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Conflicts of Interest in Financial Markets - Evidence from Bond Underwriting in the Nineties

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  • Focarelli, Dario
  • Pozzolo, Alberto Franco

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Abstract

This paper presents some new evidence on the conflict of interest that may arise when banks underwrite corporate securities and sell them to their customers. Two alternative views are confronted; a) that commercial banks possess private information on the financial condition of their clients and so perform better screening (the certification hypothesis); and b) that commercial banks might convert loans to firms in financial difficulties into bonds marketed to unsuspecting clients (the ‘naïve investor’ hypothesis). The empirical analysis compares the default rates between 2000 and 2002 of a sample of more than 5,000 securities issued from 1991 to 1999. Our results show that, on average, securities underwritten by investment houses and by commercial banks had the same probability of default. However, investment-grade issues underwritten by commercial banks had a lower probability of default than those underwritten by investment houses, while the reverse was true for noninvestment- grade issues. Based on this latter result, it is not possible to refute the ‘naïve investor’ hypothesis, as instead in Kroszner and Rajan (1994).

Suggested Citation

  • Focarelli, Dario & Pozzolo, Alberto Franco, 2005. "Conflicts of Interest in Financial Markets - Evidence from Bond Underwriting in the Nineties," Economics & Statistics Discussion Papers esdp05023, University of Molise, Dept. EGSeI.
  • Handle: RePEc:mol:ecsdps:esdp05023
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    File URL: http://web.unimol.it/progetti/repec/mol/ecsdps/ESDP05023.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Conflicts of interest; Glass-Steagall Act; Securities underwriting; Default performance.;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

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