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1990 Working Papers

  • WP 90-19 | Tastes and Technology in A Two-Country Model of the Business Cycle: Explaining International Co-Movements

    Alan Stockman Linda Tesar


    This paper develops a two-country real business cycle model and confronts it with an extensive set of empirical observations. In particular, we examine the model's consistency with the behavior of international as well as domestic variables, the cyclical behavior of relative prices and the model's implications for economic aggregates at the sectoral level. This line of research is motivated by a desire to understand the international transmission of business cycles and changes in international competitiveness as reflected in the behavior of relative prices, such as real exchange rates and the terms of trade. We also hope to extend our understanding of business cycles in closed economies by studying a broader and different set of observations. Read More

  • WP 90-18 | Prointegrative Subsidies and Their Effect on Housing Markets: Do Race-Based Loans Work?

    Brian Cromwell


    An analysis of the effects of race-based housing subsidies on racial composition and housing prices, examining their impacts in Shaker Heights, Ohio. Read More

  • WP 90-17 | An Insider's View of the Political Economy of the Too-Big-to-Fail Doctrine

    Walker Todd James Thomson


    Understanding interbank exposure is the key to understanding the too big to fail doctrine. In this paper, we present arguments supporting three principal hypotheses: high levels of interbank exposure reduce the safety and soundness of the banking system; interbank exposure affects the ability of the Federal Deposit Insurance Corporation (FDIC) and bank regulators to use market discipline as a constraint on banks' risk-taking; and arising level of interbank exposure is indicative of reduced stability of the financial system. In addition, we provide evidence that interbank exposure does not, at this time, appear to be a generalized problem for U.S. banks; however, some banks in all categories of asset size stiIl have comparatively high ratios of interbank exposure to capital, despite a general decline in these ratios since the Continental Illinois failure (1984). Read More

  • WP 90-16 | Some Problems of Infinite Regress in Social-Choice Models: A Category Theory Solution

    Fadi Alameddine


    In modern Western democracies, economic and political institutions often have been criticized on moral grounds. The arguments pinpoint the resulting inequalities and inefficiencies as the evidence of these institutions' inadequacy to provide justice. However, evaluating institutions in retrospect (ex post), by contrasting their ex-post resource allocation with other allocations known to be feasible ex post, is misleading. Social decisions must be made under conditions of uncertainty. Hence, institutions must be evaluated before the uncertainty is resolved (ex ante), i.e., according to their expected performance, as delimited by the information available at the time decisions are made. So an institution can be condemned only if an alternative one exists yielding preferable outcomes (by any measure to be decided upon) under the same ex-ante information set. Read More

  • WP 90-15 | Loan Commitments and Bank Risk Exposure

    Robert Avery Allen Berger


    Loan commitments increase a bank's risk by obligating it to issue future loans under terms that it might otherwise refuse. However, moral hazard and adverse selection problems potentially may result in these contracts being rationed or sorted. Depending on the relative risks of the borrowers who do and do not receive commitments, commitment loans could be safer or riskier on average than other loans. The empirical results indicate that commitment lqans tend to have slightly better than average performance, suggesting that commitments generate little risk or that this risk is offset by the selection of safer borrowers. Read More

  • WP 90-14 | Cointegration and Transformed Series

    Jeffrey Hallman


    A large and growing literature is concerned with the theory, estimation, and applications of cointegrating vectors and associated error correction models. A cointegrated system is a set of time series that individually follow difference-stationary linear processes, but one or more linear combinations of the series do not require differencing to appear stationary. The stationary linear combinations indicate stable long-run relationships. Engle and Granger (1987) demonstrate the correspondence between cointegrated time series and error correction models: generating processes for cointegrated systems have error correction representations, and error correction models generate cointegrated series. Read More

  • WP 90-13 | What Does the Capital Income Tax Distort?

    Jinyong Cai Jagadeesh Gokhale


    This paper examines two proposals to correct the risk-taking incentives embedded in the current deposit insurance system and to provide protection to the deposit insurance fund. The first would require banks to issue subordinated debt, and the second would require bank stockholders to post surety bonds. We use the cash-flow version of the Capital Asset Pricing Model to show how each proposal would affect the values and rates of return on uninsured deposits and equity. We then indicate the impact that each proposal would have on the values of the Federal Deposit Insurance Corporation claim and on the bank, emphasizing the role of deposit insurance pricing. Read More

  • WP 90-12 | The Effect of Subordinated Debt and Surety Bonds on Banks' Cost of Capital and on the Value of Federal Deposit Insurance

    William Osterberg James Thomson


    This paper examines two proposals to correct the risk-taking incentives embedded in the current deposit insurance system and to provide protection to the deposit insurance fund. The first would require banks to issue subordinated debt, and the second would require bank stockholders to post surety bonds. We use the cash-flow version of the Capital Asset Pricing Model to show how each proposal would affect the values and rates of return on uninsured deposits and equity. We then indicate the impact that each proposal would have on the values of the Federal Deposit Insurance Corporation claim and on the bank, emphasizing the role of deposit insurance pricing. Read More

  • WP 90-11 | Information and Voting Power in the Proxy Process

    Sanjai Bhagat Richard Jefferis Jr.


    We document shareholder support for wealth-decreasing changes in corporate governance in the form of antitakeover charter amendments. The enactment of these amendments is shown to be related to ownership structure. This gives rise to a sample selection bias that contaminates traditional event-study results and explains the discrepancy between our findings and those reported in previous studies. We also provide evidence that strategic behavior by managers plays a role in the adoption of these amendments. Read More

  • WP 90-10 | Consumption and Fractional Differencing: Old and New Anomalies

    Joseph G. Haubrich


    Consumption depends on income, so testing theories of consumption involves testing theories of income. A prominent recent example is the work by Campbell and Deaton (1989), which uncovers a paradox. They model income as having a unit root instead of as a fluctuation around a trend, and so they find that consumption looks too smooth: the permanent-income hypothesis does not hold. Like some previous researchers, they find that a difference-stationary process fits the data better than a trend-stationary process. Read More

  • WP 90-08 | Sticky Prices, Money, and Business Fluctuations

    Joseph G. Haubrich Robert King


    Can nominal contracts create monetary nonneutrality if they arise endogenously in general equilibrium? Yes, if (1) agents have complete information about the money stock and (2) shocks to the system are purely redistributive and private information, precluding conventional insurance markets. Without contracts, money is neutral toward aggregate quantities. However, risk-sharing between suppliers and demanders creates an incentive for both parties to use nominal contracts. In particular, if an increase in the money growth rate signals a rise in the dispersion of shocks to demanders' wealth, then prices adjust only partially to monetary shocks and money is positively associated with output. Read More

  • WP 90-09 | Intervention and the Foreign Exchange Risk Premium: An Empirical Investigation of Daily Effects

    Owen F. Humpage William Osterberg


    Currency markets have witnessed a sharp increase in government intervention since 1985. Many observers believe that this intervention promoted the dollar's depreciation between 1985 and early 1987, and that intervention has since helped to stabilize dollar exchange rates. This paper tests for a systematic effect of daily dollar intervention on exchange rate risk premia. We test for both portfolio balance effects and signaling influences by using daily data on central bank intervention (in dollars) against both the yen and the West German mark. Following work by Dominguez (1989) and Loopesko (1984), we measure the daily risk premium in terms of the deviation from uncovered interest parity. However, we follow other empirical analyses of exchange rates and allow for generalized conditional autoregressive heteroscedasticity (GARCH). Some evidence is found for both the portfolio balance and signaling channels. Read More

  • WP 90-07 | Optimal Financial Structure and Bank Capital Requirements: An Empirical Investigation

    William Osterberg James Thomson


    This paper presents an empirical analysis of the determinants of the leverage ratios (the book value of liabilities divided by the total of the book value of liabilities' and the market value of equity) for 232 bank holding companies for December 1986, June 1987, and December 1987. Many theoretical models of bank behavior assume that bank capital requirements will be binding, and empirical research has generally shown that almost all- banks will meet capital guidelines. However, if the optimal leverage ratios differ among banks, then banks' responses to changes in capital requirements or to changes in factors that influence their optimal leverage ratio may vary in a cross section. The theoretical framework is a variant of the one developed in Bradley, Jarrell, and Kim (1984). The optimal leverage ratio balances the tax advantage of debt with the costs of bankruptcy. In addition to considering nondebt tax shields and tax rates as determinants of the optimal ratio, we analyze the simultaneity between leverage and investment in municipal securities (munis). Previous research indicates that banks utilize munis to' minimize tax liabilities. Read More

  • WP 90-06 | Inflation and the Personal Tax Code: Assessing Indexation

    David Altig Charles T. Carlstrom


    A reexamination of the potential costs of anticipated inflation in view of the inflation indexing system established during the 1980s. Read More

  • WP 90-05 | In Defense of Zero Inflation

    William Gavin


    An argument supporting zero inflation as the sole objective of monetary policy, with particular emphasis on the Bank of Canada's commitment to an explicit, low inflation target. Read More

  • WP 90-04 | Cross-Sectional Analysis of Public infrastructure and Regional Productivity Growth

    Randall Eberts


    An analysis of the relationship between local public capital stock and regional manufacturing output, inputs, and productivity between 1965 and 1977. Results show that the effect of public capital stock on regional productivity, although limited, cannot be dismissed, and that public infrastructure appears to be a major factor in explaining growth rates of inputs. Read More

  • WP 90-03 | Failed Delivery and Daily Treasury Bill Returns

    Ramon DeGennaro James Moser


    If the seller of a Treasury bill does not provide timely and correct delivery instructions to the clearing bank, the bank does not deliver the security. Further, the seller is not paid until this "failed delivery" is rectified. Since the purchase price is not changed, these "fails" generate interest-free loans from the seller to the buyer. Read More

  • WP 90-02 | On the Choice of the Exchange-Rate Regimes

    Chien-Nan Wang


    This paper utilizes recent research developments in portfolio balance theory and in real exchange-rate instability to synthesize, update, and test the optimum currency area (OCA) theory. Four hypotheses, capturing the central features of the OCA theory, are advanced and tested in a multinomial-logit setup. The empirical results establish the linkage between a fixed rate and financial integration, trade integration, plus inflation convergence. The Mundell-Fleming ranking of regime is refuted in a fundamental way. These findings are applied to a discussion of European monetary integration, in relation to both its final objective and its intermediate procedure. Read More

  • WP 90-01 | The Determinants of Commercial Bank Holdings of Municipal Securities: 1985-1988

    William Osterberg


    This paper presents an empirical analysis of commercial bank holdings of municipal securities (munis) from June 1985 through December 1988, using the FFIEC's Reports of Condition and Income. While motivated by previous analyses suggesting that a shift from munis to taxable securities is a primary determinant of the overall impact of the Tax Reform Act of 1986 on bank profitability, this paper does not directly analyze the impact of that legislation. However, the paper modifies the specification of muni demand employed in previous analyses to consider roles for state pledging requirements, realization of capital gains or losses, and the simultaneous provision for loan losses. The results provide some support for including state pledging requirements, realization of capital gains and losses, and the loan loss provisions in analyses of muni holdings. Read More