The pernicious effects of contaminated data in risk management

Banks hold capital to guard against unexpected surges in losses and long freezes in financial markets. The minimum level of capital is set by banking regulators as a function of the banks’ own estimates of their risk exposures. As a result, a great challenge for both banks and regulators is to validate internal risk models. We show that a large fraction of US and international banks uses contaminated data when testing their models. In particular, most banks validate their market risk model using profit-and-loss (P/L) data that include fees and commissions and intraday trading revenues. This practice is inconsistent with the definition of the employed market risk measure. Using both bank data and simulations, we find that data contamination has dramatic implications for model validation and can lead to the acceptance of misspecified risk models. Moreover, our estimates suggest that the use of contaminated data can significantly reduce (market-risk induced) regulatory capital.     

The Abuse of the “Confident Consumer” as a Justification for EC Consumer Law

A reference to the need to create confident cross-border consumers who can contribute to the strengthening of the internal market has often been used as one of the main arguments for EC consumer policy and legislation. The argument has been presented in order to justify both the creation of a minimum safety net for consumers (the minimum confidence argument) and the current turn towards more total harmonisation of consumer protection (the harmonised confidence argument). In the paper these lines of argument are critically evaluated with reference to common sense knowledge about the behaviour of consumers as well as on the basis of Eurobarometer data concerning consumer confidence. In this light the substantive minimum harmonisation measures which have been justified with reference to the need for promoting consumer confidence seem only to a limited extent relevant with respect to the creation of such confidence. The current turn towards total harmonisation most certainly cannot be justified in this way. Other substantive measures, facilitating the access to a counterparty, would be more important in order to create consumer confidence in cross-border shopping, but the Community has almost systematically avoided adopting such measures.     

Adverse selection and bilateral asymmetric information

A simple principal-agent model with bilateral asymmetric information and common values is developed. The agent(s) has private information about his characteristics but does not knowhow these affect outcomes. The principal knows how the characteristics translate into outcomes, but does not observe the characteristics. It is shown that equilibrium contracts aresimple in being designednot to reveal the agent's characteristics. When the agent knows howsome of his characteristics affect the outcome, contracts will be differentiated with respect to precisely those characteristics. An application to the use of genetic information is considered.     

The income effect and supplier induced demand. Evidence from primary physician services in Norway

A much debated issue within the health economic literature is whether physicians can induce demand for their services. The relationship between physicians' ‘nonpractice income’ and supply of primary physician services in Norway is examined. It is argued that, if inducement exists, physicians with a low nonpractice income who work in municipalities where competition for patients is high, compensate for lack of patients by inducing demand. This model is adapted to the institutional setting of the Norwegian primary physician services, where there is a fixed fee schedule. The analyses were performed on a large set of data, encompassing all primary care physicians in Norway who are remunerated per item of treatment. Data on output in practice were merged with information about nonpractice income from the tax forms of the physician and her/his spouse. In municipalities with high physician density, nonpractice income had no effect on the number of consultations per physician, or on the number of treatment items per consultation. The results are interpreted as evidence against the inducement hypothesis.     

Exchange rates dynamics revisited: a panel data test of the fractional integration order

We test the possibility that exchange rates from nine developed countries have a unit root against the alternate possibility that they are fractionally integrated. Theoretically, exchange rates are only expected to follow a random walk under restrictive assumptions. However, most traditional unit root tests cannot reject a unit root in exchange rates, and time series tests that allow for fractional integration have given inconclusive results. To increase the power of the test of the integration order we develop two panel data tests of the fractional integration order. Monte Carlo simulations show that these tests are correctly sized and have relatively high power compared to other similar tests. Moreover, our empirical results show that we can reject a unit root in exchange rates with a high probability, but the integration order is close to one. This indicates that exchange rates are mean-reverting, although the reversion is slow, resulting in long swings.     

Dealing with Ignored Attributes in Choice Experiments on Valuation of Sweden’s Environmental Quality Objectives

Using a choice experiment, this paper investigates how Swedish citizens value three environmental quality objectives. In addition, a follow-up question is used to investigate whether respondents ignored any attributes when responding. The resulting information is used in model estimation by restricting the individual parameters for the ignored attributes to zero. When taking the shares of respondents who took both the environmental and the cost attributes (52–69% of the respondents) into account, then the WTP for each attribute changes if the respondents who ignored the attributes have a zero WTP. At the same time, we find evidence that not all respondents who claimed to have ignored an attribute really did. However, the most commonly ignored non-monetary attributes always have the lowest rankings in terms of WTP across all three environmental objectives. Thus, our results show that instead of ignoring attributes completely, respondents seem to put less weight on the attributes they claimed to have ignored.