This paper studies the impact of financial development on asset valuation. We model the agency theoretic perspective of risk-averse investors and financiers in a general equilibrium setting under the framework of rational expectations (i.e., symmetric information). We focus on real estate, as it constitutes a special case of complete market contracting where adverse selection and moral hazard are easily mitigated. Our results illustrate an increase in pareto-efficiency, as financial architecture advances from: (i) banks to capital markets; and (ii) plain vanilla debt to an innovative one with participation clauses. This is attributed to the reduction in agency costs and cross-sectional risk-sharing, leading to an increase in the value of property. Our results predict that an optimal financial system will orient itself towards efficient financial contracts, irrespective of its source of origination. We also rationalize the co-existence of banks and capital markets, and generalize our results under a set of restrictive conditions.

This paper studies the imposition of position limits on commodity futures from the perspective of curbing excessive speculation and thus manipulation. We present a simple general equilibrium model in a static rational expectations framework and agent heterogeneity to illustrate that excessive speculation serves to enrich other agents at the expense of the speculator. Position limits, on the contrary, are not only superfluous, but also counter-productive, as they exacerbate market power and lead to a deterioration in efficiency. Position limits not only reduce social welfare but also cannot restrain market manipulation.

This paper studies pension fund design in the context of investment in the debt and equity of a firm. We employ a general equilibrium framework to demonstrate that: (i) the asset location ‘puzzle’ is purely a partial equilibrium phenomenon, conceived in a risk neutral setting, that disappears with the introduction of sufficient risk aversion; (ii) the inability of policy makers to manage an economy with multiple firms yields a mixed equilibrium, where bonds are observed in both taxable and tax-deferred accounts; and (iii) the Pareto-efficient pension plan comprises of a defined benefit plan.

Securitization enhances liquidity of debt contracts. However, its structural deficiency at origination has led to the freezing of its secondary market and failure of institutions holding the collateral. This paper builds on key cultural (i.e., Islamic) rulings to rectify flaws entrenched in securitized debt stemming from asymmetric information and agency issues. These injunctions help in the efficient underwriting of debt contracts across the globe to: (i) redeem its ‘toxicity’; (ii) guarantee liquidity; (iii) alleviate fragility of the financial system; and (iv) promote economic growth. Finally, this study promotes a rethink of the current ‘Islamic’ financial system from a narrow literalist juridical perspective to one that is grounded in financial economics.

We employ Amortizing Participation Mortgage (APM) to offer a novel ex post renegotiation method of a foreclosure. APM belongs to the family of home loan credit facilities advocated in the Dodd–Frank Wall Street Reform and Consumer Protection Act 2010. In our framework, APMs reduce the endemic agency costs of debt by improving affordability. These benefits increase the demand for real estate in bust times and reduce fragility of the financial system thereby preventing foreclosures. We evaluate APMs in a stochastic control framework and provide solutions for an optimal amortization schedule. We generalize our approach to partially amortizing and commercial mortgages which encompass balloon payments. Finally, we provide concrete numerical examples of home loan modifications. We also offer detailed sensitivity analysis to market parameters such as house price volatility and interest rates.

This paper establishes a basic framework to study three different variants of Participating Mortgages (PMs). We obtain results for Shared Appreciation Mortgages (SAMs), Shared Income Mortgages (SIMs) and Shared Equity Mortgages (SEMs) in closed-form. We illustrate our findings with examples that show PMs are also attractive in an environment where prepayment can occur. Finally we conclude with the public policy implications of employing PMs as workout loans, especially post sub-prime crisis. We argue that by facilitating better risk sharing, PMs offer a means to enhance the efficiency and resiliency of the financial system.