credit risk measurement developments over the last 20 years abstract this paper traces developments in the credit risk measurement literature over the last 20 years the paper is essentially divided into two parts in the first part the evolution of the literature on the credit risk measurement of individual loans and portfolios of loans is traced by way of reference to articles appearing in relevant issues of the journal of banking and finance and other publications in the second part a new approach built around a mortality risk framework to measuring the risk and returns on loans and bonds is presented this model is shown to offer some promise in analyzing the risk return structures of portfolios of credit risk exposed debt instruments

alternative forms of deposit insurance pricing and bank incentive issues abstract this paper derives formulas for a deposit insuring agency s liability and hence a fair value deposit insurance premium and the equilibrium value of bank equity considering a wide variety of factors affecting individual bank risk both fixed rate and variable rate risk sensitive insurance systems are analyzed consideration is made as to whether the deposit insuring agency makes direct payments to depositors or arranges mergers following bank closings the effect of these various policy choices on banks incentive for risk taking is also analyzed

pricing risk adjusted deposit insurance an option based model this paper presents a methodology for arriving at empirical estimates of deposit insurance premiums from market data by using isomorphic relationships betweeen equity and a call option and insurance and a put option the data utilizes the market value of equity to solve for the asset value and its volatility market perceptions of fdic bailout policies are explicitly modeled so as to eliminate the bias in inverted values of assets and their volatility sensitivity analyses are performed to show that rank orderings based on premiums are robust to changes in specification thus facilitating allocation of aggregate premium across banks while economists have long argued in favor of risk adjusted deposit insurance as both more equitable and more efficient than the current system of flatrate premiums various recent developments have further contributed to an increasing dissatisfaction with the current system first both the banking industry and the government seem to be tending to the view that deregulation of the banking industry would be necessary in order to meet more sophisticated future demands on the industry as well as desirable as a policy means of stimulating greater competition among banks moreover a sudden rise in the incidence of bank failures 1 and the vulnerability of the u s banks to the socalled international debt crisis have served to bring to the fore concern about the health of the banking industry in the absence of deposit insurance riskier banks will be able to attract deposits only at higher rates and these higher costs of funding serve as built in market regulated incentives to limit excessive risk taking by banks as introduction of deposit insurance makes deposits equally risk free across banks these incentives disappear and regulation and close supervision of the banking industry must necessarily replace them as deterrents to excessive risk taking thus when insurance is offered at a flat premium regulation is designed to ensure that the risk posed to the insurer both asset and financial risk is appropriately uniform

a new test of money income causality this paper investigates the prima facie causal relationship between money and income employing a methodology the multiple rank f test the results of which are invariant to monotonic transformations of all variables and robust over alternative distributions of the errors in contrast to prior functional form dependent parametric analyses evidence of prima facie causality between money and income is found for the 1970 88 time period this evidence is consistent with an elementary theoretical framework in which the direction and strength of causality is dependent upon the definition of money copyright 1992 by ohio state university press

money inflation and causality in a financially repressed economy algeria 1970 88 the objective of the paper is to replicate tests identifying the line of causality between the money supply and the rate of inflation using algerian date for the period 1970 88 and provide new evidence for a developing economy the methodology adopted is that of granger and the results show that there is a very strong relationship between the money supply and the rate of inflation with the line of causation being unidirectional that is from the money supply to inflation with no feedback effects

assessing the risk return trade off in loan portfolios abstract this paper proposes a methodology to analyse the risk and return of large loan portfolios in a joint setting i propose a tractable model to obtain the distribution of loan returns from observed interest rates and default frequencies i follow a sectoral approach that captures the heterogeneous cyclical features of different kinds of loans and yields moments in closed form i investigate the validity of mean variance analysis with a value at risk constraint and study its relationship with utility maximisation finally i study the efficiency of corporate and household loan portfolios in an empirical application to the spanish banking system

the causal factors of government expenditure growth in greece 1950 80 the notion of causal relationships is the basis on which the empirical testing of theoretical propositions rests this paper considers the risks from the wrong identification of causal relationships and then by using the pierce haugh test attempts to establish the correct causal patterns between various groups of government expenditures within the context of the greek economy from 1950 to 1980 and other variables which have appeared in the literature of the determinants of government expenditure growth

appearance and reality in deposit insurance the case for reform abstract this paper argues that the staffs and explicit insurance reserves of u s deposit insurers have been overwhelmed by de facto financial disaster the full costs of financing federal deposit insurance have become enormous and increasingly inequitable in distribution to reduce voluntary risk taking authorities must reprice and redesign the system of de facto deposit insurance coverage six complementary reforms are discussed 1 accounting for institutional assets liabilities and net worth at market value 2 enhancing opportunities for deposit insurers to manage their risk exposure 3 recalibrating insurance coverages 4 imposing risk rated premiums 5 mixed private and governmental competition in deposit insurance and 6 constraining insurance agency and federal reserve authority to bail out insolvent institutions

causality between export growth and industrial development empirical evidence from the nics a comment abstract in a recent article chow 1987 argued that his empirical evidence supports the hypothesis that export growth causes industrial development in this comment i point out several serious shortcomings of chow s analysis

flexible labor compensation risk sharing and company leverage abstract in a traditional wage system the union and the firm bargain ex ante over a compensation level that does not depend on the state of the world under this regime both the wage and the interest earned by debt holders represent predetermined fixed claims on the value of the firm on the other hand in a profit sharing system the union and the firm bargain ex ante over a compensation schedule that does depend on the state of the world in this case the flexible compensation earned by workers becomes a residual claim on the value of the firm similar to the dividend earned by stock holders the implications of this correspondence between compensation structure and financial structure are explored the estimation of a model for the issuance of new long term debt supports the hypothesis of interdependence between financial and compensation decisions

what s different about banks abstract negotiable certificates of deposit cd s trade in the capital market in competition with other securities like commercial paper and bankers acceptances if cd s must pay lenders competitive monetary interest the reserve tax on cd s is borne by bank borrowers viability of the tax means there must be something special about bank loans that makes some borrowers willing to pay higher interest rates than those on other securities of equivalent risk moreover there must be something special about banks that prevents other intermediaries from competing to assure that it never pays to finance loans with cd s

capital regulation and deposit insurance abstract a model of deposit insurance in which the bank closure rule can systematically deviate from the economic insolvency condition used in earlier models is developed simulation of that model for plausible parameter values suggests that the failure to close banks on a timely basis has a profound effect in increasing the insurer s liability the implications of these results for capital regulation are discussed

oligopoly profit sharing contracts and the firm s systematic risk abstract this article examines the properties of wage and profit sharing contracts in a model of oligopoly with capital market equilibrium while profit sharing contracts dominate market wage contracts profit sharing also reduces the firm s cost of equity capital under fairly broad conditions of oligopoly by enforcing lower costs in exchange for a pre determined share of cash flows to workers this form of operational leverage both reinforces the classical effect of market power on systematic risk and the impact of profit sharing on the corporate finance of the firm as previously suggested by ichino 1994 european economic review 38 1411 1422

variable rate deposit insurance a re examination abstract this paper investigates the impact of variable rate deposit insurance on the financial and real sectors of the economy and its role as an absorber of bankruptcy risk within these sectors a variable rate system raises the cost of funds to the real sector and increases probability of bankruptcy of the borrowing firms when such bankruptcies occur society experiences a dead weight loss we argue that appropriate deposit insurance pricing must weigh the social costs connected with both financial firm failure and real sector bankruptcy

energy and economic growth in the usa a multivariate approach abstract this paper examines the causal relationship between gdp and energy use for the period 1947 90 in the usa the relationship between energy use and economic growth has been examined by both biophysical and neoclassical economists in particular several studies have tested for the presence of a causal relationship in the granger sense between energy use and economic growth however these tests do not allow a direct test of the relative explanatory powers of the neoclassical and biophysical models a multivariate adaptation of the test vector autoregression var does allow such a test a var of gdp energy use capital stock and employment is estimated and granger tests for causal relationships between the variables are carried out although there is no evidence that gross energy use granger causes gdp a measure of final energy use adjusted for changing fuel composition does granger cause gdp

federal deposit insurance regulatory policy and optimal bank capital this paper seeks to explain the combination of explicit and implicit pricing for deposit insurance employed by the fdic essentially the fdic sells two products insurance and regulation to span the product space it must and does set two prices we argue that the need to establish regulatory disincentives to bank risk taking is the heart of the controversy over the adequacy of bank capital and that the ability to close risky banks before exhausting their charter value i e the value of their right to continue in business stands at the center of these disincentives and in front of the fdic s insurance reserves just as a book shouldn t be judged by its cover a government agency shouldn t be judged by the words behind its initials with the fdic federal deposit insurance corporation the agency s name describes only part of its formal operations the fdic is quasi governmental has a regional structure and sells deposit insurance however the initials fail to convey the fdic s critical place in the governmental regulatory structure as the sole federal overseer of the approximately 8900 state chartered commercial banks that have chosen not to belong the federal reserve system reflecting the federal reserve s membership problem the number of these banks is growing year by year besides selling deposit insurance at bargain explicit rates the fdic performs four regulatory functions 1 entry regulation it passes on new banks applications for deposit insurance and on branch and merger proposals as well thereby protecting the value of existing bank charters 2 examination two thirds of fdic employees are concerned with inspecting bank records and supervising managerial activity 3 regulation of deposit rates and conditions for withdrawal by tradition fdic policies on these matters conform entirely with regulations applicable to federal reserve member banks and 4 disposition of failed banks when an insured bank fails the fdic usually chooses not to liquidate it 2

the valuation of fdic deposit insurance using option pricing estimates when congress set the premium rate for fdic deposit insurance in the banking act of 1935 which authorized a permanent federal insurance system neither experience nor theory could offer much guidance regarding an appropriate fee structure although rates have since been periodically revised the fdic has yet to attempt to set the insurance rate at a ifair level that is a level equal to administrative costs plus the ex ante value of the insurance such a premium is the rate that would be charged by competitive private insurers however7 the garn st germain act of 1982 directed the fdic to consider the feasibility of a risk based premium structure in response the fdic has suggested a trial system in which each insured bank will be placed in one of three risk classes based on credit and interest rate risk relative to capital and a premium rate will be assigned to each group those rates will be determined in part by the loss experience of the entire banking system fdic 1983 another approach to the determination of the appropriate insurance premium has been offered by merton 1977 who suggested using the analogous relationship between deposit guarantees and put options to value fdic insurance in this paper we follow merton s suggestion and calculate bank specific estimates of the proper premium for deposit insurance for the banks in our sample we find that fdic rates greatly exceed estimates of the fair value of the insurance derived from the blackscholes 1972 option pricing model

business tax policy the lucas critique and lessons from the 1980 s in 1976 robert lucas published a devastating critique of the then current practice for quantifying the effects of alternative policies he argued that in formulating plans economic agents necessarily look into the future and thus the decision rules guiding their actions depend on parameters describing the expectations of future variables as well as parameters of taste and technology lucas viewed economic policy as the selection of rules that generate the values of policy variables rather than the selection of arbitrary sequences of policy variables thus any change in policy will systematically alter the structure of econometric models 1981 p 126 and the estimated coefficients in the then current consumption wageprice or investment models could not be considered structural that is invariant to alternative policy regimes the important and damning implication for policy analysis is that these econometric relationships will prove unstable in precisely those situations in which they are called upon to analyze proposed policies this paper seeks to exploit the substantial variation in business tax policy during the 1980 s to shed some light on the quantitative importance of the lucas critique lc and to evaluate the ability of explicit theory to enhance econometric analysis in august of 1981 the economic agenda of the reagan revolution began to be put in place with the passage of the economic recovery tax act erta this was followed by the tax equity and fiscal responsibility act of 1982 the deficit reduction act of 1984 and the tax reform act of 1986 other changes such as the increase in defense spending and growth of and restrictions on the federal deficit indicate that expectations of the current and future course of fiscal policy were altered radically during the reagan administration maintained in this paper is the assumption that these changes in tax and other aspects of fiscal policy can be viewed as an unanticipated change in policy regime in regard to the 1981 legislation the economic report of the president claimed that t his tax policy is a sharp break from the policies of the recent past it reflects a different understanding of the way tax policy affects the u s economy 1982 p 109 under the assumption that the 1980 s witnessed a fundamental change in the stochastic process characterizing fiscal policy econometric equations susceptible to the lc should become temporally unstable those models that successfully address the lc by isolating expectation parameters should remain stable the quantitative importance of the lc is evaluated by examining the stability of four different econometric models of business investment that to varying degrees are vulnerable to the lc the neoclassical model studied extensively by robert hall and dale jorgenson 1967 robert eisner and m ishaq nadiri 1968 and their numerous collaborators the q model associated with james tobin the vector autoregressive model var s advanced by christopher sims 1982 and a hybrid var model var h used to study investment by robert gordon and john veitch 1986 since the four models differ in the extent to which they are guided by explicit theoretical frameworks these results will also be useful in assessing the impact of economic theory on econometric performance university of chicago chicago il 60637 i thank charles hulten robert lucas and allen sinai for critical comments on a preliminary draft all errors omissions and conclusions remain my sole responsibility

money inflation and casuality another look at the empirical evidence for the usa 1953 84 this paper addresses the issue of the existence of a causal relationship between inflation i e change in the price level and change in the money supply three different causality tests are discussed and implemented for two separate time periods the results are mixed and somewhat difficult to interpret on intuitive grounds while a causal relationship is found to exist between changes in the consumer price index and changes in the narrowly defined money supply there is no relationship indentifiable between the other price and money supply data series used given this result one can see why different results are frequently obtained the different researchers focusing on the question of a relationship between the supply of money and prices finally the results of a previous paper by feige and pearce are called into question as the result of a serious misspecification

a framework for assessing credit risk in depository institutions toward regulatory reform abstract this paper develops and illustrates a new method for evaluating the credit risk borne by depository institutions that may prove to be an important element in a regulatory mechanism sensitive to risk in our framework depository institutions are forced to bear the costs of their risk exposure and hence to internalize this cost when extending loans using various loan portfolios and alternative macroeconomic scenarios we present numerical calculations demonstrating the ability of our framework to capture variations in risk exposure and highlighting the significance of portfolio concentrations these calculations are based on an important new source of information that permits an econometric analysis of loan losses by industry

financial structure and aggregate economic activity an overview this paper surveys literature that explores the possible links between the financial system and aggregate economic behavior the survey is in two parts the first reviews the traditional work and the second discusses new research copyright 1988 by ohio state university press

is fairly priced deposit insurance possible we analyze risk sensitive incentive compatible deposit insurance in the presence of private information and moral hazard without deposit linked subsidies it is impossible to implement risk sensitive incentive compatible deposit insurance pricing in a competitive deregulated environment except when the deposit insurer is the least risk averse agent in the economy we establish this formally in the context of an insurance scheme in which privately informed depository institutions are offered deposit insurance premia contingent on reported capital the result holds for alternative sorting instruments as well this suggests a contradiction between deregulation and fairly priced risk sensitive deposit insurance this paper exposes a conflict between a deregulated competitive financial services industry on the one hand and fairly priced risk sensitive deposit insurance on the other we show that if depository institutions dis are perfectly competitive i e each makes zero profits on average then it is impossible to implement incentive compatible risk sensitive deposit insurance pricing recent distress among dis has fueled debate about reform of the existing deposit insurance system many believe that the prevailing risk insensitive premium structure encourages dis to choose excessively risky assets and that it should be replaced by deposit insurance premia linked to the dis choices of risk 2 risk sensitive deposit insurance pricing however imposes greater informational demands on the deposit insurer and runs afoul of both

a reexamination of the over or under pricing of deposit insurance this study shows how fair deposit insurance premia can be calculated using data on bank stock prices interest rate movements and income and balance sheet accounts fair insurance premia are estimat ed under the alternative assumptions that the fdic provides either a limited term variable rate or unlimited term insurance cont ract to banks the paper s results suggest that for nearly all of the large commerical banks in the sample the actual insurance premium c harged by the fdic falls between the bounds of fair limited term and unlimited term insurance premia copyright 1987 by ohio state university press

keynes versus wagner public expenditure and national income for three african countries the public expenditure income hypothesis has long been debated in economics following keynes public expenditure is seen as an exogenous factor to be used as a policy instrument to influence growth on the other hand wagner argues that expenditure is an endogenous factor or an outcome not a cause of growth in national income the purpose of this paper is to apply both the granger and holmes hutton statistical procedures to test the income expenditure hypothesis for three african countries ghana kenya and south africa we find that the hypothesis of public expenditure causing national income is not supported by the data for these african countries

applying portfolio theory to global bank lending abstract portfolio theory provides some insights into how a bank should manage its global exposures practical application of some of the principles of portfolio analysis is possible if comparable credit ratings are available and if the impact on each loan s rating of likely future events can be assessed if further restrictive assumptions are made about which quality dimensions of the portfolio are more important and how much more important and if judgements can be quantified about what risk return tradeoffs are acceptable then it is possible to derive measures to guide exposure and pricing decisions this article is related to the other papers in this special issue in that country and corporate risk assessment methodologies can provide important inputs into the portfolio analysis this paper however attempts to go beyond the evaluation of risk at the level of individual companies countries or other loan customers and to focus instead on the problem of managing the riskiness of the overall bank loan portfolio

a casual varma model analysis with an application to canadian money and income data 1988 a casual varma model analysis with an application to canadian money and income data applied economics vol 20 no 9 pp 1167 1183

profit sharing risk sharing and firm size implications of efficiency wages by taking account of output fluctuations this paper constructs a synthesis of profit sharing and efficiency wage models to highlight the role of the risk attitudes of the firm and its employees we show contrary to the traditional efficiency wage theory that in a profit sharing economy unemployment is no longer a necessary device to induce work effort and consequently the labor market equilibrium may be characterized by full employment such a result is more likely to be true when the economy is characterized by small sized firms in addition we also provide a preliminary sketch of the situations in which the firm chooses a profit sharing program or a fixed wage one and discuss how a firm determines its pay parameters and employment in response to output fluctuations

are causal relationships sensitive to causality tests 1987 are causal relationships sensitive to causality tests applied economics vol 19 no 4 pp 459 465