... phrases come to mind, such as the title of the book Men Are From Mars, Women Are From Venus (Gray, 1992), and the adage, opposites ...
Story - antoq - 10/02/2010 - 02:09 - 0 comments - 0 attachments
Financial crises often involve amplification effects whereby adverse developments in financial markets and in the real economy mutually reinforce each other. The literature in macroeconomics has typically emphasized the following four elements to describe financial amplification effects: 1 First, individual agents face financial constraints that limit their economic activity, e.g. by constraining the amount of funds available for investment. Second, the aggregate level of economic activity affects the price of productive assets in the sector. Third, the price of productive assets determines the net worth of individual agents who own them. Fourth, net worth governs the tightness of their financial constraints by affecting the availability or price of external finance. This reduces economic activity further, which in turn depresses asset prices further and so on, leading to a self-reinforcing cycle of falling asset prices, deteriorating net worth, tightening financing conditions, and declining economic activity.
A shock to any of the four elements involved – financing capacity, economic activity, asset prices, or net worth – can trigger amplification effects when financing constraints are binding. For example, a negative shock to the net worth of financial institutions can trigger sharp declines in their financing capacity, their lending activity, the financial health of their borrowers and hence the value of their loan portfolio, and their net worth. 2 Financial crises entail large welfare costs and are therefore of great concern to both economists and policymakers. Every financial crisis – including the current subprime crisis – therefore brings up the question of whether exisiting regulations are sufficient or new regulations to limit risk-taking by financial market participants are desirable.
Over the past two decades, mutual funds have been one of the fastest growing institutions in this country. At the end of 1980, they managed less than 150 billion dollars, but this figure had grown to over 4 trillion dollars by the end of 1997 a number that exceeds aggregate bank deposits (Pozen (1998)). From 1988 to 2000, the percentage of American households owning mutual funds rose from 24 percent to 49 percent (Investment Company Institute (2000)). While the flow of new money has leveled off recently in the face of market declines, the mutual fund industry remains among the most important in the economy. Moreover, actively managed funds control a sizeable stake of corporate equity and play a pivotal role in the determination of stock prices (see, e.g., Grinblatt, Titman and Wermers (1995), Gompers and Metrick (2001)).
The economics literature on mutual funds has largely focused on two issues. The first, which dates back to Jensen (1968), is whether managers are able to beat the market. The consensus is that a typical manager is not able to earn enough returns to justify her fee, i.e. funds under-perform the market by about 1% annually (see, e.g., Malkiel (1995), Gruber (1996)). The second is the agency problem (between individual investors and mutual fund companies) arising out of delegated portfolio management. An important message of this literature is that performance-based incentives (whether explicit or implicit incentives related to fund flows) influence the risk-taking behavior of fund managers (see, e.g., Brown, Harlow and Starks (1996), Chevalier and Ellison (1997, 1999)).
Chari,Kehoe and McGrattan(2005)(CKM)argue that a procedure they call Business Cycle Accounting (BCA) is useful for identifying promising directions for model development. The key substantive finding of CKM is that financial frictions like those analyzed by Carlstrom andFuerst (1997) (CF) and Bernanke, Gertlerand Gilchrist (1999) (BGG) are not promising avenues for studying business cycles. Based on our analysis of business cycle data for the US inthe 1930 sandforthe US and 14 other OECD countries in the postwar period, we find that the CKM conclusion is not warranted.
