DSpace Collection: Financial Institutions

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Who You Know Matters: Venture Capital Networks and Investment Performance

Tue, 07 Dec 2004 22:58:59 GMT

Title: Who You Know Matters: Venture Capital Networks and Investment Performance

Hochberg, Yael; Ljungqvist, Alexander; Lu, Yang

Abstract: Many financial markets are characterized by strong relationships andnetworks, rather than arm’s-length, spot-market transactions. Weexamine the performance consequences of this organizational choice inthe context of relationships established when VCs syndicate portfoliocompany investments, using a comprehensive sample of U.S. based VCs overthe period 1980 to 2003. VC funds whose parent firms enjoy moreinfluential network positions have significantly better performance, asmeasured by the proportion of portfolio company investments that aresuccessfully exited through an initial public offering or a sale toanother company. Similarly, the portfolio companies of better networkedVC firms are significantly more likely to survive to subsequent roundsof financing and to eventual exit. The magnitude of these effects iseconomically large, and is robust to a wide range of specifications. Ourmodels suggest that the benefits of being associated with awell-connected VC are more pronounced in later funding rounds. Once wecontrol for network effects in our models of fund and portfolio companyperformance, the importance of how much investment experience a VC hasis reduced, and in some specifications, eliminated.

What Constitutes Appropriate Disclosure for a Financial Conglomerate?

Thu, 21 Nov 2002 22:58:59 GMT

Title: What Constitutes Appropriate Disclosure for a Financial Conglomerate?

White, Lawrence J.

Abstract: This paper addresses the disclosure issues for financial conglomeratesprincipally from the same perspective as that of the Basel Committee onBanking Supervision: that disclosure is important for the safety andsoundness of banks. However, we reach substantially differentconclusions with respect to three important disclosure issues: the roleof market value accounting; the frequency of disclosures; and the roleof subordinated debt. We start by asking why any special disclosuremight be required for financial conglomerates. This question immediatelyleads to a discussion of what is special about financial conglomerates.We also address the question of, "Disclosure to whom?" Thereare at least two potential audiences for information disclosures:financial regulators; and the public investors/creditors/customers of afinancial conglomerate. Issues of the appropriate structure for afinancial conglomerate, and the information revelation that shouldaccompany that structure, are also raised. Finally, we return to thetitle topic: What constitutes appropriate disclosure for a financialconglomerate. Unfortunately, by turning its back on the three mostimportant steps that could be taken to improve information disclosure --mandating market value accounting (MVA) for banks' reports toregulators, aiming toward daily submission of these reports, andrequiring the issuance of subordinated debt -- the Basel Committee hasfundamentally undermined its efforts to enhance banks' safety and soundness.

Venture Capital Contracts and Market Structure

Sat, 29 Dec 2001 22:58:59 GMT

Title: Venture Capital Contracts and Market Structure

Inderst, Roman; Mueller, Holger M.

Abstract: We examine the relation between optimal venture capital contracts andthe supply and demand for venture capital. Both the composition and typeof financial claims held by the venture capitalist and entrepreneurdepend on the market structure. Moreover, dierent market structuresinvolve dierent optimal forms of transferring utility: sometimes it isoptimal to transfer utility via equity stakes, sometimes it is optimalto use debt. Transferring utility via equity stakes affects incentives.Consequently, the net value created, the success probability, the market(or IPO) value, and the performance of venture-capital backedinvestments all depend on the supply and demand for capital. Similarly,venture capitalists face dierent incentives to screen projects ex anteif the capital supply is low or high. We then endogenize the capitalsupply and study the relation between venture capital contracts andentry costs, public policy, investment profitability, and markettransparency. Finally, we show that entry by inexperienced investorscreates a negative externality for the value creation in venturesfinanced by (regular) venture capitalists.

The Savings and Loan Debacle: A Perspective from the Early Twenty-First Century

Tue, 31 Dec 2002 22:58:59 GMT

Title: The Savings and Loan Debacle: A Perspective from the Early Twenty-First Century

White, Lawrence J.

The Role of Banks in Takeovers

Wed, 29 Dec 2004 22:58:59 GMT

Title: The Role of Banks in Takeovers

Ivashina, Victoria; Nair, Vinay B.; Saunders, Anthony; Massoud, Nadia Ziad

Abstract: To transfer loans from one debtor to another debtor, banks mighttransmit borrower information which is collected in the lending processto potential acquirers. In this paper, we investigate the importance ofbanks in the effectiveness of the takeover mechanism and hence incorporate governance. Using unsolicited takeovers between 1992 and 2003,we find that bank lending intensity and bank client network (the numberof firms that the bank deals with) have a significant and positiveeffect on the probability of a borrower firm becoming a target. We findthat this effect is enhanced in cases where the target and acquirer havea relationship with the same bank and is robust to the inclusion ofseveral firm characteristics including the presence of large externalshareholders. Moreover, takeover completion rates are positively relatedto bank lending intensity. Finally, we find that the equity market viewstakeovers where the target and the acquirer deal with the same bank morepositively relative to takeovers with no bank involvement. Overall, theevidence supports the view that banks increase the disciplining role ofthe market for corporate control.

The Role of Bank Advisors in Mergers and Acquisitions

Wed, 28 Nov 2001 22:58:59 GMT

Title: The Role of Bank Advisors in Mergers and Acquisitions

Allen, Linda; Jagtiani, Julapa; Peristiani, Stavros; Saunders, Anthony

Abstract: This paper looks at the role of commercial banks and investment banks asfinancial advisors. Unlike some areas of investment banking, commercialbanks have always been allowed to compete directly with traditionalinvestment banks in this area. In their role as lenders and advisors,banks can be viewed as serving a certification function. However, banksacting as both lenders and advisors face a potential conflict ofinterest that may mitigate or offset any certification effect. Overall,we find evidence of the certification effect for target firms, butconflicts of interest for acquirers. In particular, the target earnshigher abnormal returns when the target's own bank certifies the (moreinformationally opaque) target's value to the acquirer. In contrast, wefind no certification role for acquirers. This may be due to tworeasons. First, certification plays less of a role for acquirers becauseit is the target firm that must be priced in a merger. Second, acquirerspredominantly utilize commercial bank advisors in order to obtain accessto bank loans that may be used to finance the post-merger transitionperiod. Thus, we find that acquirers tend to choose their own banks(those with prior lending relationships to the acquirer) as advisors inmergers. However, this choice weakens any certification effect andcreates a potential conflict of interest because the acquirer's advisornegotiates the terms of both the merger transaction and future loancommitments. Moreover, the advisor's merger advice may be distorted byconsiderations related to the bank's credit exposure resulting from bothpast and future lending activity. The market prices these conflicts ofinterest; we find significantly negative abnormal returns for bankadvisors when they advise their own loan customers in acquiring other firms.

The New Economy and Banks and Financial Institutions

Tue, 31 Dec 2002 22:58:59 GMT

Title: The New Economy and Banks and Financial Institutions

White, Lawrence J.

The Long-Run Behavior of Debt and Equity Underwriting Spreads

Tue, 31 Dec 2002 22:58:59 GMT

Title: The Long-Run Behavior of Debt and Equity Underwriting Spreads

Kim, Dongcheol; Palia, Darius; Saunders, Anthony

Abstract: This paper is the first to look at the long-run (30-year) behavior ofunderwriting spreads in the markets for corporate equity and debt.Specifically, we analyze the determinants of underwriting spreads oncorporate bond issues, secondary equity offerings and initial publicofferings over the period 1970-2000. We explain the time-varyingcross-sectional behavior of these spreads by analyzing three sets ofvariables or factors: macro (systematic) factors, investment bankingmarket structure factors and issuer specific characteristics. We alsoanalyze the relationship between the direct costs (underwriting spreads)and indirect costs (underpricing) of new issues. Among our many resultswe find an apparent decline in spreads over time, an increasedclustering in spreads for both IPOs and SEOs, the dominance of issuer-specific characteristics in explaining spreads, and a relatively weaklinkage between the direct and indirect costs of issuance.

The Link between Default and Recovery Rates: Theory, Empirical Evidence and Implications

Wed, 26 Feb 2003 22:58:59 GMT

Title: The Link between Default and Recovery Rates: Theory, Empirical Evidenceand Implications

Altman, Edward I.; Brady, Brooks; Resti, Andrea; Sironi, Andrea

Abstract: This paper analyzes the association between aggregate default andrecovery rates on credit assets, and seeks to empirically explain thiscritical relationship. We examine recovery rates on corporate bonddefaults, over the period 1982-2002. Our econometric univariate andmultivariate models explain a significant portion of the variance inbond recovery rates aggregated across all seniority and collaterallevels. The central thesis is that aggregate recovery rates arebasically a function of supply and demand for the securities, withdefault rates playing a pivotal role. Such a link would bring about asignificant increase in both expected and unexpected losses as measuredby some widespread credit risk models, and would affect theprocyclicality effects of the New Basel Capital Accord. Our results havealso important implications for investors in corporate bonds and bankloans, and for all markets (e.g., securitizations, credit derivatives,etc.) which depend on recovery rates as a key variable.

The Investment Behavior of Private Equity Fund Managers

Wed, 29 Oct 2003 22:58:59 GMT

Title: The Investment Behavior of Private Equity Fund Managers

Ljungqvist, Alexander; Richardson, Matthew

Abstract: Using a unique dataset of private equity funds over the last twodecades, this paper analyzes the investment behavior of private equityfund managers. Based on recent theoretical advances, we link the timingof funds’ investment and exit decisions, and the subsequentreturns they earn on their portfolio companies, to changes in the demandfor private equity in a setting where the supply of capital is‘sticky’ in the short run. We show that existing fundsaccelerate their investment flows and earn higher returns wheninvestment opportunities improve and the demand for capital increases.Increases in supply lead to tougher competition for deal flow, andprivate equity fund managers respond by cutting their investmentspending. These findings provide complementary evidence to recent papersdocumenting the determinants of fund-level performance in private equity.

The Effects of Focus and Diversification on Bank Risk and Return: Evidence from Individual Bank Loan Portfolios

Thu, 06 Dec 2001 22:58:59 GMT

Title: The Effects of Focus and Diversification on Bank Risk and Return:Evidence from Individual Bank Loan Portfolios

Acharya, Viral V.; Hasan, Iftekhar; Saunders, Anthony

Abstract: We study empirically the effect of focus (specialization) vs.diversification on the return and the risk of banks using data from 105Italian banks over the period 1993–1999. Specifically, we analyzethe tradeoffs between (loan portfolio) focus and diversification using aunique data set that is able to identify individual bank loan exposuresto different industries, to different sectors, and to differentgeographical regions. Our results are consistent with a theory thatpredicts a deterioration in bank monitoring quality at high levels ofrisk and a deterioration in bank monitoring quality upon lendingexpansion into newer or competitive industries. We find that industrialloan diversification reduces bank return while endogenously producingriskier loans for all banks in our sample, this effect being mostpowerful for high-risk banks. Sectoral loan diversification onlyproduces an inefficient risk–return trade-off for banks with veryhigh levels of risk. Geographical diversification on the other hand doesresult in an improvement in the risk–return tradeoff for bankswith low levels of risk. Overall, our results suggest thatdiversification of bank assets is not guaranteed to produce moreperformance efficient and/or safer banks.

The Effects of Cross-Border Bank Mergers on Bank Risk and Value

Tue, 26 Feb 2002 22:58:59 GMT

Title: The Effects of Cross-Border Bank Mergers on Bank Risk and Value

Amihud, Yakov; DeLong, Gayle L.; Saunders, Anthony

Abstract: This paper examines the effects of cross-border bank mergers on the riskand (abnormal) returns of acquiring banks. We find that overall, theacquirers’ risk neither increases nor decreases. In particular, onaverage neither their total risk nor their systematic risk fallsrelative to banks in their home banking market. The abnormal returns toacquirers are negative and significant, but are somewhat higher whenrisk increases relative to banks in the acquirer’s home country.

The Cash Flow, Return and Risk Characteristics of Private Equity

Wed, 08 Jan 2003 22:58:59 GMT

Title: The Cash Flow, Return and Risk Characteristics of Private Equity

Ljungqvist, Alexander; Richardson, Matthew

Abstract: Using a unique dataset of private equity funds over the last twodecades, this paper analyzes the cash flow, return, and riskcharacteristics of private equity. Unlike previous studies, we havedetailed cash flow data for each fund, rather than aggregate oraccounting returns. We also know the exact timing of investments andcapital returns to investors and the number and types of companies eachfund invested in. We document the draw down and capital return schedulesfor the typical private equity fund, and show that it takes severalyears for capital to be invested, and over ten years for capital to bereturned to generate excess returns. We provide several determiningfactors for these schedules, including existing investment opportunitiesand competition amongst private equity funds. In terms of performance,we document that private equity generates excess returns on the order offive to eight percent per annum relative to the aggregate public equitymarket. Moreover, while we estimate the betas of the private equityfunds’ portfolios to be greater than one, we show that on arisk-adjusted basis the excess value of the typical private equity fundis on the order of 24 percent relative to the present value of theinvested capital. One interpretation of this magnitude is that itrepresents compensation for holding a 10-year illiquid investment.

Strategies in Financial Services, the Shareholders and the System Is Bigger and Broader Better?

Wed, 18 Sep 2002 22:58:59 GMT

Title: Strategies in Financial Services, the Shareholders and the System IsBigger and Broader Better?

Walter, Ingo

Abstract: The classic structure-conduct-performance approach to industrialorganization centers on three questions. First, why is does an industrylook the way it does, in terms of numbers of competitors, market sharedistribution and various other metrics? Second, how do firms actuallycompete, in terms the formation of prices, product and service quality,rivalry and collaboration within and across strategic groups, and otherattributes of economic behavior? And third, how does the industryperform for its shareholders, its employees, its clients and suppliers,and within the context the system as a whole in terms of its impact onincome and growth, stability, and possibly less clearly defined ideasabout such things as social equity? In the financial services industry,these same questions have attracted more than the normal degree ofattention. The industry is "special" in a variety of ways,including the fiduciary nature of the business, its role at the centerof the payments and capital allocation process with all its static anddynamic implications for economic performance, and the systemic natureof problems that can arise in the industry. So the structure, conductand performance of the industry have unusually important public interestdimensions. One facet of the discussion has focused on size of financialfirms, however measured, and the range of activities conducted by them.Exhibit 1 depicts a taxonomy of broad-gauge financial servicesbusinesses. What are the strategic opportunities and competitiveconsequences of deepening and broadening a firm’s business withinand between the four sectors and eight sub-sectors? Is size positivelyrelated to total returns to shareholders? If so, does this involve gainsin efficiency or transfers of wealth to shareholders from otherconstituencies, or maybe both? Does greater breadth generate sufficientinformation-cost and transaction-cost economies to be beneficial toshareholders and customers, or can it work against their interests inways that may ultimately impede shareholder value as well? And whatabout the “specialness,” notably the industry's fiduciarycharacter and systemic risk -- is bigger and broader also safer? Thispaper begins with a simple strategic framework for thinking about theseissues from the perspective of the management of financial firms. Whatshould they be trying to do, and how does this relate to the issues ofsize and breadth? It then reviews the available evidence and reaches aset of tentative conclusions from what we know so far, both from ashareholder perspective and that of the financial system as a whole.

Strategies in Banking and Financial Services Firms: A Survey

Tue, 31 Dec 2002 22:58:59 GMT

Title: Strategies in Banking and Financial Services Firms: A Survey

Walter, Ingo

Abstract: This survey paper reviews the basic parameters of strategic positioningand execution in multi-functional financial services firms. We beginwith a model of financial intermediation between end-users of thefinancial system as a way of locating specific financial intermediationfunctions. Shifts in intermediation shares are superimposed on thisflow-of-funds profile, focusing on their implications for alternativebusiness models available to financial institutions. The next section ofthe paper links the structural story to a normative strategicpositioning matrix, which combines standard structure-conductperformance precepts with the potential realization of scale, scope,x-efficiency, market-power, transaction- and information-costdimensions, as well as imbedded risk exposures and conflicts ofinterest. The final section of the paper considers the value of naturalhedges incorporated into multifunctional business platforms against theaccompanying potential for a conglomerate discount in the share price.

So What Do I Get? The Bank’s View of Lending Relationships

Wed, 29 Oct 2003 22:58:59 GMT

Title: So What Do I Get? The Bank’s View of Lending Relationships

Bharath, Sreedhar; Dahiya, Sandeep; Saunders, Anthony; Srinivasan, Anand

Abstract: While a number of empirical studies have documented benefits of lendingrelationships to borrowers (lower loan rates, better creditavailability, etc.), not much is known about benefits of suchrelationships for lenders. For a relationship lender, its comparativeadvantage in information gathering/processing yields two potentialbenefits. First, a relationship lender would have a higher probabilityof selling future information-sensitive products (e.g. loans, securityunderwriting, etc.) to its borrowers compared to a non-relationshiplender. We refer to this as higher volume benefit of relationshiplending. Second, if borrower-specific information is only available torelationship lender, it can use this information monopoly to chargehigher rates on future loans. We refer to this as increased pricingbenefit of relationship lending. Our results show that, on average, alender with a past relationship with a borrower has a 42% probability ofproviding it with future loans, while a lender lacking a pastrelationship with a borrower has only a 3% probability of providing itwith a future loan. Consistent with theory, we find that borrowers withgreater information asymmetries (e.g. small borrowers, or non-ratedborrowers) are significantly more likely to use their relationship banksfor future loans. Although the association between past lendingrelationship and probability of being chosen to provide debt and equityunderwriting services in the future is statistically significant, theeconomic impact is much smaller compared to loan markets. However, ourfindings do not provide strong support for an increased pricing benefitfor relationship lenders. On average, the rate of interest for similarborrowers is 6-10 basis points lower if the loan is provided by arelationship lender. Underwriting fee for initial public offerings (IPO)with relationship lender(s) as lead underwriter(s) is 26 basis pointslower. This suggests that lenders are prepared to share some of thebenefits of relationship lending with borrowers.

Sharing Underwriters with Rivals: Implications for Competition in Investment Banking

Mon, 05 Dec 2005 22:58:59 GMT

Title: Sharing Underwriters with Rivals: Implications for Competition inInvestment Banking

Asker, John; Ljungqvist, Alexander

Abstract: We conjecture that issuing firms seek to avoid sharing underwriters withtheir product-market rivals in order to limit the risk thatstrategically sensitive information is leaked to a rival firm via theunderwriter relationship. We investigate this conjecture in a sample of5,272 equity deals and 12,453 debt deals by large U.S. firms between1975 and 2003. Using several distinct sources of identification, we findthat this phenomenon is at least as important in determining the choiceof lead underwriter as the bank's reputation or the issuing firm'sexisting relationship with the underwriter. We argue that this findinghas important implications for understanding the nature of competitionamong investment banks, the durability of underwriting relationships,the success of entrants, and the likely impact of investment bankmergers on market power.

Scaling the Hierarchy: How and Why Investment Banks Compete for Syndicate Co-Management Appointments

Wed, 28 Sep 2005 22:58:59 GMT

Title: Scaling the Hierarchy: How and Why Investment Banks Compete forSyndicate Co-Management Appointments

Ljungqvist, Alexander; Marston, Felicia C.; Wilhelm Jr., William J.

Abstract: We investigate the empirical puzzle why banks pressured their analyststo provide aggressive assessments of issuing firms during the 1990s whendoing so apparently had little positive effect on their chances ofreceiving lead-management appointments and ultimately led to regulatorypenalties and costly structural reform. We show that aggressivelyoptimistic research can attract co-management appointments and thatco-management appointments eventually lead to more lucrativelead-management opportunities. Our results suggest a potentialunintended anticompetitive effect of the Global Settlement if forcinggreater separation of research and investment banking diminishesco-management opportunities for (and thereby potential competition from)marginal competitors in securities underwriting, especially in the debt markets.

Risk Management, Capital Structure and Capital Budgeting in Financial Institutions

Tue, 26 Sep 2000 22:58:59 GMT

Title: Risk Management, Capital Structure and Capital Budgeting in Financial Institutions

Cebenoyan, A. Sinan; Strahan, Philip E.

Abstract: We test how active management of bank credit risk exposure affectscapital structure, capital budgeting and profits. We find that banksthat rebalance their C&I loan portfolio exposures by both buying andselling loans hold less capital and lower levels of liquid assets thanother banks; they also lend more to businesses, both as a percentage oftotal assets and as a percentage of their overall lending, and theyenjoy higher profits. The results hold controlling for bank size andholding company affiliation and are robust over time. We conclude thatincreasingly sophisticated risk management practices in banking arelikely to improve the availability of bank credit.

Revisiting Credit Scoring Models in a Basel 2 Environment

Sun, 28 Apr 2002 22:58:59 GMT

Title: Revisiting Credit Scoring Models in a Basel 2 Environment

Altman, Edward I.

Abstract: This paper discusses two of the primary motivating influences on therecent development/revisions of credit scoring models, i.e., theimportant implications of Basel 2’s proposed capital requirementson credit assets and the enormous amounts and rates of defaults andbankruptcies in the US in 2001-2002. Two of the more prominent creditscoring techniques, Z-Score and KMV’s EDF models, are reviewed.Finally, both models are assessed with respect to default probabilitiesin general and in particular to the infamous Enron debacle. In order tobe effective, these and other credit risk models should be utilized byfirms with a sincere credit risk culture.

Privatization Matters: Bank Efficiency in Transition Countries

Fri, 27 Feb 2004 22:58:59 GMT

Title: Privatization Matters: Bank Efficiency in Transition Countries

Wachtel, Paul; Bonin, John; Hasan, Iftekhar

Abstract: To investigate the impact of bank privatization in transition countries,we take the largest banks in six relatively advanced countries, namely,Bulgaria, the Czech Republic, Croatia, Hungary, Poland and Romania.Income and balance sheet characteristics are compared across four bankownership types. Efficiency measures are computed from stochasticfrontiers and used in ownership and privatization regressions havingdummy variables for bank type. Our empirical results support thehypotheses that foreign-owned banks are most efficient andgovernment-owned banks are least efficient. In addition, the importanceof attracting a strategic foreign owner in the privatization process isconfirmed. However, counter to the conjecture that foreign banks creamskim, we find that domestic banks have a local advantage in pursuingfee-for-service business. Finally, we show that both the method and thetiming of privatization matter to efficiency; specifically, voucherprivatization does not lead to increased efficiency and early privatizedbanks are more efficient than later-privatized banks even though we findno evidence of a selection effect.

Mortgage Backed Securities: Another Way to Finance Housing

Tue, 10 Aug 2004 22:58:59 GMT

Title: Mortgage Backed Securities: Another Way to Finance Housing

White, Lawrence

Abstract: The introduction of mortgage-backed securities (MBS) as a channel forhousing finance is a relatively recent event for the United States,having occurred less than three-and-a-half decades ago. This paperprovides a brief overview of the MBS process in the U.S. The paperplaces the MBS process in the larger contexts of finance in general andhousing finance in particular, discusses its special features and itsadvantages and disadvantages, addresses its special infrastructurerequirements, and describes the historical and recent experiences in the U.S.

Measuring the Value of Strategic Alliances in the Wake of a Financial Implosion: Evidence from Japan's Financial Services Sector

Tue, 07 Oct 2003 22:58:59 GMT

Title: Measuring the Value of Strategic Alliances in the Wake of a FinancialImplosion: Evidence from Japan's Financial Services Sector

Chiou, Ingyu; White, Lawrence J.

Abstract: This paper examines the wealth effects of financial-institutionstrategic alliances on the shareholders of the newly allied firms. Ourpaper is different from previous studies of non-financial jointventures, financial and non-financial mergers and acquisitions, andnon-financial strategic alliances in three important aspects/ways:First, we focus on financial institutions that form strategic alliances.Second, while most related studies use U.S. data, this paper employsJapanese data for the late 1990s, directly testing financial theory in adifferent setting. Finally, we study whether different types ofalliances result in differing magnitudes of stock market responses. Ourprimary results are as follows: First, we find that a strategicalliance, on average, increases the value of the partner firms. This isconsistent with the “synergy” hypothesis. Second, the gainsfrom the alliance are spread more widely among the partners than wouldbe suggested by a random alternative, supporting a “win-win”hypothesis. Third, smaller partners tend to experience largerpercentage gains, which is consistent with a “relative size”hypothesis. Fourth, the market values inter-group allianceannouncements more than intra-group alliance announcements; the lattermay well be seen as redundant. This is consistent with an“inter-group synergies” hypothesis. Fifth, we do not find asignificant difference in the abnormal returns showed bydomestic-foreign alliances and domestic-domestic alliances, althoughboth sets of alliances show significantly positive returns. We thus donot find support for a “foreign firm superior” hypothesis.Finally, we find that an investment-banking alliance has a strongpositive effect on abnormal returns, indicating that investment banking,which has been underdeveloped in Japan relative to the U.S., may be apromising business for financial institutions. Overall, this papercomplements the existing literature in that we analyze the value offinancial institution alliances. Our analysis reconfirms that strategicalliances are value-enhancing. This is consistent with previous studiesthat find increased value in the announcement of a strategic alliance ora merger. Our results are consistent with the notion that financialderegulation tends to increase competition, which, in turn, encouragesfirms to adopt aggressive corporate strategies. This is viewed as apositive move by investors, as evidenced by the average gains of theshareholders of these alliance-forging firms.

Market Size and Investment Performance of Defaulted Bonds and Bank Loans: 1987-2002

Wed, 29 Jan 2003 22:58:59 GMT

Title: Market Size and Investment Performance of Defaulted Bonds and BankLoans: 1987-2002

Altman, Edward I.; Jha, Shubin

Abstract: The defaulted and distressed, public and private debt markets in theUnited States increased enormously to a record $942 billion (face value)at the end of 2002. The market value of this increasingly attractivealternative investment segment was approximately $512 billion.Defaulted securities performed below average in 2002; absolute returns,as measured by our various defaulted debt indexes, were - 6.0% on bonds,+3.0% on bank loans, and - 0.5% on the combined defaulted public bondsand private bank loans index. The Altman-NYU Salomon Center Index ofDefaulted Bonds grew to a face value of $61.5 billion. Themarket-to-face value ratio of the Bond Index fell to 0.17 from 0.21 oneyear ago. The face value of our Defaulted Bank Loan Index was $37.7billion and the market-to-face value ratio dropped to a record low levelof 0.46 by the end of 2002. The recovery rate on defaulted bonds (pricejust after default) was very low at 25 cents on the dollar; likewise,the weighted average bank loan recovery rate in 2002 dropped to 52 centson the dollar. With new defaulted bonds rising in 2002 to a record $96.9billion (default rate of 12.8%) and the default outlook for 2003 high,but lower than for 2002, investment opportunities should abound in thedistressed debt market. Indications are that distressed investors (bothold and new entities) are successfully raising funds because investorexpectations are buoyant.

Managing Ethical Risk: The Securities Industry and the Law

Sun, 29 Oct 2000 22:58:59 GMT

Title: Managing Ethical Risk: The Securities Industry and the Law

Alan Bear, Larry; Maldonado-Bear, Rita

Abstract: We examine the interplay of markets, ethics and law, and rising demandfor ethical behavior in a market driven society coping with the promiseand peril of rapid technological innovation. We analyze the marketaffecting role of our Common Law/Rule of Law System, its adaptability tosocial need and resultant legal and regulatory action promotingadherence to the spirit as well as the letter of the law. We provideexamples of manager and firm harm from sanctions imposed despiteadherence to “the rules.” Finally, we discuss competitivemarket/common law interplay in the coming era of the genome.

Issues in the Credit Risk Modeling of Retail Markets

Wed, 29 Jan 2003 22:58:59 GMT

Title: Issues in the Credit Risk Modeling of Retail Markets

Allen, Linda; DeLong, Gayle; Saunders, Anthony

Abstract: Retail loan markets create special challenges for credit riskassessment. Borrowers tend to be informationally opaque and borrowrelatively infrequently. Retail loans are illiquid and do not trade insecondary markets. For these reasons, historical credit databases areusually not available for retail loans. Moreover, even when data areavailable, retail loan values are small in absolute terms and thereforeapplication of sophisticated modeling is usually not cost effective onan individual loan-by-loan basis. These features of retail lending haveled to the development of techniques that rely on portfolio aggregationin order to measure retail credit risk exposure. BIS proposals for theBasel New Capital Accord differentiate portfolios of mortgage loans fromrevolving credit loan portfolios from other retail loan portfolios inassessing the bank’s minimum capital requirement. We survey themost recent BIS proposals for the credit risk measurement of retailcredits in capital regulations. We also describe the recent trend awayfrom relationship lending toward transactional lending, even in thesmall business loan arena traditionally characterized by small banksextending relationship loans to small businesses. These trends createthe opportunity to adopt more analytical, data-based approaches tocredit risk measurement. We survey proprietary credit scoring models(such as Fair, Isaac and SMEloan), as well as options-theoreticstructural models (such as KMV and Moody’s RiskCalc) and reducedform models (such as Credit Risk Plus).

Is There a Customer Relationship Effect from Bank ATM Surcharges?

Sat, 28 Jun 2003 22:58:59 GMT

Title: Is There a Customer Relationship Effect from Bank ATM Surcharges?

Massoud, Nadia; Saunders, Anthony; Scholnick, Barry

Abstract: This paper investigates the use of ATM surcharges as a strategic deviceto increase bank profitability. We show that ATM surcharge changes canhave both a direct effect on bank profitability and an indirect effectvia customer switching and a related customer relationship effect. Thatis, customer switching results in an increase in the demand for otherservices provided by the surcharge-increasing bank. Using uniquedatabases, we provide evidence to show that overall bank profitabilityis favorably affected by surcharge increases. We also show evidencesupporting the existence of an indirect effect, especially for larger banks.

IPO Pricing in the Dot-Com Bubble: Complacency or Incentives

Sun, 11 Nov 2001 22:58:59 GMT

Title: IPO Pricing in the Dot-Com Bubble: Complacency or Incentives

Ljungqvist, Alexander P.; Wilhelm, William J. Jr.

Abstract: IPO initial returns reached astronomical levels during 1999-2000. Weshow that the regime shift in initial returns and other elements ofpricing behavior can be at least partially accounted for by a variety ofmarked changes in pre-IPO ownership structure and insider sellingbehavior over the period which reduced key decision-makers™incentives to control underpricing. After controlling for these changes,there appears to be little special about the 1999-2000 period, asidefrom the preponderance of Internet and high-tech firms going public. Ourresults suggest that it was firm characteristics that were unique duringthe “dot-com bubble” and that pricing behavior followed fromincentives created by these characteristics.

IPO Allocations: Discriminatory or Discretionary?

Tue, 28 Aug 2001 22:58:59 GMT

Title: IPO Allocations: Discriminatory or Discretionary?

Ljungqvist, Alexander; Wilhelm, William J. Jr.

Abstract: We estimate the structural links between IPO allocations, pre-marketinformation production, and initial underpricing returns, within thecontext of theories of book building. Using a sample of both U.S. andinternational IPOs we find evidence of the following: · IPOallocation policies favor institutional investors, both in the U.S. andworldwide. ·Constraints on the discretion bankers exercise in theallocation of IPO shares reduce institutional allocations.·Constraints on allocation discretion result in offer prices thatdeviate less from the indicative price range established prior tobankers’ efforts to gauge demand among institutional investors. Weinterpret this as indicative of diminished information production.· Initial returns, which reflect a significant indirect cost ofgoing public, are directly related to this measure of informationproduction and inversely related to the fraction of shares allocated toinstitutional investors.

Investment Banking Relationships and Merger Fees

Fri, 28 Sep 2001 22:58:59 GMT

Title: Investment Banking Relationships and Merger Fees

Saunders, Anthony; Srinivasan, Anand

Abstract: This paper is among the first to investigate the effect of a priorinvestment banking relationship on merger advisory fees paid byacquiring firms. We find that acquiring firms pay a higher fee toadvisors when they have had a continuing relationship and a lower feewhen they switch to an advisor with whom they have had no priorrelationship. We develop a measure of relationship strength between anacquiring firm and its merger advisor based on previous debt, equity andmerger transactions completed by the acquiring firm. We also examine therelationship between a merger advisor’s reputation and its abilityto retain clients. We find that firms are more likely to switch if theirM and A advisor is not a top tier investment bank. To test if higherfees are compensation for better performance, we examine differencesbetween the average announcement returns of acquiring firms that switchadvisors and those that do not. We find no significant differencebetween these two return samples. Overall, our findings indicate thatacquiring firms perceive benefits of retaining merger advisors with whomthey have had a prior relationship (even at the cost of higher fees)and/or they face some other (higher) costs of switching to new bank advisors.

Informative Trading or Just Noise? An Analysis of Currency Returns, Market Liquidity, and Transaction Costs in Proximity of Central Bank Interventions

Tue, 08 Oct 2002 22:58:59 GMT

Title: Informative Trading or Just Noise? An Analysis of Currency Returns,Market Liquidity, and Transaction Costs in Proximity of Central Bank Interventions

Pasquariello, Paolo

Abstract: We study the impact of Central Bank intervention on the process of priceformation in currency markets. We use a unique dataset of tick-by-tickindicative quotes posted by dealers on Reuters terminals and of intradaysterilized spot interventions and customer transactions executed onbehalf of the Swiss National Bank (SNB) on the Swiss Franc/U.S. Dollarexchange rate (CHFUSD) between 1986 and 1998. We find that potentiallyinformative SNB interventions (but not ex post uninformative customertransactions), although small relative to daily trading volumes in theCHFUSD market, had significant and persistent (albeit asymmetric,depending on their sign) effects on daily currency returns, especiallywhen (relatively) large in magnitude, expected by the market, orinconsistent with existing momentum. The market did not anticipate theoccurrence of incoming interventions un-less if chasing the trend. TheSNB was much less successful in smoothing fluctuations of the currency,for daily CHFUSD volatility always surged in proximity of interventions,as did average absolute and proportional spreads. Decomposition ofestimated absolute spread shocks also reveals that SNB actions inducedmisinformation among market participants, impacted trading immediacy,and increased market liquidity and competition among dealers. Many ofthese changes translated into higher transaction costs borne by thepopulation of investors.

Informational Efficiency Of Loans Versus Bonds: Evidence From Secondary Market Prices

Thu, 29 Jan 2004 22:58:59 GMT

Title: Informational Efficiency Of Loans Versus Bonds: Evidence From SecondaryMarket Prices

Altman, Edward; Gander, Amar; Saunders, Anthony

Abstract: This paper examines the informational efficiency of loans relative tobonds surrounding loan default dates and bond default dates. We examinethis issue using a unique dataset of daily secondary market prices ofloans over the 11/1999-06/2002 period. We find evidence consistent witha monitoring role of loans. Specifically, consistent with a view thatthe monitoring role of loans should be reflected in more preciseexpectations embedded in loan prices, we find that the price decline ofloans is less adverse than that of bonds of the same borrower aroundloan and bond default dates. Additionally, we find evidence that thedifference in price decline of loans versus bonds is amplified aroundloan default dates that are not preceded by a bond default date of thesame company. Our results are robust to several alternativeexplanations, and to controlling for security-specific characteristics,such as seniority, collateral, covenants, and for multiple measures ofcumulative abnormal returns. Overall, we find that the loan market isinformationally more efficient than the bond market around loan defaultdates and bond default dates.

Informational Efficiency of Loans versus Bonds: Evidence from Secondary Market Prices

Sun, 28 Sep 2003 22:58:59 GMT

Title: Informational Efficiency of Loans versus Bonds: Evidence from SecondaryMarket Prices

Altman, Edward; Gande, Amar; Saunders, Anthony

Abstract: This paper examines the informational efficiency of loans relative tobonds surrounding loan default dates and bond default dates. We examinethis issue using a unique dataset of daily secondary market prices ofloans over the11/1999-06/2002 period. We find evidence consistent with amonitoring role of loans. First, consistent with a view that themonitoring role of loans should be reflected in more preciseexpectations embedded in loan prices, we find that the price reaction ofloans is less adverse than that of bonds around loan and bond defaultdates. Second, we find evidence that the difference in price reaction ofloans versus bonds is amplified around loan default dates that are notpreceded by a bond default date of the same company. Finally, we find ahigher recovery rate for loans as compared to bonds, suggesting that themonitoring role of loans does not diminish significantly in the postdefault period. Our results are robust to controlling forsecurity-specific characteristics, such as seniority, and collateral,and for multiple measures of cumulative abnormal returns around defaultdates. Overall, we find that the loan market is informationally moreefficient than the bond market around default dates.

Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature

Thu, 28 Nov 2002 22:58:59 GMT

Title: Incorporating Systemic Influences Into Risk Measurements: A Survey ofthe Literature

Allen, Linda; Saunders, Anthony

Abstract: Procyclicality has emerged as a potential drawback to adoption ofrisk-sensitive bank capital requirements. Systematic risk factors mayresult in increases (decreases) in bank capital requirements when theeconomy is depressed (overheated), thereby decreasing (increasing) banklending capacity and exacerbating business cycle fluctuations.Procyclicality may result from systematic risk emanating from commonmacroeconomic influences or from interdependencies across firms asfinancial markets and institutions consolidate internationally. Wedescribe cyclical effects on operational risk, credit risk and marketrisk measures.

Hot Markets, Investor Sentiment, and IPO Pricing

Mon, 17 Sep 2001 22:58:59 GMT

Title: Hot Markets, Investor Sentiment, and IPO Pricing

Ljungqvist, Alexander P.; Nanda, Vikram; Singh, Rajdeep

Abstract: Our model of the initial public offering process links the three mainempirical IPO ‘anomalies’ – underpricing, hot issuemarkets, and long-run underperformance – and traces them to acommon source of inefficiency. We relate hot IPO markets (such as the1999/2000 market for Internet IPOs) to the presence of a class ofinvestors who are ‘irrational’ in the sense of havingexuberant expectations regarding future performance. Underpricing andlong-run underperformance emerge as underwriters attempt to maximizeprofits from the sale of equity, at the expense of these exuberantinvestors. Underpricing serves to compensate regular IPO investors fortheir role in restricting the supply of available shares and maintainingprices. The model is shown to be consistent with many aspects of the IPOprocess. It also generates a number of new empirical predictions.

Global Integration in Primary Equity Markets: The Role of U.S. Banks and U.S. Investors

Thu, 07 Sep 2000 22:58:59 GMT

Title: Global Integration in Primary Equity Markets: The Role of U.S. Banks andU.S. Investors

Ljungqvist, Alexander; Jenkinson, Tim; Wilhelm, William J. Jr.

Abstract: We examine the costs and benefits of the global integration of primaryequity markets associated with the parallel diffusion of U.S.underwriting methods. We analyze both direct and indirect costs(associated with underpricing) using a unique dataset of 2,132 IPOs bynon-U.S. issuers from 65 countries in 1992-1999. Bookbuilding typicallycosts twice as much as a fixed-price offer, but on its own, does notlead to lower underpricing. However, when conducted by U.S. banks and/ortargeted at U.S. investors, bookbuilding can reduce underpricingsignificantly, relative to fixed-price offerings or bookbuilding effortsconducted by ‘local’ banks. These results are obtained afterallowing for the endogeneity and interdependence of issuers’choices. For the great majority of issuers, the gains associated withlower underpricing outweighed the additional costs associated withhiring U.S. banks or marketing in the U.S. This suggests a quality/pricetrade-off contrasting with the findings of Chen and Ritter [Journal ofFinance 55, 2000], particularly since non-U.S. issuers raisingUS$20m-80m also typically pay a 7% spread when U.S. banks and investorsare involved.

Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?

Fri, 29 Oct 2004 22:58:59 GMT

Title: Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?

Frame, W. Scott; White, Lawrence J.

Abstract: The roles of Fannie Mae and Freddie Mac have become increasinglycontroversial in the modern world of residential mortgage finance. Wedescribe the special features of these two companies and their roles inthe mortgage markets. We then discuss the controversies that surroundthem and offer recommendations for improvements in public policy.

Financial Intermediaries and Markets

Thu, 18 Dec 2003 22:58:59 GMT

Title: Financial Intermediaries and Markets

Allen, Franklin; Gale, Douglas

Abstract: A complex financial system comprises both financial markets andfinancial intermediaries. We distinguish financial intermediariesaccording to whether they issue complete contingent contracts orincomplete contracts. Intermediaries such as banks that issue incompletecontracts, e.g., demand deposits, are subject to runs, but this does notimply a market failure. A sophisticated financial system–a systemwith complete markets for aggregate risk and limited marketparticipation–is incentive-efficient, if the intermediaries issuecomplete contingent contracts, or else constrained-efficient, if theyissue incomplete contracts. We argue that there may be a role forregulating liquidity provision in an economy in which markets foraggregate risks are incomplete.

Financial Integration Across Borders and Across Sectors: Implications for Regulatory Structures

Wed, 29 May 2002 22:58:59 GMT

Title: Financial Integration Across Borders and Across Sectors: Implicationsfor Regulatory Structures

Walter, Ingo

Abstract: This paper considers the generic processes and linkages that comprisefinancial intermediation - the basic 'financial hydraulics' thatultimately drive efficiency and innovation in the financial system andits impact on real-sector resource allocation and economic growth.Maximum economic welfare demands a high-performance financial system.What does this actually mean? It documents some of the structuralchanges that have occurred in both national and global financialsystems, and suggests how the microeconomics of financial intermediationwork. These can have an enormous impact on the industrial structure ofthe financial services industry and on individual firms. Sequentially,financial channels that exhibit greater static and dynamic efficiencyhave supplanted less efficient ones. Competitive distortions can retardthis process, but they usually extract significant economic costs and atthe same time divert financial flows into other venues, eitherdomestically or elsewhere. The paper also examines the consequences ofthis process in terms of financial sector reconfiguration, both withinand between the four major segments of the industry (commercial banking,securities and investment banking, insurance, and asset management) aswell as within and between national financial systems. Finally, thepaper superimposes key regulatory overlays onto the basic economics andfacts of reconfiguration in financial intermediation. This is a'special' industry, due both to the imbedded systemic risks and itsfiduciary nature. Balancing financial efficiency against stability andfairness is not easy. The economics of financial intermediation arehighly regulation-sensitive, so small changes in regulation can createimportant changes in markets. Regulators inevitably make some mistakes,and regulatory mandates are unusually contentious and vulnerable toentrenched economic interests. This is also a discussion of the linkagesbetween structural change in financial intermediation and supervisoryand regulatory functions, including some comparisons between US andEuropean legacies and prospects.

Financial Fragility, Liquidity and Asset Prices

Fri, 05 Sep 2003 22:58:59 GMT

Title: Financial Fragility, Liquidity and Asset Prices

Allen, Franklin; Gale, Douglas

Abstract: We define a financial system to be fragile if small shocks havedisproportionately large effects. In a model of financialintermediation, we show that small shocks to the demand for liquiditycause either high asset-price volatility or bank defaults or both.Furthermore, as the liquidity shocks become vanishingly small, theasset-price volatility is bounded away from zero. In the limit economy,with no shocks, there are many equilibria; however, the only equilibriathat are robust to the introduction of small liquidity shocks are thosewith non-trivial sunspot activity.

Financial Distress and Bank Lending Relationships

Fri, 28 Sep 2001 22:58:59 GMT

Title: Financial Distress and Bank Lending Relationships

Dahiya, Sandeep; Saunders, Anthony; Srinivasan, Anand

Abstract: One of the most important risks faced by a bank is that of loan defaultby its borrowers. Existing literature has documented the negativeannouncement-period returns for lending banks when a big sovereignborrower announces a moratorium on its bank loans. In contrast, littleresearch has been undertaken that analyzes bank shareholder wealtheffects when a major corporate borrower declares default and/orbankruptcy. This paper uses a unique data set of bank loans to examinethe wealth effects on lead lending banks when their borrowers’suffer financial distress. For the 10-year period from 1987 to 1996, weexamine a sample of 71 firms that defaulted on their public debt and asample of 101 firms that filed for bankruptcy. We find a significantnegative wealth effect for the shareholders of the lead lending banks onthe announcement of bankruptcy and default by the borrowers of theirbank. We also find that the banks with relatively higher exposure to thedistressed firms have larger negative announcement-period returns,although individual loan details are not public knowledge. Thus, themarket appears to discriminate among lenders in a way not inconsistentwith a correct inference of individual borrower exposures. We alsoexamine the impact of various loan and bank characteristics on themagnitude of announcement returns. We find that the existence of a pastlending relationship with the distressed firm results in larger wealthdeclines for the bank shareholders. Finally, we find that financialdistress also has a significantly negative effect on borrower’s returns.

Fannie Mae, Freddie Mac, and Housing:Good Intentions Gone Awry

Thu, 13 Jul 2006 22:58:59 GMT

Title: Fannie Mae, Freddie Mac, and Housing:Good Intentions Gone Awry

White, Lawrence J.

Abstract: he Federal National Mortgage Association (Fannie Mae) and the FederalHome Loan Mortgage Corporation (Freddie Mac) are the two dominantentities in the secondary market for residential mortgages in the UnitedStates. This chapter describes and discusses these two companies andtheir special status in the U.S. residential mortgage market andrecommends their true privatization, as well as a set of additionalreform measures that would improve the efficiency of housingconstruction and consumption in the U.S. economy. Along the way, we willaddress a number of major issues that concern housing and its specialplace in the political landscape of America.

Fannie Mae, Freddie Mac, and Housing Finance: Why True Privatization is Good Public Policy

Tue, 10 Aug 2004 22:58:59 GMT

Title: Fannie Mae, Freddie Mac, and Housing Finance: Why True Privatization isGood Public Policy

White, Lawrence

Explaining Credit Spread Changes: Some New Evidence from Option-Adjusted Spreads of Bond Indices

Thu, 29 May 2003 22:58:59 GMT

Title: Explaining Credit Spread Changes: Some New Evidence from Option-AdjustedSpreads of Bond Indices

Huang, Jing-zhi; Kong, Weipeng

Abstract: We examine the question of the determinants of corporate bond creditspreads using both weekly and monthly option-adjusted spreads for ninecorporate bond indexes from Merrill Lynch from January 1997 to July2002. We find that the Russell 2000 index historical return volatilityand the Conference Board composite leading and coincident economicindicators have significant power in explaining credit spread changes,especially for high yield indexes. Furthermore, these three variablesplus the interest rate level, the historical interest rate volatility,the yield curve slope, the Russell 2000 index return, and theFama-French [1996] high-minus-low factor can explain more than 40% ofcredit spread changes for five bond indexes. In particular, these eightvariables can explain 67.68% and 60.82% of credit spread changes for theB- and the BB-rated indexes, respectively. Our analysis confirms thatcredit spread changes for high-yield bonds are more closely related toequity market factors and also provides evidence in favor ofincorporating macroeconomic factors into credit risk models.

Evidence of Information Spillovers in the Production of Investment Banking Services

Mon, 20 Aug 2001 22:58:59 GMT

Title: Evidence of Information Spillovers in the Production of InvestmentBanking Services

Benveniste, Lawrence M.; Ljungqvist, Alexander; Wilhelm, William J. Jr.; Yu, Xiaoyun

Abstract: We present evidence that firms attempting IPOs learn from the experienceof their contemporaries. These information spillovers affect revisionsin offer terms and the decision whether to carry through with anoffering. The evidence also supports the argument that IPOs areimplicitly bundled as a means of promoting more equitable sharing ofinformation production costs. One apparent consequence of this behavioris that while initial returns and IPO volume are positively correlatedin the aggregate, the correlation is negative among contemporaneousofferings subject to a common valuation factor. These findings areconsistent with the Benveniste, Busaba, and Wilhelm (2001) argument thatthe dynamics of volume and initial returns in primary equity marketsreflect, at least in part, an institutional response to information externalities.

Emerging Competition and Risk-Taking Incentives at Fannie Mae and Freddie Mac

Wed, 29 Oct 2003 22:58:59 GMT

Title: Emerging Competition and Risk-Taking Incentives at Fannie Mae andFreddie Mac

White, Lawrence J.; Frame, W. Scott

Abstract: This paper examines two major forces that may soon increase competitionin the U.S. secondary conforming mortgage market: 1) the expansion ofFederal Home Loan Bank mortgage purchase programs, and 2) the adoptionof revised risk-based capital requirements for large U.S. banks (BaselII). We argue that this competition is likely to reduce the growth andrelative importance of Fannie Mae and Freddie Mac and hence theirfranchise values and effective capital. Such developments could, inturn, lead to more risky behaviors by these two GSEs. It is this lastconsequence that warrants greater regulatory awareness.

Does Prospect Theory Explain IPO Market Behavior?

Mon, 23 Feb 2004 22:58:59 GMT

Title: Does Prospect Theory Explain IPO Market Behavior?

Ljungqvist, Alexander; Wilhelm, William J. Jr.

Abstract: We derive a behavioral measure of the IPO decision-maker’ssatisfaction with the underwriter’s performance based on Loughranand Ritter’s (2002) application of prospect theory to IPOunderpricing. We assess the plausibility of this measure by studying itspower to explain the decision-maker’s subsequent choices.Controlling for other known factors, IPO firms are less likely to switchunderwriters for their first seasoned equity offering when ourbehavioral measure indicates they were satisfied with the IPOunderwriter’s performance. Underwriters also appear to benefitfrom behavioral biases in the sense that they extract higher fees forsubsequent transactions involving satisfied decision-makers. Althoughour tests suggest there is explanatory power in the behavioral model,they do not speak directly to whether deviations from expected utilitymaximization determine patterns in IPO initial returns.

Do Markets React to Bank Examination Ratings? Evidence of Indirect Disclosure of Management Quality Through BHCs' Applications to Convert to FHCs

Thu, 28 Sep 2000 22:58:59 GMT

Title: Do Markets React to Bank Examination Ratings? Evidence of IndirectDisclosure of Management Quality Through BHCs' Applications to Convertto FHCs

Allen, Linda; Jagtiani, Julapa; Moser, James

Abstract: Certain nonrecurring circumstances associated with the passage of theFinancial Services Modernization Act of 1999 have created a uniqueopportunity for the market to obtain bank examination ratings ofmanagement quality. We utilize this natural experiment in order todetermine how the market views this heretofore private information. Wefind that the stock market utilizes bank examination ratings in order toreveal regulatory intent, rather than simply as information aboutmanagement quality. Revelation of unsatisfactory M ratings (denoted“bad news”) causes BHC stock returns and market risk betasto increase, whereas revelation of acceptable M ratings (“goodnews”) causes BHC stock returns and market risk betas to decrease.The market thrives on “bad news” because unsatisfactory Mratings indicate that regulatory intervention is likely to occur,possibly benefiting both shareholders and creditors. On the other hand,revelation of acceptable M ratings (“good news”) indicatesthat bank regulators are unprepared to intervene in the near future.Moreover, we find lower bond spreads for a subsample of FHCs withsatisfactory M ratings revealed upon conversion.

Discounted Stocks and Excess Analyst Coverage

Tue, 15 Jan 2002 22:58:59 GMT

Title: Discounted Stocks and Excess Analyst Coverage

Doukas, John A.; Kim, Chansog; Pantzalis, Christos

Abstract: In this paper we examine whether the negative excess value of stocks(stock discounts in the Berger and Ofek (1995) spirit) is associatedwith low excess analyst coverage over the 1979-1997 period. We defineexcess analyst coverage as the difference between a firm’s actualanalyst following and its imputed coverage. We hypothesize that firmswith high excess (low) analyst coverage are exposed to less (more)information asymmetry between managers and investors, managerialmisconduct and uncertainty about future earnings than do other firms.Therefore, stocks with low excess analyst coverage profile are expectedto trade at low prices, as they would be more difficult for investors tovalue. Our findings provide evidence in support of the view that excessanalyst coverage explains a significant portion of stocks’discount, indicating that higher (lower) excess analyst coverage leadsto more (less) informative stock prices and offers an information-basedexplanation on why stocks trade at a premium (discount) . Our empiricalresults are also consistent with the notion that stocks of firms withhigh managerial power (i.e., low investor rights/weak corporategovernance) trade at a discount. Finally, our analysis indicates thatthe information inherent in the dispersion of analyst forecasts, asurrogate for investor uncertainty, plays an important role in thedetermination of asset prices.

Defaults and Returns on High Yield Bonds: The Year 2002 in Review and the Market Outlook

Wed, 29 Jan 2003 22:58:59 GMT

Title: Defaults and Returns on High Yield Bonds: The Year 2002 in Review andthe Market Outlook

Altman, Edward I.; Bana, Gaurav

Abstract: The year 2002 was remarkably difficult on many fronts for most financialmarkets. For the high yield bond market, it was again a year of recordamounts of defaults which contributed to low recovery rates and slightlynegative absolute returns. The default rate registered a massive 12.8%,based on $757 billion outstanding. Despite these record default totalsand rates, the market’s decline was orderly with little panic andactually ended the year with reduced defaults and highly positivereturns in the fourth quarter. Default amounts registered its fourthconsecutive record year and almost topped $100 billion ($97.9 billion)for the first time. This total was more than 52% higher than lastyear’s record. Combined with a near record low recovery rate of 25cents on the dollar, weighed down by Telecom’s average recoveryrate of 16%, loss rates from defaults reached record levels of about 10%-- even adjusted for fallen angel default recoveries. The pervasiveinfluence of WorldCom’s massive default had a profound effect onboth the default and recovery rates. Without WorldCom, the year’sdefault rate would have been 9.27% -- a differential of about 3.5%. Thisreport documents and comments upon the high yield bond market’srisk and return performance over the period 1971-2002. We will presenttraditional, dollar-denominated default rates as well as our ownmortality rate statistics. Default rate analysis will be complemented bydiscussion on corporate bankruptcies and the immense impact of fallenangels on the high yield market. We conclude with our annual estimate ofthe size of the distressed debt market and our forecast for defaults in2003. Our analysis will include an update on our default recoveryforecasting model which was extremely accurate in estimating2002’s recovery rate of about 25%. Based on the fourthquarter’s reduction in default rate to 1.82% and ouraging-mortality conceptual framework, we are predicting a reduction inthe dollar denominated default rate to 7.5-8.0%, as much as 5% less than2002 (but still far above the average rate). This should help provide amore attractive environment for high yield debt new issues and returnsin 2003. In 2002, there was $65.6 billion in new high yield bondissuance, down from 2001’s $88.2 billion. We expect new issuancein 2003 to escalate unless the economic/political scene motivatesanother flight to quality in our financial markets.

Cyclicality in Catastrophic and Operational Risk Measurements

Tue, 31 Dec 2002 22:58:59 GMT

Title: Cyclicality in Catastrophic and Operational Risk Measurements

Allen, Linda

Abstract: Using equity returns for financial institutions we estimate bothcatastrophic and operational risk measures over the period 1973-2001. Wefind evidence of cyclical components in both the catastrophic andoperational risk measures obtained from the Generalized ParetoDistribution and the Skewed Generalized Error Distribution. Our new,comprehensive approach to measuring operational risk shows thatapproximately two thirds of financial institutions’ returnsrepresents compensation for operational risk.

Credit Risk Analysis and Security Design

Sat, 29 May 2004 22:58:59 GMT

Title: Credit Risk Analysis and Security Design

Inderst, Roman; Müller, Holger M.

Abstract: We consider the security design problem of a lender who can assess theborrower’s project prior to making an accept or reject decision.The lender’s subjective assessment is represented by a privatesignal. Unless the lender extracts the full surplus from the project,her cutoff signal above which she is willing to accept the project isinefficiently high, i.e., the lender is too conservative. The uniqueoptimal security is standard debt. Debt maximizes the lender’spayoff from financing bad–i.e., low-signal–projects, thusimplementing a lower cutoff signal than other securities. While thelender could, in principle, make the loan terms indirectly contingent onthe signal by choosing a security from a prespecified menu, such ex-postfine-tuning is generally not optimal. Rather, it is optimal to eithergrant credit at standardized terms or not at all. Our model suggests anatural segmentation among lenders, whereby inside (i.e., local orrelationship) lenders attract low-NPV borrowers while arm’s-lengthlenders attract high-NPV borrowers.

Credit Risk Analysis and Security Design

Tue, 29 Oct 2002 22:58:59 GMT

Title: Credit Risk Analysis and Security Design

Inderst, Roman; Mueller, Holger M.

Abstract: This paper considers the potential cost of subjective judgment anddiscretion in credit decisions. We show that subjectivity and discretionin the evaluation of borrowers create an incentive problem on the partof the lender. The lender’s incentives to accept or reject aborrower depend only on the value of her own claims, not on the totalvalue of the project. Unless the lender obtains the full NPV her creditdecision is too conservative, i.e., she uses too high a hurdle rate.Given this problem we show that the unique optimal security is standarddebt. Among all securities debt is the one that makes the lender theleast conservative, thus providing her with optimal incentives to tradeotype-1 and type-2 errors. Among other things, this suggests that thecommon folk wisdom whereby giving banks equity makes them less cautiousin their credit decisions is generally not correct

Credit Ratings and the BIS Reform Agenda

Fri, 09 Feb 2001 22:58:59 GMT

Title: Credit Ratings and the BIS Reform Agenda

Altman, Edward; Saunders, Anthony

Abstract: This is an updated and revised paper from the authors’ report on“An Analysis and Critique of the BIS Proposal on Capital Adequacyand Ratings” [S-CDM-00-02] (submitted to the BIS and published inthe Journal of Banking & Finance, Vol. 25, #1, January, 2001).Thispaper was first prepared for the NYU Salomon Center/University ofMaryland research project on “The Role of Credit Reporting Systemsin the International Economy,” sponsored by the Center forInternational Political Economy. It was prepared for the project’sconference in Washington D.C. on March 1-2, 2001 at the headquarters ofthe World Bank.

Conflicts of Interest and Market Discipline Among Financial Services Firms

Tue, 31 Dec 2002 22:58:59 GMT

Title: Conflicts of Interest and Market Discipline Among Financial Services Firms

Walter, Ingo

Abstract: here has been substantial public and regulatory attention of late toapparent exploitation of conflicts of interest involving financialservices firms based on financial market imperfections and asymmetricinformation. This paper proposes a workable taxonomy of conflicts ofinterest in financial services firms, and links it to the nature andscope of activities conducted by such firms, including possiblecompounding of interest-conflicts in multifunctional clientrelationships. It lays out the conditions that either encourage orconstrain exploitation of conflicts of interest, focusing in particularon the role of information asymmetries and market discipline, includingthe shareholder-impact of litigation and regulatory initiatives.External regulation and market discipline are viewed as both complementsand substitutes – market discipline can leverage the impact ofexternal regulatory sanctions, while improving its granularity thoughdetailed management initiatives applied under threat of marketdiscipline. At the same time, market discipline may help obviate theneed for some types of external control of conflict of interest exploitation.

Conflicts of interest and efficient contracting in IPOs

Thu, 19 Sep 2002 22:58:59 GMT

Title: Conflicts of interest and efficient contracting in IPOs

Ljungqvist, Alexander

Abstract: We study the role of underwriter compensation in mitigating conflicts ofinterest between companies going public and their investment bankers.Making the bank’s compensation more sensitive to theissuer’s valuation should reduce agency conflicts and thusunderpricing. Consistent with this prediction, we show that contractingon higher commissions in U.K. IPOs leads to significantly lowerunderpricing: a one percentage point increase in the commission ratereduces the initial return by 11 percentage points, after controllingfor other influences on underpricing. Moreover, we present evidenceconsistent with issuers choosing commission rates optimally. Overall,our results indicate that issuers and banks contract efficiently in U.K. IPOs.

Competition and Financial Stability

Fri, 05 Sep 2003 22:58:59 GMT

Title: Competition and Financial Stability

Allen, Franklin; Gale, Douglas

Abstract: Competition policy in the banking sector is complicated by the necessityof maintaining financial stability. Greater competition may be good for(static) efficiency, but bad for financial stability. From the point ofview of welfare economics, the relevant question is: What are theefficient levels of competition and financial stability? We use avariety of models to address this question and find that differentmodels provide different answers. The relationship between competitionand stability is complex: sometimes competition increases stability. Inaddition, in a second-best world, concentration may be sociallypreferable to perfect competition and perfect stability may be socially undesirable.

Competing for Securities Underwriting Mandates: Banking Relationships and Analyst Recommendations

Sun, 07 Dec 2003 22:58:59 GMT

Title: Competing for Securities Underwriting Mandates: Banking Relationshipsand Analyst Recommendations

Ljungqvist, Alexander; Marston, Felicia; Wilhelm, William J. Jr.

Abstract: We investigate directly whether analyst behavior influenced thelikelihood of banks winning underwriting mandates for a sample of 16,625U.S. debt and equity offerings sold between December 1993 and June 2002.We control for the strength of the issuer’s investment-bankingrelationships with potential competitors for the mandate, prior lendingrelationships, and the endogeneity of analyst behavior and thebank’s decision to provide analyst coverage. We find no evidencethat aggressive analyst recommendations or recommendation upgradesincreased their bank’s probability of winning an underwritingmandate after controlling for analysts’ career concerns and bankreputation. Our findings might be interpreted as suggesting that bankand analyst credibility are central to resolving information frictionsassociated with securities offerings.

Competing for Securities Underwriting Mandates: Banking Relationships and Analyst Recommendations

Sun, 13 Jul 2003 22:58:59 GMT

Title: Competing for Securities Underwriting Mandates: Banking Relationshipsand Analyst Recommendations

Ljungqvist, Alexander; Marston, Felicia; Wilhelm, William J. Jr.

Abstract: We investigate directly whether analyst behavior influenced thelikelihood of banks winning underwriting mandates for a sample of 16,456U.S. debt and equity offerings sold between December 1993 and June 2002.We control for the strength of the issuer’s investment-bankingrelationships with potential competitors for the mandate and for theendogeneity of analyst behavior and the bank’s decision to provideanalyst coverage. Contrary to recent allegations, we find no evidencethat aggressive analyst recommendations or recommendation upgradesincreased a bank’s probability of winning an underwriting mandateonce we control for analysts’ career concerns. In fact, theopposite appears to be the case. Nor do we find that banks competedsuccessfully for equity deals on the basis of their ability to makelow-cost corporate loans available. Only among debt deals sold since thederegulation of commercial banks is there evidence of aggressiverecommendations helping banks to win underwriting mandates.

Commercial Bank Underwriting of Credit-Enhanced Bonds: Are there Certification Benefits to the Issuer?

Tue, 26 Feb 2002 22:58:59 GMT

Title: Commercial Bank Underwriting of Credit-Enhanced Bonds: Are thereCertification Benefits to the Issuer?

Saunders, Anthony; Stover, Roger D.

Abstract: Recent studies have expanded the commercial bank certificationhypothesis to include banks acting in an underwriting capacity. Thispaper further develops that research by focusing on the industrialrevenue bond market in which banks have the unique opportunity tosimultaneously act as both credit guarantor and underwriter. Whenexplicitly allowing for bank-issued standby letters of credit(guarantees), we find significantly greater yield spreads for thosebonds underwritten by commercial banks compared to bonds underwritten byinvestment banks. Overall, no net benefit appears to accrue to the bondissuer when attempting to achieve joint (or double) certificationbenefits by employing commercial banks as both credit guarantor andunderwriters except in the special case where the same bank acts as bothguarantor and underwriter. This limited certification effect is furthervalidated when the credit quality of participating banks is accountedfor. This result is consistent with an "economy of scope" inmonitoring and reusing information.

Commercial Bank Underwriting of Credit-Enhanced Bonds: Are there Benefits to the Issuer?

Sun, 22 Jul 2001 22:58:59 GMT

Title: Commercial Bank Underwriting of Credit-Enhanced Bonds: Are thereBenefits to the Issuer?

Saunders, Anthony; Stover, Roger D.

Abstract: Recent studies have expanded the commercial bank certificationhypothesis to include banks acting in an underwriting capacity. Thispaper further develops that research by focusing on the industrialrevenue bond market in which banks have the unique opportunity tosimultaneously act as both credit guarantor and underwriter. Whenexplicitly allowing for bank-issued standby letters of credit(guarantees), we find significantly greater yield spreads for thosebonds underwritten by commercial banks compared to bonds underwritten byinvestment banks. Overall, no net benefit appears to accrue to the bondissuer when attempting to achieve joint (or double) certificationbenefits by employing commercial banks as both credit guarantor andunderwriters except in the special case where the same bank acts as bothguarantor and underwriter. This latter result is consistent with an"economy of scope" in monitoring and reusing information.

Central Bank Intervention and the Intraday Process of Price Formation in the Currency Markets

Thu, 03 Oct 2002 22:58:59 GMT

Title: Central Bank Intervention and the Intraday Process of Price Formation inthe Currency Markets

Pasquariello, Paolo

Abstract: We study the impact of Central Bank intervention on the microstructureof currency markets. We analyze the two major channels of effectivenessof currency management policies, imperfect substitutability andsignaling, in a model of sequential trading in which the stylizedmonetary authority is a rational but not necessarily profit-maximizingplayer. In the context of our model and consistently with the availableempirical literature, intervention has long-lived effects on quotes wheninformative about policy objectives and economic fundamentals, or whenthe threat of future government action is significant and credible. Amonetary authority attempting to lean against the wind or to chase thetrend of the domestic currency is more successful when dealers competeagainst each other for the incoming trades. The resulting process ofintraday price formation and bid-ask spreads are shown to dependcrucially on the degree of market power held by the forex dealers, onthe sign and magnitude of the announced and realized intervention, onthe perceived likelihood of a future intervention to occur, on thetransparency of the order flow induced by the intervention, on thedirection and heterogeneity of agents' beliefs and expectations, and onthe elasticity of risk-averse investors' demand for foreigncurrency-denominated assets.

Birth of the Federal Reserve: Crisis in the Womb

Sun, 28 Sep 2003 22:58:59 GMT

Title: Birth of the Federal Reserve: Crisis in the Womb

Silber, William L.

Abstract: The outbreak of World War I shut the New York Stock Exchange for morethan four months. The conventional explanation maintains that theclosure prevented a collapse in stock prices that threatened arepetition of the Panic of 1907. This paper shows that the WilsonAdministration encouraged the suspension of trading to pave the way forlaunching the Federal Reserve System, which was in the process of beingborn. Closing the Exchange helped to forestall an outflow of gold.Federal Reserve insiders considered an adequate stock of gold crucial tothe success of the new monetary system.

Bank Management and Market Discipline

Sun, 28 Sep 2003 22:58:59 GMT

Title: Bank Management and Market Discipline

Landskroner, Yoram; Paroush, Jacob

Abstract: In recent years market discipline attracted interest as a mechanism toaugment or to partially replace government oversight (discipline) of thefinancial sector, specifically depository institutions. Despite theabundance of research, mostly empirical studies, in the area no formalmodel has been presented to analyze the different aspects of the issue.This paper attempts to fill this gap. In our model we incorporate thecharacteristics of the regulatory structure and market discipline andexamine the effects of several parameters on the optimal decisions ofthe bank. For example we consider the effects of changes in risk,deposit insurance coverage, and degree of market discipline. In mostcases our results are compatible with recent empirical findings.

Allocations, Adverse Selection and Cascades in IPOs: Evidence from Israel

Fri, 28 Sep 2001 22:58:59 GMT

Title: Allocations, Adverse Selection and Cascades in IPOs: Evidence from Israel

Amihud, Yakov; Hauser, Shmuel; Kirsh, Amir

Abstract: This paper examines three theories of IPO underpricing, using data fromIsrael where the allocations to subscribers are equally prorated andpublicly known. Rock’s (1986) theory of adverse selection issupported: subscribers receive greater allocations in overpriced IPOs.And, while the average IPO excess return is 12%, the simulatedallocation-weighted return to uninformed investors is slightly negative.Welch’s (1992) theory of information cascades is supported by thepattern of allocations: demand is either extremely high or there isundersubscription, with very few cases in between. Also supported is theproposition that underpricing is a means to increase ownership dispersion.

A Survey of Cyclical Effects in Credit Risk Measurement Models

Sun, 28 Apr 2002 22:58:59 GMT

Title: A Survey of Cyclical Effects in Credit Risk Measurement Models

Allen, Linda; Saunders, Anthony

Abstract: We survey both academic and proprietary models to examine howmacroeconomic and systematic risk effects are incorporated into measuresof credit risk exposure. Many models consider the correlation betweenthe probability of default (PD) and cyclical factors. Few models adjustloss rates (loss given default) to reflect cyclical effects. We findthat the possibility of systematic correlation between PD and LGD isalso neglected in currently available models.