Jamesian Philosophy Refreshed

In Eco 101 you probably learned that one of the big issues that arises whenever there is an effort at collective action in the absence of a central authority is the free-rider problem, otherwise known as "positive externalities." Let's go over it again, because some of us (myself included) have allowed our memories of Eco 101 lessons to become ... less than fresh. Textbook analogy: An entrepreneur creates a drive-in movie theatre, because it is cheaper just to put up a screen than to build a whole building. At first things work fine but over time cinephiles discover that they don’t have to drive into the entrepreneur’s lot and pay him in order to watch the movie: they can enjoy the same movie for free by parking on the opposite side of the street. The entrepreneur either internalizes the benefit (puts up walls) or he goes out of business. So external benefits, that is, benefits available to freeloaders, threaten the viability of the whole enterprise. That is on...

Picking up a discussion we had been engaging in of late about the types of risk faced (and, one must hope, managed) by financial institutions....   Default risk is the risk that some counterparty with which the risk manager’s own concern is doing business, and from whom they are receiving contracted-for payments, will stop making those payments. They might stop payment either with malice aforethought (as with crooks who take your valuables, promise you a series of payments, and then skip town), or they may stop payment due to some financial crisis that leaves them incapable of doing so. In other words, your own liquidity risk as defined above is somebody else’s default risk. Interest-rate risk is the risk that a change in interest rates will undermine the value of an entity’s assets. For example: on any given day there is some risk that a central bank’s decision to increase interest rates will hurt the value of stocks (because it makes lending money relatively more attra...