A perspective on liability management and bank risk
Asset mispricing, arbitrage, and volatility
Market efficiency remains a contentious topic among financial economists. The theoretical case for efficient markets rests on the notion of risk-free, cost-free arbitrage. In real markets, however, arbitrage is not risk-free or cost-free. In addition, the number of informed arbitrageurs and the supply of financial resources they have to invest in arbitrage strategies is limited. This article builds on an important recent model of arbitrage by professional traders who need?but lack?wealth of their own to trade. Professional abitrageurs must convince wealthy but uninformed investors to entrust ...
Recourse risk in asset sales
Holding company interest-rate sensitivity: before and after October 1979
Since October 1979, market interest-rate movements have been frequent and large. Over the same time period, for a variety of reasons, competition has intensified in both bank loan and deposit markets. These developments have changed the benefits and costs of various types of asset/liability management strategies or alternatively a financial institution's level of interest-rate risk exposure. In this study, the rate-sensitivity postures of a sample of holding companies are examined over the 1977 to 1983 interval to determine whether and how asset/liability management strategies changed after ...
On asset-liability matching and federal deposit and pension insurance
Asset-liability mismatch was a principal cause of the Savings and Loan Crisis of the 1980s. The federal government's failure to recognize the mismatch risk early on and manage it properly led to huge losses by the Federal Savings and Loan Insurance Corporation, which had to be covered by taxpayers. In dealing with the problems now facing the defined-benefit pension system and the Pension Benefit Guaranty Corporation (PBGC), the government seems to be making some of the same mistakes it made then. Among the causes is the fallacious belief that because pension funds have a long time horizon the ...
Interpreting the volatility smile: an examination of the information content of option prices
This paper evaluates how useful the information contained in options prices is for predicting future price movements of the underlying assets. We develop an improved semiparametric methodology for estimating risk-neutral probability density functions (PDFs), which allows for skewness and intertemporal variation in higher moments. We use this technique to estimate a daily time series of risk-neutral PDFs spanning the late 1980's through 1999, for S&P 500 futures, U.S. dollar/Japanese yen futures and U.S. dollar/deutsche mark futures, using options on these futures. For the foreign exchange ...
Macroeconomic state variables as determinants of asset price covariances
This paper explores the possible advantages of introducing observable state variables into risk management models as a strategy for modeling the evolution of second moments. A simulation exercise demonstrates that if asset returns depend upon a set of underlying state variables that are autoregressively conditionally heteroskedastic (ARCH), then a risk management model that fails to take account of this dependence can badly mismeasure a portfolio's "Value-at-Risk" (VaR), even if the model allows for conditional heteroskedasticity in asset returns. Variables measuring macroeconomic news are ...
Economic theory and asset bubbles
The author summarizes what economic theory tells us about when asset price bubbles can occur and what the welfare implications are from bursting them. In some cases, bursting a bubble may make society worse off by exacerbating the market distortions that give rise to the bubble in the first place.
Performance and asset management effects of bank acquisitions
An analysis of how bank acquisitions affect the performance and asset management of the acquired bank, its acquirer, and the newly formed banking organization, showing that after the acquisition, the acquired bank is transformed along a wide variety of dimensions such that it becomes a replica of the acquirer.