Submission Date

4-27-2015

Document Type

Paper

Department

Business & Economics

Adviser

Andrew Economopoulos

Committee Member

Scott Deacle

Committee Member

Richard King

Department Chair

Jennifer VanGilder

Project Description

Free banks in Illinois could issue bank notes backed by state or U.S. bond collateral. A decline in bond prices as the Civil War approached resulted in banks being unable to redeem their noteholders in gold specie and subsequently resulted in bank failures. Previously economic historians believed that failures of free banks were due to wildcat banking rather than the portfolio allocation of free banks. Over time, other researchers have found that banks that took greater ex ante risk prior to the failure were more likely to fail. There were other price declines during the 1850s, in particular the Panic of 1857, so managers should have been able to determine the likelihood of price declines that would result in failure. Since it was the bonds of the Southern states that sharply declined in value, examining potential reasons that these banks held large amounts of these bonds were also examined. The bond portfolios being analyzed include the securities held by the Illinois free banks in November of 1858 and in November of 1860. The value-at-risk and Sharpe ratio metrics measured price risk and return per unit of risk respectively to help assess whether the free banks took undue risk. Overall, the Illinois free banks appeared to be taking undue risk with their bond portfolios since they did not adequately reduce their risk over time, with the riskier older bank portfolios also receiving less return per unit of risk in 1860.

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