Kim R. Sawyer

Underdetermination in Economics. The Duhem-Quine Thesis

This paper considers the relevance of the Duhem-Quine thesis in economics. In the introductory discussion which follows, the meaning of the thesis and a brief history of its development are detailed. The purpose of the paper is to discuss the effects of the thesis in four specific and diverse theories in economics, and to illustrate the dependence of testing the theories on a set of auxiliary hypotheses. A general taxonomy of auxiliary hypotheses is provided to demonstrate the confounding of auxiliary hypotheses with the testing of economic theory.

The Necessary Illegitimacy of the Whistleblower

This article examines the plight of the whistleblower using elements of organizational legitimacy theory. In recognizing the negative correlation between the actions of the organization and the whistleblower, it becomes clear that the continuing legitimacy of the organization necessitates the illegitimacy of the whistleblower. This helps explain the blacklisting of the whistleblower and their vilification which results in the destruction of both their career and their reputation. Only specific protective legislation can provide insurance for their career.

How Oil Moves Stock Prices

An important question in asset markets is whether oil prices are a global factor in asset returns. In this paper, we propose a hierarchical model of stock returns which assumes that markets are integrated conditional on a set of factors, including oil. The hierarchical model is a variant of the Jorion and Schwarz model of market integration and permits significance testing of factors at three levels; global, country and sector. In an application to three countries across nine common sectors, we found the pattern of significance of oil was different than for six other commodities. While there is no evidence that oil is a global or country factor, there is evidence that oil is more significant at the sector level than other commodities. The average P-values for oil are less than for other commodities and, in Wald tests across sectors, oil behaves like a global market factor and a country market factor. The effect of oil is therefore both disaggregated and heterogeneous. There are two important implications of this study. First, in the aggregate, stock prices appear remarkably insensitive to oil prices, suggesting that the correlation between stock prices and oil prices is less certain than usually perceived. While an oil shock may cause a real economy recession, it does not necessarily cause an asset economy recession. A second implication relates to the testing of linear factor models. If factors affect asset prices in a hierarchy rather than linearly, tests of factor models must adjust for the hierarchical structure.

How Eventful are Event Studies

This paper reexamines the event study methodology in finance. We consider a formal specification of an event study in terms of a system of abnormal returns and, in particular, emphasise the possible limitations of using a methodology when misspecification may be present. In the first section of the paper, the theory of the event study is reviewed, with reference to the definition problems associated with the measurement of abnormal returns, the conditional information set embedded in return expectations, the determination of the event window, and the similarity across events. A major insight of our paper is to emphasise the importance of conditionality, learning and convergence in the theory of event studies and in the evolution of abnormal returns. In one section of the paper, we look at the question of recursive residuals, residuals formed when the information set is updated period by period, and implicitly question why they have not been used in event studies. In another section, the focus is on the specification of learning models, both across events and within the event period. Furthermore, we provide some conjectures about how to measure the information in events. Finally, we bring together the issues into a coherent methodology.

An Option Theory of Social Networks

This paper constructs a new theory of social networks based on the options individuals buy on each other. The model assumes that when an individual connects with another it is equivalent to buying options on the other’s reputation. The option model confers advantages not present in existing models. First, the payoff to connecting is endogenously determined by the reputation of the network. Secondly the strategy to connect is an option strategy. Thirdly, the network forms as individuals take option positions; the network evolves as individuals adjust those positions. The model allows for powerful insights into network structure, the price of connecting and the value of connecting.

The Independent Regulator

This essay considers the question how should regulators be regulated. To regulate is to observe, arbitrate and equilibrate in the public interest when that interest is not well-defined. The market for regulation is incomplete; while there is a limitless demand for regulation the supply of regulation is constrained. The response to market incompleteness has been threefold; deregulation, self-regulation and whistleblowing. Whistleblowing, in particular, has conferred many insights about regulation. Whistleblowing has shown the power of the independent regulator.Regulating conflict of interest is the unifying principle of the essay. A portfolio theory of regulation is developed where a regulator manages a portfolio of the public interest; and constrains the conflict between private interests and the public interest. The theory of regulation which emerges suggests a system of regulation with four principles: (1) Regulation of conflict of interest on a case-by-case basis; (2) Regulation by incentivizing all observers; (3) Regulation using sampling and red flags; (4) Regulatory courts.

Meta-Economic Principles

In this paper we consider meta-economic principles, those principles which underscore the theoretical thinking of economics. Meta-economic principles are different from laws; they relate to the principles of theory construction, to the assumptions which are implicit in theory, to the constraints imposed on theories and to the analysis and scope of theories. We identify seven meta-economic principles; self-interest, the structure of incentives, minimisation of transactions costs, rationality and time consistency, individuals as economic agents, the pricing of everything and completion of markets. These are the principles which have spanned generations of economic thinking. To illustrate the role of meta-principles in economic theory, we consider a number of articles from the Journal of Political Economy. The testability of meta-economic principles is examined, both in terms of the normative principles adopted in economic theory, and in observed economic behaviour.

A General Test for Non-Nested Hypotheses

A simple technique is proposed for increasing the asymptotic efficiency of tests of non-nested hypotheses. The principle is to consider the asymptotic regression of one hypothesis test on another. Under certain conditions this produces a test with a smaller variance under the null hypothesis and larger expectation under the alternative, implying an improvement in the asymptotic slope. Some improvements to existing tests are then demonstrated in finite samples.

Time to Maturity Volatility: An Application to Index Derivatives

The basic assumption of the Black-Scholes option pricing is that volatility is constant over the time to maturity of the option. We consider how the estimation of volatility is affected by the time to maturity. In particular, we consider the empirical distribution of volatility as a function of the time to maturity and propose a threshold estimator based on the reverting behavior of implied volatility towards the median of the empirical volatility distribution. This estimator is compared with implied and historical volatility estimators in a forecasting study of the Australian SPI 200 index futures contract. The new estimator generates smaller forecast errors of realized volatility and is the basis of a profitable trading strategy.

Recognition versus Disclosure: The Case of Land and Buildings’ Revaluations

This study examines the value relevance of recognised and disclosed revaluations of land and buildings for a large sample of Australian firms from 1993 through 1997. In contrast to prior research, we control for risk and cyclical effects and find no difference between recognised and disclosed revaluations, using yearly‐cross‐sectional and pooled regressions and using both market and non‐market dependent variables. We also find only weak evidence that revaluations of recognised and disclosed land and buildings are value relevant.