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The Enforceability of Private Money Contracts, Market Efficiency, and Technological Change

  • Gary Gorton

The period prior to the U.S. Civil War saw the introduction and rapid diffusion of the railroad. It was also the Free Banking Era (1838-1863) during which some states allowed relatively free entry into banking. Banks in all states issued distinct private monies, called bank notes, which circulated at discounts from face value in secondary markets at locations away from the issuing bank. This paper proposes a pricing model for bank notes, and then, using a newly discovered data set of monthly bank note prices for all banks in North America, studies the secondary market for privately issued bank notes during the American Free Banking Era, 1838-1863. To test the model, the durations and costs of trips from Philadelphia to other locations are constructed from pre-Civil War travellers’ guides in order to measure improvements resulting from the diffusion of the railroad during this period. The results suggest that the note market accurately prices risk. Systematic wildcat banking was not possible. The transportation costs of note redemption explain only part of bank note discount variation. Bank default risk was differentially priced and such risk premia varied cyclically.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 19-90.

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Handle: RePEc:fth:pennfi:19-90
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  1. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
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  18. Geske, Robert, 1977. "The Valuation of Corporate Liabilities as Compound Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 541-552, November.
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