Remarks on Income Contingent Loans: How Effective Can They Be at Mitigating Risk?

A well-known principle holds that equity provides better risk sharing opportunities than debt, but that there are greater enforcement problems associated with equity. Income contingent loans (ICL) represent an efficient (low transactions cost) way of implementing equity contracts for human capital.1 The amount the individual repays is dependent on his or her income. While it seems natural to link ICL with investments that increase the value of human capital — most notably education — there is no necessary reason to limit it to such investments

Crises: Principles and Policies: With an Application to the Eurozone Crisis

Economies around the world have faced repeated crises — more frequently over the past thirty years. The fact that they have become more frequent and pervasive at the same time that we believe we have learned more about the management of the economy and as markets have seemingly improved poses a puzzle: shouldn't rational markets avoid these catastrophes, the costs of which outweigh, by an enormous amount, any benefit that might have accrued to the economy from the actions prior to the crisis that might have contributed to it? This is especially true of the large fraction of crises that can be called “debt crises,” precipitated by a country’s difficulty in repaying what it owes. The benefits of income smoothing (arising from the difference in the marginal utility of income in periods when income is low and when income is high) are overwhelmed by the social and economic costs of the ensuing crisis

Complex Derivatives

The intrinsic complexity of the financial derivatives market has emerged as both an incentive to engage in it, and a key source of its inherent instability. Regulators now faced with the challenge of taming this beast may find inspiration in the budding science of complex systems. When financial derivatives were cast in 2002 as latent 'weapons of mass destruction', one might have expected the world at large to sit up and listen — particularly in the wake of subsequent events that led to the financial crisis of 2008. Instead, the derivatives market continues to grow in size and complexity (Fig. 1), spawning a new generation of financial innovations, and raising concerns about its potential impact on the economy as a whole. A derivative instrument is a financial contract between two parties, in which the value of the payoff is derived from the value of another financial instrument or asset, called the underlying entity. In some cases, this contract acts as a kind of insurance: in a credit default swap, for example, a lender might buy protection from a third party to insure against the default of the borrower. However, unlike conventional insurance, in which a person necessarily owns the house she wants to insure, derivatives can be negotiated on any underlying entity — meaning anyone could take out insurance on the house in question. Speculation therefore emerges as another reason to trade in derivatives. By engaging in a speculative derivatives market, players can potentially amplify their gains, which is arguably the most plausible explanation for the proliferation of derivatives in recent years. Needless to say, losses are also amplified. Unlike bets on, say, dice — where the chances of the outcome are not affected by the bet itself — the more market players bet on the default of a country, the more likely the default becomes. Eventually the game becomes a self-fulfilling prophecy, as in a bank run, where if each party believes that others will withdraw their money from the bank, it pays each to do so. More perversely, in some cases parties have incentives (and opportunities) to precipitate these events, by spreading rumours or by manipulating the prices on which the derivatives are contingent — a situation seen most recently in the London Interbank Offered Rate (LIBOR) affair. Proponents of derivatives have long argued that these instruments help to stabilize markets by distributing risk, but it has been shown recently that in many situations risk sharing can also lead to instabilities

Testing for inconsistencies in the estimation of UK capital structure determinants

This article analyses the determinants of the capital structure of 1054 UK companies from 1991 to 1997, and the extent to which the influence of these determinants are affected by time-invariant firm-specific heterogeneity. Comparing the results of pooled OLS and fixed effects panel estimation, significant differences in the results are found. While the OLS results are generally consistent with prior literature, the results of our fixed effects panel estimation contradict many of the traditional theories of the determinants of corporate financial structure. This suggests that results of traditional studies may be biased owing to a failure to control for firm-specific, time-invariant heterogeneity. The results of the fixed effects panel estimation find larger companies to have higher levels of both long-term and short-term debt than do smaller firms, profitability to be negatively correlated with the level of gearing, although profitable firms tend to have more short-term bank borrowing than less profitable firms, and tangibility to positively influence the level of short-term bank borrowing, as well as all long-term debt elements. However, the level of growth opportunities appears to have little influence on the level of gearing, other than short-term bank borrowing, where a significant negative relationship is observed

Explaining productivity in a poor productivity region

© 2017, © The Author(s) 2017. Productivity is the preferred measure of firm-level efficiency and perceived to reflect resource use rates. Semi-structured interviews with restaurant managers in a tourism-dominated low productivity rural area reveal that they are motivated to supply products that they believe in and to sustain a quality of life that meets their needs rather than striving to achieve higher productivity. Pricing strategies, managerial objectives and local market characteristics are found to radically influence the area’s productivity value. An area’s productivity value might not be an indicator of resource use rates or productive efficiency, and could instead reflect resident managers’ motivations towards money and the presence of opportunities to achieve scale economies

Whither Capitalism? Financial externalities and crisis

As with global warming, so with financial crises – externalities have a lot to answer for. We look at three of them. First the financial accelerator due to ‘fire sales’ of collateral assets -- a form of pecuniary externality that leads to liquidity being undervalued. Second the ‘risk- shifting’ behaviour of highly-levered financial institutions who keep the upside of risky investment while passing the downside to others thanks to limited liability. Finally, the network externality where the structure of the financial industry helps propagate shocks around the system unless this is checked by some form of circuit breaker, or ‘ring-fence’. The contrast between crisis-induced Great Recession and its aftermath of slow growth in the West and the rapid - and (so far) sustained - growth in the East suggests that successful economic progress may depend on how well these externalities are managed

The Relationship Between Financial Distress and Life-Course Socioeconomic Inequalities in Well-Being:Cross-National Analysis of European Welfare States

Objectives. We investigated to what extent current financial distress explains the relationship between life-course socioeconomic position and well-being in Southern, Scandinavian, Postcommunist, and Bismarckian welfare regimes. Methods. We analyzed individuals (n = 18 324) aged 50 to 75 years in the Survey of Health, Ageing, and Retirement in Europe, 2006–2009. Well-being was measured with CASP-12 (which stands for control, autonomy, self-realization, and pleasure) and life satisfaction. We generated a life-course socioeconomic index from 8 variables and calculated multilevel regression models (containing individuals nested within 13 countries), as well as stratified single-level models by welfare regime. Results. Life-course socioeconomic advantage was related to higher well-being; the difference in life satisfaction between the most and least advantaged was 2.09 (95% confidence interval = 1.87, 2.31) among women and 1.65 (95% confidence interval = 1.43, 1.87) among men. The weakest associations were found among Scandinavian countries. Financial distress was associated with lower well-being and attenuated the relationship between life-course socioeconomic position and well-being in all regimes (ranging from 34.26% in Postcommunist to 72.22% in Scandinavian countries). Conclusions. We found narrower inequalities in well-being in the Scandinavian regime. Reducing financial distress may help improve well-being and reduce inequalities