Strategic behaviors in financial markets and applications of the market discipline mechanism

This dissertation provides theoretical and empirical support for the mechanism of market discipline as an alternative channel complementing supervisory efforts of prudential regulation. The model introduced in the first part is based on a novel risk-return technology that summarizes the lending opportunities of the financial intermediaries. The geometric properties and assumptions underlying the risk-return function are also studied. The main result of the model asserts that a banking institution is rewarded by revealing more information about its portfolio structure and penalized by preventing information pertaining to its asset portfolio to generate ambiguity and uncertainty about its condition. Therefore these results encourage bank managers for meaningful disclosure of bank data in a timely fashion. In fact to do so is in the best interest of the bank itself.;The model asserts also that relying solely on capital requirements might be insufficient for establishing safety and soundness of the banking system. Besides, policies like deposit safety nets and "too big to fail" protection severely undermine the effective functioning of market discipline.;The dissertation gathers summary statistics related to subordinated debt issued by the 100 largest U.S. banks from 1984 until 2007. U.S. banks released larger amounts of these types of securities over the recent years in compliance with greater efforts to enhance market discipline over banks in the U.S.;The second part of the dissertation compares the significance of market discipline in Turkey before and after the 2001 financial crisis. Unlike the literature and past empirical studies about Turkish banking, estimation results from a 3SLS instrumental variable regression is reported. The results support that market discipline is stronger following the crisis. The interaction between deposit insurance and market discipline is also analyzed for the period between the 3rd quarter of 1997 and the first quarter of 2007. Applications of the "too-big-to-fail" protection during and following financial crises are justified from the dataset and regression estimation results. This type of coverage for large banks certainly diminishes the efficiency of the market discipline mechanism in Turkey in the post crisis period.