The objective of this paper is to compare the effectiveness of financial markets and financial intermediaries in financing new industries and technologies in the presence of diversity of opinion. In markets, investors become informed about the details of the new industry or technology and make their own investment decisions. In intermediaries, the investment decision is delegated to a manager, who is the only one who needs to become informed, which saves on information costs, but investors may anticipate disagreement with the manager and be unwilling to provide funds. Financial markets tend to be superior when there is significant diversity of opinion and information is inexpensive. Journal of Economic Literature Classification Numbers: G1, G2

We compare institutional execution costs across the major U.S. exchanges using a sample of institutional equity orders in firms that switch exchanges. Execution costs including commissions are essentially indistinguishable across these exchanges. We also find the fraction of trading volume from momentum traders is greater on the NYSE than either the Nasdaq or AMEX and that orders are more likely to be worked by an institution's trading desk on the NYSE than on the Nasdaq. These results suggest that institutions actively manage execution strategies, taking into account characteristics of the markets in which they trade

Households and businesses in the U.S. prefer to use checks over less costly means of payment. Earlier studies have focused on check “float” as an explanation for the continued popularity of this seemingly inefficient technology. We construct a general equilibrium model of check payment and show that the presence of float does not necessarily lead to inefficiency. However, we also identify two potential sources of inefficiency associated with check float: (1) if float is not always priced, then it acts as a distorting tax, and (2) inefficiencies can result if people engage in costly activities designed to accelerate check presentment. Journal of Economic Literature Classification Numbers: E58, G21, G28.

Brian Huge, David Lando; Swap Pricing with Two-Sided Default Risk in a Rating-Based Model *, European Finance Review, Volume 3, Issue 3, 1 January 1999, Pa

Edwin J. Elton, Martin J. Gruber, Christopher R. Blake; Common Factors in Active and Passive Portfolios, European Finance Review, Volume 3, Issue 1, 1 Janu

An important determinant of option prices is the elasticity of the pricing kernel used to price all claims in the economy. In this paper, we first show that for a given forward price of the underlying asset, option prices are higher when the elasticity of the pricing kernel is declining than when it is constant. We then investigate the implications of the elasticity of the pricing kernel for the stochastic process followed by the underlying asset. Given that the underlying information process follows a geometric Brownian motion, we demonstrate that constant elasticity of the pricing kernel is equivalent to a Brownian motion for the forward price of the underlying asset, so that the Black–Scholes formula correctly prices options on the asset. In contrast, declining elasticity implies that the forward price process is no longer a Brownian motion: it has higher volatility and exhibits autocorrelation. In this case, the Black–Scholes formula underprices all options

Richard A. Brealey, Ian A. Cooper, Evi Kaplanis; What is the International Dimension of International Finance?, European Finance Review, Volume 3, Issue 1,

Risk management methods based on Value-at-Risk estimate the lowest quantile of possible profits and losses over a fixed time horizon. To calculate this value there is a need to construct an approximation of the probabilistic distribution of P&L. One of the most popular techniques is based on an assumption that the portfolio value can be expressed as a deterministic function of some basic market parameters. Having a distribution of these parameters one can construct the distribution of the value function. The most popular method is delta approach. Here a first order expansion of the value function is used in order to approximate the distribution at the end of the period. Typically the time period is assumed short, in which case the changes in market parameters are distributed almost normally and under this linear approximation the value of the approximated portfolio is also normally distributed. Value-at-Risk methods based on a delta approximation can not take into account different forms of convexity. An appropriate solution to this problem is to consider a longer series expansion, for example the so-called delta-gamma approximation. However the delta-gamma approximation loses a very useful property of “delta only” approach ‐ linearity. This linearity property is very convenient computationally, since it guarantees that as soon as the market factors are distributed normally, the resulting changes in the portfolio value are also normally distributed. Denote by x a vector of n market parameters that can be easily measured and their historical distributions are known. For example stock prices, interest rates, exchange rates. Denoting the calendar time by t we can price a portfolio of assets V.t, x/. The Value-at-Risk measures the lowest 1% (sometimes 5%) quantile of the distribution of profits and losses of the fixed portfolio over a fixed time horizon (in banking for example 10 business days). The standard assumption of this measurement is that over a short time horizon the changes in the market factors 1x are normally distributed. If the value of the portfolio is linear in the market factors then the P&L distribution is normal as well and any quantile can be expressed analytically through its mean and standard deviation. However the assumption of linear dependence is often very restrictive, a higher order approximation is required to reflect convexity. Consider the value functionV.x,t/around the current market valuesx. As soon as the market changes are small and the function V smooth, we can use the Taylor expansion. However the variablex is stochastic. Thus instead of the standard series

Edwin J. Elton, Martin J. Gruber; Reflections on the Origins of the European Finance Association, European Finance Review, Volume 3, Issue 1, 1 January 199