Bias in an Empirical Approach to Determining Bond and Mortgage Risk Premiums

Empirical studies of bond and commercial mortgage performance often quantify a required risk premium by examining the difference between the promised yield and the realized yield as adjusted for default occurrence. These studies omit the effects of various other sources of risk, however, including collateral asset market risk, interest rate risk, and possibly call risk. These omissions downwardly bias the empirical risk premium estimate on the debt. In this paper, we disentangle and quantify the sources of this bias by modeling secured coupon debt (the commercial mortgage) as used in the calculation of a realized investment return. We consider deterministic and stochastic interest rate economies with mortgage contracts that are either noncallable or subject to a temporary prepayment lockout period. Given realistic parameter values associated with the term structure, underlying asset dynamics, and debt contracting, we show that the magnitude of the bias can be significant.     

IES 4 — Ethics Education Revisited

In 2003, the International Federation of Accountants (IFAC) issued a set of International Education Standards (IES). IES 4 Professional Values, Ethics and Attitudes aims to equip candidates for membership of an IFAC member body with the appropriate professional values, ethics and attitudes to function as professional accountants. This paper explores the implications of IES 4 and analyses some of the challenges arising from an international professional accounting body prescribing ethics education. It concludes with an overview of considerations to be addressed to ensure that the implementation of IES 4 is successful .     

Estimating the Tax Advantage of Corporate Debt

This paper presents estimates of the effective tax value of incremental interest deductions for corporations taking into account that they may not be able to utilize all their interest deductions fully because of either insufficient taxable income or the availability of nondebt tax shields. After describing particular features of the tax code which may drive a wedge between statutory and effective tax rates for debt finance, we present estimates using the Treasury Corporate Tax Model of effective tax rates for a variety of industry groupings. Our estimates suggest that the after-tax cost of debt varies widely across industries.     

Precautionary Saving of Chinese and U.S. Households

We employ a model of precautionary saving to study why household saving rates are high in China and low in the United States. The use of recursive preferences gives a convenient decomposition of saving into precautionary and nonprecautionary components. Over 80% of China's saving rate and nearly all U.S. saving arises from the precautionary motive. The difference between U.S. and Chinese household income growth rates is vastly more important than income risk for explaining the saving rates. The key mechanism is that precautionary savers have target wealth‐to‐income ratios, and rapid income growth necessitates high saving rates to maintain the ratio.     

“Time for a Change”: Loan Conditions and Bank Behavior when Firms Switch Banks

This paper studies loan conditions when firms switch banks. Recent theoretical work on bank–firm relationships motivates our matching models. The dynamic cycle of the loan rate that we uncover is as follows: a loan granted by a new (outside) bank carries a loan rate that is significantly lower than the rates on comparable new loans from the firm's current (inside) banks. The new bank initially decreases the loan rate further but eventually ratchets it up sharply. Other loan conditions follow a similar economically relevant pattern. This bank strategy is consistent with the existence of hold‐up costs in bank–firm relationships.     

Acquisition Targets and Motives in the Banking Industry

This paper uses a large sample of individual banking organizations, observed from 1996 to 2005, to investigate the characteristics that made them more likely to be acquired. We use a definition of acquisition that we consider preferable to that used in much of the previous literature, and we employ a competing-risk hazard model that reveals important differences that depend on the type of acquirer. Since interstate acquisitions became more numerous during this period, we also investigate differences in the determinants of acquisition between in-state and out-of-state acquirers. We also employ a subsample of publicly traded banking organizations to investigate the role of managerial ownership in explaining the likelihood of acquisition. The hypothesis that acquisitions serve to transfer resources from less efficient to more efficient uses receives substantial support from our results, as do a number of other relevant hypotheses.     

Learning to Wait: A Laboratory Investigation

Human subjects decide when to sink a fixed cost C to seize an irreversible investment opportunity whose value V is governed by Brownian motion. The optimal policy is to invest when V first crosses a threshold V * = (1 + w *) C , where the wait option premium w * depends on drift, volatility, and expiration hazard parameters. Subjects in the Low w * treatment on average invest at values quite close to optimum. Subjects in the two Medium and the High w * treatments invested at values below optimum, but with the predicted ordering, and values approached the optimum by the last block of 20 periods.