Research in Finance: Volume 18

This paper provides a basic reference to the development of the safety and soundness of banks as a concept, the utility of stochastic coefficient estimation as a means to measure risks, and to the development of capital adequacy evaluation and portfolio selection procedures that permit regulators and banks to estimate the key ratios of equity to assets and return on assets before interest and taxes to the interest rate on liabilities on a fall market value accounting basis.

This article provides new interpretations of some of the key findings of research on the economic consequences of financial services industry consolidation. These new interpretations are more plausible than the previously given interpretations. The article also presents some new results on the effects of mergers on the solvency probabilities of participating financial institutions.

Banks may face environmental liability when they extend secured loans but this liability does not extend to public secured debt. This paper introduces the concept of lender environmental liability to the literature of theoretical finance by extending the work of Stulz and Johnson (1985) and Schwartz (1981, 1984) to distinguish among three possible cases for lender environmental liability. Using option payoff graphs we demonstrate that secured debt can be worth less to the lender than unsecured debt. We reinforce this conclusion by employing a formal debt valuation model based on an extension of Lai (1995).

In this paper, we develop a specific valuation model far the American perpetual put option with uncertain exercise price and empirically verify that the closed-end fund (CEF) discount puzzle can be explained by a put model.Using available sample data of 56 CEFs for the most recent seven years, we find strong empirical evidence for our discount approach. We find no significant differences between the average discounts and average returns of domestic and international funds. However, the international funds seem to have significantly greater volatility of returns than that of domestic funds, implying that foreign financial assets could be priced differently from domestic funds.

Price-matching refunds are frequently used by sellers as part of their overall pricing strategy. While previous research on price-matching refunds has focused on providing a rationale for its existence, our focus is on the financial aspect of such pricing policies. In particular, we contend that a price-matching refund offer is a contingent liability undertaken by sellers. As such, this liability, contingent on whether buyers identify a lower price and claim the refund, has financial value. This contingent-claims perspective enables us to draw on the option pricing literature to analyze price-matching refund offers and identify the key parameters that determine the value of a refund “put” option. The option pricing model provides insights regarding the optimal design of price-matching policies. Importantly, this perspective enables us to numerically compare the costs of offering a price-matching refund policy to alternative pricing strategies. Further, the contingent-claims perspective allows us to represent the existing rationales for price-matching matching refund policies in a parsimonious framework

The effect of time complementarity is examined on the equity premium and consumption smoothing. Under time complementarity (or substitutability), the equity premium is smaller (or larger) and the growth rate in consumption is less (or more) volatile than under time additive preference. It is shown that a resolution of the consumption smoothing puzzle and the equity premium puzzle critically depends on the choice of the risk aversion measure.

This research investigates yield spreads between traditional preferred and a new type of tax-deductible preferred that is essentially a form of debt upon which the issuer has some rights to defer payments. Risk-adjusted pretax yields on the tax-deductible preferred are empirically found to be only slightly higher than those on traditional preferred, and only for highgrade or liquid issues, while they are discovered to be insignificantly different from those on bonds. The results imply that large after-tax yield advantages exist for corporate investors to hold traditional preferred and for corporate issuers to finance with the tax-deductible preferred if they can afford the greater liquidity and bankruptcy risk, respectively.

Black (1976) model assumes a lognormal distribution for futures prices, and has been shown to misprice deep in-the-money and deep out-of-the-money futures options. in this paper, the jump-diffusion stochastic interest rates model developed by Doffou and Hilliard (1999a) is fitted to currency futures and futures options data to yield probabilistic information. The model implies non-normal skewness and kurtosis for the log of price relative, and prices currency futures options better than Bates' (1991) model and far better than Black's model.

The purpose of this paper is to determine the best way to hedge currency risk using futures contracts. Various techniques of hedging currency risk are compared, and a new method is proposed. This paper also documents the duration and the expiration effects on the optimal hedge ratio. The main finding of this paper is that, of the techniques examined, the hedge ratio derived by Vishwanath (1993) performs the best. This paper also finds that as the duration of the hedge increases, the hedge ratio increases. For one week and two weeks duration hedges, as the time left to futures contract expiration increases, the hedge ratio increases and there is linear relationship. The results are not as pronounced for four and six-week duration hedges.

The paper is an investigation of the possible long-run and short-run dynamics between the stock and foreign exchange markets in Thailand and Indonesia. The cointegration methodology is applied using the weekly data from November 8, 1991 through December 26, 1997. Each variable is non-stationary in levels and depicts I(1) behavior. There is no evidence of cointegration between these variables. Simple Granger causality tests confirm bidirectional causality, however