Knowledge that Transforms

Controversial econometric studies of mortgage data show that mortgage loan applications by some minorities are denied more frequently than are applications by whites with similar observable default risk factors. But recent evidence indicates that minority borrowers also default more frequently than whites with similar observable risk. This paper presents a simple equilibrium model of discriminatory credit rationing and finds parametric restrictions consistent with both these empirical findings. However, in this model, proposed antidiscrimination policies have surprising side effects. Thus, policy analysts accepting this empirical evidence should not expect to derive model-free conclusions about the effects of proposed policies. Journal of Economic Literature Classification Numbers: G21, G28, D63.

I show that dual trading reduces the net order flow and market depth. Trading volume and gross (of commission fees) profits of informed traders are lower with dual trading, while trading volume and gross losses of uninformed traders are unaffected. When the broker′s commission income is independent of the customer′s trading volume, the competitive commission fee is lower with dual trading. The utility of uninformed traders (net of commission fees) increases with dual trading, while the net profits of informed traders decrease. Journal of Economic Literature Classification Numbers: G12, G13, D82.

We develop an integrated model in which a risk-neutral informed trader optimally chooses any combination of a market buy, a market sell, a limit buy including the limit buy price, and a limit sell including the limit sell price. Limit orders undercut the market maker and generate transactions inside the bid-ask spread. The informed trader exploits limit orders by submitting market orders even when the terminal value is inside the spread. When the terminal value is above the bid, a combined market buy-limit sell is more profitable than a market buy only. We obtain an analytic solution. Journal of Economic Literature Classification Numbers: D40, D82, G12, G14.

Banks are modeled as Bryant/Diamond-Dybvig "insurers" against the risk of early consumption. Consumption claims must be verified by clearing and settlement. A clearinghouse does this efficiently as long as banks are sufficiently liquid. If liquidity requirements cannot be enforced against all banks then the threat of panics is necessary to induce banks to hold sufficient liquidity. If the clearinghouse can issue emergency currency, then banks can coexist with less liquid institutions. However, if banks′ return to holding reserves is low during "normal times," then there must be times when the return to liquidity is abnormally high. We associate these episodes with the panics of the National Banking Era. Journal of Economic Literature Classification Numbers: 042, 311, 314.

We contrast equilibria in loan markets with bilateral bank-borrower ties, in which proprietary technological knowledge of borrowers is not revealed to product market competitors, with equilibria under multilateral financing in which such knowledge may be shared among competing borrowing firms. Using each of these two institutional arrangements, we examine the conditions for existence of equilibrium, its ex ante optimality, and borrowing firms′ incentives to engage in private costly research. Also explored is the potential for lending banks to coordinate postinvention collusion in product markets by multiple inventing firms. Journal of Economic Literature Classification Numbers: 310, 312, 314.

This paper extends the standard single-period model of deposit insurance to a mutliperiod setting. It incorporates a variety of features describing bank and regulator behavior, such as endogenous capital adjustments and regulatory forbearance. Budgetary costs of deposit insurance are found using contingent claims techniques. We show how the market value of a bank′s net worth, a critical input of the model, can be estimated using accounting cash flow data and information from aggregate bank stock prices. Using Call Report data on U.S. commercial banks, we provide empirical estimates of the aggregate cost of deposit insurance under alternative regulatory policies. Journal of Economic Literature Classification Numbers: G13, G21, G28, H61.

We examine the financing and insurance policies of a firm with private information regarding its operating cash flows and insurance risk. When its insurable losses are small, the firm chooses either self-insurance or full insurance. It chooses self-insurance, it may display a preference for equity financing. However, if it chooses full insurance, it prefers debt financing. When the firm′s insurable losses are large, its insurance and financing decisions can signal its private information. While both debt and equity complement insurance decisions in signaling private information, debt facilitates signaling favorable information for a larger set of parameters. Journal of Economic Literature Classification Numbers: D82, G22, G32.

This paper examines the form of futures contracts which a monopolistic exchange will offer to maximise transaction revenue when transaction fees are endogenously determined. We establish the desirable characteristics of participants in contracts. For example, we show that contracts which appeal to hedgers on one side of the market and to speculators on the other are desirable. In contrast to earlier work, we show that the sequentially selected set of contracts may not be optimal. It may be desirable for the exchange to offer correlated contracts, or even to bundle several contracts together and sell the bundled contract at a fee lower than the fee charged for the set of contracts purchased separately. Journal of Economic Literature Classification Numbers: G13, G20.

Small- and medium-size, high quality, entrepreneurial firms may prefer bilateral to multilateral financing arrangements, in order to avoid disclosure of private information which might leak to competitors. In the presence of a cost differential between these forms of financing, the higher quality firms (those with more to lose from disclosure) prefer bilateral financing. The cost differential prevents competitors from unambiguously inferring that these firms are hiding information. Journal of Economic Literature Classification Numbers: D82, G21, G32, K22.

There is a common perception that many firms issue convertible debt as a form of delayed equity. The advantage of issuing equity in this delayed manner has been linked to the lower adverse selection properties of convertible debt as compared to equity; one can first issue convertibles and later call, forcing conversion, presumably preserving the initial advantage of the convertibles. However, this paper suggests that the benefits of callable convertible debt as delayed equity are preserved only if conversion is voluntary. This appears to be consistent with the empirical evidence. Journal of Economic Literature Classification Numbers: G32, D82.