guaranty funds and risk taking evidence from the insurance industry abstract this paper examines change in property liability insurers risk taking around enactments of state guaranty fund laws our evidence suggests that the risk of insurers asset portfolios increases following enactments but this increase in risk is significant only for stock insurers our evidence of increased risk taking following guaranty fund adoptions suggests that the way these funds are organized creates counterproductive investment incentives especially for stock companies because these laws were enacted by states over the period 1969 1981 our evidence on changes in risk taking helps resolve statistical problems that have been troublesome for studies of bank deposit insurance

incentive effects of benevolent intervention the case of government loan guarantees abstract there has been a substantial recent growth in government loan guarantees to ailing firms in the united states this paper investigates the potential incentive effects of this practice using the simplest available two period model it is shown that when firms know that loan guarantees may be forthcoming they may be induced to adopt riskier investments and take on more leverage these perverse incentive effects imply that the actual loan guarantees related contingent liability of the government could be much larger than suspected our policy recommendation is that the government either abandon the practice altogether or set up a federal agency that sells loan guarantees to all firms at prices that depend on the riskiness of the firm s assets and its leverage

sectoral shocks and aggregate fluctuations abstract this paper presents a multisector dynamic general equilibrium model of business cycles with a distinctive feature aggregate fluctuations are driven by independent sectoral shocks the model hypothesizes that trade among sectors provides a strong synchronization mechanism for these shocks due to the limited but locally intense interaction that is characteristic of such input trade flows limited interaction characterized by a sparse intermediate input use matrix reduces substitution possibilities among intermediate inputs which strengthens comovement in sectoral value added and leads to a postponement of the law of large numbers in the variance of aggregate value added the chief virtue of this model is that reliance on implausible aggregate shocks is not necessary to capture the qualitative features of macroeconomic fluctuations building on horvath 1998 review of economic dynamics 1 781 808 which establishes the theoretical foundation for the relevance of limited interaction in the context of a stylized multisector model this paper specifies a more general multisector model calibrated to the us 2 digit standard industrial code economy simulations prove the model is able to match empirical reality as closely as standard one sector business cycle models without relying on aggregate shocks

reversion taxes contingent benefits and the decline in pension funding abstract the evidence since the mid 1980s contradicts the axiom that firms maximize the arbitrage value of their tax exempt pension funds instead it suggests the emergence of a new minimum funding paradigm a prominent candidate to explain the change is a sequence of escalating reversion taxes enacted between 1986 and 1990 a valuable option to a pension plan sponsor is its ability to cancel the contingent portion of its pension obligations pension promises beyond those legally required as a result of reversion taxes this option value is preserved only if the firm maintains zero excess assets and falls in proportion to the amount of excess assets retained in the pension fund the potential for this tax policy to profoundly affect the economics of pension funding seems apparent by 1995 the cumulative effect of the new contribution behavior resulted in a 60 percent reduction in excess pension assets

prompt corrective action and bank efforts to recover from undercapitalization abstract this study empirically examines the likelihood and timing of bank recoveries from positions of undercapitalization our findings indicate that 1 there appears to be only a limited capacity for banks to correct positions of undercapitalization by growth limitations or dividend restrictions 2 the impact of profitability on recovery is greater the longer a bank remains undercapitalized and 3 equity infusions are the primary mechanism by which banks can recapitalize quickly this evidence is relevant to regulators in their implementation of the fdic improvement act of 1991 which requires that undercapitalized banks take prompt corrective actions to recapitalize quickly under threat of early closure

valuation of landmass degradation using fuzzy hedonic method a case study of national capital region a hedonic model to determine the revealed willingness to pay for landmass of different suitability classes based on landmass functional characteristics obtained through subjective assessments is developed for the national capital region in india the inherent non specificity involved in subjective evaluation is minimized using fuzzy logic based regression technique the proposed fuzzy regression involves regression using central values of triangular fuzzy number and minimization of non specificity using linear programming the revealed willingness to pay for landmass of different suitability classes is used for valuation of disbenefits due to urban expansion on landmass of different agricultural suitability classes in national capital territory of delhi appropriate pricing policies to prevent the future inappropriate landuse practices are developed using the landmass valuation

pension benefit insurance and pension plan portfolio choice pension bene t guarantee policies have been introduced in several countries to protect private pension plan members from the loss of income that would occur if a plan was underfunded when the sponsoring rm terminates a plan most of these public insurance schemes face nancial di culty and consequently policy reforms are being discussed or implemented economic theory suggests that such schemes will face moral hazard and adverse selection problems in this note we test a speci c theoretical predic

market rate versus fixed rate demand deposits abstract in an economy with uninsured banks market rate deposits are shown to provide services identical to fixed rate deposits without risking banking panics as long as there is not both aggregate uncertainty about liquidity demands and asymmetric information about bank asset quality however if both factors are present then the preferred deposit form depends on the riskiness of bank assets and information revealed through market prices the analysis may explain the evolution of fixed rate deposits before the introduction of deposit insurance moreover it provides currently relevant insights regarding deposit contract forms and deposit insurance

the economic functions of private pensions an empirical analysis this paper presents an empirical analysis of the economic functions of defined benefit db pensions firms providing pensions choose between db and defined contribution formats the latter is essentially a tax preferred savings account the former may fill other roles determinants of firms choice of plan are estimated using plan sponsors reports to the internal revenue service firms that are larger are unionized employ mainly one sex invest in specific training and pay lower wages are more likely to provide db coverage these results suggest that the economic role of pensions is broader than mere provision of tax preferred savings accounts

deposit insurance reform what are the issues and what needs to be fixed abstract the current problems in the commercial banking industry have led to widespread calls for reform of the deposit insurance contract on the grounds that it promotes moral hazard we review the empirical evidence for the significance of moral hazard as an important cause of the present crisis we then evaluate various reform proposals grouped into two broad classes proposals that seek to impose greater discipline on bank stockholders and proposals to increase the disciplinary role of bank debtholders finally we identify some issues that have received inadequate attention in the literature on bank regulation

bonding and nonbonding signals of product quality this article examines the essential role of bonding in most signaling models where quality is subject to moral hazard problems an advertising model in which advertising is a durable asset whose value is reduced by cheating illustrates how the bonding capacity of a signal determines its cost characteristics of the market that govern how well a signal is targeted to relevant consumers and how information about cheating is spread are critical to determining bonding capacity and hence to the choice among potential signals this bonding perspective explains the literature s widely divergent predictions about the conditions necessary for quality signals copyright 1990 by the university of chicago

an empirical model of labor supply in a life cycle setting this paper formulates and estimates a structural intertemporal model of labor supply using theoretical characterizations derived from an economic model of lifetime behavior a two step empirical analysis yields estimates of intertemporal and uncompensated substitution effects which provide the information needed to predict the response of hours of work to life cycle wage growth and shifts in the lifetime wage path

cointegration relationships and hedonic pricing of differentiated commodities an application to price dynamics in the us dairy sector this study investigates the implications of hedonic pricing for price dynamics of differentiated commodities a conceptual model of hedonic pricing is developed under a leontief technology showing how commodity prices reflect the underlying value of their components implications for the existence of cointegration relationships among commodity prices are derived an application to the pricing and dynamics of selected us dairy commodities is presented it provides evidence on the role of component valuation in the dynamics of dairy commodity prices in the short run as well as in the long run distinguishing between market regime and government regime when the government price support is active the analysis finds significant differences in dairy price dynamics between the two regimes

average derivative estimation of hedonic price models conventional parametric techniques for estimatinghedonic price models require a correct functionalform in this paper we side step this parametricshortcoming by estimating a hedonic price model usingaverage derivative estimation ade thissemiparametric approach produces robust estimates ofthe marginal effects without assuming a specificfunctional form a priori in our application ofthe model to a unique data set on korean home prices ade produced estimates consistent with priorexpectations providing initial evidence that themodel may represent a viable alternative when usingthe hedonic approach

behavioral rationality in finance the case of dividends as the title suggests this paper attempts to get to the specifics of the behavioral rationality theme of this conference by focusing on an area in the main core of finance namely the demand and supply of dividends where by common consent the essentially rationalist paradigm of the field seems to be limping most noticeably important and pervasive behavior patterns on both the paying and the receiving ends have despairingly been written off as puzzles even by theorists as redoubtable as fischer black see esp his much cited 1976 article behaviorists have homed in on precisely these same dividendrelated soft spots in the current body of theory see esp shefrin and statman 1984 we seem to have in sum an ideal place to look for signs of an imminent paradigm shift in the behavioral direction of precisely the kind envisioned by some of the other contributors to this conference the dividend related difficulties and supposed anomalies at issue here are more than just the parochial concern of finance specialists the dividends seem a natural area in finance where the introduction of behavioral cognitive elements might help resolve long standing anomalies particularly the seeming failure of supply to adjust to taxinduced price penalties a closer look at the empirical record however particularly at evidence of responsiveness to major structural changes shows behavior of the aggregates to be less anomalous than conventional handwringing might suggest behavioral cognitive elements whatever they might contribute to the description of particular microdecisions do not appear to be essential adjuncts to the basic finance model in the major comparative static applications for which it was intended helpful comments on an earlier version of this paper have been received from nai fu chen jean marie gagnon gur huberman kose john james poterba and especially melvin reder

the implicit pension contract developments and new directions pension economics has emerged as a separate literature over the past decade some of the early pension work was devoted to financial issues including implications of pensions for savings rates and portfolio allocation most new developments however have stemmed from research surrounding labor markets this research has led to an implicit contract theory of pensions a theory that has pensions playing a more complicated role in worker firm relation than heretofore realized the theory explains much of economic behavior in labor markets and bridges a gap between labor and financial literatures this essay describes the genesis for these ideas and traces some of the most important research results in the area an equal amount of spece is devoted to a consideration of likely directions for future research

risk shifting incentives of depository institutions a new perspective on federal deposit insurance reform abstract we characterize the risk shifting incentives of a depository institution as arising fundamentally from the existence of limited liability and the associated convex payoff to equity holders this risk incentive feature is unchanged by deposits being insured and hence excessive risk taking by depository institutions is not solely attributable to the flat rate insurance premium consequently the incentive problem cannot be resolved through a risk based insurance premium contrary to the prevailing view we propose a solution that eliminates risk shifting through an optimal tax structure and specify a corresponding insurance premium that is revenue neutral from the social planner s regulator s standpoint the solution is derived in the context of a social objective function that trades off the benefits of liquidity services by banks and the unique informational role of bank loans with the costs of investment distortions engendered by risk shifting

the financial instability hypothesis a stochastic microfoundation framework this paper examines the dynamics of financial distress and in particular the mechanism of transmission of shocks from the financial sector to the real economy the analysis is performed by representing the linkages between microeconomic financial variables and the aggregate performance of the economy by means of a microfounded model with firms that have heterogeneous capital structures the model is solved both numerically and analytically by means of a stochastic approximation that is able to replicate quite well the numerical solution these methodologies by overcoming the restrictions imposed by the traditional microfounded approach enable us to provide some insights into the stabilization policies which may be effective in a financially fragile system

market expectations of the effects of the tax reform act of 1986 on banking organizations abstract this study investigates market expectations regarding the effect of the tax reform act of 1986 on the banking industry the evidence shows that overall the tax reform did not adversely affect the stocks of banking institutions the findings suggest that overall banking organizations were expected to largely mitigate any negative effects of the tax reform on their cash flow by rebalancing and or repricing their portfolios of assets and liabilities the most significant provision of the new act was the limitation on foreign tax credits interestingly the markets did not expect any adverse valuation effects from the recapture of loan loss reserves or the elimination of the interest deductibility for carrying tax exempt securities

unions pension wealth and age compensation profiles this paper examines the effect of unions on both the magnitude and distribution of pension benefits an analysis of experience during 1973 79 under a sample of defined benefit plans shows that beneficiaries retire at an earlier age under collectively bargained plans than under other plans receive larger benefits when they retire and receive larger increases in their benefits after they retire also benefit differentials within and across cohorts of retirees are smaller among union than nonunion beneficiaries the average union nonunion differential is therefore greater in total compensation wages plus pension benefits than in wages alone because pension benefits grow more rapidly with years of service in the nonunion sector however the total compensation differential narrows with age more quickly than the wage differential

the market valuation implications of net periodic pension cost components abstract this paper examines whether market participants implicitly assign different coefficients to pension cost components when determining security prices the major findings are 1 the pension cost components coefficients generally differ from one another as predicted the transition asset amortization coefficient is lower than other pension coefficients and is insignificantly different from zero 2 consistent with the market viewing pension related income streams as less risky the pension coefficients are generally larger than the nonpension coefficients additional specification tests permitting nonpension coefficients to vary with risk tax payer status and industry membership generally support the basic findings although the significance levels are generally higher

a monetary minsky model of the great moderation and the great recession abstract steve keen s model of minsky s financial instability hypothesis keen 1995 displayed qualitative characteristics that matched the real macroeconomic and income distributional outcomes of the preceding and subsequent fifteen years a period of economic volatility followed by a period of moderation leading to a rise of instability once more and a serious economic crisis this paper extends that model to build a strictly monetary macroeconomic model which can generate the monetary as well as the real phenomena manifested by both the great recession and the great moderation

do capital adequacy requirements reduce risks in banking abstract in a dynamic framework it is shown that capital adequacy rules may increase a bank s riskiness in addition to the standard negative effect of rents on risk attitudes of banks a further intertemporal effect has to be considered the intuition behind the result is that under binding capital requirements an additional unit of equity tomorrow is more valuable to a bank if raising equity is excessively costly the only possibility to increase equity tomorrow is to increase risk today

new evidence on the structure of production real and austrian business cycle theory and the financial instability hypothesis abstract this article develops the relationships among real business cycle rbc theory austrian business cycle abc theory and minsky s financial instability hypothesis fih in rbc models recessions are caused on the supply side by random technology shocks which are independent of monetary policy however in abc models credit expansion results in negative productivity shocks as the marginal return on investment is lowered and the production structure is extended by commitment to more capital intensive activities thus abc theory helps resolve several problems with rbc theory the fih describes a process of endogenous overleveraging which unsustainably overvalues assets and exposes the financial sector to greater risk this paper argues that the overleveraging described by the fih is compatible with the unsustainable expansion of production described in abc theory and further argues that credit expansion would both provide additional funds to finance overleveraging as well as encourage the process by making it cheaper with lower interest rates

the effect of capital structure on a firm s liquidation decision abstract a firm s liquidation can impose costs on its customers workers and suppliers an agency relationship between these individuals and the firm exists in that the liquidation decision controlled by the firm as the agent affects other individuals the customers workers and suppliers as principals the analysis in this paper suggests that capital structure can control the incentive conflict problem of this relationship by serving as a pre positioning or bonding mechanism appropriate selection of capital structure assures that incentives are aligned so that the firm implements the ex ante value maximizing liquidation policy

state contingent regulatory mechanisms and fairly priced deposit insurance abstract this paper presents a model of incentive compatible bank regulation under moral hazard and adverse selection we derive a wide range of simple and conceptually implementable mechanisms that can solve each type of incentive problem separately and also achieve the first best outcome but only when regulatory instruments involve ex post pricing that is contingent on the bank s performance relative to the market an important feature of these mechanisms is that they do not involve a subsidy to the bank when the regulator faces both moral hazard and adverse selection simultaneously we identify the conditions under which the same mechanism can achieve the first best solution

retail level hedonics and the valuation of milk components a retail level hedonic model for analyzing the value of milk components contained in aggregate dairy product commodities is developed and applied to household food consumption survey data the findings support perrin s conjecture that a hedonic approach applied at the retail level can be used to value milk components milk component values are found to be a function of household sociodemographic variables the sample weighted average implicit fat value estimate was very similar to values published in two of three previous component value analyses in the journal but protein values were significantly different

capital requirements monetary policy and aggregate bank lending theory and empirical evidence capital requirements linked solely to credit risk are shown to increase equilibrium credit rationing and lower aggregate lending the model predicts that the bank s decision to lend will cause an abnormal runup in the borrower s stock price and that this reaction will be greater the more capital constrained the bank i provide empirical support for this prediction the model explains the recent inability of the federal reserve to stimulate bank lending by increasing the money supply i show that increasing the money supply can either raise or lower lending when capital requirements are linked only to credit risk the motivation of this article is first to examine the impact of risk based capital requirements namely those that link mandatory capital to asset ratios for banks to their loans on aggregate bank lending these requirements called the basle capital rules or bis guidelines went into effect in march 1989 for banks in the leading industrialized nations these rules initially required banks to maintain capital equal to 7 25 percent of business and most consumer loans with the requirement increasing to 8 percent by the end of 1992 secondly i wish to understand the link between monetary policy and aggregate bank credit in the presence of risk based capital requirements my curiosity is sparked in part by two recent phenomena one is the experience of the u s economy which displayed sluggish growth during 1989 93 despite a monetary policy that attempted to spur bank lending and economic activity and the other is the striking decline in loans relative to security holdings mostly government bonds in the asset portfolios of u s

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

the economics of workout lending lenders are forced to consider a workout loan when a borrower loses access to financial markets and must seek loans from existing creditors to continue servicing outstanding loans a model of the loan decision is developed that distinguishes socially useful from socially wasteful workout loans the analysis is extended to examine two collective action problems that may arise when many lenders have claims on a troubled borrower the paper concludes with a consideration of the implications of the model for the establishment of prudential lending limits and of policies to stimulate new lending to troubled debtor countries copyright 1989 by ohio state university press

what drives corporate pension plan contributions moral hazard or tax benefits in testing moral hazard and tax benefit hypotheses regarding defined benefit plan funding and contribution incentives by incorporating sponsors bankruptcy risk the authors proposed that high bankruptcy risk sponsors have a strong moral hazard incentive because the put value of the u s pension benefit guaranty corporation guarantee is high for low bankruptcy risk sponsors the put value is low maximizing tax benefits associated with pension contributions becomes a powerful incentive results based on sponsors voluntary contributions support both hypotheses

valuation capital structure and shareholder unanimity for depository financial intermediaries the theory of corporate finance is not directly applicable to financial intermediary decision making the lack of applicability stems largely from the particular conditions that distinguish intermediary operations from those of the nonfinancial firm first when intermediaries accept deposit financing they must produce services such as liquidity and convenience at considerable expense for real resources second the introduction of intermediation is likely to be accompanied by incomplete markets so that shareholder unanimity is not in general valid in this paper a model with incomplete markets is developed and a shareholder approved rule for intermediary capital structure decisions is derived

the impact of human capital investments on pension benefits this article develops a model with deferred compensation and severance pay that predicts that workers bear all the costs and receive all the returns of human capital investments and that specific investments yield higher returns than general investments this model also predicts that pensions which efficiently defer compensation will be positively related to specific investments evidence from the national longitudinal survey of older men confirms these predictions participation in company sponsored training programs proxying for specific investments increases the probability of pension receipt and the level of benefits more general training outside the firm has much smaller effects on pensions

risk in banking and capital regulation this paper investigates the role of bank capital regulation in risk control it is known that banks choose portfolios of higher risk because of inefficiently priced deposit insurance bank capital regulation is a way to redress this bias toward risk utilizing the mean variance model the following results are shown a the use of simple capital ratios in regulation is an ineffective means to bound the insolvency risk of banks b as a solution to problems of the capital ratio regulation the theoretically correct risk weights under the risk based capital plan are explicitly derived and c the theoretically correct risk weights are restrictions on asset composition which alters the optimal portfolio choice of banking firms the recent increase in bank failures especially after the 1980 and 1982 deregulatory acts has again ignited a controversy over the risk portfolio of the banking industry given the importance of this sector there has been increased scrutiny of the industry s motives for risk taking and possible regulatory changes to improve its stability these investigations have centered around two rather complementary areas the first of these is the role of deposit insurance and how its current pricing procedure encourages risk taking and justifies current bank regulations the works of buser chen and kane 4 kane 9 and benston et al 2 have made substantive contributions the authors demonstrates the way in which our current fixed rate insurance system rewards risk taking by the firm and insulates it through deposit insurance from the market discipline that needs to exist to ensure proper risk evaluation this realization has led these authors to propose a series of regulatory changes to encourage proper portfolio choice within the industry these include a shift to market value accounting risk based deposit insurance premiums and additional capital regulation the last of these serves as a method of coinsurance whereby higher capital levels require the bank to absorb greater losses in the event of failure and encourage additional prudence in management in essense it is one method of risk reduction that may offset the risk preference imposed on the industry due to the inappropriate insurance pricing because the amount of capital influences the probability of bank insolvency and thus the soundness of the entire banking system the regulators ceteris paribus prefer more capital to

an empirical investigation of pension funding levels in canada in the literature three non mutually exclusive approaches explain pension plan funding decisions the traditional view friedman 1983 the corporate view bodie et al 1985 and the bonding view ippolito 1985 an investigation of pension funding levels is presented here relying on an empirical model integrating these three different views the results based on data covering 115 relatively large canadian firms in 1990 offer strong support for the bonding view

the pbgc s flat fee schedule moral hazard and promised pension benefits abstract the pension benefit guarantee corporation pbgc initially insured private pension benefits in exchange for a premium that was not risk sensitive this paper derives conditions under which a moral hazard problem caused promised pension benefits to increase the hypotheses are tested using data on individual pension contracts from the pre and post pbgc periods

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

three paradigms for the role of capitalization requirements in insured financial institutions standard models for deposit insurance strike analogies to more familiar financial contracts and conceive of risk as exogenous the oldest model of deposit insurance likens it to passively underwriting casualty insurance a more sophisticated but still bilateral model likens deposit insurance to writing a passive put option on the enterprise whose funding is insured delays in acknowledging the wreck of the s l industry and its federal insurer fslic discredit these models as guides to managing a deposit insurance fund deposit insurance is better interpreted as a trilateral performance bond that enhances the credit of an insured institution this interpretation endogenizes risk emphasizes incentive conflict and underscores the need to optimize loss control activity the bonding model clarifies that a subset of the monitoring and disciplinary activities traditionally undertaken by government officials can usefully be privatized

the role of pensions in the labor market a survey of the literature because employer sponsored group pension plans entail agreements between workers and their employers explicitly linking future payment and employment they offer an unusual window into long term employment relationships this review of recent research on pensions explores how pensions influence employee compensation retirement turnover and other matters central to the determination of labor s price and quantity over time the authors also outline some unanswered questions and difficult to reconcile findings because the pension promise involves an explicit and relatively well documented set of statements regarding future contingent payment and employment an examination of the design and operation of employersponsored group pension plans can yield important insights into the long term employment relationship specifically pension research illuminates some important labor market questions in two ways it offers insight into an important element of compensation in its own right and it furthers our understanding of labor markets in which long term

bank capital and equity investment regulations abstract this paper uses an intermediation model to study the efficiency and welfare implications of both banks minimum required capital asset ratio and the regulation that limits and in some countries forbids banks investments in the equity of nonfinancial firms there are two sources of moral hazard in the model one between the bank and the provider of deposit insurance and the other between the bank and an entrepreneur who demands funds to finance an investment project among other things the paper shows that capital regulation improves the bank s stability and can also be pareto improving equity regulation is never pareto improving and does not increase the bank s stability

fixed versus variable rate loans this paper discusses the nature of fixed and variable loan contracts and derives the conditions which determine the optimal quantity of each the results indicate that the payoff functions are quite different and dependent upon the project financed the appropriate conditions for the allocation of loan terms to a set of borrowers are then developed finally the analysis derives the optimal portfolio frontier and risk return trade off for the banking firm here it is demonstrated that the solution is unlikely to be at a point of zero interest rate risk

deposit insurance around the world in the past two decades in a series of banking crises around the world banks have become systematically insolvent these crises have occurred in developed and developing economies alike to make such financial system breakdowns less likely and to limit their costs if they occur policymakers feel the need for financial safety nets these include such policies as implicit or explicit deposit insurance a lender of last resort function of the central bank bank insolvency resolution procedures and bank regulation and supervision of these policies explicit deposit insurance has been gaining popularity in recent years since the 1980s the number of countries with explicit deposit insurance schemes almost tripled with most oecd countries and an increasing number of developing economies adopting some form of explicit depositor protection in 1994 deposit insurance became the standard for the newly created single banking market of the european union establishing an explicit deposit insurance scheme became part of the generally accepted best practice advice given to developing economies

determinants of commercial bank interest margins and profitability using bank level data for 80 countries in the years 1988 9s this article shows that differences in interest margins and bank profitability reflect a variety of determinants bank characteristics macroeconomic conditions explicit and implicit bank taxation deposit insurance regulation overall financial structure and underlying legal and institutional indicators a larger ratio of bank assets to gross domestic product and a lower market concentration ratio lead to lower margins and profits controlling for differences in bank activity leverage and the macroeconomic environment foreign banks have higher margins and profits than domestic banks in developing countries while the opposite holds in industrial countries also there is evidence that the corporate tax burden is fully passed onto bank customers while higher reserve requirements are not especially in developing countries

determinants of corporate pension funding strategy abstract several hypotheses concerning pension funding strategy are tested in a cross sectional regression model on a sample of 255 firms results are consistent with the following explanations 1 finance incentives tax benefits and financial slack for high level funding 2 labor incentives for low level funding and 3 financial statement incentives relating to political costs for high level funding and debt contracting costs for low level funding pension funding strategy appears to be complex involving tradeoffs between funding incentives the nature of these interactions and tradeoffs remains to be clarified through future research

bank capital regulation and the valuation effects of latin american debt moratoriums abstract we examine effects of the mexican and bolivian debt moratoriums on bank share prices and analyze whether bank capital regulation influences these returns we hypothesize that investors perceived that capital deficient banks with exposure to this debt would sustain greater regulatory costs due to increased pressure from regulators to strengthen their capital bases or to reduce leverage consistent with this hypothesis we find that the impact of these debt moratoriums on bank stock returns is more unfavorable for capital deficient banks than for banks that met regulatory standards of capital adequacy

the anticipated real interest rate capital utilization and the cyclical pattern of real wages abstract this paper develops a channel through which increases in anticipated real interest rates can be expansionary for current aggregate labor demand and current output supply the key feature of the model is the introduction of a user cost of capital utilization which confronts the firm with the intertemporal problem of the optimal choices of capital utilization and depreciation the resulting variation in capital utilization and capital services in response to fluctuations in the real rate of interest shifts the marginal product of labor and thus the demand for labor at the same time and in the same direction that lucas rapping real interest rate effects operate on labor supply the complete model places no a priori restrictions on the cyclical pattern of real wages thus avoiding the countercyclical real wage prediction made by keynes and various classical writers that is rejected by the data estimates of a labor demand schedule for the annual u s data reveal a significantly positive real interest rate effect

unionization and shareholder interests drawing on agency theory this study examines union nonunion differences in the allocation of both firm profits and business risk to employees and shareholders using a sample of more than 1 000 large private sector firms the authors find that over the period 1970 81 shareholders in unionized firms assumed less of the firm s business risk than shareholders in nonunion firms this finding is interpreted as evidence that managers of unionized firms attempted to minimize agency costs by capitalizing on the incentive effects of risksharing in addition risk adjusted returns to shareholders were lower in unionized firms than in nonunion firms the authors view the relatively poor performance of union firms as a primary motivating factor behind the restructuring of the american industrial relations system during the period studied

modeling the banking firm a survey this paper reports on the status of the literature on micro bank modeling and assesses our understanding of the banking firm s optimal behavior this is no mean task for much has been written on banking broadly defined over the past couple of decades the review is developed in pieces each major subproblem is outlined and the analysis used to deal with the issue explicated this is not the best way to summarize the development of a field it should be immediately recognized one would prefer to have a smooth continuum of development moving the frontier of knowledge evenly through time and across subareas yet this is rarely the way a field develops more likely individual questions attract attention and are the subjects of a substantial number of contributions after a time the field moves on to the new area of interest the banking field is no exception before embarking upon the review however a couple of lines should be devoted to previous attempts there have been essentially three first pyle 1972 analyzes the uncertainty portfolio models at a time when little existed in the literature and hence one finds the review a bit vague and sketchy baltensperger s contributions 1978 1980 are the next serious and rather extensive reviews the quality of these

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

intertemporal substitution in labor supply evidence from micro data the sensitivity of the supply of labor to intertemporal variation in the wage is an important issue in macroeconomics the analysis of social security and pensions and the study of life cycle patterns of work this paper explores two approaches to the measurement of intertemporal substitution that have appeared in the literature the first approach is to use consumption to control for wealth and unobserved expectations about future wages in the labor supply equation the second approach is to estimate a first difference equation for hours in which labor supply from the previous period serves as a control for wealth and wage expectations the results indicate that intertemporal substitution elasticity for married men is positive but small

discontinuities in pension benefit formulas and the spot model of the labor market implications for financial economists in their analysis of corporate pension plans financial economists typically invoke the simplest and the most tractable model of the labor market this is the spot model where the worker s cash wage plus accruing pension benefit equals the value of his marginal product in each and every period this paper provides evidence against the empirical validity of the spot model and uses provisions common to most pension plans to do so these findings are relevant to the appropriate measurement of pension liabilities and thus to the present controversy surrounding the termination of overfunded plans and the recapture of surplus assets by the employer the existence of incentive effects ruled out by the spot model may help to unravel certain well known puzzles such as the failure of employers to fully fund their plans in spite of the tax advantages of doing so

a nonlinear programming analysis of production response to multiple component milk pricing the problem of feeding holstein cows so as to maximize revenue over feed costs was analyzed under various scenarios concerning milk component prices results suggested that production response of milk components to component price incentives was inflexible when compared to baseline solutions generated under a standard federal order pricing system fat production was within 3 5 and solids nonfat and fluid carrier within 1 0 of baseline levels for a 100 cow herd component pricing scenarios having blend prices equal to the blend price in the baseline scenario were associated with reductions in revenue over feed costs of less than 4

the bank capital decision a time series cross section analysis this paper seeks to explain the dramatic decline in capital to asset ratios in u s commercial banks during the last two decades it is hypothesized that the rise in nominal interest rates during this period might have contributed substantially to the fall in capital ratios time series cross section estimation supports the hypothesis regarding the interest rate bank capital is the sum of equity plus debt subordinated to deposits capital provides a cushion that protects the bank from insolvency when the value of its assets falls a bank can meet its obligations to depositors as long as losses on its asset portfolio do not exceed its capital the ratio of capital to total assets in u s commercial banks has fallen dramatically in the last two decades dropping from 11 7 percent in 1961 to 5 7 percent in 1978 the lowest level since world war ijj1 figure 1 shows the decline in the ratio of capital to noncash assets these figures suggest that the federal deposit insurance corporation fdic and uninsured depositors are being exposed to increased probabilities of losses from bank insolvencies however relatively little empirical research has been devoted to the determinants of the bank capital decision further the existing work see for example peltzman 24 mingo 20 or mayne 17 18 uses only cross sectional data and therefore does not necessarily explain the decline in capital to asset ratios over time previous empirical research has also focused on book values rather than market values of debt and equity although market values provide better estimates of the protection afforded by capital this practice might be partly justified by the attention paid to book values by bank regulators however the increasing use of qualitative factors as well as book ratios in capital regulation indicates that regulators are aware of the deficiencies in book values many of the so called qualitative considerations are precisely the factors that distinguish market from book value 6 pp 78 80 finally difficulties arise over the proper measure of capital the empirical studies cited above treat equity and debt capital symmetrically both equity and assistant professor of finance economics boston university school of management this paper was originally written as part of a doctoral dissertation at m i t helpful suggestions from robert mcdonald richard schmalensee larry summers and edward j kane are gratefully acknowledged l these statistics are based on the market values of capital and assets the methods used to construct the market value series are described in the appendix capital asset ratios based on book values also have fallen over the period in question although not as severely

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

loan sales and the cost of bank capital this paper considers a model where banks may improve the returns on loans by monitoring borrowers bank regulation together with competitive deposit and equity financing can give banks an incentive to sell loans but the extent of their loan selling is limited by a moral hazard problem a solution is given for the optimal design of the bank loan buyer contract that alleviates this moral hazard problem an explanation is also given as to why some banks might buy loans and why loan sales volume has recently increased banks practice of making loans and then selling them to other institutions and individuals has grown in popularity an important example in the development of loan selling has been the increase in banks mortgage loans that are insured and pooled under the authority of the government national mortgage association gnma and then sold to secondary market investors recently however there has been a dramatic rise in the volume of other types of loans being sold especially by money center banks portions of commercial loans originated by these larger banks are being sold to smaller banks foreign banks and other financial and nonfinancial institutions in addition banks car loans and credit card receivables have also been pooled and sold to institutions and individuals selling loans that were once considered nonmarketable assets a process that has been termed asset securitization may be signalling the start of a fundamental change in the commercial banking business the leading banks in loan selling operations now view themselves more as originators and distributors of loans rather than as institutions holding loans as assets the potentially large impact of loan sales on the future of commercial banking naturally evokes the question of what incentives exist for banks to sell loans in this paper we show that loan sales allow some banks to finance loans less expensively than by traditional deposit or equity issue because bank funds received via loan sales can avoid costs associated with required reserves and

the labor contract and true economic pension liabilities most pension covered workers in the united states are covered solely or primarily by defined benefit plans in these plans workers are typically promised a pension that is proportional to their years of service in the firm and their final wage depending upon how workers pay for it the existence of a pension in the labor contract may play either an important role or no role at all in the worker firm relationship this paper addresses the issue how workers pay for the cumulating pension benefit over their tenure cycle in the firm and derives several economic implications for the worker firm contract while the theory itself has ambiguous implications the data confirm the longstanding presumption that pensions offer strong incentives for the worker to complete the normal tenure cycle in the firm not to quit early but if this intuitive notion is accepted it is shown that a perhaps less intuitive notion is also true firms make workers longterm bondholders in the firm the same flow of worker pension savings that tie workers to the firm are not accounted for in the pension trust fund pension plans are significantly underfunded in a true economic sense this is a peculiar characteristic of the labor contract which raises several unanswered questions the paper also shows that the nature of the pension contract can play an important role in determining the wage service profile and the capitalized value of the firm recent contributions to the literature pose an interesting and unconventional view of pensions one which leads to the conclusion that pensions play a relatively minor role in the worker firm contract the argument has been implicitly made by burt barnow and ronald ehrenberg 1979 and william sharpe 1976 but has recently been stated more directly by jeremy bulow 1982 2 in essence their views rest on a legal interpretation of pension liabilities namely since the firm can legally terminate its pension plan anytime the firm s pension liabilities cannot exceed the present value of the nominal pension promises it would owe workers if the firm terminated the plan immediately if workers believe the firm will exercise its legal right it is intuitively apparent and easy to show that workers will deposit only that amount of compensation into the pension plan that they expect to receive upon immediate termination using this interpretation of pension plan liabilities pensions have no influence on whether the worker leaves or remains in the firm moreover it will be shown that if the pension contract is written in nominal terms reflecting the legal view workers are not bondholders in the firm pension plans are excessively overfunded an alternative view is that the pension plan is an implicit contract between the worker and the firm see for example jack treynor 1977 an implicit contract theory implies that workers anticipating careers with a firm will consider the package of wage and pension benefits they expect to collect over their life cycle it is shown that these expectations lead quite directly to several implications that the pension contract is written in real terms that firms intend to meet their pension promises and that the firm will re u s department of labor s 4521 washington d c 20210 the views expressed in this paper are my own and do not necessarily represent the views of the department of labor the paper has substantially benefited from the comments of pauline ippolito and discussions with jeremy bulow i am also indebted to robert clark gary fields alan gustman olivia mitchell james pesando john turner michael ward and participants at the labor relations workshop at cornell university and the law and economics workshop at the university of chicago for comments see my 1985a book 2 the argument is also implicit in other related papers see for example martin feldstein and randall morck 1982

the plucking model of business fluctuations revisited the recent surge of renewed interest in business cycles in general and real business cycles in particular brought to mind a plucking model of business fluctuations that i suggested some twenty five years ago but that has since sunk into complete oblivion 1 i was led to the model in the course of investigating the direction of influence between money and income did the common cyclical fluctuations in money and income reflect primarily the influence of money on income or of income on money one of the five kinds of evidence that i examined was the serial correlation of amplitudes of cycle phases 2 as i wrote is the magnitude of an expansion related systematically to the magnitude of the succeeding contraction does a boom tend on the average to be followed by a large contraction p 271 to find out i calculated rank difference correlations between measures of the amplitudes of expansions and successive contractions in three different series for the period 1879 to 1961 the three series were rate of change of the stock of money a physical index of general business and clearing debits as an indicator of dollar value change in general business similarly i asked the same question except starting with a contraction in the given series and correlating its amplitude with the amplitude of the succeeding expansion 3 the results were striking for all three series the correlation was trivial between the amplitude of an expansion and the amplitude of the succeeding contraction on the other hand for both the rate of change of the money stock and the physical index of general business the correlation was high and statistically significant between the amplitude of a contraction and the amplitude of the succeeding expansion for clearing debits this correlation too was low i concluded there appears to be no systematic connection between the size of an expansion and of the succeeding contraction whether size is measured by physical volume or by dollar value pp 272 73 on the other hand a large contraction in output tends to be followed on the average by a large business expansion a mild contraction by a mild expansion p 273 though that is not so for the dollar value of the expansion and contraction i went on this phenomenon if it should be confirmed by a fuller analysis of data for the united states and other countries would have important implications for the analysis of business cycles in general not solely for our monetary studies for one thing it would cast grave doubt on those theories that see as the source of a deep depression the excesses of the prior expansion the mises cycle theory is a clear example 4 for another it would raise serious questions about both the analytical models in terms of which most of us have come to approach the analysis of cycles and the statistical methods we use to analyze them our analytical models generally involve a conception of a self generating cycle in which each phase gives rise to the next and which may be kept going by a sequence of random shocks each giving rise to a series of damped perturbations the corresponding physical analogy is of an electrical network in which responses are described by sine waves the asymmetric serial correlation patter suggests that this analogy may be misleading that a better one is what can be termed a plucking model consider an elastic string stretched taut between two points on the underside of a rigid horizontal board and glued lightly to the board let the string be plucked at a number of points chosen more or less at random with a force that varies at random and then held down at the lowest point reached the result will be to produce a succession of apparent cycles in the string whose amplitudes depend on the force used in plucking the string the cycles are symmetrical about their troughs each contraction is of the same amplitude as the succeeding expansion

what determines corporate pension fund risk taking strategy abstract corporate sponsors of defined benefit pension plans generally assume low investment risk when they have low funding ratios and high default risk consistent with the risk management hypothesis however for financially distressed sponsors and sponsors that freeze terminate or convert defined benefit to defined contribution plans the risk shifting incentive moral hazard dominates pension fund risk taking is also affected by labor unionization and sponsor incentives to maximize tax benefits restore financial slack and justify the accounting choices of pension assumptions sponsors shift toward an aggressive risk strategy when their pension plans emerge from underfunding bankruptcy risk is reduced or marginal tax rate decreases overall we show that corporate sponsors adopt a dynamic risk taking strategy in their pension fund investments

affect or information labeling policy and consumer valuation of rbst free and organic characteristics of milk abstract using a labeling policy framework we answer the question of whether attitude has an impact on consumers valuation of rbst free and organic characteristics of milk we utilize 2 years of consumer survey data and a hedonic model to estimate marginal effects of attitude on consumer valuation of rbst free and organic milk findings indicate that in 2001 milk value was impacted by attitude regardless of whether attitude was measured using an opinion based or behavioral construct in 2004 the contribution of attitude to value was insignificant implications for labeling policy are discussed

tax planning regulatory capital planning and financial reporting strategy for commercial banks we test whether banks investment and financing policies can be explained by tax status we document changes in bank holdings of municipal bonds in response to changes in tax rules relating to deductibility of interest expense we also document an association between banks marginal tax rates and their investment and financing decisions which is consistent with the existence of tax clienteles however banks do not sort themselves perfectly into investment and financing clienteles because of adjustment costs we posit specific types of transaction cost impediments to tax planning and document that banks apparently trade off these costs against tax planning benefits article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

capital and risk in property liability insurance markets abstract this paper investigates the capital and portfolio risk decisions of property liability insurance firms a theoretical model based on option pricing theory is developed which predicts a positive relationship between insurer capital and risk as firms balance these two factors to achieve their desired overall insolvency risk the implications of the model are then tested empirically using a simultaneous equations methodology the results support the predictions of the model they also provide evidence that managerial incentives play a role in determining capital and risk in insurance markets the findings have significant implications for insurance solvency regulation

investment policy financing policy and performance characteristics of de novo savings and loan associations abstract this paper develops a simultaneous equation model to investigate the investment policies financing policies and risk return characteristics of de novo thrift institutions a model to explain state entry rates for de novo institutions is also presented entry dates are significantly influenced by investment powers as the numbers of de novo charters are found to be significantly higher in states with the most liberal set of permissible activities economic growth and the demand for financial services also contributed to higher entry rates utilization of the liberal powers did not however contribute positively to returns firms with riskier asset portfolios were found to have lower realized returns efficiency in operations and strong capitalization were found to be positively associated with higher returns

deposit insurance pricing and social welfare abstract recent literature has established that financial disruption has real costs which justify government intervention in the financial sector one form of government intervention is deposit insurance in this paper we determine the optimal pricing and subsidy of deposit insurance in a social welfare context the main conclusion is that optimal deposit insurance need not be actuarially fair in an economy with a real and a financial sector we consider the effects of taxation and social political weights of the sectors we analyze two policy tools government supervision and deposit insurance pricing

avoiding bank runs in transition economies the role of risk neutral capital abstract in a general equilibrium model with risk neutral and risk averse agents we show that if banks issue both demand deposits and equity then free banking is run proof and efficient in particular we obtain the first best insurance solution if there is adequate risk neutral capital if sufficient risk neutral capital is unavailable then a partial suspension of convertibility is optimal in general therefore policies like capital adequacy norms and deposit insurance are neither necessary nor desirable

a simplified stock flow consistent dynamic model of the systemic financial fragility in the new capitalism in the last few years many financial analysts and heterodox economists but even some dissenters among orthodox economists have referred to the contribution of hyman p minsky as fundamental to understanding the current crisis however it is well known that the traditional formulation of minsky s financial instability hypothesis shows serious internal logical problems furthermore minsky s analysis of capitalism must be updated on the basis of the deep changes which during the last three decades have concerned the world economy in order to overcome these theoretical and empirical troubles this paper first introduces the reader to the mechanics of the financial instability theory according to the formulation of the traditional minskian literature section 2 second it shows why minsky s theory cannot be regarded as a general theory of the business cycle section 3 third the paper attempts to supply a simplified but consistent re formulation of minsky s theory by inter breeding it with inputs coming from the new cambridge theories and the current formal minskian literature the aim of this is to analyze the impact of both capital asset inflation and consumer credit on the financial soundness of the non financial business sector sections 4 7 some concluding remarks are provided in the last part of the paper section 8

capital regulation and insured banks choice of individual loan default risks abstract how bankers choose the riskiness of their individual assets is an important question it is well known that fixed premium deposit insurance leads a bank to prefer a high variance asset portfolio but its effect on individual asset choice has not been carefully evaluated this paper demonstrates how bank examination procedures and capital adequacy standards can make the value of a bank s deposit insurance contract concave in individual asset risks insured bankers may therefore have a rational preference ceteris paribus for relatively safe individual loans even while they prefer risky portfolio returns the model s implications for loan securitization and the federal regulators new risk based capital standards are discussed

the effects of a shift in monetary policy regime on the profitability and risk of commercial banks abstract this paper examines the effects of the fed s october 6th 1979 change in monetary policy regime on the profitability and risk of commercial banks using capital market data and an event study methodology it was found that bank stocks exhibited significant abnormal returns during the announcement week of the policy change when these abnormal returns were decomposed into a part related to unexpected interest rate changes and a part assumed to reflect increased rate variability the results were consistent with a negative relationship between bank returns and interest rate surprises as well as between bank returns and rate variability

deposit insurance and wealth effects the value of being too big to fail this paper investigates the effect on bank equity values of the comptroller of the currency s announcement that some banks were too big to fail and that for those banks total deposit insurance would be provided using an event study methodology we find positive wealth effects accruing to tbtf banks with corresponding negative effects accruing to non included banks we demonstrate that the magnitude of these effects differed with bank solvency and size we also show that the policy to which the market reacted was that suggested by the wall street journal and not that actually intended by the comptroller the role of deposit insurance has become a topic of increasing debate advocates argue that by removing the incentive to run deposit insurance protects individual financial institutions from instability in the intermediation process thereby providing stability to the financial system as a whole 1 the recent rise in bank failures and the concomitant crises in the s l industry however demonstrate that this stability is not guaranteed moreover critics note that deposit insurance may introduce incentive problems and wealth effects into the financial system both of which can impede the effective functioning of any deposit insurance system these problems have prompted concern about the structure of the current deposit insurance system and have led to numerous proposals regarding its restructuring 2 this paper investigates one aspect of this debate by analyzing the effect on bank equity values of the policy decision to insure completely some banks but not others specifically in september 1984 the comptroller of the currency testified before congress that some banks were simply too big to fail tbtf and that for those banks total deposit insurance would be provided while not explicitly naming the banks the comptroller admitted that this policy would apply to the eleven largest banks using an event study methodology we analyze