Commercial Mortgage Default: A Comparison of Logit with Radial Basis Function Networks

This article explores the use of artificial neural networks in the modeling of foreclosure of commercial mortgages. The study employs a large set of individual loan histories previously used in the literature of proportional hazard models on loan default. Radial basis function networks are trained (estimated) using the same input variables as those used in the logistic. The objective is to demonstrate the use of networks in forecasting mortgage default and to compare their performance with that of the logistic benchmark in terms of prediction accuracy. Neural networks are shown to be superior to the logistic in terms of discriminating between good and bad loans. The study performs sensitivity analysis on the average loan and offers suggestions on further improving prediction of defaulting loans.     

On the microstructure of price determination and information aggregation with sequential and asymmetric information arrival in an experimental asset market

Summary. Experiments were conducted on an asset with the structure of an option. The information of any individual is limited, as if only the direction of movement of the option value known for a single period without information of the value from when movement was initiated. However, if all information of all insiders were pooled, the value of the option would be known with certainty. The results are the following: (1) Information becomes aggregated in the prices as if fully informative rational expectations operated; and (2) The mechanism through which information gets into the market is captured by a path dependent process that we term The Fundamental Coordination Principle of Information Transfer in Competitive Markets. The early contracts tend to be initiated by insiders who tender limit orders. The emergence of bubbles and mirages in the markets are coincident with failures and circumstances that prevent the operation of the Fundamental Principle.The financial support of the national science foundation and the Caltech Laboratory for Experimental Economics and Political Science are gratefully acknowledged. The authors have benefited from helpful comments of David Grether, Kerry Back, Ivana Komunjer and Pete Kyle.     

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.     

Optimal Consumption Taxes and Social Security Under Tax Measurement Problems and Uncertainty

A representative individual lives for two periods; works when young and depends on savings and a government operated social security system when old—the returns on both sources of income, when old, are random. Due to administrative problems the returns to savings are observed with some measurement error. Two alternative consumption tax systems are considered; the Registered Asset Treatment (RAT) and the Non-Registered Asset Treatment (NRAT). The advantage of the RAT is that it can perform a social insurance role while the disadvantage is that it imposes measurement error risk. Correlation between the random return on saving and its measurement error can provide a risk-hedging role that can be further strengthened by the RAT version. The NRAT version neither provides social insurance nor imposes measurement error risk. Both tax systems hedge against the uncertainties in the social security system. The taxpayer engages in precautionary saving in response to future uncertainty.     

Interest-only and principal-only mortgage strips as interest-rate contingent claims

Interest-only (IO) and principal-only (PO) mortgage strips are valued in a stochastic interest-rate environment. The prepayment rate of the underlying mortgages is affected by two considerations not present in the pure financially rational model: (1) The property owner's holding period is assumed to follow a Gamma distribution, resulting in the possibility of prepayment due to the sale of the property (i.e., prepayment that is too early based on market interest rates); and (2) borrowers are assumed to face heterogeneous transaction costs related to refinancing the existing mortgage, and delay refinancing when market conditions make it optimal to do so (refinancing too late). Properties of IO/PO strips are identified by the finite difference method.     

On a Simple Econometric Approach for Utility-Based Asset Pricing Model

The Journal of Finance has published an important paper entitled A Simple Econometric Approach for Utility-Based Asset Pricing Model by Brown and Gibbon (1985). The main purpose of this paper is to extend the research of Brown and Gibbons (1985) and Karson, Cheng and Lee (1995) in estimating the relative risk aversion (RRA) parameter in utility-based asset pricing model. First, we review the distributions of RRA parameter estimate . Then, a new method to the distribution of is derived, and a Bayesian approach for the inference of is proposed. Finally, empirical results are presented by using market rate of return and riskless rate data during the period December 1925 through December 2001.     

Bid-ask bounce and speads in the foreign exchange futures market

This paper examines the intraday bid-ask bounce in Deutschemark and Japanese yen futures prices. The intraday Markovian bid-ask bounce process, which leads to a desirable equilibrium condition of reaching a bid or an ask transaction type with equal chances, is identified. A second-order Markov chain transition matrix model is used to derive a generalized estimator of bid-ask spreads in the foreign exchange futures market. It incorporates the conditional probabilities of a subsequent transaction being the same type as the current transaction's () and that of the next transaction being the same as the current type but different from the previous type (). The specification is {-Cov(P _t ,P _t+1 )/[(1–)(–)]}^1/2. The empirical results show that the average implied bid-ask spread is about $10, which is less than one tick's value of $12.50. It is also found that spreads are higher at the beginning and end of the trading day than the rest of the day, reflecting the uncertainty due to information flows and overnight inventory carrying costs, respectively.     

Getting the Unemployed Back to Work: The Role of Targeted Wage Subsidies

This paper examines alternative approaches to wage subsidy programmes. It does this in the context of a recent active labour market reform for the young unemployed in Britain. This New Deal reform and the characteristics of the target group are examined in detail. We discuss theoretical considerations, the existing empirical evidence and propose two strategies for evaluation. The first suggests an ex-post trend adjusted difference in difference estimator. The second, relates to a model based ex-ante evaluation. We present the conditions for each to provide a reliable evaluation and fit some of the crucial parameters using data from the British Labour Force Survey. We stress that the success of this type of labour market programmes hinge on dynamic aspects of the youth labour market, in particular the pay-off to experience and training.     

Government Deposit Insurance and the Diamond-Dybvig Model

The apparent banking market failure modeled by Diamond and Dybvig [1983] rests on their inconsistently applying their sequential servicing constraint to private banks but not to their government deposit insurance agency. Without this inconsistency, banks can provide optimal risk-sharing without tax-based deposit insurance, even when the number of type 1 agents is stochastic, by employing a contingent bonus contract. The threat of disintermediation noted by Jacklin [1987] in the nonstochastic case is still present but can be blocked by contractual trading restrictions. This article complements Wallace [1988], who considers an alternative resolution of this inconsistency.     

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.     

Short notes on Charlier's method for expansion of frequency functions in series

Abstract

1. In 1905 Charlier outlined some methods for the expansion of functions in series. ¹ C. V. L. Charlier, Über die Darstellung willkürlicher Funktionen (Meddelanden från Lunds Observatorium, Ser. I, nr 27). Particularly he was dealing with frequency functions, but the method has a more general application. As is well known there were two kinds of developments considered, namely in terms of the differentials and in terms of the differences of a conveniently chosen developing function. The outstanding examples are — respectively — the expansions of the so called types A and B. The difference series has later gained a special attention by its deduction being attached to the theory for generating functions. ² I. V. Uspensky, On Ch. Jordan's Series for Probability (Annals of Mathematics, Vol. 32, 1931). The true pivotal function in this respect seems, however, to be the moment generating function. In the following notes it will be shown that the differential series as well as difference series built up by the advancing and the central differences are obtainable in a similar way. By employing some convenient cumulants the different expansions can be written down compactly in symbolic forms which reveal their mutual formal relations. It will further be observed that Charlier's method of expansion is the inversion of a method indicated by Abel.     

The Market for Corporate Control and the Agency Paradigm

The paper analyzes the role of agency driven takeover activity. The analysis shows that takeovers can play an important role in reducing agency costs even though the gains from the corporate restructuring that follows the takeovers are zero, which counters existing models of agency driven takeover activity. The model can therefore form the basis for deriving empirical predictions which discriminate between the agency paradigm and the corporate restructuring paradigm of takeover activity. Negative post-merger performance (Agrawal et al., 1992), which is inconsistent with corporate restructuring is consistent with this model, and that takeover targets' investment levels are below or at the average (Servaes 1994), which is inconsistent with the free cash flow theory is also consistent with this model.     

Parallel cartoons of fractal models of finance

Summary. Having been crafted to welcome a new scientific journal, this paper looks forward but requires no special prerequisite. The argument builds on a technical wrinkle (used earlier but explained here fully for the first time), namely, the authors grid-bound variant of Brownian motion B(t). While B(t) itself is additive, this variant is a multiplicative recursive process the author calls a cartoon. Reliance on this and related cartoons allows a new perspicuous exposition of the various fractal/multifractal models for the variation of financial prices. These illustrations do not claim to represent reality in its full detail, but suffice to imitate and bring out its principal features, namely, long tailedness, long dependence, and clustering. The goal is to convince the reader that the fractals/multifractals are not an exotic technical nightmare that could be avoided. In fact, the authors models arose successively as proper, natural, and even unavoidable generalization of the Brownian motion model of price variation. Considered within the context of those generalizations, the original Brownian comes out as very special and narrowly constricted, while the fractal/multifractal models come out as nearly as simple and parsimonious as the Brownian. The cartoons are stylized recursive variants of the authors fractal/multifractal models, which are even more versatile and realistic.This revised version was published online in January 2005 with corrections to the Cover date.     

Ethnicity, Endogeneity, and Housing Tenure Choice

Home ownership rates for New Zealanders of European descent aged twenty five to fifty four are 16 percentage points higher than for Maori in the same age group. This article explores the relative attainment of home ownership of the two ethnic groups by estimating a series of tenure choice models and decomposing the difference in rates into endowment and residual effects. Particular attention is given to the endogeneity of current income and wealth relative to the tenure choice decision and to the methods for decomposing group mean differences. The article also applies more appropriate methods for estimating incomes and wealth than have been used in most previous studies of tenure choice. The study concludes that only a small proportion of differences in home ownership rates is explained by household endowments. It is shown that controlling for the endogeneity of income and wealth has a substantial impact on the tenure choice and decomposition results.     

Company investment announcements and the market value of the firm

This paper examines the stock market reaction to 402 company investment announcements made by UK companies during the 1991–1996 period. The market-adjusted abnormal returns are generally positive but small. Investment announcements are classified according to functional categories, and we find the level of abnormal returns to vary according to the type of capital investment being announced. In particular, we find the market to react more favourably to investments that ‘create’ future investment opportunities, than to investments which can be categorized as ‘exercising’ investment opportunities. The market reaction also varies with firm size, with large companies tending to experience smaller responses to announcements than do smaller firms. Chung et al. (1998 Chung, KH, Wright, P and Charoenwong, C. (1998). Investment opportunities and market reaction to capital expenditure decisions. Journal of Banking and Finance, 22: 41–60.  ) reported that the quality of a company's investment opportunities is the primary determinant of market reactions to capital expenditure decisions. The findings presented here lend some support to a role for investment opportunities in market valuations. Project size is also found to have a significant positive impact on the level of abnormal returns.     

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 Impact of Taxing Unemployment Insurance Benefits on Unemployment Duration and Post-unemployment Earnings

In 1979, unemployment insurance benefits became taxableincome for recipients with income above a specified threshold.Further legislation in 1982 lowered the income threshold. Thispaper uses the Continuous Wage and Benefit History (CWBH) database to evaluate the effects of the 1982 change on the compensatedduration of unemployment and post-unemployment earnings. The1982 episode is a particularly useful natural experimentbecause the treatment group (those newly subject to benefittaxation) is the middle income category and the two controlgroups (those whose benefits were already taxed and those whosebenefits still were not taxed) are the high and low income categories.If the two control groups show similar trends in unemploymentduration (or post-unemployment earnings) and the treatment groupshows a strikingly different pattern, this is compelling evidenceof a tax effect. The empirical results suggest that taxing unemploymentbenefits reduced the affected workers' mean compensated durationby more than a week, but did not have a statistically significanteffect on their post-unemployment earnings.     

Asymptotic analysis for optimal investment and consumption with transaction costs

We consider an agent who invests in a stock and a money market and consumes in order to maximize the utility of consumption over an infinite planning horizon in the presence of a proportional transaction cost . The utility function is of the form U(c) = c^1-p/(1-p) for p > 0, . We provide a heuristic and a rigorous derivation of the asymptotic expansion of the value function in powers of , and we also obtain asymptotic results on the boundary of the no-trade region.Received: July 2003, Mathematics Subject Classification (1991): 90A09, 60H30, 60G44JEL Classification: G13Work supported by the National Science Foundation under grants DMS-0103814 and DMS-0139911.