Competitive viability in banking : Scale, scope, and product mix economies

Conventional scale and scope economies are inadequate to determine the competitive viability of banks that vary in scale and product mix simultaneously. This paper develops two new and more general measures of multi-product economies. Slight diseconomies of scale and product mix are found for banks, usually on the order of 1 to 3 percent, which may be due to demand-side influences. These are robust to differing cost and output specifications, organizational levels, and competitive environments. These results differ from other banking studies that found scope economies, a conflict that may be due to methodological difficulties.     

DIRECT LABOUR COST ALLOCATION FOR A MULTI-PRODUCT HOSPITAL LAUNDRY

This paper discusses the application of correlation and regression methods to the analysis of productivity and allocation of costs in a laundry serving several hospitals, with several types of laundry being processed in the same production line. In particular, it is shown how the methods can be used to allocate the direct labour costs between the types of laundry. Analysis of residuals also permits investigation of temporal and product mix effects upon productivity. The regression paradox is discussed in relation to this problem, and it is shown that productivity is not a uniquely defined concept, because there is a difference between production being predicted from labour input and labour input being predicted from required production. Potential application of the model to other multi-product processes is discussed.     

Revenue and expenditure variance analyses for local governments

Managerial accounting techniques do not appear to be widely applied to local governmental units by accounting educators. This article explains how variance analysis procedures used in the private sector can be modified for analysis of governmental operations to identify the components contributing to changes in actual revenues or expenditures from year to year. Specifically, changes in funding levels due to inflation, population and funding decisions are isolated. The changes due to funding decisions are desegregated further to determine the extent of shifts in funds and the proportional share of the remaining increase or decrease in funds. This latter “shift and share” component of the analyses (similar to mix variance computations) can more clearly identify the funding emphasis of the local political unit.     

Mechanisms for improving reliability and reducing risk by stochastic and deterministic separation

The paper provides for the first time a comprehensive introduction into the mechanisms through which the method of separation achieves risk reduction and into the ways it can be implemented in engineering designs. The concept stochastic separation of critical random events on a time interval, which consists of guaranteeing with a specified probability a specified degree of distancing between the random events, is introduced. Efficient methods for providing stochastic separation by reducing the duration times of overlapping critical random events on a time interval are presented. The paper shows that the probability of overlapping of critical events, randomly appearing on a time interval, is practically insensitive to the distribution of their duration times and to the variance of the duration times as long as the mean of the duration times remains the same. A rigorous proof is presented that this statement is valid even for two random events on a time interval. The paper also provides insight into various mechanisms through which deterministic separation improves reliability and reduces risk. It is demonstrated that the separation on properties is an efficient technique for compensating the drawbacks associated with homogeneous properties. It is demonstrated that improving reliability by including redundancy, improving reliability by segmentation and some of the deliberate weak link techniques and stress limiters techniques for reducing risk are effectively special cases of a deterministic separation. Finally, the paper demonstrates that in a number of cases, the way to extract benefit from the method of separation is to build and analyse a mathematical model based on the method of separation. A comprehensive classification of the discussed methods for stochastic and deterministic separation is also presented.     

Market share and market size variances in a multi-product environment: An evaluation of competing formulations

Market share and market size variances are typically included in cost and managerial accounting texts in the discussion on sales variances. Shank and Churchill (1977) introduced a widely-adopted methodology wherein these variances are equal to the sales quantity variance, with the sales mix variance accounting for the entire variation in sales mix. Hirsch (1988) treats multiple products differently than Shank and Churchill (1977) and offers an alternative formulation for analyzing market share and market size variances. This paper compares the two variance formulations and demonstrates that the market share and market size variances under the Hirsch formulation more realistically reflect changes in market share and market size. As a result, the variances under the Hirsch formulation are more useful for managerial decision-making.     

Risk invariant linear estimation

Abstract

We show how to construct risk invariant (equalizer) linear estimators in credibility models, when the variance components are unknown but constrained by linear equations. Risk invariant linear estimators will often be minimax and admissible. They are useful in situations with unidentifiable variance components, but may also be used when reliable estimates of the variance components are not available.     

On market price of risk in Asian capital markets around the Asian flu

This study investigates a contemporaneous relationship between realized market risk premia, and conditional variance and covariance in nine Asian markets and the US. The time period for this study is before, during, and after the Asian financial crisis. A contemporaneous state-dependent capital asset pricing model (CAPM) that allows for negative and positive market prices of variance and covariance risk is investigated. In the light of significant upstate and downstate reward to local and world variance risk for all markets and all periods, we conclude that a market return-generating process is a piecewise function of local and world variance over time. Furthermore, a cross-sectional analysis of upstate and downstate market prices of variance and covariance risk indicates that reward to risk is a mix of reward to local and world variance, depending on the ever-changing correlation with the world market. Our findings are consistent with the one-factor conditional international CAPM.     

Assessing competition in the banking industry: A multi-product approach

This paper investigates the competitive aspects of multi-product banking operations. Extending Panzar and Rosse’s (1987) model to the case of a multi-product banking firm, we show that higher economies of scope in multi-product banking are associated with lower Panzar–Rosse measures of competition in the banking sector. To test this empirical implication and determine the impact of multi-production on market power, we use a new dataset on the Brazilian banking industry. Consistent with our theoretical prediction, we find that banks that offer classic banking products (i.e., loans and credit cards) and other banking products (i.e., brokerage services, insurance and capitalization bonds) have substantially higher market power than banks that offer only classic products. These results suggest a positive bias in the traditional estimates of competition in which multi-output actions are not considered.     

Pricing Warrants: An Empirical Study of the Black-Scholes Model and Its Alternatives

This paper uses a sample of over 25,000 daily warrant prices to empirically investigate potential problems with the commonly used warrant pricing model proposed by Black and Scholes as an extension of their call option model. One problem seems to be especially important: the constant variance assumption of the dilution adjusted Black-Scholes model appears to cause biases in model prices for almost all warrants and over the entire sample period. We show that more accurate price forecasts are obtained with a specific form of the constant elasticity of variance model.     

Adaptive basket liquidation

We consider the infinite-horizon optimal basket portfolio liquidation problem for a von Neumann–Morgenstern investor in a multi-asset extension of the liquidity model of Almgren (Appl. Math. Finance 10:1–18, 2003) with cross-asset impact. Using a stochastic control approach, we establish a “separation theorem”: the sequence of portfolios held during an optimal liquidation depends only on the (co-)variance and (cross-asset) market impact of the assets, while the speed with which these portfolios are reached depends only on the utility function of the trader. We derive partial differential equations for both the sequence of portfolios reached during the execution and the trading speed.     

Cash-flow or return predictability at long horizons? The case of earnings yield

We examine the predictive ability of the aggregate earnings yield for both market returns and earnings growth by estimating variance decompositions at multiple horizons. Based on weighted long-horizon regressions, we find that most of the variation in the earnings yield is due to return predictability, with earnings growth predictability assuming a minor role. However, by using implied estimates from a first-order restricted VAR, we find an opposite predictability mix. The inconsistency in results stems from a misspecification of the restricted VAR. Using an unrestricted first-order VAR estimated by OLS, or alternatively, estimating the restricted VAR by the Projection Minimum Distance method, produces long-run variance decompositions that are substantially more similar to the decomposition obtained under the direct method. Hence, earnings yield is not fundamentally different from the dividend yield. These results suggest that the practice of analyzing long-run return and cash-flow predictability from a restricted VAR can be quite misleading.     

Making behavioral science more useful

Universal theories do not always fit the situation in which they are used, and management practice is no exception. In fact, the difficulty in applying such behavioral science theories has been the interpretation that they are applicable to all situations. This author asks managers and academics alike to recognize that the easy way does not always work, that more theories should be developed to fit different situations, and that staffs should be educated in the theories and techniques that are available.     

Scale and scope economies in the multi-product banking firm

The multi-product nature of the banking firm is examined utilizing the translog cost function. This analysis indicates that, contrary to conventional wisdom, natural monopoly, scale economies and product-specific decreasing costs are not robust characterizations of the banking industry. There is, however, evidence that the cost function is characterized by economies of scope. The implications of these results are discussed and extensions of this approach suggested.     

MULTIPRODUCT C-V-P ANALYSIS AND UNCERTAINTY: A LINEAR PROGRAMMING APPROACH

The most general extension of the traditional one product C-V-P model incor- porates a multiproduct setting under uncertainty. This study utilizes LP to address both components (product mix and uncertainty of resource prices) to obtain the best product mix available in an ex ante sense. The results provide a benchmark for the evaluation of future operations and enable one to calculate the probability of any level of contribution margin. The study also serves as a useful educational tool by providing a mathematical and graphical depiction of the complexity of the problem, and by explicitly demonstrating the role of uncertain resource costs and uncertain selling prices in a simple LP formulation.     

A Case Study of a Variance Analysis Framework for Managing Distribution Costs*

Managing the distribution function as part of an overall supply‐chain management strategy has become increasingly important given rising fuel costs in recent years. This paper presents a comprehensive variance analysis framework developed by supply‐chain managers at Catalyst Paper Corporation as a tool for reporting and controlling distribution costs. The model decomposes the overall static‐budget variance into four primary variance categories: volume, customer mix, distribution mix, and carrier charges. The framework addresses key limitations in the coverage of variance analysis contained in many management accounting textbooks. Specifically, Catalyst's framework incorporates: (a) mix variance calculations where there is more than one mix factor within a single cost element; (b) the impact of unplanned and unrealized activities; and (c) multiple nested mix variance calculations. Although developed in the context of distribution costs, the framework can be applied to the analysis of other manufacturing and non‐manufacturing costs where multiple mix factors exist. L'importance de la gestion de la fonction de distribution dans le cadre de la stratégie globale de gestion de la chaîne d'approvisionnement s'est accrue avec la hausse des coûts du carburant des dernières années. Les auteurs présentent un cadre complet d'analyse des écarts, élaboré par les gestionnaires de la chaîne d'approvisionnement chez Catalyst Paper Corporation aux fins de la présentation et du contrôle des coûts de distribution. Le modèle décompose l'écart global du budget fixe en quatre grandes catégories d'écarts: les écarts sur volume, les écarts sur composition de la clientèle, les écarts sur composition de la distribution et les écarts sur frais de transport. Le cadre résout les principales limites de la couverture de l'analyse des écarts évoquées dans de nombreux manuels de comptabilité de management. Le cadre d'analyse de Catalyst Paper Corporation englobe: a) les calculs de l'écart sur composition lorsqu'il existe plus d'un facteur de composition dans un même élément de coût; b) l'incidence des activités non planifiées et non réalisées; et c) les calculs de l'écart sur composition à multiples critères de classification. Bien qu'il ait été élaboré dans le contexte des coûts de distribution, ce cadre peut être appliqué à l'analyse d'autres coûts liés ou non à la fabrication, lorsque les facteurs de composition sont multiples.     

Optimal investment strategies for general utilities under dynamic elasticity of variance models

This paper studies the optimal investment strategies under the dynamic elasticity of variance (DEV) model which maximize the expected utility of terminal wealth. The DEV model is an extension of the constant elasticity of variance model, in which the volatility term is a power function of stock prices with the power being a nonparametric time function. It is not possible to find the explicit solution to the utility maximization problem under the DEV model. In this paper, a dual-control Monte-Carlo method is developed to compute the optimal investment strategies for a variety of utility functions, including power, non-hyperbolic absolute risk aversion and symmetric asymptotic hyperbolic absolute risk aversion utilities. Numerical examples show that this dual-control Monte-Carlo method is quite efficient.     

HOW SHOULD PENSION FUNDS MANAGE RISK?

Despite recent advances in risk management techniques, pension funds are still struggling with the concept of risk and with the practical challenges of managing and measuring it in useful ways. This article addresses this problem by showing that pension fund managers must manage two types of risk that affect a pension fund balance sheet's funded ratio. The most important of the two is asset policy risk, which arises from the choice of an asset mix policy that does not match the accrued pension liabilities. The other risk results from the decision to implement the chosen asset mix using active rather than passive management strategies.
This article shows how both types of risk can be measured and managed through an adapted value at risk (VAR) metric: the funded ratio VAR. A study of the performance of 98 pension funds during the period 1992–1995 shows that the funds were adequately compensated, on average, for taking on the policy risk, but not for implementation risk.     

Conditional Value-at-Risk,spectral risk measures and (non-)diversification in portfolio selection problems – A comparison with mean–variance analysis

We study portfolio selection under Conditional Value-at-Risk and, as its natural extension, spectral risk measures, and compare it with traditional mean–variance analysis. Unlike the previous literature that considers an investor’s mean-spectral risk preferences for the choice of optimal portfolios only implicitly, we explicitly model these preferences in the form of a so-called spectral utility function. Within this more general framework, spectral risk measures tend towards corner solutions. If a risk free asset exists, diversification is never optimal. Similarly, without a risk free asset, only limited diversification is obtained. The reason is that spectral risk measures are based on a regulatory concept of diversification that differs fundamentally from the reward-risk tradeoff underlying the mean–variance framework.     

Asymptotic Expansion Formula of Option Price Under Multifactor Heston Model

The stochastic volatility model of Heston (Rev Financ Stud 6(2):327–343, 1993) has found difficulty in describing some of the important features of implied volatility dynamics, leading to a quest for multifactor extensions as well as the incorporation of time-dependent model parameters. In this paper, an asymptotic expansion approach to the multifactor Heston model with time-dependent parameters is developed. The results of Benhamou et al. (SIAM J Financ Math 1(1):289–325, 2010) are extended and it is shown that the extension to the multifactor model involves an extra expansion term that captures the interaction between variance factors. The expansion formula under constant parameters can be explicitly computed and the incorporation of time-dependent parameters is straightforward under the framework. As illustration, a two-factor model is calibrated to data of index options and variance swaps and it is found that it is possible to distinguish a short-term and long-term variance factor from the implied volatility surface and variance swap rates. Moreover, the two-factor model is able to reproduce the shapes of the implied volatility surface during various market scenarios.     

Banking technology and the existence of a consistent output aggregate

This paper addresses the question of the existence of a consistent output aggregate in banking. Specific, necessary and sufficient conditions for output aggregation are developed and tested in the context of a second-order approximation to any arbitrary multi-product bank cost function. The analysis provides evidence that a composite (aggregate) measure of output fails to provide a proper representation of banking technology and therefore previous studies that used aggregate output measures may well be subject to specification errors.