Mortgage Put Options and Real Estate Markets

In this paper we offer direct evidence that financial intermediation does impact underlying asset markets. We develop a specific observable symptom of a banking system that underprices the put option imbedded in non-recourse asset-backed lending. Using a dataset for 19 countries and over 500 real estate investment trusts, we find that, following a negative demand shock, the “underpricing” economies experience far deeper asset market crashes than economies in which the put option is correctly priced.

Regulator Scrutiny and Bank CEO Incentives

This study analyzes the effects of monitoring intensity on compensation and turnover for CEOs of publicly-traded banks. Using a sample of banks from 1992 to 2004, I find that monitoring intensity plays a significant role in compensation levels, pay-for-performance sensitivity, and CEO turnover. The results show that CEOs from highly-rated institutions receive smaller pay than CEOs from competing institutions, and that monitoring intensity, as proxied by CEO age, influences the relationship between market performance and executive incentives. These findings suggest that regulatory ratings and CEO age impact optimal bank governance structure by varying incentive sensitivity to market performance.

The Interaction between Mortgage Financing and Housing Prices in Greece

Although the close empirical relationship between the evolution of mortgage lending and housing prices is well established in the literature, the direction of causation is less clear from a theoretical standpoint. We apply multivariate cointegration techniques in order to address this issue empirically for the Greek economy. Our results, based on a cointegration relationship that we identify as a mortgage loan demand equation, indicate that housing prices do not adjust to disequilibria in the market for housing loans. This suggests that in the long run the causation does not run from mortgage lending to housing prices. In the short run we find evidence of a contemporaneous bi-directional dependence.

Market Risk of Mortgage-Backed Securities with Consistent Measures

Due to the complex prepayment behavior, mortgage contracts and their derivatives are generally priced using Monte Carlo simulations. The typical approach used by the industry, which involves simulating interest rates under the risk-neutral measure and applying a physically measured prepayment function, is subject to the problem of internal inconsistency. This is the first paper that directly investigates the potential impact of this issue. Following the general equilibrium setting by Cox, Ingersoll and Ross, we incorporate the market risk price parameter to derive the physical interest rate process from an observed yield curve. This allows us to model mortgage values under the consistent physical measures of interest rates and prepayment functions. By analyzing a default-free Ginnie Mae MBS, we find that the mixed measures lead to slower prepayment rate estimates and overpriced mortgage securities by approximately 5%. Further, there can be substantial biases in the duration and convexity measures depending on market condition and the particular security of interest. The internal inconsistency also leads to biased predictions of both expected and stressed returns for different investment horizons. Depending on the particular security, the bias in expected and stressed returns can be either positive or negative. These biases in risk estimates can introduce misallocation of risk-based capital and/or failure in hedging the market risk of a mortgage-related portfolio.

Concentration of Banking Relationships in Switzerland: The Result of Firm Structure or Banking Market Structure?

Switzerland is one of the countries with the highest concentration of bank–customer relationships. The present paper seeks to find out whether this can be explained by the structure of Swiss firms or by the organization of the Swiss banking market. Using survey data from small and medium-sized enterprises in 1996 and 2002, we examine the influence of firm-, loan-, and bank-specific variables on the number of banking relationships. We find that firm and industry structure have the largest explanatory power, while banking market structure and conduct play a minor role. Relationship lending by state-owned cantonal banks and small regional banks tends to enhance the concentration of banking relationships.

Property Derivatives and Index-Linked Mortgages

Economists have forcefully argued for the introduction and use of property derivatives as a hedge against house price risk (e.g. Shiller and Weiss, J. Real Estate Finance Econ., 19(1):21–47, 1999). The rationale for these financial instruments seems clear, as many households are heavily invested in housing and standard financial instruments offer a poor hedge. In practice, however, most of the property derivatives available have been targeted to meet the needs of institutional investors, not those of owner-occupiers. Building on the recent launch of the first Swiss property derivative, we here propose index-linked mortgages tailored to retail consumers. The payments of these mortgages depend on the corresponding housing market performance. We further price the instruments, discuss the stabilization of the homeowner’s net wealth, and quantify the expected decrease in the mortgage default risk achieved by this immunization effect.

Bank Competition,Risk, and Subordinated Debt

This paper studies a dynamic model of banking in which banks compete for insured deposits, issue subordinated debt, and invest in either a prudent or a gambling asset. The model allows banks to choose their level of risk after the interest rate on subordinated debt is contracted. We show that requiring banks to issue a small amount of subordinated debt can reduce their gambling incentives. Moreover, when equity capital is more expensive than subordinated debt, adding a subordinated debt requirement to a policy regime that only uses equity capital requirements is Pareto improving.

Introduction to <Emphasis Type="Italic">JREFE</Emphasis> Special Issue on the 2007 MCM International Symposium

This article introduces the 2007 Maastricht-Cambridge-MIT Symposium articles in this special issue. The introduction not only briefly describes each of the four articles from that symposium included in this special issue, but also describes the symposium including links to other papers and presentations of the symposium not published in this issue.

Multimarket Contact and Profitability in Banking: Evidence from Italy

In this paper we test the theory according to which multimarket contact is a crucial factor hampering competition among firms, because it lowers the incentive to behave aggressively in one market if there is fear that rivals retaliate in other common markets. We consider the Italian banking industry in the period 2002–2005, employing both market-level and firm-level data. The empirical evidence supports theory predictions, since profitability is positively related to the average number of contacts among banks, and appear to be higher for those credit institutions experiencing more links. This result has also policy implications, given the increasing consolidation (and hence the growing number of interactions in local markets) that has characterized this sector in the last years.

Estimating Default Probabilities Implicit in Commercial Mortgage Backed Securities (CMBS)

This paper uses a structural credit risk model, providing an analytical formula to estimate default probabilities implicit in commercial mortgage backed security prices. Empirical studies of CMBS default have focused on the probability of default depending on loan characteristics at the origination and market indices. Recent studies show that unobservable current loan-to-value (LTV) ratio is a key state variable driving default. We update this variable using Real Estate Investment Trust (REIT) property-type indices over time. Later, we employ first passage time approach to study CMBS default using implied LTV.

Universal Banking,Conflicts of Interest and Firm Growth

This paper studies the relationship between universal banking and firm performance. With 40 developing and developed countries, I find that the overall effect of universal banking on firm growth is negative. This suggests that the negative effect of conflicts of interest dominates the positive effect of economies of scale and scope in universal banking. However, in countries with stronger protection of creditors’ rights and higher information efficiency, conflicts of interest are less likely and the negative relationship between universal banking and firm growth is significantly weaker.

Interest rate risk of German financial institutions: the impact of level,slope, and curvature of the term structure

We investigate here the sensitivity of the equity values of a large sample of German financial institutions to movements in the term structure of interest rates. While similar approaches rely on a single interest rate factor only, we quantify the exposure to changes in level, slope, and curvature, which are the driving factors of term structure changes. Our main findings are: (i) banks and insurances are exposed to level and curvature changes but only marginally to slope movements; (ii) the interest rate risk exposure depends on the banking sector investigated; (iii) level and curvature changes are priced in the cross-section of stock returns.

International evidence on the impact of regulations and supervision on banks’ technical efficiency: an application of two-stage data envelopment analysis

This study uses a sample of 715 banks from 95 countries and two-stage data envelopment analysis (DEA) to provide international evidence on the impact of regulations and supervision approaches on banks’ efficiency. We first use DEA to estimate technical and scale efficiency. We then use Tobit regression to investigate the impact of several regulations related to capital adequacy, private monitoring, banks’ activities, deposit insurance schemes, disciplinary power of the authorities, and entry into banking on banks’ technical efficiency. We estimate several specifications while controlling for bank-specific attributes and country-level characteristics accounting for macroeconomic conditions, financial development, market structure, overall institutional development, and access to banking services. In several cases, the results provide evidence in favour of all three pillars of Basel II that promote the adoption of strict capital adequacy standards, the development of powerful supervisory agencies, and the creation of market disciplining mechanisms. However, only the latter one is significant in all of our specifications. While the remaining regulations do not appear to have a robust impact on efficiency, several other country-specific characteristics are significantly related to efficiency.

Credit Unions and Small Business Lending

Among the issues raised by consolidation within the banking industry is a concern that small businesses will be less able to obtain credit as community banks are acquired by larger or non-local institutions. Community banks have traditionally been a major source of funding for small businesses. The impact of bank consolidation on credit availability may depend in part on whether the remaining community institutions expand their small business lending activities. This study examines whether credit unions have a propensity to extend business loans in markets that have experienced bank merger and acquisition activity. We find some evidence that credit unions are more likely to engage in business lending in markets characterized by greater bank merger and acquisition activity. Moreover, the estimated economic significance is meaningful in many of the specifications.

Asset Price Spillover,Collateral and Crises: with an Application to Property Market Policy

This paper studies the impact of land supply elasticity and land use regulation. For sufficiently adverse shocks constrained entrepreneurs liquidate their assets for debt repayment. This effect can spillover to the residential property market. A crisis occurs when households are forced to default on their mortgages as well. While both converting costs and land use regulation tend to magnify the effect of adverse shock, the former generates an asymmetric effect between a positive and a negative shock on the land market, and the latter tends to raise the likelihood of a crisis, by raising the threshold value of liquidation.

The Effect of SFAS No. 131 on the Cross-segment Variability of Profits Reported by Multiple Segment Firms

Our study assesses whether SFAS No. 131 improved disclosure about the diversity of multiple segment firms’ operations. We find a post-SFAS No. 131 increase in cross-segment variability of segment profits, an increase in the association between reported and inherent cross-segment variability, and an increase in association between reported variability and capital market incentives to disclose. We interpret the results as evidence that SFAS No. 131 increased the transparency of segment profitability disclosures, and as indicating SFAS No. 131 allowed firms depending more on external financing to disclose more about differences in segment profitability.

One-and-a-half decades of global research output in Finance: 1990–2004

We provide a ranking of world finance research output by countries and institutions. Based upon 21 finance journals, the top five most productive countries are in the following order: U.S., U.K., Canada, Hong Kong, and Australia. We find that higher per capita GNP, English-speaking countries, and a capital market that offers her investors more protections are associated with higher level of finance literature production. New York University, the University of Pennsylvania, Harvard University, the University of Chicago, and UCLA take the top five spots among the 1,126 academic institutions with most JF-pages appeared in 21 finance journals during the 15-year period from 1990 to 2004. The share of U.S. in the top-100 institutions is overwhelming; 78 out of the top-100 institutions come from U.S. We also show some factors that help to explain the cross-institutional variations among a sub-sample of the institutions. Specifically, faculty size, catalyst effect, and per capita budget are positively associated with research output.

Takeover motives in a weak regulatory environment surrounding a market shock: a case study of New Zealand with a comparison of Gondhalekar and Bhagwat’s (2003) US findings

We examine the motives for takeovers in New Zealand surrounding the 1987 stock market crash and compare with the US findings of Gondhalekar and Bhagwat (2003). There are a number of structural differences between the New Zealand and US markets that could impact on merger motives. Compared with the US, New Zealand is a small capital market; with weak takeover regulation and a prolonged aftermath of the 1987 stock market crash. Consistent with US research, we find evidence of synergy and hubris motivations in New Zealand takeovers although we find the synergy motivation is stronger. Contrary to expectations we find no evidence of agency motivated takeovers.

Estimating Default Probabilities of CMBS Loans with Clustering and Heavy Censoring

This paper provides a comprehensive default estimation of commercial real estate loans with a complete commercial mortgage backed securities (CMBS) loan history database. Standard survival models assume that eventually every observation will experience the event. However, often there is a high proportion of censored observation in the sample. A mixture model is proposed to disentangle the probability of “long-term survivorship” and the timing of default occurrence. Loans within the same geographical area and property type tend to exhibit correlation in default incidence. A multilevel model is proposed to capture this correlation within and between clusters.

Regional Housing Prices in the USA: An Empirical Investigation of Nonlinearity

Existing literature on housing prices is predominantly in a linear framework, and an important question that has not been addressed is whether housing prices exhibit nonlinearity. We examine Smooth Transition Autoregressive (STAR) model based nonlinear properties of housing prices over the 1969–2004 period for the entire US and the four regions. Our main findings are (1) housing price for the entire US and all regions except for the Midwest show non-linearity, (2) the dynamic properties implied by the nonlinear estimation explain the typical patterns that have characterized each housing market, and (3) results of Granger causality tests look more plausible in the nonlinear framework where we find stronger evidence of Granger causality from housing price to employment and also from mortgage rates to housing price.