A Generic Model of Financial Repression

The paper develops a growth model in an overlapping generations framework of a financially repressed small open economy, and analyzes the effects of financial liberalization. The following observations are made: An increase (decrease) of interest rate (reserve requirements) reduces (increases) the steady-state stock of capital and the trade balance, but improves (deteriorates) the level of foreign exchange reserves. However, financial liberalization, in any form, is always welfare-improving. The paper, thus, advocates financial liberalization policies to be oriented towards reduction of reserve requirements rather than interest rate deregulation, if foreign reserve holding is not in a critical position.

The Optimal Capital Structure of Banks: Balancing Deposit Insurance, Capital Requirements and Tax-Advantaged Debt

The capital structure and regulation of financial intermediaries is an important topic for practitioners, regulators and academic researchers. In general, theory predicts that firms choose their capital structures by balancing the benefits of debt (e.g., tax and agency benefits) against its costs (e.g., bankruptcy costs). However, when traditional corporate finance models have been applied to insured financial institutions, the results have generally predicted corner solutions (all equity or all debt) to the capital structure problem. This paper studies the impact and interaction of deposit insurance, capital requirements and tax benefits on a bankÇs choice of optimal capital structure. Using a contingent claims model to value the firm and its associated claims, we find that there exists an interior optimal capital ratio in the presence of deposit insurance, taxes and a minimum fixed capital standard. Banks voluntarily choose to maintain capital in excess of the minimum required in order to balance the risks of insolvency (especially the loss of future tax benefits) against the benefits of additional debt. Because we derive a closed- form solution, our model provides useful insights on several current policy debates including revisions to the regulatory framework for GSEs, tax policy in general and the tax exemption for credit unions.

Dynamic Effects of Currency Depreciation on Stock Market Returns during the Asian Financial Crisis

The current international integration of financial markets provides a channel for currency depreciation to affect stock prices. Moreover, the recent financial crisis in Asia with its accompanying exchange rate volatility affords a case study to examine that channel. This paper applies a bivariate GARCH-M model of the reduced form of stock market returns to investigate empirically the effects of daily currency depreciation on stock market returns for five newly emerging East Asian stock markets during the Asian financial crisis. The evidence shows that the conditional variances of stock market returns and depreciation rates exhibit time-varying characteristics for all countries. Domestic currency depreciation and its uncertainty adversely affects stock market returns across countries. The significant effects of foreign exchange market events on stock market returns suggest that international fund managers who invest in the newly emerging East Asian stock markets must evaluate the value and stability of the domestic currency as a part of their stock market investment decisions.