Friday, September 30, 2011

EPA Inspector General Statement on Greenhouse Gases Endangerment Finding Report - Data Quality Processes

EPA Inspector General Statement on Greenhouse Gases Endangerment Finding Report - Data Quality Processes

Press Statement - U.S. Environmental Protection Agency
For Immediate Release
Office of Inspector General
Washington, D.C., September 28, 2011Contact: John Manibusan. Phone: (202) 566-2391

WASHINGTON, D.C. – Statement of Inspector General Arthur A. Elkins, Jr., on the Office of Inspector General (OIG) report Procedural Review of EPA’s Greenhouse Gases Endangerment Finding Data Quality Processes:
“The OIG evaluated EPA’s compliance with established policy and procedures in the development of the endangerment finding, including processes for ensuring information quality. We concluded that the technical support document that accompanied EPA’s endangerment finding is a highly influential scientific assessment and thus required a more rigorous EPA peer review than occurred. EPA did not certify whether it complied with OMB’s or its own peer review policies in either the proposed or final endangerment findings as required. While it may be debatable what impact, if any, this had on EPA’s finding, it is clear that EPA did not follow all required steps for a highly influential scientific assessment. We also noted that documentation of events and analyses could be improved.

We made no determination regarding the impact that EPA’s information quality control systems may have had on the scientific information used to support the finding. We did not test the validity of the scientific or technical information used to support the endangerment finding, nor did we evaluate the merit of EPA’s conclusions or analyses.

We make recommendations that we think will strengthen EPA’s control over data quality processes. EPA disagreed with our conclusions and did not agree to take any corrective actions in response to this report. All the report’s recommendations are unresolved.”


Thursday, September 29, 2011

Publication Bubble Threatens China's Scientific Advance

Publication Bubble Threatens China's Scientific Advance
Chinese Academy of Sciences
Sep 26, 2011

As China's economy has soared to the second place in the world, the country's scientific strength has also surged -- if only measured by the numbers.

Chinese researchers published more than 1.2 million papers from 2006 to 2010 -- second only to the United States but well ahead of Britain, Germany and Japan, according to data recently published by Elsevier, a leading international scientific publisher and data provider. This figure represents a 14 percent increase over the period from 2005 to 2009.

The number of published academic papers in science and technology is often seen as a gauge of national scientific prowess.

But these impressive numbers mask an uncomfortable fact: most of these papers are of low quality or have little impact. Citation per article (CPA) measures the quality and impact of papers. China's CPA is 1.47, the lowest figure among the top 20 publishing countries, according to Elsevier's Scopus citation database.

China's CPA dropped from 1.72 for the period from 2005 to 2009, and is now below emerging countries such as India and Brazil. Among papers lead-authored by Chinese researchers, most citations were by domestic peers and, in many cases, were self-citations.

"While quantity is an important indicator because it gives a sense of scientific capacity and the overall level of scientific activity in any particular field, citations are the primary indicator of overall scientific impact," said Daniel Calto, Director of SciVal Solutions at Elsevier North America.

Calto attributed China's low CPA to a "dilution effect."

"When the rise in the number of publications is so rapid, as it has been in China -- increasing quantity does not necessarily imply an overall increase in quality," said Calto.

He noted the same pattern in a variety of rapidly emerging research countries such as India, Brazil, and earlier in places like the Republic of Korea.

"Chinese researchers are too obsessed with SCI (Science Citation Index), churning out too many articles of low quality," said Mu Rongping, Director-General of the Institute of Policy and Management at the Chinese Academy of Sciences, China's major think tank.

SCI is one of the databases used by Chinese researchers to look-up their citation performance. The alternative, Scopus, provides a wider coverage worldwide.

"Chinese researchers from a wide range of areas and institutions are vying for publication, as it is a key criterion for academic appraisal in China, if not the only one. As a result, the growth of quality pales in comparison to that of quantity," said Mu, an expert on China's national science policy and competitiveness.

On the other hand, China also falls behind the United States in multidisciplinary research, which is a core engine for scientific advance and research excellence.

From 2006 to 2010, China published 1,229,706 papers while the United States churned out 2,082,733. According to a new metric introduced by Elsevier's Spotlight research assessment solution, China generated 885 competencies while the United States had 1,817.

In other words, China's total research output is more than half that of the United States, while the number of competencies showing China's strength in multidisciplinary research is less than half that of the United States.

Cong Cao, an expert on China's science and technology, put it more bluntly in an article he wrote: "When the paper bubble bursts, which will happen sooner or later, one may find that the real situation of scientific research in China probably is not that rosy."

China has been investing heavily in scientific research and technological development in recent years to strengthen its innovative capacity, The proportion of GDP spent on R&D grew from 0.9 percent in 2000 to 1.4 percent in 2007, according to the World Bank.

An IMF forecast in 2010 says China now ranks second globally in R&D spending. The IMF calculates China's R&D expenditure at 150 billion U.S. dollars when based on Purchasing Power Parity, a widely used economic concept that attempts to equalize differences in standard of living among countries.

By this measure, China surpassed Japan in R&D spending in 2010.

Many see China's huge investment in R&D as the momentum behind the country's explosive increase in research papers.

"Getting published is, in some ways, an improvement over being unable to get published," Mu said. "But the problem is, if the papers continue to be of low quality for a long time, it will be a waste of resources."

In China, academic papers play a central role in the academic appraisal system, which is closely related to degrees and job promotions.

While acknowledging the importance of academic papers in research, Mu believes a more balanced appraisal system should be adopted. "This is a problem with science management. If we put too much focus on the quantity of research papers, we leave the job of appraisal to journal editors."

In China, the avid pursuit of publishing sometimes gives rise to scientific fraud. In the most high-profile case in recent years, two lecturers from central China's Jinggangshan University were sacked in 2010 after a journal that published their work admitted 70 papers they wrote over two years had been falsified.

"This is one of the worst cases. These unethical people not only deceived people to further their academic reputations, they also led academic research on the wrong path, which is a waste of resources," Mu said.

A study done by researchers at Wuhan University in 2010 says more than 100 million U.S. dollars changes hands in China every year for ghost-written academic papers. The market in buying and selling scientific papers has grown five-fold in the past three years.

The study says Chinese academics and students often buy and sell scientific papers to swell publication lists and many of the purported authors never write the papers they sign. Some master's or doctoral students are making a living by churning out papers for others. Others mass-produce scientific papers in order to get monetary rewards from their institutions.

A 2009 survey by the China Association for Science and Technology (CAST) of 30,078 people doing science-related work shows that nearly one-third of respondents attributed fraud to the current system that evaluates researchers' academic performance largely on the basis of how many papers they write and publish.

Despite rampant fraud, China will continue to inject huge money into science. According to the latest national science guideline, which was issued in 2006 by the State Council, the investment in R&D will account for 2.5 percent of GDP in 2020.

"If China achieves its stated goal of investing 2.5 percent of its GDP in R&D in 2020, and sustains its very fast economic growth over the next decade, it would quite likely pass the U.S. in terms of total R&D investment sometime in the late 2010s," said Calto, adding that it is also quite likely that at some point China will churn out more papers than the United States.

According to Calto, China does mostly applied research, which helps drive manufacturing and economic growth, while basic research only accounts for 6 percent, compared with about 35 percent in Germany, Britain, and the United States, and 16 percent in Japan.

"In the long term, in order to really achieve dominance in any scientific area, I think it will be necessary to put significant financial resources into fundamental basic research -- these are the theoretical areas that can drive the highest level of innovation," Calto said. (Xinhua)

Monday, September 19, 2011

Global growth and sovereign debt concerns drive markets

In a "Special Feature" in the last Bank of International Settlements' Quarterly Review, Sep. 2011, [1]  two of BIS staff publish "Global growth and sovereign debt concerns drive markets," where they confirm the already known BIS view of several trends and facts:
1  Without credible plans to restore long-term fiscal sustainability, sovereign debt in several euro area and other advanced countries may no longer be regarded as having zero credit risk.

2  [I]n many advanced economies, government debt levels are expected to continue to rise over coming years, due to high fiscal deficits and rising pension and health care costs.

3  Moreover, the level of economic output, which underpins debt servicing capacity, is unlikely to return to its pre-crisis trend any time soon.

4  Sovereign risk premia could thus be persistently higher and more volatile in the future.

There is much dispute regarding the first point, of course. The US Executive is trying to get Congress to approve a further stimulus package, and IMF's Christine Lagarde said last week that "In many corners" of the world austerity was pushed "in too harsh a way," without letting economic growth take root, according to the WSJ. [2]


[1]  Michael Davies and Tim Ng: Global growth and sovereign debt concerns drive markets. BIS Quarterly Review, Sep. 2011.

[2]  Sudeep Reddy: Three Buttons the IMF Could Push. Wall Street Journal, Monday, Sep 19, 2011, page 12.

Thursday, September 15, 2011

Assessing Systemic Trade Interconnectedness - An Empirical Approach

Assessing Systemic Trade Interconnectedness - An Empirical Approach. By Luca Errico & Alexander Massara

Summary: The paper focuses on systemically important jurisdictions in the global trade network, complementing recent IMF work on systemically important financial sectors. Using the IMF’s Direction of Trade Statistics (DOTS) database and network analysis, the paper develops a framework for ranking jurisdictions based on trade size and trade interconnectedness indicators using data for 2000 and 2010. The results show a near perfect overlap between the top 25 systemically important trade and financial jurisdictions, suggesting that these ought to be the focus of risk-based surveillance on cross-border spillovers and contagion. In addition, a number of extensions to the approach are developed that can provide a better understanding of trade dynamics at the bilateral, regional, and global levels.


The paper has laid out our approach for assessing systemic trade interconnectedness using network analysis and the IMF’s DOTS database. Our results uncover several stylized facts offering additional insights into the changing patterns of global trade over the decade 2000-2010.  We also have shown possible applications of our approach to gain a better understanding of trade dynamics across world regions and the overlapping of trade and financial sectors of systemic importance in the top 25 jurisdictions. Our approach lends itself easily to a wide range of analytical exercises addressing specific global trade issues, as well as global (trade and financial) interconnectedness issues.

The use of DOTS has lent robustness to our analysis by providing uniform data for 169 jurisdictions representing almost 100 percent of total world trade in both the year 2000 and the year 2010. Additionally, the quarterly updating of DOTS makes it possible to recalibrate our findings to track global trade developments on a timely basis.

From a policy perspective, jurisdictions hosting both systemic trade and financial sectors would seem to be the natural focus of risk-based surveillance on cross-border spillovers and contagion.  The analysis underscores that these jurisdictions display the strongest inter-sectoral interconnectedness to the global economy. As such, they have the highest potential for transmitting disturbances to other jurisdictions or to systemic stability via either the trade or financial channel or indeed both channels simultaneously. These jurisdictions would thus seem to warrant particular attention and further analysis on the risks associated with their activities, especially when carried out through systemically important financial institutions and nonfinancial corporations.

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Monday, September 5, 2011

Higher capital's unintended effect: enabling banks to take more tail risk without the fear of breaching the minimal capital ratio

In Capital Regulation and Tail Risk (IMF Working Paper WP/11/188), authors Enrico Perotti, Lev Ratnovski, and Razvan Vlahu, study banking risk mitigation linked to capital regulation, in a realist context where banks "may choose tail risk asserts." The authors believe that this "undermines the traditional result that high capital reduces excess risk-taking driven by limited liability."

Besides, higher capital requirements "may have an unintended effect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in non-tail risky project realizations."

Excerpts of the paper's introduction:
Regulatory reform in the wake of the recent financial crisis has focused on an increase in capital cushions of financial intermediaries. Basel III rules have doubled the minimal capital ratio, and directed banks to hold excess capital as conservation and countercyclical buffers above the minimum (BIS, 2010). These arrangements complement traditional moral suasion and individual targets used by regulators to ensure adequate capital cushions.

There are two key arguments in favor of higher capital. The first is an ex post argument: capital can be seen as a buffer that absorbs losses and hence reduces the risk of insolvency. This risk absorption role also mitigates systemic risk factors, such as collective uncertainty over counterparty risk, which had a devastating propagation effect during the recent crisis. The second considers the ex ante effects of buffers: capital reduces limited liability-driven incentives of bank shareholders to take excessive risk, by increasing their “skin in the game” (potential loss in case of bank failure; Jensen and Meckling 1976, Holmstrom and Tirole 1997).

Yet some recent experience calls for caution. First, banks are increasingly exposed to tail risk, which causes losses only rarely, but when those materialize they often exceed any plausible initial capital. Such risks can result from a number of strategies. A first example are carry trades reliant on short term wholesale funding, which in 2007-2008 produced highly correlated distressed sales (Gorton, 2010). A second example is the reckless underwriting of contingent liabilities on systemic risk, callable at times of collective distress (Acharya and Richardson, 2009). Finally, the combination of higher profits in normal times and massive losses occasionally arises in undiversified industry exposures to infl ated housing markets (Shin, 2009). A useful review of such strategies is provided in Acharya et al. (2009); IMF (2010) highlights the importance of recognizing tail risk in financial stability analysis. Since under tail risk banks do not internalize losses independently of the level of initial capital, the buffer and incentive effects of capital diminish. Higher capital may become a less effective way of controlling bank risk.

Second, a number of major banks, particularly in the United States, appeared highly capitalized just a couple of years prior to the crisis. Yet these very intermediaries took excessive risks (often tail risk, or highly negatively skewed gambles). In fact, anecdotal evidence suggests that highly capitalized banks were looking for ways to put at risk their capital in order to produce returns for shareholders (Berger et al. 2008, Huang and Ratnovski 2009). Therefore, higher capital may create incentives for risk-taking instead of mitigating them.

This paper seeks to study these concerns by reviewing the effectiveness of capital regulation, and in particular of excess capital buffers (that is, above minimum ratios), in dealing with tail risk events. We reach two key results.

First, we show that the traditional buffer and incentives effects of capital become less powerful when banks have access to tail risk projects. The reason is that tail risk realizations can wipe out almost any level of capital. Left tails limit the effectiveness of capital as the absorbing buffer and restrict “skin in the game” because a part of the losses is never borne by shareholders. Hence, under tail risk, excess risk-shifting incentives of bank shareholders may exist almost independently of the level of initial or required capital.

Second, having established that under tail risk the benefits of higher capital are limited, we consider its possible unintended effects. We note that capital regulation also affects bank risk choices through the threat of capital adjustment costs when banks have to raise equity to comply with minimum capital ratios. (These costs are most commonly associated with equity dilution under asymmetric information on the value of illiquid bank assets,Myers and Majluf, 1984, or reduced managerial incentives for efficiency, Jensen, 1986).2 Similar to "skin in the game", capital adjustment costs make banks averse to risk, and may discourage risky bank strategies. However, unlike "skin in the game", the incentive effects of capital adjustment costs fall with higher bank capital because the probability of breaching the minimal capital ratio decreases.

Of course, if highly capitalized banks internalized all losses, they would have taken risk only if that was socially optimal (would have offered a higher NPV). Yet this result changes dramatically once we introduce tail risk. Then, even banks with high capital never internalize all losses, and may take excess risk. Moreover, the relationship between capital and risk can become non-monotonic. The reason is interesting. In the first place, tail risk leads to insolvency whatever the initial bank capital, so higher capital does not sufficiently discourage risk-taking for well capitalized banks through "skin in the game". At the same time, higher excess capital allows banks to take the riskier projects without breaching the minimal capital ratio (and incurring large capital adjustment costs) in the case of low (non tail) returns. So under tail risk, higher capital may create conditions where highly capitalized banks take more excess risk. Further, we show that the negative effect of extra capital on risk-taking becomes stronger when banks get access to projects with even higher tail risk.

To close the model, we derive the bank’s choice of initial capital in the presence of tail risk, and the implications for optimal capital regulation. We show that a bank may choose to hold higher capital in order to create a cushion over the minimal capital requirement so as to be able to take tail risk without the fear of a corrective action in case of marginally negative project realizations.  Then, capital regulation has to implement two bounds on the values of bank capital: a bound from below (a minimal capital ratio) to prevent ordinary risk-shifting and a bound from above (realistically, in the form of special attention devoted to banks with particularly high capital) in order to assure that they are not taking tail risk.

These results are interesting to consider in historic context. Most sources of tail risk that we described are related to recent financial innovations. In the past, tail risk in traditional loan-oriented depository banking was low (both project returns and withdrawals largely satisfied the law of large numbers), hence “skin in the game” effects dominated, and extra capital led to lower risk-taking. Yet now, when banks have access to tail risk projects, the buffer and "skin in the game" effects that are the cornerstone of the traditional approach to capital regulation became weak, while effects where higher capital enables risk-taking became stronger. Therefore, due to financial innovation, the beneficial effects of higher capital were reduced, while the scope for undesirable effects increased.

The paper has policy implications relevant for the current debate on strengthening capital regulation. The simpler conclusion is that it is impossible to control all aspects of risk-taking using a single instrument. The problem of capital buffers is that they are effective as long as they can minimize not just the chance of default, but also the loss given default. Contractual innovation in finance has enabled intermediaries to manufacture risk profiles which allow them to take maximum advantage of limited liability even with high levels of capital. The key to contain gambles with skewed returns is to either prohibit extreme bets, or to increase their ex ante cost.  Leading policy proposals now emerging are to charge prudential levies on strategies exposed to systemic risk (Acharya et al., 2010), such as extremely mismatched strategies (Perotti and Suarez, 2009, 2010), or derivative positions written on highly correlated risks.

A more intricate conclusion relates to implications for capital regulation. The results do not imply that less capital is better: this was not the case in recent years. However, they suggest the following. First, regulators should acknowledge that traditional capital regulation has limitations in dealing with tail risk. This is similar, for example, to an already-accepted understanding that it has limitations in dealing with correlation risk (Acharya, 2009). Second, banks with significant excess capital may be induced to take excess risk (in order to use or put at risk their capital), as amply demonstrated by the crisis experience. Hence, simply relying on higher and "excess" capital of banks as a means of crisis prevention may have ruinous effects if it produces a false sense of comfort. Finally, authorities should introduce complementary measures to target tail risk next to the policy on pro-cyclical and conservation buffers. In this context, enhanced supervision with a focus on capturing tail risk may be essential.

We see our paper as related to two key strands of the banking literature. First are the papers on the unintended effects of bank capital regulation. Early papers (Kahane 1977, Kim and Santomero 1988, Koehn and Santomero 1980) took a portfolio optimization approach to banking and caution that higher capital requirements can lead to an increase in risk of the risky part of the bank’s portfolio. Later studies focus on incentive effects. Boot and Greenbaum (1993) show that capital requirements can negatively affect asset quality due to a reduction in monitoring incentives. Blum (1999), Caminal and Matutes (2002), Flannery (1989) and Hellman et al. (2000) argue that higher capital can make banks take more risk as they attempt to compensate for the cost of capital. Our paper follows this literature, with a distinct and contemporary focus on tail risk.3 On the empirical front, Angora et al. (2009) and Bichsel and Blum (2004) find a positive correlation between levels of capital and bank risk-taking.

The second strand are the recent papers on the regulatory implications of increased sophistication of financial intermediaries and the recent crisis. These papers generally argue that dealing with new risks (including systemic and tail risk) requires new regulatory tools (Acharya and Yorulmazer 2007, Acharya et al. 2010, Brunnermeier and Pedersen 2008, Huang and Ratnovski 2011, Perotti and Suarez 2009, 2010).
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