network models and financial stability abstract systemic risk is a key concern for central banks charged with safeguarding overall financial stability in this paper we investigate how systemic risk is affected by the structure of the financial system we construct banking systems that are composed of a number of banks that are connected by interbank linkages we then vary the key parameters that define the structure of the financial system including its level of capitalisation the degree to which banks are connected the size of interbank exposures and the degree of concentration of the system and analyse the influence of these parameters on the likelihood of knock on defaults first we find that the better capitalised banks are the more resilient is the banking system against contagious defaults and this effect is non linear second the effect of the degree of connectivity is non monotonic i e initially a small increase in connectivity increases the contagion effect but after a certain threshold value connectivity improves the ability of a banking system to absorb shocks third the size of interbank liabilities tends to increase the risk of knock on default even if banks hold capital against such exposures fourth more concentrated banking systems are shown to be prone to larger systemic risk all else equal in an extension to the main analysis we study how liquidity effects interact with banking structure to produce a greater chance of systemic breakdown we finally consider how the risk of contagion might depend on the degree of asymmetry tiering inherent in the structure of the banking system a number of our results have important implications for public policy which this paper also draws out

when is foreign aid policy credible aid dependence and conditionality the author studies foreign aid policy within a principal agent framework he shows that one reason for foreign aid s poor overall record may be a moral hazard problem that shapes the aid recipient s incentive to undertake structural reform the model s basic prediction is a two way relationship disbursements of foreign aid are guided in part by the needs of the poor anticipating this recipients have little incentive to improve the welfare of the poor preliminary econometric work shows that the data support this hypothesis in principle conditionality could partly solve this problem but only if the donor can make a binding commitment to increase disbursements in good relative to bad states without such a commitment technology aid disbursements remain guided by the needs of the poor and recipient countries maintain a low effort to reduce poverty contrary to the conventional wisdom found in the aid literature the author shows that the welfare of all parties might be improved by using tied project aid or by delegating part of the aid budget to an international agency with less aversion to poverty

sulfur dioxide control by electric utilities what are the gains from trade title iv of the 1990 clean air act amendments caaa established a market for transferable sulfur dioxide so2 emission allowances among electric utilities this market offers firms facing high marginal abatement costs the opportunity to purchase the right to emit so2 from firms with lower costs and this is expected to yield cost savings compared to a command and control approach to environmental regulation this paper uses econometrically estimated marginal abatement cost functions for power plants affected by title iv of the caaa to evaluate the performance of the so2 allowance market specifically we investigate whether the much heralded fall in the cost of abating so2 compared to original estimates can be attributed to allowance trading we demonstrate that for plants that use low sulfur coal to reduce so2 emissions technical change and the fall in prices of low sulfur coal have lowered marginal abatement cost curves by over 50 percent since 1985 the flexibility to take advantage of these chan

a comparative analysis of current credit risk models the new bis 1998 capital requirements for market risks allows banks to use internal models to assess regulatory capital related to both general market risk and credit risk for their trading book this paper reviews the current proposed industry sponsored credit value at risk methodologies first the credit migration approach as proposed by jp morgan with creditmetrics is based on the probability of moving from one credit quality to another including default within a given time horizon second the option pricing or structural approach as initiated by kmv and which is based on the asset value model originally proposed by merton merton r 1974 journal of finance 28 449 470 in this model the default process is endogenous and relates to the capital structure of the firm default occurs when the value of the firm s assets falls below some critical level third the actuarial approach as proposed by credit suisse financial products csfp with creditrisk and which only focuses on default default for individual bonds or loans is assumed to follow an exogenous poisson process finally mckinsey proposes creditportfolioview which is a discrete time multi period model where default probabilities are conditional on the macro variables like unemployment the level of interest rates the growth rate in the economy which to a large extent drive the credit cycle in the economy 2000 elsevier science b v all rights reserved

domestic foreign interest rate differentials near unit roots and symmetric threshold models this paper investigates the near unit root behavior of interest rate differentials across countries using a symmetric band tar model that allows for a heteroscedastic error process we find that the time series properties of monthly short term interest differentials over the period 1974 2005 between the united states and canada france germany japan and the united kingdom can be characterized by a symmetric band tar process which can explain its near unit root behavior reported in the extant literature results significantly reject a linear model in favor of the alternative hypothesis of a two regime symmetric threshold model that exhibits significantly greater persistence within the threshold bands than when outside the threshold bands

effectiveness of imf supported stabilization programs in developing countries abstract this paper examines the effectiveness of fund supported stabilization programs by investigating whether the imf achieves its own objectives in such programs even though the fund s conditionality prescribes fiscal and monetary discipline in program countries the results of the empirical analysis show that the imf cannot impose its conditionality even during program years furthermore when successive interprogram periods are considered program countries enter a new program in a worse macroeconomic condition than they entered the previous program these results and the fact that stabilization programs have a revolving nature are inconsistent with the effectiveness of imf supported stabilization programs and may signal the existence of moral hazard

the intraday liquidity management game abstract we use a game theoretical framework to analyze the intraday behavior of banks with respect to settlement of interbank claims in a real time gross settlement setting the game played by banks depends upon the intraday credit policy of the central bank and it encompasses two well known game theoretical paradigms the prisoner s dilemma and the stag hunt the former arises in a collateralized credit regime where banks have an incentive to postpone payments when daylight liquidity is costly an outcome that is socially inefficient the latter arises in a priced credit regime where the postponement of payments can be socially efficient banks are risk neutral but we show that most of the results are unaffected by risk aversion

the structural adjustment debate the last decade has witnessed dramatic changes in economic policy in the developing world on every continent countries have moved to open their economies free up prices and reduce the role of the state in managing and regulating economic activity developing nations from mexico to malaysia have made changes in their economies that dwarf anything achieved by ronald reagan the design of structural adjustment programs directed at the four ations stabilization liberalization deregulation privatization has become a cottage industry efforts at structural adjustment have been assisted and encouraged by the international community most directly through multilateral financial institutions the international monetary fund has long conditioned its support on policies consistent with macroeconomic stability the imf has increasingly taken the position that changes in economic structure are necessary if stabilization is to be attained and maintained structural adjustment lending lending conditioned on specific economic policy changes has emerged as a major instrument of world bank support to developing countries and world bank investment lending has increasingly been conditioned on policy reforms given the extent of economic change that structural adjustment programs have wrought it is hardly surprising they have been controversial this paper summarizes the results of the latest world bank review of adjustment lending world bank 1992 and highlights the crucial identification problem involved in assessing structuraladjustment programs we then try to advance the debate over structural adjustment lending by distilling the main lines of criticism levied against structural adjustment programs to four critiques and assessing the validity of each in conclusion we point to three newer issues for which we believe further research and analysis are necessary

why conditional aid does not work and what can be done about it abstract this paper studies a simple reform that introduces ex post incentives for the donor to reward good policies contrary to existing practices instead of committing aid to each recipient ex ante and making aid conditional on reform the donor centralizes the disbursement decision by committing aid to a group of countries the actual amount disbursed to each individual country would depend on its relative performance this explicit linkage of the allocation and disbursement decisions has two important advantages as compared to present practices first it raises the opportunity cost of disbursing aid ex post thereby giving the donor stronger incentives to reward good policies second competition among recipients allows the donor to make inferences about common shocks which otherwise conceal the recipient s choice of action this enables the donor to give aid more efficiently

triadic power relations in rural nepal abstract we generalise basu s model of triadic power for one landlord and multiple merchants the landlord s threat towards a labourer becomes credible in the original stage game for multiple landlords and merchants we generalise more recent solutions we estimate a reduced form of the model where equilibrium rural wages are a function of the number of landlords distance to merchants characteristics of the labourers and the distance to external markets we apply living standards measurement study data from nepal and find support for the triadic model in particular the influence via the merchants depends on the number of landlords

minimal settlement assets in economies with interconnected financial obligations a model is developed where firms belonging to a group are obliged to make payments to one another by using a liquid asset the paper studies the exogenous endowments of this asset that are necessary to assure that all obligations are met conditions are presented under which the degree to which firms are interconnected so that each creditor has more debtors and each debtor has more creditors increases the number of firms that must be endowed with the liquid asset interconnectedness then makes payment defaults more likely by acquiring too many payment obligations firms may also become too interconnected

financial intermediation and delegated monitoring this paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders it presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary diversification within an intermediary serves to reduce these costs even in a risk neutral economy the paper presents some more general analysis of the effect of diversification on resolving incentive problems in the environment assumed in the model debt contracts with costly bankruptcy are shown to be optimal the analysis has implications for the portfolio structure and capital structure of intermediaries

aid policies and growth the authors of this paper use a new database on foreign aid to examine the relationships among foreign aid economic policies and growth of per capita gdp in panel growth regressions for 56 developing countries and 6 four year periods 1970 93 they find that the policies that have a great effect on growth are those related to fiscal surplus inflation and trade openness they construct an index for those three policies and have that index interact with foreign aid they have instruments for both aid and aid interacting with policies they find that aid has a positive impact on growth in developing countries with good fiscal monetary and trade policies in the presence of poor policies aid has no positive effect on growth this result is robust in a variety of specifications which include or exclude middle income countries include or exclude outliers and treat policies as exogenous or endogenous they examine the determinants of policy and find no evidence that aid has systematically affected policies either for good or for ill they estimate an aid allocation equation and show that any tendency for aid to reward good policies has been overwhelmed by donors pursuit of their own strategic interests in a counterfactual they reallocate aid reduce the role of donor interests and increasing the importance of policy such a reallocation would have a large positive effect on developing countries growth rates

company interests and foreign aid policy playing donors off against one another abstract the evidence on conditionality indicates that this instrument sometimes works and sometimes does not work we suggest that third parties to the donor recipient relationship influence the aid disbursement the halt in aid that should follow non compliance could trigger the recipient to cancel contracts with companies from donor countries which creates incentives for the companies to put pressure towards aid disbursement we use a multi agent triadic model of the relationships between a recipient and two donors and two companies to illustrate that recipients may act strategically to make third parties like companies and others influence the disbursement decision failing to take account of third parties role yields the opposite result conditionality becomes successful

liquidity saving mechanisms abstract this paper studies the incentives of participants in a real time gross settlement system with and without the addition of a liquidity saving mechanism lsm participants in the model face a liquidity shock and different costs for delaying payments they trade off the cost of delaying a payment against the cost of borrowing liquidity from the central bank the main contribution of the paper is to show that the design of an lsm has important implications for welfare in particular parameters determine whether the addition of an lsm increases or decreases welfare

settlement risk under gross and net settlement previous comparative analyses of gross and net settlement have focused on the credit risk of the central counterparty in net settlement arrangements and on the incentives for participants to alter the risk of their portfolios under net settlement by modeling the trading economy that generates the demand for payment services we are able to show some largely unexplored advantages of net settlement we find that net settlement can prevent certain gridlock situations which may arise in gross settlement in the absence of delivery versus payment requirements in addition we show that net settlement can economize on collateral requirements and avoid trading delays

aid investment and incentives promoting productive investment and economic growth are among the key objectives of most aid organizations operating in poor countries however it is not possible to conclude from existing empirical evidence that aid contributes positively to growth in this paper it is shown that those rather negative results may be explained by important incentive problems built into the aid system itself the recipient countries own efforts to contribute to investment and growth may in reality be undermined and the result may be aid dependency

systemic risk in financial systems we consider default by firms that are part of a single clearing mechanism the obligations of all firms within the system are determined simultaneously in a fashion consistent with the priority of debt claims and the limited liability of equity we first show via a fixed point argument that there always exists a clearing payment vector that clears the obligations of the members of the clearing system under mild regularity conditions this clearing vector is unique next we develop an algorithm that both clears the financial system in a computationally efficient fashion and provides information on the systemic risk faced by the individual system firms finally we produce qualitative comparative statics for financial systems these comparative statics imply that in contrast to single firm results even unsystematic nondissipative shocks to the system will lower the total value of the system and may lower the value of the equity of some of the individual system firms

what explains the success or failure of structural adjustment programs in the 1980s development assistance shifted largely from financing investments such as roads and dams to promoting policy reform this change came because of a growing awareness that developing countries were held back more by poor policies than by a lack of finance for investment after nearly 20 years experience with policy based or conditional lending there have now been many studies of adjustment lending most of which take a case study approach many conclude that policy based lending works if countries have decided on their own to reform the authors examine a database of 220 world bank supported reform programs to identify why adjustment programs succeed or fail they find that a few political economy variables can successfully predict the outcome of an adjustment loan 75 percent of the time variables under the world bank s control resources devoted to preparation and supervision or number of conditions have no relationship with an adjustment program s success or failure what development agencies must do then is select promising candidates for adjustment support when the candidates is a poor selection devoting more administrative resources or imposing more conditions will not increase the likelihood of successful reform to improve its success rate with adjustment lending the world bank must become more selective and do a better job of understanding which environments are promising for reform and which are not that is likely to lead to fewer adjustment loans unless there is a significant change in the number of promising reformers to become more effective at supporting policy reform the agency must be willing to accept that this may lead to smaller volumes of lending

aid allocation and poverty reduction the authors derive a poverty efficient allocation of aid and compare it with actual aid allocations they build the poverty efficient allocation in two stages first they use new world bank ratings of 20 different aspects of national policy to establish the current relationship between aid policies and growth onto that they add a mapping from growth to poverty reduction which reflects the level and distribution of income they compare the effects of using headcount and poverty gap measures of poverty they find the actual allocation of aid to be radically different from the poverty efficient allocation in the efficient allocation for a given of poverty aid tapers in with policy reform in the actual allocation aid tapers out with reform in the efficient allocation aid is targeted disproportionately to countries with severe poverty and adequate polices the type of country where 74 percent of the world s poor live in the actual allocation such countries receive a much smaller share of aid 56 percent than their share of the world s poor with the present allocation aid is effective in sustainably lifting about 30 million people a year out of absolute poverty with a poverty efficient allocation this would increase to about 80 million people even with political constraints introduced to keep allocations for india and china constant poverty reduction would increase to about 60 million reallocating aid is politically difficult but it may be considerably less difficult than quadrupling aid budgets which is what the authors estimate would be necessary to achieve the same impact on poverty reduction with existing aid allocations