John Kambhu

Direct controls and incentives systems of regulation

Abstract The focus of this paper is regulatory enforcement when regulators do not have absolute power—as is the case when procedures of due process and the right of appeal allow regulated enterprises to challenge decisions of regulatory agencies. Instead of passively submitting to regulatory enforcement, the regulated enterprise can contest the regulators decisions. Given this contestable view of regulatory enforcement, two regulatory models are compared: regulation with direct controls where the regulator issues directives and commands to directly regulate behavior and incentives-based regulation where fines or corrective taxes are used. In both types of regulation the regulated enterprise can contest the regulators decisions. In the first the firm may challenge the regulators directives, while in the second the firm can contest fines levied by the regulator. The question is, which regulatory regime can obtain higher compliance? The results suggest that when the regulators enforcement powers are limited, regulation with direct controls can obtain higher levels of compliance than an incentives-based system.

Trading risk and volatility in interest rate swap spreads

This paper examines how risk in trading activity can affect the volatility of asset prices. We look for this relationship in the behavior of interest rate swap spreads and in the volume and interest rates of repurchase contracts. Specifically, we focus on convergence trading, in which speculators take positions on a bet that asset prices will converge to normal levels. We investigate how the risks in convergence trading can affect price volatility in a form of positive feedback that can amplify shocks in asset prices. In our analysis, we see empirical evidence of both stabilizing and destabilizing forces in the behavior of interest rate swap spreads that can be attributed to speculative trading activity. We find that the swap spread tends to converge to a long-run level, although trading risk can sometimes cause the spread to diverge from that level.