Previous article discussed a model where dealers quote bid and ask prices that deviate from the fundamental value of the asset in order to offset the adverse selection costs that arise in the case of asymmetric information. We therefore assumed risk neutrality, so that dealers would be concerned only with adverse selection costs. In real markets, however, dealers also act as mandatory liquidity suppliers and are obliged to quote prices continuously. This means they will frequently hold undesired portfolio positions that do not lie on their efficient frontier. The costs that dealers must sustain for holding undesired positions – called ‘inventory costs’ – are another determinant of the bid–ask spread. In fact, through opposite changes in the bid–ask quotations, dealers can encourage transactions by their customers that will rebalance their portfolio. Clearly, in this context, it is crucial to assume that dealers are risk-averse, since only the riskaverse are concerned about the possible losses due to future adverse price changes.

Inventory models assign an important role to market-makers who offer the opportunity to trade at all times and therefore act as immediacy providers. The initial modelling approach (Garman, 1976) to the market-makers’ control problem assumes that their objective is to avoid bankruptcy (the ‘ruin problem’), which could be caused by the uncertainty induced by the arrival of non-synchronous buy and sell orders. As O’Hara (1995) suggests, this approach is not realistic since it assumes that a dealer quotes his prices only at the beginning of the trading game, so his inventory plays no role in the decision.

Once you have searched the stores in your area as thoroughly as you possibly can and have convinced yourself that your idea is not currently being offered in the local stores, it is time to get online and begin an Internet market search. There are a couple of steps to be completed in this search in order to be thorough here and it will be a bit time-consuming, but it is not difficult. You will do a key word search and a catalog search. You will start your Internet search by making a list of key words that might be used to describe your invention. You will be searching through the links to see what products similar to your invention are being offered for sale on the Internet. Even if you feel strongly that no similar products exist, you will be surprised by what a key word search will turn up. Use the most descriptive words you can think of and get as specific as possible in the description. By this, we mean get right down to the most common descriptive words for your invention. For example, if your product is a kitchen gadget, it is far too broad to simply type in, “Kitchen Gadget.” This would bring up many more links than you would want, or need, to search. If the invention is designed for peeling grapes, say so. Type in, “Grape Peeler.” Then, as you begin to click on and follow the links that this brings up, you will find more words on those pages that will help you to reach even more links and get even more specific. For example, you may find words that are specific to that type of product – i.e. rind removal – that would lead you to entirely new links to explore.

The rating agencies provide the most accurate data on historical default rates. Based on their data, empirical studies by Wilson  Saunders  and others suggest that default rates tend to be higher in recessionary periods. As might be expected, default rates usually peak at the end of recessions and fall when the economy is expanding. A closer look at history shows that default rates reached their highest levels in the 1930s, peaking at 9 percent in 1932. Since then they have never come close to that level. From 1940 to 1970 they were extremely low, hardly ever exceeding 1 percent. Moody’s themselves note that in the 1973 recession, the default rate was close to zero because only the best issuers had been able to access the capital markets in the previous years. In the early 1990s and at the beginning of the new millennium default rates rose significantly, reaching their peak at about 4 percent. Thus, the default cycle has mirrored the business cycle very well in the past 15 years. Yet one difference is not reflected in this figure. On a dollar-weighted basis, the 2002 default rate for speculative grade issuers was nearly twice as high as in 1991, causing painful losses for many investors.

Furthermore the 2002 default rate for US investment grade issuers reached more than 1 percent on an issuer-weighted basis and almost 3 percent on a dollar-weighted basis. This is substantially above the 30-year average of the investment grade default rate, which is about 25 basis points. Clearly, investment grade defaults are supposed to happen very infrequently.