New Economics Papers
on Banking
Issue of 2010‒06‒04
25 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Taxing risk and the optimal regulation of financial institutions By Narayana Kocherlakota
  2. Financial Connections and Systemic Risk By Franklin Allen; Ana Babus; Elena Carletti
  3. Toward a global risk map By Stephen Cecchetti; Ingo Fender; Kostas Patrick McGuire
  4. The Credit Crisis around the Globe: Why Did Some Banks Perform Better? By Beltratti, Andrea; Stulz, Rene M.
  5. Can banks circumvent minimum capital requirements? The case of mortgage portfolios under Basel II By Christopher Henderson; Julapa Jagtiani
  6. Global banks and international shock transmission: evidence from the crisis By Nicola Cetorelli; Linda S. Goldberg
  7. The functioning of the European interbank market during the 2007-08 financial crisis By Silvia Gabrieli
  8. Policy Perspectives on OTC Derivatives Market Infrastructure By Duffie, Darrell; Li, Ada; Lubke, Theo
  9. Dynamic Provisioning: Some Lessons from Existing Experiences By de Lis, Santiago Fernández; Herrero, Alicia Garcia
  10. The African Financial Development Gap By Franklin Allen; Elena Carletti; Robert Cull; Jun "QJ" Qian; Lemma Senbet
  11. Did bankruptcy reform cause mortgage default rates to rise? By Wenli Li; Michelle J. White; Ning Zhu
  12. Where is the Money Now: The State of Canadian Household Debt as Conditions for Economic Recovery Emerge By Elena Simonova; Rock Lefebvre
  13. Increased-Liability Equity: A Proposal to Improve Capital Regulation of Large Financial Institutions By Admati, Anat R.; Pfleiderer, Paul
  14. Causes of the Financial Crisis: Many Responsible Parties By Zeckhauser, Richard
  15. Forcing financial institution change through credible recovery/resolution plans: an alternative to plan-now/implement-later living wills By Ron Feldman
  16. The political, regulatory and market failures that caused the US financial crisis By Tarr, David G.
  17. Threshold Accepting for Credit Risk Assessment and Validation By Marianna Lyra; Akwum Onwunta; Peter Winker
  18. FDI in the Banking Sector By de Blas, Beatrix; Russ, Katheryn
  19. Is there a distress risk anomaly ? corporate bond spread as a proxy for default risk By Anginer, Deniz; Yildizhan, Celim
  20. Mobile payments in the United States at retail point of sale: current market and future prospects By Marianne Crowe; Marc Rysman; Joanna Stavins
  21. Performance-Based Incentives for Internal Monitors By Armstrong, Christopher S.; Jagolinzer, Alan D.; Larcker, David F.
  22. Neighborhood Information Externalities and the Provision of Mortgage Credit By Xiaoming Li; AKM Rezaul Hossain; Steohen L. Ross
  23. Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts By Axelson, Ulf; Jenkinson, Tim; Stromberg, Per; Weisbach, Michael S.
  24. Evolution of Consumption Volatility for the Liquidity Constrained Households over 1983 to 2004. By Olga Gorbachev; Keshav Dogra
  25. The Implied Cost of Capital: A New Approach By Hou, Kewei; van Dijk, Mathijs A.; Zhang, Yinglei

  1. By: Narayana Kocherlakota
    Abstract: Knowing that bailouts are inevitable because governments will rescue firms whose collapse may cause systemic failure, financial institutions fail to internalize risks their investments impose on society, thereby creating a “risk externality.” This paper proposes that just as taxes are imposed to deal with pollution externalities, taxes can also address risk externalities. ; The size of the optimal tax depends on risk-related attributes and may be difficult for supervisors to calculate and implement. A market-based method can estimate its appropriate magnitude. For a particular financial institution, the government should sell “rescue bonds” paying a variable coupon linked to the size of the bailouts or other government assistance received by the institution or its owners. Coupon prices will reflect the market’s judgment of an institution’s risk profile and can therefore be used to set the tax. ; A well-designed tax system can entirely eliminate the risk externality generated by inevitable government bailouts.
    Keywords: Financial crises ; Taxation ; Risk ; Regulation
    Date: 2010
  2. By: Franklin Allen; Ana Babus; Elena Carletti
    Abstract: An important source of systemic risk is overlapping portfolio exposures among financial institutions. We develop a model where institutions form connections through swaps of projects in order to diversify their individual risk. These connections lead to two different network structures. In a clustered network groups of financial institutions within a cluster hold identical portfolios. Defaults occur together but the number of states where this happens is small. In an unclustered network defaults are more dispersed but they occur in more states. With long term finance there is no difference between the two structures in terms of total defaults and welfare. In contrast, when short term finance is used, the network structure matters. Upon the arrival of a signal about banks' future defaults, investors update their expectations of the ability of financial institutions to repay them. If their updated expectations are low, they do not to roll over the debt and there is systemic risk in that all institutions are early liquidated. We compare the clustered and unclustered networks and analyze which is better in welfare terms.
    Date: 2010
  3. By: Stephen Cecchetti; Ingo Fender; Kostas Patrick McGuire
    Abstract: Global risk maps are unified databases that provide risk exposure data to supervisors and the broader financial market community worldwide. We think of them as giant matrices that track the bilateral (firm-level) exposures of banks, non-bank financial institutions and other relevant market participants. While useful in principle, these giant matrices are unlikely to materialise outside the narrow and targeted efforts currently being pursued in the supervisory domain. This reflects the well known trade-offs between the macro and micro dimensions of data collection and dissemination. It is possible, however, to adapt existing statistical reporting frameworks in ways that would facilitate an analysis of exposures and build-ups of risk over time at the aggregate (sectoral) level. To do so would move us significantly in the direction of constructing the ideal global risk map. It would also help us sidestep the complex legal challenges surrounding the sharing or dissemination of firm-level data, and it would support a two-step approach to systemic risk monitoring. That is, the alarms sounded by the aggregate data would yield the critical pieces of information to inform targeted analysis of more detailed data at the firm- or market-level.
    Keywords: risk map, international banking, financial crises, yen carry trade, funding risk
    Date: 2010–05
  4. By: Beltratti, Andrea (Bocconi University); Stulz, Rene M. (Ohio State University and ECGI)
    Abstract: Though overall bank performance from July 2007 to December 2008 was the worst since the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been put forth as having contributed to the poor performance of banks during the credit crisis. Our evidence is inconsistent with the argument that poor governance of banks made the crisis worse, but it is supportive of theories that emphasize the fragility of banks financed with short-run capital market funding. Strikingly, differences in banking regulations across countries are generally uncorrelated with the performance of banks during the crisis, except that banks in countries with more restrictions on banking activities performed better, and are uncorrelated with observable risk measures of banks before the crisis. The better-performing banks had less leverage and lower returns in 2006 than the worst-performing banks.
    Date: 2010–03
  5. By: Christopher Henderson; Julapa Jagtiani
    Abstract: The recent mortgage crisis has resulted in several bank failures as the number of mortgage defaults increased. The current Basel I capital framework does not require banks to hold sufficient amounts of capital to support their mortgage lending activities. The new Basel II capital rules are intended to correct this problem. However, Basel II models could become too complex and too costly to implement, often resulting in a trade-off between complexity and model accuracy. In addition, the variation of the model, particularly how mortgage portfolios are segmented, could have a significant impact on the default and loss estimated and, thus, could affect the amount of capital that banks are required to hold. This paper finds that the calculated Basel II capital varies considerably across the default prediction model and segmentation schemes, thus providing banks with an incentive to choose an approach that results in the least required capital for them. The authors also find that a more granular segmentation model produces smaller required capital, regardless of the economic environment. In addition, while borrowers' credit risk factors are consistently superior, economic factors have also played a role in mortgage default during the financial crisis.
    Keywords: Capital ; Banks and banking ; Basel capital accord
    Date: 2010
  6. By: Nicola Cetorelli; Linda S. Goldberg
    Abstract: Global banks played a significant role in transmitting the 2007-09 financial crisis to emerging-market economies. We examine adverse liquidity shocks on main developed-country banking systems and their relationships to emerging markets across Europe, Asia, and Latin America, isolating loan supply from loan demand effects. Loan supply in emerging markets across Europe, Asia, and Latin America was affected significantly through three separate channels: 1) a contraction in direct, cross-border lending by foreign banks; 2) a contraction in local lending by foreign banks' affiliates in emerging markets; and 3) a contraction in loan supply by domestic banks, resulting from the funding shock to their balance sheets induced by the decline in interbank, cross-border lending. Policy interventions, such as the Vienna Initiative introduced in Europe, influenced the lending-channel effects on emerging markets of shocks to head-office balance sheets.
    Keywords: Capital market ; Emerging markets ; International finance ; International liquidity ; Banks and banking, International ; Banks and banking, Foreign ; Financial crises ; Loans, Foreign
    Date: 2010
  7. By: Silvia Gabrieli (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: This paper analyses the functioning of the overnight unsecured euro money market during the ongoing crisis in terms of i) operational efficiency of monetary policy implementation, ii) efficient reallocation of banking system’s reserves, iii) developments in the pricing of interbank loans. The results suggest that monetary policy implementation has been hampered by the crisis, particularly after the end of September 2008. A heightened awareness of counterparty credit risk seems to be one key factor behind the downward pressure on unsecured rates, as well as behind the notable increase in their cross-section dispersion. Starting from September 2008, and even more in October 2008, banks perceived as relatively “riskier” pre-turmoil paid significantly higher interest rates to borrow overnight funds. In November, a non-uniform softening of the strains occurred: only the most active (roughly the largest) borrowers experienced a notable price improvement. This is possibly a reflection of the bailouts of “too-big-to-fail” institutions. Heterogeneous developments in banks’ funding costs also suggest a move against the integration of the euro interbank market.
    Keywords: Interbank market; Financial crisis; Monetary policy operational efficiency; Moral hazard; European financial integration
    JEL: E58 G21
    Date: 2010–05–28
  8. By: Duffie, Darrell (Stanford University); Li, Ada (Federal Reserve Bank of New York); Lubke, Theo (Federal Reserve Bank of New York)
    Abstract: In the wake of the recent financial crisis, over-the-counter (OTC) derivatives have been blamed for increasing systemic risk. Although OTC derivatives were not a central cause of the crisis, the complexity and limited transparency of the market reinforced the potential for excessive risk-taking, as regulators did not have a clear view into how OTC derivatives were being used. We discuss how the New York Fed and other regulators could improve weaknesses in the OTC derivatives market through stronger oversight and better regulatory incentives for infrastructure improvements to reduce counterparty credit risk and bolster market liquidity, efficiency, and transparency. Used responsibly with these reforms, over-the-counter derivatives can provide important risk management and liquidity benefits to the financial system.
    JEL: E61 G10 G18
    Date: 2010–01
  9. By: de Lis, Santiago Fernández (Asian Development Bank Institute); Herrero, Alicia Garcia (Asian Development Bank Institute)
    Abstract: After analyzing the different reasons why the financial system and also the regulatory framework induced procyclicality, this paper reviews the experiences of three countries which have introduced dynamic provisioning as a regulatory tool to limit procyclicality. The case of Spain—the country with the longest experience—is reviewed, as well as those of Colombia and Peru—countries that have recently adopted dynamic provisioning. A number of policy lessons are drawn from that comparison.
    Keywords: dynamic provisioning; colombia; peru; spain; bank regulation; procyclical
    JEL: E32 G21 G28 G32
    Date: 2010–05–26
  10. By: Franklin Allen; Elena Carletti; Robert Cull; Jun "QJ" Qian; Lemma Senbet
    Abstract: Economic growth in Africa has long been disappointing. We document that the financial sectors of most sub-Saharan African countries remain significantly underdeveloped by the standards of other developing countries. We examine the factors that are associated with financial development in Africa and compare them with those in other developing countries. Population density appears to be considerably more important for banking sector development in Africa than elsewhere. Given the high costs of developing viable banking sectors outside metropolitan areas, technology advances, such as mobile banking, could be a promising way to facilitate African financial development. Similarly to other developing countries, natural resources endowment is associated with a lower level of financial development in Africa, but macro policies do not appear to be an important determinant.
    Keywords: Africa, finance and growth, banks, institutions, population density
    JEL: O5 K0 G0
    Date: 2010
  11. By: Wenli Li; Michelle J. White; Ning Zhu
    Abstract: This paper argues that the U.S. bankruptcy reform of 2005 played an important role in the mortgage crisis and the current recession. When debtors file for bankruptcy, credit card debt and other types of debt are discharged - thus loosening debtors' budget constraints. Homeowners in financial distress can therefore use bankruptcy to avoid losing their homes, since filing allows them to shift funds from paying other debts to paying their mortgages. But a major reform of U.S. bankruptcy law in 2005 raised the cost of filing and reduced the amount of debt that is discharged. The authors argue that an unintended consequence of the reform was to cause mortgage default rates to rise. Using a large dataset of individual mortgages, they estimate a hazard model to test whether the 2005 bankruptcy reform caused mortgage default rates to rise. Their major result is that prime and subprime mortgage default rates rose by 14 percent and 16 percent, respectively, after bankruptcy reform. The authors also use difference-in-difference to examine the effects of three provisions of bankruptcy reform that particularly harmed homeowners with high incomes and/or high assets and find that the default rates of affected homeowners rose even more. Overall, they calculate that bankruptcy reform caused the number of mortgage defaults to increase by around 200,000 per year even before the start of the financial crisis, suggesting that the reform increased the severity of the crisis when it came.
    Keywords: Bankruptcy ; Law and legislation ; Foreclosure ; Default (Finance) ; Mortgage loans ; Global financial crisis
    Date: 2010
  12. By: Elena Simonova (Certified General Accountants Association of Canada); Rock Lefebvre (Certified General Accountants Association of Canada)
    Abstract: In 2007, and then again in 2009, CGA-Canada set out to analyze the level of debt of Canadians, the risks associated with rising indebtedness, and the extent to which the recent financial and economic crises worsened the financial positions of Canadians. In the spring of 2010, CGA-Canada revisited the topic of household indebtedness aiming to identify perspectives of Canadians on the changing level of their indebtedness and wealth, and to examine these findings in the context of publicly available facts and figures. That was done by integrating the results of a public opinion survey commissioned by CGA-Canada with an analysis of available statistical information. The analysis shows that the measures of financial wellbeing of the household sector have deteriorated significantly over 2008 and 2009. Revolving credit has become a prevailing part of consumer credit and poses an increased risk of a debt spiral. The tremendous increase in the use of personal lines of credit was not supported by increasing equity in properties. Prospects of improving households’ financial situation in the near future remain unclear whereas regional perspectives are paramount to our understanding of the state of household finances.
    Keywords: household debt, household finances, savings, wealth, household spending, income shock, assets price shock
    JEL: D1 D14
    Date: 2010–05
  13. By: Admati, Anat R. (Stanford University); Pfleiderer, Paul (Stanford University)
    Abstract: While it is recognized that the high degree of leverage used by financial institutions creates systemic risks and other negative externalities, many argue that financial institutions must rely on extensive debt financing since equity financing is "expensive." Some of the reasons debt is attractive to financial institutions, such as tax benefits and implicit guarantees, are due to subsidies that exacerbate the negative externalities associated with leverage, and are therefore not legitimate from a public policy perspective. Another argument given for high levels of debt financing is that debt serves as a disciplining device for managers who would otherwise make suboptimal or wasteful investment decisions. We propose a mechanism that allows financial institutions to maintain the contractual obligations of debt while avoiding or reducing many of the costs associated with it, including deadweight bankruptcy costs, agency costs due to risk shifting, and under-investment associated with debt overhang. Essentially, we propose a way to increase the liability of the equity issued by the financial institution without changing the limited-liability nature of publicly-held securities. The increased liability is backed by a proposed "Equity Liability Carrier," which holds the increased-liability equity of the financial institution as well as safe liquid assets. In addition to reducing or eliminating the agency problems associated with leverage, this structure concentrates the incentives to monitor and control managers within equity holders, and reduces the need for inefficient liquidation, implicit guarantees and bailouts. Our proposal can be viewed as a way for regulators to impose effectively higher capital requirements, while allowing financial institutions to undertake significant debt commitments.
    JEL: G21 G28 G32 G38 H81 K23
    Date: 2009–12
  14. By: Zeckhauser, Richard (Harvard University)
    Abstract: This analysis argues that blame for the financial crisis falls specifically and heavily on a broad range of the private players and public regulators in our financial sector. Wall Street and the government joined hands in a situation of contributory negligence. Even recognizing the triggering event of the collapse of the subprime market, a key question arises: How did a relatively small loss--$1 billion in subprime mortgages--initiate such a gigantic loss amounting to $20 trillion? By contrast, the NASDAQ swoon of 2001-02, though entailing equal direct losses, had virtually no reverberating consequences. The novel aspect of this crisis was the tremendous inter-penetration of the various affected sectors, notably due to financial engineering. Assets were put in place that were both unfamiliar and opaque. This enabled Firm B's shortfalls to become A's losses, and similarly for Firm C's impositions on B and hence A. This was a cascade of risk that A had not perceived. Such engineering, like nuclear weapons will be with us forever. Unfortunately, they are very difficult to regulate, since critical elements of secrecy provide some of their value, and creative new products are always around the corner. In the critical race between effective regulation and innovation, innovation will win at least some of the time. A modest proposal is made for a mechanism that will provide better information about the security of financial institutions and the financial system as a whole. It is also recommended that we have a financial intelligence agency, and that that agency bear no regulatory responsibilities lest it be subject to political pressures to shield its eyes or use rose-colored glasses.
    Date: 2010–04
  15. By: Ron Feldman
    Abstract: How can banks and similar institutions design optimal compensation systems? Would such systems conflict with the goals of society? This paper considers a theoretical framework of how banks structure job contracts with their employees to explore three points: the structure of a socially optimal compensation system; the structure of a compensation system that is privately optimal, given the reality of government-guaranteed bank debt; and policy interventions that can lead from the second structure to the first. Analysis reveals a potential policy option: providing proper incentives to banks by charging debt default insurance premiums that depend on the compensation structure banks choose. If policymakers consider this unwise or impractical, then it may be useful for government to regulate bank compensation more directly.
    Keywords: Financial institutions ; Financial crises
    Date: 2010
  16. By: Tarr, David G.
    Abstract: This paper discusses the key regulatory, market and political failures that led to the 2008-2009 United States financial crisis. While Congress was fixing the Savings and Loan crisis, it failed to give the regulator of Fannie Mae and Freddie Mac normal bank supervisory power. This was a political failure as Congress was appealing to narrow constituencies. In the mid-1990s, to encourage home ownership, the Administration changedenforcement of the Community Reinvestment Act, effectively requiring banks to lower bank mortgage standards to underserved areas. Crucially, the risky mortgage standards then spread to other sectors of the market. Market failure problems ensued as banks, mortgage brokers, securitizers, credit rating agencies, and asset managers were all plagued by problems such as moral hazard or conflicts of interest. The author explains that financial deregulation of the past three decades is unrelated to the financial crisis, and makes several recommendations for regulatory reform.
    Keywords: Debt Markets,Access to Finance,Emerging Markets,Banks&Banking Reform,Bankruptcy and Resolution of Financial Distress
    Date: 2010–05–01
  17. By: Marianna Lyra; Akwum Onwunta; Peter Winker
    Abstract: According to the latest Basel framework of Banking Supervision, financial institutions should internally assign their borrowers into a number of homogeneous groups. Each group is assigned a probability of default which distinguishes it from other groups. This study aims at determining the optimal number and size of groups that allow for statistical ex post validation of the efficiency of the credit risk assignment system. Our credit risk assignment approach is based on Threshold Accepting, a local search optimization technique, which has recently performed reliably in credit risk clustering especially when considering several realistic constraints. Using a relatively large real-world retail credit portfolio, we propose a new technique to validate ex post the precision of the grading system.
    Keywords: credit risk assignment, Threshold Accepting, statistical validation
    Date: 2010–05–25
  18. By: de Blas, Beatrix (Universidad Autonoma de Madrid); Russ, Katheryn (University of California, Davis)
    Abstract: It is a well known quandary that when countries open their financial sectors, foreign-owned banks appear to bring superior efficiency to their host markets but also charge higher markups on borrowed funds than their domestically owned rivals, with unknown impacts on interest rates and welfare. Using heterogeneous, imperfectly competitive lenders, the model illustrates that FDI can cause markups (the net interest margins commonly used to proxy lending-to-deposit rate spreads) to increase at the same time efficiency gains and local competition keep the interest rates that banks charge borrowers from rising. Competition from arms-length foreign loans, however, both squeezes markups and lowers interest rates. We show that allowing foreign participation is not always a welfare-improving substitute for increasing competition and technical efficiency among domestic banks.
    Date: 2010–05
  19. By: Anginer, Deniz; Yildizhan, Celim
    Abstract: Although financial theory suggests a positive relationship between default risk and equity returns, recent empirical papers find anomalously low returns for stocks with high probabilities of default. The authors show that returns to distressed stocks previously documented are really an amalgamation of anomalies associated with three stock characteristics -- leverage, volatility and profitability. In this paper they use a market based measure -- corporate credit spreads -- to proxy for default risk. Unlike previously used measures that proxy for a firm's real-world probability of default, credit spreads proxy for a risk-adjusted (or a risk-neutral) probability of default and thereby explicitly account for the systematic component of distress risk. The authors show that credit spreads predict corporate defaults better than previously used measures, such as, bond ratings, accounting variables and structural model parameters. They do not find default risk to be significantly priced in the cross-section of equity returns. There is also no evidence of firms with high default risk delivering anomalously low returns.
    Keywords: Debt Markets,Mutual Funds,Economic Theory&Research,Bankruptcy and Resolution of Financial Distress,Deposit Insurance
    Date: 2010–05–01
  20. By: Marianne Crowe; Marc Rysman; Joanna Stavins
    Abstract: Although mobile payments are increasingly used in some countries, they have not been adopted widely in the United States so far, despite their potential to add value for consumers and streamline the payments system. After describing a few countries’ experiences, we analyze the prospects for the U.S. market for mobile payments in retail payments, particularly the use of contactless and near-field communication technologies. We identify conditions that have facilitated some success in other countries and barriers to the adoption of mobile payments in the United States. On the demand side, consumers and merchants are well served by the current card system, and face a low expected benefit-cost ratio, at least in the short run. On the supply side, low market concentration and strong competitive forces of banks and mobile carriers make coordination of standards difficult. Furthermore, mobile payments are characterized by a network effects problem: consumers will not demand them until they know that enough merchants accept them, and merchants will not implement the technology until a critical mass of consumers justifies the cost of doing so. We present some policy recommendations that the Federal Reserve should consider.
    Keywords: Mobile commerce - United States ; Payment systems
    Date: 2010
  21. By: Armstrong, Christopher S. (University of Pennsylvania); Jagolinzer, Alan D. (Stanford University); Larcker, David F. (Stanford University)
    Abstract: This study examines the use of performance-based incentives for internal monitors (general counsel and chief internal auditor) and whether these incentives impair monitors' independence by aligning their interests with the interests of those being monitored. We find evidence that incentives are greater when monitors' job duties contribute more to the firm's production function, when other top managers receive greater incentives, and when a firm has lower expected litigation risk. We also find evidence that firms provide more incentives when there is greater demand for internal monitoring. We find no evidence that internal monitor incentives impair the monitoring function. Instead, our results suggest that adverse firm outcomes (e.g., regulatory enforcement actions and internal-control material-weakness disclosures) occur less frequently at firms that provide greater monitor incentives.
    Date: 2010–02
  22. By: Xiaoming Li (University of Connecticut); AKM Rezaul Hossain (St. Mary's College); Steohen L. Ross (University of Connecticut)
    Abstract: Recent theoretical models and empirical analyses argue that mortgage market activity creates information and lowers the costs of underwriting mortgages. We re-examine this question using models that control for neighborhood-lender fixed effects and address the potential endogeneity of market volume using information on lagged volumes. We find that the omission of neighborhood fixed effects substantially biases analyses of the effect of neighborhood volume on underwriting, and our tests imply that the one or two period lags of volume typically used in cross-sectional studies cannot be treated as exogenous due to the persistence of neighborhood economic shocks. In our preferred specification, we cannot rule out the possibility that overall market activity has a small positive influence on mortgage underwriting, but the statistical evidence for the existence of such effects is weak. On the other hand, we find that lender-specific activity in a neighborhood has strong positive effects on the mortgage approval decision, and this effect is underestimated in traditional cross-sectional models.
    JEL: D8 G2 L8 R3
    Date: 2010–05
  23. By: Axelson, Ulf (London School of Economics and SIFR); Jenkinson, Tim (University of Oxford and CEPR); Stromberg, Per (SIFT and Stockholm School of Economics); Weisbach, Michael S. (Ohio State University)
    Abstract: This paper provides an empirical analysis of the financial structure of large buyouts. We collect detailed information on the financing of 1157 worldwide private equity deals from 1980 to 2008. Buyout leverage is cross-sectionally unrelated to the leverage of matched public firms, and is largely driven by factors other than what explains leverage in public firms. In particular, the economy-wide cost of borrowing is the main driver of both the quantity and the composition of debt in these buyouts. Credit conditions also have a strong effect on prices paid in buyouts, even after controlling for prices of equivalent public market companies. Finally, the use of high leverage in transactions negatively affects fund performance, controlling for fund vintage and other relevant characteristics. The results are consistent with the view that the availability of financing impacts booms and busts in the private equity market, and that agency problems between private equity funds and their investors can affect buyout capital structures.
    Date: 2010–04
  24. By: Olga Gorbachev; Keshav Dogra
    Abstract: We study whether the increased income uncertainty in the US over the last quarter-century had a negative impact on household welfare by looking at variability of household consumption growth. We are particularly interested in understanding the effect of greater uncertainty on the liquidity constrained households. We study the evolution of liquidity constraints in the US in the Panel Study of Income Dynamics, extending Jappelli et al. [1998] methodology using information from the Survey of Consumer Finances. We find that although household indebtedness increased substantially, reflecting greater availability of credit, there was no decline in the proportion of liquidity constrained households between 1983 and 2007. Applying methodology developed in Gorbachev [2009], we find that the evolution of consumption volatility for the liquidity constrained households increased by economically and statistically more than for the unconstrained households. This increase was lower than that of family income volatility for these groups. Nevertheless, the welfare cost to society is substantial: we estimate that an average household would be willing to sacrifice 4.7 percent of nondurable consumption per year to lower consumption risk to its 1984 levels.
    Date: 2009–11
  25. By: Hou, Kewei (Ohio State University); van Dijk, Mathijs A. (Erasmus University Rotterdam); Zhang, Yinglei (Chinese University of Hong Kong)
    Abstract: We propose a new approach to estimate the implied cost of capital (ICC). Our approach is distinct from prior studies in that we do not rely on analysts' earnings forecasts to compute the ICC. Instead, we use a cross-sectional model to forecast the earnings of individual firms. Our approach has two major advantages. First, it allows us to estimate the ICC for a much larger sample of firms over a much longer time period. Second, it is not affected by the various issues that lead to the well-documented biases in analysts' forecasts. Our cross-sectional earnings model delivers earnings forecasts that outperform consensus analyst forecasts. We show that, as a result, our approach to estimate the ICC produces a more reliable proxy for expected returns than other approaches. We present evidence on the implications for the equity premium and a variety of asset pricing anomalies.
    Date: 2010–02

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