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This paper explores empirical linkages between
credit unions' (CUs') policies and their financial performance, as measured by
loan delinquency and profitability, using a unique micro dataset of credit
unions in three Latin American countries. The estimated translog profit
function is generalized using a slack variable concept that parameterizes any
systematic deviation from profit- maximizing behavior exhibited within the
sample. In general, we find that performance depends in important ways on two
types of CU policy variables, some associated with the incentives of borrowers
to repay and others that affect the CU's ability to screen loans.
(142 KB, 31 pages)
Commercial banks leverage their equity capital with demandable debt that participates in the economy's payments system. The distinctive nature of this debt generates an unusual degree of liquidity risk that can, at times, threaten the payments system. To reduce this threat, insurance protects deposits; and to reduce the moral hazard problems of the debt contract and deposit insurance, bank regulation constrains risk-taking and defines standards of capital adequacy. The inherent liquidity risk of demandable debt as well as potential regulatory penalties for poor financial performance creates the potential for costly episodes of financial distress that affects banks' employment of capital.
The existence of financial-distress costs implies that many banks are likely to take actions, such as holding additional capital, that increase bank safety at the expense of short-run returns. While such a strategy may reduce average returns in the short run, it may maximize the market value of the bank by protecting charter value and protecting against regulatory interventions. On the other hand, some banks whose charter values are low may have an incentive to follow a higher risk strategy, one that increases average return at the expense of greater risk of financial distress and regulatory intervention.
This paper examines how banks' employment of capital in
their production plans affects their "market value" efficiency. The authors
develop a market-based measure of production efficiency and implement it on a
sample of publicly traded bank holding companies. Our evidence indicates that
banks' efficiency and, hence, the market value of their assets are influenced
by the level and allocation of capital. However, even controlling for the
effect of size, we find that the influence of equity capital differs markedly
between banks with higher capital-to-assets ratios and those with lower ratios.
For inefficient banks with higher capital-to-assets ratios, marginal increases
in capitalization and asset quality boost their market-value efficiency. For
inefficient banks with lower levels of capitalization, the signs of these
effects are reversed. Controlling for asset size, it appears that less
capitalized banks cannot afford to mimic the investment strategy of more
capitalized banks, which may be using this greater capitalization to signal
their safety to financial markets.
(115 KB, 25 pages)
In perfectly competitive markets, prices aggregate inputs and outputs into a money metric that allows production plans to be ranked by their profitability. When informational asymmetries in competitive markets lead to adverse selection, prices in these markets assume an additional role that conveys information about product quality. In the case of banking production, quality is linked to risk because prices are linked to credit quality.
The problem of efficiency measurement is complicated by the additional role because quality varies with price and price is a decision variable of firms operating in these markets. The effect of these endogenous components of prices on financial performance is illustrated with a production-based model and a market-value model that generate "best- practice" frontiers. Unlike the standard profit function's frontier, these frontiers are not conditioned on prices so that they compare the financial performance of firms with different quality-linked prices. Hence, they identify the most efficient pricing strategies as well as the most efficient production plans.
These two alternative models for measuring efficiency are
employed to study the efficiency of highest level bank holding companies in the
United States in 1994. The contractural interest rates these banks obtain on
their loans and other assets are shown to influence their expected profit,
profit risk, market value, and efficiency.
(212 KB, 31 pages)
The trade-off between risk and return in equity
markets is well established. This paper examines the existence of the same
trade-off in the single-family housing market. That market is dominated by
homeowners, who constitute about two-thirds of U.S. households. For them the
choice about how much housing and what house to buy is a joint
consumption/investment decision. Furthermore, owner-occupied housing is by
nature a lumpy investment whose risk cannot be completely diversified. Does
this consumption/investment link negate the risk/return trade-off within the
single-family housing market? Theory suggests the link still holds. This paper
supplies empirical evidence in support of that theoretical result.
(96 KB, 25 pages)
The computerization of retailing has made price dispersion a norm
in the United States, so that any given list price or transactions price is an
increasingly imperfect measure of a product's resource cost. As a consequence,
measuring the real output of retailers has become increasingly difficult. Food
retailing is used as a case study to examine data problems in retail
productivity measurement. Crude direct measures of grocery store output suggest
that the CPI for food-at-home may have been overstated by 1.4 percentage points
annually from 1978 to 1996.
(73 KB, 34 pages)
In this paper,
the authors document that the disparity in employment densities across U.S.
metropolitan areas has lessened substantially over the postwar period. To
account for this deconcentration of metropolitan employment, the authors
develop a system-of-cities model in which an increase in aggregate metropolitan
employment causes congestion costs to increase faster for the more dense metro
areas. A calibrated version of the model reveals that the (roughly)
two-and-a-half-fold increase in postwar aggregate metropolitan employment
implies, by itself, more deconcentration than actually observed. Thus, rising
aggregate metropolitan employment appears to be a powerful force favoring
deconcentration, although some benefit of greater employment density appears to
have partially offset the effects of rising congestion costs for the more dense
(553 KB, 56 pages)
In this paper, the author examines the geographic distribution of transportation investments as well as the question of who pays for the investments in the Philadelphia metropolitan area, focusing on differences between the city and its surrounding Pennsylvania suburban counties. The author presents estimates of total, per capita, and per user benefits of highway investments, as well as fees generated by highway users at the county level. The author also examines the combined highway and transit investments in the suburbs as a whole and in the city.
There are three central findings in this analysis: (1) Highway capital expenditures in the Greater Philadelphia region are significantly higher on a per capita basis in the Pennsylvania suburbs than in the city of Philadelphia. Over the 10 years from 1986-1995, expenditures benefiting suburban residents are estimated to be $1041 per capita, about 2.5 times as large as those benefiting city residents, which were $424 per capita. (2) Total highway user fees generated differ significantly across communities because of different auto ownership rates. Users fees do not, however, have differential effects on the attractiveness of communities because the user fees that individual drivers pay are the same across communities. (3) The per user differences between Philadelphia and its suburbs are smaller than per capita differences. Per user differences affect the degree to which car travel is favored in the city versus the suburbs, but it does not capture the location effects of investment in transportation infrastructure.
The difference in per capita expenditures is likely to
have a significant effect on the competitive position of the city of
Philadelphia relative to its suburbs. Highway investments have provided an
economically significant, although not overwhelming, incentive for suburban
rather than city locations for people and firms. The author estimates that the
highway investment differential reduces employment in the city by about 40,000
(70 KB, 38 pages)
98-8 Randall Wright, "A Note on Purifying Mixed Strategy Equilibria in the Search-Theoretic Model of Fiat Money"
The simple search-theoretic model of fiat money has three symmetric Nash equilibria: all agents accept money with probability 1; all agents accept money with probability 0; and all agents accept money with probability y between 0 and 1. Here the author constructs a nonsymmetric pure strategy equilibrium, payoff-equivalent to the symmetric mixed strategy equilibrium, where a fraction N between 0 and 1 of agents always accepts money and 1-N never accepts money. Counter to what has been conjectured previously, the author finds N>y. The author also studies evolutionary dynamics and shows that the economy converges to monetary exchange if and only if the initial proportion of agents accepting money exceeds N.
98-9 Kenneth Burdett, Shouyong Shi, and Randall Wright, "Pricing with Frictions"
The authors analyze markets where each of n buyers wants to buy one unit and each of m sellers wants to sell one or more units of an indivisible good. Sellers first set prices, then buyers choose which sellers to visit. There are equilibria where each buyer visits sellers at random and faces a positive probability of rationing when too many other buyers show up at the same location. The authors solve for equilibrium prices and other variables as functions of n and m, compare the outcome to the predictions of other models, and derive some limiting results as the economy gets large. The authors also discuss the impact of changes in capacity and show that the effects of an increase in supply can be very different depending on whether it occurs along the intensive or the extensive margin (a change in the number of units of output per seller or in the number of sellers). Among other things, this last result suggests that the standard matching function in the equilibrium search literature is misspecified. On the basis of this interpretation, the authors propose that the observed outward shift in the Beveridge curve may be explained by a shift in the firm-size distribution.
For nearly two decades banks
in the United States have consolidated in record numbers—in terms of both
frequency and the size of the merging institutions. Rhoades (1996) hypothesizes
that the main motivators were increased potential for geographic expansion
created by changes in state laws regulating branching and a more favorable
antitrust climate. To look for evidence of economic incentives to exploit these
improved opportunities for consolidation, the authors examine how consolidation
affects expected profit, the riskiness of profit, profit efficiency, market
value, market-value efficiencies, and the risk of insolvency. Their estimates
of expected profit, profit risk, and profit efficiency are based on a
structural model of leveraged portfolio production that was estimated for a
sample of highest-level U.S. bank holding companies in Hughes, Lang, Mester,
and Moon (1996). Here, the authors also estimate two additional measures that
gauge efficiency in terms of the market values of assets and of equity. Their
findings suggest that the economic benefits of consolidation are strongest for
those banks engaged in interstate expansion and, in particular, interstate
expansion that diversifies banks' macroeconomic risk. Not only do these banks
experience clear gains in their financial performance, but society also
benefits from the enhanced bank safety that follows from this type of
(107 KB, 41 pages)
This paper examines the cyclical
dynamics of per capita personal income for the major U.S. regions during the
1953:3-95:2 period. The analysis reveals considerable differences in the
volatility of regional cycles. Controlling for differences in volatility, the
authors find a great deal of comovement in the cyclical response of four
regions (New England, Southeast, Southwest, and Far West), which the authors
call the core region, and the nation. The authors also find a great deal of
comovement between the Mideast and Plains regions, but these regions are only
weakly correlated with national movements. The cyclical response of the Great
Lakes region is markedly different from that of the other regions and the
nation. Possible sources underlying differences in regional cycles are
explored, such as the share of a region's income accounted for by
manufacturing, defense spending as a proportion of a region's income, oil price
shocks, and the stance of monetary policy. Somewhat surprisingly, the authors
find that the share of manufacturing in a region seems to account for little of
the variation in regional cycles.
(150 KB, 33 pages)
This paper presents a small-scale macroeconometric time-series
model that can be used to generate short-term forecasts for U.S. output,
inflation, and the rate of unemployment. Drawing on both the Bayesian VAR and
vector error corrections (VEC) literature, the author specifies the baseline
model as a Bayesian VEC. The author documents the model's forecasting ability
over various periods, examines its impulse responses, and considers several
reasonable alternative specifications. Based on a root-mean-square-error
criterion, the baseline model works best, and the author concludes that this
model holds promise as a workhorse forecasting tool.
(122 KB, 44 pages)
This paper examines the predictive power of shifts
in monetary policy, as measured by changes in the real federal funds rate, for
output, inflation, and survey expectations of these variables. The authors find
that policy shifts have larger effects on actual output than on expected
output, suggesting that agents underestimate the effects of policy on aggregate
demand. Their results help explain the real effects of monetary policy, and
they provide negative evidence on the rationality of expectations.
(127 KB, 24 pages)
In the early 1980s, economists tested inflation forecasts and found that the forecasts were very bad. Either the surveys didn't capture forecasters' expectations, or forecasters didn't have rational expectations. However, the sample period being examined consisted mostly of data from the volatile 1970s, when forecasting was extremely difficult. The question is: If we run the same types of tests that were performed 15 years ago on an updated sample, will we find the same problems with the forecasts?
This paper finds that much of the empirical work from 15
years ago does not stand the test of time. The forecast errors from the surveys
aren't nearly as bad today as they were in the 1970s. However, some problems
remain in the forecasts. It appears to be possible to improve inflation
forecasts over some sample periods using bias regressions, and the forecasts
don't pass all tests for optimality.
(264 KB, 38 pages)
98-15 Janet Ceglowski, "Has the Border Narrowed?"
In the late 1980s, Canada's provinces traded 20 times more with one another than with U.S. states of comparable size and distance. In other words, the Canada-U.S. border exerted a strong effect on the pattern of Canada's continental trade patterns. Since then, globalization and the formation of the Canada-U.S. and North American free trade areas could have reduced the impact of the border on continental trade patterns. However, estimates from a gravity model of aggregate Canadian trade reveal no evidence of a narrowing border, at least through 1996. The border effect appears remarkably stable both over time and across equation specifications.
98-16/R Janet Ceglowski, "Regionalization and Home Bias: The Case of Canada"
The bilateral trade flows between Canada and the U.S. are the world's largest and have grown rapidly in the 1990s. Are they evidence of a North American trading bloc? A gravity model of trade finds that while economic size and proximity can explain much of the substantial trade between Canada and the U.S., Canada's merchandise trade exhibits a significant U.S. bias. The model also reveals that trade between Canada's provinces is 31 times that between a province and a country other than the U.S., significantly higher than estimates of Canada's home bias relative to the U.S.
Under the European Monetary Union (EMU), member countries will be subject to common monetary policy shocks. Given the diversity in the economic and financial structures across the EMU economies, these common monetary shocks can be reasonably expected to have different effects. Little is known about what differences might arise, however, given the absence of any historical experience in Europe with a common currency.
An alternative approach is to draw upon the historical experience of monetary policy's impacts on sub-national regions in the United States. Like the countries of the EMU, U.S. states and regions differ in industry mix and financial composition, while at the same time, they employ a common currency. Thus, the lessons learned from the U.S. experience provide valuable information about the potentially varied effects of a common monetary policy across EMU economies.
In this paper, the authors use earlier findings to
construct an index that ranks EMU countries by their likely sensitivity to a
common monetary shock. The index indicates that countries fall into one of
three groups: Finland, Ireland, and Spain are likely to be most responsive to
monetary policy shocks; France, Italy, and the Netherlands will have a
relatively small response; and Austria, Belgium, Portugal, Germany, and
Luxembourg are likely to have a response close to the EMU average.
(181 KB, 33 pages)
98-18 J. David Cummins, Sharon Tennyson, and Mary A. Weiss, "Consolidation and Efficiency in the U.S. Life Insurance Industry"
This paper examines the relationship between mergers and acquisitions, efficiency, and scale economies in the U.S. life insurance industry. We estimate cost and revenue efficiency over the period 1988-1995 using data envelopment analysis (DEA). The Malmquist methodology is used to measure changes in efficiency over time. We find that acquired firms achieve greater efficiency gains than firms that have not been involved in mergers or acquisitions. Firms operating with nondecreasing returns to scale and financially vulnerable firms are more likely to be acquisition targets. Overall, mergers and acquisitions in the life insurance industry have had a beneficial effect on efficiency.
98-19 J. David Cummins, Mary A. Weiss, and Hongmin Zi, "Organizational Form and Efficiency: An Analysis of Stock and Mutual Property-Liability Insurers"
This paper analyzes the efficiency of stock and mutual organizational forms in the property-liability insurance industry using nonparametric frontier efficiency methods. We test the managerial discretion hypothesis, which predicts that the market will sort organizational forms into market segments where they have comparative advantages in minimizing the costs of production, including agency costs. Both production and cost frontiers are estimated. The results indicate that stocks and mutuals are operating on separate production and cost frontiers and thus represent distinct technologies. The stock technology dominates the mutual technology for producing stock output vectors, and the mutual technology dominates the stock technology for producing mutual output vectors. However, the stock cost frontier dominates the mutual cost frontier for the majority of both stock and mutual firms. The finding of separate frontiers and organization-specific technological advantages is consistent with the managerial discretion hypothesis, but we also find evidence that stocks are more successful than mutuals in minimizing costs, suggesting the existence of agency problems in the mutual organizational form.
This paper analyzes the accuracy
of the principal models used by U.S. insurance regulators to predict
insolvencies in the property-liability insurance industry and compares these
models with a relatively new solvency testing approach--cash flow simulation.
Specifically, we compare the risk-based capital (RBC) system introduced by the
National Association of Insurance Commissioners (NAIC) in 1994, the FAST
(Financial Analysis and Surveillance Tracking) audit ratio system used by the
NAIC, and a cash flow simulation model developed by the authors. Both the RBC
and FAST systems are static, ratio-based approaches to solvency testing,
whereas the cash flow simulation model implements dynamic financial analysis.
Logistic regression analysis is used to test the models for a large sample of
solvent and insolvent property-liability insurers, using data from the years
1990-1992 to predict insolvencies over three-year prediction horizons. We find
that the FAST system dominates RBC as a static method for predicting insurer
insolvencies. Further, we find the cash flow simulation variables add
significant explanatory power to the regressions and lead to more accurate
solvency prediction than the ratio-based models taken alone.
(243 KB, 46 pages)
Recent papers have questioned the
accuracy of the Bureau of Labor Statistics' methodology for measuring implicit
rents for owner-occupied housing. The authors propose cross-checking the BLS
statistics by using data on owner-occupied and rental housing from the American
(64 KB, 36 pages)
The authors empirically examine the hypothesis that access to
deposits with inelastic rates (core deposits) permits a bank to make
contractual agreements with borrowers that are infeasible if the bank must pay
market rates for its funds. Access to core deposits insulates a bank's costs of
funds from exogenous shocks, allowing the bank to insulate its borrowers
against exogenous credit shocks. The authors find that, controlling for
competitive conditions in loan markets, banks funded more heavily with core
deposits provide more smoothing of loan rates in response to exogenous changes
in aggregate credit risk. This suggests that a distinctive feature of bank
lending is that firms and banks form multiperiod lending relationships in which
loans need not break even period by period. It also partially explains the
declining share of bank loans (or near substitutes for bank loans) in credit
markets. As banks have increasingly been forced to pay market rates for an
increasing share of their funds, multiperiod relationship lending has become
increasingly less feasible and bank loans have lost some of their comparative
advantage over securities. The authors' results suggest that access to core
deposits is one of the foundations of relationship lending.
(145 KB, 46 pages)
This paper examines the
potential impact of the federal tax treatment of housing, which provides tax
advantages that increase with income and house value, on the pattern of
development in U.S. metropolitan areas. The authors argue that the tax
treatment of housing is likely to have impacts on older, developed communities
with fixed boundaries, such as central cities, that differ from those on
suburban areas, where there is an elastic supply of land. Using simple analytic
models, the authors show that the tax treatment of housing not only increases
the incentives for lower density development, but it also provides incentives
for increased sorting of high- and low-income households into separate
communities. Given the very large magnitude of the annual subsidies to housing
($65 billion) and the fact that these subsidies accrue to a relatively small
share of home owners, the authors believe that the impact of these subsidies on
the pattern of metropolitan development is potentially very important.
(80 KB, 27 pages)
A regulatory taking occurs when a court concludes that a government action has taken private property for a public use without paying just compensation to the owner--a violation of the fifth amendment. Often, the remedy is a monetary award whose value is determined by the court.
In recent years there has been considerable interest in creating a statutory complement to the constitutional law of takings. Some believe that a statutory scheme, using procedural financial approaches, would discourage federal regulatory activities that reduce the value of privately owned property. The procedural approach would require federal agencies to evaluate the property value effects of proposed actions before undertaking them. The financial approach would require that federal agencies pay from their own budgets for any compensation awards that result from their decisions.
This paper compares the existing procedural and financial
approaches to the ones proposed. It describes the model of agency incentives
and the regulatory environment implicitly assumed by these proposals and
compares them to the literature on regulatory decision making and
administrative law. Finally, the paper discusses some of the institutional
factors likely to affect the outcome of the proposed reforms, including the
role of the courts in enforcing analysis requirements, the extent of agency
discretion, and the federal budget process.
(146 KB, 56 pages)
Do checking accounts help banks monitor borrowers? If they do, the rationale both for allowing regulated providers of liquidity to also make risky loans to commercial borrowers and for the government's providing deposit insurance becomes clearer. Using a unique set of data that includes monthly and annual information on small-business borrowers at an anonymous Canadian bank, the authors provide evidence that a bank has exclusive access to a continuous stream of borrower data, namely, the firm's checking account balances at the bank, that helps it to monitor the borrower.
To the authors' knowledge, this paper is the first direct
empirical test of the usefulness of checking account information in monitoring
commercial borrowers. The authors directly examine the mechanism through which
a bank is able to gain an information advantage over other types of lenders and
find evidence that checking account information is indeed relatively
transparent for monitoring borrowers' collateral and that such monitoring is
useful in detecting problems with loans. As such, the authors' data provide
"smoking gun" evidence that banks are special.
(112 KB, 37 pages)