A Theory of Precautionary Regulatory Capital in Banking*
Phong T. H. Ngo(School of Finance and Applies Statistics, College of Business and Economics, Australian National University, ACT, Australia)

The orthodox assumption in the banking literature is that capital requirements are a binding constraint on banking behavior. This is in conflict with the empirical observation that banks hold a buffer of capital well in excess of the minimum requirements. This paper develops a model where capital is endogenously determined within a profit-maximizing equilibrium. Optimality involves balancing the reduction in expected costs associated with regulatory breach with the excess cost of financing from increasing capital. We demonstrate that when the equilibrium probability of regulatory breach is less than one-half, banks are expected to hold precautionary capital.

*Thanks are due to Shane Evans and Tom Smith for their comments on earlier versions of this paper. Thanks are also due to Simon Giles, Jeremy Hodgson, Stephen Mitchell and Peter Mudge for fruitful discussions during the preparation of the paper.

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How do Individual, Institutional, and Foreign Investors Win and Lose in Equity Trades? Evidence from Japan*
Kee-Hong Bae(Queen’s University, Kingston, Ontario, Canada)
Takeshi Yamada(National University of Singapore, Singapore)
Keiishi Ito(Nomura Securities, Tokyo, Japan)

We investigate the gains and losses from equity trades of individual investors, various institutional investors, and foreign investors in the Tokyo Stock Exchange. We develop a trade-weighted performance measure and examine the impact of trading intervals, price spreads, and market timing on performance. We find that different investor types gain or lose from different sources. For example, we discover that individual investors have poor market timing ability but potentially gain during short-run trading intervals as their average sell price is consistently higher than the average purchase price. In contrast, we find that foreign investors consistently generate gains from trade due to good market timing, although their average sell price is lower than the average purchase price. Also, we find that foreign investors extract significant portion of their gains by trading against Japanese institutional investors when Japanese investors trade before their fiscal-year end.

*We received useful suggestions from participants of The 5th Behavioral Economics Workshop co-sponsored by Aoyama Gakuin University and Osaka University Center for Research in Behavioral Economics. For earlier versions of the paper, we thank Junji Kawahara, Srinivasan Sankaraguruswamy, Yasuhiko Tanigawa, participants of the NFA/APFA/FMA Annual Meetings, and seminar participants at the Hong Kong University of Science and Technology, Keio University, Musashi University, Nanyang Technological University, National University of Singapore, and The University of Hong Kong for helpful comments. We appreciate the efforts of Masato Hirota and Hirotaka Kawai of the Tokyo Stock Exchange in answering our questions on institutional details. We appreciate Alisa Larson for excellent editorial assistance. Yamada acknowledges the support during stay at the Graduate School of International Corporate Strategy of Hitotsubashi University and financial support from the National University of Singapore Academic Research Grant R-315-000-047-112. The contents expressed in the paper do not reflect opinions of the institutions with which authors are affiliated.

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An Empirical Comarison of Price-Limit Models*
Tamir Levy(Netanya Academic College, Netanya, Israel)
Joseph Yagil(Haifa University, Haifa, Israel)

US banks making prime rate revisions are known to suffer stock price declines, which is consistent with the Stiglitz–Weiss adverse selection theory, given the relative stickiness of interest rates. If banks suffer price declines, then why are some banks consistent leaders when revising prime rates? This research question is the focus of our paper and is examined in the relatively concentrated banking system of Singapore. Lead banks in Singapore initiating a large number of rate increases earned an average abnormal return of 5.2%, while non-lead banks also experienced positive abnormal returns of 3.9%, a result not in agreement with US-specific evidence. We argue that the rate increases (decreases) resulting in a significant stock price increase (decrease) for lead banks are consistent with a valuation effect in a concentrated banking system. Our results could be explained as a valuation effect from anticipated higher profits or as reward for being first. The first mover advantage may thus also have signaling value on quality.

*We thank Dilip Ghosh for his extensive and useful comments on an earlier version of this paper. We also thank the anonymous referee for comments that helped improve this paper and especially the Editor, Bruce Grundy, for his useful suggestions. We are responsible for any remaining errors.

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The Valuation Effects of Prime Rate Revisions: Is There an Advantage of Being First?
Mohamed Ariff(Bond University, QLD, Australia)
Asjeet S. Lamba(University of Melbourne, Melbourne, Australia)

US banks making prime rate revisions are known to suffer stock price declines, which is consistent with the Stiglitz–Weiss adverse selection theory, given the relative stickiness of interest rates. If banks suffer price declines, then why are some banks consistent leaders when revising prime rates? This research question is the focus of our paper and is examined in the relatively concentrated banking system of Singapore. Lead banks in Singapore initiating a large number of rate increases earned an average abnormal return of 5.2%, while non-lead banks also experienced positive abnormal returns of 3.9%, a result not in agreement with US-specific evidence. We argue that the rate increases (decreases) resulting in a significant stock price increase (decrease) for lead banks are consistent with a valuation effect in a concentrated banking system. Our results could be explained as a valuation effect from anticipated higher profits or as reward for being first. The first mover advantage may thus also have signaling value on quality.

*We thank Dilip Ghosh for his extensive and useful comments on an earlier version of this paper. We also thank the anonymous referee for comments that helped improve this paper and especially the Editor, Bruce Grundy, for his useful suggestions. We are responsible for any remaining errors.

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