Linda Schmid Klein

Wealth effects of regulatory reform *1: The reaction to California's proposition 103

Abstract This paper investigates the effect of Californias Proposition 103 on the market value of publicly traded property- and liability-insurance companies. The passage of this referendum on November 8, 1988 moved California from a market-oriented to a heavily regulated insurance-pricing system. During the period surrounding the election, the average stock price of insurance companies doing business in California declined by 6.91%. The decline is positively related to the proportion of a firms premiums affected by the referendum and the proportion generated in other states where insurance regulation is likely to change, and negatively related to the firms profitability.

Lloyd's Financial Distress and Contagion within the US Property and Liability Insurance Industry

The intra-industry effect of Lloyds financial distress on publicly traded US insurance companies is examined. Given Lloyds prominence in the international insurance industry, large losses raised questions about the industrys capacity for certain types of risks and the financial solvency of other insurers. The market value of US property-liability insurers fell significantly at the announcement. This decline is related to the firms revenues from insurance and reinsurance exposure. Results support contagion between Lloyds distress and the US insurance industry. The study raises concerns about the potential for a systematic disruption of the supply of reinsurance in the international marketplace.

Reverse Mortgages and Prepayment Risk

This paper presents a detailed assessment of the Connecticut Housing Finance Authority (CHFA) reverse annuity mortgage (RAM) program. Because of the size and payment history of the program, the analysis provides an empirical framework on which to develop and assess other home equity conversion (HEC) programs. The program offers insights into the economic impact of these programs and the factors affecting prepayment. The program issued 765 annuities over five years, and 240 of these loans have terminated payments. The annuity payments had a demonstrable financial impact on the elderly participants, with an 88% average annual income increase. Prepayment rates varied across borrower and loan characteristics. The rates were most sensitive to marital status and were heavily affected by the age of the borrower and the term of the loan. Although default risk exists, the evidence indicates a low probability of the loan value exceeding the house value. Copyright American Real Estate and Urban Economics Association.

Capital Structure Swaps and Shareholder Wealth

We show how capital structure swaps can increase the wealth of a firms long-term shareholders when a firms debt or equity is misvalued. We review the conventional rule that a firm should issue equity and use the proceeds to retire outstanding debt (an equity-for-debt swap) when equity is overvalued, or repurchase equity with proceeds of new debt (a debt-for-equity swap) when equity is undervalued. We also analyse the more complex case where a firms debt and equity are both undervalued, showing the optimal swap may be to issue undervalued equity, contrary to the conventional rule.

Valuation Process and Market Efficiency for US Treasury Bonds

This paper investigates the efficiency of the bond valuation process by analyzing the effect of a call announcement on the US Treasury bond market. The Treasurys action surprised many investors since the Government had not called bonds for the preceding 30 years. Quick adjustment of prices to new information is an indicator of the efficiency with which investors incorporate changing expectations into the valuation process. Research on stock market efficiency is widely available. However, the limited research that exists on bond market efficiency focuses on corporate bonds. Our study extends the literature by providing empirical evidence on bond market changes that result from the announced call of US Treasury bonds. The focus on US government issues avoids the confounding effects of taxes, default risk, agency problems, restrictive covenants, and leverage that are associated with corporate issues. In addition, the research provides empirical evidence on the valuation of put options implicit in US Treasury bonds.

Coupon Resets Versus Poison Puts: The Valuation of Event Risk Provisions in Corporate Debt

Abstract This paper examines the valuation of the two major types of event risk indenture provisions, poison puts and coupon resets, on the debt of industrial companies. In contrast with earlier work by Crabbe (1991), we find that protection provided by poison put type of covenants is not valued by investors. The inclusion of coupon reset provisions, however, lowers the yield spread of new issued industrial bonds by 32 basis points. The yields on bonds with low credit quality ratings are reduced by including coupon reset provisions in the bond indentures.