Western Michigan University ScholarWorks at WMU Dissertations Graduate College 12-2012 Traditional and Market-Based Financial Intermediaries: Three Essays Examining Their Risk Behavior, Delisting Behavior, and Reactions to Economic Policy Uncertainty Marc S. Schaffer Western Michigan University, [email protected] Follow this and additional works at: https://scholarworks.wmich.edu/dissertations Part of the Behavioral Economics Commons Recommended Citation Schaffer, Marc S., "Traditional and Market-Based Financial Intermediaries: Three Essays Examining Their Risk Behavior, Delisting Behavior, and Reactions to Economic Policy Uncertainty" (2012). Dissertations. 118. https://scholarworks.wmich.edu/dissertations/118 This Dissertation-Open Access is brought to you for free and open access by the Graduate College at ScholarWorks at WMU. It has been accepted for inclusion in Dissertations by an authorized administrator of ScholarWorks at WMU. For more information, please contact [email protected]. TRADITIONAL AND MARKET-BASED FINANCIAL INTERMEDIARIES: THREE ESSAYS EXAMINING THEIR RISK BEHAVIOR, DELISTING BEHAVIOR, AND REACTIONS TO ECONOMIC POLICY UNCERTAINTY by Marc S. Schaffer A Dissertation Submitted to the Faculty of The Graduate College in partial fulfillment of the requirements for the Degree of Doctor of Philosophy Department of Economics Advisor: Mark Wheeler, Ph.D. Western Michigan University Kalamazoo, Michigan December 2012 TRADITIONAL AND MARKET-BASED FINANCIAL INTERMEDIARIES: THREE ESSAYS EXAMINING THEIR RISK BEHAVIOR, DELISTING BEHAVIOR, AND REACTIONS TO ECONOMIC POLICY UNCERTAINTY Marc S. Schaffer, Ph.D. Western Michigan University 2012 In the wake of our country’s greatest financial crisis since the Great Depression, the need to better understand the risks and behaviors associated with financial intermediaries has become apparent. In particular, the literature distinguishes between traditional or depository-based financial intermediaries and their market-based or non-depository counterparts. This dissertation focuses on understanding the behavioral differences across these two groups by examining their equity-based risk differences, their stock market delisting differences, and lastly how these firms react to economic policy uncertainty. The first essay uses an equity-based approach to quantify the average firm-level risk that is associated with these intermediary groups. While these intermediaries, at times, demonstrate similar risk behaviors, the market-based financial intermediaries display a distinct ten-year period of greater risk beginning in 1994. Since the 1980’s there has been a trend of increasing financial market instability that is commonly attributed to increasing competition, securitization, and deregulation. Using a historical decomposition approach, I analyze which of these factors best explains the changing relative risk behaviors across the traditional and market-based intermediaries. The most important factor in driving these behaviors was deregulation, with competition also having a significant impact. The second essay examines the stock market survival behavior of each of these respective groups and the role that risk plays in explaining delisting due to firm failure, as well as merger and acquisition activity. Using survival analysis, the delisting behavior of these intermediaries is examined where the market-based firms are more likely to delist relative to the traditional firms due to both firm failure and M&A activity. Additionally, idiosyncratic risk is found to have a statistically significant impact in driving these behaviors. The last essay focuses on how each of these intermediary groups alters their balance sheet in the face of economic uncertainty. Specifically, I examine how the debt-financing behavior of these firms reacts to an economic policy uncertainty shock using a macroeconomic approach. The key results, from the impulse response and variance decomposition analysis, indicate that market-based financial intermediaries tend to have faster responses to policy uncertainty relative to traditional intermediaries, however the small traditional financial intermediaries have the largest response. Copyright by Marc S. Schaffer 2012 ACKNOWLEDGEMENTS I would like to express my sincerest gratitude to those individuals that have helped and encouraged me throughout my academic journey. I would especially like to thank the Graduate College of Western Michigan University and the faculty and staff of the Department of Economics. To the office staff, Connie and Maggie, thank you for keeping me grounded and sane with your kind words and desire to help me in anyway possible. To my professors, thank you for your willingness to share your knowledge and wisdom to help me grow and better understand the world around me. In particular, I cannot thank Dr. Mark Wheeler, my dissertation chair, enough for his wisdom and support. His presence throughout my entire graduate career, from his service as my graduate advisor, to his teaching as my professor, and his guidance as my dissertation advisor, were vital to my success at Western Michigan. This dissertation also would not be what it is today without the valuable comments and guidance of my committee members, Dr. James Hueng and Dr. Mark Wohar. I would also like to the thank Dr. Mike Ryan for his open-door policy and serving as a great source of helpful advice. I also would not be where am I today without the loving support of my family and friends throughout my academic endeavors. To my father, the most honorable and hardest working man I have ever known, and my mother, a woman whose love and support knows no bounds, I am forever indebted to you and your sacrifices to give your children a world full of opportunities. You truly have succeeded, and I would not be who I am today without you. Lastly, I owe Megan, my rock and support line, my heartfelt gratitude for sticking by me throughout the past four and half years while I pursued my dream. Marc S. Schaffer ii TABLE OF CONTENTS ACKNOWLEDGMENTS ............................................................................................................... ii LIST OF TABLES ............................................................................................................................. vii LIST OF FIGURES ........................................................................................................................... viii CHAPTER 1. INTRODUCTION ............................................................................................................. 1 2. THE IMPACT OF COMPETITION, FINANCIAL INNOVATION, AND REGULATION ON THE RISK BEHAVIOR OF TRADITIONAL AND MARKET-BASED FINANCIAL INTERMEDIARIES ............................................ 8 2.1. Introduction ......................................................................................................... 8 2.2. Motivating the Risk Differences Between Market-Based and Traditional Financial Intermediaries ................................................................. 10 2.2.1. Technology Changes and Financial Innovation ........................ 11 2.2.2. Competition and Firm Specialization ........................................... 13 2.2.3. Financial Regulation ........................................................................ 14 2.2.4. The Rise of Market-Based Financial Intermediaries .................. 14 2.2.5. Connecting the Balance Sheet Behaviors of Market-based and Traditional Financial Intermediaries with Idiosyncratic Risk ............................................................................ 16 2.3. The Evolution of Financial Intermediary Risk: Data, Methodology, and Analysis .......................................................................................................... 17 2.3.1. Data Overview ................................................................................. 17 2.3.2. Empirical Methodology .................................................................. 19 2.3.3. Results: The Evolution of Risk Between Market-Based and Traditional Financial Intermediaries .................................... 21 iii Table of Contents—Continued CHAPTER 2.4. Explaining the Evolution: Data, Methodology, and Analysis ..................... 27 2.4.1. Data Overview ................................................................................. 27 2.4.2. Preliminary Analysis ........................................................................ 30 2.4.3. VAR Methodology and Historical Decomposition ................... 33 2.4.4. Results: Explaining the Varying Risk Behaviors of Market-based and Traditional Financial Intermediaries ........... 35 2.4.5. Are the Results Robust to the Excluding the Financial Crisis from the Estimation Sample? ............................................ 42 2.5. Concluding Remarks .......................................................................................... 43 3. THE MARKET SURVIVAL OF PUBLICLY-TRADED TRADITIONAL AND MARKET-BASED FINANCIAL INTERMEDIARIES ................................. 49 3.1. Introduction ......................................................................................................... 49 3.2. Data Overview ..................................................................................................... 51 3.3. Motivating the Differences in Firm Survival Between Market-Based and Traditional Financial Intermediaries ......................................................... 54 3.3.1. The Varying Risk Behaviors