Balance Sheets, the Transfer Problem, and Financial Crises

In a world of high capital mobility, the threat of speculative attack becomes a central issue of macroeconomicpolicy. While first-generation and second-generation models of speculative attacks both have considerablerelevance to particular financial crises of the 1990s, a third-generation model is needed to make sense of thenumber and nature of the emerging market crises of 1997-98. Most of the recent attempts to produce such amodel have argued that the core of the problem lies in the banking system. This paper sketches another candidatefor third-generation crisis modeling—one that emphasizes two facts that have been omitted from formal modelsto date: the role of companies' balance sheets in determining their ability to invest, and that of capital flows inaffecting the real exchange rate.     

Modernizing Financial Regulation: The Relation Between Interbank Transactions and Supervisory Reform

Modernized financial firms are larger than traditional institutions, and they provide a broader range of services. Although the individual regulatory issues raised by modernization are not new, the pace and scope of these market changes may imply a qualitative change in the ability of governments to guarantee financial system stability. Private market discipline is more flexible, and the value of flexibility seems to have risen. In order to elicit private monitoring, however, governments must credibly eschew too-big-to-fail policies. Toward this end, national regulators should encourage ongoing efforts to implement secure interbank settlement systems.     

The effect of early resolution of uncertainty on the valuation of assets: A dichotomy into market and non-market information

We reconsider how the temporal resolution of uncertainty about the future payoffs from capital assets affects the initial valuation of these assets. Our results regarding valuation indicate that, in an intertemporal CAPM framework, the early resolution of market uncertainty leads to an increase in the value of the market portfolio. The values of individual assets change in direct proportion to their betas. We reconcile the differing conclusions of Ross (1989) and Epstein and Turnbull (1980) regarding the early resolution of what they term idiosyncratic and asset specific information respectively.     

The impact of settlement period on sales price

This study is an empirical investigation of the impact of settlement period on sales price while controlling for marketing period and standard explanatory variables. The hypothesized positive relationship between settlement period and sales price is confirmed by the results of this study. The estimated coefficient on settlement period is 0.0008 meaning that our market, on average, exacts a premium of 0.08 percent per day of settlement period beyond a norm of 60 days. The estimated coefficient on marketing period (a control variable) is –0.0003 meaning that our market, on average, requires a discount of 0.03 percent per day of marketing period. Our findings show the relative importance of settlement period in making real estate pricing decisions.     

The “Rent-To-Own” mortgage and prepayment risk

The most important risk factor in the mortgage and mortgage-backed security market has been prepayment risk. Various innovations have arisen to deal with it but none hedge it fully. The Rent-To-Own (RTO) mortgage discussed here is a mortgage instrument that reduces or even reverses prepayment risk. It does so by creating an incentive structure within the framework of the mortgage contract that penalizes prepayment when interest rates are low and rewards it when interest rates are high. This is the opposite of standard mortgages. The RTO incentive structure is based on a unique buyout feature. Borrowers who want to buy out the financial interest of the lender may do so whenever they want, but the buyout price is a negative function of the market interest rates prevailing currently, that is, at the time of the buyout. Hence the lower these rates, the higher the buyout price. Other advantages of the RTO mortgage are also described.     

Do Market Makers Suffer from Splitting Headaches?

Studies of transactions surrounding stock split ex-dates often conclude that splitting firms either experience a decline or an improvement in their stock's liquidity, based on independent measures of trading costs and trading activity. In contrast, our evidence suggests that splits from outside into what often is deemed to be the optimal stock price range of $10.00 to $39.99 are nonevents for market makers: The spread-setting behavior of the market does not change after a split. Our analysis accounts for the interdependencies between bid-ask spreads and market microstructure effects and distinguishes between optimal and all other splitting firms.     

A New Approach to Group Structure, Burden Sharing, and the Equilibrium Provision of Public Goods

In the received model of the voluntary provision of a pure public good, the usual practice is to proceed from assumptions about the group characteristics to inferences about an implied outcome. The approach advocated in this paper reverses the traditional direction. Assuming a Nash equilibrium, we ask how to characterize the diverse set of group characteristics which will support it. Approaching the problem from this angle we define three crucial characteristics of a group-equilibrium: consumer's free rider inducing supply, zero contribution-inducing wealth and voluntary surplus tribute which is the amount by which a person's actual income exceeds his/her zero-contribution inducing wealth. Defining these indicators we show how they form the foundation of a complete mapping between the distribution of individual characteristics of a group, and equilibrium public good supply. Certain questions such as the interaction between size of the group and heterogeneity of incomes and tastes not yet adequately addressed are shown to yield easily to this approach.     

Information Monopoly and Commitment in Intermediary-Firm Relationships

A bank may use the private information that it acquires through monitoring to hold up borrowers. This information monopoly of the bank may inefficiently distort the borrowers investment decisions in environments where moral hazard is prevalent. The paper analyses how this problem is resolved within bank-firm relationships. In the benchmark case when the bank can contractually commit to future actions, the optimal contract turns out to be ambiguous in nature. When commitment contracts cannot be written, firms have an incentive to develop multiple banking relationships in order to decrease the inside banks bargaining power. However, with costly monitoring, this may defeat the initial purpose for contracting with a financial intermediary, namely information production. The paper argues that when contractual commitment is not feasible, bank size may serve as an alternative commitment device that prevents the bank from holding up borrowers in the future.     

Analyst Following and Equity Offerings Subsequent to Initial Public Offerings

Analyst forecast information is collected for firms following their IPOs and is used in an examination of subsequent seasoned equity offerings (SEOs). Consistent with information asymmetry arguments, the analysis indicates that a larger percentage of firms conducting SEOs within three years of the IPO are covered by financial analysts than those without SEOs, and that analyst coverage is a significant predictor of subsequent SEOs. In addition, the results indicate that long-term earnings growth forecasts are larger for firms with subsequent SEOs, but growth forecasts decline significantly following the SEOs. Further, SEO abnormal returns exhibit a significant negative relationship with earnings growth forecasts. These results are consistent with windows of opportunity arguments since they suggest that SEOs are timed to coincide with the peak of earnings growth expectations, but that market participants compensate by reacting more negatively to offerings by firms with high growth forecasts.     

The behavior of risky asset prices in a symmetric least squares learning environment

This paper examines the dynamics of asset prices in a heterogeneous market. Traders are made up of learners who possess limited information and use limited models for predicting the future. The market also includes noise traders in the sense of Black, along with liquidity traders. Learners revise their prediction equations using least squares learning as defined by Marcet and Sargent. We derive the equilibrium price process and show how convergence is obtained. The price process is shown to have a number of interesting properties that are consistent with propositions outlined by Black. Numerical calculations for several examples illuminate how learning takes place in the model.     

A General Theorem on the Comparative Statics of Changes in Risk

In this paper, the concept of absolutely riskier than is introduced to generalize Gollier's (Journal of Economic Theory, 66, 522–535) necessary and sufficient conditions for the comparative statics of a change in risk for risk averters. The restrictive assumption that the payoff function is monotonic in the risk is relaxed. The policymaker's choice problem, the newsboy problem, and a farmer's example are used to illustrate how easily the monotonicity assumption is violated. Finally, some important properties of the concept of absolutely riskier than, such as its relation with the concept of second-order stochastic dominance, are illustrated using the farmer's example.     

Company Tax Structure and Company Tax Incidence

This paper reviews conflicting theories of company tax incidence impliedby the alternative new and traditional views of dividends andexamines their contrasting policy implications. Whereas, under thetraditional view, closer integration of the corporate and personalincome tax systems is suggested, an alternative policy orientationemphasizing the non-distorting features of the classical system is impliedby the new view. Even if the traditional view is accepted, theimplications for design and reform of the company tax vary widely underalternative specifications of domestic and international tax policy objectives. Schedular alternatives to global income taxation are alsoconsidered.     

The Information Content of Bank Examinations

We identify three types of information from bank examinations—auditing information from verifying the honesty and accuracy of the bank's books, regulatory discipline information about the treatment of the bank by regulators, and private information about bank condition. We estimate these information effects by comparing the cumulative abnormal market returns associated with examinations in which the CAMEL rating remained unchanged, improved, and worsened. All three information effects are found to be greater for banks entering the examination process with unsatisfactory ratings from prior examinations. The only consistently strong effect found is that examination downgrades appear to reveal unfavorable private information about bank condition. The evidence also suggests that the information may reach the market in part through loan quality data released in quarterly financial statements.     

The Effect of Mortgage Price and Default Risk on Mortgage Spreads

Variations over time in mortgage yield spreads should reflect changes in the underlying prepayment option value; moreover, the relationship between mortgage yield spreads and interest rate dynamics should weaken as the value of the borrowers prepayment option declines. We verify this hypothesis through an empirical analysis of residential mortgage yield spread behavior, and we also present evidence that the strength of the relationship between mortgage spreads and interest rate dynamics weakens (strengthens) as the level of default risk increases (decreases). This result is consistent with the competing risks effect between a borrowers option to prepay or default. Our results demonstrate the importance of accounting for mortgage price discount to par as well as default risk when developing time series of mortgage yields.     

Heterogeneity in Financial Market Participation: Appraising its Implications for the C-CAPM

This paper presents empirical evidence that accounting for heterogeneity in financial market participation is important for evaluating the empirical performance of the Consumption-based Capital Asset Pricing Model (C-CAPM). Using the US Consumer Expenditure Survey as a common testing ground, I re-assess three well-known characterizations of the equity premium puzzle (i) the inconsistency of the representative agent's IMRS with Hansen and Jagannathan bounds; (ii) Mehra and Prescott's calibration of a large representative agent's risk aversion; (iii) Hansen and the Singleton's large structural estimates of the preference parameters based on aggregate data. In all three cases, the estimates of risk aversion conditional upon financial market participation are not as far from reasonable values as the corresponding unconditional ones. The differences suggest that part of the equity premium puzzle can be accounted for by the use of a representative agent assumption rather than a more appropriate "representative stockholding agent assumption.     

Corporate Real Estate and Stock Market Performance

An interesting question in corporate real estate literature is whether real estate can improve the stock market performance of property-intensive non-real estate firms. Using a data set comprising 75 non-real estate corporations that own at least 20 percent properties, this paper empirically assesses and compares the pair-wise return, total risk, systematic risk and Jensen abnormal return performance of composite (with real estate) and hypothetical business (without real estate) firms. We employed Morgan Stanley Capital International world equity index instead of a local market index to provide some insights into the performance of the local market relative to the global market during the 1997–2001 volatile periods experienced by many Asian countries. Our results suggest the inclusion of real estate in a corporate portfolio appears to be associated with lower return, higher total risk, higher systematic risk and poorer abnormal return performance. It is therefore likely that non-real estate firms own properties for other reasons in addition to seeking improvement in their stock market performance. Further research is needed to explore the main factors contributing to corporate real estate ownership by non-real estate firms.     

Computing a Multivariate Normal Integral for Valuing Compound Real Options

We extend the Geske (1979) model to a multivariate normal integral for the valuation of a compound real option. We compared the computing speeds and errors of three numerical integration methods, namely, Drezner's improved Gauss quadrature method, Monte Carlo method and Lattice method, together with appropriate critical value finding methods. It is found that secant method for finding critical values combined with Lattice method and run by Fortran took merely one second, Monte Carlo method 120 seconds. It is also found that the real option decreases with interest rate, not necessarily positively correlated with volatility , a result different from that anticipated under financial option theory. This is mainly because the underlying of real option is a non-traded asset, which brings dividend-like yield into the formula of compound real options. Dividend-like yield rises with the multiplication of correlation coefficient and . High indicates the poor diversification advantage of the new investment project in relation to the existing market portfolio, and the value of real call option decreases with . Conversely, when is low, the proposed project provides better diversification advantage and the real call option rises with . Irrespective of the value of , when interest rate increases, the value of real call option drops, especially when is high, the value of the project is dominated by interest rate.     

What is the Truth About the Scale of Japanese Banks' Bad Debts? Is the Situation Manageable?

In January 1998, the Japanese Ministry of Finance (MoF, 1998) released figures which suggested that the Japanese banking industry';s bad debts might be as high as ¥77 trillion (since revised upward to ¥87.5 trillion, if cooperative-type institutions are included; Financial Supervisory Agency (FSA), 1998). This compared with the previous official estimate of ¥28 trillion. The revelation was designed to do three things: (1) to convince investors, at home and abroad, who had long suspected that the true level of bad debts was much higher than the authorities (and the banks) were willing to admit to, that the authorities were sincere in their quest to enhance disclosure by local financial intermediaries; (2) to stifle opposition to the government's plans to use up to ¥30 trillion (since increased to ¥60 trillion) of public funds to stabilize the financial system¹ by underlining the gravity of the situation facing the Japanese economy; and (3) to pave the way for the introduction of more transparent reporting by the banks in April 1998 when a regime of prompt corrective action (PCA)² was scheduled to commence. This article explains the evolution of bad debt disclosure by the Japanese banking industry and assesses the significance of the latest figures. In particular, it highlights the extent to which accounting forbearance has been, and continues to be, used to mask the true level of the banks' bad debts and refutes the claim that the industry's bad debt burden peaked in 1995. The banking industry's ability to handle the continuing bad debt problem, in the face of a significant impairment of economic capital and the market's relentless drive for full disclosure and transparency, also is assessed.     

On Transitory Earnings

The paper develops a concept of transitory earnings and contrasts this source of earnings to core (or recurring) earnings. It is shown that any two of the following three attributes of transitory earnings imply the third: (i) forecasting irrelevance with respect to next-period aggregate earnings, (ii) value irrelevance, and (iii) unpredictability. The paper makes the case that the current dirty surplus items make sense, especially if one expands the valuation perspective to also allow for agency considerations.