New Economics Papers
on Financial Markets
Issue of 2008‒12‒07
eight papers chosen by

  1. Mutual Fund Competition in the Presence of Dynamic Flows By Michèle Breton; Julien Hugonnier; Tarek Masmoudi
  2. The case for TIPS: an examination of the costs and benefits By Jennifer Roush; William Dudley; Michelle Steinberg Ezer
  3. Optimal personal bankruptcy design : A Mirrlees approach By Borys Grochulski
  4. Stock Market in Pakistan: An Overview By Iqbal, Javed
  5. The rise in mortgage defaults By Christopher J. Mayer; Karen M. Pence; Shane M. Sherlund
  6. "Minsky and Economic Policy A Minskyan Analysis of the Subprime Crisis" By Luisa Fernandez
  7. More myths about the financial crisis of 2008 By Tatom, John
  8. The Fed’s new front in the financial crisis By Tatom, John

  1. By: Michèle Breton (CREF, GERAD, and HEC Montr´eal); Julien Hugonnier (University of Lausanne and Swiss Finance Institute); Tarek Masmoudi (Caisse de d´epˆot et placement du Qu´ebec (CDPQ))
    Abstract: This paper analyzes competition between mutual funds in a multiple funds version of the model of Hugonnier and Kaniel [18]. We characterize the set of equilibria for this delegated portfolio management game and show that there exists a unique Pareto optimal equilibrium. The main result of this paper shows that the funds cannot differentiate themselves through portfolio choice in the sense that they should offer the same risk/return tradeoff in equilibrium. This result brings theoretical support to the findings of recent empirical studies on the importance of media coverage and marketing in the mutual funds industry.
    Keywords: portfolio management, asset-based management fees, mutual funds, dynamic flows, stochastic differential game.
    JEL: G11 G12 C61
    Date: 2008–09
  2. By: Jennifer Roush; William Dudley; Michelle Steinberg Ezer
    Abstract: Several studies have shown that, ex-post, the issuance of Treasury Inflation-Protected Securities (TIPS) has cost U.S. taxpayers money. We propose that evaluations of the TIPS program be more comprehensive and focus on the ex-ante costs of TIPS issuance versus nominal Treasury issuance and, especially when these costs are negligible, the more difficult-to-measure benefits of the program. Our study finds that the ex-ante costs of TIPS issuance versus nominal Treasury issuance are currently about equal and that TIPS provide meaningful benefits to investors and policymakers.
    Keywords: Treasury bonds ; Government securities ; Inflation risk ; Liquidity (Economics)
    Date: 2008
  3. By: Borys Grochulski
    Abstract: In this paper, we develop a normative theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. First, in order to characterize this trade-off, we solve a dynamic moral hazard problem in which agents' private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which (i) agents and intermediaries repeatedly trade in secured and unsecured debt instruments, and (ii) agents obtain (restricted) discharge of their unsecured debts in bankruptcy. The structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States.
    Keywords: Bankruptcy ; Credit
    Date: 2008
  4. By: Iqbal, Javed
    Abstract: This paper reviews the main features of the Stock market in Pakistan focussing on post-liberalization period. The aspects of the market investigated include liberalization of the market, integration the market with the world markets, trading and settlement mechanism, and corporate governance issues. Finally salient features of the market are compared to a selected set of emerging and developed markets. Pakistan’s stock market is smaller in size but is significantly more active than the markets of this size. In recent years the market has provided very high returns to investors. In 2002 the market was declared as the best performing stock market globally.
    Keywords: Stock Market; Pakistan
    JEL: G10
    Date: 2008–07
  5. By: Christopher J. Mayer; Karen M. Pence; Shane M. Sherlund
    Abstract: The main factors underlying the rise in mortgage defaults appear to be declines in house prices and deteriorated underwriting standards, in particular an increase in loan-to-value ratios and in the share of mortgages with little or no documentation of income. Contrary to popular perception, the growth in unconventional mortgages products, such as those with prepayment penalties, interest-only periods, and teaser interest rates, does not appear to be a significant factor in defaults through mid-2008 because borrowers who had problems with these products could refinance into different mortgages. However, as markets realized the extent of the poor underwriting, underwriting standards tightened and borrowers began to face difficulties refinancing; this dynamic suggests that these unconventional products could pose problems going forward.
    Date: 2008
  6. By: Luisa Fernandez
    Abstract: The paper uses Minsky’s financial instability hypothesis as an analytical framework for understanding the subprime mortgage crisis and for introducing adequate reforms to restore economic stability. We argue that the subprime crisis has structural origins that extend far beyond the housing and financial markets. We further argue that rising inequality since the 1980s formed the breeding ground for the current financial markets meltdown. What we observe today is only the manifestation of the ingenuity of the market in taking advantage of moneymaking opportunities, regardless of the consequences. The so-called "democratization of homeownership" rapidly turned into record-high delinquencies and foreclosures. The sudden turn in market expectations led investors and banks to reevaluate their portfolios, which brought about a credit crunch and widespread economic instability. The Federal Reserve Bank's intervention came too late and failed to usher in adequate regulation. Finally, the paper argues that a true democratization of homeownership is only possible through job creation and income-generation programs, rather than through exotic mortgage schemes.
    Date: 2008–11
  7. By: Tatom, John
    Abstract: There are numerous myths that surround the financial crisis that began in August 2007. Some of these myths are about the role of bank credit in the crisis, while others concern the weakness of the U.S. banking system and supposed excess leverage—the ratio of assets to equity in banks-- in contributing to the crisis. This paper provides evidence that net new commercial and industrial loans at banks did not slow before the financial crisis began in August 2007, nor was there any slowing in the early months. A subsequent slowing did reach its lowest pace in June-August 2008, but even at its worst, it was not particularly severe. The paper also looks at the safety and soundness of banks as indicated by their equity-assets ratio. The concern is that bank assets are troubled and excessively leveraged, with very low equity-asset ratios so that banks could have to “deleverage” or reduce lending as their equity declines. The shrinkage of bank equity and assets due to deleveraging could deepen the recession. But banks have not suffered significant declines in their equity ratios and they have been holding near record equity ratios. Moreover bank assets are growing rapidly, with equity nearly keeping pace. Ironically the Treasury’s Troubled Asset Relief Program will add $270 beginning in the fourth quarter. The TARP’s injections of bank capital have dried up private sector injections that had appeared on the horizon from sovereign wealth funds and private equity. Equity ratios of banks could become strained in future as total loans and assets continue to expand. The financial crisis has not undermined the safety and soundness of the commercial banking system. It is not likely to do so because most of the expected losses from the foreclosure crisis have already been taken into provisions. Nonetheless, many banks heavily exposed to mortgage losses have failed and more will fail.
    Keywords: foreclosure crisis; deleverage; bank credit;
    JEL: G28 G21
    Date: 2008–11–25
  8. By: Tatom, John
    Abstract: The continuing foreclosure crisis worsened in October 2008. The Federal Reserve (Fed) continued the aggressive expansion of new private credit that it began in mid-September and it created three new credit facilities to add to the plethora of other facilities created since the financial crisis component of the foreclosure crisis began in August 2007. These new facilities are aimed at stabilizing the commercial paper (CP) market, most recently adversely affected by the failure of Lehman Brothers and the failures of several money market mutual funds (MMMF). From mid-September to the end of October, the Fed more than doubled its total assets, largely by expanding its private sector lending. Perhaps the most significant question to emerge over the past two months is whether the Fed has an exit strategy to pull all of this new financial asset creation out after it succeeds in stemming deflation and before it kick starts the economy into a major inflation problem.
    Keywords: commercial paper; monetary policy; financial crisis
    JEL: E58 G28 G21
    Date: 2008–10–31

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NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.