Jyh-Horng Lin

A contingent claim analysis of a rate-setting financial intermediary

Abstract Realizing that a financial intermediarys lending, treated as an investment opportunity, is like a financial call option clarifies the role of uncertainty. We argue that the portfolio-theoretic approach and the firm-theoretic approach have important linkages that can be used to demonstrate the contingent claim analysis of a rate-setting financial intermediary. Borrower-intermediary-lender relationships between the portfolio-theoretic combined volatilities and the firm-theoretic rate-setting modes under the Black-Scholes valuation are investigated, and the conclusions depend upon the portfolio composition redistribution effect. The effect of changes in the open market security rates on the loan rate and deposit rate settings depend on the borrower-intermediary-lender relationship, portfolio risk, and management of rate-setting strategy. Moreover, movements in open market security rates are not necessarily transmitted to the loan lender and deposit absorber.

A note on selling distressed loans with bank bailouts: modelling of bank interest margins with default probabilities

This article extends the framework of Merton (1974) with Vassalou and Xing (2004) to value a troubled but solvent banks equity by explicitly incorporating distressed assets purchased by the government in an imperfectly competitive loan market. We show that the bank may be willing to take this bailout when the purchased amount is relatively small and the margin is relatively low. However, the bank may be harder to entice even when the unit price of the bailed-out assets subsidized by the government is relatively high. As a consequence, most of the first half of the Troubled Asset Relief Programs money is not used to buy troubled assets (Wilson, 2010).

A note on bank default risk under government capital injection coinciding with high future loss expectation

This article proposes a framework for bank default risk measure under government capital injection explicitly coinciding with an adverse signal that a rescued bank is expected to have significant future losses. A bank facing a serious problem of early closure may have a strong incentive to participate in a government assistance programme. Recipients of government capital injections are encouraged to make additional loans at a reduced margin, and then increase the default risk in the banks equity returns. These results may be due to the conflicting goals of the governments capital injection programme for bank recapitalization and bank lending.

A note on bank bailout: equity quality and direct equity injections

Previous research on market-based evaluation of bank equity with government bailout has modelled the bank as a corporate firm with risky assets and liabilities. No attempt was made to analyse explicitly equity quality expressed as a situation when the carrying value of the banks equity book is above the market price, in particular, during the financial crisis. The purpose of this article is to model bank equity quality explicitly and examine the relationships between direct equity capital injections by the government and bank interest margin (and thus bank equity quality). Comparative static results with simulation exercises show that the bailout programme of direct equity injections may be efficient in terms of bank equity quality when the bailout amount is relatively small-size and the banks interest margin is relatively low.

Bank as a liquidity provider and interest rate discovery: An option-based optimization

Abstract Lending via commitment provides liquidity and interest rate discovery. These two concepts are closely related, but they are not identical. As each function can influence asset prices (and thus equity capital prices), this paper discusses how liquidity enters into equity capital price formation, and then focuses on the impact of the price discovery process on bank interest rate behavior. We use an option-based model to study the average loan interest rate of the other banks (explicitly treated as interest rate discovery in our model), the degree of capital market imperfection, and the external financing need for determining the banks optimal loan rate and loan commitment rate, and thus the default risk of its net return. We find, for example, that the default risk of the banks net return is negatively related to the average loan rate of the other banks and the external financing need, and positively related to the degree of capital market imperfection. Our findings provide alternative explanations for implications concerning liquidity and price discovery.

The Gramm–Leach–Bliley Act: optimal interest margin effects of commercial bank expansion into insurance underwriting

We examine the optimal bank interest margin effects of the Gramm–Leach–Bliley Act (GLBA), particularly allowing commercial banks to engage in insurance underwriting. This article models bank equity explicitly integrating the Down-and-Out Call (DOC) option of insurance underwriting with the standard call option of commercial banking activities. We conclude that commercial banks may not appear to benefit from broader product mix when the expansion of insurance underwriting is relatively large scale or insurance asset quality is relatively low.

The impact of e-finance strategies on depository financial intermediary's value: an option-based optimization

Which strategies generate value in electronic-finance (e-finance) environments? In a step toward answering this question, we use a two-stage option-based model to study how capital regulation, asymmetrical information, strategic e-finance and the depository financial intermediarys optimal deposit rate relates to one another. In our model, it is shown that the intermediary can use the Internet to supplant its existing delivery channels under the strategic loan-deposit complements. Both capital regulation and asymmetrical information provide incentives (disincentives) for the intermediarys developing e-finance under its strategic e-finance complements (strategic e-finance substitutes). Our finding provides an alternative explanation for e-finance, treated as not only a technology but also a strategy.

Assessing bank equity risk under Legacy Loan Program

We study the effects of purchasing distressed loan on bank equity risk under the Legacy Loan Program (LLP), in which the government is in partnership with private investors. The bank may refuse LLP when its knock-out value is too low. When the bank decides to participate in the LLP, the participation of a private investor generates a decrease in bank interest margin and an increase in equity risk, but the knock-out value with the LLP assistance generates an increase in bank interest margin and a decrease in equity risk. Our results suggest that the success of LLP depends critically on the willingness of a weak bank to participate in it. However, the participation of a private investor in LLP does not decrease the weak bank’s equity risk but poses instability to the banking system.

The effects of factors on the optimal quantity with fuzzy demand

Abstract The most serious problem for the decision-maker is to face the uncertainty of market demand. The total cost is composed of the unit production cost, the shortage cost and the holding cost. If the difference per unit between the shortage cost and the production cost is not larger than the sum of the unit production cost and the unit holding cost, then the production quantity must be less than the most possible value of market demand; otherwise, the production quantity must be more than the most possible value of market demand. The larger the most possible value of market demand (or the shortage cost), the larger the optimal quantity will be; The larger the unit cost or the holding cost, the smaller the optimal quantity will be. The effect of the spread of fuzzy number on the optimal quantity is ambiguous.

A simple model of retail banking: a liquidity-providing perspective

The banking industry is experiencing a renewed focus on retail banking, a trend often attributed to the stability and profitability of retail activities. This article examines the impact of retail banking on performance by liquidity providing and branch network strategies. Our findings suggest that the bank will use cost-minimizing electronic technology to provide liquidity and external financing, which is linked with high bank interest margins but low default risk in bank equity returns.