New Economics Papers
on Banking
Issue of 2007‒11‒10
nine papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. What does excess bank liquidity say about the loan market in Less Developed Countries? By Tarron Khemraj
  2. Credit risk and Basel II: Are non-profit firms financially different? By Barbara Luppi; Massimiliano Marzo; Antonello E. Scorcu
  3. The effect of employee stock options on bank investment choice, borrowing, and capital By Hamid Mehran; Joshua Rosenberg
  4. Professor Becker on Free Banking: A Comment By van den Hauwe, Ludwig
  5. Modelling Default Contagion Using Multivariate Phase-Type Distributions By Herbertsson, Alexander
  6. Reserve requirement systems in OECD countries By Yueh-Yun C. O’Brien
  7. Pricing k-th-to-default Swaps under Default Contagion: The Matrix-Analytic Approach By Herbertsson, Alexander; Rootzén, Holger
  8. Pricing Synthetic CDO Tranches in a Model with Default Contagion Using the Matrix-Analytic Approach By Herbertsson, Alexander
  9. Financial market perceptions of recession risk By Thomas B. King; Andrew T. Levin; Roberto Perli

  1. By: Tarron Khemraj
    Abstract: Evidence about developing countries’ commercial banks’ liquidity preference suggests the following about their loan markets: (i) the loan interest rate is a minimum mark-up rate; (ii) the loan market is characterized by oligopoly power; and (iii) indirect monetary policy, a cornerstone of financial liberalization, can only be effective at very high interest rates that are likely to be deflationary. The minimum rate is a mark-up over a foreign interest rate, marginal transaction costs and a risk premium. A calibration exercise demonstrates that the hypothesis of a minimum mark-up loan rate is consistent with the observed stylized facts.
    Keywords: Excess bank liquidity, oligopoly banking, loan market, monetary policy
    JEL: O10 O16 E52 G21 L13
    Date: 2007–11
  2. By: Barbara Luppi (CEFIN and University of Modena and Reggio Emilia, Italy); Massimiliano Marzo (University of Bologna and The Rimini Centre for Ecomonic Analysis, Italy); Antonello E. Scorcu (University of Bologna and The Rimini Centre for Ecomonic Analysis, Italy)
    Abstract: We estimate a model of credit risk for portfolios of Small and Medium-sized enterprises, conditional on being a non-profit or for-profit firms. The estimation is based on a unique dataset on Italian firms provided by a large commercial bank. We show that the main variables to identify creditworthiness are different for non-profit andcrucial for non-profit firms. Classification-JEL: G21, G28
    Keywords: SME finance; Basel II; Retail banking; Non-profit
    Date: 2007–07
  3. By: Hamid Mehran; Joshua Rosenberg
    Abstract: In this paper, we test the hypothesis that granting employee stock options motivates CEOs of banking firms to undertake riskier projects. We also investigate whether granting employee stock options reduces the bank's incentive to borrow while inducing a buildup of regulatory capital. Using a sample of 549 bank-years for publicly traded banks from 1992 to 2002, we find some evidence that the bank's equity volatility (total as well as residual) and asset volatility increase as CEO stock option holdings increase. In addition, it appears that granting employee stock options motivates banks to reduce their borrowing, as evidenced by lower levels of interest expense and federal funds borrowing. Furthermore, we show that banking firms that grant more options to their employees build up more capital in future years.
    Keywords: Stock options ; Bank stocks ; Bank directors ; Bank employees ; Employee fringe benefits ; Bank capital
    Date: 2007
  4. By: van den Hauwe, Ludwig
    Abstract: Professor Becker´s paper about free banking written in 1956 was originally intended as a reaction to the 100-percent reserve proposals that were then popular at the University of Chicago. Today the original paper clearly illustrates how considerably our views and theories about free banking have evolved in the past 50 years. This development is to a considerable extent the result of the work and the writings of economists of the Austrian School. Professor Pascal Salin is one of the most prominent members of the Austrian free banking school. In a new introduction to the 1956 paper written especially for the Festschrift in honor of Professor Pascal Salin, Professor Gary Becker partially repudiates and mitigates some of his previous conclusions. This event offers a fitting opportunity to review some developments in the theory of free banking and related issues and to add a few clarifications concerning the present “state of the art” as regards an acceptable and adequate notion of free banking.
    Keywords: Free Banking; Monetary Regimes; Monetary Standards; Business Cycles
    JEL: E42 E32 E58
    Date: 2007–10–04
  5. By: Herbertsson, Alexander (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: We model dynamic credit portfolio dependence by using default contagion in an intensity-based framework. Two different portfolios (with 10 obligors), one in the European auto sector, the other in the European financial sector, are calibrated against their market CDS spreads and the corresponding CDS-correlations. After the calibration, which are perfect for the banking portfolio, and good for the auto case, we study several quantities of importance in active credit portfolio management. For example, implied multivariate default and survival distributions, multivariate conditional survival distributions, implied default correlations, expected default times and expected ordered defaults times. The default contagion is modelled by letting individual intensities jump when other defaults occur, but be constant between defaults. This model is translated into a Markov jump process, a so called multivariate phase-type distribution, which represents the default status in the credit portfolio. Matrix-analytic methods are then used to derive expressions for the quantities studied in the calibrated portfolios.<p>
    Keywords: Portfolio credit risk; intensity-based models; dynamic dependence modelling; CDS-correlation; default contagion; Markov jump processes; multivariate phase-type distributions; matrixanalytic methods
    JEL: C02 C63 G13 G32 G33
    Date: 2007–10–31
  6. By: Yueh-Yun C. O’Brien
    Abstract: This paper compares the reserve requirements of OECD countries. Reserve requirements are the minimum percentages or amounts of liabilities that depository institutions are required to keep in cash or as deposits with their central banks. To facilitate monetary policy implementation, twenty-four of the thirty OECD countries impose reserve requirements to influence their banking systems’ demand for liquidity. These include twelve OECD countries that are also members of the European Economic and Monetary Union (EMU) and twelve non-EMU OECD countries. All EMU countries employ a single reserve requirement system, which is treated as one entity. ; The reserve requirement system for each of the twelve non-EMU countries is discussed separately. The similarities and differences among the thirteen reserve requirement systems are highlighted. The features of reserve requirements covered include: reservable liabilities, required reserve ratios, reserve computation periods, reserve maintenance periods, types of reserve requirements, calculations of required reserves, eligible assets for satisfying reserve requirements, remuneration on reserve balances, non-compliance penalties, carry-over of reserve balances, and required clearing balances.
    Date: 2007
  7. By: Herbertsson, Alexander (Department of Economics, School of Business, Economics and Law, Göteborg University); Rootzén, Holger (Department of Mathematical Statistic)
    Abstract: We study a model for default contagion in intensity-based credit risk and its consequences for pricing portfolio credit derivatives. The model is specified through default intensities which are assumed to be constant between defaults, but which can jump at the times of defaults. The model is translated into a Markov jump process which represents the default status in the credit portfolio. This makes it possible to use matrix-analytic methods to derive computationally tractable closed-form expressions for single-name credit default swap spreads and kth-to-default swap spreads. We ”semicalibrate” the model for portfolios (of up to 15 obligors) against market CDS spreads and compute the corresponding kth-to-default spreads. In a numerical study based on a synthetic portfolio of 15 telecom bonds we study a number of questions: how spreads depend on the amount of default interaction; how the values of the underlying market CDS-prices used for calibration influence kth-th-to default spreads; how a portfolio with inhomogeneous recovery rates compares with a portfolio which satisfies the standard assumption of identical recovery rates; and, finally, how well kth-th-to default spreads in a nonsymmetric portfolio can be approximated by spreads in a symmetric portfolio.<p>
    Keywords: Portfolio credit risk; intensity-based models; default dependence modelling; default contagion; CDS; kth-to-default swaps; Markov jump processes; Matrix-analytic methods
    JEL: C02 C63 G13 G32 G33
    Date: 2007–10–31
  8. By: Herbertsson, Alexander (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: We value synthetic CDO tranche spreads, index CDS spreads, kth-to-default swap spreads and tranchelets in an intensity-based credit risk model with default contagion. The default dependence is modelled by letting individual intensities jump when other defaults occur. The model is reinterpreted as a Markov jump process. This allow us to use a matrix-analytic approach to derive computationally tractable closed-form expressions for the credit derivatives that we want to study. Special attention is given to homogenous portfolios. For a fixed maturity of five years, such a portfolio is calibrated against CDO tranche spreads, index CDS spread and the average CDS and FtD spreads, all taken from the iTraxx Europe series. After the calibration, which render perfect fits, we compute spreads for tranchelets and kth-to-default swap spreads for different subportfolios of the main portfolio. We also investigate implied tranche-losses and the implied loss distribution in the calibrated portfolios.<p>
    Keywords: Credit risk; intensity-based models; CDO tranches; index CDS; kth-to-default swaps; dependence modelling; default contagion; Markov jump processes; Matrix-analytic methods
    JEL: C02 C63 G13 G32 G33
    Date: 2007–10–31
  9. By: Thomas B. King; Andrew T. Levin; Roberto Perli
    Abstract: Over the Great Moderation period in the United States, we find that corporate credit spreads embed crucial information about the one-year-ahead probability of recession, as evidenced by both in- and out-of-sample fit. Furthermore, the incidence of “false positive” predictions of recession is dramatically reduced by utilizing a bivariate model that includes a measure of credit spreads along with the slope of the yield curve; indeed, these bivariate models provide much better forecasting performance than any combination of univariate models. We also find that optimal (Bayesian) model combination strongly dominates simple averaging of model forecasts in predicting recessions.
    Date: 2007

This issue is ©2007 by Roberto J. Santillán–Salgado. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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