Robert O. Edmister

Trading cost expectations: Evidence from S&P 500 index replacement stock announcements

This paper tests the effect on stock value of an expected change in future trading costs. The capitalized value of a reduction in trading costs is hypothesized to increase the stock value, a trading cost effect. Improved liquidity reduces trading costs. Inclusion as an S&P 500 Index replacement stock is an event hypothesized to increase liquidity. We use 114 observations between January 1, 1983 and October 12, 1989 of stocks added to the Index as replacements for stocks removed. The abnormal return of each stock is regressed against the ratio of the bidask spread to the price of the stock, the change in trading volume of the stock, and the open interest in the Index futures contracts at the close of the month prior to the replacement announcement.We find that the positive abnormal returns for replacement stocks are related to increased daily trading volume after inclusion in the Index. Further, the trading cost effect is proportional to percentage bid-ask spreads prior to inclusion. The trading cost effect increases as trading in derivatives of the Index increases. The volume and stock price changes after replacement are not transitory, indicating an improvement in liquidity.Three alternate hypotheses suggested in prior research to explain the abnormal returns for replacement stocks are tested. Testing each of the three models previously considered: price pressure, inelastic demand curves, and information, we find that none can be accepted with statistical confidence.The abnormal returns of Index replacement stocks are consistent with rational pricing of an anticipated reduction in future transaction costs. This anticipated reduction is capitalized in the value of the stock at the time of the replacement announcement. These results are consistent with a trading cost effect.

Measuring interest rate sensitivity of consumer depositors

The impetus for the deregulation of consumer deposits presumed that institutions need flexibility in setting rates to control deposit levels. Previous research indicated that institutions may find varying levels of sensitivity of depositors which will make it difficult to predict volume response. This study examined the timed response of interest rate changes on deposit volume changes. Using available time series techniques, it found that volume response varied with market characteristics as well as money market conditions. In some markets, deposit volume responded significantly to interest rate differentials, while in others the deposits were insensitive to small differentials. Thus, an institution is well advised to study its particular deposit market before implementing a liability rate strategy.

Consumer deposit demand, interest rate differentials, and public welfare

Abstract Empirical estimates of the bank certificate of deposit demand schedule obtained in this study provide the basis for evaluating interest rate deregulation. A Box-Jenkins transfer function estimates bank deposit responses to intraindustry pricing changes and a sensitivity analysis shows microeconomic effects of interest rate differentials. The study concludes that 1) the public substantially subsidizes banks but banks achieve suboptimum deposit levels under thrift differential regulation, 2) removal of deposit rate regulation causes bank deposit demand schedules to shift slowly, not immediately, up with respect to interest rates, and 3) the consumer deposit demand curve is clearly interest elastic.

The Federal Deposit Insurance Corporation Improvement Act event in the bank commercial loan market

Outlines the provisions of the US Federal Deposit Insurance Corporation Improvement Act (1991) (FDICIA) and presents a study of its effects on banks and their customers. Develops a mathematical model to identify the factors contributing to the price of loans and applies it to 1977‐98 data from large and small banks. Shows that charges are affected by loan size, bank size and FIDICIA cost effects; with especially high margins in the middle market. Rejects the idea that higher interest rates are linked to increased loan defaults.