Welcome to the Public Interest Paper section. Here we store shorter papers written for expository reasons or to encourage policy debate. Longer and more technical papers can be found on the Technical Papers page.

Certification and quality signalling: regulatory reform for the ratings industry   In financial contexts such as credit rating and carbon trading, information provision has effectively become certification, highlighting the systemic importance of whether the information is fit for the intended purpose. System regulators can enhance the credibility of information signalling if agencies are offered a registration facility that sequesters part of their fee as a performance bond. Agencies can then signal the value of the rating by choosing whether or not to register and stake part of their fee. A real option analysis can be used to value the registration choice, and hence the amount that is spent by issuer on the incremental quality of research required. The framework can also inform margin and penalty setting by regulators; while an ex ante choice to register is a potential defence in professional liability litigation.   Click Here To Download

The bonus pool, mark to market and free cash flow   Proposals from G20 or national regulators that seek to limit or govern bonuses in the banking finance industry in the interests of systemic stability need to be grounded in the financial economics of producer surplus and its distribution. In this respect, existing treatments of economic agency in justifying large bonus awards are content to accept accounting P&L numbers as a basis for the managerial bonus pool. We argue that managerial bonuses and shareholder dividends should be treated more symmetrically, and constrained by free cash flow criteria that capture producer surplus created by genuine managerial ability. Priority rules should apply, such that fair market value is a compensation for shareholder risk bearing and not a source of managerial surplus. The use of free cash flow conversion ratios neutralises the free option problem that has become a social irritant in public bailouts.   Click Here To Download

Credit securitisation, information, and system stability   The leveraging of credit that precipitated the subprime crisis was vectored via a proliferation of investment vehicles and credit derivatives, driven in part by competitive pressures to enhance returns by economising on economic capital. Theoretically, this should have spread risk and improved economic efficiency, but in practice it exposed the system to a meltdown. Critical points for system stability are the certification of credit equivalence required by decentralised information trading, and the portfolio equivalence of credit default swaps and the physical loan book. Regulatory implications encompass the trade off between collateral and economic capital in liability recognition for credit default swaps; enhanced tests for fiduciary duty; managerial reward regimes; and periodic regulator advisories as to state dependence of credit ratings.   Click Here To Download

The subprime crisis and the economic fallout   The subprime crisis, as it was called in early 2007, has blown up into a global credit crunch. The economic fallout has converted what might otherwise have been a more or less routine recession into the prospect of something much worse: a full scale economic depression. Governments round the world are following a convergent policy path to try to stave off the prospect. It is dominated by good old fashioned Keynesian deficit financing and in some cases bad old fashioned money printing; involving financial bailouts or guarantees, and likewise some mega scale fiscal rescues. This public interest paper takes the form of a set of slides prepared for public lectures by Roger Bowden, and updated to early March 2009. They outline in non technical terms the causal influences and sequences, the current state, policy choices, and future prospect for the financial and economic system.   Click Here To Download

The NZ term structure: Going long in infrastructure   The NZ term structure of interest rates is long in liquidity at the short end of maturities, but entirely absent at the long end. This entails market completion and other welfare problems, notably in encouraging long term saving, retirement income support, tax non-neutralities, public sector funding, insurance support, and other exigencies. A possible issuance role for a sovereign infrastructure fund is mooted in connection with long term debt issues to support infrastructure funding. Equity in the special investment vehicle (ISFV) or fund takes the form of preference shares. The IFSV invests in primary debt securities written by state or local government to fund IFS projects and repackages these into asset backed securities issued to the public. The proposed generic structure facilitates the funding of cooperative IFS ventures involving central and local government together with private equity partnerships and can be adapted to a trans-Tasman facility. Synergistic enhancements include lifecycle derivatives and retirement funding.   Click Here To Download

An overview of ordered mean difference portfolio technology   The ordered mean difference construction provides a metric for investor surplus in the form of a simple spreadsheet construction relating the returns on a designated security or portfolio to those on a given benchmark. The metric itself is well grounded in utility theory, and represents alternative attitudes towards risk in the form of risk profiling against a range of possible investor preferences. This paper reviews the basis of the construction in non technical terms and shows how it can be applied to a range of problems in portfolio practice and related investment or risk management situations. These cover performance measurement, mispricing and anomalies, CAPM testing, risk profiling, portfolio enhancement, hedging, portfolio choice algorithms, and stochastic dominance. Discussion is illustrated with examples drawn from recent research papers in the area.   Click Here To Download