Financial Market Bubbles and Crashes
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1 Stern School of Business New York University B30.2392.30 Prof
Stern School of Business New York University B30.2392.30 Prof. Richard Sylla Spring 2009 KMC 8-65, 998-0869 Weds, 6-9 Off.Hrs: W 4-6 & by app't KMC 4-120 email: [email protected] The Development of Financial Institutions and Markets Course description: The credit crisis of 2007-08 came as no surprise to financial historians who have studied such events going back four or more centuries. This course studies the historical development of financial institutions and markets, in a comparative international context with emphasis on the USA. It covers monetary, banking, central banking, and securities market history, as well as pertinent aspects of the history of government finance and the emergence of corporations as a dominant business form. Topics include the emergence of modern financial systems in history, including the roles of public finance and money, banking and central banking, and securities and insurance markets. We study the composition, growth, fluctuations, and determinants of the money stock; the development of banking systems and their regulation; the emergence of central banking and its key role in modern financial systems; monetary policies; major trends and fluctuations in stock, bond, and money markets; and, of course, the history of financial crises. Readings: For a course such as this there are no ideal texts, despite the richness of the literature in book and article form. As a compromise between ideal and real, I have chosen several books that are comprehensive in treatments of their subjects (and perhaps one or two are worth keeping on your shelf after the course is over). -
Financial Literacy and Portfolio Diversification
WORKING PAPER NO. 212 Financial Literacy and Portfolio Diversification Luigi Guiso and Tullio Jappelli January 2009 University of Naples Federico II University of Salerno Bocconi University, Milan CSEF - Centre for Studies in Economics and Finance DEPARTMENT OF ECONOMICS – UNIVERSITY OF NAPLES 80126 NAPLES - ITALY Tel. and fax +39 081 675372 – e-mail: [email protected] WORKING PAPER NO. 212 Financial Literacy and Portfolio Diversification Luigi Guiso and Tullio Jappelli Abstract In this paper we focus on poor financial literacy as one potential factor explaining lack of portfolio diversification. We use the 2007 Unicredit Customers’ Survey, which has indicators of portfolio choice, financial literacy and many demographic characteristics of investors. We first propose test-based indicators of financial literacy and document the extent of portfolio under-diversification. We find that measures of financial literacy are strongly correlated with the degree of portfolio diversification. We also compare the test-based degree of financial literacy with investors’ self-assessment of their financial knowledge, and find only a weak relation between the two measures, an issue that has gained importance after the EU Markets in Financial Instruments Directive (MIFID) has required financial institutions to rate investors’ financial sophistication through questionnaires. JEL classification: E2, D8, G1 Keywords: Financial literacy, Portfolio diversification. Acknowledgements: We are grateful to the Unicredit Group, and particularly to Daniele Fano and Laura Marzorati, for letting us contribute to the design and use of the UCS survey. European University Institute and CEPR. Università di Napoli Federico II, CSEF and CEPR. Table of contents 1. Introduction 2. The portfolio diversification puzzle 3. The data 4. -
Riding the South Sea Bubble
Riding the South Sea Bubble By PETER TEMIN AND HANS-JOACHIM VOTH* This paper presents a case study of a well-informed investor in the South Sea bubble. We argue that Hoare’s Bank, a fledgling West End London bank, knew that a bubble was in progress and nonetheless invested in the stock: it was profitable to “ride the bubble.” Using a unique dataset on daily trades, we show that this sophisticated investor was not constrained by such institutional factors as restric- tions on short sales or agency problems. Instead, this study demonstrates that predictable investor sentiment can prevent attacks on a bubble; rational investors may attack only when some coordinating event promotes joint action. (JEL G14, E44, N23) What allows asset price bubbles to inflate? light on other important episodes of market The recent rise and fall of technology stocks overvaluation. have led many to argue that wide swings in We examine one of the most famous and asset prices are largely driven by herd behavior dramatic episodes in the history of speculation, among investors. Robert J. Shiller (2000) em- the South Sea bubble. Data on the daily trading phasized that “irrational exuberance” raised behavior of a goldsmith bank—Hoare’s—allow stock prices above their fundamental values in us to examine competing explanations for how the 1990s. Others, however, have pointed to bubbles can inflate. While many investors, in- structural features of the stock market, such as cluding Isaac Newton, lost substantially in lock-up provisions for IPOs, analysts’ advice, 1720, Hoare’s made a profit of over £28,000, a strategic interactions between investors, and the great deal of money at a time when £200 was a uncertainties surrounding Internet technology, comfortable annual income for a middle-class as causes of the recent bubble. -
Financial Markets and Trading Founded in 1807, John Wiley & Sons Is the Oldest Independent Publishing Company in the United States
Financial Markets and Trading Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and market- ing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis, as well as much more. For a list of available titles, visit our web site at www.WileyFinance.com. Financial Markets and Trading An Introduction to Market Microstructure and Trading Strategies ANATOLY B. SCHMIDT John Wiley & Sons, Inc. Copyright # 2011 by Anatoly B. Schmidt. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. -
Market Microstructure and Corporate Finance
Journal of Corporate Finance 9 (2003) 377–384 www.elsevier.com/locate/econbase Market microstructure and corporate finance Marc L. Lipson* Terry College of Business, University of Georgia, Athens, GA 30602, USA Received 20 October 2002; accepted 24 October 2002 Abstract This article provides a brief overview of the importance of market microstructure research and identifies existing areas of research that focus on links between microstructure and corporate finance. Each of the special issue articles is then summarized with particular attention given to the research contribution of the article and to the links explored between microstructure and corporate finance. D 2002 Elsevier Science B.V. All rights reserved. Keywords: Market microstructure; Stock; Corporate finance These trees are magnificent, but even more magnificent is the sublime and moving space between them. Rainer Rilke.1 While the growing complexity of both theoretical constructs and empirical method- ologies leads to ever more specialized research, a healthy preoccupation with the meaning and relevance of our research still ensures we never loose sight of the forest for the trees.2 Furthermore, an honest fascination with the myriad details and nuances of our work ensures that every tree gets more than a passing glance. What Rilke so elegantly reminds us, is to devote at least some of our attention to those topics that lie between established lines of inquiry. This special issue explores just such a set of topics—those that combine corporate finance with market microstructure.3 * Tel.: +1-706-542-3644; fax: +1-706-542-9434. E-mail address: [email protected] (M.L. -
What Is Minsky All About, Anyway?
DEPARTMENT OF ECONOMICS WORKING PAPER SERIES What is Minsky All About, Anyway? Korkut Ertürk Gökcer Özgür Working Paper No: 2009-08 University of Utah Department of Economics 1645 East Central Campus Dr., Rm. 308 Salt Lake City, UT 84112-9300 Tel: (801) 581-7481 Fax: (801) 585-5649 http://www.econ.utah.edu 1 What is Minsky All About, Anyway? Korkut Ertürk Gökcer Özgür Acknowledgements: We would like to thank Ken Jameson for his helpful comments without implicating him for any possible mistakes there might be. 2 The financial crisis has been billed a “Minsky moment” in the mainstream media, turning Hyman P. Minksy into a household name. One would think that this was at long last Minsky’s moment of posthumous vindication, and in a way it was. But, oddly, a couple of post-Keynesian luminaries would have none of it. Paul Davidson, the Editor of JPKE , and Jan Kregel, senior scholar at the Levy Institute of Bard College where Minksy had spent the last of his years, were both eager to set the record straight: the current financial debacle did not qualify as a Minskyan crisis because how it unfolded differed from Minsky’s depiction of crises in his writings (Davidson 2008, Kregel 2008a). Of course, whether we think Minsky is relevant for the current crisis or not depends on what we make of him. If Minskyan work means solely his own writings and their restatement, then, Davidson and Kregel are probably right – one cannot help but focus on what is different about the current crisis. But, if instead Minksyan refers to an evolving literature that emanate from but transcend his work, their arguments miss their mark. -
The Challenges of Risk Management in Diversified Financial Companies
Christine M. Cumming and Beverly J. Hirtle The Challenges of Risk Management in Diversified Financial Companies • Although the benefits of a consolidated, or n recent years, financial institutions and their supervisors firmwide, system of risk management are Ihave placed increased emphasis on the importance of widely recognized, financial firms have consolidated risk management. Consolidated risk traditionally taken a more segmented management—sometimes also called integrated or approach to risk measurement and control. enterprisewide risk management—can have many specific meanings, but in general it refers to a coordinated process for • The cost of integrating information across measuring and managing risk on a firmwide basis. Interest in business lines and the existence of regulatory consolidated risk management has arisen for a variety of barriers to moving capital and liquidity within reasons. Advances in information technology and financial a financial organization appear to have engineering have made it possible to quantify risks more discouraged firms from adopting consolidated precisely. The wave of mergers—both in the United States and risk management. overseas—has resulted in significant consolidation in the financial services industry as well as in larger, more complex financial institutions. The recently enacted Gramm-Leach- • In addition, there are substantial conceptual Bliley Act seems likely to heighten interest in consolidated risk and technical challenges to be overcome in management, as the legislation opens the door to combinations developing risk management systems that of financial activities that had previously been prohibited. can assess and quantify different types of risk This article examines the economic rationale for managing across a wide range of business activities. -
The Great Moderation, the Great Panic and the Great Contraction By
“The Great Moderation, the Great Panic and the Great Contraction” Speech given by Charles Bean, Deputy Governor for Monetary Policy and Member of the Monetary Policy Committee, Bank of England Given at the Schumpeter Lecture, Annual Congress of the European Economic Association, Barcelona 25 August 2009 I am grateful for the assistance of Adrian Penalver. The views expressed are those of the author and do not necessarily reflect those of either the Bank of England or the Monetary Policy Committee. 1 All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx Summary Charles Bean, the Bank of England’s Deputy Governor, Monetary Policy, was invited to deliver the Schumpeter lecture at the Annual Congress of the European Economic Association. The Great Moderation, the Great Panic and the Great Contraction, looks back at the causes of the financial crisis and subsequent recession. He argues that much of what went wrong can be analysed using standard economic tools. The Great Moderation was a period of unusually stable macroeconomic activity in advanced economies. This was partly thanks to good luck, including the integration of emerging market countries into the global economy, and partly a dividend from structural economic changes and better policy frameworks. The longer this stability persisted, the more markets became convinced of its permanence and risk premia became extremely low. Real short and long term interest rates were also low due to a combination of loose monetary policy, particularly in the US, and strong savings rates in a number of surplus countries. Low interest rates and low apparent risk created strong incentives for financial institutions to become highly geared. -
The Market's Boom/Bust Cycle
The Market’s Boom/Bust Cycle: Where are we today? Spring 2016 Presented by: Spencer Klein, CFA® - Senior Portfolio Manager IPPFA Regional Seminar – February 2016 STRICTLY PRIVATE AND CONFIDENTIAL 1 Outline A Change of Seasons … to Business Cycles … to Market Cycles … to Booms and Busts Suggestions STRICTLY PRIVATE AND CONFIDENTIAL 2 Early cycles are seasonal • Among the earliest of civilizations, business cycles can be thought to be attributed to the changing of the seasons and yields at harvest time. • Evidence for this can be found in irrigation efforts in agrarian societies of Egypt and China as well as crop rotation techniques pioneered in medieval Europe. STRICTLY PRIVATE AND CONFIDENTIAL 3 … seasons to business cycles • As civilizations matured and expanded, industry and trade advanced. • New products and methods amplified agricultural output. • Banking was not all that sophisticated. • Geographic and localized growth rate differences emerged. STRICTLY PRIVATE AND CONFIDENTIAL 4 … business cycles to market cycles • As commerce and banking became more sophisticated, differences in market could be more easily observed and serve as a base for profits themselves. • Initially, these three cycles reinforced each other. As time progressed, these three cycles would be in and out of phase for a host of reasons and an even wider range of impact. STRICTLY PRIVATE AND CONFIDENTIAL 5 Phases of the Real Business Cycle (RBC) • Expansion, Peak, Contraction, Trough • Q: When do recessions happen? • A: 2 quarterly declines in GDP. Wrong! • “The Committee -
Market Fragmentation
Market Fragmentation By Daniel Chen and Darrell Duffie∗ We model a simple market setting in which fragmentation of trade of the same asset across multiple exchanges improves al- locative efficiency. Fragmentation reduces the inhibiting e↵ect of price-impact avoidance on order submission. Although fragmenta- tion reduces market depth on each exchange, it also isolates cross- exchange price impacts, leading to more aggressive overall order submission and better rebalancing of unwanted positions across traders. Fragmentation also has implications for the extent to which prices reveal traders’ private information. While a given exchange price is less informative in more fragmented markets, all exchange prices taken together are more informative. JEL: G14, D47, D82 Keywords: market fragmentation, price impact, allocative effi- ciency, price discovery In modern financial markets, many financial instruments trade simultaneously on multiple exchanges (Eric Budish, Robin Lee and John Shim, 2019; Carole Gresse, 2012; Emiliano Pagnotta and Thomas Philippon, 2018). This fragmenta- tion of trade across venues raises concerns over market depth. One might therefore anticipate that fragmentation worsens allocative efficiency through the strategic avoidance of price impact, which inhibits beneficial gains from trade (Vayanos, 1999; Du and Zhu, 2017). Fragmentation might seemingly, therefore, lead to less aggressive trade, which could in turn impair the informativeness of prices, relative to a centralized market in which all trade flows are consolidated. Perhaps sur- prisingly, we o↵er a simple model of how fragmentation of trade across multiple exchanges, despite reducing market depth, actually improves allocative efficiency and price informativeness. In the equilibrium of our market setting, the option to split orders across dif- ferent exchanges reduces the inhibiting e↵ect of price-impact avoidance on total order submission. -
Financial Risk Management Insights CGI & Aalto University Collaboration
Financial Risk Management Insights CGI & Aalto University Collaboration Financial Risk Management Insights - CGI & Aalto University Collaboration ABSTRACT As worldwide economy is facing far-reaching impacts aggravated by the global COVID-19 pandemic, the financial industry faces challenges that exceeds anything we have seen before. Record unemployment and the likelihood of increasing loan defaults have put significant pressure on financial institutions to rethink their lending programs and practices. The good news is that financial sector has always adapted to new ways of working. Amidst the pandemic crisis, CGI decided to collaborate with Aalto University in looking for ways to challenge conventional ideas and coming up with new, innovative approaches and solutions. During the summer of 2020, Digital Business Master Class (DBMC) students at Aalto University researched the applicability and benefits of new technologies to develop financial institutions’ risk management. The graduate-level students with mix of nationalities and areas of expertise examined the challenge from multiple perspectives and through business design methods in cooperation with CGI. The goal was to present concept level ideas and preliminary models on how to predict and manage financial risks more effectively and real-time. As a result, two DBMC student teams delivered reports outlining the opportunities of emerging technologies for financial institutions’ risk assessments beyond traditional financial risk management. 2 CONTENTS Introduction 4 Background 5 Concept -
Systemic Moral Hazard Beneath the Financial Crisis
Seton Hall University eRepository @ Seton Hall Law School Student Scholarship Seton Hall Law 5-1-2014 Systemic Moral Hazard Beneath The inF ancial Crisis Xiaoming Duan Follow this and additional works at: https://scholarship.shu.edu/student_scholarship Recommended Citation Duan, Xiaoming, "Systemic Moral Hazard Beneath The inF ancial Crisis" (2014). Law School Student Scholarship. 460. https://scholarship.shu.edu/student_scholarship/460 The financial crisis in 2008 is the greatest economic recession since the "Great Depression of the 1930s." The federal government has pumped $700 billion dollars into the financial market to save the biggest banks from collapsing. 1 Five years after the event, stock markets are hitting new highs and well-healed.2 Investors are cheering for the recovery of the United States economy.3 It is important to investigate the root causes of this failure of the capital markets. Many have observed that the sudden collapse of the United States housing market and the increasing number of unqualified subprime mortgages are the main cause of this economic failure. 4 Regulatory responses and reforms were requested right after the crisis occurred, as in previous market upheavals where we asked ourselves how better regulation could have stopped the market catastrophe and prevented the next one. 5 I argue that there is an inherent and systematic moral hazard in our financial systems, where excessive risk-taking has been consistently allowed and even to some extent incentivized. Until these moral hazards are eradicated or cured, our financial system will always face the risk of another financial crisis. 6 In this essay, I will discuss two systematic moral hazards, namely the incentive to take excessive risk and the incentive to underestimate risk.