Alan C. Hess

Elements of mortgage securitization

In this paper we review the forms of mortgage securitization, analyze the demand for securitization, and demonstrate how securitization meets these demands by reducing intermediation costs. We argue that the increased use of securitization is a response to increased interest rate volatility and represents a contractual innovation that facilitates an efficient allocation of risk-bearing among households and intermediaries.

A COMPARISON OF AUTOMOBILE DEMAND EQUATIONS

This paper reports the testing of hypotheses concerning: (i) whether the household is better viewed as planning over a single-period versus a multiperiod horizon; (ii) whether the household is better viewed as planning in a single-asset or a multiasset framework; (iii) the relative importance of substitution and wealth effects as sources of change in the stock demand for automobiles. The findings are that a multiperiod, multiasset model best describes stock demand, that the separation theorem which implies a zero wealth effect is rejected, and that substitution effects are seven times more important than wealth effects. THE ECONOMIC LITERATURE CONTAINS several empirical studies of household automobile demand [3, 7, 8, and 10] and theoretical models of the household [1, 4, 5, 6, and 14] which are or could be applied to automobile demand. Two aspects of theory which are not fully reflected in the empirical studies are the implications of a multiperiod horizon and the possibility of substitution among assets. Theoretical models [5 and 15] which assume a multiperiod horizon imply that relevant asset prices are user costs and the appropriate constraint is wealth. In contrast, most empirical studies use purchase prices rather than user costs, and income rather than wealth. In addition, theoretical models [4 and 5] permit substitution over a variety of goods, whereas most empirical studies restrict substitutions to automobiles and consumption goods. To the extent that estimated equations are misspecified, the prevailing conclusion that income effects are more important than substitution effects may be due to left-out-variable bias. This paper investigates each of these three issues-the length of the horizon, the range of substitutions, and the relative importance of substitution and wealth effects-by estimating over the same set of data a variety of alternative equations which reflect different assumptions about the horizon and range of substitutions. Initially, a multiperiod, multiasset model of the household consumption-saving decision is stated and used to derive the appropriate arguments for the broadest estimating equation. A linear approximation of this equation is estimated using quarterly United States data covering the years 1952-1972. Then this estimate is compared to competing equations derived under restrictions on the multiperiod, multiasset model. Specifically, demand equations derived under multiperiod, single-asset, single-period, single-asset, and single-period, multiasset assumptions are estimated and compared to the broadest multiperiod, multiasset equation. In addition, versions of the restricted equations which have appeared in the literature are estimated and compared. The findings are: (i) a multiperiod, multiasset equation best describes automobile stock demand, (ii) estimates of substitution and wealth effects are quite sensitive to specification bias, and (iii) substitution effects are seven times more important than wealth effects in the dominant equation.

Conditional Time-Varying Interest Rate Risk Premium: Evidence from the Treasury Bill Futures Market

Existing studies of the term structure of interest rates often use spot Treasury rates to represent default-free interest rates. However, part of the premium in Treasury rates is compensation for the risk that short-sellers may default. Since Treasury bill futures are default-free, they provide cleaner data to estimate the interest rate risk premium. The mean excess return in defaultfree Treasury bill futures is zero. This suggests that the interest rate risk premium could be economically negligible. We find that although the mean unconditional premium is zero, futures returns contain economically and statistically significant time-varying conditional interest rate risk premiums. The conditional premium depends significantly positively on its own conditional variance and its conditional covariance with the equity premium. The conditional premium is large in the volatile 1979–82 period, but small afterwards.

An Explanation of Short-Run Fluctuations in the Ratio of Currency to Demand Deposits

In a recent article in this Journal, Alan Hess [8] attempts to explain short-run fluctuations in the publics desired currency-demand deposit ratio, hereafter denoted by C/D. Since statistical analyses of the C/D are few, this research by Hess is a welcome contribution. His analysis, however, is predicated upon an unproductive assumption which leads him to ignore an important determinant of the C/ D the storage costs of demand deposits . It is my purpose in this note to omit the assumption and to thereby supplement his analysis. This will be accomplished by introducing into Hesss theoretical model the out-of-pocket costs incurred in holding demand deposits which are not also incurred in the holding of currency, and by modifying his empirical analysis to include consideration of this variable.

Portfolio Theory, Transaction Costs, and the Demand for Time Deposits

Households do not rebalance their deposit portfolios in response to 200-300 basis point changes in relative yields. Is it because the deposits are poor substitutes or because transaction costs make it nonoptimal to rebalance? This study uses efficient frontier techniques from portfolio theory and a transaction-cost model to address these questions. The major findings are that the transaction-cost model explains deposit shares but the portfolio model does not and the gains from rebalancing are minuscule because banks made large changes in relative yields on poor substitutes while maintaining fairly constant spreads on close substitutes. Copyright 1995 by Ohio State University Press.

The Effects of Transaction Costs on Households' Financial Asset Demands

Changes in risk-adjusted, expected, relative rates of return on financial assets signal rebalancing trades to financial asset owners. Transaction costs reduce the number and frequency of these trades below what they would be if trading costs were smaller or nonexistent. By not trading, households incur implicit costs of holding poorly diversified portfolios. These costs range from

Experimental Evidence on Price Formation in Competitive Markets

4 billion per year, 0.28 percent of wealth, to & billion per year, 1.6 percent of wealth. The costs of not trading depend on the variability of relative rates of return and the interest elasticities of asset demands. Copyright 1991 by Ohio State University Press.

Household Demand for Durable Goods: The Influences of Rates of Return and Wealth

Standard theory of price formation in perfectly competitive markets contends that buyers and sellers bargain and recontract until the price is reached at which the quantity offered for sale is equal to the quantity demanded.1 All contracts are then made at the equilibrium price which is the only price observed in the market. Three important differences between the model and actual markets are that the latter operate under sequential binding contracts which are made at discrete points in time with imperfect information. These differences raise several questions concerning the extent to which prices and quantities observed in real markets reflect the theoretical equilibrium price given by the underlying market supply-and-demand curves in force at the opening of the market. The first of these questions is whether the average observed price is equal, in a statistical sense, to the theoretical equilibrium price. Ignorance on the part of the buyers and sellers as to the true equilibrium price and the shifting of market supply-and-demand curves as buyers and sellers make contracts and leave the market are both factors allowing for discrepancies between actual and theoretical equilibrium prices. Presumably, in the case of perfect information by all participants, all transactions are made at the equilibrium price. This is because buyers would be unwilling to pay a higher price and sellers to accept a lower one. On the other hand, in the presence of incomplete information, Lancaster (1969, p. 42) suggests that, if the actual price is above the equilibrium price, some sellers sensing that the price is too high will quickly lower their prices but not to the equilibrium price, make their sale, and leave the market. This argument from the buyers side describes behavior below the equilibrium price, so that it is possible for actual prices to be dispersed about their theoretical value. When these more astute buyers and sellers leave the market, the market supply-and-demand curves shift to the left. However, they need not shift by the same amount so that a new theoretical price is defined. The market may then converge on this changed equilibrium price, resulting in an aver-

The Financial Stability Board and Global Systemically Important Banks: Unintended Consequences?

They indicate that purchases of durable goods (DUR) are the third most volatile component behind inventory investment (INV I) and federal government expenditures (F GOV). The correlation coefficients between GNP and its components listed in the second row of table 1 show that durable goods purchases have the third hiighest covariance with GNP after inventory investment and nonresidential investment (NRI). Theoretically, these purchases represent either changes in the size of the household portfolio through changes in the flow of savings, or a reallocation of accumulated wealth among assets in response to changes in rates of return. Empirically, some effort has been given to examining the separate influences of rates of return and income. Hamburger (1967) found that interest rates, the price of durable goods relative to other prices faced by the consumer, and disposable personal income all have a significant impact on purchases of durable goods. portance of these variables as sources of fluctuation in purchases. Motley (1970) included a user cost of real assets variable in addition to the rate on savings deposits and expected income, and found in sharp contrast to Hamburger that none of them had a significant influence on the demand for the sum of durables and housing. The analysis of fluctuations in durable good purchases presented here differs from its prede-

Household response to a money rain: Real and portfolio balance effects reconsidered

We identify, measure and compare the characteristics of Global Systemically Important Banks (G-SIBs) vis-a-vis banks not chosen by the Financial Stability Board (FSB) to be in the 2011 G-SIB group; investors’ responses to banks being classified as a G-SIB and how these responses relate to banks’ characteristics; and changes in banks’ financial performance after being named a G-SIB. The G-SIBs were larger, less profitable, more levered, and riskier. We find that the cumulative effect of the FSB announcements on G-SIBs’ stock prices was predominantly negative. In the year following designation, the G-SIBs shrank, reduced their net interest margins, and increased their leverage, market betas, and co-movement among G-SIB stock returns. The increased correlation across stock returns was associated with a reduction in the diversification benefits of holding a portfolio of G-SIB banks, providing evidence that the vulnerability of a G-SIB portfolio to a negative event rose, consistent with an increase in systemic risk. The data suggest that the FSB is not yet achieving its goals.