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Insiders' assessments of the stock market's pricing of New England banks

  • John S. Jordan
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    The surge in bank failures in the late 1980s and early 1990s prompted many policy proposals in search of an improved regulatory and supervisory framework. One such reform urges the enhancement of market forces in the disciplining of banking institutions. This study assesses the effectiveness of one type of outside monitor, stock market participants, in identifying New England banks' exposure to the region's real estate market in the late 1980s and early 1990s. An examination of this issue is important for evaluating the potential role that private sector claimholders can exercise in the monitoring and disciplining of banks. Were shareholder reactions to the troubled real estate market consistent with individual banks' exposures to this market, or was there evidence of bank share prices deviating from their fundamentals?> The analysis relies on trading by bank managers, who are likely the best informed regarding the bank's risk exposure, to assess the market's accuracy in pricing bank stocks. By examining managerial trading around changes in the market's valuation of a bank, one can gain insight into the insiders' assessment of the market's pricing of their firms' shares. Trading activity by managers of surviving institutions suggests that the market had difficulty assessing a bank's exposure to the region's business cycle. The evidence supports the assertion that informational asymmetries are present in the banking industry. Given this environment, requiring bank managers to disclose more of their private information could improve the market's ability to discipline banks.

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    File URL: http://www.bostonfed.org/economic/neer/neer1997/neer497a.htm
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    File URL: http://www.bostonfed.org/economic/neer/neer1997/neer497a.pdf
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    Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

    Volume (Year): (1997)
    Issue (Month): Jul ()
    Pages: 3-16

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    Handle: RePEc:fip:fedbne:y:1997:i:jul:p:3-16
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    1. Pettway, Richard H, 1976. "Market Tests of Capital Adequacy of Large Commercial Banks," Journal of Finance, American Finance Association, vol. 31(3), pages 865-75, June.
    2. Robert E. Lamy & G. Rodney Thompson, 1986. "Penn Square, Problem Loans, And Insolvency Risk," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 9(2), pages 103-111, 06.
    3. S. Rao Aiyagari, 1988. "Banking panics, information, and rational expectations equilibrium," Working Papers 320, Federal Reserve Bank of Minneapolis.
    4. R. Alton Gilbert, 1990. "Market discipline of bank risk: theory and evidence," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 3-18.
    5. Peavy, John III & Hempel, George H., 1988. "The Penn Square Bank failure : Effect on commercial bank security returns -- a note," Journal of Banking & Finance, Elsevier, vol. 12(1), pages 141-150, March.
    6. Karafiath, Imre & Glascock, John, 1989. "Intra-industry Effects of a Regulatory Shift: Capital Market Evidence from Penn Square," The Financial Review, Eastern Finance Association, vol. 24(1), pages 123-34, February.
    7. Aharony, Joseph & Swary, Itzhak, 1983. "Contagion Effects of Bank Failures: Evidence from Capital Markets," The Journal of Business, University of Chicago Press, vol. 56(3), pages 305-22, July.
    8. Chari, V V & Jagannathan, Ravi, 1988. " Banking Panics, Information, and Rational Expectations Equilibrium," Journal of Finance, American Finance Association, vol. 43(3), pages 749-61, July.
    9. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
    10. John S. Jordan, 1997. "Manager's opportunistic trading of their firms' shares: a case study of executives in the banking industry," Working Papers 97-4, Federal Reserve Bank of Boston.
    11. Rozeff, Michael S & Zaman, Mir A, 1988. "Market Efficiency and Insider Trading: New Evidence," The Journal of Business, University of Chicago Press, vol. 61(1), pages 25-44, January.
    12. V.V. Chari & Ravi Jagannathan, 1984. "Banking Panics," Discussion Papers 618, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    13. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
    14. Jaffe, Jeffrey F, 1974. "Special Information and Insider Trading," The Journal of Business, University of Chicago Press, vol. 47(3), pages 410-28, July.
    15. James, Christopher, 1989. "Empirical evidence on implicit government guarantees of bank foreign loan exposure," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 30(1), pages 129-162, January.
    16. Gorton, Gary, 1985. "Bank suspension of convertibility," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 177-193, March.
    17. Ramakrishnan, Ram T S & Thakor, Anjan V, 1984. "Information Reliability and a Theory of Financial Intermediation," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 415-32, July.
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