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Using new transaction-level data for non-financial commercial paper (CP) in the U.S., we show that companies systematically reduce their outstanding short-term debt on quarterly and annual disclosure dates. Constraints on CP lending supply cannot explain this pattern. Instead, firms prefer repaying short-term debt over disclosing high cash holdings to signal that their cash is readily available and not trapped in foreign subsidiaries. Consistent with this interpretation, we show that firms with higher cash holdings, more sales in regions with tight capital controls, or with higher debt-equity ratios compared to industry peers reduce their short-term debt more aggressively at disclosure dates.

Valuation risk of a security—uncertainty about its fair value—is a subject of considerable concern in the mutual fund industry. If funds report different values for identical securities, investors cannot easily compare performance. Yet it is not unusual to see identical illiquid stocks, small-cap stocks, stocks with high analyst dispersion, stocks with less analyst coverage, and newly listed stocks valued differently across mutual funds. An equity fund that has positive price dispersion in its portfolio holdings, that performs poorly, that belongs to a fund family with an inclination for aggressive reporting, that holds more stocks subject to stale prices, that holds more pre-IPO firms, or that experiences net outflows will tend to show positive price dispersion again in the next quarter. This behavior is significant in a volatile market. Aggressive reporting helps funds gain in the mutual fund tournament.

During the COVID-19 pandemic, some goods suddenly became scarce due to panic purchases and stockpiling. The decision to hoard is influenced by higher-order beliefs. If an agent believes that other agents think that a good will become scarce, she concludes that these other agents will hoard, and thus tries to preempt them by hoarding herself. To capture such behaviour, we construct a model with a global game. Agents receive noisy information about some variable that influences supply or demand. They then form higher-order beliefs, and possibly panic and hoard the product. We analyze determinants of such panics. Endogenizing prices and quantities, we show that producers with market power set prices strategically to induce panics and thus boost demand. Absent market power, strong competition leads to low prices and thus little overproduction, also causing panics. We also consider firms who need the scarce good as an intermediate product in their production chain, and show that a regulator would require such firms to stockpile the product, thus increasing resilience.

This paper evaluates several investment scenarios which could result from the rather dire economic situation existing in early 2020 caused by the coronavirus pandemic that is restricting economic production of goods and services at the same time that cost-push factors and the unlimited creation of money by central banks worldwide create upward inflationary pressures. Just as during the similar situation in Germany in 1923, the nominal prices of both equities and fixed-rate instruments might be propped up, but all security investments would generate highly negative real returns short-term. Only stock prices might eventually match the inflation rate.

This paper is one of the first to quantify the welfare effects of proposed cash suppression policies. We work within the context of a general equilibrium framework in which households face an endogenous cash-in-advance constraint and firms use cash transactions to evade taxes. Eliminating currency increases transactions costs and raises effective tax rates by curbing tax evasion. Our quantitative experiments imply that a total cash ban improves steady-state welfare, but only if paired with a revenue-neutral decrease in the tax rate on capital. We show in an extension with heterogeneous agents that curtailing cash harms frequent-cash users more than others. Such distributional effects of cash suppression may be a concern for policymakers.

There is a large and growing body of literature on the benefits of established lending relationships with banks, which is an intermediated debt market. We extend that literature by testing for benefits from direct lending relationships in the commercial paper market, which is a public debt market. Diamond (1991) suggests that firms access public debt markets when they have enough reputation to no longer require the close monitoring by banks. Using daily rate data for dealer-placed and directly placed commercial paper, we find that the year-end liquidity squeeze is less pronounced in the directly place commercial paper than in the dealer-placed commercial paper, consistent with the existence of benefits from direct lending relationships in this public debt market.

We find that the commercial paper markets do not conform with the hypothesis of market efficiency and the expectations hypothesis over sample period. Only the overnight commercial paper market yields show a significant response to changes in Federal Reserve policies, and then they show nearly equivalent responses to both anticipated and unanticipated changes.

We analyze why firms use non-intermediated short-term debt by studying the commercial paper (CP) market. Using a comprehensive database of CP issuers and issuance activity, we show that firms use CP to provide start-up financing for capital investment. Firms’ CP issuance activity is driven by a desire to minimize transactions costs associated with raising capital for new investment. We show that firms with high rollover risk are less likely to enter the CP market, borrow less CP, and borrow more from bank credit lines. We find that CP is often refinanced with long-term bond issuance to reduce rollover risk.

This paper articulates three insights regarding asset prices and monetary policy: (1) Asset price appreciation due to monetary expansion, despite its “paper” wealth nature, tends to make current consumers as a whole wealthier; (2) the wealth effect of monetary policy (on consumption) is negatively correlated with Tobin’s q effect (on investment), which positively depends on investment elasticity; and (3) the soundness of asset market performances does not depend on whether they are fundamental or not, but on their compatibility with the AD-AS balance in the long run. These basic insights and their implications reveal some limitations of monetary policy as a stabilization policy, clarify some misperceptions on fundamental asset prices, and provide a rationale for monetary policy to react directly to asset market performances.

Tax revenues are forecast to increase from 23.5% of GDP in 2015-16 to 25.1% of GDP by 2019-20. Expenditures are expected to fall from 25.8% to 25.2% of GDP over the same period. Over the four year period the government's nominal tax receipts are forecast to increase by 30%. Tax receipts will amount to $500 billion by 2019-20. Whilst much of the increase is predicated on growth new tax measures will also need to contribute, and in a big way. The government plans to collect an additional $28 billion each year!

We demonstrate the importance of firm-specific and industry-specific factors in the leverage decision of Australian firms. Empirical findings show that some firm-specific factors vary across industry, while prior literature assumes equal impact of these factors. In addition, we find that industry-specific factors have direct and indirect impact on the formation of capital structure of Australian firms.

Between 1797 and 1821, Britain suspended the gold standard in order to finance the Napoleonic Wars. This measure was accompanied by large scale debt accumulation and inflation: After Napoleon’s final defeat at Waterloo in 1815, the debt to GDP ratio had climbed to 226%; the price level exceeded its 1797 level by 22.3%. Under these circumstances and given that institutional settings allowed excluding the possibility of strategic default, I will show that expectations of how debt would be stabilized in the future shaped the observed evolution of the price level. Thus, my contribution establishes the importance of fiscal determinants of the price level.

This article explores the determinants of price level fluctuations in Britain during the first suspension of the gold standard over the 1797-1821 period. I find that the contemporary price level was determined by world gold prices and expectations regarding the resumption of the gold standard at the pre-war parity. As the latter hinged on market participants’ expectations concerning the financial burden of the Napoleonic Wars, my contribution establishes the importance of fiscal factors for the determination of the price level.

This paper presents Leon Walras and Augustin Cournot views on monetary regulation. Important differences can be found in their views about the convenience of the issuing of paper money and fiat money in general. Whereas Walras is against bank notes, even if coming from a central bank, Cournot has a moderate position. He accepts the need for bank notes even without a strict adjustment to metal reserves. It can be ascertained that Cournot believes discretionary monetary regulation is convenient and acceptable, while Walras believes the only acceptable monetary system is one based exclusively on the stability of the value of money under a monetary rule following the strict equivalence between metallic reserves and a pure medium of exchange form of money. This paper shows Cournot’s ability to understand more clearly than Walras the evolution of the monetary system of his days. Whereas Walras is trying to guarantee the coherence of his pure theory with his applied theory, and he is then unable to accept the evolution toward a monetary system based on fiat money and he proposes very rigid and complex system of quasi-bimetallic circulation where banks are simple mediators between entrepreneurs and savings.

This paper tells the story of how paper money evolved as a result of lending by banks. While lending commodity money requires holding large reserves of commodity money to ensure liquidity, issuing convertible paper money reduces these costs significantly. The paper also examines the possibility of issuing inconvertible notes and shows that while they further reduce the cost of borrowing they also have adverse effects on the stability of the banking system. As a result, governments often intervened, either outlawing the issuance of such notes, or monopolizing them for themselves by issuing fiat money. The paper examines the process of creation of paper money, but also sheds light on more general issues, like the relation between money and financial intermediation.

The collapse of the securitization market during the 2007-2008 Financial Crisis resulted from investors’ concern with the value of securitized assets and securities issued by special purpose entities (SPEs). Research has shown that prior to the Crisis, investors valued equity of sponsor-originator banks (S-Os) as if there were an implicit guarantee extended to SPE creditors that would be fully honored. We predict that the Crisis caused investors to value S-O equity as if such guarantees would not be honored. We test this prediction in two ways: by estimating cross-sectional equity valuation models for banks before and during the Financial Crisis, and by testing for changes in various market metrics in response to retained interest writedown events during the Financial Crisis. The valuation tests reveal that whereas prior to the Crisis SPE debt and equity was valued similarly to S-O debt and equity, this relation ceased to hold after the Crisis unfolded. The event study results reveal an increase in trading volume, equity volatility, and spread when retained interest writedowns are announced, which is consistent with the market viewing such events as providing significant, but ambiguous information regarding whether S-Os would honor their implicit guarantees. Additional analyses reveal that investor reaction is concentrated among those S-Os where there is ambiguity as to whether they will honor their implicit guarantees.

40) Aggregate demand for emerging markets in downturn – not possible because of limited govt capacity. 41) Momentum in prices when fed starts boom. Arsonist sets fire and says wind made the blaze even more.

We develop a model of strategic capital replacement. We do so for two firms in partial equilibrium as well as for numerous firms in general equilibrium. We recognize that a firm's exercise of its capital-replacement option under fixed costs of investment and time-to-build leads not only to a temporary loss of revenues for this firm but also to a significant temporary reallocation of the firm's revenues to its competitors. Upon exercising its investment option, the firm pays a fraction of the implicit strike price to its competitors in the form of transferred foregone consumer demand. This previously unexplored effect has implications for the pro/counter-cyclicality of investment decisions and the endogenous provision of business-cycle insurance.

In this paper I consider how the systems of private money in Venice, Amsterdam and England dealt with financial crises and raise the possibility that the institutional structure of the banking system that developed in 18th century England was particularly well adapted to addressing system-wide crises that threatened the whole financial network. In all three cases, banks extended the supply of commodity money by issuing convertible claims while operating on the basis of partial reserves, thereby creating the possibility that a bank could face an unusually high demand for deposits which its reserves could not cover. From a theoretical point of view we can consider this the problem of individual uncertainty, abstracting from the issue of aggregate uncertainty. However, a partial reserve banking system where deposits are convertible into a real good is subject also to the possibility that all banks simultaneously will face an unanticipated demand for deposits which the system as a whole is unable to meet. This is the problem of aggregate uncertainty. I investigate how each of the three systems addressed the situation of an individual bank at risk and the situation of a system-wide threat to the financial network.

Financial instability is a major problem for the world's middle-income developing countries. Barry Eichengreen's proposal for dealing with the problem treats currency mismatches - the fact that developing countries borrow in dollars instead of their own currency - as the principal cause. I argue that institutional flaws, with monetary and fiscal policy for example, drive financial instability and also account for countries' inability to place local-currency denominated debt contracts. Since weak institutions are to blame, efforts to help countries build stronger institutions will likely yield greater benefits than narrow attempts to address currency mismatches per se.

In this paper, we identify exogenous shocks to credit demand, financial inter-mediation, and supply of funds, and determine the contribution of these shocks to fluctuations in the credit market and overall economic activity. We estimate a structural vector auto-regression model where the three credit shocks are identified with a set of sign restrictions motivated by a simple partial equilibrium model of financial inter-mediation. We find that the credit demand shock explains significantly the variations in the long-term loan rate proxied by the Moody's Baa corporate bond yield, while the supply of funds shock contributes to most of the fluctuations in the short-term commercial paper rate. The financial inter-mediation shock drives most of the fluctuations in the quantity of loans as well as the spread between the Baa and commercial paper rates. Of the credit shocks, we find that the financial inter-mediation shock has the largest impact on real economic activity. In fact, our analysis implies that the sharp decline in output during the 2007-2009 financial crisis is largely attributable to the financial inter-mediation shock, along with shocks originating outside of the financial system.

How do different types of debt influence firm credit risk? This paper sheds new light on this issue by decomposing the leverage ratio into market debt, bank debt, and trade credit leverage ratios by balance sheet account type classification; and short-term debt and long-term debt leverage ratios by debt maturity classification. The pecking order theory (Myers & Majluf, 1984) suggests that these debt types differ in terms of the information asymmetry. Therefore, their effects on credit risk might be distinct. We find that debt to financial markets (commercial papers, bonds, etc.) is more positively correlated with the next period's CDS spread than other debt types. CDS spread also reacts positively to bank debt leverage and responds positively to trade credit leverage only for firms in competitive sectors. With regard to maturity classification, the CDS market attributes more credit risk to long-term debt than short-term debt. We also document that the CDS market tracks firms’ accounts receivable. Our findings are also robust when we control for the credit quality of firms via credit ratings.

This white paper report provides Revenue, Economic, and Constitutional Analysis of the proposed California Tax on Extreme Wealth (ACA 8 & AB 310) and also a Plain-English Summary Outline of its major provisions.

This paper provides a theory of stepwise maturity transformations in intermediation chains, which have become a common form of financial intermediation (an example is banks with long-term assets that sell commercial paper with month-long duration to money market funds with daily demandable shares). This theory reconciles the idea of debt as disciplining device with the idea of debt as 'money-like' claim. In a first step, the paper shows that the optimal disciplining of managers requires a higher debt level but a longer debt duration than the optimal provision of money-like claims. In a second step, the paper explains how this conflict between the two purposes of debt financing can be resolved by a partial separation: a bank issues debt with 'medium' duration that is optimal for disciplining managers, while a fund holds this medium-term debt and issues short-term debt that is optimal for providing money-like claims.

This short paper indicates how the massive fiscal deficits financed by creation of fiat money by central banks worldwide (undertaken in response to the 2020 coronavirus pandemic) may lead to an inflationary depression. In particular, the supply disruptions caused by the pandemic inhibit the production of real goods and services necessary to absorb the extensive money printing to fund the large amounts of government spending could lead to an increase in the prices of real goods and services that is comparable to that occurring during the hyperinflation in Germany in 1923 except on a broad international scale.

This short paper shows how excess global saving led to asset price inflation in U.S. stocks during 1981 to 2019. It compares stock PE ratios to corporate bond values to explain that investor exuberance for stocks enabled and enhanced the extent of the secular stock rise.

We study the reaction of investors to tail events across trading institutions. We conduct experiments in which investors bid on a financial asset that delivers a small positive reward in more than 99% of the cases and a large loss otherwise. The baseline treatment uses a repeated BDM mechanism whereas the market treatment replaces the uniform draw of the BDM mechanism by a uniform draw over the bids of the other participants. Our design is such that bids should not differ across treatments in normal times while allowing for potential differences to emerge after tail events have occurred. We find that markets tend to exacerbate the reaction of investors to tail losses and we attribute this effect to emotions.

This paper develops a theoretical model as a foundation of empirical analysis of the transmission channel of non-performing loans (NPLs) on bank cost of capital, credit and liquidity creation in the Eurozone. Empirical results confirm the model’s predictions and suggest that holding non-performing loans increases the cost of capital for banks in the short-term and the long-term. Moreover, the increased cost of capital reduces credit and liquidity creation, and the more so the less capitalized is the bank. This phenomenon is found to be economically more significant for European periphery country banks than for core country banks. The identification of the transmission channel is robust to the Granger predictability test.

This short paper provides the best available evidence about the number of tax increment financing districts in US states. It provides complete sources for the data and contrasts our findings with the findings of one earlier study on this subject.

Focusing on the 2016 US money market funds (MMFs) reform, this study assesses the impact of removing rating-based rules on the behavior of regulated investors and on market prices. Difference-in-differences fund-level and security-level analyses show a positive impact of the reform on the level of risk-taking by non-government MMFs. No empirical support is found for alternative explanations for the verified change in portfolio allocation. This shift has material consequences for the pricing of credit risk: all else equal, the reform-driven increase in the demand for riskier securities by MMFs is associated with a significant decrease in credit premia for commercial papers.

In this paper, we study the dynamic relationship in the shadow banking system by examining the short-run and the long-run relationship among the financial assets of the money market fund, the commercial paper, and the repurchase agreement market. The evidence suggests that there exists a common long-term cointegrating trend among these three components of the shadow banking system for 1985-2013 sample period. Any disequilibrium in this long-run relationship among these variables is corrected by movement in the financial assets of the money market funds. The trend-cycle decomposition from the estimated cointegrating relationship shows that the cyclical component in the money market funds is large and captures the huge swings in these markets during the financial crisis. Our results are also robust to the exclusion of the financial crisis, and it reveals the changing role of the commercial paper and the repurchase agreement market in the shadow banking system.

The New Zealand Government’s recent Green Paper “Exploring Digital Convergence” (EDC) suggests that so-called “digital convergence,” or convergence in telecommunications, information technology, media and entertainment (TIME) sectors is facilitating the creation, dissemination and consumption of creative works. This paper analyses the economic performance of the film and television industry in New Zealand to see if there has been any correlated increase in revenues, employment and output during the time of this convergence. Our review suggests the evidence in New Zealand is inconsistent with any suggestion that convergence has facilitated a dramatic increase in revenues or output for the creative sector. Our findings suggest the opposite: Total screen industry revenues as measured by Statistics New Zealand’s Screen Industry Survey (SIS) which commenced in 2005 shows that from 2005-2015, there is a shortfall of total screen industry revenues over the ten-year period of approximately $4.6 billion against what they would have been had revenues kept pace with inflation and economic growth. This estimate includes just over $3 billion in the “production and post-production” (PPP) sector. Alternative scenarios described in more detail in this paper involving historical data yield estimates for the shortfall in production and post-production (PPP) revenues ranging from estimates of $3.94 billion in total over the ten-year period from 2005 to 2015, including a $600 million shortfall in the final year, to a considerably higher estimate, where the shortfall in PPP revenues reaches $4.1 billion in the last year (2015) alone. This upper scenario further suggests that by the end of the 14-year period 2001-2015, the shortfall in total screen industry revenues would have been $8.5 billion in the last year (2015) alone. In other words, total screen industry revenues in 2015 would have been closer to $12 billion in 2015, rather than $3 billion actual. At the same time, screen industry employment is also down and there has been no measurable increase in film and TV output during the data available from 2011.The data is more consistent with the need to move to stronger copyright in New Zealand to restore the effective rate of copyright protection and stem the loss of revenue and decreased production, not weaker copyright. More advanced empirical work, of course, is justified, but at this stage this is the direction to follow if one adopts an evidence-based approach to policy.

Do claims on the private sector serve the role of safe assets? We answer this question using high-frequency panel data on prices and quantities of certificates of deposit (CD) and commercial paper (CP) issued in Europe. We show that only very short-term private securities benefit from a premium for safety. Using several identification strategies, we show that the issuance of short-term CDs, but not of CPs, strongly responds to measures of safety demand. The private production of safe assets is stronger for issuers with high credit worthiness, and breaks down during episodes of market stress. We conclude that even very short-term private assets are sensitive to changes in the information environment and should not be treated as equally safe at all times.

Central banks are increasingly communicating their economic outlook in an effort to manage the public and financial market participants’ expectations. We provide original causal evidence that the information communicated and the assumptions underlying a central bank’s projection can matter for expectation formation and aggregate stability. Using a between-subject design, we systematically vary the central bank’s projected forecasts in an experimental macroeconomy where subjects are incentivized to forecast the output gap and inflation. Without projections, subjects exhibit a wide range of heuristics, with the modal heuristic involving a significant backward-looking component. Ex-Ante Rational dual projections of the output gap and inflation significantly reduce the number of subjects’ using backward-looking heuristics and nudge expectations in the direction of the rational expectations equilibrium. Ex-Ante Rational interest rate projections are cognitively challenging to employ and have limited effects on the distribution of heuristics. Adaptive dual projections generate unintended inflation volatility by inducing boundedly-rational forecasters to employ the projection and model-consistent forecasters to utilize the projection as a proxy for aggregate expectations. All projections reduce output gap disagreement but increase inflation disagreement. Central bank credibility is significantly diminished when the central bank makes larger forecast errors when communicating a relatively more complex projection. Our findings suggest that inflation-targeting central banks should strategically ignore agents’ irrationalities when constructing their projections and communicate easy-to-process information. Electronic supplementary material The online version of this article (10.1007/s10683-020-09684-6) contains supplementary material, which is available to authorized users.

Studies have analyzed the impact of firm and issue characteristics but not liquidity and solvency components of financial distress on the use of bond covenants. Using a comprehensive database of corporate bonds from 2001 to 2012, we find that firm liquidity, measured by standardized Lambda, has a negative statistical and economic impact on the inclusion of all categories and sub-categories of restrictive bond covenants. Developed from financial statement information by Emery and Lyons (1991), Lambda is designed as a coverage ratio that, under certain distribution assumptions, maps into the probability of a firm being unable to pay its short-term bills. The strongest solvency proxy is the 10-year credit default swap (CDS) spread which is significant across the categories and sub-categories for investment and payment covenants, weakly significant for the subordinated debt sub-category of the subsequent financing covenant, but strongly significant for the control poison put sub-category of event covenants. This evidence supports a model that uses SLambda as a proxy for liquidity risk and the 10-year CDS spread as a proxy for solvency risk. The liquidity/covenant relationship is dampened when firms have access to commercial paper funding or bank loans. However, during the recent financial crisis liquidity event this liquidity/covenant relationship was enhanced especially for firms which were dependent on commercial paper during this time when the commercial paper market was deteriorating.

We use the 2007 asset-backed commercial paper (ABCP) crisis as a laboratory to study the determinants of debt runs. Our model features dilution risk: maturing short-term lenders demand higher yields in compensation for being diluted by future lenders, making runs more likely. The model explains the observed ten-fold increase in yield spreads leading to runs and the positive relation between yield spreads and future runs. Results from structural estimation show that runs are very sensitive to leverage, asset values, and asset liquidity, but less sensitive to the degree of maturity mismatch, the strength of guarantees, and asset volatility.

This paper empirically examines the relevance of external credit ratings in the capital structure decision-making process with regard to an international firm sample. Using the rating outlook to measure the imminence of a rating change, allows us to test managers’ ex-ante capital structure behavior more concisely than prior studies have. The results show that companies near a rating change issue 1.8% less net debt relative to net equity as a percentage of total assets than firms not near a rating change. We find that the effect is economically larger for US firms and also if access to the commercial paper market is at risk.

The ongoing massive fiscal policy stimulus triggered increasing concerns on the potential impact on interest rate levels, as economic theory predicts. Particularly, the deterioration of some EMU countries’ fiscal positions has been putting at risk Eurozone’ financial stability. In this paper, we estimate a Panel VAR (PVAR) model on the EMU area employing annual data from 1970 to 2008 in order to assess the qualitative and quantitative impact of public debt on interest rates. Our results show that prior to the introduction of the Euro an increase in public debt led to positive and significant effect on long-term nominal interest rates, with a stronger effect for high-debt countries. After the introduction of the single currency, the effect vanishes (in line with Bernoth 2004). We interpret this result as a confirmation of the crucial role of the monetary union in weakening the automatic risk-premium-based channel between debt shocks and returns on government bond.

Three issues regarding asset prices and monetary policy are clarified. First, increases in asset prices due to monetary expansion, despite their "paper" wealth nature, tend to make current consumers as a whole wealthier. Second, the weaker (stronger) the effect of monetary policy on investment through Tobin's q effect is, the stronger (weaker) the monetary effect on consumption through the wealth effect. Third, from the perspective of macroeconomic stability, the soundness of asset market performances does not depend on whether they are fundamental or not, but on their compatibility with the AD-AS balance in the long run.

A number of falsehoods have emerged during the past two years concerning money market funds and their role in the financial system. The latest fallacy claims that MMFs can cut off the supply of funds to the banking system and thereby imperil the ability of banks to provide loans to the economy. This paper examines this fallacy and explains why it is false.

This short paper sets out how leaving a monetary union is not the technical impossibility many have recently claimed. It has been done often in the past, and while possibly uncomfortable can be the best available option. Examples are given.

This paper studies the spread between the newly issued 30 year Treasury bond and the old 30 year bond. The spread follows a systematic pattern over the auction cycle: it begins high at an auction date, and converges toward zero by the next auction date. I document the profits on establishing a long old bond/ short new bond convergence trade and rolling this over every auction cycle, over a period from 6/95 to 11/99. Despite the systematic convergence, the average profits are close to zero, and profits covary with the stock market in a manner resembling a short put option position. The difference in repo market financing rates between the two bonds is an important component of the costs in carrying the position. I then ask what economic factors account for the level and time variation in the spread. Using the spread between commercial paper and T-Bills to identify changes in investor preference for liquid assets, I establish that aggregate factors affecting liquidity preference plays an important role in the variation of the bond/old-bond spread. The evidence also establishes that new bonds are imperfect substitutes for other bonds, and therefore changes in the supply of new bonds, such as in recent Treasury buybacks, will have important effects on bond market spreads.

This paper evaluates the welfare gains arising from a deeper trade integration in the European Monetary Union. To do this, the European Monetary Union is represented in a realistic way by an intertemporal general equilibrium model with incomplete financial markets, sticky prices and home bias both in private consumption and production. The model is estimated and globally not rejected by the data. Two main results emerge: (i) an increase in vertical (intermediate goods) trade implies welfare gains while (ii) an increase in horizontal trade implies welfare losses.

This paper considers the impact of takeover (or acquisition) likelihood on firm valuation. If firms are more likely to acquire during times when they have free cash and/or when the required rate of return is low, takeover targets become more sensitive to shocks to aggregate cash flows and/or to the price of risk. Thus, ceteris paribus, firms that are exposed to takeovers will have a different rate of return from firms that are protected from takeovers. Using estimates of the likelihood that a firm will be acquired, we create a takeover-spread portfolio that buys firms with a high likelihood of being acquired and shorts firms with low likelihood of being acquired. Relative to the Fama-French model, the takeover-spread portfolio generates annualized abnormal returns of up to 12% between 1980 and 2004. Further, the takeover-spread portfolio is shown to be important in explaining cross-sectional differences in equity returns. Additionally, using a two-beta model that distinguishes cash flow shocks from discount rate shocks, we show that firms more likely to be taken over have higher betas on the aggregate cash factor. Finally, we provide an explanation for the existence of abnormal returns associated with governancespread portfolios (Gompers, Ishii and Metrick, 2003 and Cremers and Nair, 2005), and relate the takeover-spread portfolio returns to takeover activity in the economy.

We survey 384 financial executives and conduct in depth interviews with an additional 23 to determine the factors that drive dividend and share repurchase decisions. Our findings indicate that maintaining the dividend level is on par with investment decisions, while repurchases are made out of the residual cash flow after investment spending. Perceived stability of future earnings still affects dividend policy as in Lintner (1956). However, fifty years later, we find that the link between dividends and earnings has weakened. Many managers now favor repurchases because they are viewed as being more flexible than dividends and can be used in an attempt to time the equity market or to increase EPS. Executives believe that institutions are indifferent between dividends and repurchases and that payout policies have little impact on their investor clientele. In general, management views provide little support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play a secondary role. This is the final working paper version of our 2005 publication in the Journal of Financial Economics.

The 1920s and 1930s saw the Fed reject a state-of-the-art empirical policy framework for a logically defective one. Consisting of a quantity theoretic analysis of the business cycle, the former framework featured the money stock, price level, and real interest rates as policy indicators. By contrast, the Fed’s procyclical needs-of-trade, or real bills, framework stressed such policy guides as market nominal interest rates, volume of member bank borrowing, and type and amount of commercial paper eligible for rediscount at the central bank. The start of the Great Depression put these rival sets of indicators to the test. The quantity theoretic set correctly signaled that money and credit were on sharply contractionary paths that would worsen the slump. By contrast, the real bills indicators incorrectly signaled that money and credit conditions were sufficiently easy and needed no correction. This experience shows that policy measures and measurement, no matter how accurate and precise, can lead policymakers astray when embodied in a theoretically flawed framework.

This paper studies dynamic-optimizing model of a semi-small open economy with sticky nominal prices and wages. The model exhibits exchange rate overshooting in response to money supply shocks. The predicted variability of nominal and real exchange rates is roughly consistent with that of G-7 effective exchange rates during the post-Bretton Woods era. The model predicts that a positive domestic money supply shock lowers the domestic nominal interest rate, that it raises output and that it leads to a nominal and real depreciation of the country’s currency. Increases in domestic labor productivity and in the world interest rate too are predicted to induce a nominal and real exchange rate depreciation.

PurposeIn this paper, the author examines how capital structure (relative to target) affects firm innovation.Design/methodology/approachThe author uses cross-sectional OLS regressions (for each year of data) to determine whether a firm is above or below its target debt level (in that year) and then uses fixed effects OLS regressions with panel data to examine the impact of having leverage above or below the firm's target on its innovation activity.FindingsThe author shows that firms with below-target debt innovate more in terms of number of patents granted and have better quality innovations in terms of citation counts of patents and in terms of economic value of patents. The results hold for sample splits based on firm age, firm size and access to external finance. The author also shows that the findings are not driven by the negative correlation between leverage and innovation measures. Overall, the results indicate that it is not the actual level of leverage that impacts innovation; the relevant factor that impacts firm innovation is whether a firm is above or below its leverage target.Originality/valueThe author extends the literature on financing innovation by linking leverage target with firm innovation. Findings of this paper also provide supporting evidence that capital structure plays an important role on firm innovation and supplements prior literature that shows the importance of debt in financing firm innovation.

This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm-specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book-to-market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short-run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm-specific component appears larger than the underreaction to the common factors.

Economists believe in market efficiency, so when the net income of a property becomes lower due to, e.g., management fee and taxation (MT), its market price should also be lower, to be in line with the rate of return of other investments. This paper shows that such efficient price is illusionary. The full price of a purchase must include the capitalization of MT. The difference between the two prices means externality and distortion. This paper also reveals who will buy or rent properties with high MT, proves why investment in similar coops is even worse, and shows how MT further messes up the property market. Finally, this paper corrects Economics' understanding of price.