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The past three decades have been characterized by vast change and crises in global financial markets—and not in politically unstable countries but in the heart of the developed world, from the Great Recession in the United States to the banking crises in Japan and the Eurozone. As we try to make sense of what caused these crises and how we might reduce risk factors and prevent recurrence, the fields of finance and economics have also seen vast change, as scholars and researchers have advanced their thinking to better respond to the recent crises. A momentous collection of the best recent scholarship, After the Flood illustrates both the scope of the crises’ impact on our understanding of global financial markets and the innovative processes whereby scholars have adapted their research to gain a greater understanding of them. Among the contributors are José Scheinkman and Lars Peter Hansen, who bring up to date decades of collaborative research on the mechanisms that tie financial markets to the broader economy; Patrick Bolton, who argues that limiting bankers’ pay may be more effective than limiting the activities they can undertake; Edward Glaeser and Bruce Sacerdote who study the social dynamics of markets and E. Glen Weyl, who argues that economists themselves are influenced by the incentives their consulting opportunities create.

This book presents an introduction to arbitrage theory and its applications to problems for financial derivatives. This second edition includes more advanced materials; appendices on measure theory, probability theory, and martingale theory; and a new chapter on the martingale approach to arbitrage theory. The chapters cover the binomial model, a general one period model, stochastic integrals, differential equations, portfolio dynamics, arbitrage pricing, completeness and hedging, parity relations and delta hedging, the martingale approach, incomplete markets, dividends, currency derivatives, barrier options, stochastic optimal control, bonds and interest rates, short rate models, forward rate models, and LIBOR and swap market models.

This book gives a comprehensive introduction to arbitrage theory for the pricing of contingent claims, such as options, futures, and other financial derivatives. The arbitrage theory for the term structure of interest rates is given particular consideration. Also included is a self‐contained exposition of stochastic optimal control, with applications to portfolio optimisation. The mathematical development is precise but avoids the explicit use of measure theory.

This book upends the conventional wisdom about asset allocation by showing that what matters aren't asset class labels but the bundles of overlapping risks they represent. The key, the book argues, is bad times, and the fact that every investor's bad times are somewhat different. The notion that bad times are paramount is the guiding principle of the book, which offers a new approach to the age-old problem of where an investor should put their money. This book argues that the traditional approach, with its focus on asset classes, is too crude and ultimately too costly to serve investors adequately. Instead it focuses instead on "factor risks," the peculiar sets of hard times that cut across asset classes, and that must be the focus of investors’ attention if they are to weather market turmoil and receive the rewards that come with doing so. Optimally harvesting factor premiums for an investor requires identifying personal hard times, and exploiting the difference between them and those of the average investor.

This book is intended as a textbook for asset pricing theory courses at the Ph.D. or Masters in Quantitative Finance level and as a reference for financial researchers. The first two parts of the book explain portfolio choice and asset pricing theory in single‐period, discrete‐time, and continuous‐time models. For valuation, the focus throughout is on stochastic discount factors and their properties. Traditional factor models, including the CAPM, are related to or derived from stochastic discount factors. A chapter on stochastic calculus provides the needed tools for analyzing continuous‐time models. A chapter on “ex‐plaining puzzles” and the last two parts of the book provide introductions to a number of current topics in asset pricing research, including rare disasters, long‐run risks, external and internal habits, real options, corporate financing options, asymmetric and incomplete information, heterogeneous beliefs, and non‐expected‐utility preferences. Each chapter includes a “Notes and References” section and exercises for students.

Relying on the existence, in a complete market, of a pricing kernel, this book covers the pricing of assets, derivatives, and bonds in a discrete time, complete markets framework. It is primarily aimed at advanced Masters and PhD students in finance. Topics covered include CAPM, non-marketable background risks, European-style contingent claims as in Black–Scholes and in cases where risk-neutral valuation relationship does not exist, multi-period asset pricing under rational expectations, forward and futures contracts on assets and derivatives, and bond pricing under stochastic interest rates. All the proofs, including a discrete time proof of the Libor market model, are shown explicitly.

Asset prices are driven by public news and information that is dispersed among many market participants. Traditional asset pricing theories have assumed that all investors hold symmetric information. Research in the past two decades has shown that the inclusion of asymmetric information drastically alters traditional results. This book provides a detailed up‐to‐date survey that serves as a map for students and other researchers navigating through this literature.

The book starts by introducing the reader to different knowledge, equilibrium, and efficiency concepts. After explaining no‐trade theorems, it highlights the important role of asymmetric information in explaining the existence and anatomy of bubbles. The subsequent overview of market microstructure models shows how information is reflected in prices and how traders can infer it from prices. Insights derived from herding models are used to provide explanations for stock market crashes. If investors have short horizons, price correcting arbitrage activity is limited and investors have a tendency to focus on the same (possible unimportant) news, a phenomena that led Keynes to compare the stock market with a beauty contest. The book concludes with a brief summary of bank runs and their connection to financial crises.

In summary, models with asymmetric information provide a better understanding of bubbles, crashes, and other market inefficiencies and frictions.

Banks and financial institutions are faced with two apparently conflicting phenomena — interest rate deregulation on the one hand and capital adequacy requirements and prudential norms on the other. In such a situation, these institutions need to work out a strategic framework which must evolve around the profit objective so as to build up quality loan-assets portfolios and to ensure adequate capital growth. This book provides a comprehensive analysis of lending strategies, credit appraisal, risk analysis, and lending decisions within the overall objectives of a lending organization. This revised edition takes into account recent global developments in the banking sector as well as changes in the notion of banking. It includes three new chapters in which the author discusses topical issues such as the impact of capital regulation on the risk attitude and profitability of banks, strategies to protect banks from a liquidity crisis, and the need of a portfolio approach in developing models for credit exposure and loan management within a risk–return framework.

Behavioral finance is the study of how psychology impacts finance. This book represents the first general, comprehensive treatment of the subject. The book explains how psychological phenomena impact the entire field of finance. Readers will learn to recognize the influence of psychology on themselves, on others, and on the financial environment at large. Psychology is the basis for human desires, goals, and motivations. Psychology is also the basis for a wide variety of human errors that stem from perceptual illusions, overconfidence, over‐reliance on rules of thumb, and emotions. Errors and bias cut across the entire financial landscape, affecting individual investors, institutional investors, analysts, strategists, brokers, portfolio managers, options traders, currency traders, futures traders, plan sponsors, financial executives, and financial commentators in the media.

Since financial myths exploded in the 1980s, the perspective of time creates a unique opportunity to update and expand the analysis begun in Glenn Yago's 1991 book, Junk Bonds: How High Yield Securities Restructured Corporate America (OUP). When first published, Junk Bonds drew controversial responses, but some 12 years later, enough time has passed to allow this dispassionate empirical analysis to shear away the hype and hysteria that surrounded the Wall Street scandals, Washington controversies, and media frenzy of the time. In retrospect, the evidence clearly casts favorable light on the role of high‐yield securities (junk bonds), and the research presented in this book demonstrates how financial innovations enabled capital access for industrial restructuring, capital and labor productivity gains, and improved global competitiveness. The book provides a one‐stop data, reference, and case study presentation of firms and securities in the contemporary high‐yield market in the USA (and elsewhere), and of the financial innovations that spurred growth in the 1990s and will continue to finance the future. The high‐yield market incubated successive waves of financial technologies that now proliferate beyond junk bonds to all the dimensions and dynamics of global debt and equity capital markets. The book charts the recovery of the market in the 1990s, the wave of fallen angels, distressed credits and defaults in 2001–2002, and suggests how the high‐yield market will be recreated in the global market of the twenty‐first century. It also explicates the linkages between the high‐yield market and other credit and equity markets in managing a firm's capital structure to execute its business strategy. Anyone active in corporate finance, financial institutions, or capital markets will find this book useful for interpreting and understanding the recent history of both the high‐yield marketplace and its interaction with private equity, public equity, and fixed‐income markets. The material presented is arranged in 11 chapters and four appendices. The latter provide definitions of junk bonds, some technical material from Ch. 4, a “tools of the trade” glossary, and a literature review containing short summaries of seven topics (bond ratings, macroeconomic relationships, regulation, use of proceeds, Drexel Burnham Lambert – a bond underwriter, default rates, and risk) with associated references, a table of annotated references, and further references.

Despite massive investment of money and research aimed at ameliorating third-world poverty, the development strategies of the international financial institutions over the past few decades have been a profound failure. Under the tutelage of the World Bank, developing countries have experienced lower growth and rising inequality compared to previous periods. This book argues that the controversial institution is plagued by a myopic, neoclassical mindset that wrongly focuses on individual rationality and downplays the social and political contexts that can either facilitate or impede development. Drawing on the examples of Africa, Asia, Latin America, and transitional European economies, this volume proposes an alternative vision of institutional development with chapter-length applications to finance, state formation, and health care to provide a holistic, contextualized solution to the problems of developing nations.

This volume reviews the most recent research on brain drain and brain gain, producing new original results by the means of data sources specifically assembled for this study, and addressing several key policy issues. Part I focuses on brain gain, that is, it takes the standpoint of the recipient country. The first section provides an overview of skill‐selective immigration policies in the main destination countries and of the major shifts in these policies which have been recently observed. It also documents the strong economic gains from immigration of highly skilled migrants. But what drives the decisions of highly skilled migrants as to where to locate? The econometric analyses performed by the authors indicate that it is mainly the labour market that is key to attracting talent, wage premia on education in particular. R&D spending also induces greater inflows of highly skilled migrants, while generous welfare benefits and strict employment protection end up attracting more unskilled workers. Part II is devoted to the consequences of brain drain, taking the point of view of the sending country. This second section provides for the first time a measure of the net global impact of the brain drain on sending countries. The results indicate that most developing countries experience a net gain from skilled emigration. Adverse overall impacts are found to be limited only to a subset of countries exhibiting very high skilled emigration rates. A number of policy recommendations are also offered to increase the benefits of brain drain.

Business cycle theory is a broad and disparate field. Different schools of thought offer alternative explanations for cycles, often using different mathematical methods. This book aims to provide academics and graduate students of economics with an exposition of business cycle theory since Keynes. The author places the main theories — Keynesian economics, monetarism, new classical economics, the real business cycles theory, and new Keynesian economics — in a historical context by presenting them in the chronological order of their appearance and highlighting their differences and commonalities. He minimizes the necessary mathematical prerequisites by using a unifying mathematical approach: stochastic second-order difference equations, which is explained in detail. Throughout the book, the international dimension of business cycles is acknowledged. The theoretical results obtained are set alongside empirical facts in separate boxes. Each chapter finishes with a set of problems designed to deepen the reader's understanding of the theories presented, and further reading sections providing access to related material.

This book is timely since the Basel Committee on Banking Supervision at the Bank for International Settlements is in the process of making major revisions in the capital rules for banks. It is important that capital adequacy regulation helps to achieve financial stability in the most efficient way. Capital adequacy rules have become a key tool to protect financial institutions. The research contained within the book covers some key issues at stake in the capital requirements for insurance and securities firms. The contributors are among the leading scholars in financial economics and law. Their contributions analyze the use of subordinated debt, internal models, and rating agencies in addition to examining the effect on capital of reinsurance, securitization, credit derivatives, and similar instruments.

Trustworthiness in the financial services industry was eroded by deregulation and the changes to industry structure and remuneration which followed. Deregulation was based on a belief that the self-interest of individuals would produce good outcomes (Adam Smith’s ‘invisible hand’) and economists’ belief in efficient markets took this idea further by assuming that all individuals are selfish and have no regard for the interests of other people. However although Smith accepted that individuals may be self-interested, he also believed that they have other-regarding motivations, including a desire for the approbation of others. This book argues that the trust-intensive nature of financial services makes it essential to cultivate such motivations, and provides proposals for how this might be done. The book suggests reforms of governance, and of legal and regulatory arrangements, to address these issues by seeking to change the ethical culture to one that reinforces ‘other-regarding’ behaviour. Such proposals would encourage firms and individuals in the financial services to act in a more trustworthy manner by focusing on four key requirements: the appropriate definition of obligations, the identification of corresponding responsibilities, the creation of mechanisms which encourage trustworthiness, and the holding to account of those involved in an appropriate manner. Financial reforms at present lack sufficient focus on these requirements. The book explores how these requirements can be better met in specific parts of the financial services industry so as to bring about better outcomes.

This book discusses major issues in corporate governance. The chapters concentrate upon the financing of corporations, and the role of the banks and stock markets in the United Kingdom, Germany, and Japan. A central theme of the book is a constant awareness of the links between the accountability of senior managers, the system of corporate governance, and the performance of a company. The chapters examine the role of shareholders, company boards, and managers under a market-based system as in the UK and USA, in comparison with the ‘insider’ system found in Japan and, to a lesser extent, Germany. They discuss the view that this UK system leads to a preoccupation with short-term corporate performance and a greater likelihood of hostile takeovers. The contribution of the banks to corporate finance and control is also examined, including a discussion of the special problems of small firms. The Japanese and the German financial and corporate systems are authoritatively analysed.

This book provides a systematic account of the privatization process at the global scale, presenting an overarching description of the phenomenon, and panel data empirical analyses testing some of the predictions of the recent economic theory of privatization. At the macroeconomic level, privatization processes of the 1980s and 1990s are shown to be a cyclical phenomenon shaped by economic, political, and institutional determinants. At the microeconomic level, privatization has been partial and incomplete, with only minority rights transferred to the private sector. However, genuine privatization, involving the full transfer of control to the private sector, is difficult to achieve as several conditions must be met. First, markets should be competitive or suitably regulated. Second, private investors should be adequately protected by the law in order to avoid expropriation. Third, political institutions should be designed to limit the veto power of constituencies ousting full divestiture. Last but not least, governments should be credibly committed not to interfere post-privatization in the operating activity of the companies. As a consequence, private ownership is likely to coexist with public control, at least in the near future.

Britain's income distribution is like a multi-story apartment building with the numbers of residents on the different floors corresponding to the concentration of people at different income levels in any particular year. The poorest are in the basement, the richest are in the penthouse, and the majority somewhere in between. But what are the dynamics of occupancy patterns? Snapshots of the building register at different times tell us nothing about these. Over time, how much movement between floors is there, and has the frequency of moves or the distance travelled been changing over the last two decades? In particular, is there much turnover in the basement, and do basement dwellers ever reach the penthouse? Who moves the most and how far? What are the factors associated with movements up and down the income tower over time? This book addresses such questions with extensive new analysis based on data from the British Household Panel Survey (BHPS) covering 1991–2006, providing a comprehensive and original study of income mobility and poverty dynamics. There is detailed discussion of why longitudinal perspectives on the income distribution are of interest, and of the relevant concepts and measures. There is in-depth discussion of the BHPS and its household income data, and comparisons with other national and international longitudinal data sources. The book shows that patterns of income mobility in Britain have not changed over the last two decades but fewer people are persistently poor, and it discusses the reasons for these trends.

This book surveys the law and policy of regulating information flows in capital markets. Part I begins with an overview of the themes, regulatory principles, and challenges that animate information policy, and describes the principal industry, self-regulatory, and regulatory bodies that participate in the governance of information flows in capital markets. Part I further surveys four categories of information in the information production chain: corporate disclosures, quotation and transaction information, information used in credit analysis, and benchmarks. The book discusses how each category of information is generated and used and the reasons why regulators seek to intervene in its production or use. It also provides a summary of the relevant framework for securities regulation in the United States, European Union, and other jurisdictions. Part II articulates several objectives of information policy in capital markets—ensuring transparency and access, promoting standardization and higher orders of meaning, and upholding integrity. This Part considers how regulatory aims differ by category and surveys alternative regulatory strategies, often with a view to replacing relatively inflexible regulatory frameworks with more flexible market mechanisms. Part III considers three specific challenges to capital markets regulation—automation, information overload or anxiety, and globalization—and how they affect the utility, integrity, and availability of information flows. This Part assesses the strategies by which policy makers have confronted these challenges, and offers some concluding thoughts on the implications of these phenomena for financial regulation and information policy.

China’s Banking Transformation explains how Chinese banks work, analyzes their strengths and weaknesses, and sets forth the challenges they face in a slowing economy. Based on his twelve years of service on the boards of Chinese banks, the author brings the informed view of an insider to explaining the reality of China’s banks. Without minimizing the real issues Chinese banks face, China’s Banking Transformation challenges negative media accounts and reports of “China bears.” China’s Banking Transformation demonstrates that Chinese banks have transformed into modern, well-run commercial banks, playing a vital role supporting China’s economic growth. Acknowledging that China’s banks are different from Western banks, the author explains that they are hybrid banks, borrowing from Western models, but at the same time operating within a traditional Chinese cultural framework and in line with China’s governance model. From personal experience at the board level, Stent describes the governance and management of China’s banks, including the role of the Communist Party. He sees China’s banks as embedded in ancient concepts of how government and society work in China, and also as actors within market socialism. As the first account of Chinese banking by a Westerner who has worked in China’s banks, China’s Banking Transformation will interest anyone interested in the political economy of contemporary China, in Asian development issues, and in the banking industry. The book dispels misconceptions and provides insight into the financial aspects of China’s economic growth story.