Search

A unified framework is presented to characterise the capital structure of firms that face borrowing restrictions – which extends the classic theory of capital by incorporating elements from actuarial and agency theory. It is demonstrated that the bankruptcy and agency costs afforded by these firms can be expressed in terms of the actuarial prices of the underlying exposures. Then the optimal surplus is determined in order to maximise value – which is equivalent to minimise the cost of bankruptcy plus the opportunity cost of capital. The capital principle thus obtained explicitly depends on risk and expectations, and can be applied to allocate reserves both in financial and insurance companies. An optimal decentralised mechanism is also defined that stimulates the exchange of information inside multidivisional corporations.

The extent to which central banks are able to anticipate the effects of monetary policy can be assessed within the framework of the liquidity-preference proposition. An actuarial-based theory of liquidity preference is developed in this paper, which extends the traditional framework by introducing borrowing restrictions. This setting can be applied to describe a broad range of corporate, financial and economic decisions. A major result of the paper is that the interest rate elasticity of the money demand, and hence, the effectiveness of monetary policy, directly depends on the series of nominal output returns. Some states are characterized in particular, when the money demand is perfectly elastic and monetary policy is useless to deal with output fluctuations. An analysis of the historical data of the economy of the USA is additionally provided, which presents empirical evidence showing that the interest rate elasticity can increase in response to economic fluctuations. It is thus concluded that not only the growth and inflation rates should be taken into consideration when implementing monetary policy - as is currently the case in a majority of countries - but also the statistical description of the series of nominal output returns.

A model is presented to characterize the equilibrium in markets of short-term loans. First, the cash demand is characterized as the optimal balance maintained to avoid the losses produced by some portfolio with random payoffs. This problem is formulated in actuarial terms in such a way that the optimal balance is expressed as the quantile function of the probability distribution describing the underlying risk (i.e. the value-at-risk). An expression is then obtained for the semi-elasticity of the demand for balances with respect to the interest rate. The effects of credit and investment flows over the equilibrium can be precisely described on these grounds. In the particular case, when the series of price returns of the underlying portfolio is described by a Gaussian probability distribution, episodes of liquidity crises can be corresponded to specific combinations of the risk parameters and the level of the interest rate. Theoretical evidence is thus given of these phenomena.

An actuarial theoretical setting is presented to characterise the money demand and the monetary equilibrium. Two main hypotheses are stated that contradict assumptions normally sustained in empirical investigations of the money demand: national output is assumed to be a random variable, and people are supposed to face borrowing restrictions in money markets. The aggregate demand for balances is then determined in order to maximise the expected return of a certain portfolio combining risk and cash holdings. Yet, unlike under classical implementations of the utility maximixation approach, the prices of the underlying exposures are established in actuarial terms. Within this framework, the efficacy of monetary policy is shown to be explicitly affected by the statistical description of the series of national output returns. As a conclusion, in order to pursue monetary interventations ensuring sustainable growth and financial stability, monetary authorities must necessarily pay attention to nominal fluctuations.

A general theory of liquidity is proposed. The major hypothesis advanced in the paper is that individuals do face borrowing restrictions in capital markets. The value of portfolios combining risky assets and cash balances is then related to the price assigned in some market of deposit insurance, and is accordingly characterised by a method suggested by actuarial researchers and commonly used by insurers and reinsurers. It is demonstrated that in this way, macroeconomics, financial economics and actuarial sciences fuse together in a unified theoretical framework, which can be applied as an alternative to the utility maximisation approach. Episodes of liquidity crises, which lack an explanation under classic economic theory, are meaningful within the new theoretical setting.

The demand for cash balances of financial intermediaries that establish contractual liabilities with credit-sensitive customers is characterised. As stated by Merton, the success of the business activities of such firms crucially depends on their credit quality, and hence, they are obliged to rely on deposit insurance and capital cushions in order to assure that their promised payments are free of default. Unlike the Merton’s approach, the optimal guaranteeing contract is formulated in actuarial terms in this paper, because in this way the model can be extended to consider the situation of firms that can only hedge up to a limited extent. Within this framework, the equilibrium in the market determines the rate at which a unit of capital is exchange by a unit of risk, or, in other words, it determines the market price of risk. Episodes of liquidity crises are meaningful in this theoretical setting.

An alternative theoretical setting is presented to characterise the money demand and the monetary equilibrium. Two main hypotheses are stated that contradict the assumptions normally sustained by scholars and policy-makers: national output is assumed to be a random variable, and people are supposed to face borrowing restrictions in capital markets. After the model of James Tobin, 1958, the demand for balances is determined in order to maximise the expected return of a certain portfolio combining risk and cash holdings. Unlike the model of Tobin, the prices of the underlying exposures are established in actuarial terms. Then the efficacy of monetary policy is explicitly affected by the expected return and the volatility of the series of percentage returns of the national output.

A model is presented to characterise the (optimal) demand for cash balances in deregulated markets. After the model of James Tobin, 1958, net balances are determined in order to maximise the expected return of a certain portfolio combining risk and capital. Unlike the model of Tobin, however, the price of the underlying exposures are established in actuarial terms. Within this setting, the monetary equilibrium determines the rate at which a unit of capital is exchange by a unit of exposure to risk, or equivalently, it determines the market price of risk. In a Gaussian setting, such a price is expressed as a mean-to-volatility ratio and can then be regarded as an alternative measure to the Sharpe ratio. The effects of credit and monetary flows on money and security markets can be precisely described on these grounds. An alternative framework for the analysis of monetary policy is thus provided.

The capital structure of firms that face restrictions on liquidity (i.e. that cannot hedge continuously) is affected by the agency costs and moral-hazard implicit in the contracts they establish with stockholders and customers. It is demonstrated in this paper that then an optimal level of capital exists, which is characterised in terms of the actuarial prices of the involved agreements. The capital principle so obtained explicitly depends on risk and expectations and it can be naturally applied to allocate balances inside multidivisiona corporations. In particular, an optimal decentralised mechanism is defined, which stimulates the exchange of information between central and divisional administrations. A novel model of capital is thus formulated, which extends the classic theoretical framework (sustained by the well-known proposition of Modigliani and Miller and the model of deposit insurance of Robert Merton) and integrates the financial and actuarial theoretical settings.