Talks with political scientists re how federalism works - and what conservatives advocate

In An Age of Risk, Emily Nacol shows that risk, now treated as a permanent feature of our lives, did not always govern understandings of the future. Focusing on the epistemological, political, and economic writings of Hobbes, Locke, Hume, and Adam Smith, Nacol explains that in 17th-18thC Britain, political and economic thinkers reimagined the future as a terrain of risk, characterized by probabilistic calculation, prediction, and control. Nacol contends, we see 3 crucial developments in thought on risk and politics. While thinkers differentiated uncertainty about the future from probabilistic calculations of risk, they remained attentive to the ways uncertainty and risk remained in a conceptual tangle, a problem that constrained good decision making. They developed sophisticated theories of trust and credit as crucial background conditions for prudent risk-taking, and offered complex depictions of the relationships and behaviors that would make risk-taking more palatable. They also developed 2 narratives that persist in subsequent accounts of risk—risk as a threat to security, and risk as an opportunity for profit. Nacol locates the origins of our own ambivalence about risk-taking. By the end of the 18thC, a new type of political actor would emerge from this ambivalence, one who approached risk with fear rather than hope. -- Emily C. Nacol is assistant professor of political science at Vanderbilt University.
Chapter 1 Introduction 1
Chapter 2 “Experience Concludeth Nothing Universally” - Hobbes and the Groundwork for a Political Theory of Risk 9
Chapter 3 The Risks of Political Authority - Trust, Knowledge, and Political Agency in Locke’s Politics and Economy 41
Chapter 4 Hume’s Fine Balance - On Probability, Fear, and the Risks of Trade 69
Chapter 5 Adventurous Spirits and Clamoring Sophists - Smith on the Problem of Risk in Political Economy 98
Chapter 6 An Age of Risk, a Liberalism of Anxiety 124
Notes 131 -- References 157 -- Index 167
Downloaded Chapter 1 to Tab S2

The Centre for Study of Existential Risk is an interdisciplinary research centre focused on the study of human extinction-level risks that may emerge from technological advances. We aim to combine key insights from the best minds across disciplines to tackle the greatest challenge of the coming century: safely harnessing our rapidly-developing technological power. Our current major research projects include Managing Extreme Technological Risk (supported by the Templeton World Charity Foundation) and Extreme Risks and the Global Environment (supported by the Grantham Foundation), as well as our Blavatnik Public Lecture series and the Hauser-Raspe workshop series

Bordalo, Pedro, Nicola Gennaioli, and Andrei Shleifer. 2013. “Salience and Asset Prices.” American Economic Review Papers and Proceedings 103 (3): 623-628. -- In Bordalo, Gennaioli, and Shleifer (2012a)— henceforth, BGS (2012a)—we described a new approach to choice under risk that we called salience theory. In comparisons of risky lotter- ies, we argued, individuals’ attention is drawn to those payoffs which are most different or salient relative to the average. In making choices, indi- viduals overweight these salient payoffs relative to their objective probabilities. A simple for- malization of such salience-based probability weighting provides an intuitive account of a vari- ety of puzzling evidence in decision theory, such as Allais paradoxes and preference reversals.
Salience theory naturally lends itself to the analysis of the demand for risky assets. After all, risky assets are lotteries evaluated in a context described by the alternative investments avail- able in the market. An asset’s salient payoff is naturally de ned as one most different from the average market payoff in a given state of the world. We present a simple model of inves- tor choice and market equilibrium in which salience in uences the demand for risky assets. This model accounts for several time series and cross-sectional puzzles in nance in an intuitive way, based on its key implication that extreme payoffs receive disproportionate weight in the market valuation of assets. -- downloaded via iPhone to DBOX

BlackRock pre COP21 report on portfolio risks

Gus De Franco, U of Toronto, Rotman School of Management; Florin P. Vasvari, London Business School; Dushyantkumar Vyas, Rotman School of Management; Regina Wittenberg Moerman, U of Chicago, Booth School of Business -- We examine the determinants of the strength of bond covenants in protecting bondholders’ interests using a unique dataset constructed by Moody’s that allows us to measure the restrictiveness of bond covenant packages beyond the covenant inclusion measures used in the prior literature. We find that the covenant restrictiveness of a bond is highly persistent over time: it is strongly associated with the covenant restrictiveness of the borrower’s previous bond issues. We show that this persistence is driven by the restrictiveness of the covenant packages in previous bonds arranged by the firm’s underwriter or advised by the firm’s and underwriter’s legal counsels, consistent with these debt market intermediaries facing high switching costs in changing bond contractual terms. The restrictiveness of covenants in bonds issued by industry peers is another driver of the persistence, suggesting that covenants are written to facilitate bonds’ comparability. We next document that the bond covenant restrictiveness changes only when the borrower experiences a significant decline in its creditworthiness or when there is a substantial tightening in the credit supply in the economy. We also show that secondary bond market investors discount bond prices when bond covenants’ restrictiveness remains persistent despite a substantial decline in a borrower’s creditworthiness since the previous bond issue. PDF File: 64 -- Covenants, Covenant Restrictiveness, Persistence, Secondary Bond -- saved to briefcase

Amir Amel-Zadeh, University of Cambridge, Judge Business School; Mary E. Barth, Stanford, Graduate School of Business; Wayne R. Landsman, U of North Carolina Kenan-Flagler Business School -- Rock Center for Corporate Governance at Stanford University Working Paper No. 147 -- Our analytical description of how banks’ responses to asset price changes can result in procyclical leverage reveals that for banks with a binding regulatory leverage constraint, absent differences in regulatory risk weights across assets, leverage is not procyclical. For banks without a binding constraint, fair value and bank regulation both can contribute to procyclical leverage. Empirical findings based on a large sample of US commercial banks reveal that bank regulation explains procyclical leverage for banks facing a binding regulatory leverage constraint and contributes to procyclical leverage for those that do not. Fair value accounting does not contribute to procyclical leverage. -- PDF File: 46 -- Keywords: Fair value accounting, procyclicality, leverage, risk-based capital regulation, financial institutions, commercial banks -- saved to briefcase

Anne Beatty, Ohio State - Dept of Accounting & Management Information Systems; Scott Liao, U of Toronto, Rotman School of Management -- Rotman School of Management Working Paper No. 2346752 -- We survey research on financial accounting in the banking industry. After providing a brief background of the micro-economic theories of the economic role of banks, why bank capital is regulated, and how the accounting regime affects banks’ economic decisions, we review three streams of empirical research. Specifically we focus on research examining the relation between bank financial reporting and the valuation and risk assessments of outside equity and debt, the relation between bank financial reporting discretion, regulatory capital and earnings management, and banks’ economic decisions under differing accounting regimes. We provide our views about what we have learned from this research and about what else we would like to know. We also provide some empirical analyses of the various models that have been used to estimate discretion in the loan loss provision. We further discuss the inherent challenges associated with predicting how bank behavior will respond under alternative accounting and regulatory capital regimes.-- PDF File: 121 -- Keywords: financial accounting; bank regulatory capital; information asymmetry -- saved to briefcase

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (hereafter, DF), the most sweeping financial regulatory… Very good roundup of the holes that are left, the inability to force a coherent inter-agency approach to key risk regulation areas (e.g. the Financial Stability Oversight couldn't force the SEC to write adequate Money Market Funds reg, making it even worse than before the crisis), and the areas where regs are excessively complex, costly etc -- so they either won't do the job (and regulators will wind up making ad hoc exceptions because they're not workable) or their going to get gamed. Basically comes down to the age-old problem of regulation by institutional form rather than by function. The financial crisis was the best chance we had to rationalize the system, and Paulson had Treasury working on a proposal to do just that, but it got trashed when the financial system blew up and everybody was battling for narrow interests in a crisis atmosphere with inflamed populist politics -- only thing positive was finally getting rid of OCC. I do think they're unnecessarily suspicious of the new consumer protection agency -- given that a full overhaul wasn't possible, somebody needs to be responsible for looking out for consumers, since the main regulators are focused on financial risk issues at the institutional or system level.

Financial institutions have for many years sought measures which cogently summarise the diverse market risks in portfolios of financial instruments. This quest led institutions to develop Value-at-Risk (VaR) models for their trading portfolios in the 1990s. Subsequently, so-called filtered historical simulation VaR models have become popular tools due to their ability to incorporate information on recent market returns and thus produce risk estimates conditional on them. These estimates are often superior to the unconditional ones produced by the first generation of VaR models. This paper explores the properties of various filtered historical simulation models. We explain how these models are constructed and illustrate their performance, examining in particular how filtering transforms various properties of return distribution. The procyclicality of filtered historical simulation models is also discussed and compared to that of unfiltered VaR. A key consideration in the design of risk management models is whether the model’s purpose is simply to estimate some percentile of the return distribution, or whether its aims are broader. We discuss this question and relate it to the design of the model testing framework. Finally, we discuss some recent developments in the filtered historical simulation paradigm and draw some conclusions about the use of models in this tradition for the estimation of initial margin requirements. -- downloaded pdf to Note

Reviews a number of stress indexes developed since the financial crisis -- most show a good way of indicating where we are at any one time, and several may be useful in crisis management for identifying institutions with liquidity vs insolvency problems, but none tell us where we're going **--** Where does this leave us? Our answer is that we have yet another reason to be skeptical of time-varying, discretionary regulatory policy. In an earlier post, we noted that the combination of high information requirements, long transmission lags and significant political resistance made it unlikely time-varying capital requirements will be effective in reducing financial vulnerabilities. Our conclusion then, which we reiterate now, is that the solution is to build a financial system that is safe and resilient all of the time, since we really never know what is coming. That means a regulatory system based on economic function, not legal form, with sufficient capital buffers to guard against all but the very worst possibilities. In the end, a financial system that relies on an early warning indicator of imminent financial collapse seems destined to fail. -- copied to Pocket

2015. “Money Doctors.” Journal of Finance 70 (1): 91-114.
Abstract
We present a new model of investors delegating portfolio management to professionals based on trust. Trust in the manager reduces an investor’s perception of the riskiness of a given investment, and allows managers to charge fees. Money managers compete for investor funds by setting fees, but because of trust, fees do not fall to costs. In equilibrium, fees are higher for assets with higher expected return, managers on average under perform the market net of fees, but investors nevertheless prefer to hire managers to investing on their own. When investors hold biased expectations, trust causes managers to pander to investor beliefs. -- downloaded via iPhone to DBOX

Begun January 2005, slowly adding additional chapters -- This bookmark is for the Introduction -' Planned Contents -- Part I – RIBA IN THE QUR`AN *-* I - The Qur`an And The Authentic Ahadith Do Not Define Riba. *-* II - Riba In Pre-Islamic Arabia. *-* III - Riba In The Qur`an – A Detailed Examination of Relevant Verses [PDF Document] *-* IV - Riba In The Qur`an – A Closer Examination of Some Relevant Issues. *-* V- Usury/Interest In Other Societies. **--** Part II – RIBA IN THE HADITH. *-* VI -Ahadith About Husn al-Qada` *-* VII- Ahadith About Riba – An Overview. *-* VIII -Ahadith About Riba – An Examination Of Their Transmission (Naql) *-* IX- Ahadith About Riba – Making Sense Of Them. *-* Conclusion. -- We can hardly doubt that in the Qur`an riba is some kind of increase in the amount of a loan. But what is its precise nature? The commonly held traditional view is that riba is simply interest, that is, any increase in the loan required by the lender as a condition for advancing the loan. But many commonly held views, when they are scrutinized in the light of three primary sources of Islam – the Qur`an, authentic ahadith, and reason -- turn out to be either fundamentally flawed or harmful oversimplifications. Is the commonly accepted definition of riba one of the exceptions? Unfortunately, not. It turns out that this definition is a harmful oversimplification.

Mark Thornton and Chantal Saucier have accomplished the arduous task of bringing forth a new and improved translation of Cantillon’s famous work. Heretofore the only English translation of the Essai available has been the 1931 edition produced by Henry Higgs for the Royal Economic Society. Though competent, it has become less serviceable over time, as more and more of its shortcomings devolved (not the least of which is the antiquated use of “undertaker” in place of “entrepreneur”). Saucier provides a more accurate and lucid account, better suited to the 21st century. Thornton’s hand shows not only in competent guidance of the translator but in the inclusion of numerous explanatory footnotes that add historical context. Robert F. Hébert writes the foreword. -- downloaded pdf to Note

Since the 1970s, studies of risk have grown into a major interdisciplinary field of research. Although relatively few philosophers have focused their work on risk, there are important connections between risk studies and several philosophical subdisciplines. This entry summarizes the most well-developed of these connections and introduces some of the major topics in the philosophy of risk. It consists of six sections dealing with the definition of risk and with treatments of risk related to epistemology, the philosophy of science, the philosophy of technology, ethics, and the philosophy of economics.
1. Defining risk [including objective vs subjective and risk vs uncertainty - the latter comparison mostly formalized in decision tgeory]
2. Epistemology
3. Philosophy of science
4. Philosophy of technology
5. Ethics
6. Risk in economic analysis
Related Entries -- causation: in the law | causation: probabilistic | consequentialism | contractarianism | economics, philosophy of | game theory | luck: justice and bad luck | scientific knowledge: social dimensions of | technology, philosophy of

It has been argued that imprecise probabilities are a natural and intuitive way of overcoming some of the issues with orthodox precise probabilities. Models of this type have a long pedigree, and interest in such models has been growing in recent years. This article introduces the theory of imprecise probabilities, discusses the motivations for their use and their possible advantages over the standard precise model. It then discusses some philosophical issues raised by this model. There is also a historical appendix which provides an overview of some important thinkers who appear sympathetic to imprecise probabilities. *-* Related Entries -- belief, formal representations of | epistemic utility arguments for probabilism | epistemology: Bayesian | probability, interpretations of | rational choice, normative: expected utility | statistics, philosophy of | vagueness

Earlier this year, a new working paper cast doubt on one of the dominant explanations of the reasons for the 2002-2006 housing bubble in the United States—that growth in mortgage credit and income growth uncoupled as credit flowed to areas to with declining income growth. Instead, economists Manuel Adelino of Duke University, Antoinette Schoar of the Massachusetts Institute of Technology, and Felipe Severino of Dartmouth College, argue that the cause of the increase on household debt was a classic speculative mania. But a new paper by economists Atif Mian of Princeton University and Amir Sufi of the University of Chicago questions this view of the debt build-up. The seeming flaws in the dominant narrative that an increase in the supply of credit caused the bubble, they say, can be explained by one thing: mortgage fraud. -- Bunker links to both papers - didn't download but will follow debate via "House of Debt" blog

conference at GW with their Department of Homeland Security program with focus on stuff like cybersecurity and terrorism -- downloaded pdf to Note

Downloaded to iPhone -- Cogent Economics & Finance - Volume 2, Issue 1, 2014 -- Can corporate governance ratings reduce problems of asymmetric information between companies and investors? To answer this question, we set out to examine the information basis for providing such ratings by reviewing corporate governance attributes that are required or recommended in laws, accounting standards, and codes, respectively. After that, we scrutinize and organize the publicly available information on the methodologies actually used by rating providers. However, important details of these methodologies are treated as confidential property, thus we approach the evaluation of corporate governance ratings as a means to reduce asymmetric information in a more general manner. We propose that the rating process may be seen as consisting of two general activities, namely a data reduction phase, and a data weighting, aggregation, and classification phase. Findings based on a Danish data-set suggest that rating providers by selecting relevant attributes in an intelligent way can improve the screening of companies according to governance quality. In contrast, it seems questionable that weighting, aggregation, and classification of corporate governance attributes considerably improve discrimination according to governance quality.

... his analysis, which holds that we knew how to avoid, counter and cure these troubles; we have simply – largely out of wilful ignorance and lack of courage – failed to do more than the barest minimum of what was necessary. Governments, banks and international institutions did “just enough, almost too late” to prevent the worst possible result, which would have been a note-for-note replay of the 1930s including a slide into fascism and world war. But having done no more than avoid world-historic catastrophe, we find ourselves mired in a dim morass of our own making, with no sunlit uplands in sight. Wolf offers a persuasive account that is also clear, though he relies on no single factor but several: hence the title of the book. It took both long-term shifts and a series of shocks to cause a crisis of such magnitude. Our world was born in the end of the Cold War. With capitalism triumphant, the victors liberalized their economies and so did the Communist nations, particularly China. Yet all was not well in this brave new world; international finance and trade threatened the stability of smaller, emerging economies, as the crises of the 1990s demonstrated.

Nice defense of what Basle doing and why a "simple" leverage ratio is neither simple nor adequate - but is useful as a checksum that minimizes risk of gaming Risk Weighted Assets

We begin by describing our 1992 model of fire sales and the related findings in empirical corporate finance. We then show that models of fire sales can account for several related phenomena during the recent financial crisis, including the contraction of the banking system and the failures of arbitrage in financial markets exemplified by historically unprecedented differences in prices of very similar securities. We then link fire sales to macroeconomics by discussing how such dislocations of security prices and the reduction in balance sheets of banks can reduce investment and output. Finally, we consider how the concept of fire sales can help us think about government interventions in financial markets, including the evidently successful Federal Reserve interventions in 2009. Fire sales are surely not the whole story of the financial crisis, but they are a phenomenon that binds together many elements of the crisis.

Article provided by American Economic Association in its journal Journal of Economic Perspectives. Volume (Year): 25 (2011) Issue (Month): 1 (Winter) Pages: 29-48 -- paper downloaded to iPhone

At a time when the recent crisis has given financial innovation a bad name, Shiller’s contrarian message is that well-designed financial instruments and markets are an enormous boon to social welfare. We agree.

Nassim Nicholas Taleb, Rupert Read, Raphael Douady, Joseph Norman, Yaneer Bar-Yam -- Abstract -- We present a non-naive version of the Precautionary (PP) that allows us to avoid paranoia and paralysis by confining precaution to specific domains and problems. PP is intended to deal with uncertainty and risk in cases where the absence of evidence and the incompleteness of scientific knowledge carries profound implications and in the presence of risks of "black swans", unforeseen and unforeseable events of extreme consequence. We formalize PP, placing it within the statistical and probabilistic structure of ruin problems, in which a system is at risk of total failure, and in place of risk we use a formal fragility based approach. We make a central distinction between 1) thin and fat tails, 2) Local and systemic risks and place PP in the joint Fat Tails and systemic cases. We discuss the implications for GMOs (compared to Nuclear energy) and show that GMOs represent a public risk of global harm (while harm from nuclear energy is comparatively limited and better characterized). PP should be used to prescribe severe limits on GMOs. -- see summary from arxiv Medium blog, saved via Instapaper

Fixed-rate mortgages (FRMs) dominate the U.S. mortgage market, with important consequences for monetary policy, household risk management, and financial stability. In this paper, we show that the share of FRMs is sharply lower when mortgages are difficult to securitize. Our analysis exploits plausibly exogenous variation in access to liquid securitization markets generated by a regulatory cutoff and time variation in private securitization activity. We interpret our findings as evidence that lenders are reluctant to retain the prepayment and interest rate risk embedded in FRMs. The form of securitization (private versus government-backed) has little effect on FRM supply during periods when private securitization markets are well-functioning. -- Duh! That requires 77 pages to show originators are indifferent as to a GSE or a private FI as long as they can unload their product? Let's see what the authors think the big deal is about "well-functioning private markets" - private securitizers have mostly been in the well-collateralized top end that the GSEs didn't handle but the rating agencies and investors could be comfortable with. The private market eats into the GSEs business only when there's a boom that's going to end in tears - although before the Great Recession the busts were localized, so the private securitizers (and their investors, even in the equity tranches) who got into booms weren't hurt too badly if they were geographically diversified or didn't go all-in with the skeeziest originators or local bankers who were big RE promoters of marginal development. -- downloaded pdf to Note

We investigate intermediary asset pricing theories empirically and find strong support for intermediary book leverage as the relevant state variable. A parsimonious dynamic pricing model that uses detrended broker-dealer leverage as a price of risk variable, and innovations to broker-dealer leverage as pricing factor is shown to perform well in time series and cross sectional tests of a wide variety of equity and bond portfolios. The model outperforms alternative intermediary pricing specifications that use intermediary net worth as state variables, and performs well in comparison to benchmark asset pricing models. We draw implications for macroeconomic theories. -- cited in Report 690, September 2014 re forecasting US recessions and predictive power of broker-dealer margin accounts -- downloaded pdf to Note

The paper begins with some theoretical concerns relating to factors that could trigger a crisis similar to the global economic crisis that began in 2008. The first concern relates to the deregulated financial institutions and the growing uncertainty that can be witnessed in these liberalized financial markets. The second relates to financial engineering with innovations in these markets, simultaneously providing cushions against risks while generating flows of liquidity that remain beyond the conventional sources of bank credit. Interpreting the role of uncertainty, one can observe the connections between investment and finance, both of which are subject to changes in the state of expectations. The initial formulation can be traced back to Keynes’s General Theory, where liquidity preference is linked to asset prices and new investments. The Keynesian analysis was reformulated in 1986 by Minsky, who introduced the possibility of sourcing external finance through debt, which further adds to the impact of uncertainty. Minsky’s characterization of deregulated financial markets considers the newfangled sources of nonbank credit, especially with the involvement of banks in the securities market under the universal banking model. As for the institutional arrangements that provide for profits on transactions, financial assets bought and sold in the primary market as initial public offerings of stocks are usually transacted later, in the secondary market, where these are no longer backed by physical assets.In the upswing, finance creates a myriad of financial claims and liabilities, and thus becomes increasingly remote from the real economy, while innovations to hedge and insulate assets continue to proliferate in the financial market, especially in the presence of uncertainty. The paper looks especially at the US. This is appended by a stylized account of the turn of events in terms of a theoretical model that highlights the role of uncertainty in the process. -- Associated Program: Monetary Policy and Financial Structure -- downloaded pdf to Note

The global debt glut described in the Geneva 16 report, and the global saving glut described by Bernanke, are the same thing. The authors note that growth has been slowing in developed countries since 1980. Indeed it has - and during that time capital ownership and indebtedness have been increasing in tandem, as we might expect since they are opposite sides of the same coin. The report cites numerous analyses that show high debt levels - public AND private - tending to impede growth as resources that could have been turned to productive investment are spent on debt service. Secular stagnation is as much a consequence of over-indebtedness as it is of excess capital. -- When the private sector is highly indebted, saving can take the form of paying off debt. If the government runs a surplus, therefore, it impedes deleveraging in the private sector, and may even force some sectors (typically the poor) to increase debt. Reducing the sovereign debt not only reduces saving in the private sector, it comes at the price of continued and possibly rising indebtedness. The report rightly notes that transferring debt from the private to the public sector, as the US has done, isn't deleveraging. But transferring it back again isn't deleveraging either. And as transferring it back again is likely only to be possible with extensive sovereign guarantees (the UK's Help to Buy, for example), whose debt is it really, anyway? Reports such as this, that look on debt as a problem and ignore the associated savings, fail to address the real issue. The fact is that households, corporations and governments like to have savings and are terrified of loss. Writing down the debt in which people invest their savings means that people must lose their savings. THIS is the real "shock, horror". This is what people fear when they worry about a catastrophic debt default. This is what the world went to great lengths to prevent in 2008. The problem is not the debt, it is the savings.

By exploring the implications of the linkage between Knight and Pragmatism, some non-trivial implications can be argued to exist. Specifically, section 2 outlines the T. C. E. literature, and how it exists in an atmosphere mixed with Marshallian competition and Knightian uncertainty. Section 3 then considers the disparate philosophical positions behind the work of Knight and Marshall. Knight's critique of Marshall is seminal, not because of any trivial technical innovations that Knight may have inspired within economic theory, but because Knight grounds his work on a philosophical viewpoint that effectively devastated Hegelian philosophy: American Pragmatism. Section 4 then links together the previous two sections by considering how the T. C. E. literature exhibits a dependency on both Pragmatism and Hegelian philosophy. The non-trivial implications of understanding the T. C. E. literature as a branch of Marshallian economics, which recognises Knightian uncertainty, are developed in section 5. Possible conclusions and a summary of the argument are provided in section 6. -- over 100 references from Kant through the pragmatists, Knight and 20thC economics, variants of neoclassical, and empirical evidence including probability and uncertainty in econometrics with heavy emphasis on theories of the firm, transaction cost analysis, Coase and Williamson, markets and hierarchies-- downloaded pdf to Note

Trevor Houser, Robert Kopp, Solomon Hsiang, Michael Delgado, Amir Jina, Kate Larsen, Michael Mastrandrea, Shashank Mohan, Robert Muir-Wood, DJ Rasmussen, James Rising, and Paul Wilson -- The US faces a range of economic risks from global climate change — from increased flooding and storm damage, to climate-driven changes in crop yields and labor productivity, to heat-related strains on energy and public health systems. The American Climate Prospectus (ACP) provides a groundbreaking new analysis of these and other climate risks by region of the country and sector of the economy. By linking state-of-the-art climate models with econometric research of human responses to climate variability and cutting edge private sector risk assessment tools, the ACP offers decision-makers a data driven assessment of the specific risks they face. The ACP is the result of an independent assessment of the economic risks of climate change commissioned by the Risky Business Project. In conducting this assessment, RHG convened a research team, co-led by climate scientist Dr. Robert Kopp of Rutgers University and economist Dr. Solomon Hsiang of the University of California, Berkeley, and partnered with Risk Management Solutions (RMS), the world’s largest catastrophe-modeling company for insurance, reinsurance, and investment-management companies. The team’s research methodology and draft work was reviewed by an Expert Review Panel (ERP) composed of leading climate scientists and economists, acknowledged within the report. The ACP was released on June 24, 2014 alongside a Risky Business summary -- American Climate Prospectus: Economic Risks in the United States (complete report, updated August 2014, 23.2 mb)

C About

Mobilizing the world’s capital is essential for the transition to a sustainable, low-carbon economy. Today, however, too little capital is supporting the transition, and too much continues to be invested in a high-carbon and resource-intensive, polluting economy. Market participants and others recognize that prevailing rules and incentives governing financial markets can disadvantage long-term, sustainable behavior. Long-term environmental risks are not being effectively counted and green opportunities are inadequately valued. Such distortions can lead to a misallocation of capital and a danger of systemic risks to the economy and the natural environment. The UNEP Inquiry is intended to support such actions by identifying best practice, and exploring financial market policy and regulatory innovations that would support the development of a green financial system. Building on the twin pillars of UNEP’s strong track record through its Green Economy initiative and the UNEP-Finance Initiative, it will assemble the world`s best practice and forward-looking expert knowledge through an advisory council, practitioner dialogue and research. The Inquiry will produce a final options report as well as technical papers throughout its 18-24 month life from January 2014. The Inquiry`s current set up phase will ensure it is designed with guidance from practitioners and experts, and establish a network of world-class advisors and researchers. Engaging with existing initiatives will ensure that it can effectively convene and catalyze broad debate that supports the crystallization of options for advancing a more systematic approach to developing a green financial system. -- summary downloaded pdf to Note

The CEPR Press eBook on secular stagnation has been viewed over 80,000 times since it was published on 15 August 2014. -- Six years after the Crisis and the recovery is still anaemic despite years of zero interest rates. Is ‘secular stagnation’ to blame? Introduction - Coen Teulings and Richard Baldwin **--** I. Opening the debate -- 1. Reflections on the ‘New Secular Stagnation Hypothesis’, Laurence H Summers. **--** II. Three issues: Potential growth, effective demand, and sclerosis -- 2. Secular stagnation: A review of the issues, Barry Eichengreen -- 3. The turtle’s progress: Secular stagnation meets the headwinds, Robert J Gordon -- 4 Four observations on secular stagnation, Paul Krugman. -- 5. Secular joblessness, Edward L Glaeser. **--** III. Further on potential growth. -- 6. Secular stagnation? Not in your life - Joel Mokyr. -- 7 Secular stagnation: US hypochondria, European disease?, Nicholas Crafts. **--** IV. Further on effective demand. -- 8. A prolonged period of low real interest rates?, Olivier Blanchard, Davide Furceri and Andrea Pescatori. -- 9. On the role of safe asset shortages in secular stagnation, Ricardo J Caballero and Emmanuel Farhi. -- 10. A model of secular stagnation, Gauti B. Eggertsson and Neil Mehrotra. -- 11. Balance sheet recession is the reason for secular stagnation, Richard C Koo. -- 12. Monetary policy cannot solve secular stagnation alone
Guntram B Wolff. **--** V. Further on sclerosis -- 13. Secular stagnation: A view from the Eurozone, Juan F. Jimeno, Frank Smets and Jonathan Yiangou -- downloaded pdf to Note

Reuters special investigation of totally haphazard, uncoordinated, impossibly expensive problems of dealing with rising oceans and subsiding ground levels (mostly from depleting aquifers) along US shores controlled by state and local governments, driven by a combination of denial and grubbing for federal dollars for piecemeal pet projects. The pace of shore loss (1 beach up to 22 ft a yr) and costs are documented to be accelerating rapidly.

As a follow-up to our 2009 report, Risk Intelligent governance: A practical guide for boards, we’ve taken a fresh a look at helping board members achieve Risk Intelligent governance. To that end, this paper provides real-world examples and case studies compiled in our work with boards that employ state-of-the-art practices. These practices focus on six key areas: defining the board’s risk oversight role, fostering a risk intelligent culture, approving the risk appetite, helping management incorporate risk intelligence into strategy, assessing the maturity of the risk governance process and making sure the organization discloses the risk story to stakeholders. We offer this paper to directors as food for thought and a catalyst for focused action, with the caveat that Risk Intelligent governance is not a one-size-fits-all approach to be adopted by every organization or within each industry. - 24 page white paper -- downloaded pdf to Note

Historians have long maintained that the rise of the British empire brought an end to the great age of piracy, turning the once violent Atlantic frontier into a locus of orderly commerce by 1730. Guy Chet documents the persistence of piracy, smuggling, and other forms of illegal trade throughout the 18thC despite ongoing governmental campaigns to stamp it out. The failure of the Royal Navy to police oceanic trade reflected the state’s limited authority and legitimacy at port, in the courts, and in the hearts and minds of Anglo-American constituents. Chet shows how the traditional focus on the growth of the modern state overlooks the extent to which old attitudes and cultural practices continued to hold sway. Even as the British government extended its naval, legal, and bureaucratic reach, in many parts of the Atlantic world illegal trade was not only tolerated but encouraged. In part this was because Britain’s constabulary command of the region remained more tenuous than some have suggested, and in part because maritime insurance and wartime tax policies ensured that piracy and smuggling remained profitable. When Atlantic piracy eventually waned in the early 19thC, it had more to do with a reduction in its profitability at port than with forceful confrontation at sea. -- Jack Greene gives it high marks

SASB’s Materiality Map™ creates a unique materiality profile for different industries. In order to comply with the SEC’s view of materiality, our approach is designed to provide a view into the information needs of the reasonable investor. The Map relies heavily on evidence of investor interest and evidence of financial impact, and it allows for adjustments based on financial impact and long-term sustainability principles. The quantitative model is designed to prioritize the issues that are most important within an industry, to keep the standards to a minimum set of issues that are likely to be material. Sustainability accounting standards are then developed based on both the quantitative results from the Map and a qualitative research process informed by SASB’s research team. The Map looks at 40+ sustainability issues and analyzes their importance in the context of the 80+ industries in SICS. -- Issues are classified under five categories: Environmental Capital, Social Capital, Human Capital, Business Model & Innovation, and Leadership & Governance. Traditionally, sustainability issues are classified under the common ESG structure; however, SASB uses a finer grained analysis in order to surface potential impacts on the company’s ability to create long-term value.

Facts About SASB *--* The Sustainability Accounting Standards Board is an independent 501(c)3 non-profit. *--* Through 2016 SASB is developing sustainability accounting standards for more than 80 industries in 10 sectors. *--* SASB standards are designed for the disclosure of material sustainability issues in mandatory SEC filings, such as the Form 10-K and 20-F. -**- SASB is accredited to establish sustainability accounting standards by the American National Standards Institute (ANSI). Accreditation by ANSI signifies that SASB’s procedures to develop standards meet ANSI’s requirements for openness, balance, consensus, and due process. *--* SASB is not affiliated with FASB, GASB, IASB or any other accounting standards boards. --- For more information about the principles, processes and definitions relevant to SASB’s standards setting process, please read our Conceptual Framework. (Pdf downloaded to Note)

After a year of research, stakeholder engagement, feedback and refinement, SASB celebrated the reveal of its latest research results with evocative discourse about the Services Industry and its role in non-financial reporting. With over 190 participants representing 120 companies, the May Delta Series, which is the research process capstone, brought together its Industry Working Group participants as well as other integral stakeholders, to discuss the outcomes of their sector-specific research. -- panelists discussed experience getting buy in from different parts of organization and Board -- how using the quarterly 10-K form provided a familiar focus for measurement and reporting -- links to CSR and risk management, not just profitability measures, were especially important for directors

Downloaded pdf to Note - Roger Myerson, he of the 2007 Nobel Prize, wrote a glowing review of The Banker’s New Clothes, by Admati and Hellwig, for the Journal of Economic Perspectives a while back. Considering the reviewer, the journal, and the content of the review (which describes the book as “worthy of such global attention as Keynes’s General Theory received in 1936″), it’s about the highest endorsement you can imagine. - long useful review, but leaves out 20 years of disintermediation history and development of capital and money markets pre Basle risk weighted capital and universal banking that got big banks back in the game

Accounting rules, credit exposure on in-the-money, funding costs, pricing, LIBOR substitutes, and even more complexities I've never heard of in risk adjustments --- the idea of risk-neutral BlackScholes is long gone from financial regulations.

Three years ago, Nick Rowe produced this post describing a “weird world” – a world in which the equilibrium interest rate is at or below the long-term growth rate of the economy, rather than above it as we are used to. In such a world, bubbles are inevitably created as investors search for positive yield. This is also the world recently described by Larry Summers.

But I don’t think this world is weird. I think it is actually normal, and we have been living in a weird world of unstable Ponzi schemes that eventually crash and reset. Let me explain.

Authors: Miguel A. Segoviano Basurto ; Bradley Jones ; Peter Lindner ; Johannes Blankenheim -- Downloaded pdf to Note

Summary: This paper examines the financial stability implications arising from securitization markets, with one eye on the past and another on the future. The paper begins by deriving a number of “lessons learned” based on an examination of key industry developments in the years before the crisis. Emphasis is placed on the various ways in which securitization markets dramatically changed shape in the years preceding the crisis, vis-à-vis their earlier (simpler) incarnation. Current impediments to securitization markets are then discussed, including a treatment of various regulatory initiatives, the operational infrastructure of securitization markets, and related official sector intervention. Finally, a broad suite of policy recommendations is presented to address the factors that either contributed to the crisis or may currently be posing obstacles to growth-supportive, sustainable securitization markets. These proposals are guided by the objective of preserving the beneficial features of securitization, while mitigating those that pose a potential risk to financial stability.

There is a prevalent view that part of the reason for the UK’s slow recovery and poor productivity is the existence of large numbers of companies that should have died in the recession. “Zombie firms in danger of strangling the economy”, screams one newspaper headline. And another warns of the “Zombie businesses spreading like a virus”..... Papworth expresses some puzzlement that the rate of corporate insolvency appears low. His puzzlement is understandable. It is not low. He is looking at the wrong data. And because of this, the rest of the paper is seriously flawed. I am not going to argue with his use of Austrian business cycle theory, or Schumpeter’s theory of “creative destruction”. But since he is using the wrong data, he has not put together a convincing case for the existence of the zombies he says need to be cleared out....... Also, because it is widely believed that zombies are kept alive not just by low interest rates, but by damaged banks unable to take losses, there are calls for banks to “end forbearance” even if it means they fail themselves. This is madness. Every bank and building society in the UK has corporate debt on its books, and almost every bank and building society in the UK has a damaged balance sheet which could not cope with large amounts of insolvencies. So banks cannot “end forbearance”. Nor do we wish them to do so. Widespread losses across the entire UK banking sector would catapult the UK back into deep recession. I am no fan of damaged banks – indeed I have called for them to be bypassed so that the UK economy can get the credit it desperately needs. But that doesn’t mean that it would be sensible to bankrupt them all.

So it seems there is little evidence for the existence of zombie companies. But there is considerable evidence for the existence of zombie banks. Indeed the very term “zombie” was originally used about banks. During the American Savings & Loan Crisis of the 1980s & 90s,

Lots of links -- Presentation re 3 stages of economic recovery and why UK stalled for 3 years in not getting Stage 2 bounce back growth due to austerity after returning to growth in 2010 - and fears won't reach Stage 3, maintenance of high growth for long period to return to pre recession productive capacity trend line. Banks as a central worry

-- quote-- So answering the productivity puzzle is the key to knowing what kind of recovery we will have. My suspicion, shared by others at the Bank of England and elsewhere, is that some of the answer is to be found back where the recession began – with UK banks. Bank lending to firms is important in increasing productivity, because it allows the productive firms to expand (at home and overseas), and the new start ups to displace the older, less efficient firms. So when bank lending collapsed in the recession, productivity collapsed. If banks start lending again to these new and more productive (but also more risky) firms, we may be able to make up a good deal of that lost ground......

So how are we with fixing the banks? The honest answer is I do not know, but let me end with a concern. So this is a recession created by banks, and there is a real danger that the power banks have over governments, and this government in particular, may mean we never make up the ground we have lost.

NBER Working Paper No. 19612
Issued in November 2013 -- downloaded pdf to Note

We investigate whether the performance of Private Equity (PE) investments is sufficient to compensate investors (LPs) for risk, long-term illiquidity, management and incentive fees charged by the general partner (GP). We analyze the LP's portfolio-choice problem and find that management fees, carried interest and illiquidity are costly, and GPs must generate substantial alpha to compensate LPs for bearing these costs. Debt is cheap and reduces these costs, potentially explaining the high leverage of buyout transactions. Conventional interpretations of PE performance measures appear optimistic. On average, LPs may just break even, net of management fees, carry, risk, and costs of illiquidity.

The charts above illustrate that the overall picture is clearly one of falling long-term interest rates. As the authors say:

“[The] importance of monetary policy for long real rates appears to have diminished since the late 1990s… This is consistent with evidence that monetary policy has become more synchronised across countries, leaving less room for national real interest rates to diverge.”

This is what you would expect to see in a post-scarcity economy, though it is not to say that there are no projects that can deliver a real return on investment. Rather under post-scarcity conditions firms cannot have confidence in the existence of a market that can absorb all of their goods or services – so the risk adjustment of expected returns has to be larger. As such in order to get firms to part with their capital you would need to either set strongly negative nominal rates to force corporates into action or expand fiscal policy sufficiently to make it bear the investment risk that the private sector is refusing to take on. If Summers is right, however, it remains unclear whether even these measures would be sufficient to break developed economies out of secular stagnation.

Link to RWER paper - Downloaded pdf to Note - See comment to post attacking Complexity Theory that remains attached to a physical world metaphor rather than information flows (including faulty info) and varieties of reactions reflecting different sorts of individuals, institutions and their types of connections

Abstract - In this paper we argue that if we want to find a more satisfactory approach to tackling the major socio-economic problems we are facing, we need to thoroughly rethink the basic assumptions of macroeconomics and financial theory. Making minor modifications to the standard models to remove "imperfections" is not enough, the whole framework needs to be revisited. Let us here enumerate some of the standard assumptions and postulates of economic theory. [List of 7 standard assumptions]

Summary of his SSRN paper

This paper argues that the fundamental principle of contemporary financial economics is balanced reciprocity, not the principle of utility maximisation that is important in economics more generally. The argument is developed by analysing the mathematical Fundamental Theory of Asset Pricing with reference to the emergence of mathematical probability in the seventeenth century in the context of the ethical assessment of commercial contracts. This analysis is undertaken within a framework of Pragmatic philosophy and Virtue Ethics. The purpose of the paper is to mitigate future financial crises by reorienting financial economics to emphasise the objectives of market stability and social cohesion rather than individual utility maximisation. -- Downloaded pdf to Note

Although there is quite a lot of healthy skepticism on the rational expectations hypothesis (REH) here that I agree with, I still think that Thoma’s picture of the extent to which the assumption of rational expectations is useful and valid, is inadequate and unwarranted.

Let me elaborate a little on why I think so.

The concept of rational expectations was first developed by John Muth in an Econometrica article in 1961 – Rational expectations and the theory of price movements – and later — from the 1970s and onward — applied to macroeconomics. Muth framed his rational expectations hypothesis in terms of probability distributions:

Simply brilliant

This paper provides a theoretical explanation of the accumulation process, which accounts for the developments in the financial markets over the recent past. Specifically, our approach is focused on the presence of correlations between physical and financial investment, and how the latter could affect the former. In order to achieve this objective, two assets are considered: equities and bonds. This choice permits us to account for two extreme alternative possibilities: taking risk in the short run with unknown profits, or undertaking a commitment to the long run with known yields. This proposal also accounts for the influence of the cost of external finance and the impact of financial uncertainty, as proxied by the interest rate in the former case and the exchange rate in the latter case; thereby utilizing the Keynesian notion of conventions in the determination of investment. The model thus formulated is subsequently estimated by applying the difference GMM and the system GMM in a panel of 14 OECD countries from 1970 to 2010.

Scott, Hal S., Interconnectedness and Contagion (November 20, 2012). Available at SSRN: http://ssrn.com/abstract=2178475 or http://dx.doi.org/10.2139/ssrn.2178475 -- last revised Dec 2012 -- The study comes to the conclusion that contagion was the primary cause of the financial crisis and that short-term funding in particular is the primary source of systemic instability. In the context of these conclusions, the study engages in a comprehensive and detailed analysis of the possible solutions to financial contagion. The solutions include: (i) capital requirements, (ii) liquidity requirements, (iii) resolution procedures, (iv) money market mutual fund reform, (v) lender of last resort, (vi) liability insurance and guarantees, and (vii) public bailouts. Each potential solution is discussed in detail with an evaluation of its effectiveness in addressing financial contagion. --

Number of Pages in PDF File: 297 --

Keywords: interconnectedness, contagion, financial crisis, systemic risk, Lehman Brothers, bank runs, capital requirements, liquidity requirements, resolution authority, bailout

But a new paper from the International Monetary Fund suggests that unconventional monetary policies (UMPs) do not encourage speculation. Rather, they dampen it. UMPs reduce "tail risk", or the odds of extreme market outcomes like hyperinflation or a new Depression. That, in turn, tamps down market volatility, and that reduces the incentive to speculate. When America announces that it will purchase more mortgage-backed securities or government bonds, markets quickly price in lower volatility. Risk measures can drop by 10% after the Federal Reserve makes unconventional monetary policy announcements, according to the IMF paper.

Beck, Thorsten and Chen, Tao and Lin, Chen and Song, Frank M., Financial Innovation: The Bright and the Dark Sides (January 25, 2012). Available at SSRN: http://ssrn.com/abstract=1991216 or http://dx.doi.org/10.2139/ssrn.1991216 -- Date posted: January 25, 2012 ; Last revised: October 7, 2012 -- downloaded pdf to Note -- The financial turmoil from 2007 onwards has spurred renewed debates on the “bright” and “dark” sides of financial innovation. Using bank-, industry- and country-level data for 32, mostly high-income, countries between 1996 and 2006, this paper is the first to explicitly assess the relationship between financial innovation in the banking sector and (i) real sector growth, (ii) real sector volatility, and (iii) bank fragility. We find evidence for both bright and dark sides of financial innovation. On the one hand, we find that a higher level of financial innovation is associated with a stronger relationship between a country’s growth opportunities and capital and GDP per capita growth and with higher growth rates in industries that rely more on external financing and depend more on innovation. On the other hand, we find that financial innovation is associated with higher growth volatility among industries more dependent on external financing and on innovation and with higher idiosyncratic bank fragility, higher bank profit volatility and higher bank losses during the recent crisis.

Number of Pages in PDF File: 69

Keywords: Financial Innovation, Financial R&D Intensity, Bank Risk Taking, Financial Crisis, Industrial Growth, Finance and Growth

Great short piece on "regulatory capture" not by industry lobbying but by a pretty intellectual system. -- ... at least in the arena of financial economics, a vulgar version of equilibrium theory rose to dominance in the years before the financial crisis, portraying market completion as the cure to all problems, and mathematical sophistication decoupled from philosophical understanding as the key to effective risk management. Institutions such as the International Monetary Fund, in its Global Financial Stability Reviews (GFSR), set out a confident story of a self-equilibrating system.

Thus, only 18 months before the crisis erupted, the April 2006 GFSR approvingly recorded “a growing recognition that the dispersion of credit risks to a broader and more diverse group of investors… has helped make the banking and wider financial system more resilient. The improved resilience may be seen in fewer bank failures and more consistent credit provision.” Market completion, in other words, was the key to a safer system.

JSTOR: Journal of Economic Issues, Vol. 22, No. 2 (Jun., 1988), pp. 407-414 -- downloaded pdf to Note

JSTOR: Journal of Post Keynesian Economics, Vol. 29, No. 3 (Spring, 2007), pp. 363-391

There are many conflicting interpretations of security prices and price determination in financial markets. They range from academic theories based on efficient markets and rational expectations hypotheses, to more traditional methods of fundamental analysis, to theories of "value" and "growth" investing, to chart-reading and technical analysis, to notions such as "reflexivity." These interpretations are logically inconsistent with each other, but they seem to coexist, sometimes even on the same trading desk. In this paper, we seek to formulate an explanation for this strange coexistence, using some tools from critical theory to understand how financial markets operate. Structuralism is used to analyze various kinds of narratives appearing in the financial literature, which are intended to have explanatory force, and appearance of sometimes contradictory elements in such narratives; poststructuralism is used to explain the way in which contradictory interpretations coexist. We discuss some practical implications for security valuation, option valuation, trading strategies, market risk management, and volatility estimation.

Downloaded pdf to Note

Abstract

I investigate the effect of financial innovation on portfolio risks when traders have belief disagreements. I decompose traders’ average portfolio risks into two components: the uninsurable variance, defined as portfolio risks that would obtain without belief disagreements, and the speculative variance, defined as portfolio risks that result from speculation. My main result shows that financial innovation always increases the speculative variance through two distinct channels: by generating new bets and by amplifying traders’ existing bets. When disagreements are large, these effects are sufficiently strong that financial innovation increases average portfolio risks, decreases average portfolio comovements, and generates greater speculative trading volume relative to risk-sharing volume. Moreover, a profit-seeking market maker endogenously introduces speculative assets that increase average portfolio risks. JEL Codes: G11, G12, D53.

The Quarterly Journal of Economics (2013) 128 (3): 1365-1396. doi: 10.1093/qje/qjt007 First published online: March 26, 2013

Downloaded pdf to Note

International Journal of Applied Economics and Econometrics,Volume 19, No.4,October -December 2011,pp. 86-111. 

Adam Smith rejected the use of the mathematical laws of the calculus of probabilities because the basic information-data-knowledge provided in the real world of decision making did not allow a decision maker to specify precise, definite, exact, numerical probabilities or discover the probability distributions. This means that Smith rejected the classical interpretation of probability of La Place and the Bernoulli brothers, the limiting frequency-relative frequency interpretation of probability, and the personalist, subjectivist, psychological Bayesian approach used by all neoclassical schools of thought because all of these approaches to probability claim that ALL probabilities can be represented by a single numeral between 0 and 1 and the decision maker knows the probability distributions. Smith, like Keynes, rejects this immediately. 

An important conclusion of this paper is that it was Adam Smith who first explicitly recognized that the mathematical concept of probability is not applicable, in general, in real world decision making. Smith also rejects the normative and prescriptive roles of mathematical probability in decision making. 

Downloaded pdf to Note

Smith and Keynes would reject the Kahneman-Tversky behavioral economist “Heuristics and Biases“ approach that regards mathematical probability as the normative criterion that all decision makers should attempt to emulate since this approach is a more advanced mathematical version of Bentham’s original approach. Mathematical probability, which requires the use of precise or sharp numerical probabilities, can only be normative in the case where the decision maker has a complete information set and/or knows for certain that a specific probability distribution will apply now and in the future. The mathematical laws of the probability calculus only hold as a limiting case whenever humans are part of the equation. Both Keynes and Smith rely on an inexact, interval, non additive, nonlinear approach that directly conflicts with the exact, single number, additive, linear approach recommended by Tversky and Kahneman as being the hallmark of human rationality in decision making.

 On the other hand, Bentham’s approach is an earlier version of the exact, linear and additive approach recommended as being rational by Tversky-Kahneman. Smith and Keynes, however, did emphasize fields that today are called Cognitive Science and Cognitive Psychology. Here pattern recognition, similarity, induction and intuition played an important role.

Downloaded pdf to Note

Re St Petersburg Paradox, Condorcet solution, change in importance of uncertainty vs scarcity post Industrial Revolution & loss of earlier knowledge

Nice summary of issues in economic and finance models that assume ergodicity

The Basel Committee on Banking Supervision is back with another look at risk-weightings — that is, the risk weighting done by banks using their own models rather than the standardised BIS methods.

A new BIS/Basel paper focuses on the banking book, whereas a study published in Januarylooked at the trading book.Specifically, the new report looks at how credit risk is assessed because this accounts for 77 per cent of variation in risk weightings (market risk is 11 per cent and operational risk is 9 per cent). It uses information from bank regulators across numerous countries, plus information from 32 big banks who were asked to run their internal risk-weighting models on a hypothetical portfolio.

The data from both sources pointed to the same thing: “risk weights for credit risk in the banking book vary significantly across banks”.

Downloaded pdf to Note

the purpose of this paper is to attempt to explain what it means to consider different approaches and why it matters for policy. This is done by discussing two features of the financial crisis which pose particular problems for economic theory. These are the role of changing market sentiment in driving asset prices on the one hand and the breakdown of trust relationships in banking on the other (the moral hazard issue). We will see how these are addressed by mainstream theory and by alternative approaches. 

First, market sentiment is discussed within the mainstream rational-optimising framework, where risk is quantifiable, and compared with the Keynesian approach based on the general uncertainty of knowledge, where reason, evidence and sentiment are integrated. The moral hazard issue is then discussed in its mainstream form in terms of rational opportunism and in its institutionalist form in terms of the foundation of social relations (including relations between institutions) in trust. It is shown that different ways of approaching theorising in each case imply different policy measures. It is argued further that an exclusively deductive mathematical approach to analysis of market sentiment and trust is unduly limiting and that a more pluralist approach would more fully address the issues.

An econometrics paper that can make you laugh? Yes, Ed Leamer, famously the author of a 1983 paper, Let’s Take the Con Out of Econometrics (pdf), has a superb 2010 article in the Journal of Economic Perspectives, Tantalus on the Road to Asymptopia – it’s free access,  only moderately technical, and brilliant.

The point is that the available economic data will always support a range of different theories, and Leamer advocates sensitivity analyses that illustrate the spectrum of parameter values and theories consistent with observed data. Economists need to go back to 1921, he argues, and read Keynes’s Treatise on Probability and Frank Knight’s Risk, Uncertainty and Profit. Both books point out that decisions are subject to three-valued logic (yes, no, don’t know) whereas economic theory assumes away the large territory of don’t know.

CEPR Discussion Paper - downloaded pdf to Note
This paper argues that the European banking crisis can in part be explained by a “carry trade” behavior of banks. The results are supportive of moral hazard in the form of risk-taking by under-capitalized banks to exploit low risk weights and central-bank funding of risky government bond positions.

The regulation of bank capital has recently come under renewed scrutiny. This column argues that the way we implement capital regulation needs to be reconsidered because banks under-report risk, thereby escaping government intervention and maintaining market access. One possible way forward, something already implemented under Basel III, is to ask banks to satisfy a capital requirement relative to total (rather than risk-weighted) assets. Overall, simple, transparent, workable rules are what we should be aiming for.

SSRN briefcase $5
Abstract:     
 In this paper, we examine the relationship between banks’ approval for the internal ratings-based (IRB) approaches of Basel II and the ratio of risk-weighted over total assets. Analysing a panel of 115 banks from 21 OECD countries that were eventually approved for applying the IRB to their credit portfolio, we find that risk-weight density is lower once regulatory approval is granted. The effect persists when we control for different loan categories, and we provide evidence showing that it cannot be explained by flawed modelling, or improved risk-measurement alone.

Consistent with theories of risk-weight manipulation, we find the decline in risk-weights to be particularly prevalent among weakly capitalised banks, when the legal framework for supervision is weak, and in countries where supervisors are overseeing many IRB banks. We conclude that part of the decline in reported riskiness under the IRB results from banks’ strategic risk-modelling.

Number of Pages in PDF File: 45

Keywords: Basel II, capital regulation, internal ratings-based approach
JEL Classification: G20, G21, G28
working papers series 

Markets will now adjust to a new negative shock to the trio of the liquidity, risk and term premia. Heightened volatility will also fuel even greater risk aversion, including lower appetite for inventory buildup among brokers and greater cross-over investor migration back to home base.

the traditional tool of expected utility maximisation is not well suited to the nature of our knowledge about the climate problem (Heal and Millner 2013b). Because this criterion describes our knowledge with a unique probability distribution, which is treated no differently from the uncertainty in the roll of a die or the toss of a coin, it neglects the fact that in many cases we are ‘uncertain about our uncertainty’.