Bank Financing and Investment Decisions with Asymmetric Information

Banks know more about the quality of their assets than do outside investors. This informational asymmetry can distort investment decisions if the bank must raise funds from uninformed outsiders, and assets sold will be subject to a lemons discount. Using a three-period equilibrium model we examine the effect of asymmetric information about loan quality on the asset and liability decisions of banks and the market valuation of bank liabilities. The existence of a precautionary demand for T-bills against future liquidity needs depends both on the regulatory environment and the informational structure. If banks are ex ante identical, issuing risky debt to fund a deposit outflow is preferred to holding T-bills ex ante. However, if banks have partial knowledge of loan quality, and if their asset choice is observable, they may hold T-bills to signal their quality, enabling them to issue risky debt at a lower interest rate.

Joint Risk of DB Pension Underfunding and Sponsor Termination: Incorporating Options-Based Projections and Valuations into PIMS

When a private pension plan sponsor with an underfunded plan becomes insolvent, the difference between the value of the plan’s assets and its termination liabilities represents a liability for the Pension Benefit Guaranty Corporation (PBGC). Hence, accurately modeling the joint statistical distribution over time of defined benefit (DB) pension underfunding and sponsor terminations is critical for estimating PBGC’s prospective cash flows and evaluating its financial position. It appears that the current Pension Insurance Modeling System (PIMS) approach to modeling risk does a reasonable job of capturing its statistical properties effects on PBGC cash flows, though some aspects of the might be improved and metrics expanded. The paper outlines how an options-based approach to modeling the joint distribution of defaults and underfunding in PIMS might be implemented while preserving the strengths of the current model. Moving to an options-based approach would allow PIMS to be used to estimate the fair values of future liabilities. Such an approach could have a significant effect on the perceived financial position of PBGC