Steven P. Clark

Diversification in the Financial Services Industry: The Effect of the Financial Modernization Act

Abstract The intent of the Financial Services Modernization Act of 1999 (FSM) was to strengthen the overall financial services sector by allowing financial firms to diversify across industries within the financial sector. Similar to other studies of the reaction to this Act, we observe that investors consider the FSM to be good news. More interestingly, we also observe that systematic risk increased for some types of firms, but decreased for others as barriers were lowered. This finding is consistent with the idea that the reduction of regulation may increase systematic risk, but that the effects of deregulation on risk may be mitigated by anticipated effects of diversification. Specifically, bank holding companies that chose to diversify into other financial industries experienced increases in systematic risk while those that did not diversify realized decreases in systematic risk. Overall, we find that the systematic risk of financial firms converged and increased in the past few years as firms expanded into non-traditional businesses. In addition, we find that the Act reduced systematic risk for some firms, specifically those that diversified their product lines with insurance products.

ON THE CONVEXITY OF VALUE FUNCTIONS FOR A CERTAIN CLASS OF STOCHASTIC DYNAMIC PROGRAMMING PROBLEM

It is a common practice in stochastic dynamic programming problems to assume a priori that the value function is either concave or convex and later verify this assumption after the value function has been identified. It is often a difficult task to establish the concavity or convexity of the value function directly. In this paper, we prove that the value function of a certain type of infinite horizon stochastic dynamic programming problem is convex. This type of value function arises frequently in economic modeling.

A Reduced-Form Model for Valuing Bonds with Make-Whole Call Provisions

Abstract We develop a reduced-form valuation model for bonds with make-whole call provisions. Informed by the structural differences between callable bonds with fixed call prices and callable bonds with make-whole call provisions, we specify our reduced-form model so that the call spread depends inversely on the default intensity. Using a sample of make-whole callable bonds, we estimate the parameters of our model using the extended Kalman filter and compare the performance of our model with the performance of a well-known reduced-form model for fixed-price callable bonds.

REGULATORY CAPTURE AND EFFICACY IN WORKERS’ COMPENSATION

We examine changes in workers’ compensation laws from 2003 to 2011 and their effect on insurer performance as measured by loss ratios and claim costs. We study changes to: length of temporary total loss indemnity, penalties on employees who do not comply with rehabilitation efforts, employer or employee choice of physician, and limits on attorney fees. We find differential effects among these reforms with the most robust being changes to limits on temporary total indemnity and penalties for workers who do not comply with rehabilitation efforts. We measure one effect of the political environment and find that appointing authority over the workers’ compensation board or committee significantly affects loss costs. Lastly, we find evidence of regulatory capture in workers’ compensation.

A study of fractionally integrated time series using descriptive methods

ABSTRACT We demonstrate the use of some descriptive methods for nonstationary time series to better understand the sample path behaviours of fractionally integrated processes for a range of different fractional orders of integration. We are particularly interested in better understanding the behaviours of series when . In fact, we will point out that there is considerable disagreement in the literature when it comes to describing such processes, and we show that descriptive methods can be useful tools for better understanding their sample path properties. We also present an empirical example to compare conclusions from some of the descriptive methods and inference from two state-of-the-art estimators for fractional orders of integration.

Free Cash Flow and Managerial Entrenchment: A Continuous-Time Stochastic Control-Theoretic Model

In this paper, we formulate a model prescribing optimal policy for cash disbursements and seasoned equity offerings taking into account the principal-agent problems inherent in these decisions. In order to discipline managers, stockholders demand that excess free cash flow be disbursed either as cash dividends or through stock repurchases. Managers resist stockholders in this regard since they prefer to retain excess free cash flow in order to pursue personal interests and reduce the probability that the company will experience financial distress in the future. However, as a consequence of withholding cash disbursements, managers incur disutility due to the possibility that their control of the firm could be threatened by the market for corporate control. We model this situation as a stochastic impulse control problem, and succeed in finding an analytical solution. We derive several testable implications, some of which have not been fully addressed in the corporate finance literature.