Frictions, Heterogeneity and Optimality in Mortgage Modeling

The purpose of this article is to provide a unified framework for incorporating frictions into a theoretical options-pricing model (OPM) for mortgages. This article presents formulation for a frictions-adjustable mortgage model that integrates borrower heterogeneity while simultaneously preserving prepayment and default financial decisions. Our model demonstrates the flexibility of the OPM by simulating separate and concurrent effects of three categories of frictions on the mortgage and mortgage components. Researchers can use our example formulation to determine the effects of specific borrower characteristics on mortgage values without destroying the options theoretic framework.     

THE ROLE OF FINANCIAL RELATIONSHIPS IN THE HISTORY OF AMERICAN CORPORATE FINANCE

The American corporate financing system, unlike that of most other countries, has not been organized around a set of “universal banks” that perform a variety of functions for their clients. Indeed, the distinguishing feature of American financial history is the number and variety of financial intermediaries, and their relationships with corporations (and one another). Besides commercial banks, there are investment banks, insurance companies, venture capitalists, commercial paper dealers, mutual funds, and many others. The economic role of such intermediaries is to reduce market frictions such as “asymmetric information” and “agency problems” that otherwise raise the cost of outside capital for U.S. companies. This article views the changing menu of such intermediaries and their networks as the driving force behind the evolution of American corporate finance. U.S. financial history is seen as a series of institutional and financial innovations designed in large part to work around costly restrictions on relationships–particularly, limits on the scale and scope of U.S. banks–that do not exist in most other countries. In terms of its success in reducing the information and control costs of corporate finance, the history of the American financial system includes periods of significant progress as well as major reversals. Three relatively successful periods– the early 19th-century in New England, the “incipient” universal banking of the 1920s, and modernday financial capitalism–are separated by periods of drastic reductions in the menu of financial relationships– particularly the Great Depression and its 20-year aftermath. Besides new financial claims like preferred stock and new intermediaries such as venture capitalists, another important innovation is new forms of cooperation among intermediaries– especially among banks, venture capitalists, trusts, pensions, and investment banks–that have enabled the U.S. financial system to provide some of the key advantages of universal banking systems. Some of the largest U.S. commercial banks today can be viewed as positioning themselves to play a central coordinating role in these new coalitions of intermediaries. In so doing, they may become the platform for a distinctively American universal banking system.     

Financial acumen, women speculators, and the Royal African company during the South Sea bubble

Price bubbles provide a unique opportunity to study the financial acumen of shareholders. We focus on the 1720 South Sea episode as experienced by the Royal African Company whose stock was more speculative than other joint stocks. During 1720 the company had a new large stock issue. This paper examines the financial acumen of those women who traded senior and engrafted stock across 1720. We find that depending on the pricing regime, these women at worst broke even on their activities or had positive speculative gains. Our findings are consistent with a growing literature on the positive link between gender, capital gains and financial markets.     

How do investment patterns of independent and captive private equity funds differ? Evidence from Germany

Empirical literature emphasizes a positive contribution of private equity investors, which results from their combined provision of capital, monitoring, and management support. The aim of this study is to show that these previous results, which are based mostly on the analysis of US independent closed-end private equity funds, cannot be generalized since the private equity industry should not be treated as homogenous. We argue that it is necessary to distinguish between different types of private equity providers because their differing governance structures, strategic goals and experiences have a decisive influence on their value adding activities. The results of this study—which uses a data set of 179 German private equity-backed companies—are consistent with the conjecture that independent and corporate private equity providers tend to have a more pronounced role in corporate governance and monitoring of the companies they finance, than bank-dependent and governmental funds which often serve only as bridge investors.      

The Impact of Basel II on Lending to Small- and Medium-Sized Firms: A Regulatory Policy Assessment Based on Spanish Credit Register Data

The objective of this paper is to evaluate the impact on bank credit exposures to small- and medium-sized Spanish firms of the current proposal for reform of the 1988 Capital Accord using information from the Spanish Credit Register. Capital requirements for exposures to those firms, according to the various revisions of the proposed capital reform (from the January 2001 consultative document to the April 2003 one), are calculated to analyze whether the existing pattern of bank financing of small- and medium-sized firms might be altered. Finally, the incentives for individual banks to adopt the advanced internal ratings-based approach proposed by Basel II are evaluated.     

Automatic balancing mechanisms for notional defined contribution accounts in the presence of uncertainty

The notional defined contribution model combines pay-as-you-go financing and a defined contribution pension formula. This paper aims to demonstrate the extent to which liquidity and solvency indicators are affected by fluctuations in economic and demographic conditions and to explore the introduction of an automatic balancing mechanism (ABM) into the pension scheme. We demonstrate that the introduction of an ABM reduces the volatility of the buffer fund and that, in most cases, the automatic mechanism that re-establishes solvency produces the highest value of the risk-adjusted notional factor.     

Bank Competition with Financing and Savings Substitutes

This paper models the banking competition in loan and deposit markets on two levels. We measure the competition among different banks and among banks and non-bank financing and saving alternatives. We estimate a model of demand, cost, and market equilibrium equations for differentiated products by using data from the confidential reports that Spanish banks provide to the Bank of Spain during the period from 1988 to 2003. This database contains information on the effective interest rates on new loans and deposits, and the expected loan losses obtained from the Spanish Credit Register. The estimated price elasticities show that the products offered by different banks are close substitutes, which puts pressure on the banks’ profits margins. However, the substitutability between bank and non-bank products is much lower than the substitutability among products offered by different banks. The results also show that Spain’s entrance into the Eurozone did not cause a structural change in the demand and cost conditions of Spanish banks. The banks financed most of the imbalances between bank loans and domestic deposits before the crisis through the interbank market.     

Board of Directors and CSR in Banking: The Moderating Role of Bank Regulation and Investor Protection Strength

This paper brings together research on boards of directors as the backbone of corporate governance and corporate social responsibility (CSR) practices in the banking industry. The underlying idea is that some characteristics of bank boards, in particular independence and gender diversity, may impact the CSR commitments of banks. By making use of a sample of 159 banks in nine countries during the period 2004–2010, our empirical evidence suggests that banks with more independent directors and more female members on their boards incline toward socially responsible behaviour. Our results also suggest that institutional factors play a significant role in these effects. They show that in greater regulatory and stronger investor protection environments, board independence and gender diversity have more influence on the social behaviour of banks.     

Debt contracts in the presence of performance manipulation

Empirical evidence suggests that firms often manipulate reported numbers to avoid debt covenant violations. We study how a firm’s ability to manipulate reports affects the terms of its debt contracts and the resulting investment and manipulation decisions that the firm implements. Our model generates novel empirical predictions regarding the use and the level of debt covenant, the interest rate, the efficiency of investment decisions, and the likelihood of covenant violations. For example, the model predicts that the optimal debt contract for firms with relatively strong (weak) corporate governance (i.e., cost of manipulation) induces overinvestment (underinvestment). Moreover, for firms with strong (weak) corporate governance, an increase in corporate governance quality leads to tighter (looser) covenant, more (less) frequent covenant violations and lower (higher) interest rate. Our model highlights that the interest rate, which is a common proxy for the cost of debt, neither accounts for the distortion of investment efficiency nor the expected manipulation costs arising under debt financing. We propose a measure of cost of debt capital that accounts for these effects.     

Energy and CO2 emission relationships in the NAFTA trading bloc: a multi-regional multi-factor energy input–output approach

The North-America Free Trade Agreement (NAFTA) has brought together the economies of Canada, Mexico, and the US into forming one of the largest trading blocs worldwide (within the top CO₂ emitters). However, the current global protectionist discourse threatens the agreement. This paper analyzes the energy and energy-related CO₂ emission relationships between NAFTA countries in 2014 to gain insights into the climate change implications of current integration and the possible cancelation of the agreement. The analysis is performed with a multi-regional version of the multi-factor energy input–output model. The results show that NAFTA has not built a single integrated energy system, though it has helped reduce energy-related CO₂ emissions. Moreover, if NAFTA is not revoked, further integration would depend on the capacity of the Mexican energy sector to converge to the performance of its trade partners’ energy sectors. Conversely, a broken deal would induce negative environmental externalities.