Knowledge that Transforms

This paper analyzes differences in borrower risk under alternative mortgage instruments and various borrower characteristics. The traditional approach of measuring borrower risk in terms of actual delinquency and foreclosure data is rejected in favor of a model based on potential delinquency‐that is, changes in the mortgage payment to income ratio. The combinations of mortgage terms and borrower characteristics that are most likely to produce a potential delinquency are isolated based on the calculation of hypothetical payment to income ratios over an eight year period.

In markets in which sellers know more about product quality than buyers, but cannot convey their superior information either by directly issuing costly signals of the Spence type or by successfully funding the production of information, I suggest another way in which the informational asymmetry problem can be resolved; a third party can produce the necessary information at a cost and use it to price a service consumed by the sellers. Buyers can then observe a seller's choice of service consumption level and be well informed in equilibrium. In this framework I construct a model in which a borrower's choice of insurance coverage signals its default probability to lenders, and explore the properties of the resulting signalling equilibrium in a variety of cases.

Do new issues of seasoned securities cause significant price movements in the neighborhood of the issue day? This paper presents an empirical comparison of three competing hypotheses: the SEC view that a new issue causes a permanent price decline; the underwriter view that there is only a temporary price decline during the distribution period; and the efficient market hypothesis (EMH) that implies the absence of any price effects. Several empirical tests of the competing hypotheses using data on new issues of utility stocks traded on the NYSE reject the SEC and underwriter views in favor of the EMH.

Single period and dynamic valuation models in continuous time, under certainty and uncertainty, are developed for a property‐liability insurance contract to determine the “fair” (competitive) premium and underwriting profit. The intertemporal stochastic model assumes that the claim frequency and the price index of claim settlements are functions of a set of underlying state variables which follow a multivariate Wiener process. The competitive premium is shown to be proportional to the claim frequency and the price index for claim settlements at the time the policy is issued. The factor of proportionality varies directly with the claim settlement rate and the length of coverage, and inversely with the risk‐adjusted real interest rate on the dollar‐valued claim rate.

When investment opportunities arrive one at a time and are reviewed sequentially, a corporation's optimal policy differs from a standard net present value rule if the corporation exercises control over an industry state variable and control is costly. The first condition presupposes a degree of market power for the firm; the second occurs if corporate investment decisions are imperfectly reversible. To address the problem of optimal investment in this context, a firm's investment decisions are modeled as a Markov reward process. The causes of economic irreversibility are discussed and general propositions concerning the optimal investment policy are derived. These propositions are then applied to the optimization of an exploration program by an oligopolistic firm (a price leader). Under particular demand and distributional assumptions, solutions for the optimal decision rule and the value of the exploration program are obtained and their properties examined.