Optimal securities under adverse selection and moral hazard

We consider project financing under adverse selection and moral hazard and derive several interesting results. First, we provide an explanation of why good firms issue both debt and underpriced equity (even if the bankruptcy and agency costs of debt are zero). Second, we show that, in the presence of moral hazard, adverse selection may induce the conversion of negative into positive NPV projects leading to an improvement in social welfare. Third, we provide a rationale for the use of warrants. We also show that a debt–warrant combination can implement the optimal contract. Our results have a number of testable implications.     

Provider involvement in business service definition: A typology

This paper proposes a typology for provider roles in defining business services. The starting point of the study is the underlying rationale of much of the service purchasing literature that buyers have or can easily access the necessary know-how to procure business services. If this does not hold, the implication is that buying firms would shy away from buying complex services. An alternative perspective recognizes that purchasing business services requires its own set of sourcing capabilities, which may be lacking. Buying firms may have limited know-how in terms of defining and articulating their requirements or not be fully aware of them in the first place. However, the buyer's lack of sourcing capabilities need not be an injunction to internalize the service. In these circumstances, service providers step in, help buying firms specify their requirements and play a key role in defining what is procured and how. We build on this interactive view of service definition to undertake a comparative case analysis of four business service contracting situations arrayed along two dimensions — buyer perceived uncertainty and provider's buyer-specific experience. We conclude that service providers play different roles in each case. These are classified as translating, re-engineering, developing, and fine-tuning roles.     

Non parametric VaR Techniques. Myths and Realities

VaR (value-at-risk) estimates are currently based on two main techniques: the variance-covariance approach or simulation. Statistical and computational problems affect the reliability of these techniques. We illustrate a new technique – filtered historical simulation (FHS) – designed to remedy some of the shortcomings of the simulation approach. We compare the estimates it produces with traditional bootstrapping estimates.
(J.E.L.: G19).     

Indirect Re–employment Wage Discrimination

This paper looks at unemployed individuals and investigates wage differences generated by re–employment selection. It shows that discriminatory re–employment selection can result, indirectly, in discriminatory re–employment pay. A Heckman two–stage selection model is combined with an extension of Gomulka–Stern non–linear decompositions to explain how re–employment selection generates indirect discrimination. The paper uses data from pre–unification Germany in the late 1980s and finds that female human capital suffers more from unemployment and that the market is harsher to males for becoming unemployed. New policies should encourage a regime where the hiring process is more transparent and hiring decisions are monitored on a regular basis.     

The impact of the euro on Europe's financial markets

This paper presents an overview of the impact of the introduction of the euro on Europe's financial structure over the first four years since the start of EMU. It analyzes changes in money markets, bond markets, equity markets and foreign exchange markets. Euro's role in originating or catalyzing trends has been uneven across the spectrum of financial markets. From the supply side, banks and investors in fixed income markets have become more focused on the characteristics of individual borrowers rather than the nationality of the issuer and have built up expertise to evaluate credit risk. European equity markets have also been affected by the enhanced ability of investors to build strategies with a pan‐European perspective as prices increasingly reflected risk factors specific to industrial sectors rather than individual countries. On the borrower side, EMU has increased the attractiveness of market‐based financing methods by allowing debt issuers to tap institutional portfolios across the euro area. Lower barriers to cross‐border financial transactions have also increased the contestability of the market for financial services, be it at the wholesale or the retail level. The introduction of the euro has also highlighted the shortcomings of existing institutional structures and areas where excessive focus on narrowly defined interests may stand in the way of realizing the full potential benefits from the new environment. Diverging legal and institutional infrastructures and market practices can impede further financial market development and deepening. Hence, the euro has put a premium on cooperation between national authorities and institution as a means of achieving a more harmonized financial environment. The impact of EMU on depth in foreign exchange markets has been less clear‐cut, as volatility, spreads, trading volumes and liquidity appear not to have changed in a substantial way. Overall, it seems that the new currency has made some progress towards the goal of becoming a currency of international stature that would rival that of the US dollar. However, a number of the necessary next steps towards achieving this goal are also among the trickiest to implement.     

On the positive correlation property in competitive insurance markets

Most competitive models of insurance markets under asymmetric information predict a positive relationship between coverage and the accident probability. This paper derives the conditions under which this prediction holds true in a general setting involving multiple loss levels and fixed administrative costs. If there is one loss level, this prediction holds necessarily true only if all equilibrium contracts offer strictly positive coverage. With multiple loss levels, the positive relationship between coverage and the accident probability may not hold true even if all contracts offer strictly positive coverage and administrative costs are zero. These results have important implications for empirical testing.     

New products and market competition

Using a novel data set on new product introductions in U.S. manufacturing, the paper studies the relationship between new product introductions and the intensity of market competition as it is measured by industry-specific price-cost margins. New product introductions intensify market competition and depress price-cost margins. These results draw significant empirical support from a sample of five U.S. manufacturing industries. A 10 percent increase in the number of new product introductions causes price-cost margins to drop by approximately 0.5 percent. Although price-cost margins appear procyclical with respect to fluctuations in industry sales, new products make price-cost margins less procyclical and therefore, the intensity of market competition more procyclical.The author would like to thank the Board of Research at Babson College for their generous financial support. The author would also like to thank Jane Cloran for assisting with some of the data. All of the remaining errors are the responsibility of the author.     

Insurance and protection of irreplaceable commodities: The case of one's own life

This paper deals with the effect of life insurance upon the individual's ‘value of life’. In a single period framework we analyse the factors which determine whether life insurance and safety will be treated as substitutes or complements.