Macrofinancial risk management in the U.S. economy: Regulation, derivatives, and liquidity preference
This dissertation proposes an analysis and assessment of the two regimes of macrofinancial risk management in the United States since the 1950s: one based on financial regulation and government controls, from 1950 to 1971, and another based on financial derivatives, from 1972 to the present. It compares the two regimes and discusses the means to assess their relative effectiveness in mitigating financial volatility for nonfinancial corporations. Without exhausting all the different criteria to adjudicate between the two regimes, the research emphasizes some specific characteristics that must be part of any coherent mechanism of risk management such as coverage of exposed firms, impacts on financial stability and systemic risks, scope for speculative activities, degree of complexity and transparency, creation of additional risks, and potential for failures. The use of these criteria suggests that financial derivatives might be relatively less effective in mitigating financial risks and their consequences.
In order to test the proposition that financial derivatives are potentially less effective than financial regulation, an econometric analysis of the liquidity preference of nonfinancial firms, assumed to be an important hedging mechanism under capitalism, is carried out. At the aggregate level, the time series show that nonfinancial corporations have been accumulating more liquid assets since the beginning of the eighties, in contrast to the declining liquidity preference under the regulatory regime. A cointegration analysis suggests that the relationship between liquidity preference and financial risk was stable for the period 1948-2005, notwithstanding the rise of derivatives. At the firm level, using a panel consisting of balance sheet and financial statements for 170 firms over the period 1993-2005, the liquidity preference of firms is regressed against a measure of the intensity of financial derivatives usage. The evidence here suggests that, after controlling for other firms' characteristics, financial derivatives do not substantially reduce the necessity of holding liquid assets as a behavior toward financial risk. These results seem to indicate that financial derivatives are relatively less effective in hedging financial risks, making the case for financial regulation.