Seminal Literature Summary

June 5, 2015

 

The Cost of Capital Corporation Finance, and the Theory of Investment

Modigliani, F. & Miller, M. H. (1963). The cost of capital, corporate finance and the theory of investment. American Economic Review. 48, 261-97.

Summary

The Cost of Capital Corporation Finance, and the Theory of Investment, presents research relating to the theories and propositions of finance as it involves the cost of capital. Its underlying philosophical orientation is methodological and qualitative, based predominantly on empirical data; however, the study also provides a significant amount of quantitative and statistical - correlational data.            

Setting, Industry and Population

(Modigliani & Miller, 1958), use both exploratory data and confirmatory data analysis to identify the patterns in the research, such as leverage and high stock yields, which are then formalized with classical statistical inferences (Cooper, 2014, p. 406).  

Assumptions and Implications for Generalizability

(Modigliani & Miller 1958), provide the foundational evidence to validate its main propositions, including its operational definition of the cost of capital (Modigliani & Miller, 1958), and how to use the theory to improve rational investment decision-making. However, there are limitations for a static, partial equilibrium analysis based on a generality of atomistic competition in the capital markets, and with ease of access to the markets, which is only obtainable by a limited amount of firms (Modigliani & Miller, 1958).

Nature, Orientation and Approach

            The Cost of Capital Corporation Finance, and the Theory of Investment, utilizes a method of cross-tabulation to examine relationships involving categorical variables that are used to develop a framework based on statistical testing, and provides table-based analysis. The data contains one or more control variables, which are employed to create the propositions (Cooper , 2014, p.404).

 

The Financial Accelerator in a Quantitative Business Cycle Framework

Beranke, B.S., Gertler, M. & Gildchrist, S. (1998) The financial accelerator in a quantitative business cycle framework. Princeton University, New York University, and Boston University**. Retrieved from http://www.econ.nyu.edu/user/gertlerm/BGGHandbook.pdf

Summary

             The Financial Accelerator in a Quantitative Business Cycle Framework, is an important seminal work that arguably demonstrates the theoretical framework which lead to the Federal Reserve’s cooperative action in lowering interest rates still in effect today back in 2008, as a way to counteract the effects of inflation and recession.  

Setting, Industry and Population

(Beranke, Gertler, & Gildchrist, 1998), assign entrepreneurs for example, a normalizing constant, to evaluate the phenomena such as the probability for survival of firms within a period. Entrepreneurs are agents who play a key role in the analysis, as they are most commonly those who borrow capital, and are considered to be “financial accelerators" within the theoretical framework.

Assumptions and Implications for Generalizability

The “financial accelerator” effect is a relationship between “the external finance premium” and the net worth/available liquid assets, minus obligations. Agents within the framework create the credit-market frictions, which then manifest implications for the macro-economy. Future research would include the role of banks and nominal contracting to assess their role in cyclical fluctuations.

Nature, Orientation and Approach

The Financial Accelerator in a Quantitative Business Cycle Framework, in its assignation of a constant for each population element, comprises a simple random sample, which is built within a dynamic equilibrium model where each element has an equal chance of selection (Cooper, 2014, p. 349).

 

This Time is Different: A Panoramic View of 8 Centuries of Financial Crisis

Reinhart, C.M.. & Rogoff, K.S. (2008). This time is different: a panoramic view of 8 centuries of financial crisis. National Bureau of Economic Research. 15(4), 71–89. Retrieved from http://www.nber.org/papers/w13882

Summary

             The much-cited authors Reinhart, C.M. & Rogoff, K.S. are well known for their seminal works in economics and finance. The same is true of this study: This Time is Different: a Panoramic View of 8 Centuries of Financial Crisis, which is a “panoramic” analysis of financial crisis dating back to 14th century England; spanning geographically all over the globe. Through this research, the authors describe the U.S. sub-prime financial crisis as similar in its characteristics to any type of financial crisis that could occur, such as those spawned by exchange rate crashes and inflation.

Setting, Industry and Population

The data in the study covers 66 countries including: “Africa, Asia, Europe, Latin America, North America, and Oceania,” (Reinhart and Rogoff, 2008),  and measures the corresponding variables, such as external and domestic debt, GNP, exchange rates, inflation, interest rates, commodity prices, and trade.  The coverage of the study spans 8 centuries and includes systematic dating techniques to measure external debt and exchange rates.

.Assumptions and Implications for Generalizability

This Time is Different: a Panoramic View of 8 Centuries of Financial Crisis fills the gap in the available literature by incorporating important credit episodes that are left out of most other research studies, and utilizes exploratory data analysis that contains a myriad of historical and comparative data charts. The authors have determined that because domestic debt -financial crises do not frequently involve external creditors, that many circumstances go unnoticed. The authors confirm that financial crisis often originate from financial centers through the process of interest rate shocks.

Nature, Orientation and Approach                                   

This Time is Different: a Panoramic View of 8 Centuries of Financial Crisis,  utilizes exploratory data analysis containing a myriad of historical and comparative data charts, as well as  confirmatory data analysis which employs a great deal of statistical information and confidence (Cooper, 2014).

 

Banking Panics and Business Cycles

Gordon, G. (1988). Banking panics and business cycles. Oxford Economic Papers 40 (1988), 751-781. Retrieved from  http://www.jstor.org/stable/2663039

Summary

            Banking Panics and Business Cycles, is considered by economists to be an important research study into the universal problem of banking panic. The study explores the answers to many questions concerning the causal factors of the phenomena, which inevitably lead to banking and economic crisis. 

Setting, Industry and Population

             Banking Panics and Business Cycles conducts a qualitative, exploratory analysis of seven banking panics in United States history during the years of 1863-1914. The study examines the behavior of random depositors over a 100-year period, utilizing newly constructed data.  

Assumptions and Implications for Generalizability.

Simple random sampling was used to test various hypotheses, and the statistical inferences are said to have determined that the recession-hypothesis is the most helpful in constructing conditional expectation (Gordon, 1988). Depositor’s panic is predicated on the liabilities variable, which is part of the cyclical behavior of the business cycle, in which depositing is being reassessed.

Nature, Orientation and Approach

The questions being asked about banking panics include: are banking panics caused by random events? Do panics occur when ROI falls short? Are panics related to consumer behavior? Etc. The study conducts analysis on panic dates classifying them as systematic events and correlates the quantitative and empirical findings. The study tests the hypothetical characterizations having to do with deposit-currency ratios and panic dates, as well as the presumed organization of panic-related events.  

 

Fundamentals, Panics, and Bank Distress During the Depression

Calomiris, C. W. & Mason, J.R. (2003). Fundamentals, panics, and bank distress during the depression. American Economic Review, 93(5): 1615-1647. DOI: 10.1257/000282803322655473

Summary

             Fundamentals, Panics, and Bank Distress During the Depression is a quantitative study that encompasses a myriad of analysis having to do with bank failure and the market conditions that cause them. The study is referred to as seminal as it is considered to be one of the first econometric studies to comprehensively and specifically define the characteristics of bank failure during the depression era and how to identify the signals.

Setting, Industry and Population

            Between the years 1920-1933 there were 15,000 bank disappearances in the United States. The sampling of fundamental data is focused on a population of Fed member banks with the exclusion of non-member banks that have fewer members than member banks. In the bank survival model, banks during the depression era years are sampled semi-annually and divided into regional categories.

Assumptions and Implications for Generalizability

(Calomiris, & Mason, 2003) state that behavioral concerns like panic and its detrimental effects on the process of liquidity, are not as important as fundamental solvency, which was the most important component in the prevention of failure prior to 1933. The fundamental analysis is said to demonstrate that the bank failures and deposit withdrawals weren’t the most influential components of “contagion” or panic-economic states that often lead to liquidity crisis during the depression.

Nature, Orientation and Approach

            The study is composed of the bank-level data of Fed member banks and is combined with county/state/national – level economic characteristics in order to observe cross-sectional and inter-temporal variations characteristic of bank failure (Calomiris & Mason, 2003). Simple random sampling is used to test the probability of bank failures while confirmatory data analysis is employed to show the causation of failures. There are numerous frequency and time-series tables that compare the qualitative characteristics of the banks as as they failed.  

 

Growth in a Time of Debt

Reinhart, C. & Rogoff, K. (2010). Growth in a time of debt. American Economic Review. Retrieved from 100(2): 573-78. DOI: 10.1257/aer.100.2.573.

Summary

             Growth in a Time of Debt is a seminal work that analyzes the relationship between growth and debt. Its authors have found that  countries with advanced economies and an over reliance on short term borrowing, increase the likelihood of financial crisis, and that debt management is a necessary key to sustaining growth.

Setting, Industry and Population

            (Reinhart & Rogoff, 2010) have utilized a new data set that the authors have improved since its first publishing in 2008. The study employs debt data from both rich countries and emerging markets. 44 countries are analyzed over a period of 200 years and include recent data regarding external debt that is owned by both governments and private companies.

Assumptions and Implications for Generalizability

 Growth in a Time of Debt reports that countries with advanced economies and high debt/GDP levels of over 90% experience significantly lower growth outcomes, and that external debt/GDP of 60% and below, has a relationship to economic hindrances. (Reinhart & Rogoff, 2010) define debt levels that reach historical boundaries as part of a phenomena in which interest rates begin to rise and then lead to economic distress.

Nature, Orientation and Approach

(Reinhart & Rogoff, 2010) utilize exploratory data analysis, which encompasses over 3,700 annual observations that cover monetary arrangements, institutions, historical economic circumstances and political systems. The study correlates a great deal of quantitative analysis referenced from their earlier works over a 200-year period.

Conclusion

            Reinhart, C. & Rogoff, K. as well as the other listed authors of these works, are frequently cited in published research and have added a wealth of data to the current collective of financial and economic literature. The seminal nature of these selected texts have the potential to develop and support the research of the dissertation, though at the same time, seminal works are often those that are much disputed by their peers.

 

 

Cooper. Business Research Methods, 12th Edition. McGraw-Hill Learning Solutions, 2013-03-05. VitalBook file.Researcher, A. & Assistant, B. (2014).

Reinhart, C. & Rogoff, K. (2010). Growth in a time of debt. American Economic Review. Retrieved from 100(2): 573-78. DOI: 10.1257/aer.100.2.573.

Calomiris, C. W. & Mason, J.R. (2003). Fundamentals, panics, and bank distress during the depression. American Economic Review, 93(5): 1615-1647. DOI: 10.1257/000282803322655473

Gordon, G. (1988). Banking panics and business cycles. Oxford Economic Papers 40 (1988), 751-781. Retrieved from  http://www.jstor.org/stable/2663039

Reinhart, C.M. & Rogoff, K.S. (2008). This time is different: a panoramic view of 8 centuries of financial crisis. National Bureau of Economic Research. 15(4), 71–89. Retrieved from http://www.nber.org/papers/w13882

Beranke, B.S., Gertler, M. & Gildchrist, S. (1998) The financial accelerator in a quantitative business cycle framework. Princeton University, New York University, and Boston University**. Retrieved from http://www.econ.nyu.edu/user/gertlerm/BGGHandbook.pdf

 

 

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