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Industry Papers on Financial services

The Universal Credit Rating Group: Measuring Debt Ethically
Daniel Cash, World Economics, December 2016
The Universal Credit Rating Group (UCRG) is a collection of rating agencies that are aiming to redress what they see as an imbalance in the provision of credit ratings across the global economy. This article describes the UCRG and discuss as its chances of succeeding in its goal of offering a viable opposition to the Big Three rating agencies. What is proposed by this article, is that although the Group provide a welcome narrative, the foundation to their endeavour is potentially lethal to their chances of success.
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The Creation of the Asian Infrastructure and Investment Bank: America’s Loss and China’s Gain
Stuart P.M. Mackintosh, World Economics, September 2016
The Global Financial Crisis (GFC) pulled institutions together diplomatically and economically. It clarified options and failures of the past and hastened coordinated reforms. But the GFC also starkly illuminated another geopolitical dynamic: Deals struck in extremis must be adhered to after parties leave the negotiating table. Failure to do so can cause embarrassment, recriminations, and unintended consequences with long-term implications that run counter to the original aims and objectives of U.S. policymakers and reformers. This sequence of events played out with the long holdup of agreed International Monetary Fund voice and vote reforms, and the birth of the Asian Infrastructure and Investment Bank, which hastened the rise of China while weakening the role of the Bretton Woods institutions.
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International Liquidity Management Since the Financial Crisis
Richhild Moessner & William A. Allen , World Economics, December 2015
This article discusses how international liquidity management has been affected by the recent crisis. It notes that since the Bretton Woods system collapsed in 1971 it was expected that the demand for international reserves would diminish, since countries were no longer obliged to sell foreign currencies in case of need to support their own currencies in foreign exchange markets. However, international reserves increased in total from 3.1% of world gross product at the end of 1970 to 16.7% at the end of 2013. The paper explains this phenomenon in the context of the global demand for liquidity up to and after the global financial crisis of 2008-09. Different means of providing international liquidity assurance are assessed and the paper concludes that without an international lender of last resort, the world financial structure remains vulnerable to a new liquidity crisis.
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Data on Singapore’s Sovereign Wealth Fund is Flawed
Christopher Balding, World Economics, September 2015
This paper undertakes a critique of the quality of Singapore’s public economic data in the context of the claim that one of the island’s sovereign wealth funds, Temasek Holdings, reports that it has earned since inception in 1974 an average annualized rate of return of 16%. Over a similar time period the Singapore stock market earned 4.99% implying that Temasek on average outperformed the local stock market in which it was heavily invested, by a factor of more than three times every year. The paper replicates Temasek’s portfolio and analyses Singapore’s public finances and finds that irregularities may exist within Temasek financials. It concludes that if there are as of yet unknown financial weaknesses within Singaporean public finances that have yet to be realized then given the importance of the island in Asia’s financial markets, this should raise concerns over the quality of financial statements produced by government linked corporations and the public sector.
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The Endless Business of Reforming the IMF: A review of Joseph P. Joyce’s The IMF and global financial crises: Phoenix rising? and some further thoughts
Biagio Bossone, World Economics, December 2014
In this article I review Joseph P. Joyce’s thought-provoking book The IMF and global financial crises: Phoenix rising?” (Cambridge University Press, 2012). The book is a comprehensive yet concise appraisal of the IMF’s history of successes and failures in preventing crises, and in dealing with their consequences. The review is an opportunity for expressing some thoughts of my own on the subject, picking on Joyce’s reflection on how to reform the IMF, considering the needs of today’s global economy. The review discusses the role of the IMF’s largest shareholding countries in steering the institution’s strategic direction and action, as well the intellectual capture by the economic paradigm that has long prevailed in the highly financially developed world.
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New Data on Global Differences in Family Offices
Robert Eigenheer, World Economics, March 2014
A family office is not a specifically-defined institution per se. Rather, the family office is a broad concept to cover all financial needs of one or more wealthy families. While in the United States the first family offices were established in the nineteenth century, interest in the family office concept has recently been growing in emerging markets around the globe due to the increasing number of ultra-wealthy individuals and families in those regions. Nowadays, family offices are set up all over the world. This fact inevitably leads to the question: Are there regional differences among the structures of family offices, their services, their investment strategies, and their operational costs?
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Singapore’s Temasek Holdings: Investment and risk management strategies since the 2008-2009 global financial crisis
Friedrich Wu, Ng Kuan Khai & Gerald Giam, World Economics, March 2014
This paper examines shifts in Temasek Holding’s (Singapore’s sovereign wealth fund) investment and risk management strategies since the 2008–09 global financial crisis (GFC), as well as the risks it has faced in recent years. Our findings reveal that the shift in Temasek’s investment strategy has been made in response to a combination of the GFC, rising political and sovereign credit risks, as well as the desire to move away from playing a custodial role to Singapore’s government-linked companies (GLCs). We note that, apart from capitalising on lower global prices to expand its portfolio as well as minimising its exposure to the financial services industry immediately after the GFC, other changes have been part of a continued trajectory of a broader shift in investment strategy that commenced in the early 2000s, with a redirection of the geographical distribution of its portfolio from Singapore and OECD countries to Asia (excluding Japan). Furthermore, as a sovereign wealth fund, Temasek has had to deal with increasing political and sovereign credit risks in recent years. To mitigate these political risks, Temasek has pledged that it will cease seeking controlling interests in foreign companies, will increase the use of local partners and will consider the ‘emotional sentiments’ that its acquisitions may arouse in host countries. The elevated sovereign credit risks in the Eurozone and the United States have rendered Temasek more cautious in investing in those regions and, where it has invested, it has focused on the energy and natural resource sectors, which are relatively more insulated from sovereign credit risks.
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Light at the End of the Tunnel: The Eurozone’s sovereign debt problem
Elliot Y. Neaman & Shalendra D. Sharma, World Economics, June 2013
In October 2012, the Norwegian Nobel Committee honoured the EU with the 2012 peace prize for creating a peaceful and stable Europe after the destructive wars and economic crises of the twentieth century. However, it would have been more appropriate to bestow the prize on the ‘Troika’: the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF), with special acknowledgement to ‘Super’ Mario Draghi, the president of the ECB who has done more than anyone to ease the Eurozone’s ongoing and existential economic crisis and keep the union still intact.
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The International Liquidity Crisis of 2008–2009
William A. Allen & Dr Richhild Moessner, World Economics, June 2011
The ‘credit crunch’ that began in August 2007 turned into a crisis when Lehman Brothers failed in September 2008. That event caused large international capital flows, including heavy repatriation of dollars to the United States. Central banks, led by the Federal Reserve, augmented the supply of international liquidity through bilateral central bank swap facilities, and thereby prevented the crisis from becoming much worse. We discuss the reasons for establishing swap facilities, the risks that central banks run in extending swap lines and the limitations to their utility in relieving liquidity pressures. We conclude that the credit crisis is likely to have a lasting effect on the international liquidity policies of governments and central banks.
Understanding the Greek Crisis: Unlocking the puzzle of Greek banks’ deteriorating performance
Michael Mitsopoulos & Theodore Pelagidis, World Economics, March 2011
This paper focuses on the distortions that the Greek public debt has imposed on the Greek banking system, and suggests how these can be unwound. The low level of competitiveness of the Greek economy, which is well below the competitiveness of the developed countries, poses a great challenge for the Greek banks. At the same time it puts at risk Greece’s economy ability to service both the private and public debt, which, as an aggregate, are comparable to the indebtedness of the developed nations. An adjustment of economic activity to match the current low level of competitiveness will increase the risks faced by the financial system and make an orderly servicing of the debt of the economy very challenging. It follows that only one reasonable policy option remains: to increase the competitiveness of the economy through an aggressive reform agenda, so that it will match its level of indebtedness, and through the resulting growth shift the excessive debt of the public sector to the private sector.
Savings for the Poor: Banking on mobile phones
Ignacio Mas, World Economics, December 2010
This paper reviews the relevance of formal financial services – in particular, savings – to poor people, the economic factors that have hindered the mass-scale delivery of such services in developing countries, and the technology-based opportunities that exist today to make massive gains in financial inclusion. It also highlights the benefits to government from universal financial access, as well as the key policy enablers that would need to be put in place to allow the necessary innovation and investments to take place.
Paying the High Price of Active Management: A new look at mutual fund fees
Ross M. Miller, World Economics, September 2010
Financial economists have long known that actively managed mutual funds underperform comparable index funds and that investment management fees are a major contributor to this underperformance. This article shows that the impact of mutual fund fees is even greater when one examines what funds actually do with investors’ money. Many actively managed mutual funds have returns that are closely correlated with comparable index funds and yet have annual fees that can be 100 times higher. Because such ‘shadow’ or ‘closet’ index funds provide minimal active management of the assets they hold, the implied annual cost of the active management can dwarf the stated cost. This article provides a simple measure of what investors are actually paying fund managers for that active management that they can compute for themselves data available for free on the Internet. A recent sample of 731 actively managed large-cap US mutual funds has an average active expense ratio of 6.44%, more than 400% greater than their average reported expense ratio of 1.20%. This article also finds that even large, seemingly low-cost, mutual funds common in retirement plans frequently have active expense ratios above 4% a year.
George Soros’ Reflexivity and the Global Financial Crisis
Thomas D. Willett
World Economics, June 2010
There is no summary available for this paper.
Narrow Banking
John Kay, World Economics, March 2010
The credit crunch of 2007–8 was the direct and indirect result of losses incurred by major financial services companies in speculative trading in wholesale financial markets. The largest source of systemic risk was within individual financial institutions themselves. The capital requirements regime imposed by the Basel agreements both contributed to the problem and magnified the damage inflicted on the real economy after the problem emerged. The paper argues that regulatory reform should emphasise systemic resilience and robustness, not more detailed behaviour prescription. It favours functional separation of financial services architecture, with particular emphasis on narrow banking – tight restriction of the scope and activities of deposit-taking institutions.
The IMF, the Credit Crunch and Iceland: A new fiscal saga?
Sheetal K. Chand, World Economics, September 2009
Iceland was badly hit by a fundamental mismatch between the assets and international liabilities of her banking system, with severe consequences for the welfare of the population. The country now has an International Monetary Fund programme. The paper asks three questions of the programme: Is it too tight? Is the balance of payment’s target appropriate? How will the country cope with the potentially huge transfer problem associated with the now frozen external liabilities of the failed Icelandic banks? The paper notes several problems, and argues that an appropriately structured and expanded fiscal policy is needed, together with burden sharing between Iceland and the international community.
The Secret of Canadian Banking: Common Sense?
Laurence Booth, World Economics, September 2009
This article looks at the basic reasons why the Canadian banking system was recently judged by the World Economic Forum to be the soundest in the world. It does so by first examining the basic functions of a financial system and what Canadian banks are allowed to do as intermediaries within that system. It then considers the market structure of Canadian banking and the role of the Canadian government in regulating the financial system. It finishes with a discussion of the four basic management areas of any financial institution: liquidity management, asset management, liability management and capital management. On all dimensions the Canadian banks seem to be conservatively managed, well regulated and operating in a benign economic environment without obvious systemic risks, mainly due to the absence of a competing ‘parallel’ intermediation system as exists in the United States.
Understanding Crime, Political Uncertainty and Stock Market Returns: A case study of the Colombian stock market
Juan Carlos Franco Laverde, Maria Estela Varua & Arlene Garces-Ozanne, World Economics, June 2009
Colombia’s economy has experienced positive growth over the past few years despite the incidence of serious armed conflict in the region. However, the Colombia of today still faces a significant degree of sociopolitical instability as a result of organised crime associated with drug trafficking, the leftist guerrilla attacks and the right-wing paramilitary group. This paper examines the significance of organised crime and political uncertainty for the amalgamated Colombian Stock Exchange. Empirical evidence indicates that organised crime and political uncertainty negatively affect stock market returns and volatility.
The World Financial Crisis: New economy, globalisation and old-fashioned philosophy
F. Gerard Adams, World Economics, March 2009
The world financial crisis of 2008 is a consequence of new financial technologies, new accounting methods and new international linkages. These developments have come at a time when governments have returned to an old-fashioned free market philosophy. This paper links the systemic financial/economic crisis of 2008 to the new economy developments, globalisation and policy philosophy perspectives of recent decades. It raises the question of how to re-establish confidence once traditional thinking has been questioned.
Sweden’s Bank Nationalisations: Are there lessons for today?
Fredrik Erixon, World Economics, March 2009
Many banks are on the verge of bankruptcy and have received support from the government to stay afloat. Measures taken have not sufficed, and an increasing number of economists and commentators are calling for the nationalisation of banks in the United Kingdom and United States. In their advocacy, they use Sweden as an exemplar, suggesting that massive bank nationalisation was the way it fixed its collapsing banking sector in the early 1990s. This account of Sweden’s resolution policy is erroneous and exaggerates the role of nationalisation. Sweden successfully combated a banking crisis, and two banks received full government ownership. The main example of nationalisation, however, was a financial reconstruction of a bank already controlled by the government. The only real example of nationalisation of a privately owned bank hardly offers lessons for ways to resolve the current banking crisis.
Singapore’s Sovereign Wealth Funds: The political risk of overseas investments
Friedrich Wu, World Economics, September 2008
This paper examines Singapore’s two sovereign wealth funds (SWFs)-the Government Investment Corporation of Singapore (GIC) and Temasek Holdings (Temasek)—and the political risks which they are exposed to in their overseas investments. Wu argues that Temasek has hitherto exposed itself to a greater level of political risk than GIC, but is in turn rewarded with a higher rate of returns on its investments. At the same time, he finds that political risk is an inevitable challenge for SWFs in general. In fact, as worldwide opinion has turned towards demanding greater transparency and accountability from SWFs, the political risks faced by SWFs have correspondingly risen. The paper seeks to throw some light on this issue by undertaking a case study of Singapore’s two SWFs, which are consistently ranked among the global top 10 SWFs by assets, and have attracted much worldwide attention in recent times as a result of some of their politically controversial overseas investments.
The Sovereign Wealth Funds of Singapore
Anthony Elson, World Economics, September 2008
This paper examines the origin, evolution and recent operations of Singapore’s two sovereign wealth funds, Temasek Holdings (TSK) and the Government Investment Corporation (GIC). Singapore is a unique case in that it has two of the oldest and largest sovereign wealth funds. Both funds reflect a long history of sound macroeconomic fundamentals and strong fiscal discipline on the part of the Singapore government. The two funds have significantly different operating features and governance structures. TSK operates like an equity investment firm with significant independence in its day-to-day operations from the government and a relatively high degree of transparency; by contrast, GIC operates like an asset management company, under tight control by the government and with a relatively low degree of transparency. The paper concludes with some lessons from Singapore’s experience with its sovereign wealth funds for the on-going debate about the role of such funds in the international financial system.
Credit Crisis 101: (or what happened to “free and clear”?)
Edward Gottesman, World Economics, September 2008
Subprime mortgage loans were the catalyst, not the cause, of the crisis. Policy errors in both the public and private sectors stretch back nearly 40 years. Inflation, monetary policy and lax regulation all played a role in allowing individual greed and irrational risk-taking to flourish. The paper provides background to the mania that generated an alphabet-soup of derivative “obligations” with uncertain—possibly unknowable-values. The growth of derivatives and the failure of Fannie Mae and Freddie Mac are linked to the tenfold growth of median house prices in the United States, which ballooned from $11,900 in 1960 to $120,000 in 2000. Residential properties became trading inventory for speculators rather than fixed assets for homeowners. Turmoil, the author suggests, will continue as long as financial instruments are manufactured and sold through “fantastically complex” statistical models and mathematical strategies that bear little relationship to fair market values of real assets.
Risk-Pricing and the Sub-Prime Crisis
Andrew G. Haldane, World Economics, September 2008
As the sub-prime crisis celebrates its first birthday, what lessons have been learnt? The crisis was rooted in a misperception problem among end-investors, facilitated by financial engineers selling “tail risk” products. Contrary to the precrisis rhetoric, this tail risk was often transferred to those least able to manage and price it. Once crisis struck, bank balance sheets needed to be repaired. The article argues that the authorities have a key coordinating role to play in ensuring individual bank balance sheet adjustments strengthen, rather than weaken, the financial system as a whole. A credit crunch-an uncoordinated credit contraction—is an example of what policy should be seeking to avoid. Finally, the article considers two medium-term prophylactic policy measures-countercyclical regulatory policy and central trading, clearing and settlement of systemically-important financial instruments. On both theoretical and practical grounds, there are good reasons for believing their time may have come.
Trends and Challenges in Islamic Finance
Heiko Hesse, Andreas (Andy) Jobst & Juan Solé, World Economics, June 2008
The paper first discusses the current trends in Islamic finance, which has become mainstream with currently more than US$800 billion of assets worldwide and a buoyant market for sukuk bonds. However, this exorbitant growth raises many challenges, particularly in the areas of banking, capital markets and regulation. Thus, the paper then considers these challenges, notably the economic and legal bottlenecks of sukuk, banking-specific issues, such as liquidity risk management and business models, as well as disharmonized financial regulation. Despite the challenges, the paper concludes that the Islamic finance industry has a bright future.
Islamic Economics and Finance
Rodney Wilson, World Economics, March 2008
This article provides an introduction to key concepts and methods involved in an Islamic approach to business, investment, risk taking and insurance. The prohibition of riba (interest or usury) profoundly influences the way business transactions and investments are made and financial contracts must comply with Islamic law or shariah. Underlying all economic and financial transactions from an Islamic perspective is a moral dimension, with the authoritative source of guidance being the Holy Quran, the revealed word of Allah, and the Hadith, the sayings and practices of the Prophet Muhammad and his companions, referred to as the Sunnah. Notably there is a concern about the justice of outcomes for individuals. A valuable contribution of the Islamic finance industry-with over one trillion dollars’ worth of assets designated as shariah compliant-is the issues it raises about morality and social accountability in financial dealings and the challenge it poses to conventional assumptions.
The Future of Financial Regulation
Howard Davies, World Economics, March 2008
In light of the recent turmoil in global financial markets and criticisms of the performance of the regulatory system, Sir Howard Davies-who prior to his current appointment as Director of the London School of Economics was Chairman of the Financial Services Authority, the UK’s single financial regulator-gives a preliminary assessment of where there is a case for change in the rather complex global regulatory system. He identifies seven interesting and difficult questions for central banks and regulators concerning the financial markets upheaval: Did the Fed cause the problem? Is this a broader crisis of Anglo-Saxon capital markets? Is there a fundamental problem in the subprime mortgage market in the United States? Is there a fundamental problem with the credit ratings agencies? Do we need a new approach to liquidity? Is the UK’s regulatory system fundamentally flawed? Does the crisis reveal flaws in the international regulatory system? His answer to the latter question is a qualified yes. Improvements can be made, but the recent events have provided a vivid demonstration of the importance of a robust regulatory framework surrounding capital markets.
Sovereign Wealth Funds: What they are and what’s happening
Stephen Jen, World Economics, December 2007
Sovereign Wealth Funds (SWFs), much in the news of late, are a new and growing class of funds that are already large in size, and will likely grow very rapidly in the coming years. How they will operate, both in terms of their portfolio allocation and the way in which the managers of these funds communicate and interact with the private sector will have great implications for the financial markets. The author addresses some of the key features and implications of SWFs including how big they are, their likely investment strategies, their possible impact on the financial markets, the risk of financial protectionism arising as a political reaction, and issues of transparency of the funds (greater transparency by the SWFs could help restrain the rise of financial protectionism).
Does the World Need a Universal Financial Institution?
James Boughton, World Economics, June 2005
All financial institutions specialize, in dimensions that may include categories of assets and liabilities, types of services offered, customer demographics, and geographic coverage. The International Monetary Fund is the only international financial institution that is truly universal in its geographic scope, prepared to lend on request to virtually any country in the world. Why has this status come about? What are its costs and benefits? Is it an appropriate model for a world where macroeconomic imbalances, financial crises, and disparities in economic development must compete for attention and resources?
European Financial Market Integration: Distant dream or nascent reality?
Patrice Muller, World Economics, September 2004
European Monetary Union and a vigorous legislative agenda have profoundly changed the environment in which the European financial services industry operates. These developments should have contributed to a deepening of financial market integration in the European Union, especially within the Eurozone. However, actual progress has been very uneven. Eurozone money markets and bonds markets have achieved full or a very high level of integration. Eurozone equity markets show increasing signs of integration, although substantial barriers to cross-border trading remain. Bank credit markets, with the exception of inter-bank lending, and insurance and funds industries, remain still largely fragmented along national lines.
A Single European Market in Asset Management: Vision and reality
Friedrich Heinemann, World Economics, March 2004
In spite of progress with integration, the European single market is still far from perfect. In particular, financial services markets are still heavily segmented along national borders—even in the era of the Internet and the Euro. In order to understand the reasons for and consequences of incomplete integration, a detailed analysis is presented for the European asset management market. It turns out that fragmentation is very costly both in micro- and macroeconomic terms. The following obstacles are identified to be most relevant: tax discrimination, certain properties of existing distribution channels, and regulative issues related to fund mergers and registration. Only if these issues are addressed by legislators and the industry can significant progress in integration be achieved.
Blueprint for Public Company Reform
Edward Gottesman, World Economics, December 2003
The crisis of confidence in corporate governance and the opacity of public company reporting are growing concerns. These flaws in the market system have been highlighted by the stock market bubble and pose a threat to orderly capital flows. Reform is needed, but legislation may have little effect and can carry unintended consequences. Better solutions can be found by examining the way in which private companies are directed and the type of financial and operational reports they use for budgeting and control. Institutional investors, bankers, professional advisers and Boards of Directors can implement the changes needed to provide more reliable information for valuation of public company securities and to counteract the casino mentality that infects capital markets.
China’s Capital Market: Better than a casino
Stephen Green, World Economics, December 2003
Throughout the 1990s, China’s stock market was developed as a tool of industrial policy. It was used to supply capital to state-owned enterprises (SOEs) that remained controlled by the state and whose performance usually declined after listing. Secondary market trading was poorly regulated, again partly for political reasons. As a result, the market has become infamous for extreme volatility, price manipulation and grossly unreliable accounting. This is a problem for the government since the stock market is ill-equipped to support the government’s other increasingly important economic priorities. The government now needs to improve the efficiency of industry in order to sustain employment creation, to raise capital to finance its own liabilities and to put into place a modern pension system. As a result, China’s stock market is being slowly reformed. Listed companies are quietly being allowed to privatise. The regulatory framework has been rationalised. The empowered China Securities Regulatory Commission is pushing forward with a range of policies aimed at improving corporate governance. Shareholders have been allowed to pursue civil compensation claims against firms in the courts. Financial intermediaries are being privatised, the fund sector is being rapidly expanded and foreign investors are gradually being allowed in. These changes, although deeply unpopular among some important groups, will mature the market over the next decade.
Why The Five Economic Tests?: The decision about British membership of a single European currency in historical context
Ed Balls, World Economics, March 2003
Chief Economic Adviser to the Treasury, Ed Balls, sets out the government’s approach to making the decision about British membership of a single European currency in an historical context. The basis for deciding whether there is a clear and unambiguous economic case to join the single currency is the Treasury’s detailed assessment of the ‘five economic tests’. The tests are designed to avoid past failures of politicians and policymakers who paid insufficient attention to the economics in making key decisions affecting the national interest. Balls reflects upon historical examples of such failures and lessons to be learned, with a particular historical focus on 1925 and the decision to re-enter the Gold Standard.
The Puzzle of the Harmonious Stock Prices
Randall Morck & Bernard Yeung, World Economics, September 2002
A peculiar pattern is evident across the stock markets of different countries. In emerging markets, such as Peru and China, all the stocks in the country tend to rise and fall together in the course of ordinary trading. But in developed countries, such as Denmark and Canada, stocks move independently. What seems to determine how independently a country’s stock prices move is not the size of its market, the diversification of its economy, the stability of its macroeconomic policy or factors relating to the behaviour of individual firms. Rather, stock prices move more independently in countries that are less corrupt.
Some Facts about Hedge Funds
Harry M. Kat , World Economics, June 2002
Hedge funds promise investors the best of both worlds: superior performance and high diversification potential combined into one. This article discusses a number of recent findings that show that the case for hedge funds is less straightforward than often portrayed. A close look at the available hedge fund return data reveal substantial bias which makes interpretation complex. When using traditional performance measures, this will cause investors to overestimate the expected return and underestimate the risk of hedge funds. As a result, they are likely to overinvest in hedge funds.
Stock Markets and Central Bankers: The economic consequences of Alan Greenspan
Stephen Wright, World Economics, March 2002
There is a near-consensus that central bankers should focus their attention on the control of inflation, and should accordingly not pay attention to movements in stock markets. This view is reinforced by the continuing influence of the Efficient Markets Hypothesis (EMH), which maintains that financial markets correctly price firms at all times. The authors assert that this general view is incorrect. There are strong reasons, both in principle and in practice, to doubt the applicability of the EMH to the valuation of the stock market as a whole. Indicators of stock market value, such as q, show the market to have been severely overvalued at the end of the twentieth century. Previous episodes of overvaluation have been succeeded, both in the US and Japan, by severe recessions. Such recessions raise the risk of central banks losing control of inflation, due to liquidity traps; they also impose costs, in terms of output and inflation, which central bankers should take into account. Finally, central bankers already do in any case take these into account, but asymmetrically: only when markets fall, not when they rise.
Cohabiting with Goliath: How small equity exchanges will survive in the future
Avinash Persaud, World Economics, December 2001
The surviving legacy of the Long Term Capital debacle of October 1998 is an increased preference for liquidity among international investors. This process has a self-fulfilling element with liquidity following investors out of the less liquid markets and into the more liquid. A closer examination of this issue, however, suggests liquidity is not just an issue of size. There is some evidence that some markets have become bigger, yet thinner. In this paper the author focuses on the characteristics that can be used to better identify liquidity risk when a crisis hits.
Keywords: Crises, Crisis, Liquidity, LTCM     Download Paper
Bad Market Days: Lessons from the stock market crashes of 1929 & 1987
Harold Bierman, World Economics, September 2001
There are a large number of misconceptions regarding the great stock market crash of 1929 and the crash of 1987. Both crashes occurred when the general level of business was good and getting better. In 1929 there were very few hints that the great depression was two years away. In fact, in recognition of the favourable business climate, by the end of 1929 the market had recovered most of its October losses and was down only 11.9% from its highs (the major losses were to occur in 1930–1932). There were several causes of the 1929 crash. Two of the most important causes were the campaign by the Federal Government against the orgy of speculation taking place in New York City and an action by the Public Utility Commission of Massachusetts that triggered a collapse of inflated public utility stock prices. That, in turn, triggered a collapse of other stock prices.
The Rebirth of the Corporate Bond Market
Bill Robinson, John Raven & Christopher Chua , World Economics, June 2001
There has been a major switch from equity to debt finance in recent years, associated with a fall in the long-term rate of interest. The paper explores the macro-economic causes of the sea change in interest rates (lower budget deficits, independent central banks, lower inflation expectations) and the micro-economic consequences. Firms are taking on more debt partly for tax reasons and partly because at lower interest rates they have better interest cover. This means they can increase their borrowing at lower risk and hence at lower cost. An examination of a cross section of UK firms from the FTSE 350 shows two major influences on the debt-to-value ratio of large firms. Firms with healthy cash flow are allowed to borrow against that income; and firms whose income is relatively invariant across the economic cycle (as measured by a low asset beta) can afford a higher level of debt.
Keywords: Debt, Equity, Tax     Download Paper
E-money: Will it Take Off?
Peter Spencer, World Economics, March 2001
The growth of the Internet and e-commerce raises some interesting questions for those interested in the monetary system. Is a new Internet-based digital transactions medium likely to evolve and what would the consequences of this be for taxation, monetary and financial stability? This article reviews the problems that have so far prevented the adoption of digital money and the ways in which these are now being tackled. It concludes that take-off is likely in the near future and considers the consequences for policymakers.
Can Bettors Win?: A perspective on the economics of betting
Leighton Vaughan Williams, World Economics, March 2001
In this paper, a survey is undertaken of studies that examines the extent to which systematic patterns of behaviour in betting markets can generate above-average or even abnormal returns, the latter being most conveniently defined for these purposes as a profit. The paper concludes that although betting markets do tend to process efficiently the information available to them, there are clear opportunities to earn above-average returns. Moreover, there is significant evidence that some bettors are able to profit by withholding and subsequently utilising superior information.
Sending the Herd off the Cliff Edge: The disturbing interaction between herding and market-sensitive risk management practices
Avinash Persaud, World Economics, December 2000
In the international financial arena, policy makers chant three things: market-sensitive risk-management, transparency and prudential standards. The message is we do not need a new world order, just to improve the workings of the existing one. While many believe this is an inadequate response to the financial crises of the past two decades, few argue against this line. Perhaps more should. There is compelling evidence that in the short run, markets find it hard to distinguish between the good and the unsustainable, market players herd and contagion is common. In this environment, market-sensitive risk management and transparency can destabilise markets.