Joint Effects of Interest Rate Deregulation and Capital Requirements on Optimal Bank Portfolio Adjustments

Authors

  • CHUN H. LAM,

  • ANDREW H. CHEN

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    • Both authors from the Edwin L. Cox School of Business, Southern Methodist University. The authors would like to thank Chris Barry and Ed Kane for valuable comments on the paper. They also acknowledge the financial support from the Center for the Study of Financial Institutions and Markets at Southern Methodist University.


ABSTRACT

The 1980 Depository Institution Deregulation and Monetary Control Act (DIDMCA) mandates that Regulation Q be phased out by 1986. With deregulation of interest rate ceilings, the cost of raising capital funds for commercial banks would become more volatile and more closely related with interest rates in the money and capital markets. Thus, value-maximizing bank managers would need to be concerned not only with the internal risk, but also with the external risk in bank portfolio management decisions. Based upon the cash flow version of the capital asset pricing model, this paper analyzes the joint impact of interest rate deregulation and capital requirements on the portfolio behavior of a banking firm.

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