Haircuts

“When confidence is lost, liquidity dries up.” The authors investigate the meaning of “confidence” and “liquidity” in the context of the recent financial crisis, which they maintain is a manifestation of an age-old problem with private money creation: banking panics. The authors explain this problem and provide some evidence with respect to the recent crisis.Bank liquidity ; Financial crises

The economics of private equity funds

Capital market ; Securities

Price versus Quantity: Market Clearing Mechanisms When Sellers Differ in Quality

High-quality producers in a vertically differentiated market can reap superior profits by charging higher prices, selling greater quantities, or both. If qualities are known by consumers and production costs are constant, then having a higher quality secures the producer both higher price and higher quantity; if marginal costs are rising, having a higher quality assures only higher price. If only some consumers can discern quality but others cannot, then high- and low-quality producers may set a common price, but the high-quality producer will sell more. In this context, quality begets quantity. Empirical analyses suggest that in both the mutual fund and automobile industries, high-quality producers sell more units than their low-quality competitors, but at no higher price (or markup) per unit.

Regulating the Shadow Banking System

regulation, banks, shadow banking, MMMFs, money market mutual funds, insurance

Getting up to Speed on the Financial Crisis: A One-Weekend-Reader's Guide

All economists should be conversant with “what happened?” during the financial crisis of 2007-2009. We select and summarize 16 documents, including academic papers and reports from regulatory and international agencies. This reading list covers the key facts and mechanisms in the build-up of risk, the panics in short-term-debt markets, the policy reactions, and the real effects of the financial crisis.

Patterns of behavior in biodiversity preservation

Conservation budgets are limited, so it is right to ask of biodiversity programs, What should be preserved? How much should be preserved? Where? Recent papers on optimal preservation policy have tried to integrate three considerations: the relative uniqueness of different species or habitats, the degree of risk to their continued survival, and the opportunity cost of the resources needed to enhance their prospects for survival. It is natural to ask, How are we doing? Have biodiversity conservation resources been optimally allocated? What determines government decisions about the preservation of endangered species? The authors submit the first report card, an empirical analysis of U.S. species preservation policy, the best-documented country experience currently available. The authors discuss the most common normative justifications for biodiversity preservation and identify measurable proxies for a subset of those justifications. Proxies include"scientific"species characteristics, such as"degree of endangerment"and"taxonomic uniqueness,"as well as"visceral"characteristics, such as physical size and to what extent a species is considered a"higher form of life."They find that both kindsof characteristics, but especially"visceral"characteristics, influence government decisions on whether to protect a species under the Endangered Species Act. The authors find that"visceral"characteristics- especially physical size and taxonomic class - are also important in explaining how much is spent on endangered species. Perhaps more surprising is their finding that more is spent on animals with lower risk of extinction than on animals with a higher risk of extinction. The author's results are sobering. Many millions have been spent on species preservation, but neither uniqueness nor risk has weighed heavily in resource allocation. Instead there has been a heavy bias toward"charismatic megafauna"- large, well-known birds and mammals ("higher forms of life,"in the human value system). Other classes of fauna - including, say, eels or wild toads - and all flora, have gotten extremely short shrift. Prominent examples of species with high charisma, high attention, and relatively low endangerment are the bald eagle, the Florida scrub jay, and the grizzly bear. Other species may have less charisma but could have more scientific value or species risk.Wildlife Resources,Wetlands,Environmental Economics&Policies,Information Technology,Biodiversity

Bayesian Performance Evaluation

This paper proposes a Bayesian method of performance evaluation for investment managers. We begin with a flexible set of prior beliefs that can be elicited without any reference to probability distributions or their parameters. We then combine these prior beliefs with a general multi-factor model and derive an analytical solution for the posterior expectation of alpha', the intercept term from the model. This solution can be computed using only a few extra steps beyond maximum likelihood estimation and does not require a comprehensive or bias-free database. We then apply our methodology to a sample of domestic diversified equity mutual funds and ask what prior beliefs would imply zero investment in active managers?' To justify such a zero-investment strategy, we find that a mean-variance investor would need to believe that less than 1 out of every 100,000 managers has an expected alpha greater than 25 basis points per month. Overall, our analysis suggests that even when the average manager is expected to underperform passive benchmarks, it requires very strong prior beliefs to imply zero investment in managers with the best past performance.

The Profits to Insider Trading: A Performance-Evaluation Perspective

This paper estimates the profits to insiders when they trade their company's stock. We construct a rolling purchase portfolio' that holds all shares purchased by insiders over the previous year and an analogous sale portfolio' that holds all shares sold by insiders over the previous year. We then analyze the returns to these value-weighted portfolios using performance-evaluation methods. This approach allows us to study the returns to insider transactions beginning on the day after their execution, and is free of the statistical difficulties that plague event studies on long-horizon returns. Using a comprehensive sample of reported insider transactions from 1975 - 1996, we find that the purchase portfolio earns abnormal returns of about 40 basis points per month, with about one-sixth of these abnormal returns accruing within the first five days after the initial transaction, and one-third within the first month. The sale portfolio does not earn abnormal returns. Our portfolio-based approach also allows for straightforward decompositions of the purchase and sale portfolios by various characteristics. We find that the abnormal returns to insider trades in small firms are not significantly different from those in large firms, and that top executives do not earn higher abnormal returns than do other insiders.