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arXiv2012

What are the limits on Commercial Bank Lending?

Analysis of the 2007-8 credit crisis has concentrated on issues of relaxed lending standards, and the perception of irrational behaviour by speculative investors in real estate and other assets. Asset backed securities have been extensively criticised for creating a moral hazard in loan issuance and an associated increase in default risk, by removing the immediate lender's incentive to ensure that the underlying loans could be repaid. However significant monetary issues can accompany any form of increased commercial bank lending, and these appear to have been overlooked by this analysis. In this paper we propose a general explanation for credit crises based on an examination of the mechanics of the banking system, and in particular its internal controls on the supply of credit. We suggest that the current credit crisis is the result of multiple failures in the Basel regulatory framework, including the removal of central bank reserve requirements from some classes of deposit accounts within the banking system, allowing financial instruments representing debt to be used as regulatory capital, and in particular the introduction of securitized lending which effectively removed a previously implicit control over the total quantity of lending originating from the banking system. We further argue that the interaction of these problems has led to a destabilising imbalance between total money and loan supply growth, in that total lending sourced from the commercial bank sector increased at a faster rate than accompanying growth in the money supply. This not only created a multi-decade macro-economic debt spiral, but by increasing the ratio of debt to money within the monetary system acted to increase the risk of loan defaults, and consequentially reduce the overall stability of the banking system.

q-fin.GN↗

arXiv2009

An Introduction to Hedge Funds

This report was originally written as an industry white paper on Hedge Funds. This paper gives an overview to Hedge Funds, with a focus on risk management issues. We define and explain the general characteristics of Hedge Funds, their main investment strategies and the risk models employed. We address the problems in Hedge Fund modelling, survey current Hedge Funds available on the market and those that have been withdrawn. Finally, we summarise the supporting and opposing arguments for Hedge Fund usage. A unique value of this paper, compared to other Hedge Fund literature freely available on the internet, is that this review is fully sourced from academic references (such as peer reviewed journals) and is thus a bona fide study. This paper will be of interest to: Hedge Fund and Mutual Fund Managers, Quantitative Analysts, "Front" and "Middle" office banking functions e.g. Treasury Management, Regulators concerned with Hedge Fund Financial Risk Management, Private and Institutional Investors, Academic Researchers in the area of Financial Risk Management and the general Finance community.

q-fin.GN↗

arXiv2010

Generalized supermartingale deflators under limited information

We undertake a study of markets from the perspective of a financial agent with limited access to information. The set of wealth processes available to the agent is structured with reasonable economic properties, instead of the usual practice of taking it to consist of stochastic integrals against a semimartingale integrator. We obtain the equivalence of the boundedness in probability of the set of terminal wealth outcomes (which in turn is equivalent to the weak market viability condition of absence of arbitrage of the first kind) with the existence of at least one strictly positive deflator that makes the deflated wealth processes have a generalized supermartingale property.

q-fin.GN↗

arXiv2009

Macroeconomic Phase Transitions Detected from the Dow Jones Industrial Average Time Series

In this paper, we perform statistical segmentation and clustering analysis of the Dow Jones Industrial Average time series between January 1997 and August 2008. Modeling the index movements and log-index movements as stationary Gaussian processes, we find a total of 116 and 119 statistically stationary segments respectively. These can then be grouped into between five to seven clusters, each representing a different macroeconomic phase. The macroeconomic phases are distinguished primarily by their volatilities. We find the US economy, as measured by the DJI, spends most of its time in a low-volatility phase and a high-volatility phase. The former can be roughly associated with economic expansion, while the latter contains the economic contraction phase in the standard economic cycle. Both phases are interrupted by a moderate-volatility market, but extremely-high-volatility market crashes are found mostly within the high-volatility phase. From the temporal distribution of various phases, we see a high-volatility phase from mid-1998 to mid-2003, and another starting mid-2007 (the current global financial crisis). Transitions from the low-volatility phase to the high-volatility phase are preceded by a series of precursor shocks, whereas the transition from the high-volatility phase to the low-volatility phase is preceded by a series of inverted shocks. The time scale for both types of transitions is about a year. We also identify the July 1997 Asian Financial Crisis to be the trigger for the mid-1998 transition, and an unnamed May 2006 market event related to corrections in the Chinese markets to be the trigger for the mid-2007 transition.

q-fin.GN↗

arXiv2009

La Loi organique relative aux lois de finances (LOLF) dans les institutions culturelles publiques du spectacle vivant en France

In a crisis of public finances, France bases all its hopes on the "evaluation of performance" to moderate the effects of a complex crisis. Under the banner of "modernization of the State", a new "financial constitution" called the Organic Law on finance laws (LOLF) became the main lever of reform of public management. Fully applied to the Cultural Affairs since 2006, the LOLF is based on a set of performance indicators and sets the public performance arts institutions specific targets. This article defines and analyzes the pattern of the design and the course of these indicators and targets. It also examines the controversy generated by this new mode of governance.

q-fin.GN↗

arXiv2009

A Consistent Model of `Explosive' Financial Bubbles With Mean-Reversing Residuals

We present a self-consistent model for explosive financial bubbles, which combines a mean-reverting volatility process and a stochastic conditional return which reflects nonlinear positive feedbacks and continuous updates of the investors' beliefs and sentiments. The conditional expected returns exhibit faster-than-exponential acceleration decorated by accelerating oscillations, called "log-periodic power law." Tests on residuals show a remarkable low rate (0.2%) of false positives when applied to a GARCH benchmark. When tested on the S&P500 US index from Jan. 3, 1950 to Nov. 21, 2008, the model correctly identifies the bubbles ending in Oct. 1987, in Oct. 1997, in Aug. 1998 and the ITC bubble ending on the first quarter of 2000. Different unit-root tests confirm the high relevance of the model specification. Our model also provides a diagnostic for the duration of bubbles: applied to the period before Oct. 1987 crash, there is clear evidence that the bubble started at least 4 years earlier. We confirm the validity and universality of the volatility-confined LPPL model on seven other major bubbles that have occurred in the World in the last two decades. Using Bayesian inference, we find a very strong statistical preference for our model compared with a standard benchmark, in contradiction with Chang and Feigenbaum (2006) which used a unit-root model for residuals.

q-fin.RM↗

arXiv2009

A Markovian Model Market - Akerlof's Lemmons and the Asymmetry of Information

In this work we study an economic agent based model under different asymmetric information degrees. This model is quite simple and can be treated analytically since the buyers evaluate the quality of a certain good taking into account only the quality of the last good purchased plus her perceptive capacity β. As a consequence the system evolves according to a stationary Markovian stochastic process. The value of a product offered by the seller increases with quality according to the exponent α, which is a measure of technology. It incorporates all the technological capacity of production systems such as education, scientific development and techniques that change the productivity growth. The technological level plays an important role to explain how the asymmetry of information may affect the market evolution in this model. We observe that, for high technological levels, the market can control adverse selection. The model allows us to compute the maximum asymmetric information degree before market collapse. Below this critical point the market evolves during a very limited time and then dies out completely. When βis closer to 1(symmetric information), the market becomes more profitable for high quality goods, although high and low quality markets coexist. All the results we obtained from the model are analytical and the maximum asymmetric information level is a consequence of an ergodicity breakdown in the process of quality evaluation.

q-fin.GN↗

arXiv2009

Presentation Du Nouvel Accord De Bale Sur Les Fonds Propres

In order to adapt to the liberalization of the financial sphere started in the Eighties, marked in particular by the end of the framing of credit, the disappearance of the various forms of protection of the State whose profited the banks, and the privatization of the near total of the establishments in Europe, the banking regulation evolved to a prudential approach, perceived like the only mode of regulation not entering in contradiction with the rules of the market. The current banking regulation is pressed on the supervision, the discipline of the market and the ratios prudential; in particular the ratios of the minimal own capital stocks. The object of this article is the presentation of the architecture of the new agreement of Basle (1999) which is based on three pillars consolidating it self mutually.

q-fin.GN↗

arXiv2010

On the Martingale Property of Certain Local Martingales

The stochastic exponential $Z_t=\exp\{M_t-M_0-(1/2) _t\}$ of a continuous local martingale $M$ is itself a continuous local martingale. We give a necessary and sufficient condition for the process $Z$ to be a true martingale in the case where $M_t=\int_0^t b(Y_u)\,dW_u$ and $Y$ is a one-dimensional diffusion driven by a Brownian motion $W$. Furthermore, we provide a necessary and sufficient condition for $Z$ to be a uniformly integrable martingale in the same setting. These conditions are deterministic and expressed only in terms of the function $b$ and the drift and diffusion coefficients of $Y$. As an application we provide a deterministic criterion for the absence of bubbles in a one-dimensional setting.

math.PR↗

arXiv2009

Simulation and Use of Heuristics for Peripheral Economic Policy

Recent trends in Agent Computational Economics research, envelop a government agent in the model of the economy, whose decisions are based on learning algorithms. In this paper we try to evaluate the performance of simulated annealing in this context, by considering a model proposed earlier in the literature, which has modeled an artificial economy consisting of geographically dispersed companies modeled as agents, that try to maximize their profit, which is yielded by selling an homogeneous product in different cities, with different travel costs. The authors have used an evolutionary algorithm there, for modeling the agents' decision process. Our extension introduces a government agent that tries to affect supply and demand by different taxation coefficients in the different markets, in order to equate the quantities sold in each city. We have studied the situation that occurs when a simulated annealing algorithm and a simple search algorithm is used as the government's learning algorithm, and we have evaluated the comparative performance of the two.

math.OC↗

arXiv2009

A la Recherche des Facteurs Déterminants de l'Intégration Internationale des Marchés Boursiers : une Analyse sur Données de Panel

The aim of this paper is to identify the determinants of international stock markets integration. Intuitively we selected a great number of factors linked to financial integration. Then, we developed an international asset-pricing model with time-varying degree of integration. This model is estimated for 30 countries (10 developed countries and 20 emerging countries) using panel data econometrics. In order to investigate whether the financial integration in emerging markets and that in developed markets react differently to the economic and financial innovations, we estimated the model as well jointly for all markets as separately for developed markets and emerging markets. Our results show that trade openness exerts a positive effect on financial integration across all markets, the global factors drive integration in developed markets whereas the factors related to economic and political stability affect financial integration in emerging markets.

q-fin.GN↗

arXiv2009

Structural Breaks in the Mexico's Integration into the World Stock Market

This article investigates the evolution of the Mexican stock market integration into the world market. First, we estimate the time-varying Mexican degree of market integration using an international conditional version of the CAPM with segmentation effects. Second, we study the structural breaks in this series. Finally, we relate the obtained results to important facts and economic events

q-fin.GN↗

arXiv2009

A Prediction Market for Toxic Assets Prices

We propose the development of a prediction market for forecasting prices for "toxic assets" to be transferred from Irish banks to the National Asset Management Agency (NAMA). Such a market allows market participants to assume a stake in a security whose value is tied to a future event. We propose that securities are created whose value hinges on the transfer amount paid for loans from NAMA to a bank. In essence, bets are accepted on whether the price is higher or lower than a certain quoted figure. The prices of the securities represent transfer prices for toxic assets increases or decreases in line with market opinion. Prediction markets offer a proven means of aggregating distributed knowledge pertaining to fair market values in a scalable and transparent manner. They are incentive compatible (i.e. induce truthful reporting) and robust to strategic manipulation. We propose that a prediction market is run in parallel with the pricing procedure recommended by the European Commission. This procedure need not necessarily take heed of the prediction markets view in all cases but it may offer guidance and a means of anomaly detection. An online prediction market would offer everybody an opportunity to "have their say" in an open and transparent manner.

q-fin.GN↗

arXiv2009

Complementarity between private and public investment in R&D: A Dynamic Panel Data analysis

This paper investigates the relationship between private and public investment in R&D, while taking into account the effect of several instruments policies such as subsidies and taxes. We design a new look of knowledge spillovers and R&D cooperation to explain the contribution of public and private R&D on growth. We propose a heterogeneous dynamic panel data model to consider the endogenous effect of R&D investment. We also distinguish between the estimated long and short run results. Our results based on a sample of 23 countries over the period 1992-2004 indicate that both public and private investments in R&D are complementary. By establishing an endogenous growth model, the estimates indicate that public and private R&D depends on the host country's human capital investment. Results indicate that foreign direct investment is a more significant spillover channel than imports.

q-fin.GN↗

arXiv2010

An example of a stochastic equilibrium with incomplete markets

We prove existence and uniqueness of stochastic equilibria in a class of incomplete continuous-time financial environments where the market participants are exponential utility maximizers with heterogeneous risk-aversion coefficients and general Markovian random endowments. The incompleteness featured in our setting - the source of which can be thought of as a credit event or a catastrophe - is genuine in the sense that not only the prices, but also the family of replicable claims itself is determined as a part of the equilibrium. Consequently, equilibrium allocations are not necessarily Pareto optimal and the related representative-agent techniques cannot be used. Instead, we follow a novel route based on new stability results for a class of semilinear partial differential equations related to the Hamilton-Jacobi-Bellman equation for the agents' utility-maximization problems. This approach leads to a reformulation of the problem where the Banach fixed point theorem can be used not only to show existence and uniqueness, but also to provide a simple and efficient numerical procedure for its computation.

q-fin.GN↗

arXiv2009

Spiraling toward market completeness and financial instability

I study the limit of a large random economy, where a set of consumers invests in financial instruments engineered by banks, in order to optimize their future consumption. This exercise shows that, even in the ideal case of perfect competition, where full information is available to all market participants, the equilibrium develops a marked vulnerability (or susceptibility) to market imperfections, as markets approach completeness and transaction costs vanish. The decrease in transaction costs arises because financial institutions exploit trading instruments to hedge other instruments. This entails trading volumes in the interbank market which diverge in the limit of complete markets. These results suggest that the proliferation of financial instruments exacerbates the effects of market imperfections, calling for theories of market as interacting systems. From a different perspective, in order to prevent an escalation of perverse effects, markets may necessitate institutional structures which are more and more conspicuous as their complexity expands.

q-fin.ST↗

arXiv2009

Economic interactions and the distribution of wealth

This paper analyzes the equilibrium distribution of wealth in an economy where firms' productivities are subject to idiosyncratic shocks, returns on factors are determined in competitive markets, dynasties have linear consumption functions and government imposes taxes on capital and labour incomes and equally redistributes the collected resources to dynasties. The equilibrium distribution of wealth is explicitly calculated and its shape crucially depends on market incompleteness. In particular, a Paretian law in the top tail only arises if capital markets are incomplete. The Pareto exponent depends on the saving rate, on the net return on capital, on the growth rate of population and on portfolio diversification. On the contrary, the characteristics of the labour market mostly affects the bottom tail of the distribution of wealth. The analysis also suggests a positive relationship between growth and wealth inequality.

q-fin.GN↗

arXiv2009

Money Distributions in Chaotic Economies

This paper considers the ideal gas-like model of trading markets, where each individual is identified as a gas molecule that interacts with others trading in elastic or money-conservative collisions. Traditionally this model introduces different rules of random selection and exchange between pair agents. Real economic transactions are complex but obviously non-random. Consequently, unlike this traditional model, this work implements chaotic elements in the evolution of an economic system. In particular, we use a chaotic signal that breaks the natural pairing symmetry $(i,j)\Leftrightarrow(j,i)$ of a random gas-like model. As a result of that, it is found that a chaotic market like this can reproduce the referenced wealth distributions observed in real economies (the Gamma, Exponential and Pareto distributions).

q-fin.GN↗