Information Risk and Fair Values: An Examination of Equity Betas

Using a sample of U.S. financial institutions, we exploit recent mandatory disclosures of financial instruments designated as fair value level 1, 2, and 3 to test whether greater information risk in financial instrument fair values leads to higher cost of capital. We derive an empirical model allowing asset‐specific estimates of implied betas, and find evidence that firms with greater exposure to level 3 financial assets exhibit higher betas relative to those designated as level 1 or level 2. We further find that this difference in implied betas across fair value designations is more pronounced for firms with ex ante lower‐quality information environments: firms with lower analyst following, lower market capitalization, higher analyst forecast errors, or higher analyst forecast dispersion. Overall, the results are consistent with a higher cost of capital for more opaque financial assets, but also suggest that differences in firms' information environments can mitigate information risk across the fair value designations.     

Are Options on Index Futures Profitable for Risk‐Averse Investors? Empirical Evidence

American options on the S&P 500 index futures that violate the stochastic dominance bounds of Constantinides and Perrakis (2009) from 1983 to 2006 are identified as potentially profitable trades. Call bid prices more frequently violate their upper bound than put bid prices do, while violations of the lower bounds by ask prices are infrequent. In out‐of‐sample tests of stochastic dominance, the writing of options that violate the upper bound increases the expected utility of any risk‐averse investor holding the market and cash, net of transaction costs and bid‐ask spreads. The results are economically significant and robust.     

Compensation and Incentives: Practice vs. Theory

A thorough understanding of internal incentive structures is critical to developing a viable theory of the firm, since these incentives determine to a large extent how individuals inside an organization behave. Many common features of organizational incentive systems are not easily explained by traditional economic theory—including egalitarian pay systems in which compensation is largely independent of performance, the overwhelming use of promotion-based incentive systems, the absence of up-front fees for jobs and effective bonding contracts, and the general reluctance of employers to fire, penalize, or give poor performance evaluations to employees. Typical explanations for these practices offered by behaviorists and practitioners are distinctly uneconomic—focusing on notions such as fairness, equity, morale, trust, social responsibility, and culture. The challenge to economists is to provide viable economic explanations for these practices or to integrate these alternative notions into the traditional economic model.     

MEDICAL RESEARCH AND GENETIC RESOURCES MANAGEMENT: THE CASE OF TAXOL

Commercial development of the anti-cancer drug taxol has involved a complex set of interlocking research agreements. This paper explores the implications of such agreements and discusses diverse policy issues surrounding taxol development. Among these are forest management, species preservation, intellectual property rights, and the economics of biomedical research. Advances in genetic research increasingly have linked natural resource and technology policy issues. Institutional innovations in public/private research arrangements play a vital role in biotechnology development but are poorly understood. Policymakers need formal analyses of such agreements in order to evaluate complex research programs.     

Trading Volume and Transaction Costs in Specialist Markets

Prior work with competitive rational expectations equilibrium models indicates that there should be a positive relation between trading volume and differences in beliefs or information among traders. We show that this result is sensitive to whether and how transaction costs are modeled. In a specialist market with endogenous transaction costs we show that trading volume can be negatively related to the degree of informational asymmetry in the market. Our analysis highlights the dependence of volume on market structure, and our results suggest that the “volume effects” of corporate or macroeconomic events reflect a decrease, rather than an increase, in heterogeneity of beliefs or asymmetry of information.     

Beyond Time Discounting

The intertemporal tradeoffs made by most persons appear inconsistent when viewed through the lens of the standard time-discounting model. At different times and in different decision contexts, the same individual will often display behavior suggestive of a wide range of discount rates, from strongly positive (indicative of a lack of concern of future consequences) to strongly negative (implying greater concern for the future than the present). We argue that many of these apparent inconsistencies can be attributed to three aspects of time preference that are not part of the conventional model: decreasing impatience, a preference for sequences of outcomes that improve over time, and preference interactions between consumption and payments.     

Explaining House Prices in Australia: 1970–2003*

This paper aims to explain changes in real house prices in Australia from 1970 to 2003. We develop and estimate a long-run equilibrium model that shows the real long-run economic determinants of house prices and a short-run asymmetric error correction model to represent house price changes in the short run. We find that, in the long run, real house prices are determined significantly and positively by real disposable income and the consumer price index. They are also determined significantly and negatively by the unemployment rate, real mortgage rates, equity prices and the housing stock. Employing our short-run asymmetric error correction model, we find that there are significant lags in adjustment to equilibrium. When real house prices are rising at more than 2 per cent per annum, the housing market adjusts to equilibrium in approximately four quarters. When real house prices are static or falling, the adjustment process takes six quarters.     

Why Do British Unions Oppose Privatisation?

British trade unions have always been opposed to the removal of state monopolies from the public sector. George Watson examines the inconsistency of union attitudes, since monopoly tends to favour the powerful and rich at the expense of the weak and poor. British trade unionists, he says, should re-assess their unreasoned opposition to privatisation if they claim to serve the interests of their members.