An Empirical Test of the Incentive Effects of Deposit Insurance: The Case of Junk Bonds at Savings and Loan Associations

This paper analyzes how financial markets reacted to S&L diversification into junk bonds. We report that junk bond holdings are positively correlated with both the volatility of S&L equity returns and the interest rates paid on large CDs. Next, we examine the impact of junk bonds on equity r...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 1994-02, Vol.26 (1), p.146-164
Main Authors: Brewer, Elijah, Mondschean, Thomas H.
Format: Article
Language:English
Subjects:
Banking law
Bonds
Capital markets
Coefficients
Common stock
Credit market
Credit markets
Deposit insurance
Economic aspects
Financial investments
Insurance
Investment risk
Junk bonds
Market value
Mortgage loans
Savings and loan associations
Savings banks
Variable coefficients
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Summary:This paper analyzes how financial markets reacted to S&L diversification into junk bonds. We report that junk bond holdings are positively correlated with both the volatility of S&L equity returns and the interest rates paid on large CDs. Next, we examine the impact of junk bonds on equity returns. For poorly capitalized S&Ls, greater risk taking increases the value of deposit insurance and should lead to higher stock returns. However, a well-capitalized institution that increases junk bond holdings should not experience stock price gains. We find that this is the case for the sample of S&Ls we studied. (Printed by permission of the publisher.)
ISSN:0022-2879
1538-4616
DOI:10.2307/2078039