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The Fama and Frenchs three factor model ( Fama and French, 1992 , Fama and French, 1993 ) is now the most popular replacement for CAPM. In the model, the fact that the model excludes financial firms is significant because financial firms are a large fraction of the value of the U.S. stock market. Also, there is no theoretical reason for excluding financial firms. Modigliani and Miller, 1958 , Modigliani and Miller, 1963 suggest that leverage affects beta, but it does not invalidate the capital asset pricing model. It would therefore be more satisfying if the pricing model applied generally, rather than being restricted to non-financial corporations. Thus, we assess the validity of size and value risk as common risk factors to measure of the cross-section of expected stock returns in financial companies. Empirical asset pricing tests suggest two findings. First, size and value risk premia commonly exists in both nonfinancial and financial firms, even if two factors are less explicable in financial firms. Second, an interest rate risk premium ( Δ L / L ) which defined as a financial firm specific risk factor only appears in financial companies.

Empirical investigation of the external finance premium has been conducted on the margin between internal finance and bank borrowing or equities but little attention has been given to corporate bonds, especially for the emerging Asian market. In this paper, we hypothesize that balance sheet indicators of creditworthiness could affect the external finance premium for bonds as they do for premia in other markets. Using bond-specific and firm-specific data for China, Hong Kong, Indonesia, Korea, Philippines, Singapore and Thailand during 1995–2009 we find that firms with better financial health face lower external finance premia in all countries. When we introduce firm-level heterogeneity, we show that financial variables appear to be both statistically and quantitatively more important for financially constrained firms. Finally, when we examine the effects of the 1997–1998 Asian crisis and the 2007–2009 global financial crisis, we find that the sensitivity of the premium is greater for constrained firms during the Asian crisis compared to other times.

It has been claimed that the ability of emerging markets to adopt optimal stabilization policies is hampered by a number of factors. Among them, it has been recently emphasized the role of financial instability, inefficiencies, and financial market imperfections. It is claimed here that the current financial regulatory paradigm, embodied in Basel II, may improve financial stability but reinforces cyclicality. Therefore, countries should emphasize financial efficiency since it would lead to enhanced financial stability, without increasing cyclicality.

This paper constructs a general equilibrium model of banking and financial markets. The model allows to compare financial systems in which banks have access to financial markets with financial systems in which banks do not have access to financial markets. Allen and Gale [A welfare comparison of intermediaries and financial markets in Germany and the US. European Economic Review 39 (1995) 179–209] find that the Anglo-Saxon model of financial intermediation in which financial markets play a dominant role does not necessarily improve social welfare in comparison with the German model in which banks dominate. Our model provides a theoretical foundation for this view.

This comment discusses the review by Franklin Alien and Anthony Santomero of the theory of financial intermediation in the 20th anniversary special issue of the Journal of Banking and Finance. We do not fully agree with their view that risk management is only of recent importance to the financial industry and with putting central the concept of participation costs. We suggest how the theory of financial intermediation might be developed further in order to understand present-day phenomena in the financial services sector. (C) 2000 Elsevier Science B.V. All rights reserved. JLSL classtfication: E51; G10; G20; L23.