Financial Economics and Economic Organization

The Transition From Student to Researcher

• A key goal of this course is to help you make the transition from student to researcher

• You must think like a producer and a competitor in the world of research, not a consumer

• A consumer reads papers (or just skims the abstracts or introductions) and tends to take the results at face value

• A producer/competitor looks deeper and asks “How did the author do this?” “Could I do this?” “If not, why not?” “Could I improve on this literature in any way?” and so on

Research Approaches

• We will emphasize research that stays close to observable data: “applied work”

• The standard approach in applied work is to predict the behavior of the agents of interest and then test to determine whether the predictions are correct

• In the research we will discuss, the main agents of interest are firms, individuals in firms, and investors

Positive Models in Economics

• Scientific progress occurs through the process of generating testable hypotheses, testing them, and refining the hypotheses

• There are alternative approaches to generating testable hypotheses

• In the finance and strategy literatures, hypotheses are often based on discussion of the previous literature or on loose reasoning

• In economics, formal models are more common• In formal models, assumptions are precise, and the use of

mathematics ensures that the hypotheses follow logically from the assumptions

Testable Hypotheses

• Testable hypotheses are essentially predictions about relationships between economic variables

• Hypotheses may be testable in principle but not in practice

• Other things equal, the most useful hypotheses are those that can be tested using observable data

• For example, the literature on the theory of the firm has generated several predictions about how behavior depends on transaction costs and the use of incomplete contracts, but transaction costs and measures of contractual incompleteness are difficult to come up with

Testing Hypotheses

• Testing hypotheses in economics typically involves collecting or assembling data and using statistical or econometric techniques to analyze it

• Most of the focus is on testing candidate hypotheses against alternatives

• In many cases, alternatives are lacking

• The “alternative” is often simply a null hypothesis that there is no relationship between the variables of interest

• A stronger paper considers real alternatives

Verifying Assumptions

• In general, applied work does not pay much attention to verifying the assumptions that generate the hypotheses in the first place

• Clearly, an empirical analysis is stronger if it can verify the assumptions underlying the theory

• Many assumptions used in economics are standard, such as rational optimizing behavior, equilibrium, perfect foresight, etc., and typically no attempt is made to verify these assumptions

• Other assumption are more model-specific, such as the assumption that an equity link creates closer ties between firms in Filson and Morales (2004)

Distinguishing Between Alternative Explanations

• The strongest empirical work can distinguish between alternative explanations

• Often this is not possible using available data

• We will see in Filson and Morales (2004) that there are alternative explanations for the observed empirical relationships

Positive vs. Normative Analysis

• Often economists are interested in normative conclusions

• Should the government subsidize research and development? Should it increase the taxes on corporate profits or dividends?

• Proper normative analysis requires an accurate positive model; we must be able to predict the behavior of the agents in the economy before we can assess the impacts of policy changes

• Thus, positive analysis precedes normative analysis

Other Types of Analysis

• There are other types of analysis that are not directly involved in either generating or testing hypotheses but are indirectly related to these efforts

• For example, some work in econometrics involves developing new estimation techniques

• Other work focuses on estimating unknown parameters (such as demand function parameters) or even unknown variables (such as product quality)

• These techniques and estimates can be used in other studies to test hypotheses

Other Types of Analysis

• Some work in theory develops concepts or frameworks, which may not be testable themselves but are critical for structuring subsequent research (transaction costs; CAPM)

• Some work is more historical/descriptive; often work on institutions is of this nature

• Some work reviews and assesses the literature in a particular area; this can be useful for introducing non-specialists to the area, determining where researchers agree and disagree, and highlighting open questions

Data Sources

• One of the key difficulties researchers have is collecting adequate data to test interesting hypotheses

• When you read an empirical paper, it is important to ask “Where did the author get the data?” “Could I get this data?” “Could I get better data?”

• Along with these questions, you can also ask “Could I use better econometric techniques?” but for now let’s emphasize data

Public vs. Private Sources

• The advantage of publicly available data is that it is available; the disadvantage is that it may have already been exploited

• The advantage of private data is that it is unique to you; the disadvantage is that it is difficult to obtain

• Data sources vary by field• Finance uses mostly public data: WRDS, CRSP,

Compustat• In Industrial Organization and Strategy some studies use

public data, but many use private data provided by firms or data collection companies

Public vs. Private Sources

• A large amount of data on the banking industry is publicly available

• In general, more data is available for regulated industries where firms have to provide information to the public

• I have a large amount of data on biotechnology firms• I collected this data from the web at a time when it was

publicly available from a consulting company; now the company charges for the data

• If anyone is interested, they could participate in a study of firm value, growth and decline, and R&D success/failure using the biotech data and other sources

Public vs. Private Data

• In studies that attempt to get inside the firm, there is very little good publicly available data

• Compustat provides some division-level financial data for firms

• There is some available data on CEO compensation contracts

• There are some contracts data that researchers have collected and put in the public domain

• Much of the data in this area is private

Data Sources

Econlit and Web of Science are particularly useful for literature reviews; ABI Inform is also useful for management sources not covered by Econlit

Lexis-Nexis is extremely good for company press releases and other industry information

Compustat provides company-specific financial information

Gross Product by Industry is Census data organized by SIC code going back over 50 years

Data Sources

Other online library resources that may be useful are:

Dow Jones/Factiva: Financial information going back to 2000

Mergent Online/FIS Online: Securities and Exchange Commission (SEC) filings for the past 10 years

Wall Street Journal Online: WSJ news going back to 1986

Data Sources

Other online resources not provided through the library are:

www.rfe.org: Resources For Economists

www.nber.org: National Bureau of Economic Research

www.yahoo.com: Yahoo! Finance provides historical stock market quotes and other financial information for publicly traded companies (many other sites do this, too)

Data Sources

Standard & Poors Industry Surveys survey particular industries on a periodic basis and describe the main firms, industry trends, and provide lists of other industry publications

Trade Journals: Essentially all industries have one or more trade journals that describe the activities of firms, industry trends, etc.

Industry Associations: Industry Associations may provide online or offline information (for example, Recording Industry Association of America provides online reports)

Journals

There are many economics, finance, and strategy journals, and it is important to be aware of their relative importance; it affects what you cite and where you try to publish

Practitioners generally agree on the list of the top “general interest” journals within each field

In Economics:

American Economic Review, Journal of Political Economy, Quarterly Journal of Economics, Econometrica

Journals

In Finance:

Journal of Finance, Journal of Financial Economics, Journal of Business, Journal of Financial and Quantitative Analysis, Review of Financial Studies, Financial Management, Journal of Banking & Finance

In Strategy:

Strategic Management Journal

Second Tier Journals

There are a large number of “second tier” general interest economics journals, and there is not as much agreement about the relative importance of these journals

Some examples that frequently have good articles on contracts and the theory of the firm:

Economic Inquiry, the Journal of the Western Economics Association

Journal of Economic Behavior & Organization

Journals

Two other leading economics journals provided by the American Economic Association specialize in articles for general audiences

The articles are typically much more readable than most economics journal articles. The articles are primarily literature reviews and are often aimed at those unfamiliar with the topic:

Journal of Economic Literature, Journal of Economic Perspectives

Industrial Organization Journals

Every field in Economics has its own “field journals”

In Industrial Organization:

Rand Journal of Economics, Journal of Law and Economics, Journal of Economics & Management Strategy, Journal of Industrial Economics, International Journal of Industrial Organization

Studies that Rank Journals

• It is useful to follow studies that rank journals• This is an active area of research with its own

methodological issues• Which journal set is considered?• Impacts outside a predetermined set of journals are

ignored, so journals like Journal of Health Economics, which has an impact in medical journals, are under-weighted

• It makes a big difference whether or not finance journals are included when economics journals are ranked

• The studies are best used as rough guides

Studies that Rank Journals

• Arnold et al. “Impact: What Influences Finance Research?” Journal of Business 76:2 (April 2003): 343-61.

• Lists high impact articles and journals – the articles are useful for identifying critical contributions in particular areas of research

• Katailzidakis, Mamuneas, and Stengas “Rankings of Academic Journals and Institutions in Economics” Journal of the European Economic Association 1:6 (December 2003): 1346-66. Available online: www.econ.ucy.ac.cy/papers/0110.pdf

WRDS

• PhD students can apply for their own account

• I can also set up a class account if needed

• To apply for an account, go to wrds.wharton.upenn.edu

• Follow the links:

account request

request a user account

acct type: PhD

school: Claremont McKenna College