Institutional Details Research Articles

What Can We Learn for Today from 300-Year-Old Writings about Stock Markets?

��� In this article I catalog how historical analysis using a variety of writings on stock markets from around the early eighteenth century can help inform our understanding of financial market institutions and behavior. In so doing, I hope to suggest how the history of economic thinking can have direct value for today’s financial economist. Old writings, of course, are a trove of interesting vignettes. For example, the term bear to describe a stock-market pessimist derives from the seventeenth-century slang for short-sellers, a reference to risk-addled speculators who dared to sell the bear’s skin before catching the bear; John Burr Williams, who is frequently credited with inventing the dividend discount model in his Theory of Investment Value (1938), was nonetheless writing well over 200 years after the widespread use of such valuation techniques; and the explosion in the use of put and call options in the 1970s occurred nearly 300 years after their use swept the Amsterdam and then London stock exchanges in the late 1600s. But more importantly, the historical record is also a source of institutional detail and substance. For instance, that record reveals how investors relied on a trader’s reputation to honor Correspondence may be e-mailed to paul.harrison@frb.gov or addressed to the author at the Federal Reserve Board, 20th and C Street NW, Washington, D.C. 20551. I thank Dan Covitz and Neil De Marchi for detailed comments and suggestions, and Craufurd Goodwin, Roy Weintraub, and seminar participants at Duke University for helpful discussion. Some of the background text for this article is drawn directly from Harrison 2001. Naturally, the views expressed here are mine and not those of the Federal Reserve or the Board of Governors. This article is, to a large extent, a summary of an ongoing research project of mine and so draws directly on previous published and unpublished research where some of the points are made in more detail.

Whither Political Science? Reflections on Professor Sartori's claim that “American-type political science…is going nowhere. It is an ever growing giant with feet of clay”

Political science remains an emergent discipline; but research within it has congealed around a set of well-defined programs that has engaged an international community of scholars. Here I will identify three of these programs in order to show the continued intellectual vibrancy of the discipline. First, in normative theory, political scientists are working out the implications of John Rawls' A Theory of Justice in a program that has reinvigorated liberalism to make it speak to core political issues of our time. Second, in a program once embedded bureaucratically in “American Politics,” political scientists are working out the implications of Duncan Black's median voter theorem in an expanded set of democratic countries with different institutional details to address the core political issues of representation and accountability. Third, relying on extensive cross-sectional time-series data previously unavailable, on computer programs not imaginable a generation ago, and on theoretical developments in econometrics, political scientists are fulfilling a dream of the founders of the behavioral revolution (Stein Rokkan, S. M. Lipset, and Karl Deutsch) by addressing systematically the sources of democracy and political order. To be sure, there are other political science research programs, for example, in international relations, in comparative political economy, and in political psychology, that could well have been elucidated in this essay. My goal here, in addressing Professor Sartori's jeremiad, is not to show the scope of the field, but rather its quality, its internationalism, and its real-world relevance. This is best done with a few select examples.

How do UK‐based foreign exchange dealers think their market operates?

AbstractThis paper summarizes the results of a survey of UK‐based foreign exchange dealers conducted in 1998. It addresses topics in three main areas: the microeconomic operation of the foreign exchange market; the beliefs of dealers regarding the importance, or otherwise, of observable macroeconomic fundamental factors in affecting exchange rates; microstructure factors in FX. We find that heterogeneity of traders' beliefs is evident from the results but that it is not possible to explain such disagreements in terms of institutional detail, rank or trading technique (e.g. technical analysts versus fundamentalists). As expected, non‐observable fundamental factors are thought to dominate short horizon changes in exchange rates, but observable fundamentals are deemed important over much shorter horizons than the mainstream empirical literature would suggest. Finally, market ‘norms’ and behavioural phenomena are very strong in the FX market and appear to be key determinants of the bid–ask spread. Copyright © 2004 John Wiley & Sons, Ltd.

Manager-Investor Conflicts in Mutual Funds

Half of all of U.S. households own shares in one or more mutual funds, either directly or through personal or employer-sponsored retirement accounts. This article describes the structure and regulation of mutual funds and the resulting incentives facing those who make decisions for the funds. After providing some basic institutional details, it focuses on the cash flows from mutual fund investors to fund managers, brokers, and other third parties and the associated conflicts of interest. The article concludes with a summary of recent legal proceedings against mutual fund managers and brokers based on improper trading practices and regulatory proposals to curb those practices.

Overview of the Issue

This issue features four articles and a book review section. The first article in the issue is by Stefan Engström (Stockholm School of Economics) and Anna Westerberg (National Social Insurance Board) and examines “Which Individuals Make Active Decisions in the New Swedish Pension System?” The vast majority of empirical evidence on how individuals make decisions in defined contribution plans has been based on US experience and the unique choices available within 401(k) plans. Therefore, the paper by Engström and Westerberg, which examines the situation in Sweden where the institutional details and investment choices are somewhat different, is a most welcome contribution to the literature.

When is the median voter paradigm a reasonable guide for policy choices in a representative democracy?

The median voter paradigm (MVP) has been widely used to study the interactions between economic and political behavior. While this approach is easy to work with, it abstracts from institutional detail. This paper explores whether the MVP leads on average to the same policies that would be chosen in a two‐party representative democracy (RD). When it does not, the paper fully characterizes the size and magnitude of the average divergence (or bias) between policy choices in MVP and in RD in terms of the degree of polarization between the parties, their relative electoral prospects, and the distribution of electoral uncertainty. The results are then applied to the influential Meltzer and Richard (1981) theory of the size of government.

Mass privatization in Central and East European countries

Mass privatization is one form of changing the property rights regime of formerly publicly‐owned means of production in the former peoples’ republics of Central and Eastern Europe. From an economic point of view, the central question at this transition is whether the change in property rights regimes significantly and benevolently affects the governing structure of the assets in question. This short essay attempts to provide a framework which is theoretical enough to guide meaningful questions, and open and naïve enough not to preclude relevant insight. The contribution of this article consists in a theoretically driven questionnaire which, based on the current state of the property rights theory of the firm, the relevant aspects of law and economics as well as financial economics, tries to elicit scholarly information about issues of institutional detail. Ultimately, the aim is to show how the different approaches to mass privatization can be evaluated from the point of view of creating viable governing structures.

Is Portugal Really so Arteriosclerotic? Results from a Cross-country Analysis of Labor Adjustment

Reputation indexes of employment protection have proven popular constructs in studies of the covariation of labor market institutions and macroeconomic outcomes. Portugal occupies an unenviable rank order in such measures of the stringency of employment protection. We critique this reputation in two ways: first, by offering a modicum of 'corrective' institutional detail on the nature of employment protection in Portugal; and, second, and more substantively, by offering a detailed analysis of the process of labor adjustment in Portugal, benchmarked to other-country experience. The latter exercise - based on a two- and one-stage error correction model - reveals Portugal to have a very high speed of adjustment to deviations from the long-run employment-output equilibrium - a result that is clearly at odds with its allegedly sclerotic labor market. More in accord with received wisdom is the very smooth labor adjustment mechanism characterizing the United Kingdom. The most notable feature of the German results is the deterioration in that country's speed of adjustment in recent years. The Spanish case is distinguished by its erratic path of long-run adjustment.

Seigniorage Wealth and Redistribution in Central and Eastern European Countries

The analysis presented in this article focuses on seigniorage revenues in five Central and Eastern European Countries: Bulgaria, the Czech Republic, Hungary, Poland and Romania. A comprehensive discrete period accounting framework for measuring the sources and uses of seigniorage in the 1990s is presented. The framework is based upon the gross concept of seigniorage that defines seigniorage in the broadest possible sense as the sum of revenues resulting from the monopoly power to issue money. Legal, institutional and operational details which are relevant for the creation of base money in a country are taken into account. The article reveals similarities and differences in seigniorage wealth between the countries under scrutiny, evaluates the magnitude of seigniorage and shows that accession to the European Monetary Union will create significant once-and-for-all gains of seigniorage wealth for the countries resulting from redistributing seigniorage wealth.

The overnight interbank market: Evidence from the G-7 and the Euro zone

We study the interbank markets for overnight loans of the major industrial countries, linking the behavior of short-term interest rates to the operating procedures of these countries’ central banks. We find that many of the key behavioral features of US federal funds rates, on which previous studies have focused, are not robust to changes in institutional details, along both cross-sectional and time-series dimensions of the data. Our results indicate that central banks’ operating procedures and intervention styles play a crucial role in shaping empirical features of short-term interest rates’ day to-to-day behavior in industrial countries.

A Model of the Federal Funds Rate Target

This paper is a statistical analysis of the manner in which the Federal Reserve determines the level of the federal funds rate target, one of the most publicized and anticipated economic indicators in the financial world. The paper introduces new statistical tools for forecasting a discrete‐valued time series such as the target and suggests that these methods, in conjunction with a focus on the institutional details of how the target is determined, can significantly improve on standard vector autoregression forecasts of the effective federal funds rate. We further show that the news that the Fed has changed the target has statistical content substantially different from the news that the Fed failed to make an anticipated target change, causing us to challenge some of the conclusions drawn from standard linear VAR impulse‐response functions.

Government-initiated community resource management and local resource extraction from Nepal's forests

This paper considers the effect on local resource extraction of an ambitious, government-initiated community forestry program in Nepal. Beginning in 1993, the government of Nepal began to transfer all accessible forestland from the national government to local communities by creating local groups of forest users. This study uses institutional details about the implementation of this program to evaluate its impact on the extraction of wood for fuel. Transferring forests to local groups of forest users is associated with a significant reduction in resource extraction in communities that receive new forest user groups.

The enforcement of competition policy in the candidate countries

T he policy of competition development constitutes an important element of the transformation of the economy in the candidate countries, which are constructing their market economies after almost fifty years of central planning. This process requires a new legal system adequate for market economies. That is why all the candidate countries apply competition law or, precisely speaking, a legal system for the promotion and protection of competition consisting of regulations concerning anti-competitive agreements (vertical and horizontal), restrictive business practices, merger and acquisition (M&A) control, unfair competition and state aid. A distinctive feature of the candidate countries in comparison to the mature market economies of the EU Member States is that they not only need to protect competition but first of all to promote it during the economic transformation. This justifies the significance of competition agencies for the economic policies of the governments in the candidate countries. A pro-competitive economic policy is thus a precondition for the effective enforcement of the legal system promoting and protecting competition. Progress by the Candidate Countries Competition law and competition agencies were established in the candidate countries at different times. Poland was the first country to introduce these regulations and establish an Anti-monopoly Office. The experience gained during the first years of competition law enforcement constituted the basis for the adoption of new competition acts or for major amendments in the existing law. There is no doubt that these changes took place in connection with the requirement of the adjustment of competition laws in the candidate countries to the acquis. Although the competition protection systems in the candidate countries are similar in their basic elements, they vary in substantive and institutional details. A comparative analysis of the main features of competition protection systems in the candidate countries is presented in Table 1. In all the candidate countries with the exception of Hungary and Romania competition agencies are independent

Revisiting Optimal Call Policy for Convertibles

When a company calls its convertible bonds, it typically must give the bondholders a notice period of approximately 30 days to decide whether to convert the bonds. This important institutional detail substantially affects the optimal call policy for convertible bonds. When the company calls the bonds, it fixes the price at which bondholders can redeem them, effectively giving bondholders a 30-day put option. The optimal time to call the convertibles minimizes the value of the conversion option net of the put option. This optimization problem is solved here, and a simple decision rule for the company results. This solution contains those of previous researchers as a special case.

The Postsocialist Experience and Comparative Politics

I see four areas where the study of postsocialism has made significant contributions to our understanding of politics, One is in providing an ideal laboratory for comparison. Here, I refer to three aspects of the region. First, it contains a large number of cases—28 in all and a good deal more, once we take into account “patch-work” politics and economics of the Russian Federation, for example. Second, the “great transformation,” to borrow from Polanyi and to refer in this instance to an even “greater” process involving the construction of economic and political regimes, nations, and states, deals with virtually all the fundamental issues of politics. Finally, the region exhibits enormous variation in political and economic outcomes, whether we focus on economic and political regime types and the institutional details of these regimes; economic performance, levels of economic development, types of economic reforms, and the role of foreign capital; the age and size of the state and its capacity to define and defend borders, command compliance and extract resources; and the national composition of the population. At the same time, causes are limited, largely because of the homogenizing effects of state socialism and the temporal similarities in when these great transformations commenced. This combination of variable outcomes and constrained causes is, of course, precisely what comparativists value.

The Overnight Interbank Market: Evidence from the G-7 and the Euro Zone

We study the interbank markets for overnight loans of the major industrial countries, linking the behaviour of short-term interest rates to the operating procedures of these countries' central banks. We find that many of the key behavioural features of US federal funds rates, on which previous studies have focused, are not robust to changes in institutional details, along both cross-sectional and time-series dimensions of the data. Our results indicate that central banks' operating procedures and intervention styles play a crucial role in shaping empirical features of short-term interest rates' day-to-day behaviour in industrial countries.

Major Players: Bureaucracies In American Government

For more than 50 years, Herbert Kaufman has been an astute observer of public bureaucracies. In this essay, Kaufman draws on his extensive experience in explaining the role of public bureaucracies in the American political system. Kaufman was motivated to write the essay because of his concern that public bureaucracies are not given adequate attention in American government textbooks. We hope that PAR readers will use the essay to educate students and others about the important role of public bureaucracies in American government.—LDT

Alternating Offer Bargaining Experiments with Varying Institutional Details

The game theoretic prediction for alternating offer bargaining depends crucially on how 'the pie' changes over time, and whether the proposer in a given round has ultimatum power. We study experimentally eight such bargaining games. Each game is once repeated before moving on to the next one what defines a cycle of altogether 16 successive plays. Participants play three such cycles. There are no major experience effects but strong and reliable effects of anticipated rule changes. The latter, however, are not due to strategic considerations but rather to the social norms of fairness and efficiency.

Family labor supply and proposed tax reforms in the Netherlands

This paper presents a discrete choice static neo-classical labor supply model for married or cohabiting couples in the Netherlands. The model simultaneously explains the participation decision and the desired number of hours worked. Due to its discrete nature, institutional details of the tax system can be fully incorporated. The model is estimated using Dutch cross-section data. The results are used to simulate the first order labor supply effects of several proposed reforms of the Dutch income tax system. In particular, it is shown that some of the proposed reforms would have a negative effect on the number of married females who prefer a small part-time job. This pitfall is avoided in the proposal that has gone to Parliament.

Unemployment, Growth, and Trade Unions

This paper develops a two‐sector endogenous growth model with a dual labor market caused by the operation of trade unions. Trade unions strive for the extraction of rents from the growth generating imperfectly competitive primary sector. This union behavior results in a non‐competitive wage differential between the primary and secondary (perfectly competitive) sector. How the relationship between growth and unemployment depends on the institutional details of the labor market is analyzed. In general, growth and unemployment are intimately related for two reasons. Unemployment affects the scale of operation of the economy and thereby the growth rate. Growth affects inter‐temporal decisions of workers about where to allocate on the labor market once they are laid off, and thereby it affects equilibrium unemployment.