capital requirements and bank behaviour empirical evidence for switzerland abstract in recent years regulators have increased their focus on the capital adequacy of banking institutions to enhance the stability of the financial system the purpose of the present paper is to shed some light on whether and how swiss banks react to constraints placed by the regulator on their capital building on previous work by shrieves and dahl cf shrieves r e dahl d 1992 the relationship between risk and capital in commercial banks journal of banking and finance 16 439 457 we use a simultaneous equations model to analyse adjustments in capital and risk at swiss banks when those approach the minimum regulatory capital level our results indicate that regulatory pressure induce banks to increase their capital but does not affect the level of risk

money demand amid financial sector developments in malaysia both long and short run real money demand functions of malaysia with money variously defined as m0 m1 and m2 have been estimated using the johansen cointegration technique and the general to specific approach respectively the period under review is 1973q1 1991q4 while liberalization and innovation in the malaysian financial system have not ruled out the existence of stable long run money demand relationships as attested to by the presence of cointegrating vectors they have rendered short run relationships unstable hence it may not be appropriate for one to conclude that monetary policy efficacies have been sacrosanct to the financial liberalization and innovation process on the basis of cointegrating relationships this is especially true as monetary policy is essentially a short run stabilization policy aimed at ironing out undue macroeconomic fluctuations this prompted us to re estimate short run money demand functions over more recent periods in order to boost the policy relevance of the estimat

the effectiveness of bank capital adequacy regulation a theoretical and empirical approach the aim of this paper is to analyse how banking firms set their capital ratios that is the rate of equity capital over assets in order to study this isue two theoretical models are developed both models deal with the existence of an optimal capital ratio the first one for firms not affected by capital adequacy regulation the second one for firms which are the models have been tested by estimating a disequilibrium model using data of spanish savings banks

joint effects of interest rate deregulation and capital requirements on optimal bank portfolio adjustments the 1980 depository institution deregulation and monetary control act didmca mandates that regulation q be phased out by 1986 with deregulation of interest rate ceilings the cost of raising capital funds for commercial banks would become more volatile and more closely related with interest rates in the money and capital markets thus value maximizing bank managers would need to be concerned not only with the internal risk but also with the external risk in bank portfolio management decisions based upon the cash flow version of the capital asset pricing model this paper analyzes the joint impact of interest rate deregulation and capital requirements on the portfolio behavior of a banking firm the 1980 depository institution deregulation and monetary control act didmca mandates that regulation q be phased out by 1986 with deregulation of interest rate ceilings the cost of raising capital funds for commercial banks would become more volatile and more correlated with interest rates in the money and capital markets the bank s cash profit would be more dependent on the interest rate fluctuation ceteris paribus thus the value of a banking firm would also be more dependent on the correlation of the banking firm s cash profit with that of the external market ceteris paribus therefore as deregulation continues a value maximizing bank manager would need to be concerned not only with variance and covariances among the returns on bank assets but also with covariances between rates on bank assets and liabilities as well as that in the external markets study of portfolio behavior of a banking firm should distinguish between the impact of internal risk and external risk on firm value furthermore with interest rate deregulation and the ensuing interactions among various risks banks may also react differently to capital regulation imposed by the regulatory agency despite numerous studies on regulation of bank capital the joint effects of interest rate deregulation and capital requirements on bank

the purchasing power of money and nominal interest rates a re examination while it has been known for some time that under uncertainty the original version of the fisher hypothesis is not precisely correct empirical researchers have largely ignored this fact such an omission has possibly resulted in erroneous conclusions concerning other hypotheses most notably the impact of prices on the real economy this paper clarifies some of the previous interpretations of the existing empirical literature and provides a theoretical version of the relation between prices and interest rates empirical tests based on both the livingston survey data and data from time series forecasting models provide support for the fisher effect and the hypothesis that only covariance risk is priced in the treasury bill market one of the basic hypotheses concerning rationality in financial markets is based on statements generally attributed to fisher 18 fisher argued that the nominal or money rate of return on an asset should compensate an investor for his or her required real rate of return and changes in the purchasing power of money for the uncertainty case fisher replaced known purchasing power changes with the expected inflation rate whereas the fisher relationship under certainty is well defined his basic theorem under uncertainty is not precise as fama 15 has argued it is changes in the purchasing power of money not the inflation rate that should concern investors under uncertainty the expected value of one is not by jensen s inequality the inverse of the expected value of the other moreover fama and farber 16 grauer and litzenberger 20 and benninga and protopapadakis 3 have shown that when investors are risk averse the fisher relationship will generally not hold even after adjustment has been made for the distinction between purchasing power changes and the inflation rate in particular these authors show that an adjustment must be made for the fact that the real rate of return on nominal bonds is random while these issues have been discussed in the theoretical literature they have largely been ignored in the empirical work on this topic given the fact that nominal rates do not seem to adjust as rapidly to price changes as fisher hypothesized numerous empirical researchers have expanded the basic fisher model in an attempt to explain this empirical anomaly these extensions include the incorporation of a inflation rate variability and the growth in real output

klein s price variability terms in the u s demand for money a note one recent innovation in the empirical work on the demand for money has been the inclusion of a measure of the past or future variability of the inflation rate or the interest rate 1 one particularly unique empirical and theoretical treatment is developed by klein 12 who reports a positive and significant effect on the u s demand for money by a price uncertainty variable s p which allegedly measures the quality of cash balances these results substantiate his theoretical development that an increase in the uncertainty of the inflation rate lowers the quality of the services from a stock of money which thereby increases the demand for money the s p term represents a measure of the past variability of the rate of change of prices and is analogous to an adaptive expectations term for the rate of inflation 2

nominal costs and the demand for real transactions balances the standard specification of constant real transactions costs assumes that over the sample period transactions costs move in lock step with the gnp deflator our model assumes that transactions costs move negligibly compared to the gnp deflator that is nominal transactions costs are assumed constant here rather than real transactions costs as in other estimates of money demand we find with this nominal transactions cost specification that the real money demand function is more stable in terms of the stability of the coefficients and the accuracy of out of sample predictions than indicated by earlier studies

the neutrality of the real equilibrium under alternative financing of government expenditures abstract in this paper we derive necessary and sufficient conditions under which the real equilibrium of an economy is independent of government financing policies the economy to which these conditions apply has lump sum taxes complete markets and it is characterized by consumers that form expectations rationally under uncertainty the important theorem we prove is that in such an economy consumption is neutral to alternative government financing policies weak neutrality if and only if the present value of taxes paid by each consumer including the inflation tax remains fixed and consumer utility functions are separable in money and consumption we show that no economy can be simultaneously neutral to financing shifts between debt and taxes debt and money and money and taxes

endogenous risk in a portfolio balance rational expectations model of the deutschemark dollar rate abstract a portfolio balance model of the dm s rate under rational expectations is specified in which systematic risk induced deviations from uncovered interest parity are allowed this leads to a reduced from containing a potentially time varying risk premium which we approximate and estimate using an arch in mean approach the maximum likelihood estimator and a lagrande multiplier test for arch in mean are developed the estimation results indicate a small but non negligible time varying risk premium

implications of corporate capital structure theory for banking institutions the determination of an optimal capital structure for commercial banks has stimulated discussion and controversy among scholars bankers and regulators for many years while numerous studies e g 5 16 18 19 21 24 have explored this issue the underlying question remains unresolved at the same time the issue of optimal capital structure has seen a resurgence of interest in the corporate finance literature in recent years the effects on corporate capital structure of the tax system 15 agency costs 10 23 and bankruptcy costs 9 as well as the combined effects of these factors 2 6 have all come under scrutiny although several previous papers e g 3 5 8 24 have argued that banks are susceptible to corporate capital structure theory to our knowledge the full range of recent developments in this theory has not been brought to bear on the bank capital decision the purpose of this paper then is to draw implications from this theory for the determinants of bank capital structure over time and across banks of different size in section 1 below we briefly review recent work in corporate finance theory on the capital structure effects of taxes and agency costs in section 2 we discuss the effects of the interaction between the tax system and the production function for financial services on commercial bank capital structures in section 3 we analyze the nature of bankruptcy and agency costs in banking and their potential influence on bank capital finally in section 4 we summarize and draw conclusions from our analysis

the basic paradigms of eu economic policy making need to be changed the anaemic growth of the european union euro area derives from its economic paradigms the principle one size fits all behind european central bank policy activates centrifugal forces diverging trends in unit labour costs external competitiveness and external balances follow german policy actively supports this excessive external surplus procedures against countries generating large surpluses at the expense of domestic consumption and the partners rising debt should be instituted the stability and growth pact needs modification the 3 fiscal deficit gdp mark may prevent automatic stabilisation insistence on the budgetary positions being close to balance or in surplus lacks rationale when the private sector s propensity to save is larger than its propensity to invest that requirement cannot be observed a permanent fiscal deficit may be a secular necessity problems related to rising public debt may also need to be addressed for the euro area these problems could be rendered far less serious than often believed

variability of the inflation rate and the forward premium in a money demand function the case of the german hyperinflation since cagan s 1956 classic study the specification of the demand for money in the german hyperinflation has attracted much attention

banks buffer capital how important is risk abstract most banks hold a capital to asset ratio well above the required minimum defined by the present capital adequacy regulation basel i using bank level panel data from norway important hypotheses concerning the determination of this buffer capital are analyzed focus is on the importance of i risk ii the buffer as an insurance iii the competition effect iv supervisory discipline and v economic growth a negative or non significant risk effect is found which suggests that introducing a more risk sensitive capital regulation basel ii is likely to affect norwegian banks support is found for the hypothesis that buffer capital serves as an insurance against failure to meet the capital requirements

the impact of regulation on bank equity infusions abstract this article examines the extent to which regulatory capital standards influence infusions of external equity into commercial banks while such infusions occur infrequently they result in large adjustments to overall bank capital and provide important signals to regulators of managerial intent using a sample of 753 equity capital issues occurring during 1986 and 1987 we find evidence that regulatory minimum capital constraints are instrumental in influencing the financing decisions made by a significant subset of banks

money bonds and foreign exchange in the theory of finance capital markets provide securities which allow the ownership of productive assets to be allocated among investors according to their willingness to bear risk in exchange for return and independently of their tastes for the productive services provided by the assets this paper uses the theory of finance to study the role of money as a productive asset and the transformation of money into a portfolio asset true to its purpose the capital market provides securities nominal bonds that allow an allocation of the current services of the money supply according to its current productivity and without regard for its future purchasing power risk and an allocation of the future purchasing power risk of the money supply according to the willingness of investors to bear this risk in exchange for return and without regard for investor needs for the future transactions services of money in open

sensitivity of the bank stock returns distribution to changes in the level and volatility of interest rate a garch m model abstract the objective of this paper is to employ the generalized autoregressive conditionally heteroskedastic in the mean garch m methodology to investigate the effect of interest rate and its volatility on the bank stock return generation process this framework discards the restrictive assumptions of linearity independence and constant conditional variance in modeling bank stock returns the model presented here allows for shifts in the volatility equation in response to the changes in monetary policy regime in 1979 and 1982 to be estimated arch garch and volatility feed back effects are found to be significant interest rate and interest rate volatility are found to directly impact the first and the second moments of the bank stock returns distribution respectively the latter also affects the risk premia indirectly the degree of persistence in shocks is substantial for all the three bank portfolios and sensitive to the nature of the bank portfolio and the prevailing monetary policy regime

inflation hedging and the demand for money some empirical evidence this paper explores the role of nominal rate of return uncertainty and inflation hedging as potentially important factors explaining the pattern of money demand using u s quarterly data over the period 1952 2 1982 4 it is shown that in conformity with theoretical considerations the nominal rate of return uncertainty variable tends to have a significantly positive effect and the inflation hedging variable the covariance between nominal rate of return and inflation rate a significantly negative effect on the demand for money these findings seem to be reasonably robust in terms of various definitions of income interest rates inflation rate and money variables as well as in terms of different estimation methods

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

some macro implications of risk using the capital asset pricing model as the financial sector of a conventional rational expectations macro model an increase in expected inflation reduces the long run capital stock contrary to the usual result this occurs because the induced fall in real balances increases equity s share in the market raises equity s beta and discount rate and reduces investment increases in the variance of disturbances to aggregate demand reduce the capital stock while increases in the variance of inflation raise the stock a proportionate increase in both variances reduces the captial stock copyright 1987 by ohio state university press

inflation risk taxes and the demand for owner occupied housing a bstract a portfolio choice model is formulated which focuses on the possibility of inflation hedging motives in housing demand in the 1970s an asset demand equation is used to estimate the capitalization of inflation expectations into house prices through tax mortgage and hedging effects the empirical results indicate that even after accounting for tax and mortgage effects the hedging motive was significant in bidding up house prices one implication is that the tax effects of inflation may have been overstated in previous research that ignored inflation risk

the capital crunch neither a borrower nor a lender be the dramatic reduction in the growth rate of bank lending associated with the 1990 91 recession particularly in new england has evoked claims by many observers of a credit crunch however because of the difficulty in determining whether the observed slow credit growth is a demand or supply phenomenon convincing evidence of the practical importance of credit crunches for economic activity remains elusive we overcome this obstacle by examining a cross section of banks in new england that have experienced the same economic downturn effectively controlling for changes in demand we find empirical support for a capital crunch whereby poorly capitalized institutions shrink to satisfy capital requirements this alone is not a sufficient condition for a credit crunch however we find s6me additional evidence that the ca ital crunch may have limited credit availability in new england

is the international convergence of capital adequacy regulation desirable the merit of international convergence of bank capital requirements in the presence of divergent closure policies of diierent central banks is examined the lack of a complementary variation between minimum bank capital requirements and regulatory forbearance leads to a spillover from more forbearing to less forbearing economies and reduces the competitive advantage of banks in less forbearing economies linking the central bank s forbearance to its alignment with domestic bank owners it is shown that in equilibrium a regression toward the worst closure policy may result the central banks of initially less forbearing economies also adopt greater forbearance i analyze the joint design of two bank regulatory mechanisms minimum capital requirements which are an ex ante mechanism to prevent bank failures and closure policy which is an ex post mechanism to manage the cost of bank failures at the heart of the paper is a simple but fundamental point ex post policies affect ex ante incentives and hence the design of an ex ante mechanism must take into account any feedback from the ex post policies the optimal design of capital requirements is thus tied to the extent of forbearance exercised by the central bank s closure policy this warrants a closer scrutiny of the merits of creating a level playing eld in capital requirements across countries as proposed and

effects of legislation events on us gaming stock returns and market turnings abstract the deregulation of casino gaming has becomea new trend across the us since the beginning of this decade but from the mid 1990s on the voice of tightened regulation is lifted up by the public while the cyber casino online gambling business is also developing its own customer base this study examines various federal and state legislation events regarding casino gaming regulation and deregulation and finds that the announcement effects on stock portfolio returns vary across different types of gaming companies on average gaming equipment suppliers and small casino operators are found to react to legislation events more significantly compared with those large casino firms furthermore since the casino gaming business is believed to be highly sensitive to the economic upturns and downturns this paper also investigates the impacts on the risk adjusted return alpha and the systematic risk beta of gaming stocks across bull up and bear down market situations the results indicate that between july 1993 and december 1997 gaming stocks on average yield a significantly lower return and a significantly greater systematic risk against the us stock market after changes in stock market conditions are controlled the systematic risk is still considerably above the market average but the excess return turns out insignificant

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

credit market competition and capital regulation market discipline for financial institutions can be imposed not only from the liability side as has often been stressed in the literature on the use of subordinated debt but also from the asset side this will be particularly true if good lending opportunities are in short supply so that banks have to compete for projects in such a setting borrowers may demand that banks commit to monitoring by requiring that they use some of their own capital in lending thus creating an asset market based incentive for banks to hold capital borrowers can also provide banks with incentives to monitor by allowing them to reap some of the benefits from the loans which accrue only if the loans are in fact paid off since borrowers do not fully internalize the cost of raising capital to the banks the level of capital demanded by market participants may be above the one chosen by a regulator even when capital is a relatively costly source of funds this implies that capital requirements may not be binding as recent evidence seems to indicate

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

inflation risk and the speed of adjustment in short run money demand functions abstract after 1973 money demand functions show a slow speed of adjustment including inflation risk does not help this the ser shows multiple minima as a function of the estimated rho in the error with higher speeds and rhos associated

uncertain inflation exchange rates and bond yields abstract the yields on international bonds are affected by exchange rate risk and country risk in addition to factors such as default and duration that are relevant in the pricing of domestic bonds this paper constructs a theory of bond yields in a single period framework with the risk of nominal bonds being endogenous to the model the behaviour of the monetary authority is modelled explicitly and is shown to be a crucial determinant of the risk of nominal bonds a distinction is made between the risk of default in the usual sense and the risk of being paid in currency which is worth less in real terms with the type of risk that is relevant in a particular case depending on the monetary policy followed the implications of results for exchange rate risk are also explored in a world where purchasing power parity holds

optimum consumption and portfolio rules with money as an asset this article generalizes merton s optimum consumption and portfolio rules in continuous time by introducing money as a capital asset and allowing for uncertain inflation assuming that prices are log normally distributed a three funds theorem is derived and the introduction of money is shown not to change the form of the standard inflation adjusted capm but to change the market price of risk the individual s consumption portfolio problem is completely solved under uncertain inflation if his utility function is iso elastic in its arguments comparative statics are used to assess the influence of changes in exogenous parameters on the individual s optimal rules

functional income distribution and aggregate demand in the euro area an increase in the wage share has contradictory effects on the subaggregates of aggregate demand private consumption expenditures ought to increase because wage incomes typically are associated with higher consumption propensities than capital incomes investment expenditures ought to be negatively affected because investment will positively depend on profits net exports will be negatively affected because an increase in the wage share corresponds to an increase in unit labour costs and thus a loss in competitiveness therefore theoretically aggregate demand can be either wage led or profit led depending on how these effects add up the results will crucially depend on how open the economy is internationally the paper estimates a post kaleckian macro model incorporating these effects for the euro area and finds that the euro area is presently in a wage led demand regime implications for wage policies are discussed

the dispersion of relative commodity prices under very rapid inflation abstract the hypothesis that inflation is not neutral with respect to relative commodity prices has recently received a great deal of attention in this paper the recent experience of argentina a country suffering from a very high rate of inflation is considered it is found that the increase in relative price variability which is associated with higher rates of inflation is caused mainly by surprises or unanticipated changes in the inflation rate and that fully expected inflation appears to have less or no relative price effects an additional result indicates that increased variability of relative commodity prices have effects on financial portfolio composition reducing the holdings of real cash balances

fisher phillips friedman and the measured impact of inflation on interest a reply the purpose of this paper is to demonstrate that empirical findings which persistently appear to contradict the fisher hypothesis that the nominal rate of interest should rise by the full amount of an increase in anticipated inflation are due basically to a failure to control for changes in the real rate of interest that are associated with changes in anticipated inflation we are guided in our search for proper specification of a fisher equation by a simple general equilibrium model which is employed to derive the impact of a change in anticipated inflation upon nominal interest given the requirement that commodity money and labor markets remain in equilibrium in effect we depart from the empirical tradition which has grown up around testing of the fisher hypothesis that takes the real interest rate to be independent of anticipated inflation and argues that for anticipated inflation properly measured the data ought to support the fisher hypothesis 1

are empirical measures of macroeconomic uncertainty alike there is a plethora of time series measures of uncertainty for inflation and real output growth in empirical studies but little is known whether they are comparable to the uncertainty measure reported by individual forecasters in the survey of professional forecasters are these two measures of uncertainty inherently distinct this paper shows that compared with many uncertainty proxies produced by time series models the use of real time data with fixed sample recursive estimation of an asymmetric bivariate generalized autoregressive conditional heteroskedasticity model yields inflation uncertainty estimates which resemble the survey measure there is however overwhelming evidence that many of the time series measures of growth uncertainty exceed the level of uncertainty obtained from survey measure our results highlight the relative merits of using different methods in modelling macroeconomic uncertainty which are useful for empirical researchers

the cyclical effects of the basel ii capital requirements abstract capital requirements play a key role in the supervision and regulation of banks the basel committee on banking supervision is in the process of changing the current framework by introducing risk sensitive capital charges some fear that this will unduly increase the volatility of regulatory capital furthermore by limiting the banks ability to lend capital requirements may exacerbate an economic downturn the paper examines the problem of capital induced lending cycles and their pro cyclical effect on the macroeconomy in greater detail it finds that the capital buffer that banks hold on top of the required minimum capital plays a crucial role in mitigating the impact of the volatility of capital requirements

arch models properties estimation and testing abstract the aim of this survey paper is to provide an account of some of the important developments in the autoregressive conditional heteroskedasticity arch model since its inception in a seminal paper by engle 1982 this model takes account of many observed properties of asset prices and therefore various interpretations can be attributed to it we start with the basic arch models and discuss their different interpretations arch models have been generalized in different directions to accommodate more and more features of the real world we provide a comprehensive treatment of many of the extensions of the original arch model next we discuss estimation and testing for arch models and note that these models lead to some interesting and unique problems there have been numerous applications and we mention some of these as we present different models the paper includes a glossary of the acronyms for the models we describe

the relationship between inflation and inflation uncertainty in the uk 1885 1998 abstract using a long series of uk inflation data i have provided strong evidence in favour of the hypothesis that inflationary periods are associated with high inflation uncertainty this result supports the friedman ball hypothesis and has important implications for the inflation output relationship provided that more inflation uncertainty leads to lower output

capital requirements and the behaviour of commercial banks abstract i study the consequences of capital regulations on the portfolio choices of commercial banks elaborating on previous work by kareken and wallace 1978 koehn and santomero 1980 and kim and santomero 1988 i obtain the following results if the objective of commercial banks is maximization of the market value of their future profits value maximizing banks capital regulations cannot prevent banks from choosing very specialized and very risky portfolios risk based insurance premia are in fact the relevant instrument for that purpose on the other hand if banks behave as portfolio managers utility maximizing banks capital regulations can be effective but only if the weights used in the computation of the ratio are proportional to the systematic risks of the assets their betas because of limited liability of commercial banks a minimum capital regulation or a closing rule may become necessary as well to prevent failing banks from betting for resurrection

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

convergence in the trends and cycles of euro zone income multivariate unobserved components structural time series models are fitted to annual post war observations on real income per capita in countries in the euro zone the aim is to establish stylized facts about convergence as it relates both to long run and short run movements a new model in which convergence components are combined with a common trend and similar cycles is proposed the convergence components are formulated as a second order error correction mechanism this ensures that the extracted components change smoothly thereby enabling them to be separated from transitory cycles copyright 2005 john wiley sons ltd

uncertainty in the demand for money during hyperinflation much recent empirical work on hyperinflation has centered on the direct and indirect effects of uncertainty on the demand for money we test the hypothesis originally put forward by klein that uncertainty positively affects the demand for real balances a variant of cagan s demand for money function is utilized and operational measures of uncertainty are derived by fitting autoregressive integrated moving average models to the inflation series for each of three hyperinflation nations we find that the most reasonable measures of variation do not significantly enter the money demand function for any of the three hyperinflations studied

a reexamination of mean variance analysis of bank capital regulation abstract the mean variance framework has been used to analyze the effects of bank capital regulation on the asset and bankruptcy risk of insured utility maximizing banks this literature claims that more stringent capital regulation will increase asset risk and can increase bankruptcy risk these conclusions are notable because they are opposite to those obtained for insured value maximizing banks in this paper we show that the utility maximization literature does not support its conclusions regarding the effects of bank capital regulation because it has mischaracterized the bank s investment opportunity set by neglecting the option value of deposit insurance

bank holding company capital targets in the early 1990s the regulators versus the markets abstract several studies suggest that the credit crunch was due in large part to banks needs to raise their capital ratios the changes in bank capital ratios may have been in response to financial market or regulatory standards this study develops a model to test the relative impact of the regulators and the financial markets on bank holding companies bhcs capital ratios the results suggest that most bhcs were relatively satisfied with their capital ratios in 1989 however the regulators appear to have placed increased pressure on banks in 1990 1991 and 1992 especially bhcs that were subject to regulatory orders

uncertainty and labor contract durations this paper provides an empirical investigation into the relationship between ex ante u s labor contract durations and uncertainty over the period 1970 to 1995 we construct measures of inflation uncertainty as well as aggregate nominal and real uncertainty the results not only corroborate previous findings of an inverse relationship between contract durations and inflation uncertainty but also document that this relationship extends to both measures of aggregate uncertainty we also explore the robustness of this relationship to various measures of inflation uncertainty that have appeared in the literature

personal income inequality and aggregate demand this paper presents a theoretical and empirical investigation of how changes in the size distribution of income can aect aggregate demand and the demand regime of an economy after presenting empirical evidence for the us economy that the propensity to save increases signicantly from the bottom to the top quintile of wage earners we demonstrate that more equal distributions always lead to higher output in the traditional neo kaleckian macroeconomic model we also present conditions under which a reduction of income inequality among workers turns demand more wage led this view is supported by the results of an econometric study for the united states 1967 2010 which show that the rise after 1980 in income inequality has made the us economy more prot led

the relationship between forecast dispersion and forecast uncertainty evidence from a survey data arch model this paper examines empirically the relationship between measures of forecast dispersion and forecast uncertainty from data on inflation expectations from the livingston survey series and the survey research center src survey series because the survey series do not provide probabilistic forecasts of inflation we derive measures of inflation uncertainty by modelling the conditional variance of the inflation forecast errors from the survey series as an autoregressive conditional heteroscedastic arch process the analysis is complicated by the fact that the overlap of forecast horizons for the survey series does not preclude the model s disturbance terms from displaying autocorrelation and also places a restriction on the specification for the arch measures of inflation uncertainty we estimate the model using hansen s 1982 generalized method of moments gmm procedure to account for the presence of serial correlation and conditional heteroscedasticity in the disturbance terms the results generally support the hypothesis that the measures of forecast dispersion across survey respondents are positively and statistically significantly associated with the measures of inflation uncertainty however the appropriateness of using forecast dispersion measures as proxies for inflation uncertainty is sensitive to the choice of the survey series

hysteresis and instability in the natural rate of unemployment in this paper it is pointed out that the long run phillips curve genus contains upward and downward sloping species as well as the vertical species two models are used in one the rate of inflation helps determine the natural rate of unemployment as proposed by friedman in the other the process of moving from one inflation rate to another helps shape the natural rate according to the hysteresis effect proposed by phelps in both cases the resulting models are unstable implying that a vertical long run phillips curve will not be regained if disturbed

the value of time and recent u s money demand instability much controversy has surrounded the u s money demand relationship or more precisely its stability this is rather disappointing in light of the central importance of money demand estimates for the formulation and implementation of effective monetary policy and for almost all theories of aggregate economic activity to date the vast majority of alternative money demand specifications have generally failed to produce a stable money demand function throughout the 1970s and 1980s

a sectoral net lending perspective on europe the paper investigates net lending and net borrowing flows of the institutional sectors in europe since the introduction of the euro in 1999 applying a simple statistical apparatus this paper is novel in describing the sectoral behavior leading up to and during the crisis we find that 1 many countries of the northern group were characterized by low public deficits or even budget surpluses current account surpluses and a private sector in a net lending position in countries of the southern periphery in the anglo saxon countries as well as in many eastern european economies private sector net borrowing coincided with a budget deficit and substantial current account deficits 2 with the onset of the crisis private net lending soared in all countries while all governments incurred deficits consistent with the notion of a balance sheet recession 3 private net lending is pro cyclical reinforcing the economic downturn while public net lending is countercyclical in all countries 4 household net lending tends to lead the business cycle while corporate net lending tends to lag it especially in the northern group 5 prominent concepts asserting causal relationships in sectoral net lending such as ricardian equivalence and the twin deficit hypothesis are not supported by the data authors abstract

causality between inflation and real growth abstract the paper investigates inflation growth causality over 1947 2005 with varma ml asymmetric vgarch the results imply that one uncertainty affects positively its level and much less negatively the other level whereas one level influences positively both uncertainties friedman s hypothesis was not strongly rejected

declining us output volatility and its effect on labour flow volatility an mgarch analysis this article analyses flow rates of us workers between employment and unemployment using new quarterly data for the period 1967 to 2002 multivariate garch models are used to investigate links between flow rate volatilities the results suggest that links changed substantially in the mid 1980s coinciding with the documented decline in output volatility these changes in adjustment dynamics are consistent with a move to greater use of hours rather than worker adjustment

a liquidity in advance model of the demand for money under price uncertainty abstract we develop a model of money demand in which the asset and goods markets open sequentially money balances are subject to price level and consumption risk empirical evidence from a bivariate arch framework suggests both sources of risk reduced money demand in the 1970s inflation risk depresses money demand throughout our sample 1962 1987 the econometric analysis resolves conflicting empirical estimates reported in the literature

capital regulation and bank risk taking a note abstract this paper examines theoretically the effects of more stringent capital regulation on bank asset portfolio risk the analysis shows that for a value maximizing bank incentives to increase asset risk decline as its capital increases thus as long as regulatory efforts to contain asset risk and size are not reduced more stringent capital regulation unambiguously reduces the expected liability of the deposit insurance system

regulation and the determination of bank capital changes a note the effectiveness of bank capital adequacy requirements is examined in this paper using empirical tests similar to those employed by peltzman and mingo no significant relationship is found between changes in bank capital and the capital standards imposed by regulators the findings conflict with those of previous studies the conflict in findings it is argued results from the failure of previous studies to account for the effect of binding deposit rate ceilings this paper reexamines the question of whether bank capital adequacy standards formulated by the regulators have any effect on the capital decisions of commercial banks using a much larger sample of banks and a different time period than previous studies we provide evidence that regulatory capital standards are not in general effective moreover we suggest that the conflicting conclusions reached by previous studies concerning the influence of bank capital standards result from a failure to account for the influence of other bank regulations particularly the effect of deposit interest rate ceilings bank capital serves two purposes it is a source of funding and it is a residual capable of absorbing losses these two functions of capital in banking do not differ qualitatively from the role of capital in a nonfinancial corporation the incentives for equity financing in banking differ from the incentives to use equity in nonfinancial firms primarily because of deposit insurance deposit insurance transfers default risk from depositors to the insurer as currently structured deposit insurance premiums are insensitive to the risk assumed by the insurer the federal deposit insurance corporation fdic a conflict therefore arises between the level of equity desired by bank shareholders and the level desired by the fdic this conflict arises because with complete insurance additional equity reduces the contingent liability of the insurer but does not reduce the cost of deposit financing through adjustments in deposit interest rates or through lower insurance premiums the absence of these benefits causes a conflict between the bank shareholders and the deposit insurer and

high and variable inflation further evidence on the friedman hypothesis abstract this study employing a garch model finds a positive and significant relationship between the level and variability of inflation this provides evidence in support of friedman s friedman 1977 view that high inflation leads to more variable inflation

estimates of the variance of u s inflation based upon the arch model it is generally agreed that the unpredictability of future inflation is a major component of the welfare loss associated with inflation perfectly predicted inflation might induce some costs through institutional rigidities governmental interference and transaction costs but in the long run these should be rather minimal as these institutions adopt various forms of indexing when inflation is unpredictable risk averse economic agents will incur a loss even if prices and quantities are perfectly flexible in all markets inflation is a measure of the relative price of goods today and goods tomorrow thus uncertainty in tomorrow s price impairs the efficiency of today s allocation decisions friedman in his nobel lecture 8 argues convincingly that higher variability of inflation would lead to decreased output ceteris paribus he then conjectures that higher rates of inflation are generally associated with higher variability of inflation and presumably greater uncertainty about future rates if this is true then higher rates of inflation would also be associated with low levels of output which implies a positively sloped phillips curve this paper uses a new statistical technique arch to estimate the conditional mean and variance of inflation from u s time series data the main finding is that the variance of inflation in the seventies was only slightly greater than in the sixties

risk premia and the sources of inflation the process of inflation is associated not only with a rising general price level but also with uncertainty about its rate of change it is the latter aspect of inflation that may give rise to risk premia on nominal assets as compared with a real safe asset a possible framework for analyzing the structure of risk premia under inflationary conditions is the well known capital asset pricing model capm developed by sharpe and lintner indeed a number of papers have recently dealt with these risk premia by means of the capm framework or some close variety of it we may mention the works of roll 9 sarnat 10 fischer 4 chen and boness 1 and friend landskroner and losq 5 1 the capm and its extentions to conditions of inflation use a microeconomic approach in a partial equilibrium analysis of the risk premia a basic feature of the foregoing literature is the implicit treatment of inflation as exogenous alternatively there is no theory to relate the real return on money to be denoted 7r to the other variables in the capm formulation this leads to two important shortcomings first the covariance of 7r with the rates of return appears as completely arbitrary second since x was considered as exogenous the authors did not consider the need to include in their models the government s nominal transfer pay

aggregate uncertainty investment and asymmetric adjustment in the uk manufacturing sector theory suggests that the level of uncertainty facing firms should affect both the rate of adjustment to and the steady state level of investment although there is ambiguity about the sign of the effect a non linear model of investment behaviour incorporating time varying adjustment speeds with threshold effects is estimated for the uk manufacturing sector the most general non linear specification is found to be most congruent with the data uncertainty has a large and significant effect on both levels and rates of adjustment

money demand during hyperinflation and stabilization bolivia 1980 1988 i introduction the stability of demand for money equations has been at issue in both econometric research and policy analysis the academic debates about the relative merits of the traditional buffer stock and the error correction models of demand for money have centered on parameter stability 1 in policy discussion the scope for remonetization following stabilization depends on the upward shift in the demand for money and the consequent predictability of higher money demand with lower rates of inflation 2 only an increased demand for money would make further credit expansion non inflationary inflation uncertainty has a pervasive effect in the money price nexus high inflation uncertainty makes money a riskier asset depressing the demand for money on a long term and possibly short term basis this impact on the demand for money means that policies influencing inflation will have an additional effect through their impact on inflation uncertainty as well as on expected inflation this paper examines the role of inflation uncertainty in a dramatic case study bolivia during the 1980s this was a decade of extreme macroeconomic instability annual inflation rates reached over 20 000 percent motivating a subsequent stabilization which drove annual inflation rates down to less than 25 percent where they have remained for more than five years perhaps more than any other country in recent history bolivia has undergone a dramatic structural shift in its macroeconomic policy regime to what extent did the demand for money shift during this period in its sensitivity to expected inflation inflation uncertainty and to underlying monetary disequilibria as the inflation stabilization progressed how fast did the money demand parameters react to this new regime change was there scope for remonetization in bolivia following the now famous stabilization plan of august 1985 the new economic plan introduced by president victor paz estenssoro 3 previous literature on the demand for money has explored the role of inflation uncertainty with ambiguous results 4 klein 1977 observed that inflation rate uncertainty reduced the average and marginal productivity of real cash balances in providing monetary services effectively a greater volume of real cash balances is required to obtain the same quality adjusted level of cash balances while the impact on the demand for money is theoretically uncertain because the income and substitution effects work in opposite directions klein provided empirical evidence that inflation uncertainty measured by a moving five year variance around a moving ten year trend with data from 1880 to 1972 actually increased the demand for money in the united states around the same time boonekamp 1978 presented a two period mean variance model of money and bond demand highlighting the potential importance of a hedging role in the demand for money in the face of inflation uncertainty related to aspects of both of these two approaches and working with a capital asset pricing model capm sweeney 1988 drew on university of michigan survey data on inflationary expectations to resolve the theoretical ambiguity of the impact of inflation uncertainty his results based on post war quarterly u s data contrasted with those of klein by showing a negative impact of inflation uncertainty on money demand in his study of the demand for money in the six hyperinflations originally examined by cagan 1956 khan 1977 measured inflation uncertainty by the absolute value of the change in inflation his model assumed that inflation uncertainty would affect the demand for money not directly but by altering the adaptive expectations parameter in the adjustment of inflation expectations his empirical estimates implied a negative impact of inflation uncertainty on the demand for money during accelerating inflation engle 1982 introduced the concept of arch autoregressive conditional heteroskedastic models with a specific application to inflation expectations

on the theory of inflation and optimal investment policy equilibrium considerations the increase in the rate of inflation in recent years has brought forth a variety of articles concerning the effects of inflation on investment and valuation under conditions of equilibrium numerous authors 2 3 5 9 10 11 12 16 20 have derived an asset pricing model with uncertain inflation nelson 18 and kim 15 have analyzed the effects of inflation on the optimal level of investment in the capital budgeting process nelson under the assumption of perfect net operating income sensitivity states it is clear that the optimal investment will be smaller the higher the anticipated rate of inflation this result also is demonstrated to be a special case of kim s analysis while nelson and kim make important contributions their work should be extended under conditions of equilibrium chen 4 recognizing the need for an equilibrium framework has applied the asset pricing model to examination of optimal investment policy by utilizing the jensen long 15 methodology in a world of uncertain inflation the jensen long methodology is not without controversy james 13 has recently argued extending fama s 8 critique that the capital asset pricing model is inappropriate for analysis without the assumption of a perfectly competitive capital market whereas an imperfectly competitive capital market is explicit in the jensen long methodology on the other hand a competitive capital market