Undergraduate Business Journal - April 2014

April 2014

Vincent Yu, Rahim Damji, Vrushank Vora, Lokesh Anand

The rapid growth and increasing profitability of microfinance throughout the world have sparked calls for increased regulation. Existing literature on microfinance regulation has treated regulation as a binary variable, i.e., whether the Microfinance Institution (MFI) was being regulated or not. This approach, however, fails to capture the granularities associated with the regulations imposed on MFIs. In this paper, we study two specific relationships: (1) the indirect impact of traditional prudential regulation, as proxied by the Capital Adequacy Ratio (CAR) requirements, on the sustainability and profitability of MFIs; (2) the causal relationship between MFI outreach, represented by percentage of active female borrowers, and the MFI’s profitability. To demonstrate a causal link between outreach and profitability, we employed an instrumental variable approach, with sanitation as an instrument for MFI outreach. Our findings associate more stringent prudential regulation with increases in MFI profitability and decreases in outreach. Furthermore, our 2SLS results demonstrate a negative causal relationship between MFI outreach and profitability. Therefore, when imposing regulation on MFIs, emerging market policy makers should look beyond standard balance sheet items, and account for metrics such as an MFI’s percentage of women borrowers (PWB). Such a policy making framework allows regulators to account for the mission-oriented nature of MFIs, allowing them to strike the right balance between the sustainability and outreach of these firms.

Bryan Tisdale

Credit Rating Agencies (CRAs) have experienced immense growth and influence in the modern financial landscape. The power exhibited by these CRAs caused great concern regarding their particular practices and compensation models. The United States’ federal government intervened by creating the Credit Rating Agency Reform Act of 2006 (CRARA) in an effort to protect investors and curb the potential misuses of such a unique power. This paper aims to explore the intervention of the federal government by analyzing the implementation of the CRARA of 2006, and to a lesser extent the Dodd-Frank Act of 2010, and understand how the implementation of Congressional acts affect the economic conditions and capitalistic mode that drives not only the United States, but most of the world. In order to understand the effects of government intervention, the paper delves into the nuances of CRARA and how Congress delegated and divided regulatory power over the CRAs using the “Nationally Recognized Statistical Rating Organization” (NRSRO) status. By applying NRSRO status to CRAs that complied with Congressional mandates, the CRA industry was supposed to provide increase transparency, accountability, and competition among companies in the hopes of improving ratings quality. CRARA targeted CRAs and attempted to reform the ratings of securities, while the real dilemma lay in the financial institutions themselves. CRARA’s misdiagnosis of the problem resulted in less effective results that arguably contributed to the “Great Recession.” In lieu of failed policies like CRARA, financial institutions should be governed by more ethical standards to avoid recessions of this kind.

Josh Morris-Levenson

During the last decade, a boom and bust in the US housing market contributed to a financial crisis and severe economic downturn. This paper provides a coherent explanation of this event by connecting two explanations put forth by economists. Atif Mian and Amir Sufi argue in their 2009 paper that mortgage securitization allowed the extension of mortgage credit to subprime borrowers, setting up a wave of defaults and subsequent credit crunch. In a 2007 NBER paper, Robert Shiller argues that homebuyers’ speculative psychology drove the housing boom, and that the expansion of subprime loans was a consequence of borrowers’ irrationally high home price expectations. This paper bridges the gap between these two theories by drawing an empirical connection between homebuyers’ price expectations and mortgage choices. Using American Housing Survey data from 2000-2009, I find that homebuyers who expected higher growth in the value of their homes chose mortgages with a higher loan to value ratio. This finding integrates the credit supply- and psychology-based theories of the housing boom.

Rishab Mittal

The objective of this study is to explore the presence of a causal relationship between stock market development and economic growth. This study aims to explore this relationship in the nine Newly Industrialized Countries (NIC’s): Brazil, China, India, Malaysia, Mexico, Philippines, South Africa, Thailand and Turkey. 2005 nominal GDP values are used as a proxy for economic growth, and market capitalization ratio (MCR) is used as a proxy for stock market development. To address this relationship, a Granger Causality Test was employed. However, before running a Granger Causality test, it must be determined whether the variables are stationary and, if not, whether they are co-integrated. To test whether variables are stationary, an augmented Dickey-Fuller unit root test (ADF) was employed. All of the countries rejected the null except for Mexico. Following an ADF test, an Engle-Granger Co-integration test (Engle test) was employed. Mexico failed to reject the null for the Engle test; thus no accurate conclusions for Mexico can be made following this study. Finally, the Granger Causality Test can be employed. Results show bi-directional causality for China, Thailand and Turkey between GDP and MCR. Unidirectional causality for MCR to GDP exists for India and Mexico. Uni-directional causality for GDP to MCR exists for Malaysia, the Philippines and South Africa. No causality is determined for Brazil. The results show that the financial markets are important for economic growth in India, Mexico, China, Thailand and Turkey. It is important to remember that this causal relationship is country specific. Therefore, a general statement cannot be made that the stock market causes economic growth.

Megan Chen, Ming Li Chew, Sanya Goyal, Muzoon Matar, Zeynep Yavuz

This paper offers a macroeconomic investigation regarding the stabilization of Turkey’s economy following the crises it experienced in the late 20th century when Turkey began to liberalize its economy. In the early 2000s, following decades of chronic inflation, Turkey succeeded in lowering its inflation rate to unprecedented levels. But what caused the crisis, how did the Turkish economy recover so well from it, and how did Turkey manage to combat mounting inflationary pressure? The 2001 crisis was caused by structural problems, namely bad debt management and poorly run public and finance sectors, which were detrimental to consumer confidence. After analyzing key data and conducting surveys of literature on this subject, we conclude that the success of Turkey’s stabilization program is due to a binding and abrupt regime change. This demonstrates the rational expectations model, emphasizing the importance of timing and credibility of a wellimplemented program. Finally, we study the relationships between inflation and other macroeconomic variables, and conclude that inflation growth rates remained impressively low despite unanticipated economic shocks.