Knowledge that Transforms

Term structure intermediation, in which institutions purchase assets and sell liabilities of different maturities, is analyzed theoretically and the results are applied to current policy issues. The theoretical model allows the identification of alternative reasons for mismatched portfolios, including risk-loving utility functions, interest rate forecasts that differ from the market's forward rates, and risk premia in the yield curve. The risk premia case appears empirically relevant, and intermediation in which lending is long (earning the risk premium) and borrowing is short (not paying a risk premium) may offset capital market imperfections. But such intermediation is also risky, creating a dilemma for bank regulators.

The paper presents a new measure to evaluate models which predict severe bank weakness or failure. The conventional measure has been the ‘percentage classified correctly (CC)’. This measure can be quite high even though a low percentage of weak or failed bank is classified correctly. We resolve this problem by weighting CC by two additional factors: (1) banks that actually weakened or failed as a percentage of those that fail a model's ‘hurdle test’, and (2) the percentage of all weak or failed banks correctly classified. The paper then compares the performance of several recently published early warning models using the new measure.

Recently a number of mathematical programming models have been developed to assist banks in their portfolio (balance sheet) management decision making. Generally, the model structures used may be classified as either linear, linear goal, or two-stage linear programming. Of these, linear programming models are the most common. The purpose of this paper is to discuss the optimal bank portfolio management solutions produced by each of the above programming structures. In addition, a new model structure, two-stage linear goal programming, is developed and compared to the other structures. From a decision-making perspective, this new model structure is found to provide additional useful information.