Modeling of CPDOs – Identifying optimal and implied leverage

When the subprime crisis started to emerge, collateralized products based on credit default swap (CDS) exposures combined with security features seemed to be a more rational alternative to classic asset backed securities. Constant Proportion Collateralized Debt Obligations (CPDOs) are a mixture of Collateralized Debt Obligations (CDOs) and CPPIs with inverse mechanism. This new asset aims at meeting the investors’ demand for credit derivatives with security enhancements, but to our knowledge quantitative approaches for pricing other than simulation algorithms do not exist yet. CPDOs became famous notably by Standard & Poor’s rating model error which illustrated that closed-form analytical pricing is necessary in order to evaluate and understand complex derivatives. This article aims to shed a light on CPDOs’ specific structural enhancements and mechanisms. We quantify inherent risks and provide a dynamic closed-form pricing formula.     

Small-sample inference with spatial HAC estimators

This paper examines the small-sample performance of spatial HAC (SHAC) estimators of the standard errors on parameters. We find that, in small to moderately-sized datasets, the use of HAC estimators may be recommended only with a relatively large degree of cross-sectional interdependence.     

Joining a capitated IPA: should you, or shouldn't you?

The "bygone" doctor practiced in the good old days under a relatively uncomplicated, clearly defined system. Physicians could afford to be independent. To survive in practice today, say the authors of "Renegotiating Health Care: Resolving Conflict to Build Collaboration," physicians must adapt to change or the health-care market will pass them by. Today's "evolving" doctor is a partner, contributing to and deriving benefit through collaborative patient-care networks, physician practice organizations, and medical services organizations. Historical rivalries have been forgotten as hospitals, insurers, and physicians seek and achieve innovative alliances. Still, resistance to these plans runs strong. The following story typifies one dilemma that faces physicians today. It concerns a hypothetical group practice that must decide whether to form a capitated individual practice association.     

Preferred risk habitat of individual investors

The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks whose volatilities are commensurate with their risk aversion. The data, 1995–2000 holdings of over 20,000 clients at a large German broker, are consistent with the predictions of the hypothesis: the returns of stocks within each portfolio have remarkably similar volatilities, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk-averse customers indeed hold less volatile stocks. Greater volatility specialization is associated with lower Sharpe ratios, primarily because more specialized investors hold fewer stocks and thereby expose themselves to more unsystematic risk.     

Ending Financial Repression in China1

Abstract

China has the most restricted capital markets in Asia. Constraints on capital freedom have resulted in politicization of investment decisions, corruption, waste of capital, and loss of personal freedom. Ending financial repression in China by liberalizing macro-economic prices and making the Yuan fully convertible would help China become a world-class financial centre. To do so, however, would require widespread privatization and rule of law-both of which would undermine the power of the Chinese Communist Party. The West should be patient with China and recognize that gradual reform and engagement are preferable to destructive protectionism.     

CREATING A CONSTITUTIONAL ORDER OF FREEDOM IN EMERGING MARKET ECONOMIES1

Economic liberalisation offers the greatest hope for bringing the developing world out of poverty, but to be successful economic liberalisation also requires political and constitutional reform to safeguard private property rights and secure the rule of law. This article examines the process of constitutional reform in a number of developing nations that have recently undergone economic liberalisation, with particular reference to the experience of reform in China.     

Madison's constitutional political economy: Principles for a liberal order

When persons are modelled as self-interested in politics ... the constitutional challenge becomes one of constructing and designing framework institutions or rules that will, to the maximum extent possible, limit the exercise of such interest in exploitative ways and direct such interest to furtherance of the general interest. It is not surprising, therefore, to discover the roots of a public choice perspective ... in the writings of the American Founders, and most notably in James Madison's contributions toThe Federalist Papers. This paper draws on my earlier work covering Madison's political and economic thought (Dorn 1988, 1990). I wish to thank Thomas M. Humphrey and an anonymous referee for their comments on an earlier version of the paper, and William A. Niskanen and Roger Pilon for fruitful discussions of the general topic. The usual caveat applies.