measuring the financial sophistication of households many households invest in ways that are hard to reconcile with standard financial theory and that have been labelled as investment mistakes campbell 2006 calvet campbell and sodini henceforth ccs 2007 there is increasing interest among household finance research ers in the concept of financial sophistication defined as the ability of a household to avoid making such mistakes a growing empirical lit erature documents a cross sectional correlation between household characteristics and invest ment mistakes richer better educated house holds tend to be better diversified marshall blume and irwin friend 1975 ccs 2007 william goetzmann and alok kumar 2008 annette vissing jorgensen 2003 display less inertia julie agnew pierluigi balduzzi and annika sunden 2003 yannis bilias dimitris georgarakos and michael haliassos 2008 campbell 2006 ccs 2009 vissing jorgensen 2002 and have a weaker disposition to hold losing and sell winning stocks ccs 2009 ravi dhar and ning zhu 2006 than other house holds one feature of these earlier papers is that mistakes are investigated one at a time often

comparative equilibrium versus comparative statics two approaches are often used to analyse the effects of uncertainty upon individual decision making the comparative equilibrium approach compares an uncertain model with a certainty model usually with the random variable replaced by its mean the comparative statics approach introduces more uncertainty into an already uncertain model and considers the effects upon optimal decisions this paper demonstrates that these two approaches are qualitatively equivalent for the class of models where uncertainty is completely exogenous to the decision maker when individual decisions affect this uncertainty the two analyses are generally qualitatively different an example of each type of model is presented followed by a general analysis

productivity convergence in the european regions 1980 2003 a sectoral and spatial approach this article analyses the evolution of the eu productivity between 1980 and 2003 both across regions and sectors by making use of various techniques cross section nonparametric and spatial approaches it concludes that 1 the regional and sectoral dispersion of productivity is quite high 2 the gains experienced in aggregate productivity are due entirely to the sectors productivity growth effect 3 there is a weak beta convergence process at the aggregate and sectoral levels 4 the accounting decomposition of the aggregate productivity convergence process reveals the sectoral productivity growth effect to be the only responsible factor for regional catching up 5 finally there are clear signs of spatial dependence which when properly addressed increase the speed of convergence at the aggregate level

product market imperfections and loan commitments i show in a model of competitive banks that the characteristics of loan contracts are affected by product market imperfections in the borrower s industry a bank loan commitment increases the value of a borrower firm operating in an imperfectly competitive industry and thus dominates a simple loan even in the absence of risk sharing considerations and informational asymmetries between the borrower and the bank while it is individually rational for a firm to obtain a loan commitment all the firms in that industry taken together are made worse off by the existence of loan commitments a loan commitment is a contract guaranteeing future availability of credit to a borrower at a prespecified fixed or stochastic interest rate although bank loan commitments are an important financial instrument and there exists an extensive literature analyzing them the rationale for their existence is still a matter of research this paper provides an explanation for the existence of bank loan commitments to borrowers from industries in which there is imperfect competition in the product market it is shown that in such industries the option to acquire financing at predetermined rates enhances the borrower s strategic power and thus creates value for the individual borrower consider an industry with imperfect competition where firms face the problem of noncooperatively exploiting a product market opportunity the optimal product market strategy of a firm depends on the output of its rivals a firm with access to resources at a lower marginal cost than its competitors has a strategic advantage that it can exploit to gain a larger market share and profits it is shown here that a firm that does not have such a strategic advantage can create it by purchasing for a fixed initial fee an option to acquire a factor of production such as financing at favorable terms specifically by initially negotiating a bank loan commitment the firm can finance an expansion of output to meet a strategic contingency at more favorable terms than would be possible if the expansion had to be financed in the spot market the ability to exercise the commitment enables the firm to threaten its rivals strategically and moves the industry to an equilibrium more favorable to that firm thus creating value for the borrower it is shown below that it is optimal for all firms to acquire bank loan commitments altering the industry equilibrium in the process

a small monetary system for the euro area based on german data previous euro area money demand studies have used aggregated national time series data from the countries participating in the european monetary union emu however aggregation may be problematic because macroeconomic convergence processes have taken place in the countries of interest therefore in this study quarterly german data until 1998 are combined with data from the euro area from 1999 until 2002 and these series are used for fitting a small vector error correction model for the monetary sector of the emu a stable long run money demand relation is found for the full sample period moreover impulse responses do not change much when the sample period is extended by the emu period provided the break in the extended data series is captured by a simple dummy variable copyright 2006 john wiley sons ltd

debt in industry equilibrium this article shows 1 how entry and exit of firms in a competitive industry affect the valuation of securities and optimal capital structure and 2 how given a trade off between tax advantages and agency costs a firm will optimally adjust its leverage level after it is set up we derive simple pricing expressions for corporate debt in which the price elasticity of demand for industry output plays a crucial role when a firm optimally adjusts its leverage over time we show that total firm value comprises the value of discounted cash flows assuming fixed capital structure plus a continuum of options for marginal increases in debt article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

how does industry affect firm financial structure we examine the importance of industry to firm level financial and real decisions we find that in addition to standard industry fixed effects financial structure also depends on a firm s position within its industry in competitive industries a firm s financial leverage depends on its natural hedge its proximity to the median industry capital labor ratio the actions of other firms in the industry and its status as entrant incumbent or exiting firm financial leverage is higher and less dispersed in concentrated industries where strategic debt interactions are also stronger but a firm s natural hedge is not significant our results show that financial structure technology and risk are jointly determined within industries these findings are consistent with recent industry equilibrium models of financial structure copyright 2005 oxford university press

household risk management and optimal mortgage choice the portfolio of the typical american household is quite unlike the diversie ed portfolio of liquid assets discussed in e nance textbooks the major asset in the portfolio is a house a relatively illiquid asset with an uncertain capital value the value of the house generally exceeds the net worth of the household which e nances its homeownership through a mortgage contract to create a leveraged position in residential real estate other e nancial assets and liabilities are typically far less important than the house and its associated mortgage contract the importance of housing in household wealth is illustrated in figure i this e gure plots the fraction of household assets in housing and in equities against the wealth percentile of the household poor households appear at the left of the e gure and wealthy households at the right data come from the 1989 and 1998 survey of consumer finances the e gure shows that middle class american families from roughly the fortieth to the eightieth percentile of the wealth distribution have more than half their assets in the form of housing even after the expansion of equity ownership during the 1990s equities are of negligible importance for these households 1

on the firm s production capital structure and demand for debt some economists have ignored corporate financing decisions on the assumption that they do not affect the investment and production decisions of firms yet even if this extreme position is accepted firms must still make financing decisions which in turn have impacts on other sectors of the economy since interest payments on corporate debt are tax deductible the reliance of firms on debt as opposed to equity financing directly affects the revenue the federal government collects through taxation of corporate profits the corporate presence in bond markets and corporate borrowing from banks can be expected to affect both interest rates and the demand for money thus any large macro model must somehow account for the borrowing behavior of firms yet in assessing this portion of the 1965 brookings quarterly econometric model of the united states de leeuw 1965 p 506 writes that the regressions for business borrowing are the least successful of the model in this paper we derive an equation for the long term debt ratio capital structure of a firm which can be estimated using available data unlike some recent qualitative studies on the aggregate corporate debt ratio as related to inflation and taxation over time our primary aim is to explain differences in the debt behavior among individual firms tobit estimation results explicitly allowing for the fact that some firms have no long term debt are presented for both u s and japanese firms our theoretical model implies that the long term debt ratio which maximizes the present value of the existing stockholder s equity depends positively on the cost of equity and negatively on the cost of debt capital productivity and retained earnings our estimation results are generally in agreement with these expectations in particular we find that capital productivity which has not been included as an explanatory variable in most previous studies 2 and the cost of equity capital are both important determinants of the firm s capital structure our empirical results also support the view put forward by komiya3 that debt ratios for japanese firms are higher than those for u s firms in part because the cost of equity has been historically higher in japan than in the united states in relation to the cost of debt other important attempts to explain the debt ratio as a behavioral function of the price of debt and other variables include the studies of de leeuw 1965 and goldfeld 1969 4 certain conceptual problems mar these studies however short term and long term debt are not distinguished despite the fact that long term debt is usually used to finance capital spending while short term debt is used to finance inventory and

bankruptcy risk and optimal capital structure this study finds shortcomings in empirical tests of the capital structure irrelevance hypothesis the alternative hypothesis is that firms choose value maximizing mixes of debt and equity on account of bankruptcy costs and the tax deductibility of interest payments based upon the cross sectional implications of the tax shelter bankruptcy cost hypothesis an alternative test of the irrelevance hypothesis is performed the test examines the relationship between failure rates and leverage ratios for 36 lines of business the results are inconsistent with the irrelevance hypothesis in their landmark paper modigliani and miller 26 demonstrate that under certain assumptions the market value of a firm is independent of its capital structure these assumptions include the absence of taxes transactions costs and bankruptcy costs recently miller 24 has argued that the introduction of corporate and personal taxes does not alter the capital structure irrelevance result in the absence of bankruptcy costs 1 the inclusion of bankruptcy costs generally considered in conjunction with the tax deductibility of interest payments has led others to conclude that capital structure will affect the value of the firm 2 in this case value maximizing firms may choose optimal capital structures consisting of both debt and equity there have been numerous attempts to discriminate empirically between the miller irrelevance mi hypothesis and the tax shelter bankruptcy cost ts bc hypothesis several are discussed in section i of this paper there it is argued that studies attempting to measure directly the effect of changes in capital structure on firm values are subject to serious complications and are unable to discriminate between the mi and ts bc hypotheses other studies focus on cross sectional implications of the mi and ts bc hypotheses the cross sectional tests are based on the assertion that bankruptcy costs may tend to induce firms with greater business risk to include less debt in their capital structures whereas the mi hypothesis does not predict such a relationship unfortunately the existence of positive bankruptcy costs is not sufficient to ensure that the ts bc hypothesis will predict the inverse relation

early marketing matters a time varying parameter approach to persistence modeling are persistent marketing effects most likely to appear right after the introduction of a product the authors give an affirmative answer to this question by developing a model that explicitly reports how persistent and transient marketing effects evolve over time the proposed model provides managers with a valuable tool to evaluate their allocation of marketing expenditures over time an application of the model to many pharmaceutical products estimated through exact initial kalman filtering indicates that both persistent and transient effects occur predominantly immediately after a brand s introduction subsequently the size of the effects declines the authors theoretically and empirically compare their methodology with methodology based on unit root testing and demonstrate that the need for unit root tests creates difficulties in applying conventional persistence modeling the authors recommend that marketing models should either accommodate persistent effects that change over time or be applied to mature brands or limited time windows only

micro economic applications of marginal changes in risk abstract extending a recent definition we propose a theorem on the impact of marginal changes in risk on the optimal decision of a risk averse individual several micro economic applications are then provided

determinants of capital structure evidence from a major developing economy a major shortcoming of capital structure studies on developing economies is that they generally restrict their analyses to large publicly traded manufacturing firms consequently we know little about the applicability of various capital structure theories to firms that are private small and or outside the manufacturing industry in these economies in this paper we conduct a comparative test of the trade off and pecking order theories using a comprehensive firm level dataset that covers manufacturing non manufacturing small large publicly traded and private firms in a major developing economy turkey the trade off theory provides a better description of the capital structures of all firm types than the pecking order theory moreover the trade off theory appears to be particularly suitable for understanding the financing choices of large private firms in the non manufacturing sector and when the economic environment is relatively stable by contrast pecking order theory is most useful when it comes to small publicly traded manufacturing firms especially when the economic environment is relatively unstable

comparative statics of changes in risk on monotonically and partially responsive kinked payoffs abstract this paper derives two sets of necessary and sufficient conditions on the comparative statics of changes in risk under kinked payoff functions that are monotonically responsive and partially responsive to the realization of risk respectively the former case includes the newsboy problem with backorder the latter case includes the newsboy problem without backorder and under some restrictions also includes the optimal deductible insurance problem some relatively non restrictive conditions derived from the necessary and sufficient conditions reveal that the three problems can be quite different even though they are often viewed in the literature as being congruous these conditions lead to simple predictions of the direction of change in any risk averse agent s optimal choice upon a change in risk without assuming specific functional forms for the utility function

perquisites risk and capital structure in a corporate agency problem perquisites and risk interact to produce novel complex comparative statics for example even if additional debt induces risk neutral insiders to increase risk they never seek to increase the market value of their stock instead insiders decrease the present value of their subsequent conditionally optimal perquisites also the firm s optimal capital structure includes a risky bond with an agreement to remove insiders whenever the bond defaults however the optimal sharing rule between corporate claimants cannot be supported solely by standard securities such as bonds stocks options and their hybrids

asset redeployability liquidation value and endogenous capital structure heterogeneity firms with lower leverage are not only less likely to experience financial distress but are also better positioned to acquire assets from other distressed firms with endogenous asset sales and values each firm s debt choice then depends on the choices of its industry peers with indivisible assets otherwise identical firms may adopt different debt policies with some choosing highly levered operations to take advantage of ongoing debt benefits and others choosing more conservative policies to wait for acquisition opportunities our key empirical implication is that the acquisition channel can induce firms to reduce debt when assets become more redeployable

human capital bankruptcy and capital structure we derive a firm s optimal capital structure and managerial compensation contract when employees are averse to bearing their own human capital risk while equity holders can diversify this risk away in the presence of corporate taxes our model delivers optimal debt levels consistent with those observed in practice it also makes a number of predictions for the cross sectional distribution of firm leverage consistent with existing empirical evidence it implies persistent idiosyncratic dierences in leverage across firms an important new empirical prediction of the model is that ceteris paribus firms with more leverage should pay higher wages

financial illiteracy and mortgage refinancing decisions we analyze the effect of an exogenous shock to the italian mortgage market where a reform has abolished prepayment fees and simplified mortgage refinancing making it a virtually cost free decision for households this law along with the considerable drop in market interest rates has generated important gains for fixed rate borrowers which we quantify at up to 15 of the principal balance nevertheless only about 13 of borrowers have locked in this opportunity we study the relationship between this sluggish behavior and their level of financial literacy

learning about and exploiting exhaustible resource deposits of uncertain size the kemp loury model of a single uncertain deposit is cast in an n state framework and optimal programs characterized robson s problem of arranging the optimal sequence of uncertain deposits is recast and a market failure involving the jointness of learning about deposit size and gaining revenue from extracted ore is isolated the value of learning by preliminary extraction is characterized and extensions to the problem of arranging optimal sequences are noted this abstract was borrowed from another version of this item

productivity across industries and countries time series theory and evidence the authors examine whether convergence in aggregate productivity is also occurring at the industry level in fourteen oecd countries from 1970 to 1987 using both cross section and time series methods they find convergence in some sectors such as services however surprisingly the authors find that convergence does not hold for the manufacturing sector decomposing aggregate convergence into industry productivity gains and changing sectoral shares of output they find the service sector to be responsible for the bulk of cross country convergence to the united states the authors develop a new result on the asymptotic normality of panel unit root estimators to formally test within sector convergence copyright 1996 by mit press

the risk averse and prudent newsboy the effects of risk and risk aversion in the single period inventory newsboy problem are examined comparative static effects of changes in the various price and cost parameters are determined and related to the newsboy s risk aversion the addition of a random background wealth and of an increase in the riskiness of newspaper demand are also examined although many of the comparative effects generally are ambiguous some fairly simple restrictions on preferences and or risk increases are shown to lead to qualitatively deterministic results

preference for output price uncertainty by the non renewable resource extracting firm abstract we establish a general preference for price uncertainty by the price taking risk neutral non renewable resource extracting firm with orthodox convex extraction costs we prove that the relevant value function for profits over an interval is convex in output price

agro industrial processing and agricultural pricing under uncertainty processing domestically available materials for export has intuitive appeal e g if transport costs are reduced uncertainty in the supply of the raw material can be a crucial factor the theoretical model of this paper shows how to choose the optimal processing capacity and relatedly the optimal price to pay producers of the input issues include decision makers preferences sources and nature of uncertainty availability of inputs to produce the raw material and technology and costs of processing econometric estimates of the climate yield relation are used to simulate these decisions for the case of senegalese groundnut processing there is an intuitive appeal to industrial strategies based on processing domestically available raw materials for export for instance relative to export of the raw material for processing abroad domestic processing often achieves cost savings based on certain locational advantages such as the opportunity to decrease the product s weight prior to transport in this paper i analyse the costs and benefits of investing in processing capacity under particular conditions and the related question of the appropriate domestic pricing of the raw material the second part of the paper presents an application of the theory to senegalese groundnut culture and processing especially for agricultural inputs the domestic supply of the raw material is likely to be uncertain this uncertainty interacts with locational advantages in important ways affecting both the optimal choice of agro industrial processing capacity and the optimal choice of the price to be offered agricultural producers of the input from the viewpoint of the processing mills the locational advantage means that stochastically low availability of the raw material cannot be fully compensated by imports thus the problem of idle processing capacity arises similarly harvests of the input above the level that can be processed imply some loss of the locational advantages assuming that the input cannot be stored costlessly to illustrate these basic notions consider the simplest case of a single input with a given world price pj transformed at a constant unit cost r into an output with a given world price p let the size of the crop also be certain say of magnitude m so long as p pi r optimal processing capacity is m now consider a situation of uncertainty with two equiprobable states of nature faced

real convergence in europe how robust are econometric inferences the paper examines the convergence properties of productivity in fifteen european countries over the period 1960 1997 european productivity is estimated using modified translog production systems with a completely general intertemporal structure to capture the notion that trade may have an influence on aggregate convergence imports are included in the production function stationarity tests are used to test for convergence around a common long run trend including unit root tests the kpss and bayesian tests as well as testing based on fractional differencing parameter estimation for long memory models it is found that convergence inferences are sensitive to the type of test employed

the effect of capital structure on a firm s liquidation decision abstract a firm s liquidation can impose costs on its customers workers and suppliers an agency relationship between these individuals and the firm exists in that the liquidation decision controlled by the firm as the agent affects other individuals the customers workers and suppliers as principals the analysis in this paper suggests that capital structure can control the incentive conflict problem of this relationship by serving as a pre positioning or bonding mechanism appropriate selection of capital structure assures that incentives are aligned so that the firm implements the ex ante value maximizing liquidation policy

real flexibility and financial structure an empirical analysis i examine the empirical relation between real flexibility and financial structure i test whether real flexibility increases debt capacity by lowering default risk and making assets more marketable or decreases debt capacity by facilitating risk shifting and asset substitution i measure real flexibility as the sensitivity of marginal production and investment decisions to variations in the economic environment i find that financial leverage is negatively related to production flexibility but positively related to investment flexibility this split in results suggests that although asset substitution facilitated by investment flexibility can be prevented contractually risk shifting facilitated by production flexibility is intractable copyright 2003 oxford university press

dueling policies why systemic risk taxation can fail abstract two policy instruments for the banking sector are investigated namely systemic risk taxation and constructive ambiguity about bailout policy bailout expectations can induce moral hazard in the form of excessive risk taking by banks systemic risk taxation induces banks to prefer uncorrelated investments leading to lower systemic risk formation constructive ambiguity generates uncertainty about bailout prospects however systemic risk taxation also may inform banks about the regulator s concern for financial stability and thereby its bailout policy this result leads to a trade off between systemic risk taxation and constructive ambiguity and highlights the need to consider interdependence across policies when evaluating their effectiveness

the genetics of investment biases abstract for a long list of investment biases including lack of diversification excessive trading and the disposition effect we find that genetic differences explain up to 45 of the remaining variation across individual investors after controlling for observable individual characteristics the evidence is consistent with a view that investment biases are manifestations of innate and evolutionary ancient features of human behavior we find that work experience with finance reduces genetic predispositions to investment biases finally we find that even genetically identical investors who grew up in the same family environment often differ substantially in their investment behaviors due to individual specific experiences or events

a model of mortgage default in this paper we solve a dynamic model of households mortgage decisions incorporating labor income house price inflation and interest rate risk using a zero profit condition for mortgage lenders we solve for equilibrium mortgage rates given borrower characteristics and optimal decisions the model quantifies the effects of adjustable versus fixed mortgage rates loan to value ratios and mortgage affordability measures on mortgage premia and default mortgage selection by heterogeneous borrowers helps explain the higher default rates on adjustable rate mortgages during the recent u s housing downturn and the variation in mortgage premia with the level of interest rates

increases in risk and deductible insurance abstract this paper examines how mean preserving transformations in the loss distribution affect the optimal level of deductibility in an insurance contract if marginal utility is convex increases in risk affecting losses only below the deductible are shown to lead to a reduction in coverage higher deductible which can be viewed as an increase in precautionary savings on the other hand a transformation that spreads losses more towards the tails of the distribution leads to an increase in coverage lower deductible whenever preferences exhibit nonincreasing absolute risk aversion

planning and financial literacy how do women fare many older us households have done little or no planning for retirement and there is a substantial population that seems to undersave for retirement of particular concern is the relative position of older women who are more vulnerable to old age poverty due to their longer longevity this paper uses data from a special module we devised on planning and financial literacy in the 2004 health and retirement study it shows that women display much lower levels of financial literacy than the older population as a whole in addition women who are less financially literate are also less likely to plan for retirement and be successful planners these findings have important implications for policy and for programs aimed at fostering financial security at older ages

on the existence of an optimal capital structure theory and evidence one of the most contentious issues in the theory of finance during the past quarter century has been the theory of capital structure the geneses of this controversy were the seminal contributions by modigliani and miller 18 19 the general academic view by the mid 1970s although not a consensus was that the optimal capital structure involves balancing the tax advantage of debt against the present value of bankruptcy costs no sooner did this general view become prevalent in the profession than miller 16 presented a new challenge by showing that under certain conditions the tax advantage of debt financing at the firm level is exactly offset by the tax disadvantage of debt at the personal level since then there has developed a burgeoning theoretical literature attempting to reconcile miller s model with the balancing theory of optimal capital structure e g deangelo and masulis 5 kim 12 and modigliani 17 the general result of this work is that if there are significant leverage related costs such as bankruptcy costs agency costs of debt and loss of non debt tax shields and if the income from equity is untaxed then the marginal bondholder s tax rate will be less than the corporate rate and there will be a positive net tax advantage to corporate debt financing the firm s optimal capital structure will involve the trade off between the tax advantage of debt and various leverage related costs the upshot of these extensions of miller s model is the recognition that the existence of an optimal capital structure is essentially an empirical issue as to whether or not the various leverage related costs are economically significant enough to influence the costs of corporate borrowing the miller model and its theoretical extensions have inspired several timeseries studies which provide evidence on the existence of leverage related costs trczinka 28 reports that from examining differences in average yields between taxable corporate bonds and tax exempt municipal bonds one cannot reject the miller hypothesis that the marginal bondholder s tax rate is not different from the corporate tax rate however trczinka is careful to point out that this finding does not necessarily imply that there is no tax advantage of corporate debt if the personal tax rate on equity is positive indeed buser and hess 1 using a longer time series of data and more sophisticated econometric techniques estimate that the average effective personal tax rate on equity is statistically positive and is not of a trivial magnitude more importantly they document evidence that is consistent with the existence of significant leverage related costs in the economy

capital structure and interaction among firms in output markets theory and evidence i develop a simple model that examines the relations between the extent of competitive interaction among firms in output markets their capital structures and the aggressiveness of their operating strategies a firm s optimal leverage is related to the degree to which its operating strategy affects its rivals value functions and resulting optimal output market choices this relation is positive regardless of whether the competition in output markets is in strategic substitutes or in strategic complements i test the model s prediction using two proxies for the extent of competitive interaction among firms the empirical evidence provides support for the model

on the strategic role of high leverage in entry deterrence abstract this paper examines the strategic role of high levels of debt and bankruptcy threats in deterring entry into monopolistic markets in the context of an infinite horizon entry game we show that if a potential entrant has access to debt financing with limited liability the unique sub game perfect equilibrium involves the entrant successfully issuing a high level of debt entering the market and being met with cooperation if in addition to the entrant the incumbent also has access to debt with limited liability it will be highly levered and will completely pre empt any entry in equilibrium finally if the incumbent faces a variety of potential entrants with differing abilities to capture market shares its optimal capital structure will help pre empt the entry of the tougher entrants while allowing the weaker ones to share the market the results of extreme leverage are also shown to hold in an alternative formulation analyzed by kreps and wilson 1982 and milgrom and roberts 1982 and thus are robust to model specifications the empirical implications and possible application to high leverage industries are briefly discussed

financial literacy and consumer credit portfolios we use survey data from a sample of uk households to analyse the relation ship between financialliteracy and consumer credit portfolios we show that individ uals who borrow on consumer credit exhibit worse financial literacy than those who do not borrowers with poor financialliteracy hold higher shares of high cost credit such as home collected credit mail order catalogue debt and payday loans than those with higher literacy we also show that individuals with poor financialliteracy are more likely to lack confidence when interpreting credit terms and to exhibit confusion over financialconcepts they are also less likely to engage in behaviour which might help them to improve their awareness of the credit market

financial literacy and its consequences evidence from russia during the financial crisis the ability of consumers to make informed financial decisions improves their ability to develop sound personal finance this paper uses a panel data set from russia an economy in which household debt has grown at an astounding rate to examine the importance of financial literacy and its effects on behavior the paper studies both the financial and real consequences of financial illiteracy even though consumer borrowing increased very rapidly in russia only 41 of respondents demonstrate an understanding of interest compounding and only 46 can answer a simple question about inflation financial literacy is positively related to participation in financial markets and negatively related to the use of informal sources of borrowing moreover individuals with higher financial literacy are significantly less likely to report experiencing a negative income shock during 2009 and have greater availability of unspent income and higher spending capacity the relationship between financial literacy and availability of unspent income is higher in 2009 suggesting that financial literacy may better equip individuals to deal with macroeconomic shocks

the economic importance of financial literacy theory and evidence this paper undertakes an assessment of a rapidly growing body of economic research on financial literacy we start with an overview of theoretical research which casts financial knowledge as a form of investment in human capital endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population next we draw on recent surveys to establish how much or how little people know and identify the least financially savvy population subgroups this is followed by an examination of the impact of financial literacy on economic decision making in the united states and elsewhere while the literature is still young conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps a final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy jel a20 d14 g11 i20 j26

debt agency costs and industry equilibrium we show that risk characteristics of projects cash flows are endogenously determined by the investment decisions of all firms in an industry as a result in reasonable settings financial structures which create incentives to expropriate debtholders by increasing risk are shown not to reduce value in an industry equilibrium without taxes capital structure is irrelevant for individual firms despite its effect on the equityholders incentives but the maximum total amount of debt in the industry is determinate allowing for a corporate tax advantage of debt capital structure becomes relevant but firms are indifferent between distinct alternative debt levels the effect of firms financial structures on subsequent investment and output decisions has recently received considerable attention in the finance literature the central insight that equityholders control the firm s investment and production decisions and in general do not maximize the value of a levered firm has been applied to the analysis of risk shifting underinvestment and firms abilities to enter into optimal contracts with their customers existing models of firms financial structures and their effect on investment decisions are generally based on a single firm framework and do not take into account the relationship between project cash flows and the investment decisions of all firms in the industry 2 in this paper we allow the distribution of investment projects within an industry to adjust and show that this generates new insights and reverses several key results of single firm agency cost models the new predictions conform with well documented

financial constraints competition and hedging in industry equilibrium we analyze the hedging decisions of firms within an equilibrium setting that allows us to examine how a firm s hedging choice depends on the hedging choices of its competitors within this equilibrium some firms hedge while others do not even though all firms are ex ante identical the fraction of firms that hedge depends on industry characteristics such as the number of firms in the industry the elasticity of demand and the convexity of production costs consistent with prior empirical findings the model predicts that there is more heterogeneity in the decision to hedge in the most competitive industries

baby boomer retirement security the roles of planning financial literacy and housing wealth abstract we compare wealth holdings across two cohorts of the health and retirement study the early baby boomers in 2004 and individuals in the same age group in 1992 levels and patterns of total net worth have changed relatively little over time though boomers rely more on housing equity than their predecessors most important planners in both cohorts arrive close to retirement with much higher wealth levels and display higher financial literacy than non planners instrumental variables estimates show that planning behavior can explain the differences in savings and why some people arrive close to retirement with very little or no wealth

asset substitution and the agencycosts of debt financing agency costs of debt have been advanced in the literature as an important consideration foroptimal corporate debt policies recently there have been some doubts concerning the theoretical foundations of the notion that these costs increase as the firm employs more debt in this paper we examine explicitly the incentive for asset substitution by solving endogenously for the optimal risk policy the results support the notion that more debt aggravates shareholders incentives to take risk we also investigate the marginal agency cost function and discuss conditions for interior optimal capital structure

convergence in the trends and cycles of euro zone income multivariate unobserved components structural time series models are fitted to annual post war observations on real income per capita in countries in the euro zone the aim is to establish stylized facts about convergence as it relates both to long run and short run movements a new model in which convergence components are combined with a common trend and similar cycles is proposed the convergence components are formulated as a second order error correction mechanism this ensures that the extracted components change smoothly thereby enabling them to be separated from transitory cycles copyright 2005 john wiley sons ltd

strategic differentiation and strategic emulation in games with uncertainty when players who choose a common strategy face a common shock while players who choose different strategies face independent or imperfectly correlated shocks equilibrium choices exhibit differentiation respectively emulation when the sign of the cross partial derivative of the firms profit functions with respect to the realizations of the uncertain variables is negative respectively positive i consider a variety of applications including technology choice brand investments and r d races many of which can be characterized as two stage games in such games i demonstrate that differentiation is more likely to occur when the second stage game is a game of strategic substitutes

the value of the tax subsidy on risky debt the effect of corporate taxes on the market value of a levered firm continues to be a central issue in recent contributions in finance theory e g miller 1977 deangelo and masulis 1980 kim 1982 modigliani 1982 in these and other studies e g krause and litzenberger 1973 scott 1976 brennan and schwartz 1978 kim 1978 the relationship between market value and capital structure is established by formulating a tax subsidy function that specifies the partial effect of debt on the expected tax savings at the corporate level under the existing u s tax code a working assumption in most of these studies is that both principal and interest are tax deductible this assumption is made in the spirit of the original modigliani and miller 1963 formulation in which debt is taken to be perpetual and riskless indeed it is well known that the tax shield provided by the deduction of principal in a singleperiod framework has the same value as the tax shield from interest deductions in the case of perpetual and riskless debt under this assumption it is shown that in the absence of non debtthis paper examines the relationship between leverage and the value of the firm when non debt related tax shields are available and the corporate tax is levied as an income tax in a previous paper de angelo and masulis argue that in the presence of nondebt related tax shields the relationship between debt and firm value is concave resulting in an interior optimal capital structure when there is a tax induced differential in the cost of corporate debt their result derives from the fact that they assume the payment of debt principal and non debt related depreciation charges are deductible however the former deduction is consistent with a wealth tax while the latter is consistent only with an income tax we show that if the interest alone is deductible the debt firm value function is convex resulting in corner solutions to the capital structure problem the authors wish to thank richard castanias richard green lemma senbet and especially an anonymous referee for helpful comments and richard green and robert dammon for computational assistance

energy price uncertainty and optimal factor intensity a mean variance analysis the dramatic increase in energy prices in the 1970s has stimulated interest in the effect of energy prices on the demands for various factors of production in analyzing the choice of energy using characteristics of capital it is important to recognize that a firm s energy capital ratio is much more flexible prior to undertaking a capital investment than it is after the capital is put in place in this paper we examine factor intensity choices in a stochastic putty clay model ex ante when the firm is making investment decisions the price of energy is unknown the energy capital ratio is flexible ex ante and the firm chooses the optimal energy intensity based on the probability distribution of energy prices ex post the energy capital ratio is fixed and the price of energy is known the firm cannot adjust the energy capital ratio but can choose not to use its capital if the realized price of energy is too high 2 recently kon 3 has studied factor demands in a stochastic putty clay model in which the price of output is random and the prices of factors of production are known with certainty in this paper we focus on the effects of energy prices and thus treat factor prices as random and the output price as known with certainty this difference in the source of randomness appears to make little difference in the comparison of optimal factor intensity under certainty and under uncertainty indeed proposition 1 in this paper corresponds to kon s proposition 1 in this paper we then go on to examine the effects on optimal factor intensity of changes in the mean and variance of the price of energy 3 the option to shut down during unfavorable price regimes plays an important role in our analysis in section 1 we develop a stochastic putty clay model and compare a risk neutral firm s behavior under certainty and uncertainty the effects on energy intensity of changes in the mean and variance of energy prices are analyzed in section 2

labour supply under uncertainty with piecewise linear tax regimes the analysis of labour supply under uncertainty has been developing rapidly in recent years papers by block and heineke 1973 stiglitz 1976 cowell 1981a b eaton and rosen 1980a b stern 1980 and tressler and menezes 1980 have all presented analyses of the problem almost without exception the focus of the analysis has been the effects of greater risk in the wage rate or in non labour income on the labour supply decision of the individual not surprisingly therefore the well known comparative static results of rothschild and stiglitz 1971 and diamond and stiglitz 1974 on how increases in risk influence the optimal choice of a control variable have been found to be useful in this literature some of the above mentioned papers have also considered the problem of labour supply under uncertainty when there are taxes in operation thus stiglitz 1976 cowell 1981a b and eaton and rosen 1980a b all analyse the role of taxation however none of these papers has examined labour supply under uncertainty with tax regimes of the type we observe in practicewhich are typically piecewise linear 1 moreover in all the studies i am aware of the tax regime itself is held to be constant thus the role of tax risk as opposed to wage risk remains unanalysed the object of this paper therefore is to advance the literature on labour supply under uncertainty in these two directions first we ask the more common question about the impact of greater risk on labour supply but this time in the context of piecewise linear tax regimes it will be seen that the answers now have to be modified in interesting ways in particular it will be shown that the problem belongs to a general class of problems in decision making under uncertainty analysed in kanbur 1980 1982 where the pay off function has a kink or non differentiability at a critical value of the random variable in such a setting the rothschild stiglitz 1971 and diamond stiglitz 1974 results are no longer directly applicable we have to use their generalized counterparts developed in kanbur 1981 second we ask a question that has not been asked in the literature up to now what is the impact of greater uncertainty about the tax regime on labour supply decisions it will be seen that the piecewise linear regime allows us to parametrize such tax regime risk in a convenient and manageable way the plan of this paper is as follows section i introduces the model and in the context of the model gives a precise statement of the questions that this paper asks section ii begins the analysis by considering the effects of greater risk in the wage rate and in non labour income sections iii and iv then consider the question of tax regime risk section v concludes the paper

why do so few hold stocks the authors investigate why 75 percent of u s households do not hold stocks despite the equity premium and predictions of expected utility models the question is relevant for privatization asset pricing and tax progressivity issues they show that risk aversion per se heterogeneity of beliefs habit persistence time nonseparability and quantity constraints on borrowing do not account for the phenomenon a wedge between borrowing and lending rates and minimum investment requirements are plausible but empirically weak factors more promising explanations are inertia and departures from expected utility maximization there is also qualified support for nondiversifiable income risk as a contributing factor copyright 1995 by royal economic society

the critical implicit tax rate and capital structure in a miller world firms are indifferent between debt and equity when the tax rate that isimplicitly used to price a bond is equal to the statutory corporate tax rate in this paper we derive the implicit tax rate that makes a firm marginally indifferent between debt and equity when debt related tax savings are uncertain we analyze the functional relationship between this critical tax rate and the amount of debt issued by a firm and discuss the implications for a firm s optimal capital structure

failure to refinance households that fail to refinance their mortgage when interest rates decline can lose out on substantial savings based on a large random sample of outstanding u s mortgages in december of 2010 we estimate that approximately 20 of households for whom refinancing would be optimal and who appeared unconstrained to do so had not taken advantage of the lower rates we estimate the present discounted cost to the median household who fails to refinance to be approximately 11 500

till mortgage do us part mortgage switching costs and household s bank switching abstract we investigate the role of mortgage switching costs in shaping the households decision to change their main bank to this end we use a unique panel dataset that enables us to infer household s bank switching in conjunction with a legal reform that exogenously slashed down the mortgage switching costs the empirical evidence which survives to a variety of robustness checks supports the hypothesis that the explicit switching costs in the retail banking market are a weighty factor in shaping households bank switching despite any potential informational lock in dissecting the results we show that the effects of the reform were not uniform across households the more educated households those with a longer or broader relationship with their previous bank and those residing in ex ante less competitive banking markets were at the forefront of the wave of bank switching

the measurement of firm specific indexes of technical change this paper proposes a methodology for obtaining estimates of firm specific technical change econometrically and contrasts those estimates with a multilateral total factor productivity index based on a panel data set of airlines two measures are contrasted in a variety of ways to the extent that output characteristics differ as in the case of airlines the two measures differ significantly both measures are regressed on a variety of factors potentially influencing technical efficiency confirming that improvements in fuel efficiency and load factor have played major roles with hubbing and competition playing smaller roles in explaining efficiency improvements copyright 1995 by mit press

resolving the agency problems of external capital through options this paper investigates the role of stock options in resolving the agency problems of external capital as originally identified by jensen and meckling 1976 these problems are precipitated by managerial incentives a to consume excessive non pecuniary benefits or perquisites beyond the optimal level for sole ownership and b to engage in risk shifting in productive decisions so as to transfer wealth from external capital contributors these incentive problems can be resolved through a strategy that judiciously combines call and put options retained by the owner manager and external financiers respectively the resolution of the agency problems through this mechanism provides an economic rationale for the existence of managerial stock options and convertible debt the work by jensen and meckling 7 has brought more realism to the theory of the firm in their paper jm address agency problems in the context of a firm which is viewed as a nexus of contracts among various factors of production the contractual relationships involve incentive conflicts arising from the pursuit of self interest by limiting themselves to an entrepreneur or owner manager who retains complete control of the firm jm have demonstrated that financing through the issuance of common stock or debt to outsiders engenders costs these costs are precipitated in part by the manager s propensity to consume nonpecuniary benefits or perquisites perks by employing certain resources in excess of their optimal usage 1 and by his propensity to engage in high risk investment projects so as to transfer wealth from bondholders to stockholders 2

pricing exit and location decisions of firms evidence on the role of debt and operating efficiency abstract we compare pricing and exit decisions of discounters across the business cycle cities containing high debt and or low efficiency firms display higher prices during non recession years during recessions prices increase in cities with less efficient incumbents but decrease in cities with a mix of high and low debt firms high debt firms are more likely to exit cities with lower prices and high debt exiting firms are more likely to be efficient apparently low debt firms strategically lower prices during recessions to force exit of efficient financially constrained rivals weaker competitors face another cost new entrants locate closer

market structure internal capital markets and the boundaries of the firm we study how the creation of an internal capital market an icm can invite strategic responses in product markets that in turn shape firm boundaries icms provide ex post resource flexibility but come with ex ante commitment costs alternatively stand alones possess commitment ability but lack flexibility by creating flexibility integration can sometimes deter a rival s entry but commitment problems can also invite predatory capital raising these forces drive different organizational equilibria depending on the integrator s relation to the product market hybrid organizational forms like strategic alliances can sometimes dominate integration by offering some of its benefits with fewer strategic costs this paper develops a theory of the firm in which internal capital markets affect the ability to compete in product markets in our model a firm s decision to operate an internal capital market affects the fund raising behavior of its product market rivals an internal capital market can either scare away rival firms or else induce them to compete more aggressively raising more capital than they otherwise would in equilibrium these strategic interactions determine the boundaries of the firm

safety in conformity but profits deviance durable plant must often be installed before knowing the future price of the variable inputs with which it will be combined as a result exante identical firms may adopt different production techniques in industry equilibrium strong risk aversion makes this less likely but introduces the possibility of multiple equilibria firms then have an incentive to insulate themselves from competitive risk by opting for the same technology as the rest of the industry with heterogeneous risk preferences it may be the most risk averse firms that opt for production methods intensive in the input with random price

investment incentives debt and warrants abstract this paper models and characterizes investment incentive problems associated with debt financing the decision problem of residual claimants is explicity formulated and their investment policies are characterized the paper also analyzes the use of conversion features and warrants to control distortionary incentives these claims reverse the convex shape of levered equity over the upper range of the firm s earnings and this mitigates the incentive to take risk it is shown that under certain conditions such claims can be constructed to restore net present value maximizing incentives and simultaneously meet the financing requirements of the firm

a theory of banks industry expertise market power and credit risk the author analyzes banks incentives to acquire expertise in judging the creditworthiness of borrowers in an industry with uncertain business conditions the analysis shows that industry expertise enables banks to extract rents proportional to their exposure to industry specific credit risk this exposure is in turn determined by the number of banks aiming to focus on lending to an industry in equilibrium the industry receives funding from a limited number of banks with industry expertise as well as from a competitive fringe of financiers without such expertise the equilibrium yields testable predictions about the concentration of bank lending to an industry and about the correlation between this concentration and the recovery rates default rates and interest rates of bank loans

a rationalization of bonuses penalties and kinked payment functions within an agency model abstract the optimal payment schedule of the simplest principal agent problem can be continuous smooth or kinked or semicontinuous depending on the specifications of objective functions of the principal and or of the agent using the nonsmooth mathematical analysis this article determines a mapping from classes of objective functions into classes of optimal payment functions examples provide illustrations

structural change in the mortgage market and the propensity to refinance we hypothesize that the intrinsic benefit required to trigger a refinancing has become smaller due to a combination of technological regulatory and structural changes that have made mortgage origination more competitive and more efficient and have raised financial awareness of homeowners to test this hypothesis we estimate an empirical hazard model of loan survival for two subperiods using a database that allows us to carefully control for homeowners credit ratings equity loan size and measurable transaction costs our findings strongly confirm that credit ratings and home equity have significant effects on the refinancing probability in addition we provide evidence that homeowners postpone refinancing in the face of increased interest rate volatility consistent with option value theory finally our results support the hypothesis that structural change in the mortgage market has increased homeowners propensity to refinance

regional growth and convergence evidence from the united states tsionas e g 2000 regional growth and convergence evidence from the united states reg studies 34 231 238 the paper considers regional convergence in the us both g and convergence tests indicate that in the period 1977 96 regional incomes do not converge yet kernel density estimates of the distribution show some variation in the tail characteristics of the distribution using finite normal mixtures to examine time invariance of the distribution in a more formal way the paper concludes that the distribution of the logarithms of regional income has indeed shown very little time variation the distribution of income percentages shows some mobility there is a structural break in mixing probabilities mixing means and variances but the mobility is not strong enough to imply a radical change in the co movement patterns of regional means tsionas e g 2000 la croissance et la convergence regionales des preuves provenant des etats unis reg studies 34 231 238 cet article cherche a etudie

optimal mortgage refinancing a closed form solution we derive the first closed form optimal refinancing rule refinance when the current mortgage interest rate falls below the original rate by at least in this formula w is the principal branch of the lambert w function where is the real discount rate is the expected real rate of exogenous mortgage repayment is the standard deviation of the mortgage rate is the ratio of the tax adjusted refinancing cost and the remaining mortgage value and is the marginal tax rate this expression is derived by solving a tractable class of refinancing problems our quantitative results closely match those reported by researchers using numerical methods

a time series approach to g convergence this paper applies time series analysis to study how the gap between a number of countries and the usa evolves through time as other authors it is found that time series analysis provides a better insight into the concept of convergence than the cross sectional one the econometric results show that the stochastic behaviour of the output disparity varies considerably neither the steady state equilibrium nor the speed of convergence are unique and constant across countries and time in general there is catching up for european countries convergence for east and south asian countries and neither of them for latin american countries

investment in financial literacy and saving decisions abstract we present an intertemporal consumption model of investment in financial literacy consumers benefit from such investment because financial literacy allows them to increase the returns on wealth since literacy depreciates over time and has a cost in terms of current consumption the model delivers an optimal investment in literacy furthermore literacy and wealth are determined jointly and are positively correlated over the life cycle the model drives our empirical approach to the analysis of the effect of financial literacy on wealth and saving and indicates that the stock of financial literacy early in life is a valid instrument in the regression of wealth on financial literacy using microeconomic and aggregate data we find strong support for the model s predictions