Cream-Skimming or Profit-Sharing? The Curious Role of Purchased Order Flow

Purchased order flow refers to the practice of dealers or trading locales paying brokers for retail order flow. It is alleged that such agreements are used to “cream skim” uninformed liquidity trades, leaving the information-based trades to established markets. We develop a test of this hypothesis, using a model of the stochastic process of trades. We then estimate the model for a sample of stocks known to be used in order purchase agreements that trade on the New York Stock Exchange (NYSE) and the Cincinnati Stock Exchange. Our main empirical result is that there is a significant difference in the information content of orders executed in New York and Cincinnati, and that this difference is consistant with cream-skimming.     

Forward Discount Bias: Is it Near-Rationality in the Foreign Exchange Market?*

A risk-averse US investor adjusts the shares of a portfolio of short-term nominal domestic and foreign assets to maximize expected utility. The optimal strategy is to respond immediately to all new information which arrives weekly. We develop a model to estimate the cost of optimizing less frequently and find that it is generally very small. For example, if the investor adjusts portfolio shares every three months, an average expected utility loss of 0.16 per cent p.a. is incurred. Hence, slight opportunity costs of frequent optimization may outweigh the benefits. This result may help explain forward discount bias.     

Earnings Quality, Insider Trading, and Cost of Capital

Previous research argues that earnings quality, measured as the unsigned abnormal accruals, proxies for information asymmetries that affect cost of capital. We examine this argument directly in two stages. In the first stage, we estimate firms' exposure to an earnings quality factor in the context of a Fama‐French three‐factor model augmented by the return on a factor‐mimicking portfolio that is long in low earnings quality firms and short in high earnings quality firms. In the second stage, we examine whether the earnings quality factor is priced and whether insider trading is more profitable for firms with higher exposure to that factor. Generally speaking, we find evidence consistent with pricing of the earnings quality factor and insiders trading more profitably in firms with higher exposure to that factor.     

Enforcement Mechanisms Discouraging Black–American Presence in Suburban Detroit

In metropolitan Detroit, scholars have long observed that geographic space is racialized in the sense that black Americans are not welcome in many suburban communities. This extends beyond housing segregation: black drivers are not wanted on many suburban streets. While the existence of racial animosity has been documented, the enforcement mechanisms utilized to ‘protect’ certain geographic areas from black presence have rarely been quantified and dissected. This study examines police behavior toward black motorists who were arrested during routine traffic stops in the Detroit suburb of Eastpointe. Comparison of search, arrest, and handcuff patterns of white and black motorists indicates that police bias harms blacks. Rather than simply being anti‐black, patterns of police behavior in Eastpointe enforce racialized space, signaling where black presence is tolerated and where it is discouraged. Depuis longtemps, les intellectuels observent la racialisation de l’espace géographique, au sens que les Américains noirs ne sont pas les bienvenus dans de nombreuses communautés de banlieue de la métropole de Détroit. La tendance dépasse la ségrégation des logements: les automobilistes noirs sont indésirables dans bien des rues de banlieue. Si l’existence d’une animosité raciale a été documentée, les mécanismes coercitifs utilisés pour ‘protéger’ certaines zones géographiques d’une présence noire ont rarement été quantifiés ou disséqués. Cette étude examine l’attitude policière vis‐à‐vis des conducteurs noirs arrêtés au cours de contrôles de routine dans la banlieue de Eastpointe, à Détroit. Une comparaison des types de fouilles, arrestations et menottages d’automobilistes blancs et noirs révèle un préjugé de la police au détriment des noirs. Au lieu d’être simplement anti‐noirs, les types de comportement policier à Eastpointe impose un espace racialisé, indiquant là où la présence noire est tolérée et là où elle est dissuadée.     

The MTFS or the EMS: Which Way for Credible Monetary Policy?

Since the latter part of 1988, the primary policy objective has been to head off a rise to double digit inflation. To this end, interest rates have been raised from 7112 per cent to 14per cent, while the public sector is running a large fiscal surplus. Despite this apparently very tight policy stance, policy is deficient in a crucial respect: it lacks credibility. The all too public divisions within government have weakened the efficacy of monetary policy, especially in financial markets. The ongoing uncertainty over who is in charge of the conduct of policy - No. 10 or No. 11 - further undermines confidence. The most urgent priority must be to reassert clear priorities and guidelines. In this Viewpoint, we consider how best to restore the credibility of monetary policy. There are two main possibilities: first, to reassert the Medium Term Financial Strategy (MTFS) in an appropriate form; or to join the (Exchange Rate Mechanism of the) European Monetary System (EMS). We argue that it will be very hard to derive credibility benefits from a reassertion of the MTFS: because of the inflation record of the past decade and the twists and turns of past versions of the MTFS, a mere restatement will not resolve the uncertainties that result from known differences within the government. In particular, any restatement will rely on discretion and judgement in its implementation and this will weaken its beneficial effects on expectations. Instead we argue that entry into the EMS offers a tougher and more credible commitment for monetary policy. The Chancellor has been pushed to rule out UK entry until the second half of 1990 at the earliest, but the government should make a virtue of this by announcing a firm dale for entry next year. In the interim, it should encourage a debate about the appropriate rate for entry, a debate which will increasingly guide the foreign exchange market. The government should make it clear that in choosing this rate it will do so with the commitment to low inflation very much in mind, favouring a high exchange rate. Once in the EMS, the government should rule out the possibility of devaluing the pound in an EMS realignment. This provides a firm non- discretionary anchor for both monetary policy and inflation expectations. With this commitment, the principal gain from EMS entry will be establishing a regime of low inflation for the next decade: in this, choice of the exchange rate will be less crucial than the fact of entry.     

The Long-Run Negative Drift of Post-Listing Stock Returns

After firms move trading in their stock to the American or New York Stock Exchanges, stock returns are generally poor. Although many listing firms issue equity around the time of listing, post-listing performance is not entirely explained by the equity issuance puzzle. Similar to the conclusions regarding other long-run phenomena, poor post-listing performance appears related to managers timing their application for listing. Managers of smaller firms, where initial listing requirements may be more binding, tend to apply for listing before a decline in performance. Poor post-listing performance is not observed in larger firms.     

CONSEQUENCES OF MINIMUM WAGE INDEXING

During the 1980s, the minimum wage fell relative to prices and average wages in the U.S. economy. If the minimum to average wage ratio had been constant at the level maintained through the 1970s, the minimum wage would have been $5.51 in 1993. If the 1993 minimum wage had increased to $5.51, payments to minimum wage workers would have increased by an estimated $20.3 billion, and the number of people earning that wage would have risen from 2.0 million to 14.7 million. Elasticity estimates generated from other studies indicate that employment would have fallen 240,000 (4.4%) among 16–19 year olds and 349,000 (3.0%) among 20–24 year olds. Wage payments to minimum wage workers would have substantially increased, but the effect on family income distribution would have been small. Many minimum wage workers are children living with parents or adults in a family with other earners. Consequently, 75% of minimum wage workers account for less than half of their family's income.     

ASSESSING THE VALUE OF ECONOMICS RESEARCH: THE CASE OF THE BIAS IN THE CONSUMER PRICE INDEX

Economists provide sometimes contradictory information about economic systems that contribute to policy design. How does one value this type of knowledge? A political‐economic game is presented that allows for reinforcing and contradictory research messages. Policy makers are assumed to follow a Bayesian decision theory process and the model is tested with quantitative estimates of the value of research on the degree of bias in the Consumer Price Index. Most economists agree that a bias exists, but published estimates vary widely. A blue‐ribbon panel of economists recommended revisions to how the index is calculated, and the Bureau of Labor Statistics subsequently made revisions that differed from their original plans, but how much influence did the panel really have on the revisions? (JEL Z00)     

Avoiding Accounting Fixation: Determinants of Cognitive Adaptation to Differences in Accounting Method*

Much research over the last 30 years has provided evidence that individuals display accounting fixation; that is, their cognitive process does not appropriately adapt to cross‐sectional or temporal differences in an accounting method. This paper presents the results of a quasi‐experimental test of the hypothesis that cognitive adaptation to a change in accounting method is an ordinal interactive function of three person characteristics: relevant accounting knowledge, general problem‐solving ability, and intrinsic motivation to appropriately engage in the decision task. Based on a product‐pricing decision task in which participants are provided with product costs reported by two generally employed product‐costing methods (activity‐based costing [ABC] and volume‐based costing), the results show that the majority of participants did not change their cognitive behavior when there was a change in the costing method. Further, those participants who did adapt to the change in accounting method, and thus avoided accounting fixation, did so by debiasing costs reported by volume‐based costing but not by ABC. Finally, these adapters generally exhibited high values for all three of the person characteristics compared with those who did not adapt.