Published, peer-reviewed and working papers
TECHNOLOGICAL FINANCE IN HISTORICAL PERSPECTIVE
Co-authored chapter in The Handbook of Technological Finance (Rau, Wardop and Zingales, eds.) 2021.
Technological advances often allow innovations in finance to emerge or develop more quickly. History offers numerous examples of such innovations. In this chapter, we focus on four historical case studies in microfinance, junior market initial public offerings, consumer lending and private currency. We show that while the private sector can generally be counted on to address previously unmet needs, financial innovations attract the attention of the state. As something of a warning to present day practitioners, all four cases illustrate how an initially laissez-faire regulatory regime preceded restrictive regulation, in some cases to the point of completely eliminating the emerging industry.
REVISITING SUBPRIME PRICING IRRATIONALITY DURING THE GLOBAL FINANCIAL CRISIS
With Walter Janssen, Bank of England
Journal of Financial Crises. 2021.
During the depths of the global financial crisis of 2008-2009, many holders of subprime mortgage securitizations and related derivatives were forced to mark their investments to “fair” values based on observable prices in mortgage index credit default swap markets. Research has generally claimed that crisis pricing of such indexes cannot be explained by a fundamental analysis of the underlying markets, supporting the popular opinion that marking portfolios to such “irrational” benchmarks may have contributed to severe distress in the financial sector. This paper econometrically demonstrates significant fundamentally-driven components in subprime mortgage index returns throughout the crisis. Our findings suggest that such benchmarks must be considered reasonable, though imperfect, guides for determining fair value.
HOW TOXIC WERE US SUBPRIME MORTGAGES?
This paper examines the ex post performance to October 2020 of Aaa/AAA-rated subprime mortgage-backed securities issued from 2005-7. Even after rescue packages for homeowners and mortgage investors as well as general monetary and fiscal stimuli that sent US house prices and the economy to record levels post-crisis, subprime-backed securities have behaved much worse than their original ratings implied, with further losses still expected. While government policies healed almost every financial market, US subprime markets remain the prime example of long-term negative effects of poor financial product design, misaligned incentives and incorrect market assumptions.
ON THE WRONG SIDE OF HISTORY: THE BANKERS OF THE FEDERAL ADVISORY COUNCIL AND THE GREAT DEPRESSION
With Craig Mcmahon, Villanova. 2021.
Friedman and Schwartz, along with many others, blame the Federal Reserve’s policies for deepening and lengthening the Great Depression. Records reveal that private sector bankers advising the Federal Reserve Board advocated for some of the policies now condemned by many experts. As the state implemented experimental New Deal solutions in the 1930s, the bankers instead argued for orthodox monetary and fiscal policies. To the extent that the Fed mismanaged the economic recovery, the advisory bankers shared those error-ridden views while growing more reactionary against federal government involvement in the economy.
SHADOW CREDIT, THE FED AND THE CRASH OF 1929
In the 18 months leading up to the crash of 1929, an unprecedented 30 to 40 percent of all share investments in the U.S. were purchased using non-bank “shadow” credit. The credit pyramid that developed outside of the traditional money and banking markets was the direct result of corporations and trusts lending the proceeds of newly issued securities to speculators who were buying these same shares and bonds. This system was uncorrelated to and separated from traditional monetary markets and therefore the central bank monetary policy tools available to the US Federal Reserve would have been ineffective.
REVISITING THE 1929 STOCK MARKET BUBBLE
The little evidence that exists for a bubble on the New York Stock Exchange (NYSE) before the crash of 1929 includes investment trust pricing and the changing characteristics of the market for loans that financed share purchases. This short paper uses primary source evidence and quantitative modeling to demonstrate that the data from the NYSE loan market do not support assertions that market participants were aware that the late-1920s rise in the stock market was a bubble, or that they expected a crash in 1929.
COMMODITY OPTION PRICING BEFORE BLACK, SCHOLES AND MERTON
Economic History Review, 2020.
It is often thought that the arrival of the Black Scholes Merton (BSM) model of option pricing in the early 1970s allowed traders to understand how to price and value options with greater precision. Yet, our study suggests that interwar commodity option traders may have been able to intuit ‘fair’ value and to adjust their prices to changes in the market environment well before the advent of this innovative model. A scarcity of historical price data has limited empirical tests of option price efficiency well before BSM to prior studies of stock options in the 1870s and the early twentieth century which reach contrasting findings. This study deals with option pricing in a different market – commodities – during the interwar period. We conclude that option prices were closer to their BSM theoretical values than suggested by prior studies. Institutional differences between interwar commodity options market and stock option markets in the 1870s and the early twentieth century may partly account for this result. Furthermore, we find that interwar option prices were no more mispriced and were as sensitive to changes in volatility – the key valuation parameter in the BSM model – as in modern times.
EHS Long Run blog post here: Link
THE GOVERNMENT OF MARKETS - HOW INTERWAR COLLABORATIONS BETWEEN THE CBOT AND THE STATE CREATED MODERN FUTURES TRADING
Palgrave Histories of Finance, 2019
Absent evidence to the contrary, it is usual assumed that US financial markets developed in spite of government attempts to regulate, and therefore laissez faire is the best approach for developing critically important and therefore enduring market institutions. This book makes heavy use of extensive archival sources that are no longer publicly available to describe in detail the discussions inside the CBOT and the often private and confidential negotiations between industry leaders and government officials. This work suggests that, contrary to the accepted story, what we now know of as modern futures markets were heavily co-constructed through a meaningful long term collaboration between a progressive CBOT leadership and an extremely knowledgeable and pragmatic US federal government. The industry leaders had a difficult time evolving the modern institutions in the face of powerful reactionary internal forces. Yet in the end the CBOT, by coopting and cooperating with federal officials, led the exchange and Chicago markets in general to a near century of global dominance. On the federal government side, knowledgeable technocrats and inspired politicians led an information and analysis explosion while interacting with industry, both formally and informally, to craft better markets for all.
ALTERNATIVE FINANCE: AN HISTORICAL PERSPECTIVE
Financial History Review, 2019.
Innovations in the world of alternative finance such as online consumer lending, fund-raising platforms and cryptocurrencies are proceeding apace. In this article, we examine three historical case studies of newly emerged non-bank financial markets and discuss the possible implications for today’s alternative finance markets. The first insight is that the private sector can generally be counted on to meet previously unmet needs. Moneylenders filled a gap unaddressed by the banking system of the day. Junior market IPOs provided access to funds for smaller companies that might otherwise have struggled to raise external finance. Private currencies replaced sovereign coins in transactions at various points in history. The second insight, however, is that new financial markets and instruments eventually attract the attention of regulators. Finally, these examples are a warning to industry not to take for granted that an initially laissez-faire regulatory regime precludes a stronger response at some point in the future. In all three cases, tougher regulation – in some cases even to the point of shutting down the products and markets concerned – arrived after long periods of observation and deliberation by the state.
CAN INFLATION EXPECTATIONS BE MEASURED USING COMMODITY FUTURES PRICES?
With D'Maris Coffman, UCL. Structural Change and Economic Dynamics, 2018.
This paper reexamines the use of US commodity futures price data to show that the US deflation of 1929–1932 was at best no more than partially anticipated by economic actors. By focusing on the expected real interest rate, previous studies provide some empirical support for explanations of the Great Depression that are not exclusively monetary in nature. However, these studies did not consider the context and the market microstructures from which the data was sourced. Our analysis suggests that it is more likely that agricultural commodity markets adjusted to deflationary expectations by the end of 1930. Evidence from commodities futures markets, such as the Chicago Board of Trade, therefore should not be used to critique the Keynesian challenge to the classical monetarist explanation of the Great Depression.
REPUTATION RISK MANAGEMENT IN FINANCIAL FIRMS: PROTECTING (SOME) SMALL INVESTORS
Financial Regulation and Compliance, 2014.
This paper examines a regulatory regime for retail structured financial products to determine whether there are effective constraints on mis-selling. Based on new primary research, including interviews with decision makers at a large subset of Canada’s wealth managers and other market participants, I have analyzed firm characteristics and internal approval processes for many different retail financial firms. By also accumulating data on actual product failures and some evidence of failures avoided, I was able to identify associations between structures and policies at these financial firms and past outcomes from the marketing of complex, and arguably unsafe, financial investment products to retail investors.