Financial Institutions and Markets (Money and Banking)

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              Short Reviews of Academic Articles
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> Appeared in January 13th, 2004  newsletter
 
While the NYSE to Nasdaq cross listing made quite a bit of news, cross
listing itself is not anything new. For instance, my favorite
Institutions or microstructure paper at the Southern Finance
Association’s Meeting was by Kenneth Small. He looks at the 120 Nasdaq
firms that are cross-listed on the American Stock Exchange. (By the way,
these 120 stocks are comprised of Nasdaq 100 plus 20 have Nasdaq stocks
that are in the S&P 500) He began by examining what happened over three
event dates (initial announcements, SEC approval, and the actual day of
cross listing) he found that there was an almost unbelievable 3%
positive abnormal return. Then paradoxically he finds that spreads
actually reverse in the first months of cross listing. While the costs
have since fallen, the puzzle remains. Why did they start off so high?
Was market fragmentation leading to high operating costs or a more
severe adverse selection problem?
Unfortunately I could not link to the article, but he is at the
University of Tennessee if you would like to email him.

Does the extra monitoring from bondholders make up for the added risk of
the financial leverage? NO. That is the answer provided by Krishnan,
Ritchken, and Thomson. They examine credit spreads and find that the
additional monitoring provided by subordinated debt holders does not
"control risk taking" and thus "a mandatory subordinated debt
requirement for banks is unlikely to provide the purported benefits of
enhancing risk monitoring or controlling risk taking."
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=465181

In September 2002 the SEC Regulation ATS required any market that has
greater than 5% of the trades in a security comply with additional
regulations including the way the shares trade. The Island ECN, a
market that trades over 5% in three ETFs, chose rather than simply
complying with these rules, they would scale back the transparency on
all the trades in these securities to get around the rules. Hendershott
and Jones now find that when the Island quit sharing its limit order
book (i.e. “went dark”), traders took their trades elsewhere and market
efficiency suffered (in spite of lower pricing by the Island).   (BTW
great description of ETFs and ECNs. Those two sections alone are worth
the price of admission!)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=396661

>Appeared in August 27th, 2003 newsletter

Mutual funds play a larger role in markets where fund investors have
greater protections, more money, and in countries where “defined
contribution pension plans are more prevalent.” That is the finding of
Khorana, Servaes, and Tufano who look at the mutual fund industry in 55
different nations. In nations where there are fewer protections, there
is an added importance of monitoring and subsequently more concentrated
ownership. While the findings are all pretty much as expected (say, the
article is pretty interesting and it is always nice to see when
empirical findings support theoretical musings.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=399723

There is no doubt that this one will be assigned to my class!
Westerholm, Swan, and Liu look at how market design impacts how the
market operates. That is, there is a tradeoff between transaction costs
and volatility. Having dealers available to trade continually increases
expenses, which in turn lead to larger spreads (transaction costs) for
these so-called continuous dealer markets. On the other hand in return
for these larger spreads, the dealers do help to reduce volatility,
thus, the tradeoff between transaction costs and volatility.
http://papers.ssrn.com/abstract_id=410193

This is big! In a forthcoming JFE article Naik and Yadav write that
dealer firms (i.e. firms with multiple dealers making markets in various
stocks) make their inventory decisions in isolation of what the other
dealers in the firm hold. This decentralized approach thus foregoes
some internal hedging that would take place due to diversification
across stocks held. (While I like the paper a lot, it seems a bit hard
to believe that the firms would not consider the internal hedging that
occurs.)
http://jfe.rochester.edu/02080.pdf

Continuing the same discussion, another soon to be released JFE article
that you will want to read is by Bollen, Smith, and Whaley. It models
(and tests!) the bid/ask spread of stock trades and models it as a
function of “minimum tick size, order-processing costs, inventory
holding costs, adverse selection costs, and competition.” VERY cool.
And the model even seems to work empirically!
http://jfe.rochester.edu/02503.pdf

A summer rerun? While I am fairly certain I included this story in a
previous newsletter, a loyal newsletter subscriber suggested it so hey,
why not? If the major networks can run reruns, why not me? ;) It is
widely known that European banks have grown much more “market-oriented”
over the past 20-30 years. In some sense this Americanization has been
very good for the banks and their customers. The how and whys are
actually more interesting than the historical reporting of a trend and
it is in this light that Rajan and Zingales provide an interesting look
at what has happened, why, and what may happen in the future with
respect to European banks. Short answer: the authors expect the pace of
change to slow down due to “political concerns.”
http://gsbwww.uchicago.edu/fac/finance/papers/rajanbanks.pdf

>Appeared in February 7th, 2003 newsletter

Capitalism is a leap of faith and a new paper by Macculloch and Di Tella
suggests that a lack of faith may be holding back less developed
countries and can explain the finding that poor nations are more likely
to have “left-ward leaning” government. Why? Many have experienced
corruption and are less willing to “believe in” capitalism and to the
degree that corruption leads to more calls for government intervention,
poor nations may be more willing to accept government policies which are
not conducive to business and the economy. Hence poor nations often
fall further behind. Not strictly finance, but interesting!
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=361560