Can CRR,CAR and SLR policy tools perform perversely?

A simple theoretical model is developed from the bank balance sheet identity to understand the effects of cash reserve ratio (CRR) on deposit multiplier. It is found that the deposit multiplier can behave perversely, depending on the loan demand and deposit supply parameters. Thus, CRR can work counter-factually and counter-intuitively, as a monetary policy tool. Further, it is found that the capital adequacy ratio – the Basel policy tool – can also work counter-intuitively. The statutory liquidity ratio tool almost mimics the CRR in performance.     

Perverse liquidity effect of monetary policy: some evidence for India

The liquidity effect of money supply increases, as policy-oriented measures, would generally lead to a decline in interest rates. This is the direct effect. However, such money supply increases lead to a sum of the direct effect plus the positive indirect price and income effects. In sum, the net effect may be positive leading to a net increase and not a decrease in the interest rate. The regular money demand function is suitably modified to capture the structural changes of the Indian economy to verify the net effect of monetary policy-induced money supply movements. The empirical evidence indicates the presence of a perverse liquidity effect.     

Multivariate binomial approximations for asset prices with nonstationary variance and covariance characteristics

In this article, we suggest an efficient method of approximatinga general, multivariate log-normal distribution by a multivariatebinomial process. There are two important features of such multivariatedistributions. First, the state variables may have volatilitiesthat change over time. Second, the two or more relevant statevariables involve may covary with each other in a specifiedmanner, with a time-varying covariance structure. We discussthe asymptotic properties of the resulting processes and showhow the methodology can be used to value a complex, multipleexerciseable option whose payoff depends on the prices of twoassets.     

The economic determinants of interest rate option smiles

We address three questions relating to the interest rate options market: What is the shape of the smile? What are the economic determinants of the shape of the smile? Do these determinants have predictive power for the future shape of the smile and vice versa? We investigate these issues using daily bid and ask prices of euro (€) interest rate caps/floors. We find a clear smile pattern in interest rate options. The shape of the smile varies over time and is affected in a dynamic manner by yield curve variables and the future uncertainty in the interest rate markets; it also has information about future aggregate default risk. Our findings are useful for the pricing, hedging and risk management of these derivatives.     

Behavioural Finance: A Review and Synthesis

I provide a synthesis of the Behavioural finance literature over the past two decades. I review the literature in three parts, namely, (i) empirical and theoretical analyses of patterns in the cross‐section of average stock returns, (ii) studies on trading activity, and (iii) research in corporate finance. Behavioural finance is an exciting new field because it presents a number of normative implications for both individual investors and CEOs. The papers reviewed here allow us to learn more about these specific implications.     

Patent Statistics as an Innovation Indicator? Evidence from the Hard Disk Drive Industry

We assess the usefulness of patent statistics as an indicator of innovation, using a direct measure of innovation in the hard disk industry (1976–1998). Three findings emerge: (i) patents “predict” innovations better than a random guess, and a simple refinement makes them more useful; (ii) conditional on actually innovating, conglomerates and larger firms patent more than specialised startups and smaller firms; and (iii) patent reforms seem to make the patent–innovation relationship nonstationary. These results suggest that researchers should use caution when comparing patents of different types of firms and across years.     

Social Networks and Corporate Governance

We analyse frameworks that link corporate governance and firm values to governing boards' social networks and innovations in technology. Because agents create social networks with individuals with whom they share commonalities along the dimensions of social status and income, among other attributes, CEOs may participate in board members' social networks, which interferes with the quality of governance. At the same time, social connections with members of a board can allow for better evaluation of the members' abilities. Thus, in choosing whether to have board members with social ties to management, one must trade off the benefit of members successfully identifying high ability CEOs against the cost of inadequate monitoring due to social connections. Further, technologies like the Internet and electronic mail that reduce the extent of face‐to‐face networking cause agents to seek satisfaction of their social needs at the workplace, which exacerbates the impact of social networks on governance. The predictions of our model are consistent with recent episodes that appear to signify inadequate monitoring of corporate disclosures as well as with high levels of executive compensation. Additionally, empirical tests support the model's key implication that there is better governance and lower executive compensation in firms where networks are less likely to form.     

Learning from experience and trading volume

We build a model where trading allows inexperienced agents to discern useful information sources. Upon losing money by trading on invalid information sources, investors learn from their experience and switch to alternative sources. Such activity leads to initial expected losses but later profitable trades. Trading activity is found to be increasing in the mass of such agents. Volume is greatest in firms with uncertain cash flows. Further, a greater number of information sources implies greater volume. This is consistent with the explosive growth in volume accompanying the growth of the internet, which presumably increases the number of heterogeneous information sources.