Risk and the Endogenous Economist: Some Comparisons of the Treatment of Risk in Physics and Economics

This is a talk, rather than a research or survey paper. Very little of what I say will be original, but I wish to stimulate discussion on a set of issues that arise from the nature of risk and that I consider problematic to our profession. The paper is not exhaustive of references and many of my arguments have been treated elsewhere. However, I suspect few will have approached the issues from the same starting point and assembled them in the same way.     

The role of stochastic volatility and return jumps: reproducing volatility and higher moments in the KOSPI 200 returns dynamics

This paper investigates the role of stochastic volatility and return jumps in reproducing the volatility dynamics and the shape characteristics of the Korean Composite Stock Price Index (KOSPI) 200 returns distribution. Using efficient method of moments and reprojection analysis, we find that stochastic volatility models, both with and without return jumps, capture return dynamics surprisingly well. The stochastic volatility model without return jumps, however, cannot fully reproduce the conditional kurtosis implied by the data. Return jumps successfully complement this gap. We also find that return jumps are essential in capturing the volatility smirk effects observed in short-term options.

Insider Ownership,Risk, and Leverage in REITs

We investigate the relative importance of managerial entrenchment and incentive alignment as indicated by REIT risk-taking. The two theories make contradictory predictions about the sign of the relation between insider ownership and risk. We test for the possibility of diminishing entrenchment returns to insider ownership. Empirical results for equity and asset betas soundly reject linear models in favor of nonmonotonic relations with reversals at insider ownership of 36%. Up to that point, increasingly entrenched insiders mitigate their own risk aversion. Above 36%, incentive alignment emerges as managers become more substantial owners. Leverage declines at an accelerating rate above 20% insider ownership. Together these results suggest a shift in the composition of risk, from leverage risk to asset risk, reflecting comparative advantage and a crossover in the relative monitoring costs of debt and equity. Problematically for linear models, the coefficient of insider ownership is not significant for most risk measures, producing the misleading appearance of no relation between insider ownership and risk. Institutional ownership is significantly negatively related to leverage. Thus incentives are aligned between insiders and institutional owners at insider ownership above 20%.     

Competition in the Portuguese economy: insights from a profit elasticity approach

The article uses the elasticity of profits to marginal costs, as in Boone (Econ J 111:1245–1261, 2008b), to measure the degree of competition in the Portuguese economy in a period characterised by the reallocation of resources towards the non-tradable sector and the accumulation of macroeconomic imbalances. Using firm-level data for the period 2000–2009, we find that there is lower competition intensity in the non-tradable sector. The least competitive markets within this sector lay in professional services, network industries and segments of retail trade. We also find that reductions in competition intensity are relatively widespread in the economy, but in terms of sales, gross value added and employment they are more substantial in the non-tradable sector. Results suggest that some network industries and other services exhibit low and a declining competition intensity in the period under analysis. In addition, the article discusses the coherence of the profit elasticity with classic indicators of market power, such as the Herfindahl–Hirschman index and the price-cost margin, and find that in more than half of the markets there is an agreement in the dynamics of competition intensity.     

Incentive properties of coincident peak pricing

Coincident peak pricing is used in several electricity markets to recover the embedded cost of infrastructure, such as transmission. In this approach, measured consumption at the time of the peak is used to set charges for that pricing period or a subsequent period. If transmission costs are truly sunk, then such a recovery is unlikely to be efficient. However, in the context of growing peak demand, new additions must be built. We consider the incentive properties of coincident peak pricing when related investments are not considered to be sunk, finding that it can reproduce the incentive properties of an ideal time-varying price. We also consider several variations on this assumption.     

Courts,scheduled damages,and medical malpractice insurance

We study how the functioning of the judicial system affects the availability and affordability of medical liability insurance, as proxied by the number of insurers and the premiums paid. We use two unique datasets collected in Italy from 2000 to 2010. Using the first dataset—insurance contracts for hospitals—we estimate the average treatment effect of schedules on insurers and premiums paid, conditional on judicial efficiency and proxied by different measures. Our identification rests on the partial overlap between healthcare districts and judicial districts, meaning that the caseload of a court and malpractice events at the healthcare provider level are not perfectly correlated. On average, the adoption of schedules does not produce any significant effect on insurers or on premiums paid. However, adopting schedules has a robust and significant effect on the number of insurers, but only in inefficient courts. We further investigate these findings using a second dataset comprising 17,578 malpractice insurance claims. We find evidence of a composition effect among claims that is triggered by higher levels of judicial inefficiency: As a court’s inefficiency increases, the likelihood for a case to not be decided on the merits decreases and the levels of reserve and recovery per claim decrease.