Two Essays on Financial Markets

83 p.Thesis (Ph.D.)--University of Illinois at Urbana-Champaign, 2005.The dissertation presented here is a collection of two self-contained papers on financial markets. The first paper develops a spatial model in which two banks and non-bank ATM owners compete and ATMs are installed either at commercial locations or non-commercial locations. Non-bank owned ATMs have not previously drawn much attention in spite of their large market share in ATM services. We expect that banks set lower nonmember surcharges than non-banks due to the restriction of uniform pricing, and the results show that this holds for some parameter ranges. However, when demand for ATM services at commercial locations is high enough, both banks and non-banks set the same high surcharge on ATM service. Surprisingly, when ATM service demand at commercial locations is low, banks set higher nonmember surcharges than non-bank ATM deployers. These results reconcile the observed ATM pricing. The paper then examines whether banks have incentives to take over non-bank ATMs. We find that it is never optimal for banks to purchase non-bank ATMs. Many people believe that small banks provide high quality services. Especially if a small bank confronts more efficient large banks in the same market, it differentiates itself by providing high quality services in order to survive the intense competition. We begin the second paper by asking: if this is a simple matter of product differentiation, why do only small banks provide high quality services and why cost-efficient large banks don't. We presume it is not a matter of bank size itself nor a matter of cost-efficiency, and consider the empirical finding that most small banks are dependent on insured retail deposits as their main funding source whereas large banks can get access to the low cost wholesale market. We develop a simple spatial model and show that funding restrictions can be a main cause of quality differences. We empirically test our prediction using a measure of service quality. Then we turn to the issue of competition between large and small banks in a local market. We find that large banks reduce competition in terms of the deposit interest rate, which is consistent to recent studies. However, we find that small banks facing large banks in a local market provide higher quality service than those that do not compete with large banks.U of I OnlyRestricted to the U of I community idenfinitely during batch ingest of legacy ETD