Working papers 2002
Number 2002/01 - Prof Graeme Guthrie, John Small and Julian Wright.
"Pricing Access: Forward versus Backward Looking Cost Rules"
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Abstract
Regulators across many different jurisdictions and industries have recently adopted the practice of seeting access prices based on the current costs of providing the relevant facilities. Though widely regarded as being efficient, this practice has not been formally analyzed. Our analysis shows that given stochastic costs, forward looking access prices determined by historic cost whenever investment is desired, unless the cost of investment is trending upwards with low volatility.
Number 2002/02 - Prof Graeme Guthrie and Julian Wright
"Interest Rate Dynamics and Interest Rate Targeting"
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Abstract
This paper derives the dynamic properties of interest rates at the short end of the yield curve usin a model of central bank interest rate targeting. The model predicts that conditional volatility is persistent and increasing in the spread between the market rate and the central bank's target rate, that there is excess kurtosis in high frequency interest rate movements, and that market rates will revert towards the central bank's target rate. We show these effects are present in a sample of recent daily data on U.S. interest rates. The results suggest that the spready between market rates and the central bank's target rate should be considered in empirical models of interest rate dynamics.
Number 2002/03 - Prof Graeme Guthrie and Julian Wright
"The Optimal Design of Interest Rate Target Changes"
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Abstract
Most central banks currently implement monetary policy by targeting a short-term interest rate. This paper asks: "What is the optimal form for such interest rate targeting, given the objectives facing central banks?" We find the optimal rule is for the central bank to change the target rate whenever the deviation between its preferred rate and the current target rate reaches some critical level, and in this case the target rate is changed by a discrete amount in the direction of its preferred rate. Despite the simplicity of this rule, we are able to replicate a number of puzzling features of interest rate targeting observed in practice, as well as explain some dynamic properties of market interest rates.
Number 2002/04 - Prof Glenn Boyle and Prof Graeme Guthrie
"Cashflow Immediacy and the Value of Investment Timing"
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Abstract
We examine the relationship between project value and cashflow immediacy when interest rates are uncertain and investment can be delayed. The value of investment delay has two components: the expected gain from committing now to investment at a future date and the potential gain from the ability to reverse this commitment. Holding the value of immediate investment constant, we show that the values of both components are increasing in the proportion of project cashflows that accrue in the most distant future, so total project value is greater for long-term projcts. Our results emphasize the importance of the interaction between cashflow immediacy and interest rate uncertainty for the optimal investment policy.
Number 2002/05 - Prof Glenn Boyle and Prof Graeme Guthrie
"Investment, Uncertainty and Liquidity"
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Abstract
We analyze the investment timing problem of a firm subject to a financing constraint. The threat of future funding shortfalls encourages the firms to accelerate investment beyond the level that is first-best optimal. Thus, our model highlights a new way by which costly external financing can distort investment behavior. Moreover, hedging is useful not only because it allows investment to proceed, but also because it allows investment to be delayed. These results can potentially help explain observed empirical relationships between investment and liquidity, investment and uncertainty, investment and hedging, and shareholder wealth and volatility.
Number 2002/06 - Prof Graeme Guthrie (with Prof Lew Evans)
"A dynamic theory of cooperatives: The link between efficiency and valuation"
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Abstract
Cooperative and mutual organisational forms arise for reasons tht include contracting problems between parties. Economic literature suggests a variety of allocative inefficiencies implied by these forms that largely have their origins in poor investment decisions. We demonstrate that a multi-period model and the supplier and cooperative valuations it implies are essential for understanding the sources of inefficiency and solutions to them. Using the case of a suppier cooperative we show that economic inefficiency arises because of the common over-supply of input induced by suppliers responding to average, rather than marginal, revenue, and that investment is actually efficient given the supply of input. The presence of unowned capital is an important source of over-supply. We show that if the cooperative's shares are priced at the present value of expected dividends and supplier entry and exit decisions are taken solely on the basis of profitability of membership then there is no inefficiency and we describe a functioning example. Finally, our valuations show that there is no "time horizon" investment problem, at least from an industry perspective.
Number 2002/07 - Prof Graeme Guthrie (with Prof Lew Evans)
"Dynamically-Efficient Incentive Regulation of Networks with Sunk Costs"
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Abstract
Incentive regulation allows decentralised decision-making under regulatory parameters set on the basis of industry characteristics. When there is uncertainty, sunk costs, and flexibility in the timing of investment a monopoly will invest later than is socially desirable because it garners only a fraction of the benefits, This study considers the design of regulatory profit caps based on a measure of costs, either historical or replacement costs, to which a regulatory rate of return is applied.
It demonstrates that the sources and extent of supply and demand uncertainities, and thereby characteristics of the industry, determine whether historical or replacement cost regulation is desirable. The welfare optimising level of the regulatory rate of return differs between historical and replacement cost regulation, this return is generally higher than the weighted average cost of capital, and welfare is degraded much more if it is set below, as opposed to above, the optimal regulatory return.
Number 2002/08 - Prof Graeme Guthrie (with Michael Carter)
"Cricket interruptus: fairness and incentive in interrupted cricket matches"
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Abstract
We present a new adjustment rule for interrupted cricket matches that equalizes the probability of winning before and after the interruption. Our proposal differs from existing rules in the quantity preserved (the probability of winning), and also in the point at which it is measured (the time of interruption). We claim this is both fair and free of incentive effects. We give several examples of how our rule could have been applied in past matches, including some in which the ultimate result might have been different.
Number 2002/09 - Chirok Han with Luis Orea and Peter Schmidt
"Estimation of a Panel Data Model with Parametric Temporal Variation in Individual Effect"
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Abstract
This paper is an extenstin of Ahn, Lee and Schmidt (2001) to allow a parametric function for time-varying coefficients of the individual effects. it provides a fixed-effect treatment of models like thos proposed by Kumbhakar (1990) and Battese and Coelli (1992). We present a number of GMM estimators based on different sets of assumptions. Least squares has unusual properties: its consistency requires white noise errors, and given the white noise errors it is less efficient than an GMM estimator. We apply this model to the measurement of the cost efficiency of Spanish savings banks.