Old Bank of England Working Papers
These are my old WPs that are
no longer available on the Bank of England website and are not published elsewhere. I sometimes (rarely
to be honest) get requests for these
Working Paper No 14 , 1993
“House prices, arrears and possessions: A three equation model for the UK”
by F J Breedon and M A S Joyce
The current slump in the UK housing
market has coincided with record increases in mortgage arrears and
possessions. Falling nominal house prices reduce the amount of
unwithdrawn equity in housing and, under certain conditions, provide
incentives for borrowers to accumulate arrears and for lenders to
possess. However, possessions may themselves depress house prices. This
paper attempts to analyse and quantify these interactions by estimating
a three equation econometric model of UK mortgage arrears, possessions
and house prices, in which expectations of future house prices are
formed according to the rational expectations hypothesis. The model is
simulated to examine the implications of interest rate changes and
policies to reduce possessions.
Working Paper No 39, 1995
“Valuation of underwriting agreements for UK rights issues: evidence from the traded option market”
by Francis Breedon and Ian Twinn
A recent study by Professor Marsh
of the London Business School has estimated that sub-underwriters of
rights issues (firms that commit to buy up any remaining shares at the
end of a rights issue) make an excess profit of 86% of the fee they
charge. Because of this study, the OFT (who originally commissioned it)
have argued that underwriting is too expensive and have encouraged
firms to reconsider their issuance techniques.
Marsh's study, however, is based on
a number of assumptions that are unlikely to hold in practice. In
particular, Marsh used the Black and Scholes option pricing formula to
value the economic cost of underwriting (underwriting is like a put
option since it gives the firm the right but not the obligation to sell
shares to the underwriter). But it is well known that the Black and
Scholes formula is based on a high unrealistic view of financial
markets with no transactions costs and no information asymmetries.
To make a more realistic estimate
of the economic cost of underwriting, this paper looks at the cost of
buying put options in the traded option market. This does not mean that
buying a put option in the traded option market is a viable alternative
to underwriting it simply allows for a more realistic measure of
transactions costs. By looking at the price of put options on firms who
have just announced a rights issue the paper funds, unsurprisingly,
that the true cost of put options was much higher than the Black and
Scholes formula predicted. However, it still found that underwriters
made an abnormal profit, even if it was only 40% of the fee rather than
86%.
Working Paper No 57, 1996
“Why do the LIFFE and DTB bund futures contracts trade at different prices?”
Francis Breedon
The German Bund futures contract is
the most important bond futures contract in Europe. It is also unusual
in that it trades on competing Exchanges - LIFFE in London and the DTB
in Frankfurt. This paper looks at a surprising aspect of this dually
traded contract, namely that the contract trades slightly more
expensively (1.5 basis points) in LIFFE than in the DTB. LIFFE argue
that this price difference helps make their contract more attractive.
The paper investigates three
possible explanations for the price difference. First, the calculation
of price factors (conversion factors that make bonds in the basket of
deliverables more comparable) differs slightly between Exchanges.
Second, the DTB contract carries on trading for one day longer than the
LIFFE one giving the short one more days to choose which bund in the
basket to deliver (the so-called quality option) and so makes the
contract slightly less valuable to the trader with a long position.
Third, the penalty for late delivery is harsher on LIFFE than on the
DTB and so investors fearing a short squeeze (where investors that are
supposed to deliver the underlying bunds cannot acquire them) will be
more nervous of holding a LIFFE contract than a DTB one.
It concludes that none of these
factors are important enough to explain the observed price difference
and so it is hard to explain why the price difference occurs.