Abstracts of Volume 39, Number 2, May 2004
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Closed-End Fund Discounts and Expected Investment
Performance
Robert Ferguson and Dean Leistikow
Bank
Mergers and Insider Nontrading
Tom Madison, Greg Roth, and Andy Saporoschenko
The
Pricing of Sequential Bank Loans
Manoj Athavale and Robert O. Edmister
Specialists, Limit-Order Traders, and the Components of
the Bid-Ask Spread
Kee H. Chung, Bonnie F. Van Ness, and Robert A. Van
Ness
Wei Zhang, Jinliang Li, and Chunchi Wu
Orange County Bankruptcy: Financial Contagion in the
Municipal Bond and Bank Equity Markets
John M. Halstead, Shantaram Hegde, and Linda Schmid
Klein
Kathy Czyrnik and Linda Schmid Klein
Closed-End Fund Discounts and Expected Investment
Performance
Robert Ferguson and Dean Leistikow
This paper provides empirical support for the theory
that closed-end fund discounts reflect expected
investment performance. Evidence is presented to explain
how equity closed-end fund initial public offerings
(IPOs) can sell at a premium when existing funds sell at
a discount and why the initial IPO premiums decay after
the IPO. Relative premium decay data are presented.
Tests on (a) the relation between relative premium
changes and investment performance following IPOs, (b)
relative premium mean-reversion following management
changes, and (c) net redemptions following closed-end
fund open-endings for funds trading at pre-open-ending
announcement discounts individually support and
collectively strongly support the theory.
Keywords: closed-end fund discounts, expected investment
performance
Bank
Mergers and Insider Nontrading
Tom Madison, Greg Roth, and Andy Saporoschenko
Insiders with nonpublic information that their firms are
acquisition targets can profit by purchasing their
firms’ stock or by delaying planned sales of their
firms’ stock. Under current securities laws, insiders
who execute the former strategy expose themselves to
civil and criminal liability, whereas insiders who
execute the latter strategy do not. Using a sample of
bank mergers, we find that target bank insiders
significantly decrease both share purchases and share
sales before merger announcements. These findings
suggest that securities laws effectively deter some
forms of illegal insider trading and that insiders
exploit opportunities to profit legally from nonpublic
information.
Keywords: insider trading, commercial banks, mergers
The
Pricing of Sequential Bank Loans
Manoj Athavale and Robert O. Edmister
The theory of financial intermediation assigns banks a
unique role in the resolution of information asymmetry.
Banks, in general, obtain private information about the
borrower and the project during the screening of loan
applicants and during the monitoring of loan recipients.
Incumbent banks, in particular, utilize information
obtained while monitoring previous loan extensions to
resolve information asymmetry when granting subsequent
loans. We examine the rate on a sequence of loans to a
borrower and find that the incumbent bank information
advantage has finite magnitude and is quickly reflected
in the pricing of the second loan. We also find that the
lending relationship does not deteriorate to the
detriment of the borrower. This research also provides
further evidence supporting the hypothesis that an
incumbent bank resolves information asymmetry during the
monitoring of loan extensions.
Keywords: loan pricing, sequential loans, monitoring,
relationship lending
Specialists, Limit-Order Traders, and the Components of
the Bid-Ask Spread
Kee H. Chung, Bonnie F. Van Ness, and Robert A. Van
Ness
This study compares the components of the bid-ask spread
estimated from quotes that reflect the trading interest
of specialists with those estimated from limit-order
quotes and all available quotes for a sample of NYSE
stocks. The results show that the adverse selection
component of the spread estimated from specialist quotes
is significantly smaller than the corresponding figures
from limit-order quotes and entire quotes. We interpret
this as evidence that New York Stock Exchange
specialists transfer at least a part of adverse
selection costs to outsiders through the discretionary
use of limit orders. Our results show that the
estimation/ interpretation of the components of the
spread using quote data that include both specialist and
limit-order interests is problematic.
Keywords: limit order, bid-ask spread, NYSE specialists,
spread components
Wei Zhang, Jinliang Li, and Chunchi Wu
In this paper we examine the interaction of brokerage
search with the Bayesian learning behavior of
competitive dealers under asymmetric information.
We particularly focus on the effects of price search and
discretionary trading on the performance of a dealer
market. A search process is incorporated into a
model in which brokers determine their reservation price
and whether to continue their trades. The model enables
us to uncover the interrelationships among search cost,
bid-ask spread, and price volatility. We show that both
spread revision and price volatility are dependent upon
the optimal search process, inventory fluctuation, and
search cost. Furthermore, our model predicts a
negative relationship between price volatility and
liquidity trading volume.
Keywords: search, price dispersion, trading costs
Orange County Bankruptcy: Financial Contagion in the
Municipal Bond and Bank Equity Markets
John M. Halstead, Shantaram Hegde, and Linda Schmid
Klein
We examine the spillover wealth effects of the Orange
County, California bankruptcy announcement in December
1994 on municipal bonds, municipal bond funds, and bank
stocks. This bankruptcy is prominent because of
unprecedented losses and because it was caused by a
highly leveraged derivatives strategy rather than a
shortage of tax revenues and excess spending. We find
contagion in the bond market with significantly negative
abnormal returns for municipal bond funds without direct
exposure to Orange County and for non-Orange County
municipal bonds. In addition, our findings suggest the
contagion spills over to the common stocks of investment
and commercial banks that deal in or use derivatives;
however, the equities of banks unexposed to derivatives
are not affected.
Keywords: municipal financing, contagion, derivatives,
fixed income, bank equity
Kathy Czyrnik and Linda Schmid Klein
We analyze the deregulation impact on commercial banks,
investment banks, and thrifts associated with four major
events progressively integrating commercial and
investment banking activities in the United States
during the 1990s. We find that commercial banks are the
only group to react favorably to Federal Reserve
announcements relaxing firewalls and easing restrictions
on commercial bank revenues from investment banking
activities. These regulations primarily benefit large
banks. The Bankers Trust acquisition announcement of
investment bank Alex Brown is associated with increased
wealth for each of the three types of financial service
institutions. At the eventual deregulation of the
financial services industry, with the passage of the
Financial Services Modernization Act in 1999, the values
of commercial banks and investment banks increase
significantly although thrifts are not affected.
Keywords: banking, deregulation, wealth effects,
Glass-Steagall, financial modernization,
Gramm-Leach-Bililey Act, event study
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