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Managing a Liquidity Trap: Monetary and Fiscal Policy

The 2007-8 crisis in the U.S. lead to a steep recession, followed by aggressive policy responses. Monetary policy went full tilt, cutting interest rates rapidly to zero, where they have remained since the end of 2008. With conventional monetary policy seemingly exhausted, fiscal stimulus worth $787 billion was enacted by early 2009 as part of the American Recovery and Reinvestment Act.

History of Obesity

Obesity has been evident in the human record for over 20 000 years and affected numerous aspects of human life and society (Bray, 2007a; Bray, 2007b). This introductory chapter describes the early history of human obesity, and then reviews how understanding has developed in the basic biology of obesity, its defi nitions and measurement, the complications of the disease, and fi nally its management. Some of the major scientifi c and medical milestones in the history of obesity are shown in Table 1.1.

Research on Obesity and Overweight

Over the past several decades, the prevalence of obesity among adults and children in the United States has increased dramatically and is now reaching epidemic proportions. The prevalence of obesity in adults in the United States was 30.5 percent in 1999-2000. More than twice as many adults (nearly 65percent) were considered to be either overweight or obese. Some 6 million U.S. adults were considered morbidly obese in 2001. In 2002, an estimated 15 percent of all children aged 6 to 19 years were overweight. Obesity is more common in women, but men are more likely to be overweight.


Chemotherapy, or chemical therapy, is one form of treatment that involves giving patients anti-cancer drugs. Most of these drugs are known as cytotoxic drugs, which literally means cell (cyto) killing (toxic).

Macroeconomic Volatility and Income Inequality in a Stochastically Growing Economy

The relationship between income inequality and economic growth is both important and controversial. Knowledge of how these two variables are related is essential if a policymaker is to be able to neutralize any undesired consequences of, say, a growth-enhancing policy on the economy’s distribution of income.

Does Equal Pay Legislation Reduce Labour Market Inequality?

Wage differentials between different demographic groups are a prevalent phenomenon in most developed countries. In spite of powerful equal-pay legislation and other anti–discrimination measures, these gaps remain considerable, even after controlling for workers’ qualification and experience. While wage differentials at the job cell level (occupation–establishment) are small, occupational segregation and establishment segregation are important causes of the wage gaps, and there is only weak tendency of segregation to decline.

Outsourcing, Structure of Firms, and Wage Inequality in the Market for Professional Services

Almost every firm has to decide what to produce in-house and what to purchase from the market (outsource). The outcome of this decision determines the boundaries of the firm, an issue that has been of keen interest to economists since at least Coase (1932). Not surprisingly, there have been numerous theoretical and empirical studies examining the determinants of outsourcing decisions of firms and the variation in the extent of outsourcing across industries and markets.

Asset Prices and Banking Distress: A Macroeconomic Approach

The essence of central banking lies in the pursuit of macroeconomic and financial stability. There are complete models of macroeconomic stability, and a reasonably broad consensus on how to achieve it. Not so for financial stability. There is no consensus how to achieve it, nor a widely accepted model.

On Entrepreneurial RiskTaking and the Macroeconomic Effects of Financial Constraints

This paper examines the effects of financial constraints and idiosyncratic risks in a dynamic equilibrium model of occupational choice. We determine the qualitative and quantitative response of aggregate macroeconomic activity, social mobility, and the wealth distribution to credit market improvements.

Bank Portfolio Exposure to Emerging Markets and Its Effects on Bank Market Value

Large U.S. banks have been heavily exposed to debt from emerging countries. As these countries have encountered serious financial problems, the value of emerging country debt has decreased, with a potential negative impact upon banks. This paper addresses the issue of whether the market, through the equity price of the banks, fully values these debt valuation changes. Crucial to the analysis is whether the information about individual country debt holdings of large U.S. banks is sufficiently transparent so that it can be recognized by investors.

Optimal Maturity of Government Debt without State Contingent Bonds

In this paper we explore the ability of the maturity structure of public debt to replicate the welfare enhancing properties of state contingent debt in dynamic stochastic optimal taxation Ramsey problems. We first study the theoretical conditions under which the complete markets Ramsey allocation can be implemented with non-contingent debt of different maturities. We then solve simple calibrated versions of the model to get a quantitative assessment of the optimal maturity structure.

Credit Conditions and Expected Stock and Bond Returns

Recently, an active academic debate has arisen over whether any economic variables predict future excess stock returns better than historical average excess returns. Goyal and Welch (2008) argue that many predictive variables used in the literature perform poorly both in sample and out-of-sample, especially over the last 30 years. In contrast, Campbell and Thompson (2008) show that many predictive regressions beat the historical average return, once weak restrictions are imposed on the signs of coeffcients and return forecasts.

Investment-Based Expected Stock Returns

The empirical finance literature has documented tantalizing associations between future stock returns and firm characteristics. As surveyed in, for example, Fama (1998) and Schwert (2003), traditional asset pricing models have failed to predict many of these associations, which have therefore been dubbed anomalies. Several prominent studies, such as Shleifer (2000) and Barberis and Thaler (2003), have interpreted this failure as prima facia evidence against the efficient markets hypothesis.

Vulnerable Options, Risky Corporate Bond and Credit Spread

The focus of credit risk analysis has been either on the valuation of risky corporate bonds and credit spreads, or on the valuation of vulnerable options, but never on both in the same context. Risky corporate bonds and credit spreads have been modelled by Black and Scholes (1973) and Merton (1974), and extended by Black and Cox (1976), Longstaff and Schwartz (1995), Briys and de Varenne (1997), and others. Studies of vulnerable options are pioneered by Johnson and Stulz (1987), and subsequently advanced by Hull andWhite (1995), and Jarrow and Turnbull (1995). The existing studies can be improved in several aspects.

Accruals, Financial Distress, and Debt Covenants

This paper examines whether commercial lenders incorporate the information about financial distress contained in accruals into debt covenants. It documents that, controlling for earnings, accruals provide incremental information over standard variables used in models for predicting financial distress. It further shows that firms with extreme accruals are more likely to become distressed than firms with moderate accruals. This paper also examines one possible use of the information in accruals by commercial lenders.

Accruals Management with Financing and Investing Transactions

Accruals, the difference between income from continuing operations and cash flows from operations, result from accounting rules and journal entries for the recognition of revenues and expenses. Following Healy (1985) who examined the use of discretionary accruals by managers to manage earnings used in bonus calculation, the management of accruals for earnings management has been the subject of several dozen accounting studies. Healy (1985) defined discretionary accruals as “adjustments to cash flows selected by the manager” in order to affect reported net income.

Credit and Liquidity Risk in Bond and CDS Markets

Now a days, credit derivatives markets provide a standardized alternative to bond markets in taking on and selling off credit risk exposures. This development offers a new approach to one of the most widely explored problems in fixed income analysis the separation of the corporate bond spread into its credit risk and liquidity component.

The Pecking Order Theory and the Firm’s Life Cycle

There is ongoing debate about the empirical performance of the pecking order theory of financing proposed by Myers (1984) and Myers and Majluf (1984). The theory is based on asymmetric information between the firm’s investors and its managers. Due to the valuation discount that less-informed investors apply to newly issued securities, firms resort to internal funds first, and then debt and equity last to satisfy their financing needs.

Leverage, Options Liabilities, and Corporate Bond Pricing

The recent crisis in the subprime loan market has triggered an increase in the default risk of loans and mortgage backed securities, and has emphasized the importance of accurate credit spread estimation. Default risk is generally measured by a credit spread reflecting the additional compensation that an investor requires to accept the risk. In the 1990s, many contingent-claim pricing models were proposed and implemented. As default risk attracts more and more attention, correctly pricing a corporate bond becomes a greater concern for all finance practitioners.

Bank Loans, Bonds, and Information Monopolies across the Business Cycle

The idea that there are both costs and benefits to relying on bank debt is an integral part of the modern theory of corporate finance. As formulated by Rajan (1992), the pros and cons are as follows. Being relatively concentrated, bank debt has more incentive to monitor the borrower than does dispersed “arm’s length” debt. But then the private information which the bank gains through monitoring allows it to “hold up” the borrower if the borrower seeks to switch to a new funding source, it is pegged as a lemon regardless of its true financial condition.

The Effect of Monetary Policy on Credit Spreads

Capital market theories based on the credit view of monetary policy predict that a monetary policy shock would have a stronger impact on firms with limited access to capital markets. The exact transmission mechanism depends on the assumptions of the specific model. Models based on the balance sheet channel of monetary policy (e.g. Bernanke and Gertler (1989), Kiyotaki and Moore (1997)) argue that a firm’s balance sheet serves as a collateral in financial markets with information asymmetry between borrowers and lenders.

A Consumption-Based Explanation of the Cross Section of Expected Stock Returns

Explaining the size and value premia as a tradeoff between risk and return is an important challenge for asset pricing theory. The failure of the CAPM to explain the high average returns of small stocks relative to large stocks and value stocks relative to growth stocks has been well documented (cf. Fama and French (1992)). Mankiw and Shapiro (1986) and Breeden, Gibbons, and Litzenberger (1989) find that the Consumption CAPM (CCAPM) does no better in explaining the cross section of average stock returns.

Market Skewness Risk and the Cross-Section of Stock Returns

The volatility of the stock market index return is an indicator of market-wide risk, and the CAPM predicts that it is a determinant of the market equity premium. Recent studies by Ang, Hodrick, Xing and Zhang (2006) and Adrian and Rosenberg (2008) also demonstrate that contrary to the CAPM intuition, market-wide volatility risk is priced in the cross-section of stock returns. Given these findings, and given the overwhelming evidence in the literature that market-wide skewness and kurtosis are important indicators of market-wide risk, and that those risks do not co-vary perfectly with volatility risk, an investigation of higher moments of the market return as pricing factors in the cross-section of stock returns seems worthwhile.

Accrual Quality, Realized Returns, and Expected Returns: The Importance of Controlling for Cash Flow Shocks

There is an ongoing debate as to whether the quality of accounting information influences firms’ cost of equity capital. Much of the debate centers around the existence of a priced risk factor related to the quality of accruals. In an influential set of papers, Francis, LaFond, Olsson, and Schipper (2004, 2005) (henceforth, FLOS) argue that accrual quality affects the cost of equity. FLOS base their conclusions in part on a significant positive correlation between the returns on AQ Factor (the accrual quality factor) and contemporaneous stock returns.

The Effect of Cash Flow Forecasts on Accrual Quality and Benchmark Beating

When analysts provide forecasts of both earnings and operating cash flow, they also implicitly provide a forecast of total operating accruals. Thus, cash flow forecasts enable parties external to the firm to more readily decompose an earnings surprise into the portion attributable to unexpected cash flows and a portion attributable to abnormal accruals.

Does Conservative Stock Option Accounting Lead to Aggressive Cash Flow Reporting?

In this paper, we examine how the revised accounting for employee stock options affects the properties of reported cash flows. Although most investors are aware of the new option accounting required by FAS 123(R), relatively little attention has been given to the revised accounting for the tax benefit included in this standard. Yet, the tax benefit firms receive from employee stock options has been among the largest contributors to reported cash from operations since the rise in use of options plans. For example, during 2004, the tax benefit from employee stock options comprised over 25 percent of the operating cash flows for firms in our sample.

Executive Stock Options and Financial Analysts’ Forecast Behaviors

Companies approve a stock option plan to attract, retain, and motivate the CEOs and other top management on the behalf of shareholders. Thus, stock option awards are designed as a mechanism to align the interests of managers and shareholders. However, there is a controversy over whether executive stock option awards induce opportunistic managerial behavior which is adverse to shareholders interests, and this issue has been extensively investigated in academic work for the last decade. In this study, we attempt to provide further evidence on the role of stock options as a compensation scheme on the firm.

Executive Stock Option Exercises, Insider Information and Earnings Management

The last two decades have witnessed an enormous increase in stock and option-based executive compensation. The average stock option grant for top executives was a small fraction of CEOs’ total wages in the early 1980s, but has today become an important component of executive compensation (e.g., see Hall and Liebman (1998) and Murphy (1999)). Although traditionally it has been argued that stock-based compensation is necessary to align the interests of managers and shareholders, recent arguments, in light of the corporate scandals involving WorldCom, Enron, and others, have called into question the efficacy of stock-based compensation.

Debt Dilution and Maturity Structure of Sovereign Bonds

The last decade has witnessed recurrent large-scale sovereign debt crises in many emerging markets, and most of them were resolved by debt renegotiations after default. These observances have aroused much interest in how composition and maturity structure of sovereign debts affect a country’s default probability and debt renegotiation outcome.

Private-Activity Municipal Bonds: The Political Economy of Volume Cap Allocation

In 1986, the federal government placed a cap on the volume of tax-exempt municipal bonds that states can issue each year if the proceeds are used by private entities. The cap, in year 2000 dollars per capita, has ranged from just under $50 to over $400 depending primarily on a state's population. In most states and years, the cap appears to be binding, so state governments are allocating a scarce resource.

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