, with reasonable volatility for market returns and risk free rates. The market’s Sharpe ratio and the market price of risk are very volatile. Contrary to most models, the model generates a negative correlation between conditional means and standard deviations of aggregate excess returns.
    JEL: E23 G12
    Date: 2006–08
  10. By: Amir Amadi; Paul Bergin
    Abstract: This paper argues that fixed trading costs in international asset markets help explain equity home bias. This contrasts with explanations prevalent in international macroeconomics, which tend to be based on trading frictions instead in international goods markets, such as nontraded goods or transportation costs. While the stylized fact of high trading turnover in foreign holdings has been interpreted as evidence against international asset trading costs, we show that this argument only applies to costs that are proportional to trade, and not to fixed costs of entering the foreign market. After documenting that the home bias and turnover stylized facts remain valid in recent data, the paper constructs a very simple portfolio allocation model with various configurations of trading costs and with heterogeneous types of traders. A configuration with per unit costs heterogeneous among agents and a homogeneous fixed cost is found to replicate the pair of stylized facts. Intuitively, the lower trading costs that characterize larger and more efficient traders have two implications: firstly, these traders find it more profitable to enter foreign markets; secondly, their lower trading costs encourage a higher rate of trading turnover. Since holdings of international equities are disproportionately dominated by this class of larger and more efficient traders, average trading turnover is higher among international holdings.
    JEL: F36
    Date: 2006–08
  11. By: Hansen, Bodil Olai (Department of Economics, Copenhagen Business School); Keiding, Hans (Department of Economics, Copenhagen Business School)
    Abstract: We consider a simple model of international trade under uncertainty, where production takes time and is subject to uncertainty. The riskiness of production depends on the choices of the producers, not observable to the general public, and these choices are influenced by the availability and cost of credit. If investment is financed by a bond market, then a situation may arise where otherwise identical countries end up with different levels of interest and different choices of technique, which again implies differences in achieved level of welfare. Under suitable conditions on the parameters of the model, the market may not be able to supply credits to one of the countries. The introduction of financial intermediaries with the ability to control the debtors may change this situation in a direction which is welfare improving (in a suitable sense) by increasing expected output in the country with high interest rates, while opening up for new problems of asymmetric information with respect to the monitoring activity of the banks.
    Keywords: Capital outflow; financial intermediaries; moral hazard
    JEL: D92 E44 F36
    Date: 2006–08–28
  12. By: Jaume Ventura; Fernando A. Broner
    Abstract: This paper presents a theoretical study of the e¤ects of globalization on risk sharing and welfare. We model globalization as a gradual and exogenous increase in the fraction of goods that are tradable. In the absence of frictions, globalization opens new goods markets and raises welfare. We assume, however, that countries cannot commit to pay their debts. Unlike the previous literature, and motivated by changes in the institutional setup of emerging-market borrowing, we also assume that countries cannot discriminate between domestic and foreign creditors when paying their debts. Although globalization still opens new goods markets, we find that it can also open or close some asset markets. The net e¤ect on risk sharing and welfare of this process of creation and destruction of markets might be either positive or negative depending on a variety of factors that the theory highlights.
    JEL: E24 F34 F36 G15
    Date: 2006–08
  13. By: Robert Weiner (Resources for the Future)
    Abstract: This paper looks at speculative behavior in the international oil market. Much of the blame for oil-market turbulence has been placed on speculators, particularly hedge funds. Speculative capital has been characterized as “hot money,” with capital flows driven by “herding,” “flocking,” and “contagion.” Policies to deal with volatility by weakening, or even disabling speculation, have been based largely on anecdote, convenience (speculators have long served as scapegoats for various problems), and ideology, rather than careful analysis. Part of the problem arises from the secrecy with which speculators operate. Because speculative trading cannot easily be observed, it is difficult to assess speculators’ contribution, if any, to volatility. The paper utilizes a large, detailed database on individual trader positions in crude-oil and heating-oil futures markets. The paper is exploratory, with focus on measuring and assessing the tendency of speculators to herd (trade in the same direction as a group) and flock (trade in the same direction by subgroups of speculators).
    Keywords: oil, speculation, volatility, herding, derivatives, futures
    JEL: G13 G18 L71 Q48
    Date: 2006–06–29
  14. By: M. Ayhan Kose; Eswar Prasad; Kenneth S. Rogoff; Shang-Jin Wei
    Abstract: The literature on the benefits and costs of financial globalization for developing countries has exploded in recent years, but along many disparate channels with a variety of apparently conflicting results. We attempt to provide a unified conceptual framework for organizing this vast and growing literature. This framework allows us to provide a fresh synthetic perspective on the macroeconomic effects of financial globalization, both in terms of growth and volatility. Overall, our critical reading of the recent empirical literature is that it lends some qualified support to the view that developing countries can benefit from financial globalization, but with many nuances. On the other hand, there is little systematic evidence to support widely-cited claims that financial globalization by itself leads to deeper and more costly developing country growth crises.
    JEL: F2 F3 F4 G1
    Date: 2006–08
  15. By: Lund, Diderik (Department of Economics, Copenhagen Business School)
    Abstract: Lund (2002a) showed in a CAPM-type model how tax depreciation schedules affect required expected returns after taxes. Even without leverage higher tax rates implied lower betas when tax deductions were risk free. Here they are risky, and marginal investment is taxed together with inframarginal in an analytical model of decreasing returns. With imperfect loss offset tax claims are analogous to call options. The beta of equity is still decreasing in the tax rate, but increasing in the underlying volatility. The results are important if market data are used to infer required expected returns, and in discussions of tax design.
    Keywords: Corporate tax; depreciation; imperfect loss offset; decreasing returns; cost of capital; uncertainty
    JEL: F23 G31 H25
    Date: 2006–06–02
  16. By: Ingela Alger (Boston College)
    Abstract: The paper derives the optimal organizational response of a bank (the principal) which faces a risk of collusion between the credit manager (the agent) and the credit-seeking firms. The bank can deter collusion either through internal incentives or by distorting the credit contracts. The model thus explicitly takes into account the interaction between internal (collusion) risks and external (default) risks in the optimal design of the internal organization as well as of the credit contracts. We investigate this question in two settings. In the first one, we adopt the standard assumption that the agent is always willing to collude (is corruptible) if that increases his monetary payoff. In the second one, he is corruptible with some probability only, and honest otherwise. A novel feature of our approach is to allow for screening among corruptible and honest agents. We find that if the probability that the agent is honest is sufficiently large, collusion occurs in equilibrium.
    Date: 2006–08–26
  17. By: R. Andergassen
    Date: 2005
  18. By: Christian Ewerhart (Institute for Empirical Research in Economics (IEW), Winterthurerstrasse 30, CH-8006 Zurich, Switzerland.); Nuno Cassola (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Natacha Valla (Banque de France, 39, rue Croix-des-Petits-Champs, F-75049 Paris Cedex 01, France.)
    Abstract: It is argued that bidders in liquidity-providing central bank operations should typically possess declining marginal valuations. Based on this hypothesis, we construct an equilibrium in central bank refinancing operations organised as variable rate tenders. In the case of the discriminatory pricing rule, bid shading does not disappear in large populations. The predictions of the model are shown to be consistent with the data for the euro area. JEL Classification: D44, E52.
    Keywords: Open market operations, uniform price auction, discriminatory auction, Eurosystem.
    Date: 2006–08
  19. By: Daniel A. Ackerberg; Gautam Gowrisankaran
    Abstract: We seek to determine the causes and magnitudes of network externalities for the automated clearinghouse (ACH) electronic payments system. We construct an equilibrium model of customer and bank adoption of ACH. We structurally estimate the parameters of the model using an indirect inference procedure and panel data. The parameters are identified from exogenous variation in the adoption decisions of banks based outside the network and other factors. We find that most of the impediment to ACH adoption is from large customer fixed costs of adoption. Policies to provide moderate subsidies to customers and larger subsidies to banks for ACH adoption could increase welfare significantly.
    JEL: L0 L13 L86 L88
    Date: 2006–08
  20. By: Annette Kamps (Kiel Institute for the World Economy, Düsternbrooker Weg 120, 24105 Kiel, Germany.)
    Abstract: This paper investigates the determinants of currency invoicing in international trade. Although the currency of invoicing is central for the transmission of monetary policy, empirical research on this topic is scarce due to a lack of data. With a new extensive invoicing dataset and a panel model analysis this paper shows that a country’s membership or prospective membership of the EU plays a decisive role in the choice of the euro as invoicing currency. The role of the euro as vehicle currency is increasing but still limited when compared to the U.S. dollar. Monetary instability and low product differentiation favour vehicle pricing in U.S. dollar. An increase of euro invoicing due to higher exchange rate volatility supports the role of the euro as vehicle currency, however. High market power defined as the share of a country’s total exports to world exports and membership of the euro area make invoicing in the home currency (euro) more likely. JEL Classification: F41, F42, L11.
    Keywords: International trade, currency invoicing, panel data.
    Date: 2006–08
  21. By: Hellström, Jörgen (Department of Economics, Umeå University); Simonsen, Ola (Department of Economics, Umeå University)
    Abstract: This paper empirically tests whether an open limit order book contains information about future short-run stock price movements. To account for the discrete nature of price changes, the integer-valued autoregressive model of order one is utilized. A model transformation has an advantage over conventional count data approaches since it handles negative integer-valued price changes. The empirical results reveal that measures capturing offered quantities of a share at the best bid- and ask-price reveal more information about future short-run price movements than measures capturing the quantities offered at prices below and above. Imbalance and changes in offered quantities at prices below and above the best bid- and ask-price do, however, have a small and significant effect on future price changes. The results also indicate that the value of order book information is short-term.
    Keywords: Negative integer-valued data; time series; INAR; finance; stock price; open limit order book
    JEL: C25 G12 G14
    Date: 2006–08–24
  22. By: Areendam Chanda; Laura Alfaro; Sebnem Kalemli-Ozcan; Selin Sayek
    Abstract: The empirical literature finds mixed evidence on the existence of positive productivity externalities in the host country generated by foreign multinational companies. We propose a mechanism that emphasizes the role of local financial markets in enabling foreign direct investment (FDI) to promote growth through backward linkages, shedding light on this empirical ambiguity. In a small open economy, final goods production is carried out by foreign and domestic firms, which compete for skilled labor, unskilled labor, and intermediate products. To operate a firm in the intermediate goods sector, entrepreneurs must develop a new variety of intermediate good, a task that requires upfront capital investments. The more developed the local financial markets, the easier it is for credit constrained entrepreneurs to start their own firms. The increase in the number of varieties of intermediate goods leads to positive spillovers to the final goods sector. As a result financial markets allow the backward linkages between foreign and domestic firms to turn into FDI spillovers. Our calibration exercises indicate that a) holding the extent of foreign presence constant, financially well-developed economies experience growth rates that are almost twice those of economies with poor financial markets, b) increases in the share of FDI or the relative productivity of the foreign firm leads to higher additional growth in financially developed economies compared to those observed in financially under-developed ones, and c) other local conditions such as market structure and human capital are also important for the effect of FDI on economic growth.
  23. By: Zheng, Charles
    Abstract: This paper analyzes auctions where budget-constrained bidders have options to declare bankruptcy. It predicts a bidding equilibrium that changes is continuously in a borrowing rate available to bidders. When the borrowing rate is above a threshold, high-budget bidders win, and the likelihood of bankruptcy is low. When the borrowing rate is below the threshold, the winner is the most budget-constrained bidder and is most likely to declare bankruptcy. This result explains the “high bids and broke winners” anomaly in the C-Block FCC spectrum auction. Based on its equilibrium analysis, the paper proves that a seller can profit from offering to finance the highest bidder at a below-market interest rate, even with default risk.
    Keywords: auction; budget; default; spectrum auction; C-block auction; FCC; PCS
    Date: 2006–08–24
  24. By: G. Rossini; P. Zanghieri
    Date: 2006
  25. By: Menzie D. Chinn; Ron Alquist
    Abstract: We examine the relative predictive power of the sticky price monetary model, uncovered interest parity, and a transformation of net exports and net foreign assets. In addition to bringing Gourinchas and Rey’s new approach and more recent data to bear, we implement the Clark and West (forthcoming) procedure for testing the significance of out-of-sample forecasts. The interest rate parity relation holds better at long horizons and the net exports variable does well in predicting exchange rates at short horizons in-sample. In out-of-sample forecasts, we find evidence that our proxy for Gourinchas and Rey’s measure of external imbalances outperforms a random walk at short horizons as do some of other models, although no single model uniformly outperforms the random walk forecast.
    JEL: F31 F47
    Date: 2006–08
  26. By: Laarni Bulan; Christopher J. Mayer; C. Tsuriel Somerville
    Abstract: We examine the extent to which uncertainty delays investment and the effect of competition on this relationship using a sample of 1,214 condominium developments in Vancouver, Canada built from 1979-1998. We find that increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments. Empirically, a one-standard deviation increase in the return volatility reduces the probability of investment by 13 percent, equivalent to a 9 percent decline in real prices. Increases in the number of potential competitors located near a project negate the negative relationship between idiosyncratic risk and development. These results support models in which competition erodes option values and provide clear evidence for the real options framework over alternatives such as simple risk aversion.
    JEL: D4 D52 E23 R3
    Date: 2006–08
  27. By: Terttu Luukkonen; Mari Maunula
    Keywords: venture capital, biotechnology
    JEL: O16 G24 O38 L65
    Date: 2006–08–23
  28. By: Angela Maddaloni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alberto Musso (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Philipp Rother (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Melanie Ward-Warmedinger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Thomas Westermann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the macroeconomic consequences of future demographic trends for economic growth, financial markets and public finances. It shows that in the absence of reforms and responses by economic agents, the currently projected demographic trends imply a decline in average real GDP growth and a severe burden in terms of pay-as-you-go pension and health care systems. Population ageing will change the financial landscape, with a potentially larger role for financial intermediaries and asset prices. All this points to a need to closely monitor demographic change also from a monetary policy perspective. While population projections are surrounded by considerable uncertainty and the effects of demographic change tend to be drawn out, the magnitude of the potential effects calls for an early recognition of this issue. This paper provides some input to the examination of possible policy issues.
    Date: 2006–08
  29. By: Sam Bucovetsky (Department of Economics, York University); Amihai Glazer (Department of Economics, University of California-Irvine)
    Abstract: Many mechanisms (such as auctions) efficiently allocate a good to the firm which most highly values it. But sometimes the owner of the asset or good may wish to transfer it only if it is not too valuable to potential buyers. The allocation problem becomes especially difficult when the potential buyers have private information about the asset’s value. We describe several mechanisms which are efficient, or nearly so. We also show that rent seeking, and lobbying, rather than merely wasting resources, can lead to allocations which are close to efficient.
    Keywords: Rent seeking; Lobbying; Auctions; Asymmetric information
    JEL: D44 D72 D82
    Date: 2006–01
  30. By: B. Luppi
    Date: 2005
  31. By: Pierre-Pascal Gendron (International Tax Program, Rotman School of Management, University of Toronto)
    Abstract: How to tax financial services is in many ways the key ‘frontier’ issue for VAT in developed countries. No convincing conceptually correct and practical solution for capturing the bulk of financial services under the VAT has yet been developed anywhere. Developing and transitional countries face constraints that make the taxation of financial services an even more formidable challenge. Since even developed economies with sophisticated financial institutions and markets and capable tax administrations have opted with few exceptions to exempt such activities, it is not surprising that exemption also rules in almost all developing and transitional countries. Surprisingly, however, it may not be that difficult to collect at least some VAT on financial services even in such countries. This paper examines the current VAT treatment of financial services, as well as its rationales and economic effects. It then outlines alternatives to that treatment, focusing on developing and transitional economies and their tax policy constraints. Finally, the paper outlines best practices for tax reform and then proposes an alternative to the exemption system in the form of a hybrid system to capture VAT revenues in developing and transitional economies.
    Keywords: value added tax, financial services, developing and transitional countries
    JEL: H24 O23
    Date: 2006–08
  32. By: Edsel L. Beja, Jr.
    Abstract: The paper revisits hypothesized direct linkages between external borrowing and capital flight. It reviews the cases of Indonesia, Malaysia, the Philippines and Thailand to see if such linkages exist. The results indicate that, indeed, large sums of capital flowed in and out of these four countries in a revolving door process. Thus, the results lend support to the need for: better domestic management of external debt, sound macroeconomic management and solid macro-organizational foundations (with the government at the centre of policy making), active management of capital flows, and effective domestic and international involvement and coordination in capital flows.
    Keywords: capital flight, external debt, revolving door, Southeast Asia
    JEL: F20 F30 O57
    Date: 2006–08
  33. By: Lund, Diderik (Department of Economics, Copenhagen Business School)
    Abstract: Levy and Arditti (1973) introduced depreciable assets into the Modigliani and Miller (1958) model, and analyzed the implications for the cost of capital. Assuming that the firm reinvests indefinitely to maintain a constant expected cash flow, they found that depreciation increases the cost of capital before and after tax. Most of their assumptions are maintained. However, commitment to perpetual reinvestment is in most cases not a reasonable assumption. Without it, depreciation decreases the cost of capital before and after tax. The effect of depreciation is less in absolute value than in Levy and Arditti, but not insignificant.
    Keywords: Cost of capital; depreciation; corporate taxes
    JEL: G31 H25
    Date: 2006–08–22
  34. By: Nancy Birdsall
    Abstract: Increasing integration has made the great challenge of reducing poverty and advancing human development more achievable than ever, and more dependent than ever on good global economic governance. In this paper I set out the economic logic for why good global economic governance matters for reducing poverty and inequality in the world, and then develop several arguments for how better representation of developing countries in the IMF, the World Bank, and other multilateral institutions would make those institutions more effective in that task. The arguments include the long-run viability of new financing of the institutions, and their effectiveness in managing the political economy challenges of using conditionality. To illustrate the possible link between better representation and effectiveness, I discuss the example of the Inter-American Development Bank, where the developing country borrowers control 50 percent of the votes and the Presidency. I close with a discussion of the dilemma of reconciling the need for sustaining the financial and political support of the rich country members of these global institutions, with stronger poor country representation to ensure their long-run legitimacy and effectiveness.
    Keywords: multilateral organizations, integration, poverty, human development
    JEL: F35 I32 I31 F36 O15 O19 O40 F53 D63
  35. By: Finn Valentin; Henrich Dahlgren; Rasmus Lund Jensen
    Abstract: Although biotech start-ups fail or succeed based on their research few attempts have been made to examine if and how they strategize in this core of their activity. Popular views on Dedicated Biotech Firms (DBFs) see the inherent uncertainty of research as defying notions of strategizing, directing instead the attention to the quality of their science, or the roles of boards, management, and collaborative networks etc. Using a unique comprehensive dataset on Danish and Swedish biotech start-ups in drug discovery this paper analyzes their research strategies. Adopting a Simonean point of departure we develop a contingency view on complex problem solving which structures the argument into three steps: 1) Characterising the problem architectures addressed by different types of DBFs; 2) Testing and confirming that DBFs form requisite research strategies, by which we refer to problem solving approaches developed as congruent responses to problem architectures; 3) Testing and confirming that financial valuation of firms is driven by achievements conforming to requisite research strategies. These strategies, in turn, require careful combination of multiple dimensions of research. Findings demonstrate that Shonhoovens classical argument that “strategy matters” is valid not only for the larger high-tech firms covered by her study, but also for small research-based start-ups operating at the very well springs of knowledge where science directly interacts with technologies. Even though a lot more research is needed along these lines, these findings offer new implications for the understanding, management, and financing of these firms.
    Keywords: Biotechnology; research strategy; discovery fields; valuation; performance measures
    JEL: L25 L65 O32
    Date: 2006
  36. By: R. Cesari; C. D'Adda
    Date: 2005
  37. By: Tommaso Monacelli
    Abstract: We study optimal monetary policy in an economy with nominal private debt, borrowing constraints and price rigidity. Private debt reflects equilibrium trade between an impatient borrower, who faces an endogenous collateral constraint, and a patient saver, who engages in consumption smoothing. Since inflation can positively affect borrower's net worth, monetary policy optimally balances the incentive to offset the price stickiness distortion with the one of marginally relaxing the borrower's collateral constraint. We find that the optimal volatility of inflation is increasing in three key parameters: (i) the borrower's weight in the planner's objective function; (ii) the borrower's impatience rate; (iii) the degree of price flexibility. In general, however, deviations from price stability are small for a small degree of price stickiness. In a two-sector version of our model, in which durable price movements can directly affect the ability of borrowing, the optimal volatility of (non-durable) inflation is more sizeable. In our context, and relative to simple Taylor rules, the Ramsey-optimal allocation entails a partial smoothing of real durable goods prices.
    JEL: E24 E44 E5
    Date: 2006–08
  38. By: Peter Birch Sørensen (Department of Economics, University of Copenhagen)
    Abstract: The paper surveys some main results in the theory of capital income taxation in the open economy; reviews recent trends in international taxation, and discusses alternative blueprints for fundamental capital income tax reform from the perspective of an open economy faced with growing mobility of capital income tax bases.
    Date: 2006–08
  39. By: Martimort, D.; Poudou, J.-C.; Sand-Zantman, W.
    Abstract: This article analyzes the optimal contract design between an inventor and a developer. The inventor is privately informed on the value of his idea. The developer must exert some non-verifiable effort to improve the probability of success of this innovation but may also choose to opt out of the relationship upon learning the quality of the idea. While first-best efficiency requires that all marginal returns on innovation be left to the developer, second-best efficiency taking into account this bilateral asymmetric information leads to distort downwards the developer’s incentives to prevent innovators from overstating the value of their ideas. There exists a trade-off between inviting inventor to reveal their ideas and inducing both effort and participation from the developer. The extent of this trade-off depends on the regime of property rights on ideas, i.e., on how easy to steal ideas. Since decreasing the marginal share of developers makes it more difficult to have them participating to the contract, countervailing incentives might sometimes appear. Taking into account those various effects leads to reduce the responsiveness of the contract to the exact value of the idea and might force to give up additional rents to the developer. Some extensions of our framework, including the cases of limited commitment, partial disclosure and double moral hazard, are studied to show the robustness and limits of our previous findings.
    Keywords: Contracts, Innovation, Ideas Stealing, Bilateral Asymmetric Information
    JEL: D82 D86 L24 O31
    Date: 2006
  40. By: B. Luppi
    Date: 2006
  41. By: A. Fedele; M. Tognoni
    Date: 2006
  42. By: Niklas J. Westelius (Hunter College)
    Abstract: Despite a drastic increase in transparency in recent years, most central banks remain reluctant to reveal their future intended course of policy. This paper analyzes the case where the central bank’s output gap target is private information. It is assumed that the target is subject to temporary and persistent shocks motivated either by measurement errors of potential output or as a result of political pressure. Under imperfect transparency the public cannot observe the true degree of persistence of the shock to the target and must learn by observing past data. In this setting, the paper shows that the welfare implications of imperfect transparency critically depend on whether monetary policy is characterized by discretion or commitment. Indeed, under discretion imperfect transparency decreases inflation and output gap variability and thus increases welfare. Under commitment, the effect on inflation and output variability is ambiguous and depends on the degree of persistence of the shifts in the output target. Welfare, however, is shown to unambiguously decline under imperfect transparency and commitment.
    Keywords: Transparency, Monetary Policy, Discretion, Commitment
    JEL: E5 E52 E61
    Date: 2006
  43. By: Junmin Wan (Osaka University)
    Abstract: We examine the validity of a new system of taxation called lottery receipts in China theoretically and empirically. Tax collection is difficult as the government difficultly monitors the actual economic dealings. To bring out the private information on transaction known only to a seller and a buyer, the government has set up a lottery receipt system which has been tried out in many areas. If the net revenue from a lottery receipt is invested in pure public goods, the lottery receipt will been purchased even if the consumer has expected quasi-linear utility. By issuing a lottery receipt, the government may prevent tax evasion caused by conspiracies between consumers and firms and collect tax effectively. Estimation is performed based on panel data for different periods from a total of 37 districts in Beijing and Tianjin during 1998-2003. The lottery receipt experiment has significantly raised the business tax, the growths of business tax and total tax revenues.
    Keywords: tax evasion, business tax, lottery receipt experiment, random trend (growth) model
    JEL: H26 D81 D82
    Date: 2006–09
  44. By: Cremer, Jaques; Spiegel, Yossi; Zheng, Charles
    Abstract: We study the design of profit maximizing single unit auctions under the assumption that the seller needs to incur costs to contact prospective bidders and inform them about the auction. With independent bidders’ types and possibly interdependent valuations, the seller’s problem can be reduced to a search problem in which the surplus is measured in terms of virtual utilities minus search costs. Compared to the socially efficient mechanism, the optimal mechanism features fewer participants, longer search conditional on the same set of participants, and inefficient sequence of entry.
    Date: 2006–08–24
  45. By: Cremer, Jacques; Spiegel, Yossi; Zheng, Charles
    Abstract: We study optimal auctions when contacting prospective bidders is costly and the bidders’ values are correlated. Although full surplus extraction is in general impossible, we can construct a search mechanism that fully extracts the surplus with an arbitrarily high probability.
    Keywords: optimal auction, correlated values, search costs, search mechanism,
    Date: 2006–08–24
  46. By: D. Dragone; L. Lambertini; A. Mantovani
    Date: 2006

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