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Recovering risky technologies using the almost ideal demand system: an application to U.S. banking

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Author Info
Joseph P. Hughes
William W. Lang
Loretta J. Mester
Choon-Geol Moon

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Abstract

The authors argue for a shift in the focus of modeling production from the traditional assumptions of profit maximization and cost minimization to a more general assumption of managerial utility maximization that can incorporate risk incentives into the analysis of production and recover value-maximizing technologies. The authors show how this shift can be implemented using the Almost Ideal Demand System. In addition, the authors suggest a more general way of measuring efficiency that can incorporate a concern for the market value of firms' assets and equity and identify value-maximizing firms. This shift in focus bridges the gap between the risk-incentives literature in banking that ignores the microeconomics of production and the production literature that ignores the relationship between production decisions and risk.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 00-5.

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Date of creation: 2000
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Handle: RePEc:fip:fedpwp:00-5

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Related research
Keywords: Banks and banking - Costs ; Banks and banking;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Hughes, Joseph P, et al, 1996. "Efficient Banking under Interstate Branching," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 1045-71, November. [Downloadable!] (restricted)
  2. Allen N. Berger & Loretta J. Mester, 1997. "Inside the Black Box: What Explains Differences in the Efficiencies of Financial Institutions?," Center for Financial Institutions Working Papers 97-04, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
    Other versions:
  3. Joseph P. Hughes & William W. Lang & Loretta J. Mester, 1995. "Recovering technologies that account for generalized managerial preferences: an application to non-risk neutral banks," Working Papers 95-8/R, Federal Reserve Bank of Philadelphia.
    Other versions:
  4. Rebecca S. Demsetz & Marc R. Saidenberg & Philip E. Strahan, 1996. "Banks with something to lose: the disciplinary role of franchise value," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 1-14. [Downloadable!]
  5. Joseph P. Hughes & Loretta J. Mester & Moon Choo-Geol, 2000. "Are scale economies in banking elusive or illusive? evidence obtained by incorporating capital structure and risk-taking into models of bank production," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 233-264.
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  6. Joseph Hughes, 1999. "Incorporating risk into the analysis of production," Atlantic Economic Journal, International Atlantic Economic Society, vol. 27(1), pages 1-23, March. [Downloadable!] (restricted)
  7. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December. [Downloadable!] (restricted)
  8. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June. [Downloadable!] (restricted)
  9. Gorton, Gary & Rosen, Richard, 1995. " Corporate Control, Portfolio Choice, and the Decline of Banking," Journal of Finance, American Finance Association, vol. 50(5), pages 1377-1420, December. [Downloadable!] (restricted)
  10. Saunders, Anthony & Strock, Elizabeth & Travlos, Nickolaos G, 1990. " Ownership Structure, Deregulation, and Bank Risk Taking," Journal of Finance, American Finance Association, vol. 45(2), pages 643-54, June. [Downloadable!] (restricted)
  11. Humphrey, David B & Pulley, Lawrence B, 1997. "Banks' Responses to Deregulation: Profits, Technology, and Efficiency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 73-93, February.
  12. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon, 1996. "Efficient banking under interstate branching," Working Papers 96-9, Federal Reserve Bank of Philadelphia. [Downloadable!]
    Other versions:
  13. Deaton, Angus S & Muellbauer, John, 1980. "An Almost Ideal Demand System," American Economic Review, American Economic Association, vol. 70(3), pages 312-26, June. [Downloadable!] (restricted)
  14. Hughes, Joseph P. & Lang, William W. & Mester, Loretta J. & Moon, Choon-Geol, 1999. "The dollars and sense of bank consolidation," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 291-324, February. [Downloadable!] (restricted)
    Other versions:
  15. Joseph P. Hughes & Loretta J. Mester, . "A Quality and Risk-Adjusted Cost Function for Banks: Evidence on the "Too-Big-To-Fail" Doctrine," Rodney L. White Center for Financial Research Working Papers 25-92, Wharton School Rodney L. White Center for Financial Research.
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  16. Joseph P. Hughes & Loretta J. Mester & Choon-Geol Moon, 2000. "Are Scale Economies in Banking Elusive or Illusive?," Departmental Working Papers 200004, Rutgers University, Department of Economics. [Downloadable!]
  17. Tufano, Peter, 1996. " Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Allen N. Berger & Loretta J. Mester, 1999. "What explains the dramatic changes in cost and profit performance of the U.S. banking industry?," Finance and Economics Discussion Series 1999-13, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  2. Allen N. Berger & Loretta J. Mester, 2001. "Explaining the Dramatic Changes in Performance of U.S. Banks: Technological Change, Deregulation and Dynamic Changes in Competition," Center for Financial Institutions Working Papers 01-22, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
    Other versions:
  3. Jacob Bikker & Jaap Bos, 2004. "Trends in Competition and Profitability in the Banking Industry: A Basic Framework," DNB Working Papers 018, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
  4. Robert DeYoung, 2001. "Learning-by-doing, scale efficiencies, and financial performance at Internet-only banks," Working Paper Series WP-01-06, Federal Reserve Bank of Chicago. [Downloadable!]
  5. Robert DeYoung & William C. Hunter, 2001. "Deregulation, the Internet, and the competitive viability of large banks and community banks," Working Paper Series WP-01-11, Federal Reserve Bank of Chicago. [Downloadable!]
  6. Biaggio Bossone & Jong-Kun Lee, 2002. "In Finance, Size Matters," IMF Working Papers 02/113, International Monetary Fund. [Downloadable!]
  7. Joseph P. Hughes & Choon-Geol Moon, 2004. "Estimating managers' utility-maximizing demand for agency goods," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 320-352. [Downloadable!]
  8. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon & Michael S. Pagano, 2002. "Do Bankers Sacrifice Value to Build Empires? Managerial Incentives, Industry Consolidation and Financial Performance," Center for Financial Institutions Working Papers 02-18, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
    Other versions:
  9. Koetter, Michael & Poghosyan, Tigran, 2008. "The implications of latent technology regimes for competition and efficiency in banking," Discussion Paper Series 2: Banking and Financial Studies 2008,15, Deutsche Bundesbank, Research Centre. [Downloadable!]
  10. Michael Koetter, 2004. "The Stability of Efficiency Rankings when Risk-Preferences are different," Working Papers 04-08, Utrecht School of Economics. [Downloadable!]
  11. Armah, Bernard & Park, Timothy A., 1998. "Agricultural Bank Efficiency And The Role Of Managerial Risk Preferences," 1998 Annual meeting, August 2-5, Salt Lake City, UT 20909, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  12. Koetter, Michael, 2006. "The stability of efficiency rankings when risk-preferences and objectives are different," Discussion Paper Series 2: Banking and Financial Studies 2006,08, Deutsche Bundesbank, Research Centre. [Downloadable!]
  13. Martin Desrochers & Mario Lamberte, 2003. "Efficiency and Expense Preference in Philippines' Cooperative Rural Banks," Cahiers de recherche 0321, CIRPEE. [Downloadable!]
  14. Allen N. Berger & Astrid A. Dick, 2004. "Entry into banking markets and the first-mover advantage," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 243-254. [Downloadable!]
  15. Loretta J. Mester, 2003. "Applying efficiency measurement techniques to central banks," Working Papers 03-13, Federal Reserve Bank of Philadelphia. [Downloadable!]
  16. Robert DeYoung, 2001. "Learning-by-doing, scale efficiencies, and financial performance at Internet-only banks," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 315-327.
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