nep-fmk New Economics Papers
on Financial Markets
Issue of 2006‒09‒30
85 papers chosen by
Carolina Valiente
London South Bank University

  1. The substitution of bank for non-bank corporate finance: evidence for the United Kingdom By Ursel Baumann; Glenn Hoggarth; Darren Pain
  2. Resolving banking crises - an analysis of policy options By Misa Tanaka; Glenn Hoggarth
  3. Risks of investing in the Russian stock market: Lessons of the first decade By Alexei Goriaev; Alexei Zabotkin
  4. Bank capital, asset prices and monetary policy By David Aikman; Matthias Paustian
  5. A model of bank capital, lending and the macroeconomy: Basel I versus Basel II By Lea Zicchino
  6. Determinants of long-term interest rates in the Scandinavian countries By Suzan Hol
  7. Mark-to-Market Accounting and Liquidity Pricing By Franklin Allen; Elena Carletti
  8. Bank loans versus bond finance: implications for sovereign debtors By Misa Tanaka
  9. Financial Structure and its Impact on the Convergence of Interest Rate Pass-through in Europe. A Time-varying Interest Rate Pass-through Model By Schwarzbauer, Wolfgang
  10. Modelling the cross-border use of collateral in payment systems By Mark J Manning; Matthew Willison
  11. Information Acquisition and Portfolio Performance By Luigi Guiso; Tullio Jappelli
  12. Procyclicality, collateral values and financial stability By Prasanna Gai; Peter Kondor; Nicholas Vause
  13. Investing in Real Estate: Mortgage Financing Practices and Optimal Holding Period By Winston T.H. Koh; Edward H.K. Ng
  14. Influence of News in Moscow and New York on Returns and Risks on Baltic State Stock Indices By Brännäs, Kurt; Soultanaeva, Albina
  15. Credit Cards: Facts and Theories By Carol C. Bertaut; Michael Haliassos
  16. Financial behaviour of Dutch pension funds: a disaggregated approach By Jan Kakes
  17. Direction-of-Change Forecasts for Asian Equity Markets Based on Conditional Variance, Skewness and Kurtosis Dynamics: Evidence from Hong Kong and Singapore By Peter F. Christoffersen; Francis X. Diebold; Roberto S. Mariano; Anthony S. Tay; Yiu Kuen Tse
  18. Overconfidence and Market Efficiency with Heterogeneous Agents By Diego Garcia; Francesco Sangiorgi; Branko Urosevic
  19. Stress tests of UK banks using a VAR approach By Glenn Hoggarth; Steffen Sorensen; Lea Zicchino
  20. Do corporate financial patterns in European countries converge and testitfy for disintermediation? By Rivaud-Danset, Dorothée; Oheix, Valérie
  21. Sustainable External Debt Levels: Estimates for Selected Asian Countries By Roberto S. Mariano; Delano Villanueva
  22. Multivariate GARCH models and Black-Litterman approach for tracking error constrained portfolios: an empirical analysis By Giulio PALOMBA
  24. Why are federal central banks more activist? By Hein Roelfsema
  25. Is Locking Domestic Funds into the Local Market Beneficial? Evidence from the Polish Pension Reforms By Anna Zalewska
  26. Ambiguity and Asset Prices: An Experimental Perspective By Peter Bossaerts; Serena Guarnaschelli; Paolo Ghirardato; William Zame
  27. Searching for a Metric for Financial Stability By O. Aspachs; C. Goodhart; M. Segoviano; D. Tsomocos; L. Zicchino
  28. Accounting for the Rise in Consumer Bankruptcies By Igor Livshits; James MacGee; Michele Tertilt
  29. Asset pricing, asymmetric information and rating announcements: does benchmarking on ratings matter? By Spyros Pagratis
  30. Are Canadian Banks Efficient? A Canada–U.S. Comparison By Jason Allen; Walter Engert; Ying Liu
  31. Access to credit by the poor in South Africa: Evidence from Household Survey Data 1995 and 2000 By Francis Nathan Okurut
  32. Impact Of It In The Danish Banking Industry, With Specific Illustrations From The Nordea Group And Lån & Spar Bank By Bjørn-Andersen, Niels
  33. How do mergers and acquisitions affect bondholders in Europe? : evidence on the impact and spillover of governance and legal standards By Renneboog,Luc; Szilagyi,Peter G.
  34. Industry Diversification, Financial Development and Productivity-Enhancing Investments By Schclarek, Alfredo
  35. When is mortgage indebtedness a financial burden to British households? A dynamic probit approach By Orla May; Merxe Tudela
  36. What Drives Heterogeneity in Foreign Exchange Rate Expectations : Deep Insights from a New Survey By Christian Dreger; Georg Stadtmann
  37. Monetary Cooperation in the North American Economy By David Laidler
  38. Bubbles and Self-enforcing Debt By Christian Hellwig; Guido Lorenzoni
  39. China’s Changing Economic Structures and Its Implications for Regional Patterns of Trade Production and Integration By Tan Kim Song; Khor Hoe Ee
  40. Joint Liability Lending in Microcredit Markets with Adverse Selection: a Survey By Alessandro Fedele
  41. Hedging Basket Options by Using a Subset of Underlying Assets By Xia Su
  42. The influence of the business cycle on bankruptcy probability By Suzan Hol
  43. Measuring investors' risk appetite By Prasanna Gai; Nicholas Vause
  44. Accounting for the source of exchange rate movements: new evidence By Katie Farrant; Gert Peersman
  45. Foreign exchange market interventions as monetary policy By Post, Erik
  46. Asset Prices in a Time Series Model with Perpetually Disparately Informed, Competitive Traders By Kenneth Kasa; Todd B. Walker; Charles H. Whiteman
  47. Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability By Severin Borenstein
  48. Assessing central counterparty margin coverage on futures contracts using GARCH models By Raymond Knott; Marco Polenghi
  49. Real Exchange Rate Dynamics With Endogenous Distribution Costs By Mulraine, Millan L. B.
  50. Should Insider Trading be Prohibited when Share Repurchases are Allowed? By Andrea Buffa; Giovanna Nicodano
  51. Pricing-to-market, sectoral shocks and gains from monetary cooperation By Bastiaan Verhoef
  52. Arbitrage and equilibrium in unbounded exchange economies with satiation By Cuong Le Van; Nizar Allouch; Frank H. Page
  53. Corporate expenditures and pension contributions: evidence from UK company accounts By Philip Bunn; Kamakshya Trivedi
  54. How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages By Laura Alfaro; Areendam Chanda; Sebnem Kalemli-Ozcan; Selin Sayek
  55. The welfare benefits of stable and efficient payment systems By Stephen Millard; Matthew Willison
  56. Reflexiones sobre la política cambiaria en México By Guerrero, Carlos; Urzúa, Carlos M.
  57. Consumption excess sensitivity, liquidity constraints and the collateral role of housing By Andrew Benito; Haroon Mumtaz
  58. Defined benefit company pensions and corporate valuations: simulation and empirical evidence from the United Kingdom By Kamakshya Trivedi; Garry Young
  59. Comments on “A Selective Overview of Nonparametric Methods in Financial Econometrics” by Jianqing Fan By Peter C. B. Phillips; Jun Yu
  60. Risk-neutrality in modern finance: an epistemological approach. By Xavier de Scheemaekere
  61. Affine term structure models for the foreign exchange risk premium By Luca Benati
  62. How Equilibrium Prices Reveal Information in Time Series Models with Disparately Informed, Competitive Traders By Todd B. Walker
  63. Disentangling the Importance of the Precautionary Saving Motive By Arthur Kennickell; Annamaria Lusardi
  64. High order compact finite difference schemes for a nonlinear Black-Scholes equation By Bertram Düring; Michel Fournié; Ansgar Jüngel
  65. Intraday Margining of Central Counterparties: EU Practice and a Theoretical Evaluation of Benefits and Costs By Froukelien Wendt
  66. Understanding the Offender/Environment Dynamic for Computer Crimes By Willison, Robert
  67. Stratégie monétaire des économies émergentes : les écueils de la dollarisation By Jean-François Ponsot
  68. Constrained General Regression in Pseudo-Sobolev Spaces with Application to Option Pricing By Zdenek Hlavka; Michal Pesta
  69. The importance of volatility in inflow in a deregulated hydro-dominated power market By Torstein Bye, Annegrete Bruvoll and Finn Roar Aune
  70. Honesty and Intermediation: Corporate Cheating, Auditor Involvement and the Implications for Development By Brishti Guha
  71. Skill Acquisition, Credit Constraints, and Trade By Tatyana Chesnokova; Kala Krishna
  72. How does the down-payment constraint affect the UK housing market? By Andrew Benito
  73. Pension fund efficiency: the impact of scale, governance and plan design By Jacob A. Bikker; Jan de Dreu
  74. The financing structure of non-listed firms By Suzan Hol and Nico van der Wijst
  75. Linear Approximations and Tests of Conditional Pricing Models By Michael W. Brandt; David A. Chapman
  76. Willingness to Pay for Car Safety: Evidence from Sweden By Andersson, Henrik
  77. Global Risk, Investment, and Emotions By Ronald Bosman; Frans van Winden
  78. Investigating the Relationship between Stakeholder Opinion about Wildfire Management and Landscape Context Using GIS By Pamela Kaval; John Loomis; Dave Theobald
  79. Managing Risk and Synergies R&D-Collaborations By Mahnke, Volker; Overby, Mikkel Lucas
  80. Technology Replaces Culture in Microcredit Markets: the Case of Italian MAGs By Alessandro Fedele; Federica Calidoni Lundberg
  81. The Euro Changeover and its Effects on Price Transparency and Inflation. By Giovanni Mastrobuoni; Wioletta Dziuda
  82. Financing and Access in Cooperatives By REY, Patrick; TIROLE, Jean
  83. What do current account reversals in OECD countries tell us about the US case? By Leo de Haan; Hubert Schokker; Anastassia Tcherneva
  84. Switching costs in the market for personal current accounts: some evidence for the United Kingdom By C'line Gondat-Larralde; Erlend Nier
  85. Estimating a collective household model with survey data on financial satisfaction By Rob Alessie; Thomas Crossley; Vincent Hildebrand

  1. By: Ursel Baumann; Glenn Hoggarth; Darren Pain
    Abstract: This paper investigates the extent to which changes in the quantity and cost of non-bank finance impact on the quantity and interest cost of UK-owned banks' corporate lending. The results give some support to the view that there is substitution between market finance and bank loans - loan growth rises (falls) during periods when corporate bond spreads widen (decline). In particular, bank loans seem to substitute for other forms of finance in some periods of market stress such as in 1998 Q3. Moreover, this increase in credit seems to be supplied on unchanged terms, perhaps suggesting that banks passively accommodate changes in corporate loan demand. During other episodes of disturbances in non-bank finance, such as when bond or commercial paper issuance falls sharply, banks appear to increase their loan rates, perhaps reflecting greater perceived borrower risk or some reduction in banks' own risk appetite.
  2. By: Misa Tanaka; Glenn Hoggarth
    Abstract: This paper develops a dynamic model to examine the ex-ante and ex-post implications of five policy options for resolving bank failures when the authorities cannot observe the level of non-performing loans (NPLs) held by individual banks. Under asymmetric information, we show that the first-best outcome is achievable when the authorities can close all banks that fail to raise a minimum level of new capital. But when the authorities cannot close banks and must rely on financial incentives to induce banks to liquidate their NPLs, recapitalisation using equity (Tier 1 capital) would be the second-best policy, whereas recapitalisation using subordinated debt (Tier 2 capital) is suboptimal. If the authorities do not wish to hold an equity stake in a bank, they should subsidise the liquidation of non-performing loans rather than inject subordinated debt. We also show that the cost of this subsidy can be reduced if it is offered in a menu that includes equity injection.
  3. By: Alexei Goriaev (CEFIR/New Economic School); Alexei Zabotkin
    Abstract: The modern history of the Russian stock market has mirrored ups and downs of the country’s transition as well as swings in investor perceptions. In this paper, we describe the evolution of the Russian stock market over its first decade, with particular attention to the risk factors driving stock returns. First, we analyze the development of the institutional infrastructure and dynamics of the market’s size and liquidity measured by the number of listed and traded stocks, depositary receipts and IPOs as well as trading volume in the local stock exchanges and abroad. Then, we examine major political and economic events, which influenced the investor perceptions of the country risk and were reflected in stock prices. Finally, we carry out quantitative analysis of risk factors explaining considerable time and cross-sectional variation in Russian stock returns. We document a significant role of corporate governance, political risk, and macroeconomic risk factors, such as global equity markets performance, oil prices, and exchange rates, whose relative importance varied a lot over time.
    Keywords: financial institutions, risk factors, Russian stock market
    Date: 2006–08
  4. By: David Aikman; Matthias Paustian
    Abstract: We study a general equilibrium model in which informational frictions impede entrepreneurs' ability to borrow and banks' ability to intermediate funds. These financial market frictions are embedded in an otherwise-standard dynamic New Keynesian model. We find that exogenous shocks have an amplified and more persistent effect on output and investment, relative to the case of perfect capital markets. The chief contribution of the paper is to analyse how these financial sector imperfections - in particular, those relating to the banking sector - modify our understanding of optimal monetary policy. Our main finding is that optimal monetary policy tolerates only a very small amount of inflation volatility. Given that similar results have been reported for models that abstract from banks, we conclude that assigning a non-trivial role for banks need not materially affect the properties of optimal monetary policy.
  5. By: Lea Zicchino
    Abstract: The revised framework for capital regulation of internationally active banks (known as Basel II) introduces risk-based capital requirements. This paper analyses the relationship between bank capital, lending and macroeconomic activity under the new capital adequacy regime. It extends a model of the bank-capital channel of monetary policy - developed by Chami and Cosimano - by introducing capital constraints . la Basel II. The results suggest that bank capital is likely to be less variable under the new capital adequacy regime than under the current one, which is characterised by invariant asset risk-weights. However, bank lending is likely to be more responsive to macroeconomic shocks.
  6. By: Suzan Hol (Statistics Norway)
    Abstract: The financial markets in a small open economy like the Scandinavian countries are influenced by international economic developments, especially in their major trading partners. This paper investigates to which degree nominal long-term interest rates in Norway, Sweden and Denmark are determined by fundamental domestic macroeconomic variables and by international economic conditions. Relating the level of interest rates to international macroeconomic variables also sheds some light on the degree of financial marketintegration. In Norway the currency risk, exchange rate regime, international debt and unemployment in Europe are significant in explaining the interest rate differential. In Sweden domestic and US inflation are important, while for Denmark domestic debt, domestic and US money stock, and less significantly US inflation are determinants of the interest rate differential. In these three countries with quite different economies the expectations hypothesis, the effect of domestic growth and unemployment and of international growth are not supported as determinants of long-term interest rate differentials.
    Keywords: long-term interst rates; expectation hypothesis; international macroeconomic influence; crowding out
    JEL: E43 E44
    Date: 2006–08
  7. By: Franklin Allen (Wharton School, University of Pennsylvania); Elena Carletti (Center for Financial Studies)
    Abstract: When liquidity plays an important role as in times of financial crisis, asset prices in some markets may reflect the amount of liquidity available in the market rather than the future earning power of the asset. Mark-to-market accounting is not a desirable way to assess the solvency of a financial institution in such circumstances. We show that a shock in the insurance sector can cause the current value of banks’ assets to be less than the current value of their liabilities so the banks are insolvent. In contrast, if historic cost accounting is used, banks are allowed to continue and can meet all their future liabilities. Mark-to-market accounting can thus lead to contagion where none would occur with historic cost accounting.
    Keywords: Mark-to-market, Historical Cost, Incomplete Markets
    JEL: G21 G22 M41
    Date: 2006–08–07
  8. By: Misa Tanaka
    Abstract: This paper develops a model to analyse the optimal choice between bank loans and bond finance for a sovereign debtor. We show that if banks have better information about their borrowers compared to bondholders, only the least risky sovereigns issue bonds. But if borrowers can be 'publicly monitored' by an outside agency that disseminates the information about their creditworthiness, their choice between bank loans and bond finance is determined endogenously by the trade-off between two deadweight costs: the crisis cost of a sovereign default and the cost of debtor moral hazard. In equilibrium, sovereigns use bank loans for financing short-term projects and bond issuance for projects with uncertain timing of cash flows if crisis costs are large. We also demonstrate that state-contingent debt and IMF intervention can improve welfare.
  9. By: Schwarzbauer, Wolfgang (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: So far studies concerned with the interest pass-through of monetary policy have not taken into account one central issue that arose in Europe in the late 1990s: the importance of financial structure for the convergence of monetary transmission. This study addresses this shortcoming. We estimate a time varying interest pass-through allowing us to test for the importance of financial structure and its impact on the convergence of the effects of monetary policy. We find convergence in banks' reaction to money market movements, which is additionally reduced in groups of countries with similar financial structure. Furthermore, there is a significant impact of financial structure on the extent of transmission of monetary policy impulses within the same month. Thus, differences in financial structure between countries must not be ignored when considering convergence of monetary transmission in Europe.
    Keywords: Convergence, Interest rate pass-through, EMU, Financial structure, Money and bank interest rates, Transmission mechanism
    JEL: E43 G21 E52
    Date: 2006–09
  10. By: Mark J Manning; Matthew Willison
    Abstract: Banks often rely on collateralised intraday liquidity from the central bank in order to be able to effect payments in a real-time gross settlement (RTGS) payment system. If a bank is holding insufficient eligible collateral in a particular country, and therefore cannot obtain credit from the local central bank, it may have to delay payments. This constitutes a liquidity risk to the system. Furthermore, a bank operating in multiple systems may face a mismatch between the location of its collateral holdings and liquidity needs. In this paper, we examine the extent to which the liquidity risk arising from such a mismatch may be mitigated by allowing cross-border use of collateral. We develop a two-country, two-bank model in which risk-neutral banks minimise expected costs with respect to their collateral choice in each country. In our baseline model, in which each bank faces a liquidity need in only one country, we find that liquidity risk is indeed reduced by cross-border use of collateral. This result holds despite the fact that banks may find it optimal to economise on their total holdings of collateral. However, when we extend the model to allow for the possibility that a bank faces liquidity needs in both countries simultaneously, the total quantum of collateral held is important. Indeed, when a bank finds it optimal to reduce its total holdings, there may be an increase in liquidity risk in at least one country when simultaneous liquidity demands are realised.
  11. By: Luigi Guiso (University of Rome Tor Vergata, Ente Luigi Einaudi and CEPR); Tullio Jappelli (Università di Salerno, CSEF and CEPR)
    Abstract: Rational investors perceive correctly the value of financial information. Investment in information is therefore rewarded with a higher Sharpe ratio. Overconfident investors overstate the quality of their own information, and thus attain a lower Sharpe ratio. We contrast the implications of the two models using a unique survey of customers of an Italian leading bank with portfolio data and measures of financial information. We find that the portfolio Sharpe ratio is negatively associated with investment in information. The negative correlation is stronger for men than women and for those who claim they know stocks well, arguably because these investors are more likely to be overconfident. We also show that investment in information is associated with more frequent trading, less delegation of portfolio decisions and less diversified portfolios. In each case, the effect of information is stronger for investors who, a priori, are suspected to be more overconfident.
    Keywords: Portfolio Choice, Rationality, Overconfidence, Behavioral Finance
    JEL: E2 D8 G1
    Date: 2006–10–01
  12. By: Prasanna Gai; Peter Kondor; Nicholas Vause
    Abstract: This paper analyses how the risk-sharing capacity of the financial system varies over the business cycle, leading to procyclical fragility. We show how financial imperfections contribute to underinsurance by entrepreneurs, generating an externality that leads to the build-up of systematic risk during upturns. Increased asset price uncertainty emerges as a symptom of the sectoral concentration that builds up during booms. The liquidity of the collateral asset is shown to play a key role in amplifying the financial cycle. The welfare costs of financial stability, in terms of the efficiency costs due to financial frictions and the volatility costs due to amplification, are also illustrated.
  13. By: Winston T.H. Koh (School of Economics and Social Sciences, Singapore Management University); Edward H.K. Ng (National University of Singapore)
    Abstract: Real estate investments are typically characterized by high degrees of leverage and long loan tenures. In perfect capital markets, leverage has no impact on the investment decision apart from tax considerations. However, the mortgage financing market is imperfect in many countries. In the presence of market imperfections, an optimal holding period exists for real property investments. We provide a simple rule to calculate the optimal holding period is to compare the required rate of return with the leveraged rate of return on equity.
    Keywords: mortgage financing, real estate, financial leverage, optimal holding period
    JEL: G11
    Date: 2005–02
  14. By: Brännäs, Kurt (Department of Economics, Umeå University); Soultanaeva, Albina (Department of Economics, Umeå University)
    Abstract: The impact of news of the Moscow and New York stock market exchanges on the <p> returns and volatilities of the Baltic state stock market indices is studied using daily <p> return data for the period of 2000-2005. A nonlinear time series model that accounts <p> for asymmetries in the conditional mean and variance functions is used for the em- <p> pirical work. News from New York have stronger effect on returns in Tallinn, than <p> news from Moscow. High risk shocks in New York have a strong impact on volatility <p> in Tallinn, whereas volatility of Vilnius is more influenced by high risk shocks from <p> Moscow. Riga seems to be autonomous to news arriving from abroad.
    Keywords: Estonia; Latvia; Lithuania; Time series; Estimation; Finance
    JEL: C22 C52 G10 G15
    Date: 2006–09–18
  15. By: Carol C. Bertaut (Board of Governors of the Federal Reserve System); Michael Haliassos (University of Frankfurt and CFS)
    Abstract: We use data from several waves of the Survey of Consumer Finances to document credit and debit card ownership and use across US demographic groups. We then present recent theoretical and empirical contributions to the study of credit and debit card behavior. Utilization rates of credit lines and portfolios of card holders present several puzzles. Credit line increases initiated by banks lead households to restore previous utilization rates. High-interest credit card debt co-exists with substantial holdings of low-interest liquid assets and with accumulation of retirement assets. Although available evidence disputes ignorance of credit card terms by card holders, credit card rates do not respond to competition. There is a rising trend in bankruptcy and delinquency, partly attributable to an increased tendency of households to declare bankruptcy associated with reduced social stigma, ease of procedures, and financial incentives. Co-existence of credit card debt with retirement assets can be explained through self-control hyperbolic discounting. Strategic default motives contribute partly to observed co-existence of credit card debt with low-interest liquid assets. A framework of “accountant-shopper” households, in which a rational accountant tries to control an impulsive shopper, seems consistent with both types of co-existence and with observed utilization of credit lines.
    Keywords: Credit Cards, Debit Cards, Revolving Debt, Consumer Credit, Portfolios
    JEL: G11 E21
    Date: 2006–09–19
  16. By: Jan Kakes
    Abstract: This paper examines the financial behaviour of 77 Dutch pension funds during 2002-2005. Using microdata, we investigate differences across various types of funds. Both the asset mix and the degree of home bias are related to the size of pension funds: large institutions invest more in equity and hold more foreign assets than smaller ones. Especially for industry-wide funds, bonds and equity transactions are consistent with rebalancing a strategically fixed asset mix. Finally, in the case of company-linked funds, a deterioration in the funding ratio is counteracted by a rapid increase in pension contributions. This response cannot be observed for industry-wide funds.
    Keywords: pension funds; ageing
    JEL: G23 J26
    Date: 2006–08
  17. By: Peter F. Christoffersen (McGill University and CIRANO); Francis X. Diebold (University of Pennsylvania and NBER); Roberto S. Mariano (School of Economics and Social Sciences, Singapore Management University); Anthony S. Tay (School of Economics and Social Sciences, Singapore Management University); Yiu Kuen Tse (School of Economics and Social Sciences, Singapore Management University)
    Abstract: Recent theoretical work has revealed a direct connection between asset return volatility forecastability and asset return sign forecastability. This suggests that the pervasive volatility forecastability in equity returns could, via induced sign forecastability, be used to produce direction-ofchange forecasts useful for market timing. We attempt to do so in the context of two key Asian equity markets, with some success, as assessed by formal probability forecast scoring rules such as the Brier score. An important ingredient is our conditioning not only on conditional variance information, but also conditional skewness and kurtosis information, when forming direction-of-change forecasts.
    Keywords: Volatility, variance, skewness, kurtosis, market timing, asset management, asset allocation, portfolio management.
    JEL: G10 G12
    Date: 2004–07
  18. By: Diego Garcia; Francesco Sangiorgi; Branko Urosevic
    Abstract: We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrele- vance result: when a positive fraction of rational agents (endogenously) decides to become informed in equilibrium, prices are set as if all investors were rational, and as a conse- quence the overconfidence bias does not affect informational efficiency, price volatility, ra- tional traders expected profits or their welfare. Intuitively, as overconfidence goes up, so does price informativeness, which makes rational agents cut their information acquisition activities, effectively undoing the standard effect of more aggressive trading by the overcon- fident. The main intuition of the paper, if not the irrelevance result, is shown to be robust to different model specifications.
    Keywords: partially revealing equilibria, overconfidence, rational expectations, information acquisition, price informativeness.
    JEL: D80 G10
    Date: 2005
  19. By: Glenn Hoggarth; Steffen Sorensen; Lea Zicchino
    Abstract: This paper adopts a new approach to stress testing the UK banking system. We attempt to account for the dynamics between banks' write-offs and key macroeconomic variables, through conditioning our stress test on the historical correlation between the variables and allowing for feedback effects from credit risk to the macroeconomy. In contrast to most existing empirical stress testing work, this paper uses a direct measure of banks' fragility - the write-off to loan ratio. We find that both UK banks' total and corporate write-offs are significantly related to deviations of output from potential. Following an adverse output shock, total and corporate write-off ratios increase. Mortgage arrears, on the other hand, appear to be mainly dependent on household income gearing. The results suggest that, even if the most extreme economic stress conditions witnessed over the past two decades were repeated, the UK banking sector should remain robust.
  20. By: Rivaud-Danset, Dorothée; Oheix, Valérie
    Abstract: This paper provides a quantitative comparison of the financial patterns of non-financial European firms for seven Continental European countries and the period 1991-2001. Our analytical framework departs from the common one as we consider that long-term and short-term sources of funds have to be analysed separately. Using the BACH database, principal component analysis, cluster analysis and econometrical tests are carried out in order to test for two hypotheses : i) there is a tendency toward grouping around a common corporate financial pattern; ii) there is a general tendency across countries toward less bank financing. We find that differences between European countries remain highly significant so that the first hypothesis is not validated. The second hypothesis is rejected with the long-term intermediation ratio but validated with the short-term one. Indeed, econometrical tests lead to a strong conclusion : the existence of a common trend toward disintermediation of short-term financing. The banking function of allocating liquidity for day-to-day business and providing a certain liquidity insurance to firms is declining whatever the size of firms.
    Keywords: corporate financial structure; BACH database; European convergence; financial intermediation; liquidity insurance.
    JEL: G32
    Date: 2005
  21. By: Roberto S. Mariano (School of Economics and Social Sciences, Singapore Management University); Delano Villanueva (School of Economics and Social Sciences, Singapore Management University)
    Abstract: High ratios of external debt to GDP in selected Asian countries have contributed to the initiation, propagation, and severity of the financial and economic crises in recent years, reflecting runaway fiscal deficits and excessive foreign borrowing by the private sector. Applying the formal framework proposed by Villanueva (2003) to a selected group of Asian countries, the research estimates the external debt thresholds beyond which further debt accumulation will have negative effects on growth and will become unsustainable. The framework is an extension of the standard neoclassical growth model that incorporates global capital markets. ‘Sustainability’ is measured in terms of the steady-state ratio of the stock of external debt to GDP, as functions of real world interest rates, risk spreads and their responsiveness to external debt burdens and market perceptions of country risk, marginal propensities to save out of national disposable income and foreign borrowing, rates of technical change, and parameters of the production function. The major policy implications are that in the long run, fiscal consolidation and the promotion of private saving are critical, and that reliance on foreign saving in a globalized financial world has limits, particularly when the risk spreads are positively correlated with rising external debt levels.
    Date: 2005–03
  22. By: Giulio PALOMBA ([n.a.])
    Abstract: In a typical tactical asset allocation set up managers generally make their investment decisions by inserting private information in an optimisation mechanism used to beat a benchmark portfolio; in this context the sole approach a' la Markowitz (1959) does not use all the available information about expected excess return and especially it does not take two main factors into account: first, asset returns often show changes in volatility, and second, the manager's private information plays no role in the optimisation process. This paper provides an empirical work for large scale tactical asset allocation strategy in which a multivariate GARCH estimation is used in portfolio optimisation, given a tracking error constraint (Jorion, 2003). Moreover, the use of Black and Litterman (1991, 1992) approach allows for the possibility to tactically manage the selected portfolio through a very short time, combining informations taken from the time varying volatility model with some personal "view" about asset returns.
    Keywords: Black and Litterman approach, multivariate GARCH models, tactical asset allocation
    JEL: C32 C53 G11
    Date: 2006–09
  23. By: Fulgencio López Martínez (Caja de Ahorros del Mediterráneo); José Yagüe (Universidad de Murcia); Pedro Martínez Solano (Universidad de Murcia)
    Abstract: This paper examines the reaction of the Spanish continuous market to the announcement of securitisation operations by listed banks in the period 1993-2003. Results indicate the existence of positive and significant abnormal returns on the day immediately following the announcement date. The average cumulative abnormal returns over windows of varying lengths around the announcement date are also positive and significant. The market’s reaction is stronger when the bank has a higher proportion of equity in its capital structure and is less profitable. Este trabajo examina la reacción del mercado continuo español ante el anuncio de emisiones de titulización realizadas por bancos cotizados en el período 1993-2003. Los resultados obtenidos indican la existencia de rentabilidades anormales positivas y significativas en el día inmediatamente posterior al de la Comunicación Previa a la CNMV. También resultan ser positivos y significativos los promedios de las rentabilidades anormales acumuladas en varios intervalos de días en torno a la fecha de anuncio. La reacción del mercado es mayor ante anuncios realizados por bancos con un mayor peso de los recursos propios en su pasivo y menos rentables.
    Keywords: Titulización, banca, rentabilidad, eficiencia, estudio de eventos Securitisation, banking, profitability, efficiency, event study
    JEL: G14 G21
    Date: 2006–09
  24. By: Hein Roelfsema
    Abstract: This paper analyzes monetary policy making by a committee of regional representatives in a currency union with asymmetric shocks. By considering strategic delegation of monetary policy making, we show that regional representatives in a federal policy making committee may be more activist than the average citizen in their district. Hence, in our model federal central banks such as the ECB and the FED respond more aggressively to output shocks when compared to individual central banks.
    Keywords: Central Banking, Asymmetric Shocks, Federations, Strategic Delegation
    JEL: F33 F53 E58
    Date: 2006–09
  25. By: Anna Zalewska
    Abstract: This paper is concerned with the effect of enforced home bias on the development of emerging stock markets. It provides a detailed study of the impact on the Warsaw Stock Exchange of the Polish pension fund reforms and the associated restrictions on international investment. The time path of market development for the Warsaw Stock Exchange is compared with a benchmark sample consisting of the other seven post-communist countries that joined the EU in May 2004. It is shown that benefits arising from the pension funds’ increased investment in the home market are short-lived. In the long run, the relative performance of the Polish market returned to pre-1999 levels or worse, suggesting that enforced home bias on emerging markets may be detrimental, rather than beneficial, to the long-run development of the market.
    Keywords: pension reforms, home bias, stock market development, transition countries
    JEL: G23 G28 G11
    Date: 2006–07
  26. By: Peter Bossaerts; Serena Guarnaschelli; Paolo Ghirardato; William Zame
    Abstract: Most of the economics and finance literature assumes that individual agents obey the Savage axioms; that is, they maximize expected utility according to subjective priors. However, Knight, Ellsberg and others argue that individual agents distinguish between risk (known probabilities) and uncertainty, or ambiguity (unknown probabilities), and that individual agents may display aversion to ambiguity, just as they display aversion to risk. This paper studies the impact of ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets. It argues that attitude toward ambiguity is heterogeneous in the population, just as attitude toward risk is heterogeneous in the population, but that heterogeneity in attitude toward ambiguity has di erent implications than heterogeneity in attitude toward risk: agents who are su ciently ambiguity averse find open sets of prices for which they refuse to hold an ambiguous portfolio. This leads to a wider range of state price densities and to potential reversals of ranking of state price densities. Experiments confirm the theoretical predictions. The experiments also suggest a positive correlation between risk aversion and ambiguity aversion, which in turn suggests an explanation of the "value effect."
    Keywords: ambiguity, risk aversion, asset prices, portfolio holdings, experimental economics.
    JEL: C9 D81 G11 G12
    Date: 2006
  27. By: O. Aspachs; C. Goodhart; M. Segoviano; D. Tsomocos; L. Zicchino
    Abstract: We propose a metric of financial stability that is a weighted average of the probability of default and the equity of each country. The weights are obtained in the VAR and must reflect that the welfare changes due to financial instability are produced primarily through changes of the probability of default and secondarily through changes of the equity value. The metric is based on the definition of financial instability suggested by Tsomocos (2003 a and b) and Goodhart, Sunirand and Tsomocos (2006).
    Date: 2006
  28. By: Igor Livshits (University of Western Ontario); James MacGee (University of Western Ontario); Michele Tertilt (Stanford University)
    Abstract: Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households' earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, stories related to a change in the credit market environment are more plausible. In particular, we find that a combination of a decrease in the transactions cost of lending and a decline in the cost of bankruptcy does a good job in accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.
    Keywords: consumer bankruptcy; uncertainty; credit markets; stigma
    JEL: E21 E44 G18 K35
    Date: 2006
  29. By: Spyros Pagratis
    Abstract: Using an intertemporal model of asset pricing under asymmetric information, we demonstrate how public ratings about the quality of a risky asset could enhance information efficiency, albeit at a cost of higher asset price volatility. The analysis also draws implications for the use of ratings for benchmarking purposes, in particular, ratings-based capital requirements and an investment/subinvestment grade dichotomy depending on the rating of the asset. In this situation, allowing a class of market participants (eg pension funds) to hold an asset only if its rating exceeds a certain threshold may lead informed traders to overreact to news about fundamentals. In this case, ratings induce lower price efficiency and excessive asset price volatility.
  30. By: Jason Allen; Walter Engert; Ying Liu
    Abstract: The authors compare the efficiency of Canada's largest banks with U.S. commercial banks over the past 20 years. Efficiency is measured in three ways. First, the authors study key performance ratios, and find that Canadian banks are as productive as U.S. banks. Second, they investigate whether there are economies of scale in the production functions of Canadian banks and broadly comparable U.S. bank-holding companies (BHCs). They find larger economies of scale for Canadian banks than for the U.S. BHCs, which suggests that Canadian banks are less efficient in terms of scale, and have more to gain in terms of efficiency benefits from becoming larger. Third, the authors measure cost-inefficiency in Canadian banks and in U.S. BHCs relative to the domestic efficient frontier in each country (the domestic best-practice institution). They find that Canadian banks are closer to the domestic efficient frontier than are the U.S. BHCs. Canadian banks have also moved closer to the domestic efficient frontier than have the U.S. BHCs over time. Finally, the authors examine the dispersion in cost-inefficiency found in Canadian banks and attribute some of the dispersion to differences in information and communication technology investment. Comparisons are made with the U.S. BHC experience.
    Keywords: Financial institutions
    JEL: G21 D24 C33
    Date: 2006
  31. By: Francis Nathan Okurut (Department of Economics, University of Botswana)
    Abstract: This study specifically investigated the factors that influenced access by the poor and Blacks to credit in the segmented financial sector in South Africa, using income and expenditure survey data from 1995 and 2000. The study sheds light on the extent of financial sector deepening through household participation especially among the poor and Blacks, in the context of the fight against poverty. In this study, three types of credit were identified. Formal credit was defined to include debts from commercial banks (including mortgage finance and car loans), semi-formal credit included consumption credit (for household assets such as furniture and open accounts in retail stores), and informal credit specifically referred to debts from relatives and friends.Multinomial logit models and Heckman probit models with sample selection were used for analytical work. The results suggest that the poor and Blacks have limited access to the formal and semi-formal financial sectors. At the national level, access to bank credit is positively and significantly influenced by age, being male, household size, education level, household per capita expenditure and race (being Coloured, Indian or White). Being poor has a negative and significant effect on formal credit access. Semi-formal credit access is positively and significantly influenced by household size, per capita expenditure, provincial location (Eastern Cape, Northern Cape, Free State and North West) and being Coloured. The negative and significant factors in determining access to semi-formal credit include being male, rural location, being poor and being White. Informal credit access is negatively and significantly influenced by education level and race (being Coloured or White). Among the poor, access to bank credit is positively and significantly influenced by being male, provincial location (Western Cape, Gauteng and Mpumalanga) and being Coloured. Access to semi-formal credit is positively and significantly determined by household per capita expenditure, provincial location (Western Cape, Northern Cape, North West and Gauteng) and being Indian. Access to informal credit by the poor is positively and significantly influenced by provincial location (Kwazulu Natal and Gauteng). Within the black population, access to bank credit is positively and significantly influenced by age, being male, household per capita expenditure and education level. Semi-formal credit access by Blacks is positively and significantly influenced by household size, household per capita expenditure, education level and provincial location (Eastern Cape, Northern Cape, Free State and North West). However being male, poor and located in a rural area negatively affected access to semi-formal credit by Blacks. Informal credit access by Blacks is negatively influenced by education level, but positively influenced by being located in the Western and Eastern Cape. These findings confirm that improving access to organized credit markets (i.e formal and semi-formal credit markets) by the poor and Blacks, remains important in the fight against poverty.
    Keywords: credit, poverty, South Africa
    JEL: N27 D14 G2
    Date: 2006
  32. By: Bjørn-Andersen, Niels (Department of Informatics, Copenhagen Business School)
    Abstract: Danish banks have traditionally been in the absolute forefront globally as regards the automation and introduction of IT since the mid 60’ies. But when the e-commerce opportunities emerged in the late 90’ies, the majority of the Danish banks resisted the development. They saw no reason to be the prime movers in cannibalising their own key competitive advantage, the 2.500+ retail-outlets (branches) placed on all the best locations on corners of the shopping streets1. However, once pure Internet banks were introduced in 1998 - 2000, all major banks (and the computing centres servicing the smaller banks) launched massive initiatives to bring the brick-and-mortar banks back into the driver seat using Internet banking. At the end of 2003 more than 30% of all Danish bank customers are using Internet. This development in the banking industry is illustrated using two cases. The first is one of the most ambitious attempts at creating a Nordic based large international financial service company, capable of spearheading the transition to the digital economy - the case of Nordea. This bank is in the midst of various transformation processes across the organisation due to several years of multiple cross boarder mergers and acquisitions, new composition of the group executive management, increasing thrives towards automation of business processes to reduce costs, and different innovations involving a change of the roles of value network partners. The other case is Lån & Spar Bank, which is one of the smaller Danish banks, who have its basic IT services done at a joint computing centre owned with many other smaller banks, but have its own IT development for strategic purposed done in-house in close collaboration with the business units. This bank has been in the forefornt in adopting new IT-solutions. This report consists of an analysis of the background for the development of the Danish banking sectors, the key processes in the Danish banking industry, the environmental and policy actors influencing the development, the e-commerce readiness in the Danish banking sector, the diffusion of e-commerce, and finally the impact on efficiency, industry structure and competition. The main results are that there are more Danish financial institutions having Internet technologies and Internet applications than in the other nine countries in the GEC survey. Furthermore, we suspect that they have had it for a longer period on average than found elsewhere in the sample. However, when we compare the figures in the GEC-survey on the ‘ Use of Internet for the different business processes’, and ‘On-line support’, the number of Danish financial institutions having Internet applications is not higher than in the other countries.
    Keywords: None
    JEL: O30
    Date: 2006–09–20
  33. By: Renneboog,Luc; Szilagyi,Peter G. (Tilburg University, Center for Economic Research)
    Abstract: This paper contributes to the comparative corporate governance literature by showing how crosscountry differences in governance and legal standards affect the bondholder wealth effects of European merger and acquisitions (M&As). Using investment-grade Eurobonds, we find some remarkable results. Firstly, M&As involving European firms are considerably more bondholder-friendly than are US domestic deals. Bidding firm bondholders earn economically significant positive returns, while target bondholders incur positive but insignificant returns. Overall, acquisitions do generate value to European bidding firms, but most of the wealth effect is captured by the bondholders. Secondly, bondholder gains in both bidding and target firms are systematically higher in M&As that involve Continental European firms. Thirdly, bidder abnormal bond returns are lower in cross-border deals. However, this is counterbalanced if creditor rights and the efficiency of credit contract enforcement are stronger in the target country. There is also strong evidence that, consistent with cross-border spillovers, improved creditor protection redistributes wealth from shareholders to bondholders. Finally, we document that bondholder wealth changes are subject to changes in asset risk and to a negative listing effect similar to that previously reported for changes in shareholder wealth.
    Keywords: Bondholder returns;Eurobonds;Mergers and acquisitions;Creditor rights; Takeover;Corporate governance;Shareholder returns;M&A;Insolvency
    JEL: G34 G32 G12 G14
    Date: 2006
  34. By: Schclarek, Alfredo (Department of Economics, Lund University)
    Abstract: This paper theoretically studies the role of the financial system in promoting macroeconomic stability and growth. It also explains endogenously the development of the financial system as part of the growth process. The productive sector engages in R\&D activities, and finances its activities through access to the financial system. While vertical innovation spurs economic growth, horizontal innovation creates new industry sectors, and thus enhances industry diversification. Higher industry diversification deepens the financial system by improving its ability to finance the productive sector. Economies that are more diversified, and thus more financially developed, have higher growth rates and are less volatile. There is a role for the government to subsidize innovation, especially horizontal innovation.
    Keywords: vertical innovation; horizontal innovation; industry diversification; financial development; economic growth; imperfect information
    JEL: E22 E32 E44 O16 O30 O41
    Date: 2006–09–20
  35. By: Orla May; Merxe Tudela
    Abstract: Since the mid-1990s the volume of secured lending to households has expanded rapidly, both in absolute terms and in relation to household incomes. This paper examines the determinants of households' ability to service this stock of secured debt. It estimates a random effects probit model for the probability of households having mortgage payment problems. It is found that past experience of payment problems increases the probability that the household has difficulties servicing its secured debt today. At the household level, becoming unemployed, interest income gearing of 20% and above, high loan to value ratios and having a heavy burden of unsecured debt are all associated with a significantly higher probability of mortgage payment problems. Saving regularly and having unsecured debt which is not a problem are both associated with a significantly lower probability of mortgage payment problems. The only non-household-specific variable to have a significant effect is mortgage interest rates - the probability of payment problems increases with the level of mortgage interest rates. An aggregate measure of debt at risk is calculated. This has decreased between 1994 and 2002, as falls in the probability of mortgage payment problems have more than offset increases in the stock of mortgage debt outstanding. It is found that the fall in the probability of mortgage payment problems has been greatest among the most highly indebted households.
  36. By: Christian Dreger; Georg Stadtmann
    Abstract: Foreign exchange rate expectations play a central role in virtually all monetary models for the open economy. Therefore, it is extremely important to gain empirical insights into the expectations formation process. In this paper, we use a unique disaggregated data set to model the expectations of the Yen/USD exchange rate of about 50 leading foreign exchange rate professionals. The survey includes not only forecasts of the exchange rate, but also for macroeconomic fundamentals, like GDP growth, inflation, and interest rates. Different expectations of fundamentals might lead to different views of exchange rate dynamics. Using panel models, we are able to confirm the het-erogeneity of exchange rate expectations often detected by former authors. More impor-tant, we provide strong evidence regarding the likely source of heterogeneity. In line with forward looking models for the exchange rate, expected fundamentals have a sub-stantial impact on exchange rate expectations, thereby challenging the backward look-ing evidence of previous studies. However, the heterogeneity in the expectations of macroeconomic fundamentals is not sufficient to explain the heterogeneity in exchange rate expectations.
    Keywords: Exchange rate expectations, heterogeneity of expectations, expected fundamentals
    JEL: F31 F37 C23
    Date: 2006
  37. By: David Laidler (University of Western Ontario)
    Abstract: The economic integration of North America, unlike that of Europe, has no parallels on the political front, and U.S. economic and political interests are world-wide, while those of Canada and Mexico are predominantly regional. These facts have important implications for the degree of policy integration, not least in monetary matters, that is feasible within NAFTA. Each member has an interest in the monetary stability of the others, but a common currency -- even a pegged exchange rate system -- is not desirable without a significantly greater degree of labour market integration than currently exists, and without a willingness on the part of the U.S. authorities to subordinate national to regional interests in their policy making. Absent these preconditions, monetary stability within NAFTA is best achieved by each country pursuing its own domestic stability, while maintaining the current high degree of formal and informal communications about economic conditions and policy intentions implicit in current arrangements.
    Keywords: NAFTA; economic integration; currency unions; exchange rate regimes; monetary policy; inflation targets
    JEL: E41 E58 E61 F15 F33 F42
    Date: 2006
  38. By: Christian Hellwig; Guido Lorenzoni
    Date: 2006–09–18
  39. By: Tan Kim Song (School of Economics and Social Sciences, Singapore Management University); Khor Hoe Ee (Monetary Authority of Singapore)
    Abstract: There is tremendous momentum for economic and financial integration in East Asia today. Partly inspired by the formation of the European Union and partly as a response to the 1997/98 Asia financial crisis, many East Asian countries are showing greater commitment to regional economic cooperation. A number of bilateral free trade agreements (FTAs) have either been concluded or are being negotiated.1 At a less formal level, the ASEAN+3 grouping has brought the whole region together in regular consultations over trade, investment, as well as monetary and exchange rate policy matters.
    Date: 2005–11
  40. By: Alessandro Fedele
    Abstract: This paper reviews recent literature on joint liability lending in microcredit markets characterized by adverse selection. This mode of lending consists of granting individual loans to wealthless borrowers provided that they form groups: if a group does not fully repay its obligations, then the microlender cut off all members from future credit until the debt is repaid. Joint liability lending is able to extract information through a peer selection mechanism, with the effect of raising both repayment rates and welfare with respect to individual lending.
    Keywords: microcredit, underdeveloped economies, joint liability lending.
    JEL: D82 L31 O12 O16
    Date: 2006–09
  41. By: Xia Su
    Abstract: This paper proposes two-step static hedging strategies for European basket options by using only plain-vanilla options on a subset of underlying assets. The basic idea is stimulated from a static super-hedging strategy dependent on the whole basket. However, it would be too complicated to handle when there is a large number of assets in the basket. It becomes even worse when some of the underlying assets are illiquid or not available for trading. Meanwhile, this strategy completely neglects the correlation structure of the basket which has indeed a great effect on the basket option's price. To solve these problems, Principal Components Analysis is used to figure out the subset of dominant assets through a careful study on the modified covariance of the basket. On this basis, the optimal strikes of those significant assets' plain-vanilla options are obtained in the second step via optimization. The optimality criterion depends on the risk attitude of hedgers and is defined by a certain risk measure, e.g., super-replication, minimum expected shortfall given a constraint on the hedging cost. Through analyzing a numerical example, it is concluded that this static hedging portfolio captures a trade-off between reduced hedging costs and overall super-replication. Even without considering transaction costs, hedging by using only a subset of underlying assets performs well: only a reasonable small hedging error arises when investing the capital required by the super-hedging portfolio which is composed of plain-vanilla options on all underlying assets and hence is difficult to implement or even not available in the market.
    Keywords: Basket options, Principal Components Analysis, Super-replication, Expected shortfall
    JEL: G13
    Date: 2006–06
  42. By: Suzan Hol (Statistics Norway)
    Abstract: I combine two fields of research on default prediction by empirically testing a bankruptcy prediction function where unlisted firms are evaluated on the basis of both their financial statement analysis and the macroeconomic environment. This combination is found to improve the default prediction compared to financial statements alone. The GDP-gap, a production index and the money supply M1 in combination with some financial health indicators for individual firms are found to be significant predictors on default for Norwegian firms during both a recovery and expansion in the 1990’s.
    Keywords: bankruptcy prediction; macroeconomic environment; financial ratios; logit model
    JEL: G32 G33
    Date: 2006–08
  43. By: Prasanna Gai; Nicholas Vause
    Abstract: This paper proposes a new method for measuring investor 'risk appetite'. Like other indicators in the literature, it is based on a comparison of risk-neutral probabilities of future returns with the corresponding subjective probabilities. The precise nature of the comparison is novel, however, and involves comparing probabilities across the full range of potential returns. Unlike other indicators, our measure of market sentiment distinguishes risk appetite from risk aversion, and is reported in levels rather than changes. Implementation of the approach yields results that respond to crises and other major economic events in a plausible manner.
  44. By: Katie Farrant; Gert Peersman
    Abstract: This paper analyses the role of the real exchange rate in a structural vector autoregression framework for the United Kingdom, euro area, Japan and Canada versus the United States. A new identification strategy is proposed building on sign restrictions. The results are compared to the benchmark conventional approach of Clarida and Gali based on long-run zero restrictions. Although the restrictions are derived from the same theoretical model, the results are strikingly different. In contrast to the benchmark model, an important role for nominal shocks in explaining real exchange rate fluctuations is found.
  45. By: Post, Erik (Department of Economics)
    Abstract: This paper sets up a simple model for interventions and interest rate setting assuming that the policy maker cares about deviations in inflation from a target level. Under a quadratic cost of interest rate adjustments and interventions the policy maker should use a combination of interest rate adjustment and interventions. According to the model interventions (purchases of foreign currency) will be negatively correlated with interest rate deviations from the steady state level but positively correlated with interest rate deviations pertaining to non-stabilizing motives or a binding zero lower bound. The model also predicts that interventions will be decreasing in inflation expectations and in the real exchange rate but increasing the expected interventions. Interventions are shown to be positively serially correlated if the policy maker cares about the future. Following the theoretical model closely two sets of regression results are presented using both Two Stage Least Squares and an Ordered Probit model. The empirical analysis uses daily intervention data for Australia, Japan and Sweden. Overall, the predictions of the model is supported in most dimensions indicating that interventions have been used in a way that is consistent with monetary policy considerations.
    Keywords: foreign exchange interventions; monetary policy; central banks
    JEL: E52 E58 F31
    Date: 2006–09–26
  46. By: Kenneth Kasa (Simon Fraser University); Todd B. Walker (Indiana University Bloomington); Charles H. Whiteman (University of Iowa)
    Abstract: This paper develops a dynamic asset pricing model with persistent heterogeneous beliefs. The model features competitive traders who receive idiosyncratic signals about an underlying fundamentals process. We adapt Futia’s (1981) frequency domain methods to derive conditions on the fundamentals that guarantee noninvertibility of the mapping between observed market data and the underlying shocks to agents’ information sets. When these conditions are satisfied, agents must ‘forecast the forecasts of others’. The paper provides an explicit analytical characterization of the resulting higher-order belief dynamics. These additional dynamics can explain apparent violations of variance bounds and rejections of cross-equation restrictions.
    Keywords: Asymmetric Information, Blaschke Factors
    JEL: G12 D82
    Date: 2006–09
  47. By: Severin Borenstein
    Abstract: One of the most critical concerns that customers have voiced in the debate over real-time retail electricity pricing is that they would be exposed to risk from fluctuations in their electricity cost. The concern seems to be that a customer could find itself consuming a large quantity of power on the day that prices skyrocket and thus receive a monthly bill far larger than it had budgeted for. I analyze the magnitude of this risk, using demand data from 1142 large industrial customers, and then ask how much of this risk can be eliminated through various straightforward financial instruments. I find that very simple hedging strategies can eliminate more than 80% of the bill volatility that would otherwise occur. Far from being complex, mystifying financial instruments that only a Wall Street analyst could love, these are simple forward power purchase contracts, and are already offered to retail customers by a number of fully-regulated utilities that operate real-time pricing programs. I then show that a slightly more sophisticated application of these forward power purchases can significantly enhance their effect on reducing bill volatility.
    JEL: L51 L94
    Date: 2006–09
  48. By: Raymond Knott; Marco Polenghi
    Abstract: This study considers how the probability of exceeding central counterparty (CCP) initial margin levels can be estimated, in order to provide a timely and informative measure of risk coverage. Previous studies of CCP margining have largely focused on the unconditional distribution of returns, estimating margin coverage on a long-term average basis. The present study extends previous work by estimating conditional margin coverage using a GARCH (1,1) model, so that variations in coverage can be tracked over a much shorter time frame. The model is applied to estimating non-coverage probabilities for two heavily traded derivatives contracts, the Brent and FTSE 100 futures. To account for the well-documented fat-tailed characteristics of distributions of futures returns, several variants of the GARCH model are estimated. These assume that innovations are distributed according to either normal, Student t, extreme value or historical distributions. Backtesting is used to select the best performing distribution. During the sample period, margins are found to provide a coverage level generally in excess of 99%, over a one-day time horizon. It is noted, however, that the coverage probability implied by the model is likely to fall under more volatile market conditions; under these circumstances central counterparties will reset initial margin more frequently and call for margin intraday.
  49. By: Mulraine, Millan L. B.
    Abstract: The importance of distribution costs in generating the deviations from the law of one price has been well documented. In this paper we show that a two-country flexible price dynamic general equilibrium model driven by exogenous innovations to technology, and with a localized distribution services sector can replicate the key dynamic features of the real exchange rate. In doing so, the paper identifies the importance of two key channels for real exchange rate dynamics. That is, we show: (i) that shocks in the real sector are important contributors to movements in the real exchange rate, and (ii) that the endogenous wedge created by distribution costs of traded goods is a significant source of fluctuation for the real exchange rate, and the overall macro-economy as a whole. The evidence presented here demonstrates that this model - without any nominal rigidities, can account for up to 89% of the relative volatility in the real exchange rate.
    Keywords: Distribution costs; Real exchange rate dynamics; Law of one price
    JEL: E32 F41 E37
    Date: 2006–09
  50. By: Andrea Buffa; Giovanna Nicodano
    Abstract: This paper considers share repurchases as the way long-term shareholders preserve their ability to use corporate information for speculative purposes when insider trading regulation is enforced. This use of corporate information increases the adverse selection losses of short-term shareholders. Thus, buy-back programs reduce their incentive to invest in stocks that back the most productive technology, leading to a socially inefficient equilibrium. It follows that insider trading should not be banned when share repurchases are allowed.
    Keywords: insider trading, share repurchase, liquidity, securities regulation, corporate information
    JEL: G18 G14 D82 K22
    Date: 2006
  51. By: Bastiaan Verhoef
    Abstract: Recent literature states that international monetary cooperation results in substantial welfare gains in an environment with imperfectly correlated sectoral shocks and with prices only set in firms (domestic) currency. However, empirical studies provide evidence that firms not only set their prices in their own currency, but in foreign currency as well. The question is whether the result of substantial welfare gains due to imperfectly correlated sector-specific shocks applies to the case where firms in the tradable sector apply pricing-to-market, i.e. prices are set in both domestic and foreign currency. This paper finds that this is not the case. For imperfectly correlated sectoral shocks and local currency pricing, welfare benefits of international monetary cooperation are fairly small.
    Keywords: nominal rigidities; international cooperation; local currency pricing
    JEL: E31 E52 F42
    Date: 2006–08
  52. By: Cuong Le Van (CES - Centre d'Economie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I]); Nizar Allouch (Queen Mary, University of London - [Queen Mary, University of London]); Frank H. Page (University of Alabama - [University of Alabama])
    Abstract: In his seminal paper on arbitrage and competitive equilibrium in unbounded exchange economies, Werner (Econometrica, 1987) proved the existence<br />of a competitive equilibrium, under a price no-arbitrage condition, without assuming either local or global nonsatiation. Werner's existence result<br />contrasts sharply with classical existence results for bounded exchange economies which require, at minimum, global nonsatiation at rational allocations.<br />Why do unbounded exchange economies admit existence without local or global nonsatiation? This question is the focus of our paper. First, we show that in unbounded exchange economies, even if some agents' preferences are satiated, the absence of arbitrage is suffcient for the existence of competitive equilibria, as long as each agent who is satiated has a nonempty set of useful net trades - that is, as long as agents' preferences satisfy weaknonsatiation. Second, we provide a new approach to proving existence in unbounded exchange economies. The key step in our new approach is to transform the original economy to an economy satisfying global nonsatiation such that all equilibria of the transformed economy are equilibria of the<br />original economy. What our approach makes clear is that it is precisely the condition of weak nonsatiation - a condition considerably weaker than local<br />or global nonsatiation - that makes possible this transformation.
    Keywords: Arbitrage, Asset Market Equilibrium, Nonsatiation, Recession Cones.
    Date: 2006–09–18
  53. By: Philip Bunn; Kamakshya Trivedi
    Abstract: This paper examines how corporate behaviour is related to financial pressure, where the financial pressure is on account of pension contributions to the company pension scheme. Using a large panel of quoted non-financial UK firms from 1983-2002, we estimate generalised methods of moments models for dividends and investment. Our results suggest that dividends are reduced in response to higher pension contributions. There is only weak evidence of any impact on investment. Companies that seek to tackle underfunding of defined benefit pension schemes by raising their contributions could pay lower dividends than they would have otherwise.
  54. By: Laura Alfaro; Areendam Chanda; 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.
    JEL: F23 F36 F43 O40
    Date: 2006–09
  55. By: Stephen Millard; Matthew Willison
    Abstract: The Bank of England's second core purpose is to maintain the stability of the financial system. Payment systems, by supporting transactions, are a key aspect of this. In this paper, we examine the importance of smoothly functioning payment systems to the economy by extending a recently developed theoretical model of banks. In the model the risk of theft implies a cost to using cash. This risk can be avoided by depositing cash in banks and transferring money through an interbank payment system. However, agents are then exposed to the risk that the payment system is unreliable. Agents will use a payment system (rather than cash) to make transactions if the system is sufficiently cheap to use and/or it is sufficiently reliable. We show that the introduction of a payment system that buyers and producers choose to use unambiguously increases social welfare if it expands the number of trades occurring in the economy. This is more likely the more reliable is the payment system. When the introduction of a payment system does not increase the number of trades, social welfare may increase or decrease depending on the trade-off between the risk of using cash and the risk that the payment system is unreliable. We again show that the more reliable is the payment system, the more likely welfare is increased by its introduction and we illustrate how this benefit might be quantified.
  56. By: Guerrero, Carlos (Tecnológico de Monterrey, Campus Ciudad de México); Urzúa, Carlos M. (Tecnológico de Monterrey, Campus Ciudad de México)
    Abstract: El documento pasa revista a cinco posibles alternativas cambiarias que podrían contemplar las autoridades en el momento actual. La primera es seguir con el actual status quo. Una segunda alternativa es la dolarización unilateral. La tercera es dar más mandatos al Banco de México. Una cuarta alternativa es la fijación de una tasa de inflación socialmente óptima. Y una quinta alternativa, que nos parece la más razonable, es que la Comisión de Cambios establezca un régimen que permita la restauración de la competitividad del tipo de cambio.
    Keywords: México, política cambiaria, política monetaria, autonomía del banco central, tipo de cambio real
    JEL: E52 E58 F31 F41
    Date: 2006–03
  57. By: Andrew Benito; Haroon Mumtaz
    Abstract: Using a switching regression technique we provide unique evidence on three questions concerning the consumption behaviour of UK households. First, what percentage of households display excess sensitivity to income? Second, what affects the likelihood of being in that group? Third, is there a collateral channel from house prices to consumption? We find 20%-40% of households display excess sensitivity. These households may be liquidity constrained or saving for other precautionary reasons. This is found to be more likely for those without liquid assets, with negative home equity, the young, unmarried, non-white and the degree-educated. According to the 'collateral channel', house prices influence consumption by allowing households that would otherwise be liquidity constrained to borrow on more attractive terms. A key implication of that view is that capital gains on housing should influence the consumption of the liquidity constrained/precautionary saving households, but not other households. We test that implication for the first time and find direct evidence in support.
  58. By: Kamakshya Trivedi; Garry Young
    Abstract: This paper examines the role of defined benefit company pensions in amplifying the effect of common shocks to companies' stock market valuations. It identifies and evaluates the significance of two channels of amplification: cross-holdings of equities in pension schemes, and leverage induced by pension liabilities. Econometric analysis of weekly stock market data for a sample of FTSE 350 UK companies confirm that these effects are statistically significant and robust to outlying observations.
  59. By: Peter C. B. Phillips (Yale University); Jun Yu (School of Economics and Social Sciences, Singapore Management University)
    Abstract: Our comments on Fan’s paper will concentrate on two issues that relate in important ways to the paper’s focus on misspecification and discretization bias and the role of nonparametric methods in empirical finance.
    Date: 2005–04
  60. By: Xavier de Scheemaekere (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussels.)
    Abstract: This paper discusses the epistemological status of modern finance with a special emphasis on its very quantitative nature. Hence, besides the linguistic paradigm shift put forward by McGoun (2003), two major aspects are taken into account: 1) finance relies on sophisticated mathematical methods; 2) its underlying reality is not stable and recurring but radically uncertain. In consequence, financial results are simultaneously accurate and of a global shape – beyond the modelling of causal predictions and individual realities. This is because finance deals objectively with an utterly subjective issue: uncertainty itself. This special combination provides modern finance with a unique epistemological status among social sciences.
    Keywords: Black-Scholes option pricing model; Modern finance; Asset pricing; Uncertainty; Risk.
    JEL: B16 G12 G13
    Date: 2006–09
  61. By: Luca Benati
    Abstract: This paper uses two affine term structure models from the Duffie-Kan class - a three-factor Cox-Ingersoll-Ross model, and a three-factor model in the spirit of Longstaff and Schwartz - to extract historical estimates of foreign exchange risk premia for the pound with respect to the US dollar. The term structures of interest rates for the two countries are estimated jointly, together with the dynamics of the nominal exchange rates between them, via maximum likelihood. The likelihood function is computed via the Kalman filter, and is maximised numerically with respect to unknown parameters. Particular attention is paid to the robustness of the results across models; to the overall (filter plus parameter) econometric uncertainty associated with risk premia estimates; and to the ability of estimated structures to replicate Fama's 'forward discount anomaly'. The paper's main results may be summarised as follows. First, risk premia estimates are not consistent across the two models. Second, both models fail to replicate the forward discount anomaly, with theoretical values of ? in the Fama regressions implied by estimated structures being consistently positive at all horizons from 1 to 12 months.
  62. By: Todd B. Walker (Indiana University Bloomington)
    Abstract: Accommodating asymmetric information in a dynamic asset pricing model is technically challenging due to the problems associated with higher-order expectations. That is, rational investors are forced into a situation where they must forecast the forecasts of other agents. In a dynamic setting, this problem telescopes into the infinite future and the dimension of the relevant state space approaches infinity. By using the frequency domain approach of Whiteman (1983) and Kasa (2000), this paper demonstrates how information structures previously believed to preserve asymmetric information in equilibrium, converge to a symmetric information, rational expectations equilibrium. The revealing aspect of the price process lies in the invertibility of the observed state space, which makes it possible for agents to infer the economically fundamental shocks and thus eliminating the need to forecast the forecasts of others.
    Keywords: Asset Pricing, Asymmetric Information
    JEL: G12 D82
    Date: 2006–09
  63. By: Arthur Kennickell (Board of Governors of the Ferderal Reserve System); Annamaria Lusardi (Dartmouth College, Department of Economics)
    Abstract: We evaluate the importance of the precautionary saving motive by relying on a direct question about precautionary wealth from the 1995 and 1998 waves of the Survey of Consumer Finances. In this survey, a new question has been designed to elicit the amount of desired precautionary wealth. This allows us to assess the amount of precautionary accumulation and to overcome many of the problems of previous works on this topic. We find that a precautionary saving motive exists and affects virtually every type of household. However, precautionary savings account for only 8 percent of total wealth holdings. Even though this motive does not give rise to large amounts of wealth, particularly for young and middle-age households, it is particularly important for two groups: older households and business owners. Overall, we provide strong evidence that we need to take the precautionary saving motive into account when modeling saving behavior.
    Keywords: Risk, Buffer-stock Models of Saving, Old Cohorts Wealth, Business Owners Wealth
    JEL: D91 E21 C21
    Date: 2006–06–20
  64. By: Bertram Düring (Department of Mathematics and Informatics, University of Mainz); Michel Fournié (Laboratoire MIP, Université Paul Sabatier, Toulouse); Ansgar Jüngel (Department of Mathematics and Informatics, University of Mainz)
    Abstract: A nonlinear Black-Scholes equation which models transaction costs arising in the hedging of portfolios is discretized semi-implicitly using high order compact finite difference schemes. In particular, the compact schemes of Rigal are generalized. The numerical results are compared to standard finite difference schemes. It turns out that the compact schemes have very satisfying stability and non-oscillatory properties and are generally more e±cient than the considered classical schemes.
    Keywords: Option pricing, transaction costs, parabolic equations, compact finite difference discretizations
  65. By: Froukelien Wendt
    Abstract: Intraday margin is a generally accepted risk management tool of central counterparties to cover increased risk exposure during the day. Central counterparties may call for intraday margin on a routine basis, but also in case of extreme price volatility or large changes in positions of clearing members. An increase in the use of a routine intraday margin call can be seen at central counterparties in the EU. Three central counterparties have recently introduced a routine intraday margin call and two central counterparties intend to do so. This article explores the concept of intraday margin and its role within the risk management framework of the central counterparty. In addition, an overview is given of the benefits, cost and side effects of intraday margining to the central counterparty, its clearing members and the capital market in general. Finally, the article examines the practice of intraday margining of central counterparties in the EU and the differences in intraday margining policies.
    Keywords: Clearinghouse; Central counterparty; Replacement cost risk; Intraday margin.
    JEL: G29 G30
    Date: 2006–08
  66. By: Willison, Robert (Department of Informatics, Copenhagen Business School)
    Abstract: There is currently a paucity of literature focusing on the relationship between the actions of staff members, who perpetrate some form of computer abuse, and the organisational environment in which such actions take place. A greater understanding of such a relationship may complement existing security practices by possibly highlighting new areas for safeguard implementation. To help facilitate a greater understanding of the offender/environment dynamic, this paper assesses the feasibility of applying criminological theory to the IS security context. More specifically, three theories are advanced, which focus on the offender’s behaviour in a criminal setting. Drawing on an account of the Barings Bank collapse, events highlighted in the case study are used to assess whether concepts central to the theories are supported by the data. It is noted that while one of the theories is to be found wanting in terms of conceptual sophistication, the case can be made for the further exploration of applying all three in the IS security context.
    Keywords: None
    JEL: O30
    Date: 2005–09–19
  67. By: Jean-François Ponsot (LEPII - Laboratoire d'Economie de la Production et de l'Intégration Internationale - [CNRS : FRE2664] - [Université Pierre Mendès-France - Grenoble II])
    Abstract: Cette recherche vise à dégager les implications d'un arrangement monétaire particulier -la dollarisation officielle et intégrale- à partir de l'étude du cas équatorien. Elle montre comment la dollarisation officielle et intégrale a introduit une stabilisation monétaire artificielle et instauré deux niveaux de fragilisation : (1) une insécurité macroéconomique, en raison d'une dynamique des taux d'intérêt et du crédit défavorable aux petites et moyennes entreprises ; (2) une insécurité financière liée à l'absence théorique de marges de manoeuvre sur la gestion de la liquidité et le prêt en dernier ressort. L'évolution des prérogatives de la Banque centrale est soulignée, notamment sur la question des mécanismes imaginés par les autorités équatoriennes pour limiter l'influence de l'insécurité macroéconomique et financière. L'impact de ces deux niveaux de fragilisation sur la croissance demeure néanmoins modeste, compte tenu d'un environnement favorable à l'accumulation de pétrodollars. Tant que les recettes d'exportation de pétrole demeureront élevées, les tendances déflationnistes du régime de dollarisation seront atténuées.
    Keywords: monnaie ; politique monétaire ; prêt ; banque centrale ; taux d'intérêt ; système financier ; dollar ; Equateur
    Date: 2006–09–25
  68. By: Zdenek Hlavka; Michal Pesta
    Abstract: State price density (SPD) contains important information concerning market expectations. In existing literature, a constrained estimator of the SPD is found by nonlinear least squares in a suitable Sobolev space. We improve the behavior of this estimator by implementing a covariance structure taking into account the time of the trade and by considering simultaneously both the observed Put and Call option prices.
    Keywords: isotonic regression, Sobolev spaces, monotonicity, multiple observations, covariance structure, option price
    JEL: C10 C13 C14 C20 C88 G13
    Date: 2006–09
  69. By: Torstein Bye, Annegrete Bruvoll and Finn Roar Aune (Statistics Norway)
    Abstract: In 2002/2003, the Nordic hydro-dominated power market faced a short-term supply shock. In autumn, precipitation and inflow were unusually low. As a result, there were record high prices in the following winter. Questions were raised whether the deregulated market creates sufficient incentives to invest in new production and transmission capacity to secure supply when overall inflow fails. One fear is that the market could break down when precipitation and inflow fails during the whole year, which is more probable than a short-term extreme inflow failure. We apply a market model to simulate the market effects with two events: i) an overall inflow shortage 25 per cent lower than normal, and ii) a seasonally biased inflow shortage, as happened in 2002/03. The 25 per cent low inflow scenario shows that significantly higher price effects are likely to occur in the Nordic power market in the future than in the past. However, the price effects are less than one would expect when compared to 2002/03, but prices remain higher for a longer period of time. The simulations do not indicate any problems in the functioning of the market within these scenarios.
    Keywords: Volatile power markets; deregulated power markets; security of supply
    JEL: C61 D41 Q41
    Date: 2006–09
  70. By: Brishti Guha (School of Economics and Social Sciences, Singapore Management University)
    Abstract: We examine self-enforcing honesty in firm-investor relations in an imperfect public information game. Minimum firm size requirements and moral hazard limit ability to raise outside capital, yielding a floor on personal wealth required to enter entrepreneurship. Credible auditing could create efficiency gains. We propose mandatory disclosure of audit fees and an interpretation of international differences in shareholding patterns. We endogenize auditor-firm collusion and extortion by auditors. We embed our game-theoretic analysis in a general equilibrium model to generate unique equilibria that trace the impact of the distribution of wealth on the existence of the market and consequences for development.
    Keywords: Corporate governance, moral hazard, vicious circles, inequality and development, general equilibrium, repeated games.
    JEL: D82 G3 O1
    Date: 2005–09
  71. By: Tatyana Chesnokova; Kala Krishna
    Abstract: This paper looks at the effect of credit constraints on skill acquisition when agents have heterogeneous abilities and wealth. We use a two factor general equilibrium model and assume credit markets are absent. We explore the effects of trade on factor earnings as well as the evolution of the distribution of income in small and large economies. Our work suggests that developed countries need to ensure access to education when liberalizing trade to ensure they reap the potential gains from trade.
    JEL: F16 O15 O16
    Date: 2006–08
  72. By: Andrew Benito
    Abstract: A house purchase typically requires a deposit (or down-payment) and so a significant amount of cash. This paper considers the empirical implications of this borrowing constraint for the housing market. It shows that, at the aggregate level, models of the housing market that incorporate the constraint are consistent with the following stylised facts: i) a positive correlation between house price inflation and transactions; ii) greater volatility of former owner-occupiers' house price inflation than for first-time buyers; iii) the presence of first-time buyers in the market falls with the rate of change of house prices; and iv) house prices are more sensitive to the incomes of the young. The paper then exploits variation across local housing markets in the rate of change in house prices and considers how leverage affects the response of the rate of change of house prices to shocks. The evidence, based on data for 147 district-level housing markets for the period 1993-2002, suggests that a large incidence of households with high levels of leverage (loan to value ratios) raises the sensitivity of house prices to a shock. This is also consistent with the down-payment constraint model of the housing market.
  73. By: Jacob A. Bikker; Jan de Dreu
    Abstract: Administrative and investment costs per participant appear to vary widely across pension funds. These costs are important because they reduce the rate of return on the investments of pension funds and consequently raise the cost of retirement security. This paper examines the impact of determinants of these costs, such as the size, governance, pension plan design and outsourcing decisions, using data on all Dutch pension funds across the 1992-2004 period, including more than 10,000 observations. We find that economies of scale dominate the strong dispersion in both administrative and investment costs across pension funds. Industry-wide pension funds are significantly more efficient than company funds and other funds. The operating costs of pension funds’ defined contribution plans are lower than those of defined benefit plans. Higher shares of pensioners make funds more costly, whereas the reverse is true when relatively many participants are inactive.
    Keywords: Administrative costs; investment costs; economies of scale; pension plan design; governance; defined benefits; defined contribution; outsourcing; reinsurance.
    JEL: D61 G14 G23 H55
    Date: 2006–08
  74. By: Suzan Hol and Nico van der Wijst (Statistics Norway)
    Abstract: This paper presents an analysis of how Norwegian non-listed firms are financed. Using a unique database covering all limited liability firms in Norway, both the size (leverage) and composition (maturity structure) of debt are investigated. The empirical evidence provides support for the effects of taxes, asymmetric information and size suggested in the theoretical literature, and rejects the effects of agency costs and the pecking order theory.
    Keywords: financing structure; non-listed firms; debt maturity; panel data
    JEL: G32 D92
    Date: 2006–08
  75. By: Michael W. Brandt; David A. Chapman
    Abstract: We construct a simple reduced-form example of a conditional pricing model with modest intrinsic nonlinearity. The theoretical magnitude of the pricing errors (alphas) induced by the application of standard linear conditioning are derived as a direct consequence of an omitted variables bias. When the model is calibrated to either characteristics sorted or industry portfolios, we find that the alphas generated by approximation-induced specification error are economically large. A Monte Carlo analysis shows that finite-sample alphas are even larger. It also shows that the power to detect omitted nonlinear factors through tests based on estimated risk premiums can sometimes be quite low, even when the effect of misspecification on alphas is large.
    JEL: G0 G10 G12 G14
    Date: 2006–09
  76. By: Andersson, Henrik (VTI)
    Abstract: This study estimates a marginal willingness to pay (WTP) function for a road-mortality risk reduction. Observed marginal WTP from the Swedish car market is used and found to be positively correlated with the baseline risk of the cars. Among owner attributes, we find that income increases marginal WTP, whereas background risk reduces marginal WTP. Also, when comparing the estimated monetary value of a non-marginal risk reduction derived from the integral of the marginal WTP-function with an estimate based on marginal WTP, we find that the estimates are different and that the difference is 15-25 percent for larger estimates, but negligible for smaller risk reductions (which is in line with expectations).
    Keywords: car safety; hedonic prices; non-marginal willingness to pay; background risk
    JEL: C51 D61 J28
    Date: 2006–09–20
  77. By: Ronald Bosman; Frans van Winden
    Abstract: We investigate a novel dynamic choice problem in an experiment where emotions are measured through self-reports. The choice problem concerns the investment of an amount of money in a safe option and a risky option when there is a “global risk” of losing all earnings, from both options, including any return from the risky option. Our key finding is that global risk can reduce the amount invested in the risky option. This result cannot be explained by classical Expected Utility or by its main contenders Rank-Dependent Utility and Cumulative Prospect Theory. Anexplanation is offered by taking account of emotions, using the emotion data from the experiment and recent psychological findings. We also find that people invest less if own earnings are at stake, compared to money obtained as an endowment.
    Keywords: investment; global risk; real effort; emotions; dynamic choice.
    JEL: A12 C91 D80 G11
    Date: 2006–09
  78. By: Pamela Kaval (University of Waikato); John Loomis (Colorado State University); Dave Theobald (Colorado State University)
    Abstract: Colorado residents living in the wildland urban interface (WUI) were asked about their perception of wildfire risk and their willingness-to-pay (WTP) for three fire management procedures: fuel reduction by thinning, fire suppression and prescribed fires. Respondent home locations were then digitized to enable the calculation of wildfire danger variables from various GIS map layers. These two processes resulted in perceived and actual wildfire risk variables which were then compared and analyzed. Perceived and actual fire danger variables were then used as explanatory variables in WTP functions. Results show that each fire management technique had different variables that would increase a persons WTP. However, overall, WTP values for each of the approaches were substantial. We believe this information shows that people living in the WUI would be willing-to-pay for an annual “wildfire management fee” to offset risks they consciously take by living in the WUI. This fee could potentially decrease the wildfire management cost burden that is currently incurred by taxpayers.
    Keywords: Contingent valuation; GIS; wildfire; wildland urban interface
    JEL: Q51 Q51 Q43
    Date: 2006–09–26
  79. By: Mahnke, Volker (Department of Informatics, Copenhagen Business School); Overby, Mikkel Lucas (Department of Informatics, Copenhagen Business School)
    Abstract: Many companies in the cross section of telecommunication and mobile technology engage in R&D collaborations to manage uncertainty, create synergies and learn. While the challenges of managing individual collaborations are well documented, little is known on how to systematically manage several R&D collaborations simultaneously. We use modern portfolio theory as an analogy to show how companies active in mobile telecommunication manage risks and create synergies by simultaneously engaging in several inter-firm collaborations.
    Keywords: Portfolio theory; risk; synergy; R&D collaboration; mobile commerce
    JEL: O30
    Date: 2006–09–19
  80. By: Alessandro Fedele; Federica Calidoni Lundberg
    Abstract: We collect data from three Italian microcredit institutions, MAG2, MAG4 and MAG6, which operate in Milan, Turin and Reggio Emilia respectively, by targeting two categories of wealthless borrowers: single entrepreneurs and organizations (cooperatives and associations). Evidence shows that organizations repay with higher probability and are charged a lower average interest rate than individuals. We use these findings to construct a lending scheme which consists of granting loans provided that borrowers form production teams (i.e. organizations). We consider a microcredit market with adverse selection à la De Meza-Webb and we verify that both repayment rate and welfare increase, while interest rate falls with respect to individual lending if the above scheme, which we refer to as production team lending, is implemented. Our instrument, like joint liability implemented in rural economies, is able to extract information from borrowers through a peer selection mechanism but, differently from joint liability, fits to urban contexts where borrowers do not know each other and social sanctions are weak.
    Keywords: microcredit, urban areas, production team lending.
    JEL: D82 L31 O12 O16
    Date: 2006–09
  81. By: Giovanni Mastrobuoni; Wioletta Dziuda
    Abstract: Despite the expectations of economists that the euro changeover would have no effect on prices, we show that European consumers perceived the contrary. The data indicate that consumers based their perceptions about inflation on goods that are cheaper and more frequently purchased. We use this insight to develop and estimate a model of imperfect information that explains why these goods were subject to higher price growth after the changeover. The data indicate that some retailers, aware of the consumers' diffculties in adopting the new currency, used the changeover to increase profits by increasing prices. We also propose an explanation of why this effect was smaller in more concentrated retail markets.
    Keywords: euro, currency changeover, imperfect information, search costs, price setting.
    JEL: D83 F33 L11
    Date: 2005
  82. By: REY, Patrick; TIROLE, Jean
    JEL: L2 L3 D7
    Date: 2006–06
  83. By: Leo de Haan; Hubert Schokker; Anastassia Tcherneva
    Abstract: This study examines macro-economic developments around reversals in current account deficits in 29 OECD countries over four decades and draws some inferences for the present US deficit. Estimates of a probit model indicate that the deepness of the deficit itself, absence of spare production capacity and a beginning real depreciation are factors that increase the likelihood of a current account reversal in the following year. For the US each of these three indicators of a reversal are now on, making a near reversal probable. Over the past 40 years half of the current account deficit reversals in the OECD area were followed by a recession in the countries concerned.
    Keywords: Current account adjustment; US; forecasting reversals
    JEL: F32 F47
    Date: 2006–08
  84. By: C'line Gondat-Larralde; Erlend Nier
    Abstract: This paper provides an analysis of the competitive process in the market for personal current accounts in the United Kingdom. Using survey data, we first describe some stylised developments in this market over our sample period (1996-2001). We find a gradual change in the distribution of market shares over time. This contrasts with a marked dispersion in price, which appears to persist through time. Analysing the evolution of market shares, we address two key questions: (i) are bank market shares responding to price differentials?; (ii) if not, which type of imperfect competition best fits the data? Our conclusions point to the existence of customer switching costs as a key determinant of the nature of competition in the market for personal current accounts. The results of this study are therefore broadly supportive of a number of recent initiatives to facilitate switching bank accounts in the United Kingdom.
  85. By: Rob Alessie; Thomas Crossley (Institute for Fiscal Studies and McMaster University); Vincent Hildebrand
    Abstract: We estimate a collective household model with survey data on financial satisfaction from the European Community Household Panel. Our estimates suggest that cohabitating individuals enjoy returns to scale in consumption that are towards the larger end of the range of estimates reported in the literature. They also suggest that the share of household income provided by the female partner is a significant determinant of her share of household consumption in most countries of the countries we study.
    Keywords: Consumption, returns to scale, collective household models
    JEL: D12 D13 I31
    Date: 2006–09

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