There has been a long-standing doctrine that high levels of employment tend to be accompanied by inflation. Closely related is the view that unemployment or slack economic conditions in general can be relieved by increases in the supply of money. These views have been held by economists of widely varying persuasions and particularly with widely varying views on appropriate economic policy. During the postwar period, the concept of a trade-off between inflation and unemployment was studied empirically and also used an extension of the basic Keynesian framework of analysis (a needed supplement since the General Theory had little to say about price movements in the absence of full employment).

Virtually all commercial banks in the United States are supervised by one of the three Federal bank regulatory agencies. Although these agencies share the objective of identifying banks with financial difficulties that may lead to their failure under adverse conditions, they have never reached an agreement as to a uniform approach to capital adequacy. Under these circumstances and because of its critical value to bank regulation, the issue of capital adequacy has been extensively investigated by both practitioners and academicians. Those efforts have tended in recent years to concentrate on characterizing problem banks by using multivariate discriminant analysis. Typical examples are studies by Dince and Fortson [10], Sinkey [25, 26], and Sinkey and Walker [27], which use this method to identify the most indicative financial ratios for bank soundness and compare the ability of different formulas to predict bank failure.

Despite the proliferation of banking services, the basic commercial and industrial lending process remains the lifeblood of commercial banks and other banking institutions. The lending process is a relatively straightforward series of activities involving two principal parties whose association ranges from the initial loan request to the successful or unsuccessful repayment of the loan. Most students of banking would agree that the process is an interdependent one, but the exact dependencies are rarely articulated in a rigorous manner. One of the purposes of this paper is to investigate the association between at least two important aspects of the lending process, namely, the credit evaluation stage and the sequence of events that describes and quantifies the charge-off and subsequent recovery experience.

This paper studies the relationship between real interest rates and housing using a microeconomic approach. The primary impact of interest rates is on the demand side. The partial equilibrium, comparative static model of demand behavior presented is based on intertemporal preference maximization subject to a multiperiod income constraint. The model is always in terms of real prices and interest rates and operates in discrete time. Consumer preferences are represente by a smooth utility function which depends on two kinds of goods, housing and other nondurables. This study is couched in a neoclassical framework with all markets assumed perfect unless otherwise specified. With this approach the theory of housing and interest rates becomes part of standard consumer theory, rather than being based on inappropriate present value considerations.

Professors Kau and Keenen (K & K) explore in this paper the microeconomic foundations of the demand and supply of housing. In order to investigate these foundations, K & K adopt the standard neoclassical framework: the demand for housing arises from solution of a multiperiod consumption problem; and, the supply of new housing is derived from a one–period profit maximization problem. Within this general framework, K & K argue that owner–occupied housing is distinguished from other consumption goods by its durability. As a consequence of this durability, the stock of housing held enters into each period's budget constraint. The utility, on the other hand, from housing enters only as a flow of services in each time period. Because of the stock/flow nature of housing, the comparative statics of the model become interesting. K & K investigate the comparative statics of the model with special attention focused on the impact of changes in the real rate of interest. K & K show, by use of fairly elegant duality theory, that if consumers of owner–occupied housing are net debtors, then an increase in the real rate of interest leads to a fall in the immediate demand for housing. This result is as it should be, since an increase in the real rate of interest reduces the wealth of net borrowers for any given level of future income and, consequently, demand for normal goods falls. K & K argue that a similar net debtor condition must hold to produce the same result in the rental market. I am sure this is a stronger condition than is necessary since an increase in the real rate of interest lowers the price of future consumption and to the extent that current consumptions of rental housing are a substitute for future consumption, it would be expected that current demand for rental housing would fall.

In placing a new security issue, an investment banker has an opportunity to obtain private information by conducting preselling activities during the registration period. The task of the issuer is to design a contract that both induces the banker to use this information to the issuer's advantage and provides a disincentive for the banker to price the issue too low in order to reduce the effort required to sell the issue. This paper characterizes the class of price response functions that the issuer can induce the banker to choose under a delegation scheme and demonstrates that delegating the pricing decision to the banker can be optimal.

This paper (1) constructs a signaling model with a weaker existence condition than in most signaling models, (2) demonstrates that, using a popular model of innovation under uncertainty, an equilibrium signaling schedule exists for a broad range of boundary conditions and parameter values. These results are derived in a model of a firm possessing private information about an investment opportunity, where the firm issues new equity to finance the investment. The proprietary information cannot be explicitly disclosed to potential investors without also disclosing it to potential competitors, but if investors are unaware of the firm's prospects, shares will have to be issued at a price less than their “intrinsic” value.

Managerial aversion to reduce dividends is not only an assertion to be found in the financial literature (see, for example, [2], [4], [8], [9]), but is also the basis for the informational content of dividends hypothesis (see [8]). Furthermore, its existence, if known to investors, can explain dividend payments which involve tax and transaction related costs. Surprisingly, the empirical evidence on this assertion is less than satisfactory. This study examines the existing empirical evidence on this assertion and points out its limitations. A new test, that can refute the informational content associated with the reluctance to cut dividends, is then performed.

Avner Kalay makes a point that managerial reluctance to cut dividends is a necessary condition for the existence of a signaling equilibrium in which dividends are employed as a signaling device. He argues, however, that the available empirical evidence is unable to confirm the reluctance to cut dividends. In particular, the well-known Lintner's (1956) partial adjustment model, which is often cited in support of the reluctance to cut dividends, is empirically indistinguishable from an alternative model which is devoid of such a reluctance. Kalay then conducts an alternative test, but it too leads to an inconclusive result on the issue.

Among the many financial problems facing managers of firms, capital budgeting problems are often the most important. Over the years these problems have received considerable attention from financial economists with more recent work emphasizing two separate approaches. One currently popular approach to capital budgeting is based on the simple linear relationship between risk and return from the intertemporal capital asset pricing model (CAPM) of Merton [20]. Papers in this category include Brennan [7], Bogue and Roll [4], Treynor and Black [26], Myers and Turnbull [21], Fama [15], Bhattacharya [2], and Constantinides [9].

The convertible bond is a hybrid security which, while retaining most of the characteristics of straight debt, offers, in addition, the upside potential associated with theunderlying common stock. As a quid pro quo for the upside potential the convertible bond is typically subordinated to other corporate debt and carries a lower coupon rate than would an otherwise equivalent straight bond.

The valuation of realistically complicated corporate liabilities is arguably one of the most exciting fields in finance today. It is exciting because it seems quite feasible that what was once a somewhat esoteric body of theory may soon be a viable method of valuing actual securities of many kinds. (This promise was, of course, clearly seen at the outset by both Black and Scholes and Merton in their respective seminal papers.)

Sven Grassman's [2] empirical observation that most exports from small open economies are denominated in the currency of the exporter stimulated much theorizing on the currency denomination of international trade contracts. As Rao and Magee [6] note, the problem is nontrivial only if exchange risk exists and the two traditional hedging techniques, forward exchange and international borrowing and lending, are too costly to be employed. With international contracting, both parties typically agree on the quantity to be traded and on a price fixed in one of the two currencies at the time the letter of credit is agreed upon; thus, apart from commercial risk the only source of uncertainty is the real value of the future nominal payment. The degree to which this risk is borne by the importer or the exporter depends, in part, on the currency of denomination.

Bradford Cornell's paper develops a small, but important result for the literature on currency of denomination of international trade contracts. The selection of a contract currency determines which party will bear exchange risk in addition to inflation risk. The contract currency problem in international trade is therefore closely related to other contracting issues, such as the pricing of nominal bonds under inflation uncertainty. More graphically, exchange risk can be illustrated by a difference in the units ofaccount of income and consumption streams. For example, if an agent produces only corn and consumes only wheat, he faces an exchange risk if the price of wheat relative to cornis uncertain.

Modern contingent pricing theory (CPT) dates its genesis from the pioneering work of Arrow [1] and Debreu [9] in the context of complete markets. Beja [2, 3] demonstrated the application of contingent pricing concepts to incomplete markets. The approach has been applied to the valuation of options (Cox and Ross [7]; Rubinstein [30]) and a variety of other financial instruments (e.g., Ross [28])- Tne fundamental insight of CPT is that in arbitrage-free markets complex securities may always be viewed as additive combinations of simple “state-claims” having positive value which, in effect, pay off one unit if and only if a given state is attained at a given date. Concurrently, the continuoustime viewpoint pioneered by Black and Scholes [4] and Merton [22] has grown in significance. The basic simplification of the continuous-time approach is that relevant valuation quantities may all be expressed in terms of the first two moments, i.e., mean and variance, of the state variable distributions employed. When CPT adopts a continuous-time format, it has been shown (Garman [13]) that a basic differential equation holds for all securities; that differential equation involves, of course, the state-claim values, the distributional parameters of state variable evolution, and the prices and dividends of securities. Alternatively, somewhat stronger assumptions which lead to the existence of a rational consensus investor allow thedifferential equation to be expressed in terms of marginal utilities (Cox, Ingersoll, and Ross [8]). This paper applies the techniques of continuous-time CPT to the foreign exchange market. Since we wish to substantively treat inflationary and productive sources of risk in two countries, four state variables are necessarily involved. In a sense, therefore, this is an ambitious attempt since the mostcomplex continuous-time models to date (e.g.. Brennan and Schwartz [5]), have substantively treated only two state variables. Such complexity is simplified through the use of some compact notation, but not by the use of ad hoc modeling. Indeed, it should be emphasized that the present treatment is a full-equilibrium approach, and that while the compact quality of the notation might be made to incorporate a significant amount of possible additional structure, nothing here is inconsistent with a complete equilibrium.

Research in the field of international capital markets has grown considerably during the past few years. The growth of this research activity can be explained both in terms of the “need to know” motive, and the “extension of models” motive. The “need to know” motive reflects the changes in the international monetary system, and the international capital market in general since 1973. The introduction of flexible exchange rates among the major currencies, the sharp increase in both the rate and the volatility of world and relative currency inflation, and the radical changesin the relative price of at least one highly traded good—oil—have made it extremely important to gain a better understanding of the risk in the international market. The “extension of models” motive has to do with the natural interest in the field to extend and to test models developed in financial economics on a different, and important, set of problems.

A currency is not risky because devaluation is highly likely. If the devaluation were certain, there would be no risk at all. A weak currency can be less risky than a strong currency. A strong currency does not become risky because it has been used to denominate a firm's debt.

The unique characteristic of a foreign asset is that the real purchasing power of the cash flows from the asset depends on the exchange rate prevailing on the conversion date. A naive view is that this dependence exposes foreign assets to exchange risk proportional to the volatility of the exchange rate and, other things equal, makes foreign assets much riskier than domestic ones. Anothe extreme is that for nonmonetary foreign assets, purchasing power parity (PPP) causes exchange rates to move inversely todifferential inflation rates, thereby eliminating exchange risk. Aliber and others maintain that a similar argument applies to foreign monetary assets. The international Fisher effect (IFE) causes the exante equilibrium return on all default-free monetary assets, measured in the domestic currency, to be the same regardless of the currency denomination of the instrument. The fact is, however, that PPP and IFE cannot be expected to hold instantaneously throughout time, but only on average over time. Consequently, although foreign assets may promise the same expected return as domestic assets, they will have a higher variance of return as seen by domestic investors. To justify the holding of foreign assets by a domestic investor, one must introduce portfolio considerations, the possibility of consumption expenditures denominated in the foreign currency, heterogeneous expectations, or market imperfections.