Knowledge that Transforms

This paper examines whether golden parachute adoptions in the banking industry during the eighties aligned the interests of CEOs with those of regulators and or shareholders. Our results provide evidence supporting concerns expressed by regulators: that boards of directors behaved opportunistically by adopting golden parachutes prior to large bank failures in order to exploit the FDIC guarantee. Parachute adoption was correlated with poor performance ex ante and ex post. Moreover, adoption of parachutes virtually ceased when the FDIC guarantee was withdrawn by FDICIA.

We first derive a one-state-variable partial differential equation, easy to implement, which characterizes the price of a European type Asian option. This result is explained and related to previous literature. We then derive new results on the hedging of an Asian option and propose analytical and numerical analysis on the comparison between Asian and European options. Our methodology which applies to “fixed-strike” Asian options as well as to “floating-strike” Asian options completes and clarifies various results in the literature. In this paper we focus on “backward-starting” Asian options. Our approach is quite general however, and we explain how to adapt our main results to the case of “forward-starting” Asian options.

In this paper we study the dynamic nature of the relationship between earnings and investment. If managers act as wealth maximizers, we would expect that new investments should lead to increased earnings. However, past research has found that investment is not causally prior to earnings. Using recent developments in time-series econometrics, we show that the dynamic nature of the relationship between earnings and investment exhibits bi-directional causality. Our results are consistent with managers investing in positive NPV projects, but managers appear to face financing constraints because investment decisions are driven by the availability of internally generated earnings.

Over the last decade, there has been considerable public debate in the U.S. on the need to maintain legal barriers (firewalls) between commercial and non-traditional banking. However, no theoretical model has yet been developed that examines the joint influence of various factors suggested, such as competition, production economies and regulatory subsidies that affect the bank's incentive to undertake non-traditional activities. This paper applies a stochastic control model to examine the joint effects of these factors on a bank's optimal investment decisions in non-traditional banking and develops some empirically testable hypotheses.

In this paper, we investigate the magnitude of the benefits from international diversification from the Nordic point of view. Special attention is paid to whether potentially increased co-movement of stock markets together with more volatile Nordic currencies have resulted in decreased benefits from international diversification towards the end of the 1980s. Moreover, the paper presents evidence on the benefits from international diversification for a currency which has recently started its free float, the Finnish markka (FIM). We find significant increases in stock market co-movement. Both unhedged ex ante strategies as well as strategies hedged for exchange rate risk are investigated, revealing substantial benefits from international diversification for the Nordic countries. However, we obtain mixed results concerning the question of the optimality of hedging.

This paper discusses seigniorage in an economy with imperfect competition in the banking sector. The amount of total seigniorage and its division between the central bank and the banking sector are derived by using the opportunity cost concept of seigniorage. The paper analyzes the impact of changes in inflation, reserve requirements, competition and technology on the division of seigniorage and on the welfare loss and relates the analysis to the concept of the optimal quantity of money.

This paper tests the hypothesis that banks with more risky loans and higher interest-rate risk exposure would select loan and deposit rates to achieve higher net interest margins. Call Report data for different size classes of banks for 1989–1993 show that the net interest margins of commercial banks reflect both default and interest-rate risk premia. The net interest margins of money-center banks are affected by default risk, but not by interest rate risk, which is consistent with their greater concentration in short-term assets and off-balance sheet (OBS) hedging instruments. By contrast, (super-) regional banking firms are sensitive to interest-rate risk but not to default risk. The data show that OBS activities promote a more diversified, margins-generating asset base than deposit- or equity-financing, and that cross-sectional differences in interest-rate risk and liquidity risk are related to differences in OBS exposure.

For many years, Government of Canada bonds with high coupons traded at much higher yields than those with lower coupons. This apparent market inefficiency virtually disappeared over a short period of time during 1993. Several events occurred in 1993 which relate to the narrowing of the spread. This paper shows the earlier yield spread to be consistent with restrictions on the trading of strip bonds. It also finds it difficult to defend the hypothesis that the higher yield spread represented unexploited profit opportunities.

We examine voluntary acquisitions of solvent stock-held thrift institutions since 1979, and find that bidding firms suffered losses, target firms gained, and the impact of the merger on the bidder-target pair was positive on average. During the post-FIR-REA period acquirers experienced smaller losses and targets experienced smaller gains relative to the pre-FIRREA period. An investigation into the motives of bidding firm management provides evidence indicating the presence of synergy, agency, and hubris motivations in the pre-FIRREA period. Although the acquisitions environment underwent substantial changes in the post-FIRREA period, we find no evidence of corresponding changes in acquisition motivations.

This paper develops a geometric methodology with which to analyze the no-arbitrage condition, with special reference to tax arbitrage in government bonds. Using this methodology, it is shown that a country's bond-issuing authority might be able to painlessly avoid market equilibria which is likely to induce tax arbitrage activities. The simple bond-issuing policy which will achieve this goal is identified, and its limitations are discussed. An examination of the Canadian and Israeli bond markets shows that adopting the prescribed bond-issuing policy does not meaningfully impinge on the bond-issuing authority's ability to sell bonds.