Abstract: This article builds a theory of financial system architecture. We ask: what is a financial market, what is a bank, and what determines the economic role of each? Starting with basic assumptions about primitives--the types of agents and the nature of the informational asymmetries--we provide a theory that explains which agents coalesce to form banks and which trade in the capital market. It is shown that borrowers of higher observable qualities access the financial market. Moreover, a financial system in its infancy will be bank-dominated, and increased financial market sophistication diminishes bank lending. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Abstract: We present a simple model of a stock market where a random communication structure between agents gives rise to a heavy tails in the distribution of stock price variations in the form of an exponentially truncated power-law, similar to distributions observed in recent empirical studies of high frequency market data. Our model provides a link between two well-known market phenomena: the heavy tails observed in the distribution of stock market returns on one hand and 'herding' behavior in financial markets on the other hand. In particular, our study suggests a relation between the excess kurtosis observed in asset returns, the market order flow and the tendency of market participants to imitate each other.

Abstract: We present a simple model of a stock market where a random communication structure between agents gives rise to a heavy tails in the distribution of stock price variations in the form of an exponentially truncated power-law, similar to distributions observed in recent empirical studies of high frequency market data. Our model provides a link between two well-known market phenomena: the heavy tails observed in the distribution of stock market returns on one hand and 'herding' behavior in financial markets on the other hand. In particular, our study suggests a relation between the excess kurtosis observed in asset returns, the market order flow and the tendency of market participants to imitate each other.

Abstract: This article is about a market for credence goods. With a credence good, consumers are never sure about the extent of the good they actually need. Therefore, sellers act as experts determining the customers' requirements. This information asymmetry between buyers and sellers obviously creates strong incentives for sellers to cheat on services. I analyze whether the market mechanism may induce nonfraudulent seller behavior. From the observation of market data such as prices, market shares, etc., consumers can infer the sellers' incentives. I show that market equilibria resulting in nonfraudulent behavior do indeed exist.

Abstract: Anumber of developments in recent years have combined to put the issue of financial stability at the top of the agenda, not just of supervisory authorities, but of public policymakers more generally. These developments include: the explosive growth in the volume of financial transactions, the increased complexity of new instruments, costly crises in national financial systems, and several high pro

Abstract: The making of the European financial area is the clearest contemporary example of how states, regulatory authorities, and networks of market interests can combine to redefine the boundaries of financial markets in terms of both space and characteristics. By forging the single market for financial services as a major part of the Single Market Programme (SMP) of the then European Communities, the EU member states and their various financial market constituencies agreed to extend markets across political boundaries in ways once thought impossible or at least very unlikely. The EU negotiators of the legislation proposed in the 1985 Commission White Paper and of the 1986 Single European Act1 transformed a number of relatively closed and restricted domestic financial markets into a desegmented, transnational financial space contiguous with global markets.

Abstract: Social Security is in trouble. With declining population growth and rising life expectancy, the cost of Social Security benefits is rising relative to payroll tax revenues. As a result, the Social Security retirement fund is expected to run out around 2030.1 Recently, the 1994–1996 Advisory Council on Social Security (1997) proposed three different plans to address the problem. Interestingly, all three plans involve Social Security investments in the stock market. This paper examines the impact of Social Security reform on financial markets, commenting specifically on the Advisory Council’s proposals and more generally on the question of how to operate Social Security under uncertainty and under adverse demographic conditions. The effects of Social Security on financial markets have long been the subject of debate among economists. The debate has generally focused on issues of intergenerational redistribution, using deterministic or certaintyequivalent economic models and taking for granted that government debt and the Social Security trust funds involve essentially safe securities. The thrust of this literature is that Social Security reduces individual savings incentives, raises interest rates, and crowds out investment. The debate is about how much and under what conditions. The Advisory Council proposals about equity investments raise significant new questions about the workings of Social Security under uncertainty. These questions are fundamentally about the allocation of macroeconomic risks between generations, about intergenerational risk-

Abstract: Despite the enormous amounts of resources devoted to concept and product testing and the continued use of pretest market (PTM) modeling procedures, estimates of new product failures are still alarm...

Abstract: Are all financial time series alike? This article raises that question by establishing that eighteenth- and twentieth-century equity-market time series behave similarly. The distribution of price changes now and then both exhibit the same patterns or regularities. In particular, the distribution of price changes is leptokurtic, and fluctuations in variance are persistent. This article provides further evidence that financial market regularities are stable and not contingent on specific times and places. The historical evidence shows that eighteenth-century stock markets and traders are not so different from those of today.

Abstract: The sharp differences between financial markets as they exist in Latin America and how we might expect them to look under full integration suggest that the financial constraints on Latin American economic development have much to do with the region`s financial markets` incomplete integration in the world financial system. This paper suggests that the underlying cause of Latin America`s limited integration with world financial markets is not explicit barriers to international financial transactions. Rather, weaknesses in the domestic financial markets that would be called upon to intermediate international capital flows impedes integration. An appropriate financial integration approach can strengthen and deepen the domestic financial system by permitting indirect imports of the requisite public goods (provided by the banks` home countries) and by allowing a greater diversification of national risks.

Abstract: The results of this note indicate that the return–leverage relation turned from negative to positive in Finland in the late 1980s. This finding is explained by the liberalization of Finnish financial markets and the decrease in the degree of financial leverage of Finnish listed firms. The results highlight the remarkable effect of the financial market liberalization on the financial management of Finnish firms and the empirical results on the Finnish financial markets.

Abstract: Recent years have seen the emergence of U.S. financial institutions as major players in the worldwide market for financial derivatives. Over-the-counter (OTC) derivatives, such as interest rate swaps, have proven to be an important tool for the management of risk in banking. This paper provides some guidelines on the proper measurement of fair market value and risk for banks' derivatives positions. Proper assessment of market value and risk, it is argued, is essential for effective internal control and external regulation.

Abstract: There has been an extraordinary increase in the use of financial derivatives in the capital markets. Consequently derivative instruments can have a significant impact on financial institutions, individual investors and even national economies. This relatively recent change in the status of derivatives has led to calls for regulation. Fears that using derivatives to hedge against risk carries in itself a new risk was brought sharply into focus by the collapse of Barings Bank in 1995. The principal concerns of regulators about how legislation may meet those concerns are the subject of current debate between the finance industry and the regulators. Recommendations have been made and reviewed by some of the key players in the capital markets at national and global levels. There is a clear call for international harmonization and its recognition by both traders and regulators. There are calls also for a new international body to be set up to ensure that derivatives, while remaining an effective tool of risk management, carry a minimum risk to investors, institutions and national/global economies. Having reviewed derivatives and how they work, proceeds to examine regulation. Finds that calls for regulation through increased legislation are not universally welcome, whereas the regulators’ main concern is that the stability of international markets could be severely undermined without greater regulation. Considers the expanding role of banks and securities houses in the light of their sharp reactions to increases in interest rates and the effect their presence in the derivatives market may have on market volatility. Includes the reaction of some 30 dealers and users to the recommendations of the G‐30 report and looks at some key factors in overcoming potential market volatility.

Abstract: Barings, P.L.C. (Barings) was the oldest investment firm in Britain and one of its most illustrious. It was a 223-year-old financial institution that financed the Louisiana Purchase and the Napoleonic Wars long before it served as an investment adviser to Queen Elizabeth II. Yet, despite a prominent history, this venerable institution collapsed on February 26, 1995, as the result of a single trader’s derivative activities in Singapore. The story of the Barings collapse raises a host of issues in derivatives trading, risk management, systemic risk, and international securities and banking regulation. In the aftermath of the collapse, many questions and concerns have arisen. How could an old, prominent, and stable institution like Barings collapse so quickly? Do other financial institutions face similar risks? What lessons can be learned from Barings and steps implemented to prevent similar, if not more catastrophic, collapses from occurring in the future? More specifically, the collapse raises concerns about the regulation of derivative activities by banks, involving both the proper scope and role of international regulation of derivative activities as well as the proper extent and effectiveness of external regulatory controls. This Note explores these questions and proposes possible solu-

Abstract: The availability of market price data (MPD) is extensive and can be obtained through continuous electronic based real-time data feeds or through on-line links to historical data suppliers. Whatever the form of access and independent of the supplier, all MPD is subject to the possibility of embedded errors: whether due to transcription and input error, electronic transmission errors or simple transpositions such as evidenced when ask prices are less than the corresponding bid prices for a specific time point. The concern which arises with errors embedded in data are to do with the propagation which results when the unfiltered (or undetected) bad data point(s) is used in pricing, risk measures or any other quantitative data analysis. The authors are not strictly concerned with obvious data errors as outliers in time series. Indeed, most outlier detection, as is shown, is not challenging. Their interest is with demonstrating a set of data filtering and data cleaning analytic functions and their rational assembly in terms of generic computer algorithms which are not dependent on the market data type. They consider the attributes of: data frequency, data relationships and plausibility (e.g., bid is always less than ask), date and time sequences, negative rates, decimal point adjustment, bid price filtering, bid-ask spreads, ask price filtering and, of course, jumps and spike detection.

Abstract: This paper examines the impact of speculative financial markets on corporate behavior under the Japanese and US financial systems. While both countries experienced speculative financial booms during the 1980s, real sector corporate decision making was relatively insulated from such activity in Japan by its bifurcated capital markets: high-turnover trading of much equity coexists with another segment in which large blocks of firms equity and debt are held long term, by capital suppliers who are strategic business allies. In the American system, in contrast, fluid and impersonal stock trading leaves firms vulnerable to the impact of short term price movements. This avenue for speculative financial market pressures has militated toward reduced time horizons and financial ratio-based decision criteria in the US corporate sector. The main implication is that mechanisms must be found for insulating American corporate decision making from speculative pressures. Rather than attempting to mimic the undemocratic ro...

Abstract: The open financial economic systems of six Asian countries Taiwan, Malaysia, Singapore, Philippines, Indonesia and Japan - over the period 1986 through 1995 are identified from empirical data to determine how their stock markets, economies and financial markets are interrelated. The objective is to find rational stock market valuations using a country's nominal GDP and a short term interest rate, based on a modified version of the Dividend Discount Model. But our empirical results contradict such conventional financial economic theory. Various methods are used to analyze the 3D data covariance ellipsoids: spectral analysis, analysis of information matrices, 2D and 3D noise/signal determination and ''super-filter'' system identification based on 3D projections. The new ''super-filter'' method provides the sharpest identification of the Grassmanian invariant q of the empirical systems and the best computation of the finite boundaries of the empirical parameter ranges. All six Asian systems are high noise environments, in which it is very difficult to separate systematic signals from noise. Because of these high noise levels, spectral analysis is not reliable. By plotting all 3D q = 2 {Complete} Least Squares projections we find that only Taiwan has a clear q = 2 system, i.e., Taiwan's stock market, economy and financial market are rationally coherent. In contrast, Malaysia, Singapore, Philippines and Indonesia have q = 1 systems, in which stock markets and economies are closely related, but unrelated to the respective domestic financial markets. Several possible economic explanations are provided. We also quantitatively establish the incoherence of Japan's financial economic system. Japan's stock market operates independently from its economy and from its financial market, which are mutually unrelated.

Abstract: ‘While the usual job search problem is a microeconomic one, this paper applies labour market data to a standard search model to extract macroeconomic implications. A theoretical relationship between the minimum wage, subsistence wage and reservation wage is posited and found to be violated in the data. The paper raises several issues of public policy. It finds that the minimum wage offered is low. It provides a measure of the ‘quality’ of the labour market, and discusses how it may be improved, by increasing the minimum wage, reducing bargaining between the supply and demand sides of the labour market, and curbing wage volatility.

Abstract: We build a model with a wide variety of players (liquidity traders, speculators, market makers, financial intermediaries, borrowers and lenders). The paper derives the individual and aggregate behavior of participants who are involved in financial interchanges taking into consideration the capacity of some participants to choose the role they want to play and the capacity to allocate funds between financial intermediaries and markets. It is shown that the values of the parameters are crucial in determining which players will and will not exist.

Abstract: In this paper we use the optimization models developed by D’Ecclesia and Zenios (1996), which extend Frankel’s (1985) earlier mod els to analyze financial asset demand for the Italian market. We relax the assumption of normality of asset returns and assume that investors maximize an expected utility of their terminal wealth based on heterogeneous attitude toward risk. Solving a bi-level optimization program we endogenously esti mate the risk aversion parameters and derive the optimal market composition for each agent. The optimization models are applied to Italian market data over the 1987–94 period.