Showing papers on "Financial market published in 1986"

Asymmetric Information and Risky Debt Maturity Choice

Abstract: When capital market investors and firm insiders possess the same information about a company's prospects, its liabilities will be priced in a way that makes the firm indifferent to the composition of its financial liabilities (at least under certain, well-known circumstances). However, if firm insiders are systematically better informed than outside investors, they will choose to issue those types of securities that the market appears to overvalue most. Knowing this, rational investors will try to infer the insiders' information from the firm's financial structure. This paper evaluates the extent to which a firm's choice of risky debt maturity can signal insiders' information about firm quality. If financial market transactions are costless, a firm's financial structure cannot provide a valid signal. With positive transaction costs, however, high-quality firms can sometimes effectively signal their true quality to the market. The existence of a signalling equilibrium is shown to depend on the (exogenous) distribution of firms' quality and the magnitude of underwriting costs for corporate debt. THE CONDITIONS UNDER WHICH financing decisions are irrelevant to a firm's market value and real investment incentives are now well-established. Most of the literature in this area has assumed, inter alia, that firm insiders and the market fully share all available information about the distribution of returns accruing to real investment opportunities. In this situation, insiders and outsiders agree about the value of possible financing changes, and equilibrium security prices make the firm indifferent among alternative financing plans. However, if the market's information is less accurate than insiders' information, firms with different "intrinsic" (or insider's) values will be indistinguishable to outsiders. Insiders may then prefer one type of financing plan over another even in equilibrium. Stiglitz [16] first showed how differences between owners' and potential lenders' bankruptcy assessments will lead to an optimal debt-equity ratio. Subsequently, Leland and Pyle [7] and Ross [14] evaluated the signalling implications of asymmetric information for capital market equilibrium, demonstrating that insiders could-and would-adjust the firm's financial structure to signal their assessment of true firm quality. (Downes and Heinkel [4] have provided empirical evidence supporting Leland and Pyle's main hypothesis about market valuation, although Ritter [13] questions the robustness of their results.) Campbell and Kracaw [3] described how relatively high-quality firms would willingly pay

Oligopoly and Financial Structure: The Limited Liability Effect

Abstract: We argue that product markets and financial markets have important linkages. Assuming an oligopoly in which financial and output decisions follow in sequence, we show that limited liability may commit a leveraged firm to a more aggressive output stance. Because firms will have incentives to use financial structure to influence the output market, this demonstrates a new determinant of the debt

Asset Pricing in a Production Economy with Incomplete Information

Abstract: This paper analyzes an economy in which investors operate under partial information about technology-relevant state variables. It is shown that for Gaussian information structures under incomplete observations, the consumer's problem can be transformed into an equivalent program with a completely observed state: the conditional expectation of the underlying unobservable state variables. A consequence of this transformation is that classic results in finance remain valid under an appropriate reinterpretation of the state variables. THE STATIC CAPITAL ASSET Pricing Model (CAPM) of Sharpe [24], Lintner [16], and Mossin [20] states that the expected premium on any risky asset is proportional to the premium on the market as a whole. This theoretical linear relationship, however, is subject to criticisms on two grounds. First, it does not seem to be supported by the empirical evidence.' Second, it is based on the premises of a constant opportunity set. Merton [19] subsequently relaxes this assumption, and shows that when the opportunity set fluctuates over time due to changes in the state of the economy, individual securities are also priced with respect to selected portfolios (funds), providing a hedge against unanticipated fluctuations.2 More recently, Breeden [3] has extended Merton's results by emphasizing the role of aggregate consumption in pricing relationships. In this paper, we seek to further our understanding of asset pricing by relaxing the assumption that investors observe the state of the economy. In the MertonBreeden framework, observed state variables affect the means and variances of asset returns, implying deformations of the opportunity set over time. From a practical point of view, it seems that this complete information assumption is violated. Investors in financial markets operate under partial knowledge of the microvariables which influence production and the returns on assets. Their decisions rely mostly on information through noisy channels such as newspapers, technical reviews, or weather reports. In this paper, we attempt to model such

Tobin's q and the Structure-Performance Relationship: Comment

Abstract: The exchange of comments between William Shepherd and Michael Smirlock, Thomas Gilligan, and William Marshall (this Review, December 1986) raised two key points that remain unresolved. The first point is whether Tobin's q ratio, a firm's financial market value divided by replacement cost of its assets, is a better measure of firm performance than accounting rates of return. The second point of contention is whether superior performance, however measured, can be attributed to efficiency rather than market power. This paper offers further clarification on both of these points. In Section I the performance measure choice is shown to be influenced by fundamental differences between finance and economics. In Section II, the structure-performance model employed by Smirlock, Gilligan, and Marshall (hereafter, SGM) and Shepherd is shown to be a special case of a more general model allowing for a dependence of the market-share-performance relationship on the concentration ratio. The same data from the original study by SGM (1984) are used in Section III to provide a comparison of SGM's findings with empirical results from an alternative specification of the structure-performance model. This comparison suggests that attributing superior firm performance exclusively to efficiency is not well founded. Concluding remarks are found in Section IV.

Alternative Explanations of the Money-Income Correlation

Abstract: Standard explanations of the bivariate correlation of money and income attribute this correlation to an inability of agents to discriminate in the short run between real and nominal sources of price shocks. This paper is an empirical comparison of the standard explanation with two alternatives: 1) the"credit view", which focuses on financial market imperfections rather than real-nominal confusion; and 2) the real business cycle approach, which argues that the money-income correlation reflects a passive response of money to income. The methodology, which is a variant of the Sims VAR approach, follows Blanchard and Watson (1984) in using an estimated, explicitly structural model to orthogonalize the VAR residuals. (This variant methodology, I argue, is the more appropriate for structural hypothesis testing.) The results suggest that the standard explanations of the money-income relation are largely, but perhaps not completely, displaced by the alternatives.

International financial markets

Abstract: This text delineates the basic rules of the game in each of the three major international financial markets - foreign exchange, eurocurrencies, and international bonds. Content is presented as the prerequisite material for later courses in multinational corporate finance, open-economy macroeconomics, and international banking.

Callable Bonds: A Risk-Reducing Signalling Mechanism

Abstract: The theory of financial economics has failed to distinguish advantages of callable bonds from those of short-term debt. This paper shows that either type of borrowing can signal a firm's better prospects but that short-term debt does so at the cost of weakened risk-sharing with capital markets. By issuing either equity or long-term, non-callable debt, a firm with poor investment opportunities will not pool its prospects with those of a better firm. But equity produces superior risk-sharing. Perhaps this explains the almr,ost complete absence of long-term, non-callable bonds from observed corporate capital structures. FINANCIAL THEORY HAS FOUND only moderate success in explaining the routine inclusion of call provisions among the covenants of corporate bonds. In the absence of market imperfections or incompleteness, the incremental compensation promised to bondholders should exactly offset the value of the call provision retained by equityholders. Indifference should obtain.1 Nevertheless, it is hard to accept indifference as an explanation, given the near universality of call provisions in corporate bond contracts. In this paper, we argue that, in the presence of asymmetric information about investment quality, corporate managers can signal their firm's better prospects by issuing bonds that include call provisions. Our major result shows that this signalling mechanism can be more attractive to risk-averse managers than would be the choice of short-term debt (which could also serve to signal). Furthermore, we demonstrate that non-callable corporate debt is a dominated security. That is, both it and equity signal "Bad News," but equity provides risk-sharing. This finding helps to explain the relative absence of long-term, non-callable debt from corporate financial markets. Previous attempts to explain the prevalence of call provisions in corporate bond contracts fall into four categories. Two categories involve pure wealth transfers from bondholders to stockholders. In these constant sum environments, a gain to one group constitutes a loss to the other. In the first category, managers possess private information with regard to future interest rate movements. Issuing callable bonds will capture gains for stockholders when anticipated drops

The Effects of Changing Margin Levels on Futures Market Activity, the Composition of Traders in the Market, and Price Performance

Abstract: In December 1984 the Board of Governors of the Federal Reserve System released "A Review and Evaluation of Federal Margin Regulation" (Federal Reserve Bank 1984). This study reexamined the purpose and the necessity of federal margin regulation in light of the changing structure of U.S. and foreign financial markets. Four major issues related to the effect and usefulness of security margin requirements were discussed, including (a) the diversion of credit from productive investment to purely speculative endeavors; (b) the protection of unsophisticated investors, who might overextend their private financial resources; (c) the protection of brokers from customer default; and (d) the use of credit limitations to forestall undue destabilizing price fluctuations. Two issues related to the coordination of margin requirements on securities, options, and fu-

Exchange risk surprises in international portfolios

Abstract: 44 T his paper will show, perhaps startlingly, s $ 2 that some foreign stock market indexes were more, and none was less, exposed to exchange risk than foreign bonds between 1976 and 1979; that their exposures have generally risen since October 1979 compared to the earlier period; and that the power of portfolio diversification to reduce exposure to any given exchange rate may recently have fallen. Enroute, we offer a practical method for measuring portfolio exchange risk exposures. The possibility that these exposures to exchange risk should be hedged may be important. The vehicle for reaching these results is a new way of defining exchange risk exposure. Until now, this has been the province of accounting conventions. Here we take a financial markets approach that is applicable to stock and bond price data. Following Adler and Dumas ([l] and [3]), we define exposure as a (set of) regression coefficient(s) to be estimated in the same way as beta, the ubiquitous relative-risk measure employed in domestic portfolio analysis. This definition has the desirable property of being theoretically correct for investors who aim to hold mean-variance efficient portfolios and whose hedging instruments consist of forward and futures contracts. It has the further dual virtue of being implementable and, as we shall note, of leading to a natural way to decompose investment returns into their dollar and foreign currency components. The paper is organized as a sequence of several short sections. We first discuss the definition of cur\D rency risk exposure, derived in Adler and 1)umas ([3; appendix]), and its connection to hedging. The next section surveys the empirical procedurles and describes the data. The three following sections present, respectively, the results of estimating the exposures of foreign bonds, of individual-country stock indexes, and of diversified portfolios of stocks. We then compare and contrast the regression-based approach to estimating hedge ratios (i.e. exposures) with the alternative, dynamic hedge ratios that ernerge from continuous-time pricing models. The final section draws the implications of the results for portfolio management and draws attention to the special role of fixed-income portfolios in this connection.

Optimal profit sharing contracts and investment in an interest-free Islamic economy

Abstract: In an Islamic financial system, interest is replaced by a profit-sharing system in which risks are shared between lenders and borrowers. Concerns have been expressed that in such a system investment will decline. This paper formulates investment behavior in a profit-sharing system as a principal-agent problem and investigates the relevant issues under conditions of uncertainty and moral hazard. A major conclusion of the paper is that the assertion of investment decline cannot be justified and that, under certain conditions, a profit-sharing system may lead to an increase in investment.

Implied Interest Rates

Abstract: One of the most important assumptions in financial economics models is the existence of a risk-free rate, available for borrowing and lending. In any economy, however, the borrowing rate does not coincide with the lending rate even for the short run. The difference between the rates is considered a compensation for intermediation that is necessary in the imperfect real world. In a well-functioning financial market this difference would be small, and the smaller it is, the better off is the economy. The two short-term rates that best approximate riskless lending and borrowing rates are the Treasury-bill rate and the brokers' loan-call rate, respectively. With the introduction of put and call options a new risk-free instrument has been created. Using options alone or options combined with the underlying asset' one could turn to these markets for his borrowing or lending needs, thereby With the introduction of put and call options a new risk-free asset has been created. The objective of this study is to estimate the rate implied in option prices and compare it to other riskless instruments. We have used transactions data on Chicago Board Options Exchange options taking into account the American feature of these options. We find that options markets provide rates that are competitive with other short-term rates. These rates are closer to the borrowing rate than to the lending rate.

Accounting rationality and financial legitimation

Abstract: The quantitative measurement of value is a central requirement in capitalist production and exchange relations. A major role in this measurement has been played by public accounting since its establishment as a profession in the United States and Great Britain at the turn of the century. Public accountants see themselves as the monitors of world economic order. Their metaphor is the system, in which rationality and unity are assumed and all accounts are monetary and quantitatively measurable in precise, constant terms. Their method is positivist. Uncertainty in financial markets is reducible through objective analysis of the relations of capital in a value-free environment. Their mandate is to provide to the public a periodic independent examination of corporate financial accounts in the form of an annual audit. These audits were instituted by governments following violent fluctuations in the business cycle, particularly the world depression of the 1930s, largely in response to public demand for more comprehensive information. However, despite this charge, public accountants serve primarily the interests of their clients. Not only do they monitor actual expenditures of capital, but they are also gatekeepers of capitalist ideology. The social organization of their work, the organizational and career structures they inhabit, the body of knowledge they control, all serve to legitimate political, economic, and social arrangements.

Money and Agriculture: The Dynamics of Money Financial Market-Agricultural Trade Linkages

Abstract: This article investigates empirical relationships among the money supply, the interest rate, the exchange rate, the general price level, and agricultural exports and relative prices using three-and six-variable vector autoregressive models. Shocks to the money supply have little direct effect on agriculture, whereas positive interest rate, exchange rate, and general-price-level shocks have negative effects. The dynamic patterns characterizing monetary interactions with the financial variables do not preclude the possibility that monetary policies underlie the observed, interest rate and exchange rate Impacts, but the observed price-level shocks appear to be Independent ,of the money supply Agricultural exports and prices demonstrate little Impact on the macroeconomic variables.

Why Financial Deregulation

Abstract: Over the past six years, financial markets in Australia have been deregulated almost completely. This article attempts to explain why Australia's financial markets have been deregulated and why financial deregulation has occurred so quickly. It suggests the answers lie in changed perceptions of the usefulness of regulation as a means to specific ends. Exogenous developments in the financial environment altered the impact of regulations on financial institutions. The result was a weakening in the competitive position of regulated financial institutions relative to unregulated financial institutions and direct financiers. This led simultaneously to a reduction in the ability of the monetary authorities to control the growth of total financing and a growing perception amongst regulated institutions that the costs of regulated status outweighed the benefits. The rapid demise of the regulations can be traced to the joint realisation by the monetary authorities and the regulated institutions that the regulations no longer served their respective ends. This conjunction of ‘public interest’ and ‘private interest’ in financial deregulation can in turn be traced to the unique ability of financial markets to generate close substitutes for existing financial products at low cost.

Japanese Financial Markets: Deficits, Dilemmas, and Deregulation

Abstract: This rigorous, timely, and engaging study analyzes the main innovations in Japan's financial markets over the last fifteen years. It investigates how Japan's fiscal deficits and current account swings have generated self-perpetuating cycles of innovation and deregulation in financial markets. Using portfolio theory, the book presents much original material on hotly debated issues, including how internationalized Japan's capital market is and how monetary policy is reacting to innovations.An overview chapter describes macro trends using a tripartite framework of overall asset intensity, distribution of assets among economic sectors, and the portfolio composition of each sector. Feldman notes strengthened feedback among interest rates and bases a unique taxonomy of financial innovation on this concept of feedback. The taxonomy is applied in chapter 3 to a description of micro developments in Japanese financial markets. Chapters 4 and 5 use a formal econometric model to dig deeper into questions about the nature of the loan market and monetary policy tools.Feldman focuses next on approaches to internationalization. Chapter 6 concerns the legal approach, which emphasizes how and why regulations on capital flows changed. Surprising conclusions are reached in chapter 7 using the quantity approach, which relates who transacted how much of which types of assets, and when. The price approach, based on the concept of interest parity, puts an actual date on internationalization. These three approaches are integrated in chapter 9, in a theoretical model that shows how opening financial markets to foreigners affects exchange rates and interest rates.A concluding chapter integrates the recurrent themes of market pressure, feedback, and deregulation in a provocative set of speculations on the future of the Japanese financial system.Robert Alan Feldman is an economist at the International Monetary Fund.

Interest Rates, the Markets, and the New Financial World.

Abstract: Part 1 Introduction: from Wenings to Wall Street. Part 2 Financial markets: financial markets yesterday and today - interest-rate differences, the institutional credit structure, volatility and monetarism, the budget deficit dangers in the rapid growth of debt - rapid debt growth, danger signals, forces that encourage credit expansion, policy proposals the integrity of credit - credit without a guardian, the proper role of financial institutions, the role of government a disregard for capital - manifestations of the desregard for capital, social claims, defenders of capital ferment in financial institutions - regulation deregulation, financial innovation, financial institutions are unique, managing risk international financial problems - laissez faire, official intervention, international cooperation, fixed versus floating exchange rates banking in changing world credit markets - banking growth, growth of euromarkets, banking linkages and innovations, the freeing of markets the equity market over the long term - growth of the equity market, the emerging global equity market, the growth of proxy instruments, the expanding role of the institutional investor, a more demanding role for securities dealers, new challenges for investment decision makers fallen financial dogmas and beliefs - high real interest rates encourage substantial increases in savings, high real interest rates discourage economic recovery, financial deregulation lowers the general level of interest rates, credit quality is constant in our financial system, the growth of debt is closely linked to growth in nominal gross national product, a nation's large trade deficit weakens its currency in foreign exchange markets, fiscal policy can be a flexible anticyclical tool and, combined with monetary, can prolong economic expansion and limit economic and financial excesses. Part 3 Interest rates: secular and cyclical trends in interest rates - secular trends, cyclical trends, extremes in quality yields, interest rates and economic activity, conventional wisdoms the many faces of the yield curve - theories, four major yield curves, the optimum long opportunity, prospects changing techniques in forecasting interest rates - anticipation and realization, the effects of deregulation, international credit flows, other benefits from credit flow analysis new interest-rate precepts - the perception of high and low interest rates does not remain constant, substantial interest-rate volatility is here to stay and should be incorporated into portfolio and financing decision making, bonds are bought more for their price appreciation potential than for their income protection, (part contents).

Associationalism, Statism, and Professional Regulation: Public Accountants and the Reform of the Financial Markets, 1896-1940

Abstract: In this article Projessor Miranti contrasts the differing reactions of leaders in the public accounting profession to the structure of national economic regulation that emerged in America during the first decades of the twentieth century. Specifically, he focuses on the actions taken by two national professional organizations, the American Association of Public Accountants and its successor, the American Institute of Accountants, at two important junctures in the history of financial reform: the establishment of the Federal Reserve Board and the Federal Trade Commission and the organization of the Securities and Exchange Commission. In assessing these experiences, his article concentrates on identifying the changing circumstances and political contexts that gave rise first to an associationalist response and then to a statist response to the problem of ordering the nation's financial markets.

The assessment financial innovation: curse or blessing?

Abstract: As financial services go through one of their most radical restructurings of this century, this As sessment analyses the factors underlying these changes. A picture of the function of different fi nancial institutions emerges which allows the concerns that have been expressed about recent developments in financial markets to be re-evaluated. The worrying implication is that systems for correcting substantial financial disruption are not yet in place.

Recent developments in corporate finance

Abstract: During the decade preceding publication there were a number of significant developments in financial economics and major contributions made both by individuals who could be classified as conventional financial economists and by others who do not fit easily into this category - theoretical microeconomists, public and industrial economists. This volume contains a selection from the papers presented at a conference in Oxford in September 1985 which aimed to bring together a number of the leading participants in this field. The papers in the volume cover a wide range of topics - the efficiency of financial markets, new equity issues, asymmetric corporate taxation and investment, credit rationing, international investment, the foundations of banking theory - but they clearly reflect the main themes in financial economics at the time: the importance of informational asymmetries and of taxation.

Rational Expectations, Risk and Chaos in Financial Markets

Abstract: Begg (1984) has recently presented a rational expectations model of equilibrium bond pricing. One important feature of this model is that lenders making portfolio choices between short and long assets are risk-averse, so that the well-known principle of certainty equivalence no longer applies to the optimal demand for bonds. When the policy for the supply of bonds and a simple policy rule for interest rates are specified, an equilibrium model of equilibrium bond pricing is obtained where expectations are self-fulfilling in both the mean and variance. The key feature of this interesting model of the bonds market is that it is nonlinear. As long as the degree of risk, the degree of risk-aversion or the supply of bonds are not too large, the forward evolution of the model will be unstable and a unique rational expectations solution exists as the backward evolution of equilibrium bond prices will converge. This is very much in the spirit of the conventional saddlepoint approach to solving rational expectations models (Blanchard and Kahn, 1980), where equilibrium asset prices are considered as forward-looking jump variables. However, if the degree of risk, the degree of risk-aversion, the coupon or the supply of bonds become large enough, the forward evolution of the model becomes locally stable. Begg's (1984) interpretation is that this leads to a loss of confidence and financial panic, because there is now an infinite number of convergent rational expectations trajectories. The main objective of this paper is to show that this interpretation is incomplete and to formalise Begg's notion of financial panic. Because the forward evolution of asset prices is stable, the backward evolution is unstable when there is a large degree of risk or riskaversion. It therefore seems as if equilibrium bond prices have become predetermined and are no longer jump variables, so that it seems as if risk-aversion investors have 'given up' their forward-looking behaviour in the face of too many shocks. This is only a locally valid argument and contradicts intuition, because efficient asset prices are generally regarded as jump variables that incorporate 'news' about current and future events. It is possible, however, still to have forward-looking asset prices, because increasing the degree of uncertainty or the degree of risk-aversion eventually leads to unique speculative bubbles and possibly financial chaos for the backward evolution of equilibrium bond prices. There exists therefore, in addition to the infinity of convergent and pre-determined rational expectations paths, a unique non-

The Limits of Monetary Coordination as Exchange Rate Policy

Abstract: Introduction: The argument outlined Proposals for coordinating monetary policy in order to stabilize nominal or real exchange rates, or to target monetary policy on the nominal exchange rate, assume, explicitly or implicitly, that (a) exchange rate fluctuations are, on balance, harmful to the economy, and that (b) monetary policy can productively reduce the amplitude of these fluctuations. The main objective of this chapter is to examine the analytical basis and empirical evidence for these assumptions. The conclusion is that both hold only some of the time. This means that a coordination agreement would have to define when the assumptions hold, a difficult task, indeed. Further, proposals for a formal international conference to implement a coordination agreement – a “new Bretton Woods” – assume that this is at least politically feasible. Toward the end of the chapter I argue that this is not the case, and that the failed World Economic Conference of 1933 is a more apt metaphor than Bretton Woods. Movements in the real exchange rate of the dollar have had substantial effects on employment and output in U.S. manufacturing industries. At the level of all manufacturing, the elasticity of response of employment to the real exchange rate (up is appreciation) is –0.14. Thus a real appreciation of the dollar of 60 percent from 1980 to 1985 reduced manufacturing employment by 8.4 percent, or 1.7 million jobs.

Theories of Regulation and Changes in Regulation: The Case of Financial Markets

Abstract: A definition of regulation is offered and the relevance of regulatory theory to understanding change in financial markets is explained. The nature of financial change is sketched. Four major sets of regulatory theories are outlined—teleological, cultural, instrumental and administrative. The adequacy of each in explaining recent changes in securities markets in Britain and the United States is assessed. The article concludes that some cultural and administrative theories perform best, and argues that in the United Kingdom and the United States there is a convergence of regulatory styles.

Monetary policy through ceilings on bank lending

Abstract: Credit ceilings Carlo Cottarelli, Giampaolo Galli, Paolo Marullo Reedtz and Giovanni Pittaluga Credit ceilings have been adopted by many OECD countries in the belief that they allow rapid and precise control of activity, inflation and the balance of payments. This paper addresses three key issues. First, are credit ceilings effective when there exist sizeable non-bank financial intermediaries? The answer is clearly more a matter of degree than kind; evidence from Italy suggests that ceilings were initially very powerful but progressively lost their effectiveness as new financial markets developed during the 1970s and the 1980s. However, they remained important as a tool for influencing capital flows. Second, it is often suggested that credit ceilings are effective because they reduce the money supply in addition to constraining spending. We argue they are more likely to affect the demand rather than the supply of money and this may imply a perverse effect through the financial markets. However such an effect is empirically very small in the case of Italy. Finally the paper investigates the costs of controls. Italian evidence indicates that they significantly reduced competition between banks. Ceilings also constrained borrowers to grow at more uniform rates, thus affecting the allocation of resources.

Deposit Market Deregulation and Interest Rates

Abstract: The evolving deregulation of financial markets has sparked interest in the economic implications of increased flexibility in previously regulated markets.' Much of the analysis has focused on deposit markets in which legislated maximum rates are being replaced by market determined equilibrium rates. Moreover, because changes in deposit rates imply changes in the cost of funds to financial intermediaries, concern has been voiced about the implications of deposit rate deregulation on the overall structure of interest rates. Specifically, deregulation has been cited as one reason for the currently high rates of interest.2 In this paper, we argue that this view of deregulation is flawed and we suggest that deregulation of deposit markets will lead to lower, not higher, loan and deposit rates. Furthermore, we argue that previous analysis indicating that deposit deregulation leads to higher loan rates based on higher costs of funds to financial intermediaries depends on inadequate consideration of the role of implicit payments to depositors. Appropriate consideration of these implicit payments leads to results suggesting that deposit market deregulation should, ceterus paribus, lower loan rates; the total cost of funds to banks falls as the interest rate ceiling is relaxed. Our theoretical results previewed here are admittedly at odds with some of the prior theoretical and empirical work on this issue. Our assumptions that the implicit deposit rate is flexible, market determined, and adjusts to clear the deposit market are crucial to our results.

Economic Growth and Regulation of Financial Markets : Japanese Experience during Postwar High Growth Period

Abstract: I. Introduction During the period 1953-1972, Japan experienced an exceedingly high rate of economic growth. The annual growth rate of real GNP during the twenty years was 9.2~, exceptionally high when compared to the growth rate of 3.7~~ for 1910-38 and 3.9~ for 1973-81. The change in industrial structure was also drastic. The share of the primary sector in GDP was 36.4~~ in 1910 and 18.3~~ in 1938, but fell to 6,1~~ in 1970. The annual decrease in labor force in the primary sector was 36,500 persons during 1950-65 period, 6 times as high as 6,200 persons during 191C~40 period. It was really a turbulent period. What was particularly interesting for the researchers in money and banking was that this rapid economic growth had taken place within a highly regulated financial framework. The time deposit rate was regulated, entry into the bond issue market was regu]ated, international asset transactions were virtually forebidden, and so on. In the prewar period, the financial system was essentially free, both in terms of interest rate movements as well as entry into financial markets. After about 1975, the financial markets have been rapidly deregulated and liberalized, domestically as well as internationally. Therefore, the system during the period of high economic growth was rather exceptional.1 Moreover, somewhat surprisingly for those who are familiar with McKinnon-Shaw hypotheses, the level of financial intermediation was quite high in spite of the deposit rate regulation. Quoting from Mckinnon's recent paper, the average M2/GNP ratio for Japan during 1960-75 was 0.832, which was very high when compared with 0,184 for four Latin American countries, 0.247 for four Asian countries, 0.585 for five industrial countries and 0.447 for four rapidly

Economic Reform and Stabilization in Latin America

Abstract: Great economic change is now occuring and will continue to occur in Latin America This study analyzes the economic problems of the Latin American nations and sketches possible solutions to them The focus is on positive economic analysis rather than normative political analysis The contributors to this volume first analyze common economic and monetary problems of the Latin American nations and then suggest possible frameworks for solutions Problems discussed include: floating exchange rates, peso speculation, real exchange rates, exchange rate reform, optimal tariff policies, economic liberalization in LDCs, financial markets and income distribution, external shocks, the Latin American debt problem, and microfoundations of financial liberalization

Survey Evidence on Diffusion of Investment Among Institutional Investors

Abstract: Contagion or epidemic models of financial markets are proposed in which interest in or attention to individual stocks is spread by word of mouth. The models give alternative interpretations of the random walk character of stock prices. A questionnaire survey of institutional investors was undertaken to ascertain the relevance of such models. Questions elicited what fraction of these investors were unsystematic and allowed themselves to be influenced by word-of-mouth communications or other salient stimuli. Rough indications of the infection rate and removal rate were produced. Investors in stocks whose price had recently increased dramatically to a high P/E ratio were contrasted with a control group of investors.

Internationalisation of financial markets

Abstract: This paper analyses the effects of the internationalisation of financial markets on the conduct of macroeconomic policy and the allocation of capital. It first examines the increased integration between domestic and external (or "Euro") financial markets and the recent tendency towards convergence of real interest rates among financially open countries. After briefly touching on the macro policy consequences of financial internationalisation, the paper then deals with long-term implications for the international allocation of capital, with special emphasis on the existence of tax distortions. Using estimated tax wedges for business investment and the supply block of the INTERLINK system, it shows that, under integrated financial markets, the existing tax distortions could generate a large imbalance in the net external asset position which involves a significant welfare cost ...

Alternative Explanations of the Money-Income Correlation

Abstract: Standard explanations of the bivariate correlation of money and income attribute this correlation to an inability of agents to discriminate in the short run between real and nominal sources of price shocks. This paper is an empirical comparison of the standard explanation with two alternatives: 1) the"credit view", which focuses on financial market imperfections rather than real-nominal confusion; and 2) the real business cycle approach, which argues that the money-income correlation reflects a passive response of money to income. The methodology, which is a variant of the Sims VAR approach, follows Blanchard and Watson (1984) in using an estimated, explicitly structural model to orthogonalize the VAR residuals. (This variant methodology, I argue, is the more appropriate for structural hypothesis testing.) The results suggest that the standard explanations of the money-income relation are largely, but perhaps not completely, displaced by the alternatives.