optimal bank reorganization and the fair pricing of deposit guarantees abstract when should regulators close a financially ailing bank fdic practice in the us has moved in the direction of early closure in contrast banking regulators in japan continue to follow a more patient approach this paper analyses a series of models in which closure rules and bailout policies arise endogenously through the interaction of i regulators attempts to minimize discounted expected bankruptcy costs and ii equity holders incentives to recapitalise banks we characterize subsidy policies for distressed banks that implement socially optimal closure rules at minimum financial cost to regulators and which reduce moral hazard

limit order book as a market for liquidity we develop a dynamic model of an order driven market populated by discretionary liquidity traders these traders must trade yet can choose the type of order and are fully strategic in their decision traders differ by their impatience less patient traders demand liquidity more patient traders provide it three equilibrium patterns are obtained the pattern is determined by three parameters the degree of impatience of the patient traders which we model as the cost of execution delay in providing liquidity their proportion in the population which determines the degree of competition among the liquidity providers and the tick size which is the cost of the minimal price improvement despite its simplicity the model generates a rich set of empirical predictions on the relation between market parameters time to execution and spreads we argue that the economic intuition of this model is so basic its main results must be robust in much more general models

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

commodity liquidity measurement and transaction costs we examine the performance of liquidity proxies in commodities the amihud measure has the largest correlation with liquidity benchmarks amivest and effective tick measures also perform well these proxies are useful for studies of commodity liquidity over a long time period and those that lack access to high frequency data we use various aspects of transaction costs such as spread depth immediacy and resiliency to give insight into the costs of different execution approaches transaction costs increase with volatility and exhibit mean reversion splitting trades over one hour can reduce trading costs by two thirds compared to an immediate execution the author 2011 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

a dynamic model of firewalls and non traditional banking abstract over the last decade there has been considerable public debate in the u s on the need to maintain legal barriers firewalls between commercial and non traditional banking however no theoretical model has yet been developed that examines the joint influence of various factors suggested such as competition production economies and regulatory subsidies that affect the bank s incentive to undertake non traditional activities this paper applies a stochastic control model to examine the joint effects of these factors on a bank s optimal investment decisions in non traditional banking and develops some empirically testable hypotheses

cross sided liquidity externalities we study the empirical relevance of the participation externality between liquidity suppliers makers and demanders takers i e whether liquidity demand attracts or reduces liquidity supply and vice versa we use exogenous shocks to exchange fees and technology as experiments to identify cross sided complementarities between liquidity suppliers and demanders in the u s equity market we find that the externality is large and positive on average however the externality is negative in periods of high adverse selection we quantify the economic significance of the externality by evaluating an exchange s revenue after a fee change the internet appendix is available at https doi org 10 1287 mnsc 2016 2658 this paper was accepted by lauren cohen finance

managerial compensation contract and bank bailout policy abstract under the incomplete contract framework we consider an optimal regulatory policy for motivating bank equity owners and bank managers to restructure the bad loans of their banks in the presence of managerial compensation contracts with stock options the regulatory policy studied in this paper is mainly concerned with the design of repayment schedules in the scheme of injection of cash funds into insolvent banks by the regulator we show that the regulator cannot necessarily attain the social optimal allocation by injecting cash funds into insolvent banks through the purchase of subordinated bonds with the risk free interest rate however even in that case we also suggest that if the regulator injects cash funds into active restructuring banks through the purchase of subordinated bonds or preferred stocks with less stringent repayment conditions and nationalizes passive restructuring banks the regulator can attain the social optimal allocation by performing such a non linear injection scheme under certain conditions

high frequency trading and extreme price movements abstract are endogenous liquidity providers elps reliable in times of market stress we examine the activity of a common elp type high frequency traders hfts around extreme price movements epms we find that on average hfts provide liquidity during epms by absorbing imbalances created by non high frequency traders nhfts yet hft liquidity provision is limited to epms in single stocks when several stocks experience simultaneous epms hft liquidity demand dominates their supply there is little evidence of hfts causing epms

forbearance deposit insurance pricing and incentive compatible bank regulation abstract this paper examines the incentive compatible role of regulatory forbearance policy in the context of optimal bank regulation under moral hazard we show that when a bank s asset portfolio returns have market risk the regulator can influence the bank s choice of ex ante risk by delaying the closure of an insolvent bank the optimal closure policy involves co ordinating the closure decision with market wide performance such a policy may significantly alleviate the bank s ex ante risk shifting problem furthermore even fixed rate deposit insurance can be optimal when combined with a sound forbearance policy and a minimum capital standard

what stopped the inflation unemployment or commodity prices the main object of this paper is to argue that most of the deceleration of inflation in the oecd countries in general including britain that took place between i980 and i982 should be attributed not to the direct impact of higher unemployment on the labour market but to the fall in commodity i e primary product prices from i980 to i982 following their very sharp rise accompanying the second oil shock between i978 and i980 this led to a dramatic turn round of about 50 60 in the prices of primary products imported into the oecd countries from the rest of the world and from other oecd countries which in turn can account for the deceleration of about 20 25 in the import prices for the average industrialised country and our econometric estimates show that the pace of wage inflation is closely correlated with import prices by contrast our estimates for a variety of model specifications and choice of data do not show statistically significant correlations between aggregate unemployment and wage inflation we have not attempted to establish statistically that the turn round in commodity prices was caused mainly by the strength and duration of the posti979 recession in the industrialised countries as a whole but like most commentators we assume that this is the case given this assumption therefore our results imply that the recession in the industrialised world did not as is widely believed slow down the inflation by acting directly on the labour market e g by crushing the unions or bringing a new breath of realism into wage negotiations instead it worked by inducing a collapse of commodity prices or in the case of oil inducing a slight fall by comparison with the preceding sharp rise insofar as our results are valid there are various obvious implications for some central topical economic debates first if there is no stable direct relationship between unemployment within any country and its own rate of wage inflation then there would be no nairu and no clearly identifiable phillips curve as some other investigators have found hence debates as to whether and how far individual economies have unemployment rates above or below their nairus and so on are irrelevant in the conclusions we summarise what seem to be the main policy implications for individual countries but secondly insofar as levels of demand in the industrialised countries taken as a whole influence commodity prices which feed back on wage inflation via

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

optimal price adjustment under imperfect information abstract variations in cost and demand do not have symmetrical impact on the optimal price of the imperfectly competitive firm this asymmetry is not so important as long as information regarding both cost and demand is sufficient however it becomes crucially important in case of incomplete information usually firms have more complete or harder information on cost than on demand this difference in information status on the cost and on the demand side can explain both cost based pricing and slow price adjustment to demand in an optimizing framework with bayesian learning about changed demand conditions

the roll yield myth futures investors are frequently said to periodically pay or receive the difference in futures prices across contracts with different delivery dates but this roll yield is mythical no such cash flow occurs at the time of roll trades or on any other date however although the term is a misnomer the roll yield does contain useful information it explains when futures gains exceed or fall short of spot price changes and for storable assets it provides information regarding benefits to the marginal holder of a spot position this article clarifies the actual role of the roll yield

kaldor on commodities nicholas kaldor s commodity concerns were wide and persistent they encompassed a number of micro and macro issues some of which are still prominent in both academic and policy agendas and are capable of generating new insights this paper while attempting comprehensiveness pays special attention to the welfare economics of schemes for countering price instability and to the macroeconomic destabilization attributed to commodity price fluctuations the micro subheadings include the rationale for intervention efficiency preserving intervention distributional neutrality and income stability and market failures macro subheadings include intersectoral asymmetries flexible commodity prices and demand deficiency commodity reserve currency and severing the first link of an inflationary chain copyright 1989 by oxford university press

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

liquidity resiliency and market quality around predictable trades theory and evidence abstract we extend the theory of strategic trading around a predictable liquidation by considering the role of market resiliency our model predicts that even a monopolist strategic trader improves market quality and increases liquidator proceeds if trades temporary price impacts are quickly reversed and that competition among strategic traders strictly improves market quality we provide related empirical evidence by studying prices liquidity and individual account trading activity around the large and predictable roll trades undertaken by a large exchange traded fund etf the evidence indicates narrower bid ask spreads greater order book depth and improved resiliency on roll dates we find that a larger number of individual trading accounts provide liquidity on roll dates and do not find evidence of the systematic use of predatory strategies on balance the theory and evidence imply that traders supply liquidity to rather than exploit predictable trades in resilient markets

episodic liquidity crises cooperative and predatory trading we describe how episodic illiquidity arises from a breakdown in cooperation between market participants we first solve a one period trading game in continuous time using an asset pricing equation that accounts for the price impact of trading then in a multi period framework we describe an equilibrium in which traders cooperate most of the time through repeated interaction providing apparent liquidity to one another cooperation breaks down when the stakes are high leading to predatory trading and episodic illiquidity equilibrium strategies that involve cooperation across markets lead to less frequent episodic illiquidity but cause contagion when cooperation breaks down why is illiquidity rare and episodic pastor stambaugh 2003 detect only 14 aggregate low liquidity months over the time period 1962 to 1999 despite being of significant magnitude most of the episodes were short lived and were followed by long periods of liquidity 1 the origin of this empirical observation still remains a puzzle in this paper we attempt to shed light on this puzzle by developing a theoretical model in which a breakdown in cooperation between traders in the market manifests itself in predatory trading this mechanism leads to sudden and short lived illiquidity we develop a dynamic model of trading based on liquidity needs during each period a liquidity event may occur in which a trader is required to liquidate a large block of an asset in a relatively short time period this need for liquidity is observed by a tight oligopoly whose members may choose to predate or cooperate predation involves racing and fading the distressed trader to the market

deposit insurance and regulatory forbearance are caps on insured deposits optimal considerable academic and public policy attention has been focused on the deposit insurance contract and in particular its mispriced deposit insurance premium this has resulted in a burgeoning literature on the optimal pricing of deposit insurance guarantees see merton 1977 1978 pyle 1983 ronn and verma 1986 acharya and dreyfus 1989 and allen and saunders 1993 for examples in addition other authors have studied the ability of uninsured depositors or debtholders to provide market discipline in the form of marketbased risk premia in the absence of explicit risk based insurance premia see for example ellis and flannery 1989 and avery belton and goldberg 1988 however a third control instrument namely the setting of ceilings or caps on the amount of deposit insurance coverage has not been subject to rigorous investigation in particular while the fdic 1989 and others have considered the general pros and cons of limiting the scope of deposit insurance for instance by lowering the 100 000 ceiling on the amount of insurance per account or by restricting the brokering in of deposits l no formal analysis of the role of coverage caps can be

bank capital interbank contagion and bailout policy abstract this paper develops a theoretical framework in which asset linkages in a syndicated loan agreement can infect a healthy bank when its partner bank fails we investigate how capital constraints affect the choice of the healthy bank to takeover or liquidate the exposure held jointly with the failing bank and how the bank s ex ante optimal capital holding and possibility of contagion are affected by anticipation of bail out policy capital requirements and the joint exposure we identify a range of factors that strengthen or weaken the possibility of contagion and bailout recapitalization with common stock rather than preferred equity injection dilutes existing shareholder interests and gives the bank a greater incentive to hold capital to cope with potential contagion increasing the minimum regulatory capital does not necessarily reduce contagion while the requirement of holding conservation capital buffer could increase the bank s resilience to avoid contagion

does the debt market assess large banks risk time series evidence from money center cds abstract uninsured bank liabilities should offer a promised yield that compensates depositors for their expected default losses however the conjectural guarantees available to large u s banking firms makes it questionable whether large depositors should or do feel themselves exposed to credit risk prior papers have evaluated the determinants of bank risk premia using cross sectional data with relatively inconclusive results this paper investigates the same issue in a methodologically independent fashion using time series data on specific banks daily offering rates during the period may 1982 through july 1988 we find that cd rates paid by large money center banks include significant default risk premia

the russell reconstitution effect significant returns were associated with the annual reconstitution of the russell equity indexes from 1996 through 2002 which can be explained by both transitory price pressure and the permanent effects of index membership on the one hand the return effects represent a significant cost to index funds that rebalance on the reconstitution date on the other hand supplying immediacy at this time can be highly profitable this strategy is typically undiversified however and involves high trading costs and price risk as positions are unwound indeed dramatic intraday return volatility characterizes the day of reconstitution these factors explain the persistence of the reconstitution effects documented here

the price response to s p 500 index additions and deletions evidence of asymmetry and a new explanation we study the price effects of changes to the s p 500 index and document an asymmetric price response there is a permanent increase in the price of added firms but no permanent decline for deleted firms these results are at odds with extant explanations of the effects of index changes that imply a symmetric price response to additions and deletions a possible explanation for asymmetric price effects arises from the changes in investor awareness results from our empirical tests support the thesis that changes in investor awareness contribute to the asymmetric price effects of s p 500 index additions and deletions the long held assumption that stocks have perfect substitutes and the perfect elasticity of demand that follows from it is central to modern finance theory if securities have almost perfectly elastic demand then any supply or demand shocks that are devoid of information should have no effect on the prevailing price early empirical research on whether price changes occur in the absence of new information focused on block trades equity issues and stock splits but was unable to exclude information effects around these events since there is no obvious reason to believe ex ante that index changes contain new information they constitute a natural framework for testing whether stocks have almost perfectly elastic or horizontal demand curves a stock s excess return around such changes could be consistent with a downward sloping demand curve with the advent of indexed mutual funds in 1976 and the public announcement of s p index changes in the same year there is much evidence that such announcements are accompanied by an increase in price for firms added to the index if stocks have a short term downward sloping demand curve the price should be momentarily affected by a demand shock due to indexing but that effect

anticipated and repeated shocks in liquid markets we show that treasury security prices in the secondary market decrease significantly before subsequent auctions and recover shortly after this price pattern implies a large issuance cost for the treasury department which is estimated to be between 9 and 18 basis points of the auction size for example this cost amounts to over half a billion dollars for issuing treasury notes alone in 2007 our results appear to be consistent with the hypothesis of primary dealers limited risk bearing capacity and the imperfect capital mobility of end investors in the treasury market e g federal agencies sovereign wealth funds pension funds and etc highlighting the important role of capital mobility even in the most liquid financial markets

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 pricing of deposit insurance considering bankruptcy costs and closure policies the paper aims to study the pricing issue of deposit insurance with explicit consideration of bankruptcy costs and closure policies full coverage from deposit insurance is imposed by many regulators to stabilize the banking system in the current financial crisis despite of the potential moral hazard problems we argue that bankruptcy cost is an important factor in pricing deposit insurance especially when the insured institution is insolvent applying the isomorphic relationship between deposit insurance and put option we first derive a closed form solution for the pricing model with bankruptcy costs and closure policies then we modify the barrier option approach to price the deposit insurance in which the bankruptcy cost is set as a function of asset return volatility and more realistic closure policies considering possible forbearance can be accounted for the properties of the models are supported by numerical simulations and are consistent with the risk based pricing scheme