## Wednesday, June 06, 2007

### Capital controls against debt flows

One recurring theme in international economics is how households & firms evade restrictions on trade and capital controls. In a curious twist, policy hostility against debt flows is reminiscent of "Islamic finance" where straight debt is considered bad. So interesting ideas on rerouting business past proscriptions against Islamic finance are relevant when thinking about what the private sector will do when faced with rules against debt flows. You may also be interested in an earlier blog post on synthetic corporate bonds.

The paper referenced above is:

The Ancient Roots of Modern Financial Innovation: The Early History of Regulatory Arbitrage by Michael Knoll [direct link]. The abstract reads: Recent years have seen an explosion of financial innovation. Much of this innovation seeks to exploit inconsistencies in the regulatory environment, and one of the most popular techniques for doing so uses put-call parity. Nonetheless, regulatory arbitrage using put-call parity is not a new phenomenon, as is frequently suggested. This Essay traces the use of put-call parity to avoid the usury prohibition back to Ancient Israel. It also describes the important role that put-call parity played in developing the equity of redemption, the defining characteristic of a modern mortgage, in Medieval England. In addition, this Essay describes how Muslims living in the West are using mortgage substitutes based on put-call parity to avoid Islam's prohibition on paying interest.

#### 1 comment:

1. Dear Ajay,
I agree with your general outlook on inflation, that it's a concern, and that it should be brought down. But can the recent WPI decline really be attributed so directly to the currency appreciation? Many of the brokers had predicted it would slow down simply because the yoy comparisons were getting more favorable - i.e. there was a spike in some items 12 months ago, so it would be harder to compound inflation at the same pace unless further spikes in key items came. Also, what are the chances that inflation simply looks better because of the artificial price-capping regulatory activity (e.g. threats to steel producers, tarrif barriers trapping cement capacity within India, etc.)?
Andrew West

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