Economic Review

Gerald P. Dwyer Jr.

Banks in the United States issued currency with no oversight of any kind by the federal goverment from 1837 to 1865. Many of these banks were part of "free banking" systems with no discretionary approval of entry into banking, and these banks issued notes that were used for payments in transactions just as Federal Reserve notes are today. There was no central bank or goverment insurance, and the ultimate guarantee of the value of a bank's notes was the value of the bank's assets. As the author indicates, these banknotes have similarities to some forms of electronic money.

Free banking in the United States sometimes has been equated with wildcat banking, a name that suggests that opening a bank has much in common with drilling an oil well. The author examines notorious instances of supposed wilcat banking and finds little evidence that free banks were imprudent, let alone financially reckless. Instead, episodic difficulties faced by free banks occurred because of developments outside the banking systems.

Peter A. Abken and Saikat Nandi

Because volatility of the underlying asset price is a critical factor affecting option prices and hedge ratios, the modeling of volatility and its dynamics is of vital interest to traders, investors, and risk managers. This modeling is a difficult task because the path of volatility during the life of an option is highly unpredictable. There has been a proliferation of volatility specifications since the original, simple constant-volatility assumption of the famous Black and Scholes option pricing model. This article gives an overview of different specifications of asset price volatility that are widely used in option pricing models.

While the authors cite evidence that some stochastic-volatility option pricing models provide better market prices and hedges than the Black-Scholes model, they acknowledge that for both academic researchers and market practitioners, no consensus exists regarding the best specification of volatility for option pricing. Although a number of alternative approaches can account, at least partially, for the pricing deficiencies of the Black-Scholes models, none dominates as a clearly superior approach for pricing options.