The dark side of financial innovation: A case study of the pricing of a retail financial product

The offering prices of 64 issues of a popular retail structured equity product were, on average, almost 8% greater than estimates of the products' fair market values obtained using option pricing methods. Under reasonable assumptions about the underlying stocks' expected returns, the mean expected return estimate on the structured products is slightly below zero. The products do not provide tax, liquidity, or other benefits, and it is difficult to rationalize their purchase by informed rational investors. Our findings are, however, consistent with the recent hypothesis that issuing firms might shroud some aspects of innovative securities or introduce complexity to exploit uninformed investors.     

HUMAN CAPITAL AND CONVERGENCE: A PRODUCTION‐FRONTIER APPROACH*

Using nonparametric, production‐frontier methods, we decompose labor productivity growth into components attributable to technological change (shifts in the world production frontier), technological catch‐up (movements toward or away from the frontier), and physical and human capital accumulation (movements along the frontier). We find that (1) technological change is decidedly nonneutral, (2) productivity growth is driven primarily by physical and human capital accumulation, (3) the increased international dispersion of productivity is explained primarily by physical capital accumulation, and (4) international polarization (the shift from a unimodal to a bimodal distribution) is brought about primarily by efficiency changes (technological catch‐up).     

Applications of general equilibrium models to the 1986 tax reform act in the United States

Summary This paper examines the structure and predictions of six applied general equilibrium models used to evaluate the 1986 Tax Reform Act in the United States. The models agree that the effects on national income will be fairly small. They disagree on the size of the improvement in economic efficiency from more neutral taxation of different capital assets, and on the size of the intertemporal inefficiency when capital formation is discouraged through a higher rate of taxation. This new application of general equilibrium models to an actual reform highlights the need to test predictions against empirical evidence.The views expressed are solely those of the author and do not necessarily reflect those of the Federal Reserve Bank of Boston or the Federal Reserve System. The author is grateful to J. von Sinderen, Laus Bovenberg, Lawrence Goulder, and other participants at the conference for their helpful comments, and to the authors of the studies reviewed in this paper for instructive discussions.Prepared for The Netherlands Central Planning Bureau Symposium on Applied General Equilibrium Models, Noordwijk, December 4–5, 1989.     

Financial capital movements and central bank behavior in a two-country,short-run portfolio balance model

This paper analyzes financial capital movements in a two-country, short-run, portfolio balance model which includes two securities that are imperfect substitutes. Following a disturbance, equilibrium is, in general, reattained, but the effects on interest rates, money supplies, and international reserve holdings depend on the monetary and reserve asset management policies of the two central banks. Special attention is focused on the case in which one central bank holds its international reserves in the form of ‘key currency’ securities, thereby sterilizing for the ‘key currency’ country. There are several applications of the central result that, for any disturbance, the less changes in international reserves are allowed to affect money supplies, the larger the change in reserves required to reestablish equilibrium.