Arbitrage Opportunities in Diverse Markets via a Non-equivalent Measure Change

We study arbitrage opportunities in diverse markets as introduced by Fernholz (J Math Econ 31:393–417, 1999). By a change of measure technique we are able to generate a variety of diverse markets. The construction is based on an absolutely continuous but non-equivalent measure change which implies the existence of instantaneous arbitrage opportunities in diverse markets. For this technique to work, we single out a crucial non-degeneracy condition. Moreover, we discuss the dynamics of the price process under the new measure as well as further applications.Both authors gratefully acknowledge financial support by the National Centre of Competence in Research “Financial Valuation and Risk Management” (NCCR FINRISK). The NCCR FINRISK is a research program supported by the Swiss National Science Foundation. The first author also thanks Credit Suisse Group for financial support.     

Small and Medium Enterprises Across the Globe

This paper analyzes the relationship between the relative size of the small and medium enterprise (SME) Sector and the business environment in 76 countries. The paper first describes a new and unique cross-country database that presents consistent and comparable information on the contribution of the SME sector to total employment in manufacturing and GDP across different countries. We then relate the importance of SMEs and the informal economy to indicators of different dimensions of the business environment. We find that several dimensions of the business environment, such as lower costs of entry and better credit information sharing are associated with a larger size of the SME sector, while higher exit costs are associated with a larger informal economy.      

Do exporters really pay higher wages? First evidence from German linked employer-employee data

Many plant-level studies find that average wages in exporting firms are higher than in non-exporting firms from the same industry and region. This paper uses a large set of linked employer-employee data from Germany to analyze this exporter wage premium. We show that the wage differential becomes smaller but does not completely vanish when observable and unobservable characteristics of the employees and of the workplace are controlled for. For example, blue-collar (white-collar) employees working in a plant with an export-sales ratio of 60% earn about 1.8 (0.9) % more than similar employees in otherwise identical non-exporting plants.     

Exponential Hedging and Entropic Penalties

We solve the problem of hedging a contingent claim B by maximizing the expected exponential utility of terminal net wealth for a locally bounded semimartingale X . We prove a duality relation between this problem and a dual problem for local martingale measures Q for X where we either minimize relative entropy minus a correction term involving B or maximize the Q -price of B subject to an entropic penalty term. Our result is robust in the sense that it holds for several choices of the space of hedging strategies. Applications include a new characterization of the minimal martingale measure and risk-averse asymptotics.     

Exchange rates and perfect competition

The purpose of this note is to demonstrate that the commonly held belief that incomplete and perverse pass-through are incompatible with perfect competition is wrong! To this end, we consider two types of firms both operating in two countries. The demand sides of the markets of the two countries are separated and each type of firm produces its good in one of these countries. We study the effect of an exchange-rate change on the competitive equilibrium prices in each country. When producing for the foreign market causes the same costs as producing for the home market then the law of one price holds and an exchange-rate change is completely offset by price changes. Furthermore, when cost functions neither exhibit economies nor diseconomies of scope between producing for the home and producing for the foreign market then prices move in the right directions in response to an exchange-rate change. However, with general cost structures, even in this simple perfectly competitive model, perverse directions of price changes can result from an exchange-rate change.     

Are overtime plants more efficient than standard-time plants? A stochastic production frontier analysis using the IAB Establishment Panel

Using data from the IAB Establishment Panel, 1995–2000, we investigate between-plant variations in productivity. The study compares technical efficiencies between plants which work overtime (overtime plants) and plants which do not work overtime (standard-time plants), where technical efficiency measures the gap between feasible output and actual output for a given input combination. A fixed effects approach is applied, which does neither rely on any distributional assumptions of the inefficiencies, nor on the independence between the regressors and inefficiencies. For both, models with time-invariant and time-varying inefficiencies, we do not find evidence that the two plant-types differ in their technical efficiency.First version received: May 2002 / Final version received: August 2004The comments by Martyn Andrews and Bob Hart are gratefully acknowledged. The article has also benefited from the comments of two anonymous referees.     

Finance,inequality and the poor

Financial development disproportionately boosts incomes of the poorest quintile and reduces income inequality. About 40% of the long-run impact of financial development on the income growth of the poorest quintile is the result of reductions in income inequality, while 60% is due to the impact of financial development on aggregate economic growth. Furthermore, financial development is associated with a drop in the fraction of the population living on less than $ 1 a day, a result which holds when conditioning on average growth. These findings emphasize the importance of the financial system for the poor.      

DYNAMIC DEFAULTABLE TERM STRUCTURE MODELING BEYOND THE INTENSITY PARADIGM

The two main approaches in credit risk are the structural approach pioneered by Merton and the reduced‐form framework proposed by Jarrow and Turnbull and by Artzner and Delbaen. The goal of this paper is to provide a unified view on both approaches. This is achieved by studying reduced‐form approaches under weak assumptions. In particular, we do not assume the global existence of a default intensity and allow default at fixed or predictable times, such as coupon payment dates, with positive probability. In this generalized framework, we study dynamic term structures prone to default risk following the forward‐rate approach proposed by Heath, Jarrow, and Morton. It turns out that previously considered models lead to arbitrage possibilities when default can happen at a predictable time. A suitable generalization of the forward‐rate approach contains an additional stochastic integral with atoms at predictable times and necessary and sufficient conditions for an appropriate no‐arbitrage condition are given. For efficient implementations, we develop a new class of affine models that do not satisfy the standard assumption of stochastic continuity. The chosen approach is intimately related to the theory of enlargement of filtrations, for which we provide an example by means of filtering theory where the Azéma supermartingale contains upward and downward jumps, both at predictable and totally inaccessible stopping times.     

The role of startups for local labor markets

There are substantial differences in startup activity across US local labor markets. We study the causes and consequences of these differences. Startup productivity shocks are found to drive much of these cross-city differences in startup activity. Examples of such shocks include breakthroughs in biotech that spurred startup formation in San Diego and Philadelphia. Overall, these shocks explain half of the forecast error variance of startup job creation, accounting for 40% of population growth and long-run changes in employment. Shocks to barriers to firm entry have economy-wide effects similar to those of startup productivity shocks but operate largely through the number of startups, rather than their size. We use a novel spatial panel vector autoregression, identifying shocks using shift–share external instruments.