inducing liquidity in thin financial markets through combined value trading mechanisms asset pricing theory hypothesizes that investors are only interested in portfolios individual securities are evaluated only in terms of their contribution to portfolio risk and return yet standard financial market design is that of parallel unconnected markets whereby investors cannot submit orders in one market conditional on events in others when markets are thin this exposes them to substantial execution risk fear of ending up with unbalanced portfolios after trading may even keep investors from submitting orders further eroding liquidity and the ability of markets to equilibrate the suggested solution is a portfolio trading mechanism referred to as combined value trading cvt investors are allowed to submit orders for packages of securities and the system matches trades and computes prices by optimally combining portfolio orders in an open book we study the performance of the cvt mechanism experimentally and compare it to the performance of parallel unconnected double auctions in experiments with similar parametrization and either a similar number of subjects or substantially thicker markets we present evidence that our portfolio trading mechanism facilitates equilibration to the extent that the thicker markets do inspection of order submission and trade activity reveals that subjects manage to exploit the direct linkages between markets enabled by the cvt system

financial market innovation and security design an introduction abstract the article describes in the context of theory and practice this special issue of the journal of economic theory on financial market innovation and security design the main focus is on security design in incomplete financial markets possibly with asymmetrically informed traders we first survey the general equilibrium literature which emphasizes the spanning role of securities we then provide a unified framework encompassing the literature that employs a cara guassian setting to study the impact of financial innovation on risk sharing and information aggregation journal of economic literature classification numbers g10 d52

optimal innovation of futures contracts this article presents a simple model of the innovation of new futures contracts by transaction volume maximizing futures exchanges in incomplete markets under uncertainty with mean variance preferences and proportional transactions costs we characterize the set of nash equilibria for a number of exchanges simultaneously or sequentially choosing contracts the optimal monopolistic contract design is shown to be pareto optimal an example shows the failure of pareto optimality for aparticularnash equilibrium likewise in a monopolistic multiperiod setting an example shows the failure of pareto optimality given an incentive for the exchange to induce turnover

union nonunion wage differentials in the public administration educational and private sectors 1970 1983 over the past thirty years union membership and bargaining activity in the united states has been declining in the private sector and rising in the public sector the authors use two large micro databases to estimate changes in the union wage premium among public administration education and private sector workers for the decade of the 1970s and early 1980s their empirical analysis indicates that the union relative wage effects continue to be lower in the public sector than in the private sector despite the relative gains in public sector union membership and bargaining activities copyright 1987 by mit press

optimality of incomplete markets abstract in a static exchange economy where the traders initial endowments are risky the optimality of the financial structure is studied when markets are incomplete only financial structures with the same number of assets are compared a market structure is optimal when in a particular economy it yields an allocation of risks which cannot be pareto dominated through the implementation of any other market structure in a linear gaussian setup the optimal market structures are shown to span an eigenspace of a matrix which combines the risk exposures of the participants in the market approximately weighted by a measure of their risk aversions journal of economic literature classification numbers d60 g10

optimal financial market integration and security design 1 we study 2 period pure exchange capital asset pricing model capm economies with incomplete financial markets and restricted participation we characterize the optimal financial market structure and efficient innovations consisting of both the introduction of new assets and the integration of segmented markets welfare gains from innovations are maximal when the endowments of affected agents are negatively correlated uncoordinated innovations lead to efficient market structures if all assets have identical participation structure or the markets being integrated trade identical assets however coordination failure in the introduction of new assets may result when assets have participation structures that overlap only partially

the significance of the market portfolio the market portfolio is in one sense the least important portfolio to provide to investors in an j agent one period stochastic endowment economy where preferences are quadratic a social welfare minded contract designer would never create a contract that would allow trading the market portfolio even the complete set of contracts all j 1 of them which achieve a first best solution never span the market portfolio these conclusions rely on the assumption that the contract designer has perfect information about agents utilities we also show that as the contract designer s information about agents utilities becomes more imperfect the optimal contracts approach contracts that weight individual endowments in proportion to elements of eigenvectors of the variance matrix of endowments then if there is a strong enough market component to endowments a portfolio approximating the market portfolio may be the most important portfolio

the effects of foreign acquisition on domestic and export markets dynamics in china using recent data from the chinese manufacturing industry and the generalised propensity score this paper establishes economically significant causal effects of foreign acquisition on domestic and export markets dynamics

wages and employment in public sector unions i introduction standard economic theory states that a union which raises wages above the competitive level will reduce employment empirical evidence reviewed by lewis 1986 indeed shows that unions raise wages and that unionized establishments in the private sector show slower employment growth than comparable nonunionized establishments 1 studies in the public sector also find that unions raise wages see freeman 1986 and lewis 1988 for reviews but by less than in the private sector unionization in the public sector however often increases employment 2 in a study of 5 144 city and county governments zax 1989 finds that unionized departments increase employment by 3 1 over nonunionized departments we propose an explanation that exploits a key difference between public and private sector employers the quantity of public services provided is determined by a political process in which union members and their supporters have a voice this voice is important when shifts from a decisive voter with a lower income to one with a higher income increase the expressed demand for public services this increase implies the possibility that wages for public sector workers can increase when employment increases this possibility becomes more likely the greater is the difference in income between the previous and current decisive voter public sector workers would therefore use their electoral influence to ensure that the decisive voter is one with as high an income as possible in other words workers in the public sector gain leverage from the elasticity of demand for public sector services with respect to changes in income associated with changes of the identity of the decisive voter most importantly we show that higher employment may result even when union supporters are a small minority of the electorate though this political consideration has been suggested by others including freeman 1986 zax 1989 and zax and ichniowski 1988 it has not been explicitly modeled or explored the essential idea is expressed in the following newspaper story the port authority pat drivers union is working against county commission candidate dan fleck because he has urged pat to appeal a court ruling that ordered discontinuation of a monroeville minibus service run by a private company larry klos president of local 85 of the amalgamated transit union said yesterday we have 2 700 members and they all have relatives and friends we will target mr fleck meaning union members will vote against the thornburg republican pittsburgh post gazette 26 september 1991 p 5 not surprisingly mr fleck lost the election our analysis rests on an important debate begun by dunlop 1944 and ross 1948 concerning union objectives which asks whether unions maximize a well defined objective function such as the wage bill the union s objective has been modeled as reflecting the preferences of the median voter in the union 3 for example suppose workers care only about wages and their own employment that jobs are allocated to the most senior workers and that wage employment bargains must lie on the labor demand curve the union as farber 1986 shows would then set the wage so that the median worker is just retained such a wage policy however would make the union shrink over time researchers extended this median worker model to consider workers with foresight or uncertainty about labor demand and find that union employment shrinks less than suggested by static models or that it need not shrink at all 4 these models however cannot explain the empirical finding that public sector unionization is associated with increased employment an explanation for how unions raise both wages and employment is offered by the efficient bargains or contract curve model which supposes that unions care about both wages and employment and that unions bargain with management over both issues

information heterogeneity and market incompleteness information is market consistent if agents only use market prices to infer the underlying states of the economy this paper applies this concept to a stochastic growth model with incomplete markets and heterogeneous agents the economy with market consistent information can never replicate the full information equilibrium and there are substantial differences in impulse responses to aggregate productivity shocks these results are robust to the introduction of a noisy public signal and aggregate financial markets we argue that the principle of market consistent information should be applied to any model with incomplete markets

the impact of the new york city fiscal crisis on the interest cost of new issue municipal bonds the default of a major corporation or municipality generates debate over the impact these failures have on the borrowing cost of other issuers theory suggests that in efficient markets individual failures by themselves should not increase the level of interest rates in a market unless the default provides unanticipated information about other issuers the default of new york city in the summer of 1975 was believed by many to have provided information that increased the perceived risk of investors and consequently increased new issue borrowing costs in the municipal bond market empirical research by forbes and peterson 2 and gramlich 3 supports this contention reporting that borrowers paid as much as 119 basis points more because of the new york city crisis a study by hoffland 6 suggests that the impact of the default was not just temporary but was felt long after 1975 though less scientific others note that during 1975 municipal borrowing costs rose to record high levels with most issues carrying their interest cost during the summer of 1975

speculation and risk sharing with new financial assets while the traditional view of nancial innovation emphasizes the risk sharing role of new nancial assets belief disagreements about these assets naturally lead to speculation which represents a powerful economic force in the opposite direction this paper investigates the eect of nancial innovation on portfolio risks in an economy when both the risk sharing and the speculation forces are present financial assets provide hedging services but they are also subject to speculation because traders do not necessarily agree about their payos i de ne the average variance of traders net worths as a measure of portfolio risks for this economy and i decompose it into two components the uninsurable variance de ned as the average variance that would obtain if there were no belief disagreements and the speculative variance de ned as the residual variance that results from speculative trades based on belief disagreements financial innovation always decreases the uninsurable variance because new assets increase the possibilities for risk sharing my main result shows that nancial innovation also always increases the speculative variance this is true even if traders completely agree about the payos of new assets the intuition behind this result is the hedge more bet more eect traders use new assets to hedge their bets on existing assets which in turn enables them to place larger bets and take on greater risks my second set of results concern endogenous nancial innovation when belief disagreements are su ciently large a pro t seeking market maker introduces assets that maximize the average variance among all possible choices completely disregarding the risk sharing motive for nancial innovation my third set of results concern a calibration of the model in the context of the gdp indexed assets proposed by athanasoulis and shiller 2001 when traders have reasonable amounts of belief disagreements these assets would have the unintended consequence of increasing their consumption risks

measuring asset values for cash settlement in derivative markets hedonic repeated measures indices and perpetual futures two proposals are made that may facilitate the creation of derivative market instruments such as futures contracts cash settled based on economic indices the first proposal concerns index number construction indices based on infrequent measurements of nonstandardized items may control for quality change by using a hedonic repeated measures method an index number construction method that follows individual assets or subjects through time and also takes account of measured quality variables the second proposal is to establish markets for perpetual claims on cash flows matching indices of dividends or rents such markets may help us to measure the prices of the assets generating these dividends or rents even when the underlying asset prices are difficult or impossible to observe directly a perpetual futures contract is proposed that would cash settle every day in terms of both the change in the futures price and the dividend or rent index for that day this paper concerns problems in the measurement of asset values or present values problems that if solved may facilitate the creation of new hedging vehicles new cash settled futures options and other derivative financial products the greatest components of world wealth are not hedgeable at all and

the new york city fiscal crisis what happened and what is to be done the new york city fiscal crisis as it was played out in the nation s newspapers this year had all the elements of a first class drama there was first of all the tension would the city make it through its periodic financial hurdles would the ford administration blink what would happen if the city defaulted then there were the accusations was it the fault of wagner lindsay beame rockefeller ford the unions or economic and social forces beyond the city s control then the controversy the issue seemed ideally suited to split deficit spenders from budget balancers soft headed liberals from hardheaded accountants eastern establishment intellectuals from the silent majority finally though it did not capture as much press coverage the crisis also graphically illustrated several basic issues in the economics of federalism that are now creeping into public finance textbooks the proper role of local and national governments in stabilizing the economy and redistributing income whether the federal or the state government has an obligation to protect the financial integrity of local governments whether public expenditures can be effectively controlled in the short run this paper discusses the city s fiscal plight in the context of all of these issues i how big are the deficits

fiscal stress the new system of local government finance in england this paper assesses the impact of the reformed system of local government finance in england on the ability of local authorities to finance services for their communities it is set within the context of fiscal stress and particular attention is paid to areas of urban stress the preliminary findings are that inner city authorities face tighter financial constraints when attempting to improve service provision not just to residents but also to local business fiscal stress has been increased and local urban regeneration initiatives have been made more difficult

world income components measuring and exploiting risk sharing opportunities a method is constructedfor decomposing the variance of changes in incomes in the world into components to indicate the most important risk sharing opportunities among people of the world a constant absolute risk premium carp model an intertemporal general equilibrium model of the world is presented to permit optimal contract design for a contract designer maximizing a social welfare function the optimal contracts maximize the equilibrium world real interest rate securities are defined in terms of eigenvectors of a transformed variance matrix the method is applied using penn world table data on the g 7 countries 1950

the resiliency of the high yield bond market the ltv default this paper investigates the resiliency of the new issue high yield bond market by examining the changes in implied default rates of such bonds before and after the largest high yield bond default i e the ltv bankruptcy specifically the paper compares implied default probabilities of high yield bonds during the post ltv period calculated from actual new issue yields with instrumental default probabilities calculated on the assumption that the default had not occurred a comparison of these probabilities reveals that the market s perception of default on the hjgh risk segment of the bond market increased significantly after the ltv bankruptcy however the effect was transitory lasting only six months thus the market was resilient to a major default in recent years high yield debt has become a significant segment of the corporate bond market the main source of the growth has come from new issues of high yield corporate bonds rather than an increase in fallen angels 1 the driving force behind this new breed of high yield debt growth has been its use as a means to tap the capital markets to finance increasingly common leveraged buyouts hostile takeovers and major corporate restructurings the market acceptance of high yield bonds was further enhanced by empirical evidence that net returns on a diversified portfolio of low grade bonds exceeded those on highgrade bonds while the volatility of their monthly returns was no greater 2 the frenzied pace of growth in the high yield debt market however has been accompanied by increasing concerns from various quarters 3 critics have char

exchangeability and its economic applications abstract the symmetry possessed by exchangeability is the key to its usefulness the methods that are used to comprehend reality will edify insofar as they reflect this symmetry this is true of theoretical models empirical methods and algorithms indeed if the design of mechanisms is by rearrangement of natural matter their survival value will depend on the degree to which they retain the symmetry of the original matter this comment encompasses complex machinery and sophisticated political social and economic institutions the paper simply embroiders this observation

financial innovation and portfolio risks i illustrate the effect of financial innovation on portfolio risks by using an example with risk sharing needs and belief disagreements i consider two types of innovation product innovation formalized as an expansion of new financial assets and process innovation formalized as a reduction in transaction costs when belief disagreements are large both types of innovation increase portfolio risks moreover endogenous financial innovation is directed towards speculative assets that increase portfolio risks

individual risk and mutual insurance this paper examines how in the presence of individual risk economic efficiency can be achieved without an unrealistically large number of contingent claims market uncertainty is specified in such a way that general types of individual risk and collective risk are properly accounted for and so that specifically market clearing is always satisfied ex post as well as ex ante we show that consistency of beliefs and optimality of allocation can be guaranteed with an appropriate array of pure arrow securities to spread collective risk and mutual insurance policies to pool individual risk when there is individual risk common to like groups of individuals pooling risk by means of mutual insurance permits substantial economizing on market transactions as compared to those required if dealing instead with the full complement of pure arrow securities we show that if there are n households consisting of h types each facing the possibility of being in s individual states together with t collective states then ensuring pareto optimality requires only h s 1 t independent mutual insurance policies plus t pure arrow securities our results also help to clarify the question of which missing markets may affect allocational efficiency

the role of liquidity in futures market innovations i characterize the optimal design of a new futures market an innovation by an exchange in the presence of market frictions futures markets am characterized by both the contract and the level of trader participation both can be determined by an exchange a game in which exchanges simultaneously design markets is c onsidered and a particular equilibrium not necessarily unique is constructed a game in which exchanges sequentially design markets and incur design costs is also considered and the generically unique equilibrium is constructed the nature of equilibrium with multiple exchanges is discussed in these simultaneous and sequential settings illustrating the role played by liquidity considerations both in market design and in the nature of competition between exchanges

some results in the capm with nontraded endowments the paper establishes a positive security market line in the capm with nontraded endowments the effects of a market structure change on the security market line are analyzed when the equilibrium allocation is affected by the change

collateral motivated financial innovation collateral frictions have a profound effect on our economic landscape ranging from the design of financial securities laws and institutions to various rules and regulations we analyze a model with disagreement where securities and collateral requirements are endogenous it shows that the security that isolates the variable with disagreement is optimal in the sense that alternative securities cannot generate any trading in an economy with n states investors may introduce more than n securities and markets are still incomplete the model has several novel predictions on the behavior of basis the spread between the prices of an asset and its replicating portfolio