Showing papers on "Financial market published in 1998"

Financial Dependence and Growth

Abstract: This paper examines whether financial development facilitates economic growth by scrutinizing one rationale for such a relationship: that financial development reduces the costs of external finance to firms. Specifically, the authors ask whether industrial sectors that are relatively more in need of external finance develop disproportionately faster in countries with more-developed financial markets. They find this to be true in a large sample of countries over the 1980s. The authors show this result is unlikely to be driven by omitted variables, outliers, or reverse causality. Copyright 1998 by American Economic Association.

Stock Markets, Banks, and Economic Growth

Abstract: Do well-functioning stock markets and banks promote long-run economic growth? This paper shows that stock market liquidity and banking development both positively predict growth, capital accumulation, and productivity improvements when entered together in regressions, even after controlling for economic and political factors. The results are consistent with the views that financial markets provide important services for growth and that stock markets provide different services from banks. The paper also finds that stock market size, volatility, and international integration are not robustly linked with growth and that none of the financial indicators is closely associated with private saving rates. Copyright 1998 by American Economic Association.

Volume, Volatility, Price, and Profit When All Traders Are Above Average

Abstract: People are overconfident. Overconfidence affects financial markets. How depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price-taking traders, a strategic-trading insider, and risk-averse marketmakers are overconfident. Overconfidence increases expected trading volume, increases market depth, and decreases the expected utility of overconfident traders. Its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, and highly relevant information, and they overreact to salient, anecdotal, and less relevant information.

Real Options: Managing Strategic Investment in an Uncertain World

Abstract: Martha Amram and Nalin Kulatilaka suggest a smarter new way to think about strategic investments in terms of real options. By applying options thinking - the concept underlying the recent Nobel Prize-winning work on financial options - to the evaluation of nonfinancial assets, this innovative approach brings a financial market discipline to the evaluation of a company's opportunities. Using real options theory, managers can more effectively target crucial opportunities to redeploy, delay, modify, or even abandon capital-intensive projects as events unfold. Corporate executives in finance, investments, and project management should share this book with decision makers in information technology, strategic planning, corporate restructuring, venture capital, and law.

On the Costs of a Bank-Centered Financial System: Evidence from the Changing Main Bank Relations in Japan

Abstract: We examine the effects of bank-firm relationships on firm performance in Japan. When access to capital markets is limited, close bank-firm ties increase the availability of capital to borrowing firms, but do not lead to higher profitability or growth. The cost of capital of firms with close bank ties is higher than that of their peers. This indicates that most of the benefits from these relationships are appropriated by the banks. Finally, the slow growth rates of bank clients suggest that banks discourage firms from investing in risky, profitable projects. However, liberalization of financial markets reduces the banks' market power. THE CLOSE RELATIONSHIP BETWEEN manufacturing firms and financial institutions in Japan has recently been at the center of the debate on the appropriate financial system for the reforming economies of Eastern Europe. As opposed to the Anglo-Saxon separation of finance and industry, long-term ties between main banks and their client firms (involving bank loans, bank equity holding, and some bank-appointed personnel), which are common in Japan and Germany, have often been described as a growth-oriented financial system that could serve the needs of developing and reformed economiies better than anonymous capital markets modeled after the Arnerican and British financial systems. The claim that close ties between investmentoriented banks and industrial firms could help overcome the difficulties of "relative backwardness" dates back to Gerschenkron (1962) who investigates European development. Rosovsky (1961) applies Gerschenkron's framework to the analysis of Japanese growth. More recently, Aoki, Patrick, and Sheard (1994), Hoshi, Kashyap, and Loveman (1994), and Teranishi (1993), among others, portray the close ties between finance and industry in Japan as an important factor in the international competitiveness of modern Japanese

The Use of Foreign Currency Derivatives and Firm Market Value

Abstract: This paper examines the use of foreign currency derivatives (FCDs) by a sample of 720 large U.S. nonfinancial firms between 1990 and 1995 and its potential impact on firm value. Using Tobin's Q as an approximation of a firm's market valuation, we find a positive relationship between firm value and the use of FCDs. The hedging premium is statistically and economically significant mostly after 1993 and is on average 5.7\% of firm value. This result is robust to a) controls for size, profitability, leverage, growth opportunities, ability to access financial markets, industrial and geographical diversification, credit quality, industry classification (4-digit SIC), year-dummies and firm fixed-effects; b) the use of a weight-adjusted industry Tobin's Q and other measures of value, such as the market to book and the market to sales ratios; and, c) alternative estimation techniques that handle the potential impact of outliers. Using the ratio of foreign currency derivatives to foreign sales as a proxy for the percentage of exposure that a firm hedges, we observe a significant dispersion in our measure of the hedge ratio. In univariate tests we find a nonlinear relationship between Q and our proxy. However, firm-specific factors explain this relationship in multivariate tests and it appears that firms are hedging optimally.

A Rational Expectations Model of Financial Contagion

Abstract: We develop a multiple asset rational expectations model of asset prices to explain financial market contagion. Although the model allows contagion through several channels, our focus is on contagion through cross-market rebalancing. Through this channel, investors transmit idiosyncratic shocks from one market to others by adjusting their portfolios' exposures to shared macroeconomic risks. The pattern and severity of financial contagion depends on markets' sensitivities to shared macroeconomic risk factors, and on the amount of information asymmetry in each market. The model can generate contagion in the absence of news, as well as between markets that do not directly share macroeconomic risks. A SPATE OF RECENT FINANCIAL CRISES-the Mexican crisis of 1995, the Asian crisis of 1997 to 1998, the default of the Russian government in August 1998, the sharp depreciation of the real in Brazil in 1999-have been accompanied by episodes of financial markets contagion in which many countries have experienced increases in the volatility and comovement of their financial asset markets on a day-to-day basis. The pattern of contagion has been uneven across both time and countries-with increased volatility and comovement occurring principally during times of financial and exchange rate crises-and with some countries, particularly those with emerging financial markets, having experienced the bulk of the contagion, while countries with more developed markets have remained relatively unscathed. Although heightened financial market volatility is to be expected within countries experiencing financial and exchange rate crises, the pattern of comovement across countries is not easily explained. Some of the increased comovement among countries that compete through trade or share close economic links can be rationalized on the basis of macroeconomic theory, but these theories are less persuasive in accounting for the increased comove

A rational expectations model of financial contagion

Abstract: We develop a multiple asset rational expectations model of asset prices to study the determinants of financial market contagion, and to provide an explanation for the pattern of contagion during the Asian financial crisis. Our findings show that the pattern and severity of financial contagion depends on the size of markets' sensitivities to common macroeconomic risk factors. The amount of information asymmetry within a financial market also increases its susceptibility to contagion. We focus on contagion through the cross-market hedging of macroeconomic risks. Through this channel, idiosyncratic shocks in one market are transmitted to others. Interestingly, contagion can occur between markets that have no macroeconomic risks in common. In addition, contagion occurs in the absence of any news, and before the macroeconomic risk factors are realized. Because contagion occurs through hedging, the pattern of contagion is strongly influenced by the presence or absence of derivatives markets for unbundling and hedging the macroeconomic risks. Errors in market participants' beliefs about dynamic hedging activity influence the pattern of contagion and, in some cases, strongly magnify the size of the contagious price responses.

Is relationship lending special? Evidence from credit-file data in Germany☆

Abstract: The German financial market is often characterized as a bank-based system with strong bank–customer relationships. The corresponding notion of a housebank is closely related to the theoretical idea of relationship lending. It is the objective of this paper to provide a direct comparison between housebanks and “normal” banks as to their credit policy. Therefore, we analyze a new data set, representing a random sample of borrowers drawn from the credit portfolios of five leading German banks over a period of five years. We use credit-file data rather than industry survey data and, thus, focus the analysis on information that is directly related to actual credit decisions. In particular, we use bank-internal borrower rating data to evaluate borrower quality, and the bank’s own assessment of its housebank status to control for information-intensive relationships. The major results of our study support the view that housebanks are able to establish a distinct behavioral pattern consistent with the idea of long-term commitment. We find that housebanks do provide liquidity insurance in situations of unexpected deterioration of borrower ratings. With respect to loan pricing, we find no evidence for intra- or intertemporal price differentiation related to housebanking.

Financial market contagion in the Asian crisis

Abstract: This paper tests for evidence of contagion between the financial markets of Thailand, Malaysia, Indonesia, Korea, and the Philippines. Cross-country correlations among currencies and sovereign spreads are found to increase significantly during the crisis period, whereas the equity market correlations offer mixed evidence. A set of dummy variables using daily news is constructed to capture the impact of own-country and cross-border news on the markets. After controlling for own-country news and other fundamentals, the paper shows evidence of cross-border contagion in the currency and equity markets.

A Model of Crises in Emerging Markets

Abstract: This paper presents a perfect foresight model of speculative attacks on emerging markets. Credit constrained governments are assumed to have two objectives: to accumulate liquid assets in order to self-insure against shocks to national consumption and to insure poorly regulated domestic financial markets. This policy regime generates endogenous fiscal deficits defined to include the growth of contingent liabilities. The model sets out a sequence of yield differentials consistent with capital inflows followed by anticipated speculative attacks. The model suggests that a common shock generated capital inflows to emerging markets in Asia and Latin America after 1989.

Do measures of monetary policy in a var make sense

Abstract: No. In many vector autoregressions (VARs), monetary policy shocks are identified with the least squares residuals from a regression of the federal funds rate on an assortment of variables. Such regressions appear to be structurally fragile and are at odds with other evidence on the nature of the U.S. Federal Reserve's reaction function; furthermore, the residuals from these regressions show little correlation across various VARs or with funds rate shocks that are derived from forward-looking financial markets. My results provide a sharp critique of current monetary VARs.

Macro Markets: Creating Institutions for Managing Society's Largest Economic Risks

Abstract: Macro Markets puts forward a unique and authoritative set of detailed proposals for establishing new markets for the management of the biggest economic risks facing society Our existing financial markets are seen as being inadequate in dealing with such risks and Professor Shiller suggests major new markets as solutions to the problem Shiller argues that although some risks, such as natural disaster or temporary unemployment, are shared by society, most risks are borne by the individual and standards of living determined by luck He investigates whether a new technology of markets could make risk-sharing possible, and shows how new contracts could be designed to hedge all manner of risks to the individual's living standards He proposes new international markets for perpetual claims on national incomes, and on components and aggregates of national incomes, concluding that these markets may well dwarf our stock markets in their activity and significance He also argues for new liquid international markets for residential and commercial property Establishing such unprecedented new markets presents some important technical problems which Shiller attempts to solve with proposals for implementing futures markets on perpetual claims on incomes, and for the construction of index numbers for cash settlement of risk management contracts These new markets could fundamentally alter and diminish international economic fluctuations, and reduce the inequality of incomes around the world

Asymmetries in housing and financial market institutions and EMU

Abstract: Despite convergence pressures, differences in housing and financial market institutions across the 15 member states of the European Union are still enormous. This paper argues that they have profound effects on the responsiveness of output and inflation in the different countries to changes in short-term interest rates, as well as to asset-market shocks of external origin. The economic reasoning behind this claim is set out and the institutional differences are described. The paper assesses the sometimes conflicting empirical evidence on this issue. Barriers to convergence and implications for labour-market flexibility are discussed. The UK, Ireland, Finland and Sweden tend to cluster at one extreme of the relevant institutional characteristics. The paper concludes with a set of proposals for institutional reforms which would significantly reduce the tensions within EMU and the potential for instability in these economies entailed by EMU membership.

Pension Funds: Retirement-Income Security and Capital Markets: An International Perspective

Abstract: Coping with the ageing of the population without major economic disruption is undoubtedly one of the major challenges facing the global economy and world financial markets both now and for the coming decades. In this context, this book assesses the major economic issues raised by occupational pension funds, as they have arisen in 12 OECD countries---the US, the UK, Germany, Japan, France, Italy, Canada, Australia, Denmark, Sweden, Switzerland and the Netherlands, as well as in Chile and Singapore. Particular emphasis is placed on the performance of funds in financial markets, the influence on funds of fiscal and regulatory conditions, and the consequences of funds' development for capital markets, corporate finance and international investment. The relationship with social security, the comparativ advantages of defined benefit and defined contribution funds and the role of funds in developing countries are also examined in detail.

The Predictive Content of the Interest Rate Term Spread for Future Economic Growth

Abstract: Predicting economic activity is important for numerous reasons. It is important for business firms because it aids in deciding how much capacity will be needed to meet future demand. It is important for various government agencies when forecasting budgetary surpluses or deficits. And it is important for the Federal Reserve (the Fed) in deciding the stance of current monetary policy. One set of variables that are potentially useful in forecasting economic activity are financial variables. Financial market participants are forward-looking, and as a result the prices of various securities embody expectations of future economic activity. This pricing behavior implies that data from financial markets may reasonably be expected to help forecast the growth rate of the economy. Using financial variables to aid in economic projections, therefore, is fairly commonplace. In particular, the yield curve spread between long- and short-term interest rates has received a lot of recent attention. Although not the first to consider the implications that the spread has for predicting economic activity, Stock and Watson (1989) provided much of the impetus for further research by finding that the spread was an important component of their newly constructed index of leading economic indicators. Estrella and Hardouvelis (1991) also thoroughly document the significant relationship between interest rate spreads and future output growth. Unfortunately, one of the spread’s major predictive failures occurred immediately after the publication of these influential articles. Namely, the spread failed to predict the 1990‐91 recession. In light of that occurrence, a number

Redistributive Cooperation: Market Failure, Wealth Transfers, and the Basle Accord

Abstract: InDecember1987,policymakersbelongingtotheGroupofTen(G-10)signeda far-reaching agreement on international ” nancial regulation: the Basle Accord ontheInternational Convergence of Capital Measuresand Capital Standards. Underthetermsof thisagreement,G-10 policymakersimplemented uniform risk-based capitalrequirements on commercial banks. The origins of the Basle Accord, according toKapstein, lay in the consequencesof international ” nancial integration. International” nancial integration, by raising systemic risk and eroding regulators’ capacity toensure the soundness of national banking systems, generated a market failure evi-denced by thedebt crisis. Commercial bankshad accepted ariskier portfolioofloansthan society considered optimal and were now unwilling to bear the full costs of thislending behavior. Financial market failurecreated a demand for international regula-tiontowhichpolicymakersrespondedby supplying theBasleAccord.‘ ‘ To theextentthat the payments system had the characterof apublic good, it wasreasonable to askevery state to contribute to its maintenance. . . . Bank supervisors responded to theneed for greater oversight by negotiating the BasleAccord.’ ’

Financial Markets and Economic Growth

Abstract: The current economic problems in Southeast Asia can be attributed not to too much reliance on financial markets, but to too little. Like the U.S. economy a century ago, the emerging Asian economies do not have welldeveloped capital markets and so remain heavily dependent on their banking systems to finance growth. For all its benefits, banking is “not only basically 19th-century technology, but disaster-prone technology.” The extreme maturity (and, in some cases, currency) mismatch on banks' balance sheets plus the first-come, first-served nature of the deposit obligations mean that banks are inherently vulnerable to massive runs by depositors—and that their economies are subjected to periodic credit crunches. And, as the author says, “in the summer of 1997 a banking-driven disaster struck in East Asia, just as it had struck so many times before in U.S. history.” In this century, In this century, the U.S. economy has steadily reduced its dependence on banks by developing “dispersed and decentralized” financial markets. In so doing, it has increased the efficiency of the U.S. capital allocation process and reduced its susceptibility to the credit crunches that have occurred throughout U.S. history. By contrast, Japan has not reduced its economy's dependence on banks, and its efforts to deal with its banking problems have served only to destabilize itself as well as its neighbors. Developing countries in Southeast Asia and elsewhere are urged not to follow the Japanese example, but to take measures aimed at developing financial markets and institutions that will either substitute for or complement bank products and services.

The Emergence of the Euro as an International Currency

Abstract: The European Union will enter Stage Three of Economic and Monetary Union (EMU) in 1999. The development of euro financial markets and thickness externalities in the use of the euro as a means of payment will be the major factors determining the importance of the euro as an international currency. As euro securities markets become deeper and more liquid and transactions costs fall, euro assets will become more attractive, and the use of the euro as a vehicle currency will expand; the two effects interact, as we demonstrate. We use a three-region world model as a framework for alternative steady-state scenarios. With forex and securities market data, we access the plausibility of those scenarios and the implications for economic efficiency (welfare). We find that the euro may take on some of the current roles of the dollar, but the extent to which it does will depend on policy decisions and on the beliefs of market participants. The welfare analysis reveals potential quantitatively significant benefits for the euro area, at the cost of the US and (to a lesser degree) Japan. During the transition to the new equilibrium, the main effect of the introduction of the euro will come through portfolio shifts that are likely to favour an appreciation of the new currency vis-O-vis the dollar (and the yen). Whatever the likely long-run outcome, the dollar will remain quantitatively dominant for some time because of inertia and hysteresis u with multiple equilibria and likely threshold effects, we would not expect a quick transition to a new equilibrium. The early period could see considerable instability associated with the emergence of the euro, especially if the United States were to resist any decline in the international status of the dollar.

Volume, Volatility, Price, and Profit When All Traders Are Above Average

Abstract: People are overconfident. Overconfidence affects financial markets. How depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price-taking traders, a strategic-trading insider, and risk-averse market-makers are overconfident. Overconfidence increases expected trading volume, increases market depth, and decreases the expected utility of overconfident traders. Its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, and highly relevant information, while they overreact to salient, anecdotal, and less relevant information.

Intangible assets: how the interaction of computers and organizational structure affects stock market valuations

Abstract: An important theme in information systems research is that organizational factors are critical to the success of computer investments. This paper provides broad statistical evidence for this proposition. For our analysis, we have compiled a unique data set of over 1,000 firms which includes the total stock market value of firms, their installed base of computer capital, detailed measures of the organizational structures, and a battery of other factors. Using a theoretically-grounded model, we find that a one dollar increase in a firm’s installed computer capital is associated with an increase in the firm’s stock market valuation of over five dollars, while controlling for all other tangible assets. For this to be equilibrium, the financial markets must believe that each dollar of computer capital is accompanied by an average of over four dollars of intangible assets. We then identify a candidate for these intangible assets: certain organizational characteristics, involving the structure of decisionmaking and the nature of job design, are highly correlated with computer investments. While these organizational characteristics do not appear on a firm’s balance sheet, we find that they lead to higher stock market valuations. Strikingly, firms that combine higher computer investments with these organizational characteristics have disproportionate increases in their market valuations. Our findings are quite robust to a variety of alternative models and the results are generally strengthened when we control for potential reverse causality. We conclude that the contribution of computers to a firm’s market value is increased when they are combined with certain intangible assets, specifically including the cluster of organizational changes that we have identified.

Rural finance and poverty alleviation

Abstract: This report presents information on the credit constraints that poor rural households face in nine countries of Asia and Africa (Bangladesh, Cameroon, China, Egypt, Ghana, Madagascar, Malawi, Nepal, and Pakistan) It uses this information to make the case for appropriate public intervention in strengthening rural financial markets and draws conclusions about areas where public resources may best be spent" Preface

Insider Trading in a Continuous Time Market Model

Abstract: This paper uses the enlargement of Brownian filtrations and a probability change for modelling the observation of a financial market by an insider trader. A characterization of admissible strategies and a criterion for optimization are given. Then a statistical test is proposed to test whether or not the trader is an insider.

The Inflation Target Five Years On

Abstract: Mervyn King is the Deputy Governor of the Bank of England and a co-founder of the LSE Financial Markets Group. On Wednesday 29 October 1997 he gave a public lecture at the LSE to mark the 10th anniversary of the Financial Markets Group and the 5th annivesay of the Bank of England Inflation Target. This Special Paper is the Transcript of that lecture.

Was There Really an Earlier Period of International Financial Integration Comparable to Today

Abstract: In this paper we reconsider the international market integration, starting at high levels in the late nineteenth century, collapsing between the wars, and recovering gradually after 1945 to reach levels comparable to pre-1914 in the 1990's The empirical evidence we survey suggests that in some respects the financial integration of the pre-1914 era remains unsurpassed, but in others today's financial markets are even more closely integrated than those in the past The difference today is that new information-generating and processing technologies have reduced the market-segmenting effects of asymmetric information In consequence, the range of financial claims that are traded internationally has broadened While international financial transactions were once determined by claims on governments, railroads, and mining companies, entities with tangible and therefore relatively transparent assets, international investors now transact freely in a much broader range of securities