Optimal Hedging in Futures Markets with Multiple Delivery Specifications

Nearly all futures contracts allow delivery of any of several qualities of the underlying asset. Consequently, the price of the futures contract is associated more with the price of the expected cheapest deliverable variety than with the price of the par-delivery variety. The delivery specifications introduce a delivery risk for every hedger in the market. We derive the optimal hedging strategies in these markets. Their hedging effectiveness is evaluated for wheat futures contracts in Chicago. Hedging optimally would have significantly reduced the variance of the rates of return on hedges while yielding similar mean returns.     

Federal Deposit Insurance,Regulatory Policy,and Optimal Bank Capital*

This paper seeks to explain the combination of explicit and implicit pricing for deposit insurance employed by the FDIC. Essentially, the FDIC sells two products—insurance and regulation. To span the product space, it must and does set two prices. We argue that the need to establish regulatory disincentives to bank risk-taking is the heart of the controversy over the adequacy of bank capital and that the ability to close risky banks before exhausting their charter value (i.e., the value of their right to continue in business) stands at the center of these disincentives and in front of the FDIC's insurance reserves.     

The Term Structure of Real Rates and Expected Inflation

Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time‐varying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve in the United States is fairly flat around 1.3%. In one real rate regime, the real term structure is steeply downward sloping. An inflation risk premium that increases with maturity fully accounts for the generally upward sloping nominal term structure.     

Determinants of Mortgage Default and Consumer Credit Use: The Effects of Foreclosure Laws and Foreclosure Delays

The mortgage default decision is part of a complex household credit management problem. We examine how factors affecting mortgage default spill over to other credit markets. As home equity turns negative, homeowners default on mortgages and home equity lines of credit at higher rates, whereas they prioritize repaying credit cards and auto loans. Larger unused credit card limits intensify the preservation of credit cards over housing debt. Although mortgage nonrecourse statutes increase default on all types of housing debt, they reduce credit card defaults. Foreclosure delays increase default rates for housing and nonhousing debts. Our analysis highlights the interconnectedness of debt repayment decisions.     

Private Benefits of Control, Ownership, and the Cross-listing Decision

This paper investigates how a foreign firm's decision to cross-list on a U.S. stock exchange is related to the consumption of private benefits of control by its controlling shareholders. Theory has proposed that when private benefits are high, controlling shareholders are less likely to choose to cross-list in the United States because of constraints on the consumption of private benefits resulting from such listings. Using several proxies for private benefits related to the control and cash flow ownership rights of controlling shareholders, we find support for this hypothesis with a sample of more than 4,000 firms from 31 countries.     

An Economic Analysis of Interest Rate Swaps

Interest rate swaps, a financial innovation in recent years, are based upon the principle of comparative advantage. An interest rate swap is a useful tool for active liability management and for hedging against interest rate risk. The purpose of this paper is to provide a simple economic analysis of interest rate swaps. Alternative uses of and the appropriate valuation procedure for interest rate swaps are described.     

Government Popularity and the Economic Cycle

In June 1987 the Conservatives under Mrs. Thatcher were re-elected with a majority of over 100 seats against Labour. They received 42.3 per cent of the total vote, the size of the majority owing much to the significant number of votes received by third parties. But it is also believed that the Conservatives' share of the vote, unchanged from 1983, reflected the performance of the macro economy. In the four years of Mrs. Thatcher's second term, output rose more than 3 per cent a year and by the time of the election inflation was below 1 per cent, interest rates were under 10 per cent, and unemployment had come back below 3 million. If Mrs. Thatcher and her Cabinet colleagues had planned an economic strategy for the next four (or five) years in order to be in a strong position to win a fourth term of office, it might have included the following factors: output growth of 2–3 per cent a year; inflation staying around 1 per cent; interest rates of 10 per cent or thereabouts; unemployment down further from the near-3 million mark of June 1987. On our current forecast, that is, with the exception of output, the economic record of the Conservatives' third (Thatcher/Major) term. Yet the Conservatives have been running neck and neck with Labour in tile opinion polls and, barring unforeseen developments, the coming election will be extremely close, with the possibility still of either a small Conservative majority or a small Labour majority or even a hung Parliament. Why is it that, against the background of a similar economic performance in aggregate, the Conservatives have lost popularity? The arguments are complex and a full explanation would include the introduction of the community charge arid the fall of Mrs. Thatcher herself. But the economy is part of the explanation. The economic literature on Government popularity examines the state of a number of economic variables at the time of the election. At its most extreme, some believe that all a Government has to do to be re-elected is deliver a low mortgage rate in time for the election. Other analysts have explained Government popularity in a simple regression framework, with a lagged dependent variable to capture sluggish adjustment. A weakness of this research is that it implicitly believes all the Government has to do is to ‘get it right on the night’. As long as the economy falls into place by the time of the election, re-election is certain. This implies that the electorate both forgets and forgives, and is indifferent to the course of the economy in the previous three or four years. But it cannot be the case that the electorate evaluates only the average performance of the economy over the lifetime of a Parliament or even the most recent developments. As in any simple utility maximisation problem, it is not just the mean of the distribution that counts but also its variance. In other words the combination of late 1980s' boom and early 1990s' recession counts against the Government in a way that four or five years of steady progress would not have done. If this is correct, it may not be sufficient for the Government to deliver low inflation and interest rates and some recovery in output in time for the election; it may simply be that the electorate remains unforgiving of a five-year track record of boom and bust.     

Securities market response to pension fund termination*

Abstract. Capital market data are used to investigate the termination announcement effect of over- and underfunded corporate pension plans. Significant positive abnormal returns are initially observed for samples of both over- and underfunded plan terminations; however, after segmenting the samples on the basis of publicly available information regarding a firm's financial condition, significant returns are observed only for financially distressed subsamples. The evidence suggests that the property rights to pension fund assets and liabilities reside fully with the sponsoring firm, and that financially distressed firms may effect a wealth transfer to shareholders by fund termination. Résumé. Les auteurs utilisent les données relatives au marché financier pour analyser l'incidence des avis de discontinuation de régimes de retraite surcapitalisés et sous-capitalisés de sociétés. Des rendements positifs irréguliers importants sont d'abord observés pour des échantillons de cas de discontinuation de régimes surcapitalisés ainsi que sous-capitalisés; toutefois, après une segmentation des échantillons à partir de l'information mise à la disposition du public concernant la situation financière de la société, des rendements importants sont observés seulement pour les sous-échantillons de sociétés en difficulté financière. Les résultats donnent à penser que les éléments d'actif et de passif de la caisse de retraite échoient entièrement à la société promotrice et que les sociétés en difficulté financière peuvent procéder à un transfert de richesses au profit des actionnaires par voie de discontinuation du régime.     

Does Raising the Minimum Wage Help the Poor?*

What is the impact of raising the minimum wage on family incomes? Using data from the 1994–1995 to 2002–2003 Survey of Income and Housing, the characteristics of low-wage workers are analysed. Those who earn near-minimum wages are disproportionately female, unmarried and young, without postschool qualifications and overseas born. About one-third of near-minimum-wage workers are the sole worker in their household. Due to low labour force participation rates in the poorest households, minimum-wage workers are most likely to be in middle-income households. Under plausible parameters for the effect of minimum wages on hourly wages and employment, it appears unlikely that raising the minimum wage will significantly lower family income inequality.