Theory and Evidence on the Resolution of Financial Distress

We analyze a financially distressed owner-managed project. Themain results of the model are: (1) borrower default is an endogenousresponse to the anticipated restructuring–foreclosureoutcome; (2) the lender’s restructuring–foreclosuredecision depends critically on the interaction between projectvalue and industry liquidity; and (3) the lender waits for theindustry to recapitalize before selling assets obtained throughforeclosure. Empirical analysis of a large sample of defaultedcommercial real estate loans supports many of the model predictions,including restructuring–foreclosure outcomes that areconsistent with endogenous borrower default and firesale discountsthat vary depending on industry market conditions at the timeof foreclosure. (JEL G33)     

Maximum Likelihood Estimation of Latent Affine Processes

This article develops a direct filtration-based maximum likelihoodmethodology for estimating the parameters and realizations oflatent affine processes. Filtration is conducted in the transformspace of characteristic functions, using a version of Bayes’rule for recursively updating the joint characteristic functionof latent variables and the data conditional upon past data.An application to daily stock market returns over 1953–1996reveals substantial divergences from estimates based on theEfficient Methods of Moments (EMM) methodology; in particular,more substantial and time-varying jump risk. The implicationsfor pricing stock index options are examined.     

Modeling the Impact of Agricultural Growth and Government Policy on Income Distribution in India

This article uses a limited general equilibrium model to investigatethe growth and equity effects of a variety of economic and technicalchanges and selected agricultural policies in India. It exploreshow changes in food prices, rural wages, and farm profits associatedwith the Green Revolution period affected income distributionbetween net buyers and sellers of food. The model shows thatincome gains from the Green Revolution initially accrued tothe wealthier rural groups but that after 1972–73 theywere transferred to urban consumers and that by 1980–81the per capita incomes of poor and wealthier rural groups alikewere barely above their respective 1960–61 levels. Themodel is also used in counterfactual analysis of the impactof changes in technological, demographic, investment, taxation,and income redistribution variables. Its findings indicate theimportance of trade policies for the nature of the equity outcomesfrom agricultural growth and suggest that a reduction in populationgrowth and an increase in nonagricultural employment and incomeare required to convert agricultural growth into reduced ruralpoverty.     

Agricultural Incentives in Developing Countries: Measuring the Effect of Sectoral and Economywide Policies

The impact of sector-specific (direct) and economywide (indirect)policies on agricultural incentives for eighteen developingcountries for the period 1975–84 are estimated. The directeffect is measured by the proportional difference between theproducer price and the border price (adjusting for distribution,storage, transport, and other marketing costs). The indirecteffect has two components. The first is the impact of the unsustainableportion of the current account deficit and of industrial protectionpolicies on the real exchange rate and thus on the price ofagricultural commodities relative to nonagricultural nontradables.The second is the impact of industrial protection policies onthe relative price of agricultural commodities to that of nonagriculturaltradable goods. We find that (1) in almost all cases the directeffect is equivalent to a tax on exportable goods (–11percent on average) and to a subsidy for importables (20 percenton average); (2) the indirect effect also taxes agriculture(–27 percent on average) and dominates the direct effect(whether the direct effect is positive or negative); and (3)the direct policies for both importables and exportables stabilizedomestic producer prices.     

Risk aversion and the dynamics of optimal liquidation strategies in illiquid markets

We consider the infinite-horizon optimal portfolio liquidation problem for a von Neumann–Morgenstern investor in the liquidity model of Almgren (Appl. Math. Finance 10:1–18, 2003). Using a stochastic control approach, we characterize the value function and the optimal strategy as classical solutions of nonlinear parabolic partial differential equations. We furthermore analyze the sensitivities of the value function and the optimal strategy with respect to the various model parameters. In particular, we find that the optimal strategy is aggressive or passive in-the-money, respectively, if and only if the utility function displays increasing or decreasing risk aversion. Surprisingly, only few further monotonicity relations exist with respect to the other parameters. We point out in particular that the speed by which the remaining asset position is sold can be decreasing in the size of the position but increasing in the liquidity price impact.      

The Determinants and Consequences of the Placement of Government Programs in Indonesia

Most estimates of the consequences of public programs rely onthe cross-sectional association between region-specific programsand program outcomes. Such estimates assume that the spatialdistribution of programs is random. This article reports estimatesof the effects of public programs on basic human capital indicatorsand the biases in conventional cross-sectional estimates ofprogram effects due to non-random program placement. The estimatesare obtained from pooled observations on human capital outcomes,socioeconomic variables, and program coverage at the kecamatan(subdistrict) level. The observations are based on successivesets of Indonesian cross-sectional household and administrativedata during 1976–86. The determinants of the spatial allocationof programs in Indonesia in 1976–86 are also estimated. The empirical results indicate that the presence of grade andmiddle schools in villages has a significant positive effecton the school attendance rates of teenagers. The presence ofhealth clinics in villages also positively affects the schoolingof females ages 10–18. However, no evidence is found ofany significant effects of the presence of family planning andhealth programs on either the survival rates of children oron cumulative fertility. The estimates also suggest that theuse of cross-sectional data results in substantial biases inthe estimates of program effects because of the evident nonrandomspatial allocation of public programs.     

On the Transmission of World Agricultural Prices

Two questions are asked about the relationship between domesticprices and world prices of agricultural commodities: are variationsin world prices transmitted to domestic prices, and do thesevariations in world prices constitute an important componentof variations in domestic prices? Domestic prices are regressedon world prices in various forms, taking into account the possibleeffects of exchange rates and inflation. The empirical analysisis based on data from the Food and Agriculture Organizationof the United Nations for 58 countries for 1968–78 andfor the countries of the European Community for 1961–85.The results show that most of the variations in world pricesare transmitted and that they constitute the dominant componentin the variations of domestic prices.     

A Mixture Multiplicative Error Model for Realized Volatility

A multiplicative error model with time-varying parameters andan error term following a mixture of gamma distributions isintroduced. The model is fitted to the daily realized volatilityseries of deutschemark/dollar and yen/dollar returns and isshown to capture the conditional distribution of these variablesbetter than the commonly used autoregressive fractionally integratedmoving average model. The forecasting performance of the newmodel is found to be, in general, superior to that of the setof volatility models recently considered by Andersen et al.(2003, Econometrica 71, 579–625) for the same data.     

The Predictive Power of "Head-and-Shoulders" Price Patterns in the U.S. Stock Market

We use the pattern recognition algorithm of Lo, Mamaysky, andWang (2000) with some modifications to determine whether "head-and-shoulders"(HS) price patterns have predictive power for future stock returns.The modifications include the use of filters based on typicalprice patterns identified by a technical analyst. With datafrom the S&P 500 and the Russell 2000 over the period 1990–1999we find little or no support for the profitability of a stand-alonetrading strategy. But we do find strong evidence that the patternhad power to predict excess returns. Risk-adjusted excess returnsto a trading strategy conditioned on "head-and-shoulders" pricepatterns are 5–7% per year. Combining the strategy withthe market portfolio produces a significant increase in excessreturn for a fixed level of risk exposure.     

Top Indian Incomes, 1922-2000

This article presents data on the evolution of top incomes andwages for 1922–2000 in India using individual tax returndata. The data show that the shares of the top 0.01 percent,0.1 percent, and 1 percent in total income shrank substantiallyfrom the 1950s to the early to mid-1980s but then rose again,so that today these shares are only slightly below what theywere in the 1920s and 1930s. This U-shaped pattern is broadlyconsistent with the evolution of economic policy in India: Fromthe 1950s to the early to mid-1980s was a period of "socialist"policies in India, whereas the subsequent period, starting withthe rise of Rajiv Gandhi, saw a gradual shift toward more probusinesspolicies. Although the initial share of the top income groupwas small, the fact that the rich were getting richer had anontrivial impact on the overall income distribution. Althoughthe impact is not large enough to fully explain the gap observedduring the 1990s between average consumption growth shown inNational Sample Survey–based data and the national accounts–baseddata, it is sufficiently large to explain a nonnegligible partof it (20–40 percent).     

Bank debt covenants and firms’ responses to FAS 150 liability recognition: evidence from trust preferred stock

We examine the relation between accounting-based debt contracts and the economic response of firms with trust preferred stock (TPS) to mandated liability recognition under Financial Accounting Standard (FAS) 150. Our results show that firms’ financial covenants significantly affect their choice to redeem versus reclassify their outstanding TPS. Specifically, firms with bank debt covenants that would be adversely impacted by recognizing TPS as a debt liability are 26.88% more likely to redeem their TPS after FAS 150. We also find that firms are significantly more likely to redeem versus reclassify their TPS after FAS 150 if they used the original TPS proceeds to retire existing debt (id est, to enhance their balance sheets). Our findings suggest that when bank debt contracts use “floating” Generally Accepted Accounting Principles (GAAP) to construct financial covenant terms, changes in the underlying GAAP measure significantly influence firms’ economic behavior.     

The Model-Free Implied Volatility and Its Information Content

Britten-Jones and Neuberger (2000) derived a model-free impliedvolatility under the diffusion assumption. In this article,we extend their model-free implied volatility to asset priceprocesses with jumps and develop a simple method for implementingit using observed option prices. In addition, we perform a directtest of the informational efficiency of the option market usingthe model-free implied volatility. Our results from the Standard& Poor’s 500 index (SPX) options suggest that themodel-free implied volatility subsumes all information containedin the Black–Scholes (B–S) implied volatility andpast realized volatility and is a more efficient forecast forfuture realized volatility.     

Growth and Equity in Developing Countries: A Reinterpretation of the Sri Lankan Experience

In the important debate between the proponents of direct (basicneeds) and indirect (economic growth) measures of promotingwelfare, Sri Lanka has frequently been cited as one countrywhich has successfully pursued the direct approach—ithas raised living standards without much cost in terms of reducedgrowth. This conclusion, however, is based on analyses whichdo not account for the initial conditions of the countries beingcompared. After methodologically incorporating these concerns,neither the improvement in living standards nor the 2.0 percentper capita growth rate during the period of direct policy measures(1960–78) was exceptional. In contrast, during the periodof more indirect growth-promoting policies (1977–84),(i) economic growth more than doubled to an average rate of4.3 percent per capita per annum; (ii) expenditure inequalitydid not significantly change; (iii) consumption expendituresof the population, and the poor, generally increased; and (iv)several living standard indicators continued to improve.     

Do African Countries Pay More for Imports? Yes

The debt crisis and declining living standards require carefulhusbanding of critically scarce foreign exchange in most Africancountries. But economic theory suggests that smaller countries,which import from only a few international suppliers and cannotsupport competitive markets and infrastructure, would be likelyto pay more rather than less for imports. Analysis of importunit values for 1962–87 shows that the twenty Africanformer French colonies paid a price premium of 20–30 percenton average over other importers for iron and steel imports fromFrance. The losses associated with these adverse prices totaledapproximately 2 billion dollars by 1987. The study also findsthat similar price premia (of 20–30 percent) were paidby former Belgian, British, and Portuguese colonies in Africafor imports of these products from their former rulers.     

Remarks on the Nonlinear Black-Scholes Equations with the Effect of Transaction Costs

We deal with the solvability and a weak formulation of nonlinear partial differential equations of Black-Scholes type for the pricing of options in the presence of transaction costs. Examples include the Hoggard–Whalley–Wilmott equation, which is introduced to model portfolios of European type options with transaction costs based on the idea of Leland. The cost structure gives rise to nonlinear terms. We show the existence and the uniqueness of solutions both in the classical and the weak sense, where the notion of weak solutions is introduced.     

Public Debt Management and Macroeconomic Stability: An Overview

Recent research suggests that management of the public sector’sdebt can have important effects on a country’s macroeconomicperformance. This article provides an overview of the factorsthat the recent literature has identified as important in determiningthe optimal composition of the public debt. Based on this analysis,it attempts to establish general guidelines for public debtmanagement in emerging economies. To retain market access andpromote domestic financial market development, governments shouldgenerally finance themselves at market rates using a wide varietyof securities. Beyond this general principle, the optimal compositionof the public debt involves a tradeoff between enhancing thegovernment’s anti–inflationary credibility and reducingthe vulnerability of its budget to macroeconomic shocks. Consequently,the optimal composition of the debt depends on a country’scircumstances. Debt should be heavily weighted toward long-termnominal securities for governments that have anti–inflationarycredibility and toward long-term indexed debt for those thatdo not.      

Inequality Constraints in the Fractionally Integrated GARCH Model

In this article we derive necessary and sufficient conditionsfor the nonnegativity of the conditional variance in the fractionallyintegrated generalized autoregressive conditional heteroskedastic(p, d, q) (FIGARCH) model of the order p 2 and sufficient conditionsfor the general model. These conditions can be seen as beinganalogous to those derived by Nelson and Cao (1992, Journalof Business & Economic Statistics 10, 229–235) forthe GARCH(p, q) model. However, the inequality constraints whichwe derive for the FIGARCH model illustrate two remarkable propertiesof the FIGARCH model which are in contrast to the GARCH model:(i) even if all parameters are nonnegative, the conditionalvariance can become negative and (ii) even if all parametersare negative (apart from d), the conditional variance can benonnegative almost surely. In particular, the conditions forthe (1, d, 1) model substantially enlarge the sufficient parameterset provided by Bollerslev and Mikkelsen (1996, Journal of Econometrics73, 151–184). The importance of the result is illustratedin an empirical application of the FIGARCH(1, d, 1) model toJapanese yen versus U.S. dollar exchange rate data.     

Exchange option pricing under stochastic volatility: a correlation expansion

Efficient valuation of exchange options with random volatilities while challenging at analytical level, has strong practical implications: in this paper we present a new approach to the problem which allows for extensions of previous known results. We undertake a route based on a multi-asset generalization of a methodology developed in Antonelli and Scarlatti (Finan Stoch 13:269–303, 2009) to handle simple European one-asset derivatives with volatility paths described by Ito’s diffusive equations. Our method seems to adapt rather smoothly to the evaluation of Exchange options involving correlations among all the financial quantities that specify the model and it is based on expanding and approximating the theoretical evaluation formula with respect to correlation parameters. It applies to a whole range of models and does not require any particular distributional property. In order to test the quality of our approximation numerical simulations are provided in the last part of the paper.     

The BDS Test as a Test for the Adequacy of a GARCH(1,1) Specification: A Monte Carlo Study

In this study we examine the widely used Brock, Dechert, andScheinkman (BDS) test when applied to the logarithm of the squaredstandardized residuals of an estimated GARCH(1,1) model as atest for the adequacy of this specification. We review the conditionsderived by De Lima (1996; Econometric Reviews 15, 237–259)for the nuisance-parameter-free property to hold and addressthe issue of their necessity, using the flexible framework offeredby the GARCH(1,1) model in terms of moment, memory, and timeheterogeneity properties. By means of Monte Carlo simulations,we show that the BDS test statistic still approximates the standardnull distribution even for mildly explosive processes that violatethe majority of the conditions. Thus the test performs reasonablywell, its empirical size being rather close to the nominal one.As a by-product of this study, we also shed light on the relatedissue of the consistency of the QML estimators of the conditionalvariance parameters under various parameter configurations andalternative distributional assumptions on the innovation process.     

Civil Liberties, Democracy, and the Performance of Government Projects

This article uses a cross-national data set on the performanceof government investment projects financed by the World Bankto examine the link between government efficacy and governance.It demonstrates a strong empirical link between civil libertiesand the performance of government of projects. Even after controllingfor other determinants of performance, countries with the strongestcivil liberties have projects with an economic rate of return8–22 percentage points higher than countries with theweakest civil liberties. The strong effect of civil libertiesholds true even when controlling for the level of democracy. The interrelationship among civil liberties, civil strife, andproject performance suggests that the possible mechanism ofcausation is from more civil liberties to increased citizenvoice to better projects. This result adds to the evidence forthe view that increasing citizen voice and public accountability—throughboth participation and better governance—can lead to greaterefficacy in government action.