Showing papers in "Annals of Finance in 2009"
TL;DR: The authors showed that the existence of financial constraints to the creation of businesses implies a non-monotonic relationship between wealth and entry into entrepreneurship: the probability of becoming an entrepreneur as a function of wealth is increasing for low wealth levels, as predicted by standard static models, but it is decreasing for higher wealth levels.
Abstract: Does wealth beget wealth and entrepreneurship, or is entrepreneurship mainly determined by an individual’s ability? A large literature studies the relationship between wealth and entry to entrepreneurship to inform this question. This paper shows that in a dynamic model, the existence of financial constraints to the creation of businesses implies a non-monotonic relationship between wealth and entry into entrepreneurship: the probability of becoming an entrepreneur as a function of wealth is increasing for low wealth levels—as predicted by standard static models—but it is decreasing for higher wealth levels. U.S. data are used to study the qualitative and quantitative predictions of the dynamic model. The welfare costs of borrowing constraints are found to be significant, around 6% of lifetime consumption, and are mainly due to undercapitalized entrepreneurs (intensive margin), rather than to able people not starting businesses (extensive margin).
225 citations
TL;DR: A review of the main studies on entrepreneurship conducted during the past two decades that are relevant for the understanding of various macroeconomic issues is presented in this article, where three groups of contributions are identified: factors that affect the decision to become an entrepreneur, aggregate and distributional implications of entrepreneurship for savings and investment, and issues of economic development and growth.
Abstract: This paper reviews the main studies on entrepreneurship conducted during the past two decades that are relevant for the understanding of various macroeconomic issues. I organize the discussion by distinguishing three groups of contributions. The first group includes studies whose main purpose is to understand the factors that affect the decision to become an entrepreneur. The second group includes studies that look at the aggregate and distributional implications of entrepreneurship for savings and investment. The third group deals with issues of economic development and growth.
124 citations
TL;DR: In this article, the authors focus on the financing of very small entrepreneurs in Italy by using data in the Survey of Household Income and Wealth and find that only a little more than one fourth of these micro-firms used bank loans for business purposes.
Abstract: This paper focuses on the financing of very small entrepreneurs in Italy by using data in the Survey of Household Income and Wealth. In the period 1989–2006 only a little more than one fourth of these micro-firms used bank loans for business purposes. Supply factors may have played a role in explaining this low usage of bank loans. In this paper I look at what happens after the deregulation and innovation that started in the Italian credit market during the 1990s. Financial constraints appear to have partly lessened in the current decade. Specifically, the North/South divide is fading a little: the negative direct effect on the probability of having a bank loan for a firm located in a Southern region is less strong. However, business location still plays an important role in the process of credit allocation, though indirectly through a greater sensitivity to proxies of internal finance for small entrepreneurs located in regions that are less financially developed.
83 citations
TL;DR: In this article, the authors investigate the viability of three alternative parametric families to represent both the stylised and empirical facts: the generalised hyperbolic distribution, the generalized logF distribution, and finite mixtures of Gaussians.
Abstract: Simple parametric models of the marginal distribution of stock returns are an essential building block in many areas of applied finance. Even though it is well known that the normal distribution fails to represent most of the “stylised” facts characterising return distributions, it still dominates much of the applied work in finance. Using monthly S&P 500 stock index returns (1871–2005) as well as daily returns (2001–2005), we investigate the viability of three alternative parametric families to represent both the stylised and empirical facts: the generalised hyperbolic distribution, the generalised logF distribution, and finite mixtures of Gaussians. For monthly return data, all three alternatives give reasonable fits for all sub-periods. However, the generalised hyperbolic distribution fails to describe some features of the marginal distributions in some sub-periods. The daily return data are much more symmetric and expose another problem for all three distributions: the parameters describing the behaviour of the tails also influence the scale so that simpler alternatives or restricted parameterisations are called for.
60 citations
TL;DR: This paper revisited the empirical relationship between the probability of transition to entrepreneurship and wealth and found that the transition probability profile is hump-shaped in wealth across cohorts defined by age and education.
Abstract: This paper revisits the empirical relationship between the probability of transition to entrepreneurship and wealth. Given that wealth is correlated with both education and age, these observable characteristics cannot be treated as independent covariates in the estimation. Thus, I document the differences in the transition probability profile across age and education groups. The main result of this paper is that the estimated probability of transition to entrepreneurship is hump-shaped in wealth across cohorts defined by age and education. Therefore, the aggregate profile estimated by Hurst and Lusardi (J Polit Econ 112(2):319–347, 2004) is not representative at the micro level. In addition, this paper provides facts that evidence important differences between entrepreneurs and workers, as well as among entrepreneurs, across education and age.
42 citations
TL;DR: In this article, the authors examined changes in self-employment that have occurred since the early 1980s in the United States and found evidence of discrimination in the small business credit market, and found that firms owned by minorities in general and blacks in particular are much more likely to have their loans denied and pay higher interest than is the case for white males.
Abstract: In this paper I examine changes in self-employment that have occurred since the early 1980s in the United States. It is a companion paper to a recent equivalent paper that related to the UK. Data on random samples of approximately twenty million US workers are examined taken from the Basic Monthly files of the CPS (BMCPS), the 2000 Census and the 2006 American Community Survey (ACS). In contrast to the official definition of self-employment which simply counts the numbers of unincorporated self-employed, we also include the incorporated self-employed who are paid wages and salaries. The paper presents evidence on trends in self-employment for the US by race, ethnicity and gender. Evidence is also presented for construction which has self-employment rates roughly double the national rates and where there are strikingly high racial and gender disparities in self-employment rates. The construction sector is also important given the existence of public sector affirmative action programs at the federal, state and local levels directed at firms owned by women and minorities. I document the fact that disparities between the self-employment rates of white men and white women and minorities in construction narrowed in the 1980s, widened during the 1990s after the US Supreme Court’s decision in Croson but then narrowed again since 2000 after a number of legal cases, which found such programs constitutional. Despite this substantial disparities remain, particularly in earnings. I also find evidence of discrimination in the small business credit market. Firms owned by minorities in general and blacks in particular are much more likely to have their loans denied and pay higher interest than is the case for white males. This is only partially explained by their lack of creditworthiness and is consistent with a finding of discrimination in the credit market by banks.
38 citations
TL;DR: This article investigated three behavioral tendencies that cause investors to deviate from optimal investing: the status quo bias, the ostrich effect, and the disposition effect, finding that subjects do trade for better stocks, but do not reach their maximum potential earnings, most commonly because they choose to ignore information and continue to hold on to a stock regardless of its performance.
Abstract: Previous literature suggests specific behavioral tendencies cause investors to deviate from optimal investing. We investigate three such tendencies in a simplified stock market. Subjects do trade for better stocks, but do not reach their maximum potential earnings, most commonly because they choose to ignore information and continue to hold on to a stock regardless of its performance. The results support the predictions of the status quo bias, but not the ostrich effect or the disposition effect.
34 citations
TL;DR: This paper used Survey of Small Business Finance data to better understand how the owners of small firms use decisions about legal organization, firm size, capital structure, and owner investment in the firm to manage firm risk.
Abstract: This paper uses Survey of Small Business Finance data to better understand how the owners of small firms use decisions about legal organization, firm size, capital structure, and owner investment in the firm to manage firm risk. The main findings are: Firms with unlimited liability are smaller, both when measured by assets and number of employees, and tend to be less leveraged than those whose owners limit personal exposure to firm liabilities. Entrepreneurs tend to hold largely undiversified positions by investing heavily in their firms, and this does not differ appreciably by legal organization. The percentage of firms with limited liability has remained virtually constant through time, although within this group there is a trend toward hybrid legal organizations with beneficial tax treatment. We estimate return on assets and find that entrepreneurship is a very risky undertaking, with high upside gain. The possibility of high future returns helps explain the coexistence of a large percentage of firms with negative equity and low default rates. The shape of the return distribution and limited liability interact; the option to declare bankruptcy shields owners from personal loss in the lower tail of the distribution while preserving the potential for significant firm returns in the upper tail.
30 citations
TL;DR: The authors summarizes interviews from 1998 with 590 individuals trying to create a business centered around five questions: "Who are you?", "What are you trying to accomplish?", "What have you and others put into the business?", ''What have been accomplished?" and ''What remains to be done?"
Abstract: This paper summarizes interviews from 1998 with 590 individuals trying to create a business centered around five questions: “Who are you?”, “What are you trying to accomplish?”, “What have you and others put into the business?”, “What have you accomplished?”, “What remains to be done?” These Nascent Entrepreneurs are remarkably similar to the general population. Most have already made personally significant investments of time and money in their firms. For about half of them, these investments have yielded a fully specified product. Their most substantial sources of seed money are their own savings and loans from family and friends. A small minority of Nascent Entrepreneurs have applied for formal business loans, and only half of those applications have been approved.
27 citations
TL;DR: In this article, the authors consider the optimal contract between banks and entrepreneurs in an economy in which limitations in the punishments for default induce limiting in the credit available to entrepreneurs, and derive a very simple characterization of the optimal contracts at the time of inception of firms and show how this optimal contract shapes the evolution of the size distribution of firms.
Abstract: The presence of credit constraints can shape the entry, growth, and size distribution of firms. In this paper, I consider the optimal contract between banks and entrepreneurs in an economy in which limitations in the punishments for default induce limitations in the credit available to entrepreneurs. I derive a very simple characterization of the optimal contract at the time of inception of firms and show how this optimal contract shapes the evolution of the size distribution of firms and the aggregate levels of entrepreneurial activity and output.
20 citations
TL;DR: The uncovered interest parity (UIP) condition suggests that carry trades whereby investors borrow in the low interest rate currency and invest in the high interest level currency should not result in excess profits over the long run as mentioned in this paper.
Abstract: The uncovered interest parity (UIP) condition suggests that carry trades whereby investors borrow in the low interest rate currency and invest in the high interest rate currency should not result in excess profits over the long run. In this paper, we test the significance of the conventional empirical failure of UIP condition. Using the four bilateral pound parities we fail to detect significant excess carry trade profits for the yen, euro and swiss franc–pound parities. The only parity for which the carry trade consistently makes excess profits is the dollar–pound parity. This result is somewhat surprising as this is the currency pair with the lowest interest rate differential.
TL;DR: In this article, the authors show that credit use is not informative for predicting either rates of self-employment or the scale of Self-Employment projects, whereas alternatives in paid work are crucial for explaining self-employment rates.
Abstract: Self-employment rates and project size vary greatly across countries. The main message of this paper is that these broad regularities are consistent with an environment in which a common self-employment technology is available worldwide, but where (a) financial intermediation costs and (b) alternatives in “paid” work differ greatly. Our model indicates that alternatives in paid work are crucial for explaining self-employment rates, whereas high financial intermediation costs primarily affect the scale of projects. We also show that credit use is not informative for predicting either rates of self-employment or the scale of self-employment projects.
TL;DR: In this paper, the optimal risk allocation problem is formulated as an infimal convolution problem for agents whose choice functionals are law-invariant with respect to different probability measures.
Abstract: We model agents’ preferences by cash-invariant concave functionals defined on L∞, and formulate the optimal risk allocation problem as their infimal-convolution. We study the case of agents whose choice functionals are law-invariant with respect to different probability measures and show how, in this case, the value function preserves a desirable dual representation (equivalent to the Fatou property).
TL;DR: In this article, the authors analyze the impact of prior performance on the risk-taking behavior of mutual fund managers by using different measures of risks, a larger data set, and an econometric approach capturing non-linear effects and assigning exact probabilities to the managers' adjustment of behavior.
Abstract: We analyze the impact of prior performance on the risk-taking behavior of mutual fund managers. We contribute to the existing literature by using different measures of risks, a larger data set, and an econometric approach capturing non-linear effects and assigning exact probabilities to the mutual fund managers’ adjustment of behavior. We find that prior performance in the first half of the year has, in general, a positive impact on the choice of the risk level in the second half of the year. Successful fund managers increase the volatility, the beta, and assign a higher proportion of their portfolio to value stocks, small firms, and momentum stocks in comparison to unsuccessful fund managers. Unsuccessful fund manager increase, on average, only the tracking error.
TL;DR: In this article, the effect of the fixing published by the European Central Bank (ECB) on the hedge of discretely monitored barrier options is examined and a cost based on the additional uncertainty encountered is suggested.
Abstract: In Foreign Exchange Markets vanilla and barrier options are traded frequently The market standard is a cutoff time of 10:00 am in New York for the strike of vanillas and a knock-out event based on a continuously observed barrier in the inter bank market However, many clients, particularly from Italy, prefer the cutoff and knock-out event to be based on the fixing published by the European Central Bank on the Reuters Page ECB37 These barrier options are called discretely monitored barrier options While these options can be priced in several models by various techniques, the ECB source of the fixing causes two problems First of all, it is not tradable, and secondly it is published with a delay of about 10–20 min We examine here the effect of these problems on the hedge of those options and consequently suggest a cost based on the additional uncertainty encountered
TL;DR: In this article, the authors establish necessary and sufficient conditions for a linear taxation system to be neutral within the multi-period discrete time "no arbitrage" model, in the sense that valuation is invariant to the exact sequence of tax rates, realization dates as well as immune to timing options attempting to twist the time profile of taxable income through wash sale transactions.
Abstract: We establish necessary and sufficient conditions for a linear taxation system to be neutral—within the multi-period discrete time “no arbitrage” model—in the sense that valuation is invariant to the exact sequence of tax rates, realization dates as well as immune to timing options attempting to twist the time profile of taxable income through wash sale transactions.
“In the study of investments, taxes are largely a source of embarrassment to financial economists.”
(Introduction to Dybvig and Ross 1986)
“Accordingly, my approach in this chapter is to examine the restrictions on the income measurement rules applicable to financial instruments implied by the requirement that the rules be linear. . . . Linearity is a desideratum of a tidy tax system.”
(Bradford 2000, p. 373–374)
TL;DR: This paper surveyed the previous studies on entrepreneurship and macroeconomics and found that despite the vast existing literature on entrepreneurship, much remains to be learned, despite the fact that there is a large body of work on entrepreneurship.
Abstract: Despite the vast existing literature on entrepreneurship, much remains to be learned. This special issue starts with a review article surveying the previous studies on entrepreneurship and macroeconomics. It then moves to empirical papers that use various data sets to ask key questions about entrepreneurship such as: how do new entrepreneurs start a business? How do entrepreneurs manage risk by choosing both their legal organization and their portfolios, and how high are the returns compensating for such risks? Are some entrepreneurs discriminated against because of their race? Does financial market deregulation relax the entrepreneurs’ borrowing constraints?
TL;DR: In this article, the authors studied the capital accumulation and welfare implications of reducing capital income taxation in a general equilibrium economy with uninsurable investment risks and showed that reducing somewhat the capital income tax rate increases the capital stock and leads to a welfare gain.
Abstract: This paper studies the capital accumulation and welfare implications of reducing capital income taxation in a general equilibrium economy with uninsurable investment risks. It has been shown that, with uninsurable investment risks, under-accumulation of capital may result compared to the complete markets economy. We show that reducing somewhat the capital income tax rate increases the capital stock and leads to a welfare gain. The complete elimination of the capital income tax, however, is not necessarily welfare improving.
TL;DR: In this article, Dai and Singleton formalized and extended their results to a class of time-inhomogeneous ATSMs, and obtained a simple method for determining the indistinguishability of these models in terms of the underlying factor dynamics.
Abstract: In specifying a finite factor model for the term structure of interest rates, one usually begins by modeling the dynamics of the underlying factors. In most cases, this is sufficient to completely determine the term structure model. However, a point that is often overlooked is that seemingly different specifications of the factor dynamics may generate indistinguishable term structure models, in the sense that they produce pathwise identical bond prices. Consequently, it is important to be able to determine, at the level of factor dynamics, the conditions under which the models they generate are indistinguishable. In the case of time-homogeneous affine term structure models (ATSMs), such conditions were first described in Dai and Singleton (J Finance 55:1943–1978, 2000). In this paper, we formalize and extend their results to a class of time-inhomogeneous ATSMs, and obtain a simple method for determining the indistinguishability of these models in terms of the underlying factor dynamics.
TL;DR: In this article, it was shown that the compensating variation in endowment is the exact general equilibrium measure of welfare costs of perfectly anticipated inflation, and that a good approximation to the welfare costs is given by the area under the compensated demand for M0, a result that brings us back to Bailey (J Polit Econ 64:93-110, 1956).
Abstract: In monetary models where M0 has no social costs and a positive demand for cash and deposits is taken as a primitive, we show that the compensating variation in endowment is the exact general equilibrium measure of welfare costs of perfectly anticipated inflation. As a consequence, we show that a good approximation to the welfare costs of inflation is given by the area under the compensated demand for M0, a result that brings us back to Bailey (J Polit Econ 64:93-110, 1956). The estimated welfare costs of inflation are bounded at less than a quarter of a percent of the GDP for the U.S. economy.
TL;DR: This paper showed that put options held by bank owners dominate deposit financing in that they also discipline bankers but do not give rise to inefficient runs, thus not necessary for liquidity creation in the Diamond-Rajan framework.
Abstract: Diamond and Rajan (J Finance 55:2431–2465, 2000; Am Econ Rev Papers Proc 91:422–425, 2001a; Carnegie–Rochester Conf Series Public Policy 54:37–71, 2001b; J Pol Econ 109:287–327, 2001c) have shown in a series of papers that it is precisely the fragility of their capital structure which allows banks to create liquidity. This is because the threat of runs by depositors forces bankers to extract full repayment on otherwise illiquid assets. This result has important implications for financial regulation, such as for capital requirements and deposit insurance. This note shows that put options held by bank owners dominate deposit financing in that they also discipline bankers but do not give rise to inefficient runs. Fragility is thus not necessary for liquidity creation in the Diamond–Rajan framework.
TL;DR: In this article, a duopolistic credit market in which borrowers differ in risk is studied, and one lender is in an advantaged position with respect to the other due to past relations with the borrowers.
Abstract: This paper studies a duopolistic credit market in which borrowers differ in risk. In our competition game, one lender is in an advantaged position with respect to the other due to past relations with the borrowers. We investigate the features of the equilibrium contract and show that the best borrower is indifferent between the dominant and the opponent lenders’ contract while the other borrowers prefer that of the dominant lender. Also, repayment and collateral do not depend upon the borrowers’ respective project risk.
TL;DR: In this paper, the authors studied the effect of competition between banks and financial markets on risk-sharing offered by deposit contracts in a competitive financial system and showed that if competition among banks mainly affects the reallocation of deposits, then such competition only limits inefficient monopoly rents without restraining risk sharing.
Abstract: A competitive financial system can help reduce banks’ monopoly power and the associated inefficiencies. However, according to Diamond (J Polit Econ 105: 928–956, 1997) and Fecht (J Eur Econ Assoc 6(2), 2004) competition with the financial sector may also constrain the amount of liquidity insurance that banks can provide to households affected by unobservable idiosyncratic liquidity shocks. To study this trade-off, we model competition between banks and between banks and financial markets. Our analysis shows that competition between banks and financial markets can constrain the risk-sharing offered by deposit contracts. This effect is the same if competition between banks mainly affects the reallocation of deposits. However, if banking competition primarily affects new deposits, then such competition only limits inefficient monopoly rents without restraining risk-sharing.
TL;DR: In this paper, the authors consider an infinite horizon cash-in-advance market economy with symmetric agents and show that the expected rate of inflation across each cycle of length k is strictly greater with random endowments from cyclic distributions than with deterministic ones.
Abstract: We consider an infinite horizon cash-in-advance market economy with symmetric agents. In each stage, a representative agent receives an independent, random endowment from one of k known distributions. The endowment distribution changes cyclically across stages. We suppose that a central bank sets a fixed, nominal interest rate for both borrowing and investing. In equilibrium, the expected rate of inflation across each cycle of length k is strictly greater with random endowments from cyclic distributions than with deterministic endowments.
TL;DR: The authors proposed a more accurate procedure for calibrating two models: Leland-Toft and Collin-Dufresne and Goldstein (J Finance 56:2177-2208, 2001).
Abstract: Empirical findings are mixed about the performance of structural models for term structure of credit spreads. It is commonly believed that all structural models have equally poor performance after calibration. However, proper calibration is not a trivial issue, especially for highly structural models. This paper proposes a more accurate procedure for calibrating two models: Leland–Toft (J Finance 51:987–1019, 1996) and Collin-Dufresne and Goldstein (J Finance 56:2177–2208, 2001). Using rating-based bond data, we find that the Leland–Toft model has significantly greater explanatory power for credit spreads across rating categories than previously reported. We provide theoretical explanations for these findings, and further extend our empirical analysis to include 286 individual senior bonds. Our findings help clarify the controversies over the performance of structural models in general and that of the Leland–Toft model in particular. In addition, we offer a rigorous procedure that can be used for calibrating other structural models more effectively.