Noise Trading and the Management of Operational Risk; Firms,Traders and Irrationality in Financial Markets*

abstract Efficient market models cannot explain the high level of trading in financial markets in terms of asset portfolio adjustment. It is presumed that much of this excessive trading is irrational ‘noise’ trading. A corollary is that there must either be irrational traders in the market or rational traders with irrational aberrations. The paper reviews the various attempts to explain noise trading in the finance literature, concluding that the persistence of irrationality is not well explained. Data from a study of 118 traders in four large investment banks are presented to advance reasons why traders might seek to trade more frequently than financial models predict. The argument is advanced that trades do not simply occur in order to generate profit, but it does not follow that such trading is irrational. Trading may generate information, accelerate learning, create commitments and enhance social capital, all of which sustain traders' long term survival in the market. The paper treats noise trading as a form of operational risk facing firms operating in financial markets and discusses approaches to the management of such risk.     

The dynamics of moonlighting in Russia1

This paper uses the Russian Longitudinal Monitoring Survey (RLMS) to analyse the dynamics of moonlighting by the working‐age population. We find that moonlighting is transitory and that a desire to switch jobs expressed in the past is positively related to moonlighting in the present and to actual job changes in the future. We also find that workers who moonlighted as self‐employed in the past represent 26.5 percent of the new self‐employed. These results suggest that moonlighting in Russia can be seen as an effective incubator for setting up new self‐employed businesses, thereby providing long‐term benefits for the economy.     

Call centres and beyond: a thematic evaluation

This introduction aims to place the articles in this special edition in the context of the wider literature on call centres. The discussion is arranged around four themes: the characteristics and organisational features of call centre work, the choices and strategies that are available to manage the work, the effects of this type of work on employees and, finally, the responses and reactions of call centre staff to their work experiences. The articles selected, which are drawn from a conference sponsored by this journal, are then summarised.     

Improved estimation of portfolio value‐at‐risk under copula models with mixed marginals

Portfolio value‐at‐risk (PVAR) is widely used in practice, but recent criticisms have focused on risks arising from biased PVAR estimates due to model specification errors and other problems. The PVAR estimation method proposed in this article combines generalized Pareto distribution tails with the empirical density function to model the marginal distributions for each asset in the portfolio, and a copula model is used to form a joint distribution from the fitted marginals. The copula–mixed distribution (CMX) approach converges in probability to the true marginal return distribution but is based on weaker assumptions that may be appropriate for the returns data found in practice. CMX is used to estimate the joint distribution of log returns for the Taiwan Stock Exchange (TSE) index and the associated futures contracts on SGX and TAIFEX. The PVAR estimates for various hedge portfolios are computed from the fitted CMX model, and backtesting diagnostics indicate that CMX outperforms the alternative PVAR estimators. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:997–1018, 2006     

Initial Public Offerings: CFO Perceptions

We examine four issues pertaining to initial public offerings (IPOs) using a survey of 438 chief financial officers (CFOs). First, why do firms go public? Second, is CFO sentiment stationary across bear and bull markets? Third, what concerns CFOs about going public? Fourth, do CFO perceptions correlate with returns? Results support funding for growth and liquidity as the primary reasons for IPOs. CFO sentiment is generally stationary in pre‐ and post‐bubble years. Managers are concerned with the direct costs of going public, such as underwriting fees, as well as indirect costs. We find a negative relation between a focus on immediate growth and long‐term abnormal returns.     

On the Implications of the Internet for Insurance Markets and Institutions

By most accounts, the Internet and related advances in information technology significantly affect financial services in general and insurance markets and institutions in particular. Coupled with other important trends such as globalization and regulatory reform, these changes are forcing far‐reaching changes upon the insurance industry and making it more competitive. This article focuses specifically on the implications of the Internet for insurance markets and institutions. The conventional wisdom that the Internet constitutes a sufficient condition for the disintermediation of traditional insurance distribution networks is called into question. To the extent that the Internet reduces transaction costs, it will create opportunities for new intermediaries as well as for existing ones. It will also influence product design, in some cases making it economically attractive to unbundle and repackage various forms of coverage. By removing entry barriers and reducing insurance costs, the Internet will also provide a private market solution to a major insurance regulatory concern—enhancing insurance affordability and availability.     

Parallel sourcing and supplier performance in the Japanese automobile industry

Japanese auto makers are reported to enjoy high supplier performance through long-term relationships, specific investments, and sole sourcing. Quality management consultants in the U.S. have been strongly advocating adoption of these practices. But economic and management theorists would predict that the combination of a high level of relationship-specific investments and sole sourcing will lead to problems with supplier performance. In fact the Japanese auto makers use a hybrid form of organization we term parallel sourcing. We present a transaction costs model that shows how parallel sourcing provides incentives for supplier performance associated with multiple sourcing while preserving claimed benefits of sole sourcing.     

A model of fractional cointegration, and tests for cointegration using the bootstrap

The paper proposes a framework for modelling cointegration in fractionally integrated processes, and considers methods for testing the existence of cointegrating relationships using the parametric bootstrap. In these procedures, ARFIMA models are fitted to the data, and the estimates used to simulate the null hypothesis of non-cointegration in a vector autoregressive modelling framework. The simulations are used to estimate p-values for alternative regression-based test statistics, including the F goodness-of-fit statistic, the Durbin–Watson statistic and estimates of the residual d. The bootstrap distributions are economical to compute, being conditioned on the actual sample values of all but the dependent variable in the regression. The procedures are easily adapted to test stronger null hypotheses, such as statistical independence. The tests are not in general asymptotically pivotal, but implemented by the bootstrap, are shown to be consistent against alternatives with both stationary and nonstationary cointegrating residuals. As an example, the tests are applied to the series for UK consumption and disposable income. The power properties of the tests are studied by simulations of artificial cointegrating relationships based on the sample data. The F test performs better in these experiments than the residual-based tests, although the Durbin–Watson in turn dominates the test based on the residual d.     

Ambient Taxes Under m-Dimensional Choice Sets, Heterogeneous Expectations, and Risk-Aversion

We consider the design of ambient taxes forrisk-neutral and risk-averse polluters whenpolluters and the regulatory agency haveasymmetric information about environmentalrelationships and probabilities associatedwith random events. Unlike prior work, we showthat under these conditions, optimal ambienttaxes must be firm-specific, and accompaniedby additional incentives to influencepolluters' choices of abatement techniques.