Steven E. Plaut

The theory of collateral

Abstract This paper develops a model of the loan market, noting interrelationships between size of loan, collateral arrangements, interest rate, maturity and repayment schedule. Collateral quality is explored.

Industrial structure in the Eurocredit underwriting market

Abstract While the complexity of underwriting syndicates is well-known there has been very little empirical analysis of syndicate structure. The short-term Eurocredit market is a promising market for the analysis of industrial structure because underwriting syndicates generally come in a two-tier structure. The structures of syndicates in this market are analyzed here empirically. Our evidence suggests that the lead managers in these syndicates seem to be recruited primarily for paycosts of risk bearing and sharing, while the regular managers appear to be recruited primarily for the purpose of dealing with expanded underwriting distribution, risks held constant. Contract parameters that affect syndicate size and structure are examined in detail for various instruments.

Tenure decisions, mortgage interest, and the spatial distribution of housing demand: A theoretical analysis

Abstract This paper develops a model for analyzing household tenure decisions and life cycle planning decisions that must be made simultaneously with housing location decisions. It is found that increases in the leverage sensitivity of mortgage interest structures lead to flatter housing gradients within the city. We examine conditions under which households tend to move further from the center with age and income and under which home purchasers will tend to outbid renters at distances further from the center.

International institutional lending arrangements to sovereign borrowers

Abstract Recent financial crises in east Asia and elsewhere have illustrated the problems that plague emergency liquidity arrangements and the ‘lender of last resort’ role of the International Monetary Fund and other international institutions. In particular, these act under conditions of extreme uncertainty, where potential sovereign borrowers, as well as private financial institutions, are ‘kept in the dark’ regarding the intentions of the emergency lenders and the amounts and terms of emergency liquidity that can be tapped. From April 1999, longer-term credit lines are being offered by the IMF, designed to be awarded to ‘healthy’ countries before they experience contagion or distress. The paper evaluates the advantages of this form of IMF lending and this new trend in IMF operations. It is argued that provision of IMF financing through such long-term lending facilities is better in some senses than shorter-term lending. Long-term contracts reduce the uncertainty with respect to IMF intentions. Moral hazard problems are reduced for the borrowing country and financial markets know the future level and terms of IMF support. Another advantage is that long-term loan contracts improve the allocation of resources within the borrowing country. Much as private-sector facility lending is the dominant mode of finance in many markets, so facility lending has efficiency advantages when it is provided by the IMF. This efficiency advantage is derived formally. It is shown that sovereign borrowers are actually better off when utilizing these as backup lines of credit, instead of emergency borrowing that is conducted after distress occurs. Facility lending by international institutions can lead to a welfare improvement and superior resource allocation for sovereign borrowers. The intuition for this is that when financial distress drives these borrowers to increase their debt, risk premia in borrowing rates would not rise, at least up to the limits established by the size of the facility.

The Economics of Housing Savings Plans

Housing Savings Plans (HSP) are contractual savings products in which a household is granted a mortgage at preferential terms (or option for such) in exchange for accumulating savings in the plan and in the institution offering it. As such, they represent a bundle of savings and borrowing financial services. While such plans are common in some countries, the reasons for their use have not been fully explored. In some cases, HSPs are used because financial markets and institutions have not reached sufficient levels of development to attract savings or raise capital for housing finance, and in other cases, tax and subsidy incentives may be at play. Here, we ask under which circumstances households and financial institutions will voluntarily contract to participate in HSPs even in advanced capital markets and in the absence of tax/subsidy incentives. We argue that the HSPs may be chosen by households because of their hedging qualities. We model HSPs and show how changes in variables affect the willingness of households to join the HSP and the characteristics of any HSP chosen.

Trade Secrets, Firm-Specific Human Capital, and Optimal Contracting

Trade secrets are innovations jointly produced by firms and employees that are generally not protected by patents. They are commonly protected within the framework of labor contracts, where an obligation of confidentiality is imposed upon the employee. Specifically this obligation applies to the employee even after he has left the employer for a period of time determined in the contract, known as a “cooling off” period. Often employees are prohibited not only from revealing trade secrets, but also from utilizing their specific human capital developed at the original place of employment in competitor firms during this period. Their specific human capital is in effect inseparable from the trade secret. Failure to protect the trade secret will result in its revelation and its becoming public and hence worthless for the innovator. The inability of an employee to reveal trade secrets and utilize his specific human capital after leaving his place of employment imposes costs and losses upon him. Some form of compensation will be paid for these contingent losses within the employment contract. Employers know that the longer the “cooling off” period imposed upon employees, the greater employees must be compensated for this in the contract. Longer “cooling off” periods thus cost the employer more, but also enable him to earn greater rents from the innovation itself. In this paper profit-maximizing periods of trade secret protection are derived, based on these two countervailing factors, and comparative statics exercises are performed. How the selection of profit-maximizing periods of trade secret protection when the incidence of resignation is itself affected by contract parameters and incentives is explored.

Currency swaps, hedging, and the exchange of collateral

Abstract A model of currency swaps is developed where swaps provide superior hedging capabilities. Under the swap two parties in effect ‘lease’ assets that they own to one another for use as collateral, creating supewrior loan-collateral matching. This superior matching is reflected in lower borrowing costs to both agents (creating a dominant borrowing and hedging method). The swap contract is self-enforcing due to a mutual double bonding arrangement, where each side has an interest in the continuation of the exchange relationship. (JEL G2, F3)

Whose sabbath matters?, or, when does the weekend effect occur?

Abstract The weekend effect and other seasonal anomalies in financial markets are now familiar in many countries. In searching for explanations for the ‘weekend effect’ in particular, it would be helpful to know when exactly ‘it’ occurs, whatever the ‘it’ may be that produces the effect. Since most countries do not have weekend trading in financial assets, the timing of ‘it’ has not been narrowed down. Israel has trading in all financial assets (except currency trading) on Sunday. By examining day-of-the-week effects for Israel, it appears that the weekend effect occurs on Sunday late in the day, and not an Friday evening ar Saturday. Other seasonal anomalies in Israel seem to be similar to those elsewhere. The generalizability of the findings to other countries is discussed.

Disclosure Costs, Regulation, and the Expansion of the Private-Placement Market:

The private-placement debt market has grown dramatically in recent years. Private placements have a “competitive advantage” over public placements in being exempt from many regulations, including disclosure procedures and auditing requirements. Here, a model is developed to explain the growth in the private-placement market. Corporate borrowers choose between public and private placement of debt so as to minimize borrowing costs. Borrowers in the public-placement market incur higher regulatory cost, but are also able to signal accurately their true risk of default. In private placements, there is an asymmetric information problem. This results in an equilibrium where the debt market gets partitioned between private and public placements. It is shown that raising regulatory costs will lead to an expansion of the market share of private placements. It will also lead to an increase in the overall default rate on corporate debt.

Interest rate indexation and the pricing of loan commitment contracts

Abstract The central question addressed in this paper is why most loan pricing agreements between banks and their commercial customers involve additive rather than multiplicative markups over the base lending rate. It is argued that banks generally prefer additive pricing because the real value of the premiums moves inversely with inflation. Therefore this pricing formula provides an automatic partial inflation hedge for banks. Most borrowers who hold long positions in nominal assets also prefer this formula for the same reason. However, some borrowers who hold net short positions in nominal assets prefer multiplicative pricing. Banks provide them with such a form of pricing in exchange for appropriate compensation. Supporting empirical evidence is provided.