nep-fmk New Economics Papers
on Financial Markets
Issue of 2008‒12‒14
six papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Northern Rock: The anatomy of a crisis – the prudential lessons By Sonia Ondo-Ndong; Laurence Scialom
  2. The regulation of hedge funds under the prism of the financial crisis By Michel Aglietta; Sandra Rigot
  3. The Private Equity Premium Puzzle Revisited : New Evidence on the Role of Heterogeneous Risk Attitudes By Frank M. Fossen
  4. Mispricing of S&P 500 Index Options By George M. Constantinides; Jens Carsten Jackwerth; Stylianos Perrakis
  5. Emerging Market Currency Excess Returns By Stephen Gilmore; Fumio Hayashi
  6. Bank competition and collateral: theory and evidence By Hainz , Christa; Weill , Laurent; Godlewski, Christophe

  1. By: Sonia Ondo-Ndong; Laurence Scialom
    Abstract: This paper attempts to analyse the main characteristics of the Northern Rock crisis and the responses of the Bank of England as lender of last resort. On the basis of the diagnosis about the causes and the handling of this banking crisis we detect the shortcomings prevailing in the UK prudential device. We therefore try to draw the prudential lessons of this experience. As we cannot claim to present an exhaustive picture of the crisis’s implications from a prudential point of view, we chose to focus instead on the points with practical significance far beyond the UK’s case.
    Keywords: bank bankruptcy, deposit insurance, liquidity regulation
    JEL: G38 G33 G32 G28
    Date: 2008
    URL: http://d.repec.org/n?u=RePEc:drm:wpaper:2008-23&r=fmk
  2. By: Michel Aglietta; Sandra Rigot
    Abstract: This paper deals with two issues. On the one hand, it shows that structural changes in financial markets and in the hedge funds industry make the “light-touch” arguments for regulating hedge funds no longer relevant. On the other hand, pleas for stronger regulation of hedge funds are getting more attention. In the first part of the paper the huge expansion of the industry is outlined and the state of current regulation is highlighted. In the second part an in-depth analysis of risks associated with hedge funds is carried out. It is shown that systemic risk can arise from leverage and from concentration of exposures amongst hedge funds. The part played by hedge funds in the spread of the crisis of structured credit is portrayed. In the third section, the recommendations of professional organisations, regulatory authorities and international institutions are summed up within the framework of risk mapping. This oversight shows the ways of reform: the need of direct regulation, the enhancement of indirect regulation and the overhaul of securitization. The prospective pattern of regulation encompasses macro and micro issues, and impinges upon factors of demand and supply. It emphasizes the enhanced role of public regulators and displays the conditions of an effective market discipline performed by long run institutional investors.
    Keywords: financial leverage, prime brokers, securitization, extreme risks, systemic risk, opacity, long run institutional investors, due diligence, monitoring, disclosure, market discipline, public regulator
    JEL: G23
    Date: 2008
    URL: http://d.repec.org/n?u=RePEc:drm:wpaper:2008-20&r=fmk
  3. By: Frank M. Fossen
    Abstract: The empirical finding that entrepreneurs tend to invest a large share of their wealth in their own firms despite comparably low returns and high risk has become known as the private equity premium puzzle. This paper provides evidence supporting the hypothesis that lower risk aversion of entrepreneurs, and not necessarily credit constraints, may explain this puzzle. The analysis is based on a large, representative panel data set for Germany, which provides information on asset portfolios and experimentally validated risk attitudes. The results show that both the ownership probability and the conditional portfolio share of private business equity significantly increase with higher risk tolerance.
    Keywords: Entrepreneurship, Private Equity, Investment, Risk Aversion
    JEL: G11 G32 L26 J23 D81
    Date: 2008
    URL: http://d.repec.org/n?u=RePEc:diw:diwwpp:dp839&r=fmk
  4. By: George M. Constantinides; Jens Carsten Jackwerth; Stylianos Perrakis
    Abstract: Widespread violations of stochastic dominance by one-month S&P 500 index call options over 1986-2006 imply that a trader can improve expected utility by engaging in a zero-net-cost trade net of transaction costs and bid-ask spread. Although pre-crash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data. Substantial violations by post-crash OTM calls contradict the notion that the problem primarily lies with the left-hand tail of the index return distribution and that the smile is too steep. The decrease in violations over the post-crash period 1988-1995 is followed by a substantial increase over 1997-2006 which may be due to the lower quality of the data but, in any case, does not provide evidence that the options market is becoming more rational over time.
    JEL: G12 G13
    Date: 2008–12
    URL: http://d.repec.org/n?u=RePEc:nbr:nberwo:14544&r=fmk
  5. By: Stephen Gilmore; Fumio Hayashi
    Abstract: We discuss the foreign currency forward premium puzzle in the context of 20 internationally tradable emerging market currencies. We find that since the late 1990s the broad basket of emerging market currencies has provided significant equity-like excess returns against a number of major market currencies, but with low volatility. We also find that the forward premium, or carry, is significant in explaining that excess return but that excess returns would still have existed even in the absence of positive carry. Our calculation shows that transactions cost due to bid/offer spreads is substantially lower than commonly supposed in the academic literature.
    JEL: F31 G11 G15
    Date: 2008–12
    URL: http://d.repec.org/n?u=RePEc:nbr:nberwo:14528&r=fmk
  6. By: Hainz , Christa (University of Munich); Weill , Laurent (Université Robert Schuman, Strasbourg); Godlewski, Christophe (University of Strasbourg)
    Abstract: We investigate the impact of bank competition on the use of collateral in loan contracts. We develop a theoretical model incorporating information asymmetries in a spatial competition framework where banks choose between screening the borrower and asking for collateral. We show that presence of collateral is more likely when bank competition is low. We then test this prediction empirically on a sample of bank loans from 70 countries. We estimate logit models where the presence of collateral is regressed on bank competition, measured by the Lerner index. Our empirical tests corroborate the theoretical predictions that bank competition reduces the use of collateral. These findings survive several robustness checks.
    Keywords: collateral; bank competition; asymmetric information
    JEL: D43 D82 G21
    Date: 2008–12–02
    URL: http://d.repec.org/n?u=RePEc:hhs:bofrdp:2008_027&r=fmk

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