Risk management lessons from Long‐Term Capital Management

The 1998 failure of Long‐Term Capital Management (LTCM) is said to have nearly blown up the world's financial system. For such a near‐catastrophic event, the finance profession has precious little information to draw from. By piecing together publicly available information, this paper draws risk management lessons from LTCM. LTCM's strategies are analysed in terms of the fund's Value at Risk (VAR) and the amount of capital necessary to support its risk profile. The paper shows that LTCM had severely underestimated its risk due to its reliance on short‐term history and risk concentration. LTCM also provides a good example of risk management taken to the extreme. Using the same covariance matrix to measure risk and to optimize positions inevitably leads to biases in the measurement of risk. This approach also induces the strategy to take positions that appear to generate 'arbitrage' profits based on recent history but also represent bets on extreme events, like selling options. Overall, LTCM's strategy exploited the intrinsic weaknesses of its risk management system.     

Fiscal Policy when Individuals Differ with Regard to Altruism and Labor Supply

This paper studies the incidence of tax-transfer policy in a growth model wherein individuals differ according to their level of intergenerational altruism and have an endogenous labor supply. The main result is that public debt is neutral at the macro level but redistributes resources from nonaltruists to altruists. Capital income taxation can hurt the nonaltruists who do not have any wealth more than it hurts the altruists who own all of it. Whether or not the altruists supply a positive amount of labor makes a big difference as to the incidence of alternative tax transfer policies.     

Wage Inequality and the New Economy

Many economists have argued that the observed increase in wageinequality in developed economies over the past 30 years isdue to skill-biased technical progress. In this paper we putforward a somewhat different technology-based argument, namelythat the increased inequality was caused by technical changelinked to the pervasive innovation wave associated with theNew Economy. This technical change was not skill-biased in theusual sense, but rather raised the reward to adaptability. Thisalternative approach based on the notion of ‘general-purposetechnology’ can shed light on a number of outstandingpuzzles on the evolution of wage inequality both between andwithin educational groups.     

Spatial concentration and plant-level productivity in France

This paper analyzes empirically the effect of spatial agglomeration of activities on plant-level productivity, using French firm and plant-level data from 1996 to 2004. We exploit short-run variations of variables by making use of GMM estimation. This allows us to control for endogeneity biases that the estimation of agglomeration economies typically encounters. This means that our paper focuses on a subset of agglomeration economies, the short-run ones. Our results show that French plants benefit from localization economies, but we find very little - if any - evidence of urbanization economies. We also show that those localization benefits are relatively well internalized by firms in their location choice: we find very little difference between the geography that would maximize productivity gains in the short-run and the geography actually observed.     

THE PRECAUTIONARY PRINCIPLE: A HIGH‐RISK PRINCIPLE1

The precautionary principle ‐ recently added to the French constitution and part of the draft Constitution of the European Union ‐ aims to protect the public from the risks associated with scientific and technological advance by allowing governments to ban any activity deemed to involve risks, even if those risks are unproven. In reality, the precautionary principle itself poses enormous risks of losing the advantages of projects that are banned, of preventing the development of the means by which risk may be ameliorated and of threatening the private property rights that provide the most effective environmental safeguard.     

DEFAULT RISK INSURANCE AND INCOMPLETE MARKETS1

This paper uses the existence of secondary markets for debt instruments with default risk (e.g. corporate bonds) to define default insurance along the lines of financial economics. It examines whether, in the case of several risk-neutral measures, characteristics of default can be uniquely determined by the prices of contracts involving default-prone securities.     

International portfolios, capital accumulation and foreign assets dynamics

Despite the liberalization of capital flows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversification, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversified portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation and international trade in stocks and bonds. In our model, domestic stocks are used to hedge fluctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local goods and in foreign goods. In contrast to related models, the low level of international diversification does not depend on strongly countercyclical terms of trade. The model also reproduces the cyclical dynamics of foreign asset positions and of international capital flows.     

Demystifying Fair Trade in France: The History of an Ambiguous Project

In France, Fair Trade arrived on the scene in the late twentieth century, and since then has passed through several experimental phases before becoming an enduring “realistic” economic alternative. To understand the transformation, this article defines Fair Trade as a social construct issues and tensions of which change depending on the point of entry. By conducting a secondary analysis of several data sets from varied sources, including documentary material, interviews, and observations, the authors trace the history of Fair Trade in France, define its introduction as a system, describe its institutionalization, and contribute to a greater understanding of how its ideals have changed and become more professional over time. The analyses reveal that the term “Fair Trade” has become ambiguous, spanning divergent and conflicting ideas and projects, including opening and closing conventional market systems and alter-globalization and anti-globalization.     

Consistency in Mixed Demand Systems: Contingent Valuation and Travel Cost Data

In contrast to previous literature, we propose a consistency test that does not impose any particular common functional form for the preference structure underlying the travel cost (TC) and contingent valuation (CV) models. We derive testable consistency conditions between TC and CV data in the context of mixed demand systems when valuing changes in environmental quality. These conditions are a subset of the rationality conditions. The proposed consistency tests are implemented combining TC and CV data. The empirical results show that it is possible to combine stated TC and CV, but not revealed TC and CV data.