EconSouth (Second Quarter 2004)
Research Notes and News
Research Notes and News highlights recently published research as well as other news from the Federal Reserve Bank of Atlanta.
future of Wall Street
In the aftermath of well-publicized scandals in recent years, Wall Street firms have seen their credibility with investors fall and have been taken to task by legislative, regulatory, and judicial authorities. Newly enacted or proposed regulations seek to institute more control over these firms business practices and reporting processes.
What effect will the new and proposed regulations have on Wall Street firms? That question was debated by participants, including financial industry practitioners, academics, and regulators, at the Federal Reserve Bank of Atlantas 2004 Financial Markets Conference, titled Wall Street Against the Wall: Transparency and Conflicts of Interest. Among the speakers at the conference, held on Sea Island, Ga., in mid-April, were Alan Greenspan, chairman of the Federal Reserve Board; William McDonough, chairman of the Public Company Accounting Oversight Board; Richard Baker, U.S. congressman; and Gerald Corrigan, a managing director with Goldman Sachs.
Academic and policy papers presented and discussed at the conference examined several important considerations facing financial firmsincluding mutual funds, investment banks, and stock exchangesas well as regulators as reforms are established and enforced. Conference participants discussed the amount of regulation necessary to protect investors without severely limiting financial trade.
In his remarks, Fed Chairman Alan Greenspan weighed in on this issue, stating that theres no better antidote for the business and financial transgressions of recent years than to reward trust and integrity in the marketplace. He cautioned that lawmakers and regulators must be careful not to undermine the paradigm that has so effectively governed voluntary trade. Rewriting rules that have served us well is fraught with the possibility for collateral damage.
As U.S. core inflation measures have declined in recent years, analysts have renewed their efforts to understand inflation dynamics. A common approach to this issue is to make inferences about how price changes of major components affect the aggregate inflation rate. In a recent article, Andrew Bauer, Nicholas Haltom, and William Peterman take a more rigorous approach, calculating and plotting the precise contributions of major consumer expenditure categories to core inflation measures over time.
This technique has distinct advantages. It highlights the underlying trends in inflation, enabling analysts to make more informed inferences about the near-term direction of inflation. It also allows analysts to distinguish broad-based changes in inflation from changes due to relative price movements of a few components.
The analysis focuses on the core components of the consumer price index (CPI) and the personal consumption expenditures price index (PCEPI). Over the long term, the authors note, the composition of core services inflation has remained relatively stable while the composition of core goods inflation has changed dramatically. Over the 2002Ð03 period, movements in core inflation measures resulted mainly from significant relative price changes of two components that were persistent enough to alter the path of core inflation for a sustained period, the authors conclude.
The results of this study highlight the importance of gauging the impact of relative changes in a low-inflation environment and suggest that recent concern about overall price deflation was perhaps overstated.
First Quarter 2004
A look at regulating
Many of the benefits that the housing government-sponsored enterprises (GSEs) transmit to homebuyers stem from an implied federal guarantee arising from the GSEs charter benefits and past supervisory forbearance. But this implicit guarantee also represents a risk to taxpayers if one of these GSEsFannie Mae, Freddie Mac, or the Federal Home Loan Bank (FHLB) Systembecomes insolvent and the government provides financial assistance.
In the wake of a $5 billion accounting restatement by Freddie Mac in 2003, concerns about taxpayer liability associated with the housing GSEs have led to various legislative proposals to reorganize their regulatory oversight. A recent article by W. Scott Frame and Lawrence J. White discusses these proposals, drawing on lessons from U.S. banking regulation to identify and evaluate the points of contention.
The legislative proposals generally pertain to institutional design (where the safety-and-soundness regulator is located, how it is funded, and whom it should supervise) and institutional authorities (for example, discretion to alter capital requirements and the ability to appoint conservators and receivers).
With respect to institutional design, Frame and White conclude that there may not be a clearly dominant approach. In regard to institutional authorities, the authors recommend that the safety-and-soundness regulator have responsibility for approving new programs and other activities, the discretion to set both minimum and risk-based capital requirements, receivership authority, and other enforcement authorities comparable to the federal banking agencies.
Second Quarter 2004
Link between seasonal
depression, markets explored
The study of the effects of mood determinants on stock returns has been a recent development in finance. Previous research has documented considerable links between seasonal variation in the length of day, seasonal depression (known as seasonal affective disorder, or SAD), risk aversion, and stock market returns. Given that SAD is a depressive disorder and that depression lowers the propensity to take risks, authors Ian Garrett, Mark Kamstra, and Lisa Kramer ask whether the SAD effectSADs influence on market returnscan be captured by time variation in the risk premium.
The authors use a conditional version of the capital asset pricing model (CAPM) that allows the price of risk to vary over time to determine whether such a model can explain the SAD effect. They use daily and monthly stock market returns for the United States, Japan, the United Kingdom, and Sweden in the Northern Hemisphere and New Zealand and Australia in the Southern Hemisphere to capture the hemispheric differences in the patterns of daylight and in the six-month patterns of seasonal depression.
Results in all six markets suggest that the SAD effect is fully captured by a model that allows for time variation in market risk and a time-varying price of risk. This result is consistent with the notion that the SAD effect arises because of the heightened risk aversion that accompanies seasonal depression. The authors conclude that the SAD effect may well be a natural consequence of changes in risk aversion over time.
Working Paper 2004-8