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1151. Was There Front Running During the LTCM Crisis?

Author:
Fang Cai
Publication Date:
02-2003
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper uses a unique dataset of audit trail transactions to examine the trading behavior of market makers in the Treasury bond futures market when Long-Term Capital Management (LTCM) faced binding margin constraints in 1998. Although identities are concealed in the dataset, I find strong evidence that during the crisis market makers in the aggregate engaged in front running against customer orders from a particular clearing firm (coded “PI7”) that closely match various features of LTCM's trades through Bear Stearns. That is, market makers traded on their own accounts in the same direction as PI7 customers did, but one or two minutes beforehand. Furthermore, a significant percentage of market makers made abnormal profits on most of the trading days during the crisis. Their aggregate abnormal profits, however, were more than offset by abnormal losses realized after the private sector recapitalization of LTCM. Moreover, I show that before the rescue, a market maker's cumulative abnormal profit was positively correlated both to her tie as contra party with PI7 and to the intensity of her front running, but these relationships turned negative after the rescue. The overall evidence suggests that the recapitalization plan effectively relaxed LTCM's binding constraints and therefore reversed the profitability of front running.
Topic:
Economics, Emerging Markets, and International Trade and Finance
Political Geography:
United States

1152. Transmission of Information Across International Equity Markets

Author:
Jon Wongswan
Publication Date:
02-2003
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper provides evidence of transmission of information from the U.S. and Japan to Korean and Thai equity markets during the period from 1995 through 2000. Information is defined as important macroeconomic announcements in the U.S., Japan, Korea, and Thailand. Using high-frequency intraday data, I focus the study on return volatility and trading volume because the implications of new information are much clearer than for returns. I find a large and significant association between emerging-economy equity volatility and trading volume and developed-economy macroeconomic announcements at short-time horizons. This is the first strong evidence of this sort of international information transmission. Previous studies' findings of at most weak evidence may be due to their use of lower frequency data and their focus on developed-economy financial market innovations as the measure of information.
Topic:
Economics and International Trade and Finance
Political Geography:
United States, Japan, Asia, Korea, and Thailand

1153. Annual Industrial Capabilities Report to Congress

Publication Date:
02-2003
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Section 2504 of title 10, United States Code, requires that the Secretary of Defense submit an annual report to the Committee on Armed Services of the Senate and the Committee on Armed Services of the House of Representatives, by March 1st of each year.
Topic:
Defense Policy, Economics, Industrial Policy, and Science and Technology
Political Geography:
United States

1154. Consumption, Durable Goods, and Transaction Costs

Author:
Robert F. Martin
Publication Date:
01-2003
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We study consumption of durable and nondurable goods when the durable good is subject to transaction costs. In the model, agents derive utility from a service flow of a durable good and a consumption flow of a nondurable good. The key feature of the model is the existence of a fixed transaction cost in the durable good market. The fixed cost induces an inaction region in the purchase of the durable good. More importantly, the inability to adjust the durable stock induces variation in consumption of the nondurable good over the inaction region. The variation is a function of the degree of complementarity between durable and nondurable goods in the period utility function, the rate of intertemporal substitution, and a precautionary motive induced by incomplete markets. We test the model using the PSID. Housing serves as the durable good. The data indicate an increase in consumption before moving to a smaller house and a decrease in consumption before moving to a larger house. This result is consistent with the model when there exists complementarity between the durable and nondurable good or when there is a strong precautionary effect.
Topic:
Economics, Industrial Policy, and International Trade and Finance
Political Geography:
United States

1155. Diversification, Original Sin, and International Bond Portfolios

Author:
Francis E. Warnock and John D. Burger
Publication Date:
01-2003
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
While there is a severe home bias in U.S. investors' foreign bond portfolios, we find that portfolio weights are greater for countries with more open capital accounts and whose bond returns are less correlated with U.S. returns. Positions in local-currency-denominated bonds are particularly sensitive to past and prospective returns volatility. An analysis of changes in portfolio weights over time indicates that U.S. investors have recently moved out of smaller markets and those with low and declining credit ratings. Our data also allow for an analysis of the size and currency composition of international bond markets. We find that countries with stronger institutions and better inflation performance have larger local currency bond markets. An implication for developing countries is that creditor friendly policies, such as vigilance on the inflation front and the development of strong institutions, can enable local bond market development and may in turn attract global investors.
Topic:
International Relations, Economics, and International Trade and Finance
Political Geography:
United States

1156. Long-Run Supply Effects and the Elasticities Approach to Trade

Author:
Joseph E. Gagnon
Publication Date:
01-2003
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Krugman (1989) argued that differences across countries in estimated income elasticities of import demand are due to omission of an exporter supply effect. He showed that such an effect can be derived in a theoretical model with economies of scale in production and a taste for variety in consumption. In his model, countries grow by producing new varieties of goods, and they are able to export these goods without suffering any deterioration in their terms of trade. This paper analyzes U.S. import demand from different source countries and finds strong evidence of a supply effect of roughly half the magnitude (0.75) of the income elasticity (1.5). Price elasticities for the most part are estimated close to -1, which is typical for the literature. Exclusion of the supply effect leads to overestimation of the income elasticity. Results based on U.S. exports to different destinations are less robust, but largely corroborate these findings.
Topic:
International Relations, Economics, and International Trade and Finance
Political Geography:
United States

1157. Hidden Costs of War

Author:
William D. Hartung
Publication Date:
03-2003
Content Type:
Working Paper
Institution:
Fourth Freedom Forum
Abstract:
The Bush administration's war on terrorism and its proposed military intervention in Iraq have sparked the steepest increases in military and security spending in two decades. Since September 11, 2001, the federal government has approved over $110 billion in increased military spending and military aid. Spending on national defense is slated to reach $399 billion in the Fiscal Year 2004 budget, and to rise to over $500 billion annually by the end of this decade. These vast sums do not include the costs of the ongoing war in Afghanistan or a war with Iraq. Steven Kosiak of the Center for Strategic and Budgetary Assessments estimates that only 5 to 10 percent of the Fiscal Year 2003 Pentagon budget is being set aside for anti-terror activities and homeland security.
Topic:
Security, Economics, Government, Terrorism, and War
Political Geography:
Afghanistan, United States, Iraq, and Middle East

1158. Individual Unemployment Accounts

Author:
Lawrence Brunner and Stephen M. Colarelli
Publication Date:
10-2003
Content Type:
Working Paper
Institution:
Independent Institute
Abstract:
The unemployment compensation system in the United States is out of date and in trouble. The system has four fundamental problems: (1) during recessions, it often cannot meet its financial obligations without federal aid or deficit spending; (2) it is out of step with the structural and cultural realities of the modern workforce; (3) it encourages layoffs and unemployment; and (4) it operates in isolation from other programs related to employment and financial security. We propose an alternative unemployment policy based on the individual unemployment account (IUA). The IUA would be a mandatory and portable individual trust to which the employer and employee contributed. It shifts control and responsibility from the employer and the state government to the employer and the employee, and it is compatible with the realities of a twenty-first-century economy. We begin by providing an overview of how the current unemployment insurance system works and discussing its problems. We then describe an alternative unemployment policy based on IUAs and discuss the benefits of such a policy.
Topic:
Economics, Government, and Human Welfare
Political Geography:
United States

1159. Are We Taking China's Future for Granted?

Author:
Joseph C. Folio
Publication Date:
09-2003
Content Type:
Working Paper
Institution:
Institute for the Study of Diplomacy, Edmund A. Walsh School of Foreign Service, Georgetown University
Abstract:
During Fall 2003 the Schlesinger Working Group held two meetings (September 25th and November 3rd) to explore China's estimated political/ economic outlook and to determine what potential challenges might affect its projected future. The purpose of these meetings was not to predict a Chinese stumble or even collapse, but rather to examine events that could trigger a disruption of China's current, impressively successful economic trajectory, and to analyze what form that disruption could take. During the first meeting, participants identified potential disruption scenarios to which China remains vulnerable. The second meeting considered the implications of disruption for both China and the United States, and how these scenarios might affect U.S. policy. Working Group members did not attempt to assign probabilities for the identified potential disruptions or “failures.” Rather, they focused on the hurdles or challenges posed by these disruption scenarios, which the Chinese leadership would need to confront successfully in order to avoid losing control or endangering national cohesion. Participants generally agreed that any major disruption would most likely derive from an external shock that might negatively affect China's economic situation and possibly ignite collateral internal disruption via domestic unrest or leadership division. The group concurred that the Chinese leadership has sufficient strength and cohesion to manage most forms of internal disruption, or at least to adapt quickly and effectively to those that arise.
Topic:
International Relations, Diplomacy, and Economics
Political Geography:
United States and China

1160. Living at the Edge: America's Low–Income Children and Families

Author:
Hsien-Hen Lu, Julian Palmer, Younghwan Song, Mary Clare Lennon, and J. Lawrence Aber
Publication Date:
10-2003
Content Type:
Working Paper
Institution:
Institute for Social and Economic Research and Policy at Columbia University
Abstract:
By analyzing data from the Current Population Survey March Supplements, Living at the Edge explores the following questions about children in low-income families in the United States: What are the overall changes in the low-income and poverty rates for children over the past quarter century? How has the population of children in low-income families changed over the past decade? Which children are more likel to live in low-income famlies? How have changes in parental employment status affected the likelihood children living in low-income families? What are the state by state variations in child low-income and poverty rates, and how have these changed in the last decade? How does a more inclusive definition of family income and expenses affect our understanding of the poverty and near-poverty rates of children in low-income families?
Topic:
Economics, Human Welfare, and Industrial Policy
Political Geography:
United States