Synthetic Floating‐Rate Debt: An Example of an Asset‐Driven Liability Structure

An asset‐driven liability (ADL) structure is analogous to a liability‐driven investment (LDI) strategy. In both cases, the intent is to reduce the risk arising from a mismatch of assets and liabilities by aligning the interest rate sensitivity of cash flows on both sides of the balance sheet. Increasingly, defined‐benefit pension plans have adopted LDI strategies that reduce their equity assets and increase the average duration of their debt assets to better match the typical long duration of their retirement obligations to its employees. To illustrate the concept of ADL, the authors use the example of a corporate issue of traditional fixed‐rate debt that is transformed into synthetic floating‐rate debt using an interest rate swap (in which the corporation receives the fixed rate on the swap and pays at money market reference rate like three‐month LIBOR). The use of such long‐term, floating‐rate debt reduces interest rate risk when the firm has operating revenues that are positively correlated to the business cycle. However, a problem arises in that there is limited demand for such debt securities from institutional investors, many of which, because of LDI guidelines, prefer long‐term, fixed‐rate securities. Derivatives provide a way of resolving this mismatch between issuer and investor interests. In the article, the authors present a detailed example of the cash flows on the “receive‐fixed” interest rate swap (and its valuation for financial reporting) to show how the synthetic ADL debt structure obtains the desired outcome.     

Interest on bank reserves and optimal sweeping

A key rationale offered by the Federal Reserve for the payment of interest on reserves was to remove the incentive for banks to operate sweep accounts. Sweeping shifts funds from transactions deposits subject to reserve requirements to non-reservable deposits. This paper extends a conventional banking model to analyze sweeping behavior. Sweeping responds positively to increases in bank loan rates and reserve ratios and negatively to increases in the interest rate on reserves or exogenous increases in bank equity. Sweeping generates greater responsiveness in lending to changes in loan rates or the interest rate on reserves and lower responsiveness to changes in reserve ratios or equity than in its absence. Empirical analysis of an explicit condition that we derive suggests that, with an unchanged reserve requirement, the Fed could eliminate sweeping by setting the interest rate on reserves to no less than approximately 4% points below the market loan rate.     

Knowing one’s place: The distribution of new accounting academics into a segmented labor market

New academic accountants tend to believe that there is a singular academic labor market that will receive them as they approach the completion of their doctoral programs. In such a world, the caliber of their ideas would be judged according to their ability to make a contribution to the knowledge of discipline. However, past research suggests that a prestige structure exists for doctoral programs such that a candidate’s ability to be placed at a school is a function of his/her doctoral programs position in that hierarchy. In this world, limits exist upon possible placement for most candidates such that the caliber of their work will not be a determinative factor in their placement. Various divisions of the doctoral schools in accounting show that movement to higher groups is difficult for all groups. The higher-tier schools are more able to place their graduates in the same tier. Falls to lower tiers are especially likely for the graduates of the lower prestige groups of doctoral schools. This paper seeks to help participants in the labor market, doctoral candidates and those that hire them, obtain a more informed appreciation for their realistic prospects. In this way, an achievable expectation should lead to more efficient placement behavior.     

The usefulness of inaccurate models: Towards an understanding of the emergence of financial risk management

Is the growth of modern financial risk management a result of the accuracy and reliability of risk models? This paper argues that the remarkable success of today’s financial risk management methods should be attributed primarily to their communicative and organizational usefulness and less to the accuracy of the results they produced. This paper traces the intertwined historical paths of financial risk management and financial derivatives markets. Spanning from the late 1960s to the early 1990s, the paper analyses the social, political and organizational factors that underpinned the exponential success of one of today’s leading risk management methodologies, the applications based on the Black–Scholes–Merton options pricing model. Using primary documents and interviews, the paper shows how financial risk management became part of central market practices and gained reputation among the different organisational market participants (trading firms, the options clearinghouse and the securities regulator). Ultimately, the events in the aftermath of the market crash of October 1987 showed that the practical usefulness of financial risk management methods overshadowed the fact that when financial risk management was critically needed the risk model was inaccurate.     

THE EFFECT OF MARKET PROXY REBALANCING POLICIES ON DETECTING ABNORMAL PERFORMANCE

In this paper, effects on the measured abnormal performance of test portfolios are compared against market proxies having the same or different rebalancing policies. Results show that the common practice of comparing buy-and-hold test portfolios with equally weighted market proxies produces lower Jensen [ 7 ] alphas and lower alpha t-values. Comparing buy-and-hold test portfolios with value-weighted market proxies produces higher portfolio betas and alphas, but lower alpha t-values. Finally, comparing buy-and-hold test portfolios with buy-and-hold market proxies produces the most powerful tests of abnormal performance.     

The representation problem and the efficiency of the price mechanism

It is shown in this paper that the way in which an allocation is represented (net trades, final allocation, etc.) can affect the design of any realizing mechanism or incentive compatible system. The reason is that a poor choice of representation may be imposing superfluous conditions and demands upon the realizing mechanism. So, in this paper a technique is developed to (1) find the optimal representation of an allocation, and (2) to characterize the associated, realizing mechanisms. Although this approach is designed to be applied to any smooth economic model, it is illustrated and motivated here by applying it to the price mechanism. More specifically, there are assertions in the literature by Mount and Reiter and by Hurwicz that the price mechanism is informationally efficient over the class of Pareto seeking mechanisms. These proofs are incomplete because they consider only one choice of representation for the Pareto allocations. We use this technique to (a) reassert the dimensional efficiency of the price mechanism, (b) compare mechanisms for spaces of economics with and without externalities, (c) characterize for the space of quadratic functions the other dimensionally efficient allocation concepts, and (d) characterize those two agent economics where the price mechanism is dimensionally efficient.     

When Are Commercial Loans Secured?

We analyze the factors that influence the decision to secure a commercial loan. We find evidence that variables reflecting adverse selection, moral hazard, and the prospects for default all affect the likelihood a loan will be collateralized. We find no evidence in favor of the predictions of certain theoretical models that high‐quality firms signal by providing collateral. Our results also show that lenders with less risk protection in the form of equity capital are more likely to require collateral, but that banks themselves are less likely to secure loans than nonbanks. Certain loan characteristics also influence the collateralization decision.     

CHAOS AND COMPLEXITY IN ECONOMICS

Books reviewed in this article:
William A. Barnett, John Geweke and Karl Shell (eds) (1989) Economic Complexity: Chaos, Sunspots, Bubbles and Nonlinearity
W. A. Brock and A. G. Malliaris (1989) Differential Equations, Stability and Chaos in Dynamic Economics
Carl Chiarella (1990) The Elements of a Nonlinear Theory of Economic Dynamics
Tönu Puu (1989) Nonlinear Economics Dynamics
Kumaraswamy Velupillai (ed.) (1990) Nonlinear and Multisectoral Macrodynamics