The authors examine debenture yields over the period 1983-91 to evaluate the market's sensitivity to bank-specific risks and conclude that investors have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

I show that the effect of option introductions on underlying stock prices is best described by a two‐regime switching means model whose optimal switch date occurs in 1981. In accordance with previous studies, I find positive abnormal returns for options listed during 1973 to 1980. By contrast, I find negative abnormal returns for options listed in 1981 and later. Possible causes for this switch include the introduction of index options in 1982, the implementation of regulatory changes in 1981, and the possibility that options expedite the dissemination of negative information.

We examine the long‐term stock performance following dividend initiations and resumptions from 1927 to 1998. We show that postannouncement abnormal returns are significantly positive for equally weighted calendar time portfolios, but become insignificant when the portfolios are value weighted. Moreover, the equally weighted results are not robust across subsamples. We also document postannouncement reductions in the risk factor loadings of underlying stocks. Cross‐sectionally, these reductions are negatively related to the contemporaneous price drifts, suggesting the price drifts may be a sample‐specific result of chance. Our results underscore the importance of testing for changes in risk loadings in future long‐term event studies.

We examine debenture yields over the period 1983–1991 to evaluate the market's sensitivity to bank‐specific risks, and conclude that investors have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

Previous studies of bank subordinated debenture yields have detected scant evidence that market investors rationally price bank-specific default risks. However, investors' incentives to monitor their banks' true default risks have increased over the past decade, as federal regulators have removed the conjectural guarantees on subordinated debentures that were so prominent in the period following Continental Illinois' failure. By examining debenture yields over the period 1983-91, we demonstrate that subordinated debenture prices reflect accounting risk measures, and that the market's sensitivity to bank-specific risks has rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.