File Name: stock exchange investments in theory and practice joesph burn .zip
Over the years, it has frequently been argued by economists that lighthouses need to be provided by the state. Ronald Coase demonstrated, in fact, that they could be provided privately. The same is true of financial regulation.
In finance , being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional " long " position , where the investor will profit if the value of the asset rises. There are a number of ways of achieving a short position.
Over the years, it has frequently been argued by economists that lighthouses need to be provided by the state. Ronald Coase demonstrated, in fact, that they could be provided privately. The same is true of financial regulation. Though many economists, using blackboard economics, argue that financial markets need to be regulated by the state, it is found that regulatory mechanisms evolve in the market which are effective and stable.
It is feasible that a central bank could also evolve as a private institution to regulate the banking sector. Nevertheless, there could be legitimate concern that such institutions will become concentrations of market power or will require legal privileges to operate. In fact, this was one of the concerns that was expressed in relation to the private provision of lighthouses.
The analogy between private regulatory institutions such as stock exchanges and lighthouses is therefore remarkably close. Before , securities and investment markets in Britain were regulated by a combination of private structures and some ad hoc bodies established for tightly defined purposes. For example the Takeover Panel which was a quasi-statutory body. This paper will begin by describing the story of the lighthouse and how Coase discovered that lighthouses were adequately provided in England despite relatively minimal government intervention.
The regulatory structures in relevant parts of the financial markets before will then be discussed and related to the lighthouse story. This will be followed by a discussion of the changes in regulation that took place from Finally, there will be a brief discussion of how a central bank can be organised pragmatically as a broadly private institution in a way that could restrain the development of arbitrary and intrusive bureaucratic regulation of the banking sector.
There are four insights in this paper. The first is that, just as in the case of lighthouses, regulation can develop in financial markets without state bodies being established.
Secondly, there may be some circumstances in which private forms of financial regulation are facilitated by legal privileges or exemptions from laws which are applied to other sectors of the economy.
Thirdly, in the case of both lighthouses and financial regulation, incentives are more appropriately aligned if the functions are undertaken privately. Finally, there may be problems with centres of market power developing when private bodies provide regulation just as this may also be the case with lighthouses. In the spirit of Coase, we conclude that economists should make judgements about whether private or state institutions better perform the desired functions — in other words they should ask what are the best institutional arrangements?
Dowd and Hutchinson ask exactly this question in relation to the supervision and provision of support to the US banking system before the development of the Federal Reserve.
At the beginning of his paper The Lighthouse in Economics , Coase mentions a number of leading economists who had proposed that the state should provide lighthouses. Mill, for example, held this view on the basis that, without state help, navigation aids would not be provided because enforcing payment and excluding those who did not pay would be impossible. Pigou made a similar point. Samuelson, took the argument further. He argued that, even if payment for lighthouse services could be enforced, it should not be required.
The light from the lighthouse had zero marginal cost and, as such, excluding a ship from the services of lighthouses would be inefficient if the benefit to that ship were greater than zero. In effect, Samuelson was arguing that lighthouses were a pure public good. Coase investigated the historical provision of lighthouses in England and demonstrated that they were, in fact, provided and that lighthouse fees were actually charged.
In addition, few ships would have benefited from the services of the lighthouse from which a charge was not collected, but from which it would have been feasible to collect a charge, even if the government had been directly responsible for doing so.
Thus, the institutional mechanism that existed in practice for the building and funding of lighthouses solved the problems identified by economists in a reasonable and practical way. The economists who said that lighthouses should be provided by the government according to blackboard economics should have first investigated the historical facts. There was no evidence that the provision of lighthouses was more effective in those countries where the government was responsible. In short, lighthouses in England seem to have had the characteristics of club goods rather than of public goods.
Lighthouses were not obviously under-provided and mechanisms that economists believed could not work in theory did work in practice.
Economists have argued in favour of state regulation of financial markets just as they have argued in favour of state provision of lighthouses, though with some differences between the reasoning in the two cases. See, for example, Llewellyn Akerlof , in particular, highlighted the problem of information asymmetries in markets. Akerlof concluded that information asymmetries may lead to a situation where government intervention could improve matters, but he also pointed out that private institutions could arise to deal with the problems he identified whilst mentioning that such institutions may themselves give rise to problems such as concentrations of power.
This view is reasoned and rational and, as we shall see, leads in a Coasian direction that requires economists to evaluate which is the best of alternative institutional arrangements. This view can be contrasted with the rationale put forward by financial regulators for state regulation of financial markets. In meeting our objectives in a manner consistent with the principles of good regulation, we have adopted a regulatory approach based on correcting market failure … There are, however, numerous cases where unregulated financial markets will not achieve the best outcome due to some form of market failure, making action on our part necessary.
FSA, Institutions important in creating a stable order in financial markets included independent professions see, for example, Booth, ; Bellis, With regard to professions, some of these were effectively products of the market and entirely independent of government, others had government protection. It is because of the prominence of the latter in so many areas that professions have tended not to get praise from supporters of a market economy see, for example, Friedman, As we shall see, this issue of government protection and market power is important in the debate about the lighthouse.
In addition to the above institutions that regulate behaviour in finance, markets can develop their own comprehensive regulatory institutions. Though it is the intention of this paper to examine what happened in practice rather than tie the issues into a body of theory, it is worth noting that these regulatory institutions operated on a club-like basis.
See Buchanan for the theory of the club good. Below we will examine two such mechanisms in financial markets: stock exchanges and central banks. This club developed into the first formally though privately regulated exchange in and, the following year, the exchange moved to Capel Court. The characteristics of the stock exchange included restrictions on membership, the publication of prices and lists of stocks that were traded, and the potential for the development of a rule book.
In the early years, the exchange was regulated by convention, reputation and informal rules. It is also worth noting that, in common with other exchanges at various times, the London exchange succeeded in the s in enforcing orderly transactions that were unenforceable in a court of law Kynaston, , p. This was also the case in Amsterdam, where the exchange facilitated the exchange of forward contracts and short sales that were prohibited by government and therefore unenforceable in law Stringham, There were unlicensed brokers in Amsterdam, as elsewhere, that provided competition, but reputation was important in governing business on the market Stringham and Boettke, As Stringham writes in criticising those who believe that regulation has to come from the government:.
But the Amsterdam traders were cleverer than the blackboard theorists… who assert that financial markets emerged because of government. We can see how markets actually worked by analyzing some firsthand accounts, the best of which was published in by stockbroker, Joseph Penso de la Vega.
Written in his native Spanish in the form of a dialogue, Confusion de Confusiones is a sort of seventeenth century frequently asked questions, most likely for people looking to get into the stock market. In the book de la Vega describes numerous transactions including short sales, forward contracts, option contracts, and other transactions that occurred even though they were unenforceable in courts of law.
The first codified rule book covering topics such as default and settlement was developed by the London exchange in This rule book included provisions for settlement, arbitration and dealing with bad debts. There were also rules about general behaviour designed to increase transparency for example, partnerships amongst members had to be listed publicly and about the quotation of prices Davis et al.
Davis et al. Those gaining from the activity were fined their profits which had to be paid to charity. In it became a requirement for securities to be sanctioned by the stock exchange committee before being listed on the exchange Davis et al.
Without an orderly market, companies will not seek a listing, and, without reasonable listing rules, investors will be discouraged from trading on the market. At the turn of the twentieth century, these listing requirements then became more onerous. Until all-encompassing regulation was developed by bodies reporting to the UK government under the Financial Services Act, regulation remained entirely a private matter.
After the Second World War, various Companies Acts were passed which mandated information provision by companies, but, even then, the stock exchange imposed additional requirements on companies quoted on the exchange such as the requirement for interim reports see Goff, The ability of the exchange to determine its own membership and to set the rules by which members work was crucial.
The members incurred the costs and reaped the benefits of a well-functioning rule book because it helped to create an orderly market and enhanced the reputation of the exchange. The companies quoted on the exchange also reaped the benefit of an orderly market through, for example, a lower cost of capital and, in later years, companies had to pay for the benefit of being listed.
The benefits of those rules were excludable in that the benefits would not be obtained by companies not quoted on the exchange or by those involved in exchanging stocks and shares who were not members of an exchange with a good reputation. Similarly, the costs of the rules would be borne by those trading in the form of membership fees and in the form of the non-pecuniary costs of self-restraint.
The costs of self-restraint could be considerable. For example, from , members were prohibited from performing broking functions if they also traded on their own book The rules surrounding this issue evolved but were clarified and made explicit in see Burn, , and the article reproduced therein from The Times , pp.
A Royal Commission enquiry in —78 illustrates two features that seem to be important in the regulation of securities business. The first is the influence of a small number of important players on the rules that were developed Kynaston, , p. The second is confirmation of the club-like nature of the exchange.
In reporting the outcome of the Commission, Kynaston comments p. The club, in short, preferred to stay just that […]. Not only were the benefits of the club rules excludable, it was possible for non-members to form a competing exchange with different rules. In practice, however, competition was limited. Developments in technology from the beginning of the s did, however, change this and there is now considerable competition between exchanges on an international level.
Competition also came from other markets that were effective in providing capital to companies. The state regulation of UK securities markets began in The state regulation of the US stock exchange occurred well before that of the UK. However, Paul Mahoney Mahoney, , mainly describing the development of the New York Stock exchange but referring also to others, said:. Thus stock exchange rules dealt with most of the broad categories of issues with which modern securities regulations are concerned.
In , the stock exchange system of private rule making was broken open and the London exchange opened to foreign banks. At the same time, the separation of broking and dealing functions was ended. The motivation for reform was a belief that the restrictive practices on the stock exchange were causing it to lag other international exchanges see Creaven, The sweeping away of the various restrictive practices limitations on entry to the market, fixed commissions and the separation of trading and broking followed an agreement with the government that led to the suspension of a 6-year-long enquiry by the Office of Fair Trading which had previously had its powers extended to include service industries.
That the so-called deregulation of the City of London arose as a result of challenges to the existing structures from the competition authorities is significant.
Whether this action was right or wrong, Akerlof can be thought of as being rather perceptive in identifying the issue of market power as a potential problem in privately provided systems designed to deal with information asymmetries in markets. Essentially, in , the competition authorities removed from the private institutions that regulated the market their ability to exclude members and their ability to set rules such as commission levels, separation of trading and broking, etc.
This breaking up of private regulation was followed by the development of government regulatory agencies which had arbitrary and more-or-less unlimited powers to regulate to correct what many perceived to be market failures.
Published by Layton in London. Written in English. The Theory and Practice of Investment Management is the ultimate guide to understanding the various aspects of investment management and investment vehicles, and is essential reading for practitioners and students alike. Take this opportunity to use proven investment management techniques to protect and grow any portfolio. A fth change is that the Part on exchange-rate pricing is much reduced. The former three Chapters on exchange-rate theories, predictability, and forward bias are now shrunk to two.
He has been a member of the Columbia faculty since , and received that university's highest academic rank university professor in He was the founding chair of the university's Committee on Global Thought. He is a member of the Pontifical Academy of Social Sciences. Commission on Reforms of the International Monetary and Financial System, where he oversaw suggested proposals and commissioned a report on reforming the international monetary and financial system. Stiglitz has received more than 40 honorary degrees, including from Cambridge and Harvard , and he has been decorated by several governments including Bolivia , South Korea , Colombia , Ecuador , and most recently France , where he was appointed a member of the Legion of Honor, order Officer.
In finance , being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional " long " position , where the investor will profit if the value of the asset rises. There are a number of ways of achieving a short position. The most fundamental method is the so-called "physical" short-selling, which involves borrowing assets often securities such as shares or bonds and selling them. The investor will later purchase the same number of the same type of securities in order to return them to the lender.
Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders , and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value. Correspondingly, corporate finance comprises two main sub-disciplines. Working capital management is the management of the company's monetary funds that deal with the short-term operating balance of current assets and current liabilities ; the focus here is on managing cash, inventories , and short-term borrowing and lending such as the terms on credit extended to customers. The terms corporate finance and corporate financier are also associated with investment banking.
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