David Nickerson

Self-insurance against natural disasters☆

Abstract Expenditures on self-insurance to mitigate the effects of natural disasters on the value of private assets are examined in a model where individuals are partially insured against financial loss by a public relief program and where private insurance is unavailable. The model predicts that optimal private expenditures on self-insurance will be excessive or insufficient according to the nature of the technology by which individuals protect their assets. The comparative static effects of variations in the level of public compensation, individual wealth, and attitudes toward risk and the degree of environmental uncertainty on self-insurance expenditures and on the magnitude and frequency of public compensation are also characterized and their implications for remedial government policies are examined.

Investment in internet banking as a real option: theory and tests

Abstract This paper examines the optimal exercise of strategic real options to invest in Internet banking (IB) technology within a two-stage game, parameterized by the distribution of bank size and uncertainty over the profitability of investment, and empirically tests the results. The value of the strategic investment option to a strategically significant entrant into IB depends on both expected future profits as well as the variance of those profits. Expected profits to an entrant depend, in equilibrium, on its size, as measured by existing market share (concentration) or total assets, relative to its rivals. Conditional on the degree of uncertainty, larger banks should, as a consequence, exercise their options earlier than smaller banks, for purely strategic advantages, and act as market leaders in the provision of IB services. Like ordinary options, however, the value of the strategic investment option to both large and small banks increases in uncertainty, implying that early exercise will be more likely the more information is available about potential demand. We test these hypotheses on investment in IB services with data from a sample of 1618 commercial banks in the tenth Federal Reserve District during 1999. Consistent with our hypotheses, relative bank size, as measured by measures of concentration, and demographic information predictive of future demand both positively influence the probability of entry into IB in our sample.

Discrimination Resulting from Overage Practices

Since the release in 1992 of the Federal Reserve Bank of Boston study of mortgage lending (Munnel, Browne, McEneaney, and Tootle 1992), the banking regulatory agencies have devoted extensive resources to analyses that included numerous studies of lending practices and compliance under the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA).1These studies used both data collected for a particular study by the regulatory agency and data provided by banks in defense of lending practices. The regulatory agencies have become both offensive and defensive players in the interpretation of the “fair lending” laws and regulations. In this paper, we discuss some of the fundamental theoretical and empirical issues underlying the fair lending analysis pertaining to mortgage loan pricing and present some recent results from three banks. We conclude that, although statistical analysis provides focus in examinations for mortgage loan pricing, additional information would be useful in determining whether racial discrimination exists.

Crime and residential mortgage default: an empirical analysis

This paper is the first to quantify the effect of crime rates on rates of default of residential mortgages. Based on a model of default in which crime rates can affect the liquidity of mortgageholders as well as their default option through property values, regression analysis is used to analyse default rates over a pooled sample of residential mortgages for all US states during 1981–1994. This study finds that crime, possibly acting as a proxy for more general economic conditions, significantly affects both the rate and timing of mortgage default.

Political Economy of Presidential Disaster Declarations and Federal Disaster Assistance

Billions of dollars have been transferred to state governments for disaster recovery. Owing to the discretionary authority of the president in these decisions, moral hazard may influence approval of such requests. We test within a model of recursive choice the hypothesis that the sequential executive decisions to grant disaster declarations and the conditional amount of aid allocated are affected by political incentives. We combine expenditure and approval data from FEMA with state-level census and political data for the period 1969 through 2005. After accounting for the severity of flood damage in the state and the ability of the state to recover, an incumbent president is more likely to grant disaster declarations when facing reelection, particularly in states with a larger number of electoral votes and in states with a governor from the same political party as the president. We also find Democratic presidents award more disaster aid than their Republican counterparts.

Mortgage Contracts, Strategic Options and Stochastic Collateral

This paper offers a game-theoretic model for both the analysis and valuation of mortgage contracts in the context of an economy with complete information and complete contingent claims markets. We analyze the equilibrium strategy of the lender, who holds an option over the magnitude of mortgage credit extended per dollar of collateral offered, and the mortgagor, who holds options to default or prepay, in a class of intertemporal mortgage contracts collateralized by property evolving according to a random process which is common knowledge to both parties to the mortgage contract. Using continuous—time arbitrage valuation principles, we derive the value of the mortgage contract to both parties and show, through both analytical solutions and numerical simulations, that Markov perfect equilibria exist in which, among other properties, a lower flow of housing services accruing to the borrower, per dollar of initial house value, and a correspondingly lower rate of effective depreciation, will elicit a larger volume of funds offered by a lender; the amount of credit offered, the values of the contract to both lender and mortgagor, and the expected losses to both parties from costly bankruptcy are highly sensitive to the perceived volatility of the value of the property collateralizing the mortgage, even in an economy with complete markets or risk neutrality on the parts of lender and borrower; the upper limit on mortgage credit offered by a rational lender may be a small fraction of the current fair market value of the property, regardless of the contractual yield offered by the borrower, and will decrease, at each such yield, as bankruptcy costs or housing service flows increase; and under significant but plausible values for bankruptcy and costs of liquidating property under foreclosure, the flow of mortgage credit can become negatively related to the spread of the mortgage yield over the riskless rate, with the lender preferring a lower contractual yield to a higher one.

A theorem on policy neutrality

This paper offers a general condition which resolves the debate over the neutrality of systematic monetary policy in linear macroeconomic models with non-equilibrium prices and rational expectations, as expressed in papers by Gordon, 1976 , Gordon, 1977 , Modigliani (1977) , Fischer (1977) , Phelps and Taylor (1977) , Fethke and Policano, 1979 , Fethke and Policano, 1981 , McCallum, 1977 , McCallum, 1978 , McCallum, 1979a , McCallum, 1979b , McCallum, 1980 and Green and Honkapohja (1983) . The policy neutrality theorem states that a non-equilibrium price function will preserve the neutrality of monetary feedback with respect to exchange in a representative macroeconomic model if and only if the difference between the conditionally expected values of the equilibrium and non-equilibrium prices is independent of monetary feedback in each period. The policy neutrality results of McCallum, 1977 , McCallum, 1978 , McCallum, 1979b and the policy effectiveness results of Fischer (1977) , Phelps and Taylor (1977) , Fethke and Policano, 1979 , Fethke and Policano, 1981 are analyzed in terms of the theorem.

Governance and efficiency in emerging financial markets

This paper describes how the principles underlying the economics of governance may be useful in examining the evolution of financial institutions and the role of the state in the financial markets of developing and transitional economies. The concepts of allocational efficiency and market failure are shown to be useful in evaluating the efficiency with which financial functions are performed and in the design of regulatory policy. The social costs of active financial regulation are described in terms of the implementation of such regulation in the presence of endogenous information in financial exchange. A direction for future research is suggested, in which emphasis is placed on the resolution of market failure by private financial institutions through financial innovation and market creation. The paper, intended to suggest an agenda for future research in the regulation of emerging financial markets, is descriptive rather than technical and is explicitly intended for a wide audience of policy makers, in...

The neutrality of systematic monetary policy in models with a disequilibrium price level

Abstract A condition is offered which is necessary and sufficient for the neutrality of aggregate output and the real rate of interest with respect to systematic monetary policy in a general class of stochastic macroeconomic models with rational expectations, additive disturbances, lagged information and a disequilibrium price sequence.

Dynamic monitoring of financial intermediaries with subordinated debt

Purpose – The purpose of this paper is to show that subordinated debt regulatory proposals assume that transactions in the secondary market of subordinated debt can attenuate moral hazard on the part of management if secondary market prices are informative signals of the risk of the institution. Owing to the proprietary nature of dealer prices and the liquidity of secondary transactions, the practical value of information provided by subordinated debt issues in isolation is questionable. Design/methodology/approach – A multivariate dynamic risk signal is proposed that combines fluctuations in equity prices, subordinated debt and senior debt yields. The signal is constructed as a coincident indicator that is based in a time series model of yield fluctuations and equity returns. The extracted signal monitors idiosyncratic risk of the intermediary because yields and equity returns are filtered from market conditions. It is also predictable because it is possible to construct a leading indicator based almost entirely on spreads to Treasury. Findings – The signal for the Bank of America and Bankers Trust is implemented. For Bank of America, the signal points mainly to two events of uprising risk: January 2000 when the bank disclosed large losses in its bond and interest-rate swaps portfolios; and November 2000 when it wrote off