In a dynamic model of moral hazard, competition can undermine prudent bank behavior. While capital-requirement regulation can induce prudent behavior, the policy yields Pareto-inefficient outcomes. Capital requirements reduce gambling incentives by putting bank equity at risk. However, they also have a perverse effect of harming banks' franchise values, thus encouraging gambling. Pareto-efficient outcomes can be achieved by adding deposit-rate controls as a regulatory instrument, since they facilitate prudent investment by increasing franchise values. Even if deposit-rate ceilings are not binding on the equilibrium path, they may be useful in deterring gambling off the equilibrium path.

The Home Mortgage Disclosure Act was enacted to monitor minority and low-income access to the mortgage market. The data collected for this purpose show that minorities are more than twice as likely to be denied a mortgage as whites. Yet variables correlated with both race and creditworthiness were omitted from these data, making any conclusion about race's role in mortgage lending impossible. The Federal Reserve Bank of Boston collected additional variables important to the mortgage lending decision and found that race continued to play an important, though significantly diminished, role in the decision to grant a mortgage.

Since my recent article, which cast considerable doubt on the statistical estimation approach to the derivation of cost functions, I have been expecting a comment from proponents of that approach. Instead, I am pleasantly surprised to be replying to disciples of the process analysis approach. J. R. Marsden, D. E. Pingry, and A. Whinston (MPW) feel that a linear programming application of process analysis to petroleum refining has basically the same disadvantages as the statistical cost function technique, but that these could be overcome with the adoption of their particular approach. They propose a more general formulation utilizing non-linear programming techniques and allowing for nonconvex production technologies. Let us begin by considering their four objections to my application of process analysis to petroleunm refining. First, MPW assert that the test of the classical cost function assumptions (i.e., marginal costs slope upward and average costs are U-shaped) was not really a test at all but proceeded directly from the convexity assumptions of the linear programming model of the refinery. Certainly, the fixed capital process constraints imply a finite output and a rising marginal cost curve, but the relevant question is over what output range do marginal costs rise. MPW apparently feel that because of the convexity assumption marginal costs must necessarily rise over a broad output range. To demonstrate the error in their assertion, one need only examine some output range from b74) to b(n+l) over which the basis x* does not change. Since the basis is unchanged, the dual solution vector y* will similarly not change, thereby proving that short-run marginal costs (given by the jth element of y*) are constant over the given output range. As an example, Figure 1 of my paper illustrates a case where a basis change did not occur over the output range 8.4 to 8.9 MMB/D and marginal costs are constant. Furthermore, the dots in Figure 1, indicating basis changes, suggest that even after basis changes, marginal costs need not necessarily increase as the basis changes. Therefore, under this standard linear programming problem where the production processes are convex, short-run marginal costs can either rise in a step-wise manner or remain horizontal over the output range up to the full utilization of the capital stock at which point marginal costs become vertical. Either rising short-run marginal costs or an inverted L-shaped short-run marginal cost can be obtained assuming a standard convex production technology. Since the same result may be found in statistical cost studies (i.e., constant short-run marginal costs over the observed output range), the results in both Figures 1 and 2 indicating a rising marginal cost function over a broad output range certainly do not follow from the convexitv assumptions as MPW assert. Secondly, MPW are apparently disturbed because the short-run marginal cost function as drawn in Figure 1 does not change in a step function manner. They argue that the use of parametric programming would have revealed these steps and other useful information regarding capacity limitations. Contrary to MPW's assertion, parametric programming with UNIVAC's Omega package was utilized which reports the activities entering and exiting the basis at each basis change. As indicated in footnote 10, page 49, the particular parametrics option chosen does not report the complete solution vector at each basis change within the 6 increment to the output constraint bj, but rather reports the solution values for the first basis change * Department of economics, University of Pennsylvania and the University of Houston.

We document that governments whose local currency debt provides them with greater hedging benefits actually borrow more in foreign currency. We introduce two features into a government's debt portfolio choice problem to explain this finding: risk‐averse lenders and lack of monetary policy commitment. A government without commitment chooses excessively countercyclical inflation ex post, which leads risk‐averse lenders to require a risk premium ex ante. This makes local currency debt too expensive from the government's perspective and thereby discourages the government from borrowing in its own currency.

We propose regression‐based tests for mean‐variance spanning in the case where investors face market frictions such as short sales constraints and transaction costs. We test whether U.S. investors can extend their efficient set by investing in emerging markets when accounting for such frictions. For the period after the major liberalizations in the emerging markets, we find strong evidence for diversification benefits when market frictions are excluded, but this evidence disappears when investors face short sales constraints or small transaction costs. Although simulations suggest that there is a possible small‐sample bias, this bias appears to be too small to affect our conclusions.

This paper explains why some firms prefer to pay dividends rather than repurchase shares. When institutional investors are relatively less taxed than individual investors, dividends induce “ownership clientele” effects. Firms paying dividends attract relatively more institutions, which have a relative advantage in detecting high firm quality and in ensuring firms are well managed. The theory is consistent with some documented regularities, specifically both the presence and stickiness of dividends, and offers novel empirical implications, e.g., a prediction that it is the tax difference between institutions and retail investors that determines dividend payments, not the absolute tax payments.

Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) hypothesize that asset return volatility is a deterministic function of asset price and time, and develop a deterministic volatility function (DVF) option valuation model that has the potential of fitting the observed cross section of option prices exactly. Using S&P 500 options from June 1988 through December 1993, we examine the predictive and hedging performance of the DVF option valuation model and find it is no better than an ad hoc procedure that merely smooths Black–Scholes (1973) implied volatilities across exercise prices and times to expiration.

This book presents recent literature on corporate mergers, acquisitions, takeovers, restructuring, and corporate governance as well as discussions of valuation, cost of capital, and strategic financial planning.This book discusses how MA Boeing-McDonnell Douglas; Ciba-Geigy-Sandoz, Disney-Cap Cities-ABC, and Time Warner-Turner.