New Economics Papers
on Banking
Issue of 2013‒06‒09
28 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Market Valuation and Risk Assessment of Indian Banks using Black -Scholes -Merton Model By Sinha, Pankaj; Sharma, Sakshi; Sondhi, Kriti
  2. An Integrated Financial Framework for the Banking Union: Don’t Forget Macro-Prudential Supervision By Dirk Schoenmaker
  3. Finance at Center Stage: Some Lessons of the Euro Crisis By Maurice Obstfeld
  4. Did Credit Decouple from Output in the Great Moderation? By Grydaki, Maria; Bezemer, Dirk
  5. Debt and the U.S. Great Moderation By Bezemer, Dirk; Grydaki, Maria
  6. Post-Crisis Reversal in Banking and Insurance Integration: An Empirical Survey By Dirk Schoenmaker
  7. Liquidity Shocks and the US Housing Credit Crisis of 2007–2008 By Gianni La Cava
  8. Strategic Complementarity, Fragility, and Regulation By Xavier Vives
  9. Should non-euro area countries join the single supervisory mechanism? By Zsolt Darvas; Guntram B. Wolff
  10. Goodhart, Charles A.E. and Tsomocos, Dimitros P.: The challenge of financial stability: a new model and its applications By Jean-Bernard Chatelain
  11. Bank Ownership and Credit Cycle: the lower sensitivity of public bank lending to the business cycle By Thibaut Duprey
  12. Co-Evolution of Cross-border Portfolio Investment Networks and Indicators for Financial Crises By Andreas Joseph; Guanrong Chen
  13. Large capital infusions, investor reactions, and the return and risk performance of financial institutions over the business cycle and recent finanical crisis By Elyas Elyasiani; Loretta J. Mester; Michael S. Pagano
  14. Reserve Requirement Analysis using a Dynamical System of a Bank based on Monti-Klein model of Bank's Profit Function By Novriana Sumarti; Iman Gunadi
  15. "The Wrong Risks: What a Hedge Gone Awry at JPMorgan Chase Tells Us about What's Wrong with Dodd-Frank" By Rainer Kattel; Ringa Raudla
  16. Credit ratings and bank monitoring ability By Leonard I. Nakamura; Kasper Roszbach.
  17. Big Banks and Macroeconomic Outcomes: Theory and Cross-Country Evidence of Granularity By Franziska Bremus; Claudia Buch; Katheryn Russ; Monika Schnitzer
  18. Close but not a Central Bank: The New York Clearing House and issues of clearing house loan certificates By Jon R Moen; Ellis W Tallman
  19. Impact of the Subprime Crisis on Bank Ratings: The Effect of the Hardening of Rating Policies and Worsening of Solvency By Pastor Monsálvez José Manuel; Fernández de Guevara Radoselovics Juan; Salvador Muñoz Carlos
  20. Credit access and credit performance after consumer bankruptcy filing: new evidence By Julapa Jagtiani; Wenli Li
  21. Liquidity Contractions, Incomplete Financial Participation and the Prevalence of Negative Equity Non-Recourse Loans By Miguel A. Iraola; Juan Pablo Torres-Martinez
  22. Global Banks, Financial Shocks and International Business Cycles: Evidence from Estimated Models By Robert Kollmann
  23. Systemic Risk and Home Bias in the Euro Area By Niccolò Battistini; Marco Pagano; Saverio Simonelli
  24. Estimating the Effects of Standard Fiscal and Bank Rescue Measures By Werner Roeger; Robert Kollmann; Marco Ratto; Jan in 't Veld
  25. Equity extraction and mortgage default By Steven Laufer
  26. Demand externalitites and price cap regulation: Learning from a two-sided market By Zhu Wang
  27. Is the Jump-Diffusion Model a Good Solution for Credit Risk Modeling? The Case of Convertible Bonds By Xiao, Tim
  28. Financial Sector Reform After the Crisis: Has Anything Happened? By Alexander Schaefer; Isabel Schnabel; Beatrice Weder di Mauro

  1. By: Sinha, Pankaj; Sharma, Sakshi; Sondhi, Kriti
    Abstract: The most pernicious effect of the global financial crisis is that it triggers a sequence of unpleasant consequences for the banking sector and for the entire economy as a whole. The recent financial crisis has compelled regulators to focus on the necessity of resilience of banks towards risks and sudden financial shocks. The riskiness of banks assets and its equity are two important factors for valuation of banks. These risks can be incorporated in market valuation only through Black-Scholes-Merton Model. This paper uses Black-Scholes-Merton option valuation approach for calculation of the market value and volatility of bank’s assets for a random sample of 13 Public and 8 Private sector banks in India over the period from March 2003 to March 2012. Further, it calculates yearly Z-score for each bank, allowing for capital adequacy as per the Basel II and III norms, for the periods before and after 2008 financial crisis. The obtained Z-scores suggest that the Indian banks are far from default and the impact of global recession of 2008 on the banks solvency was insignificant. All the Indian banks have market value to enterprise value ratio typically in the range of 93 to 99 per cent, suggesting that market value of bank’s assets obtained from Black-Scholes-Merton is characteristically below its enterprise value since market value considers the riskiness of the equity and assets both. It is found that the volatility of banks assets is significantly different for public and private sector banks over the period of study. Investigation of NPA to Total Assets reveals that presently NPA levels of the public sector banks are increasing whereas it is declining for the private sector banks.
    Keywords: Black-Scholes -Merton, Market value, Volatility, Z-score, Non-Performing Assets
    JEL: G01 G21 G28 G33 G38
    Date: 2013–06–06
  2. By: Dirk Schoenmaker
    Abstract: This essay reviews the sequencing of the functions of supervision, resolution, deposit insurance and the fiscal backstop in the Banking Union. All these functions deal with the soundness of individual banks. In the run-up to the 2007-2009 financial crisis, we overlooked the bigger picture of the stability of the wider financial system. This essay puts forward a concrete proposal for conducting macro-prudential policy in the prospective Banking Union. We suggest giving the lead on applying macro-prudential tools in the Banking Union to the ECB to foster a coherent approach, with important input from the national competent authorities to allow for much needed differentiation at the national level. Next, we argue that the ECB should separate the macro-prudential and micro-prudential functions. Otherwise, we may again be bogged down by the details of individual banks (micro), while losing sight of emerging imbalances in the wider financial system (macro).
    JEL: E58 G01 G21 G28
    Date: 2013–04
  3. By: Maurice Obstfeld
    Abstract: Because of recent economic crises, financial fragility has regained prominence in both the theory and practice of macroeconomic policy. Consistent with macroeconomic paradigms prevalent at the time, the original architecture of the euro zone assumed that safeguards against inflation and excessive government deficits would suffice to guarantee macroeconomic stability. Recent events, in both Europe and the industrial world at large, challenge this assumption. After reviewing the roots of the euro crisis in financial-market developments, this essay draws some conclusions for the reform of euro area institutions. The euro area is moving quickly to correct one flaw in the Maastricht treaty, the vesting of all financial supervisory functions with national authorities. However, the sheer size of bank balance sheets suggest that the euro area must also confront a financial/fiscal trilemma: countries in the euro zone can no longer enjoy all three of financial integration with other member states, financial stability, and fiscal independence, because the costs of banking rescues may now go beyond national fiscal capacities. Thus, plans to reform the euro zone architecture must combine centralized supervision with some centralized fiscal backstop to finance bank resolution in situations of insolvency.
    JEL: E44 F36 G15 G21
    Date: 2013–04
  4. By: Grydaki, Maria; Bezemer, Dirk
    Abstract: The U.S. during the 1984-2007 Great Moderation saw unusual macroeconomic stability combined with strong growth in asset prices and in credit relative to output. The distribution of credit shifted towards the financial and real estate sectors. The literature shows that each of these trends increases financial fragility, suggesting that the Great Moderation stability was destabilizing. We explore this interpretation by testing the Allen and Gale (2000) bubble feature that credit growth was driven more by past credit growth and less by output growth. We test this distinguishing between credit to asset markets and credit to the nonfinancial sectors. Results from a VAR model estimated on quarterly data for 1955-2007 suggest that the causal relations of credit aggregates and output differed before the Great Moderation and during the Great Moderation, along the lines we hypothesize. This invites a reinterpretation of the Great Moderation, and may help understand when a credit boom turns into a credit bubble.
    Keywords: great moderation, credit, output, VAR, financial fragility
    JEL: C32 C51 C52 E44
    Date: 2013–06–05
  5. By: Bezemer, Dirk; Grydaki, Maria
    Abstract: During the Great Moderation, borrowing by the U.S. nonfinancial sector structurally exceeded GDP growth. Using flow-of-fund data, we test the hypothesis that this measure of debt buildup was leading to lower output volatility. We estimate univariate GARCH models in order to obtain estimates for the volatility of output growth. We use this obtained volatility in a VAR model with excess credit growth and control variables (interest rate and inflation) over two periods, 1954-1978 (before the Great Moderation) and 1984-2008 (during the Great Moderation). We so test whether the relation between excess credit growth and GDP volatility changed between the two periods, controlling for the stance of monetary policy, for inflation, and for the endogeneity of credit to growth (as well as for other endogeneities). Results from Granger causality tests, impulse response functions and forecast error variance decompositions suggest that changes in our ‘excess credit growth’ measure of debt in the nonfinancial sector were among the causal factors of the decline in output volatility during the Great Moderation. We discuss implications.
    Keywords: great moderation, credit, VAR, causality
    JEL: C32 C51 C52 E44
    Date: 2013–06–05
  6. By: Dirk Schoenmaker
    Abstract: This empirical essay reviews post-crisis integration in banking and insurance. Looking at aggregate data, we find that cross-border banking flows have been reversed, in particular into the CESEE and peripheral counties (Portugal, Ireland and Greece). But data at the individual firm level for banks and insurers indicate that cross-border activities remain persuasive within Europe. This intensity of cross-border activities indicates that the potential for coordination failure among national authorities remains high. Host country supervisors have so far responded by ring-fencing activities in subsidiaries, leading to further fragmentation. This essay argues that if we want to keep the benefits of both the single financial market and financial stability, we need new supranational institutions that encourage integration. The advance to Banking Union with integrated supervision and resolution can provide the necessary policy push for an integrated approach.
    JEL: G21 G22 G28 H41
    Date: 2013–04
  7. By: Gianni La Cava (Reserve Bank of Australia)
    Abstract: There is extensive anecdotal evidence to suggest that a significant tightening in credit conditions, or a 'credit crunch', occurred in the United States following the collapse of the loan securitisation market in 2007. However, there has been surprisingly little formal testing for the existence of a credit crunch in the context of the US housing market. In this paper I examine whether the fall in mortgage credit over 2007–2008 was caused by a reduction in credit supply which, in turn, can be traced to a fall in the amount of financing available to mortgage lenders. I use the differential exposures of individual mortgage lenders to the collapse of the securitisation market in 2007 as a source of cross-lender variation in lender financing conditions and assess the impact on residential mortgage lending. Using loan-level information to control for unobservable credit demand shocks, I show that mortgage lenders that were particularly reliant on loan securitisation disproportionately reduced the supply of mortgage credit. The negative liquidity shock caused by the shutdown of the securitisation market explains a significant share of the aggregate decline in mortgage credit during this crisis.
    Keywords: bank liquidity; credit supply; mortgage market; housing
    JEL: C36 E21 G11 G12
    Date: 2013–05
  8. By: Xavier Vives (IESE BUSINESS SCHOOL)
    Abstract: The paper analyzes a very stylized model of crises and demonstrates how the degree of strategic complementarity in the actions of investors is an important determinant of fragility. It is shown how the balance sheet composition of a financial intermediary, parameters of the information structure (precisions of public and private information), and the level of stress indicators in the market impinge on strategic complementarity and fragility. The model distinguishes between solvency and liquidity risk and characterizes them. Both a solvency (leverage) and a liquidity ratio are required to control the probabilities of insolvency and illiquidity. It is found that in a more competitive environment (with higher return on short-term debt) the solvency requirement has to be strengthened, and in an environment where the fire sales penalty is higher and fund managers are more conservative the liquidity requirement has to be strengthened while the solvency one relaxed. Higher disclosure or introducing a derivatives market may backfire, aggravating fragility (in particular when the asset side of a financial intermediary is opaque). The model is applied to interpret the 2007 run on SIV and ABCP conduits.
    Date: 2012
  9. By: Zsolt Darvas; Guntram B. Wolff
    Abstract: Highlights 1) Irrespective of the euro crisis, a European banking union makes sense, including for non-euro area countries, because of the extent of European Union financial integration. The Single Supervisory Mechanism (SSM) is the first element of the banking union. 2) From the point of view of non-euro countries, the draft SSM regulation as amended by the EU?Council includes strong safeguards relating to decision-making, accountability, attention to financial stability in small countries and the applicability of national macro-prudential measures. Non-euro countries will also have the right to leave the SSM and thereby exempt themselves from a supervisory decision. 3) The SSM by itself cannot bring the full benefits of the banking union, but would foster financial integration, improve the supervision of cross-border banks, ensure greater consistency of supervisory practices, increase the quality of supervision, avoid competitive distortions and provide ample supervisory information. 4) While the decision to join the SSM is made difficult by the uncertainty about other elements of the banking union, including the possible burden sharing, we conclude that non-euro EU?members should stand ready to join the SSM and be prepared for the negotiations of the other elements of the banking union.
    Keywords: euro crisis, European banking union, bank supervision, single supervisory mechanism
    JEL: G21
    Date: 2013–05
  10. By: Jean-Bernard Chatelain (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, UP1 - Université Paris 1, Panthéon-Sorbonne - Université Paris I - Panthéon-Sorbonne - PRES HESAM)
    Abstract: This review of the book "The Challenge of Financial Stability: A New Model and its Applications" by Goodhart C.A.E. and Tsomocos D.P. highlights the potential of the framework of strategic partial default of banks with credit chain on the interbank market for further theoretical and applied research on financial stability.
    Keywords: Financial stability, Banking, Contagion, Default, General Equilibrium
    Date: 2013–04–16
  11. By: Thibaut Duprey (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales [EHESS] - Ecole des Ponts ParisTech - Ecole normale supérieure de Paris - ENS Paris - Institut national de la recherche agronomique (INRA), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper examines empirically to which extent public banks feature a different pattern in their lending behaviour over macroeconomic fluctuations. Based on a unique dataset from 1990 to 2010, including at most 459 public banks in 93 countries, I can handle ownership change by including records on privatisations as well as nationalisations during banking crisis, which would otherwise blur the picture. I find that (i) public bank lending is significantly less cyclical than that of private banks, (ii) public banks cut less on their loans during economic downturns, with a positive relation between economic development and their ability to absorb macro shocks, and (iii) privatised banks switch from a regime of low to high lending cyclicality. Then, the lower co-movement of public bank loans with macroeconomic fluctuations reveals both (a) a less vulnerable balance sheet structure and more stable financing sources, which is consistent with a lending relationship business model, (b) as well as delayed loan deterioration, which is a symptom of forbearance and inefficient loan management; the actual combination of the two is not orthogonal to economic development, with high income countries more likely to feature efficient public bank lending cyclicality, while evidences suggest it may reveal an inefficient credit allocation for less developed countries.
    Keywords: Lending cycle ; Procyclicality ; Public banking ; Privatisations ; Nationalisations ; Forbearance
    Date: 2013–06
  12. By: Andreas Joseph; Guanrong Chen
    Abstract: Two financial networks, namely, cross-border long-term debt and equity securities portfolio investment networks are analysed. They serve as proxies for measuring the interdependence of financial markets and the robustness of the global financial system from 2002 to 2012, covering the 2008 global financial crisis. Focusing on the largest strongly-connected core component of the threshold network, while the edge threshold is set according to the percolation properties of the long-term debt securities network, we identify two early-warning indicators for global financial distress. The spread of certain financial derivative products, such as credit default swaps and equity-linked derivatives, scales with the edge density of the long-term debt securities network. In addition, the algebraic connectivity of the equity securities network, taken as a measure for the robustness of financial markets, drops already sharply well ahead of the 2008 financial crisis.
    Date: 2013–06
  13. By: Elyas Elyasiani; Loretta J. Mester; Michael S. Pagano
    Abstract: We examine investors’ reactions to announcements of large capital infusions by U.S. financial institutions (FIs) from 2000 to 2009. These infusions include private market infusions (seasoned equity offerings (SEOs)) as well as injections of government capital under the Troubled Asset Relief Program (TARP). The sample period covers both business cycle expansions and contractions, and the recent financial crisis. We present evidence on the factors affecting FIs’ decisions to raise capital, the determinants of investor reactions, and post-infusion risk-taking of the recipients, as well as a sample of matching FIs. Investors reacted negatively to the news of private market SEOs by FIs, both in the immediate term (e.g., the two days surrounding the announcement) and over the subsequent year, but positively to TARP injections. Reactions differed depending on the characteristics of the FIs, and the stage of the business cycle. More financially constrained institutions were more likely to have raised capital through private market offerings during the period prior to TARP, and firms receiving a TARP injection tended to be riskier and more levered. In the case of TARP recipients, they appeared to finance an increase in lending (as a share of assets) with more stable financing sources such as core deposits, which lowered their liquidity risk. However, we find no evidence that banks’ capital adequacy increased after the capital injections.increased after the capital injections. ; Supersedes Working Paper 11-46.
    Keywords: Securities ; Financial services industry ; Banks and banking
    Date: 2013
  14. By: Novriana Sumarti; Iman Gunadi
    Abstract: Commercial banks and other depository institutions in some countries are required to hold in reserve against deposits made by their customers at their Central Bank or Federal Reserve. Although some countries have been eliminated it, this requirement is useful as one of many Central Bank's regulation made to control rate of inflation and conditions of excess liquidity in banks which could affect the monetary stability. The amount of this reserve is affected by the volumes of the commercial bank's loan and deposit, and also by the bank's Loan to Deposit Ratio (LDR) value. In this research, a dynamical system of the volume of deposits (dD/dt) and loans (dL/dt) of a bank is constructed from the bank profit equation by Monti-Klein. The model is implemented using the regulation of Bank of Indonesia, and analysed in terms of the behaviour of the solution. Based on some simplifying assumptions in this model, the results show that eventhough the LDR values at the initial points of two solutions are the same, the behavior of solutions will be significantly different due to different magnitude of L and D volumes.
    Date: 2013–06
  15. By: Rainer Kattel; Ringa Raudla
    Abstract: What can we learn from JPMorgan Chase's recent self-proclaimed "stupidity" in attempting to hedge the bank's global risk position? Clearly, the description of the bank's trading as "sloppy" and reflecting "bad judgment" was designed to prevent the press reports of large losses from being used to justify the introduction of more stringent regulation of large, multifunction financial institutions. But the lessons to be drawn are not to be found in the specifics of the hedges that were put on to protect the bank from an anticipated decline in the value of its corporate bond holdings, or in any of its other global portfolio hedging activities. The first lesson is this: despite their acumen in avoiding the worst excesses of the subprime crisis, the bank's top managers did not have a good idea of its exposure, which serves as evidence that the bank was "too big to manage." And if it was too big to manage, it was clearly too big to regulate effectively.
    Date: 2012–06
  16. By: Leonard I. Nakamura; Kasper Roszbach.
    Abstract: In this paper we use credit rating data from two large Swedish banks to elicit evidence on banks’ loan monitoring ability. For these banks, our tests reveal that banks’ credit ratings indeed include valuable private information from monitoring, as theory suggests. However, our tests also reveal that publicly available information from a credit bureau is not efficiently impounded in the bank ratings: The credit bureau ratings not only predict future movements in the bank ratings but also improve forecasts of bankruptcy and loan default. We investigate possible explanations for these findings. Our results are consistent with bank loan officers placing too much weight on their private information, a form of overconfidence. To the extent that overconfidence results in placing too much weight on private information, risk analyses of the bank loan portfolios in our data could be improved by combining the bank credit ratings and public credit bureau ratings. The methods we use represent a new basket of straightforward techniques that enable both financial institutions and regulators to assess the performance of credit rating systems. ; Supersedes Working Paper 10-21.
    Keywords: Credit ratings ; Risk assessment
    Date: 2013
  17. By: Franziska Bremus; Claudia Buch; Katheryn Russ; Monika Schnitzer
    Abstract: Does the mere presence of big banks affect macroeconomic outcomes? In this paper, we develop a theory of granularity (Gabaix, 2011) for the banking sector, introducing Bertrand competition and heterogeneous banks charging variable markups. Using this framework, we show conditions under which idiosyncratic shocks to bank lending can generate aggregate fluctuations in the credit supply when the banking sector is highly concentrated. We empirically assess the relevance of these granular effects in banking using a linked micro-macro dataset of more than 80 countries for the years 1995-2009. The banking sector for many countries is indeed granular, as the right tail of the bank size distribution follows a power law. We then demonstrate granular effects in the banking sector on macroeconomic outcomes. The presence of big banks measured by high market concentration is associated with a positive and significant relationship between bank-level credit growth and aggregate growth of credit or gross domestic product.
    JEL: E32 E44 F4 G0 G21
    Date: 2013–05
  18. By: Jon R Moen; Ellis W Tallman
    Abstract: The paper examines the New York Clearing House (NYCH) as a lender of last resort by looking at clearing-house-loan-certificate borrowing during five banking panics of the National Banking Era (1863–1913). In that system, adequate aggregate liquidity provision was passive and dependent upon member bank borrowing. We document bank borrowing behavior using bank-level data for clearing-house loan certif cates issued to NYCH member banks. The historical record reveals that the large New York City banks behaved in ways that resembled those of a central bank in 1884 and in 1890, but less so in the more severe crises.
    Keywords: Financial institutions ; Clearinghouses (Banking) ; Financial markets
    Date: 2013
  19. By: Pastor Monsálvez José Manuel (UNIVERSITY OF VALENCIA INSTITUTO VALENCIANO DE INVESTIGACIONES ECONÓMICAS (Ivie)); Fernández de Guevara Radoselovics Juan (University of Valencia; Ivie); Salvador Muñoz Carlos (Universidad de Valencia)
    Abstract: This working paper studies the impact of the subprime crisis on the ratings issued by the rating agencies in evaluating the solvency of banks. After ascertaining a significant worsening of ratings after the crisis, the paper hypothesizes the possibility that this worsening is not due exclusively to deterioration in the banks' credit quality, but also to a change in the behavior of the rating agencies. The study designs a methodology to separate the observed change in ratings into two multiplicative components: one associated with the deterioration of the banks' solvency itself and another associated with the change in the agencies' valuation criteria. The methodology is applied to the Spanish Banking System during the period 2000-2009. The results obtained show that the observed ratings cuts (13%) are explained (65%) by the deterioration in the solvency of the banks, but also (35%) by the hardening of the valuation criteria adopted by the agencies. This shows the procyclical character of ratings.
    Keywords: Bank ratings, subprime crisis effect, financial and environmental risk factors, ordered probit models.
    JEL: G21 G24 G32
    Date: 2012–09
  20. By: Julapa Jagtiani; Wenli Li
    Abstract: This paper uses a unique data set to shed new light on the credit availability and credit performance of consumer bankruptcy filers. In particular, our data allow us to distinguish between Chapter 7 and Chapter 13 bankruptcy filings, to observe changes in credit demand and supply explicitly, to differentiate existing and new credit accounts, and to observe the performance of each credit account directly. The paper has four main findings. First, despite speedy recovery in their risk scores after bankruptcy filing, most filers have much reduced access to credit in terms of credit limits, and the impact seems to be long lasting. Second, the reduction in credit access stems mainly from the supply side as consumer inquiries recover significantly after the filing, while credit limits remain low. Third, lenders do not treat Chapter 13 filers more favorably than Chapter 7 filers. In fact, Chapter 13 filers are much less likely to receive new credit cards than Chapter 7 filers even after controlling for borrower characteristics and local economic environment. Finally, we find that Chapter 13 filers perform more poorly than Chapter 7 filers (after the filing) on all credit products (credit card debt, auto loans, and first mortgages). Our results, in contrast to prior studies, thus suggest that the current bankruptcy system does not appear to provide much relief to bankruptcy filers.
    Keywords: Bankruptcy ; Credit ; Financial crises
    Date: 2013
  21. By: Miguel A. Iraola (Department of Economics, University of Miami); Juan Pablo Torres-Martinez (University of Chile)
    Abstract: We address a dynamic general equilibrium model where securities are backed by collateralized loans, and borrowers face endogenous liquidity contractions and financial participation constraints. Although the only payment enforcement is the seizure of collateral guarantees, restrictions on credit access make individually optimal payment strategies|coupon payment, pre-payment, and default|sensitive to idiosyncratic factors. In particular, the lack of liquidity and the presence of financial participation constraints rationalize the prevalence of negative equity loans. We prove equilibrium existence, characterize optimal payment strategies, and provide a numerical example illustrating our main results.
    Keywords: Asset-Backed Securities - Liquidity Contractions - Incomplete Financial Participation
    JEL: D50 D52
    Date: 2013–05–01
  22. By: Robert Kollmann (ECARES, Université Libre de Bruxelles a)
    Abstract: This paper takes a two-country model with a global bank to US and Euro Area (EA) data. The estimation results (based on Bayesian methods) suggest that global banking strengthens the positive international transmission of real economic disturbances. Shocks that originate in the banking sector account for roughly 20% of the forecast error variance of investment, and about 5% of the forecast variance of US and EA GDP. Bank shocks explain 5%-20% of the fall in US and EA real activity, during the Great Recession.
    Date: 2012
  23. By: Niccolò Battistini; Marco Pagano; Saverio Simonelli
    Abstract: According to conventional indicators, the euro-area financial integration has receded since 2007, mainly in the money market, sovereign debt market and uncollateralized credit markets. But price-based measures of debt market segmentation are inappropriate when solvency risk differs across countries: only the component of yield differentials that is not a reward for the issuer’s credit risk may reflect segmentation. We apply this idea to the euro sovereign debt market, using a dynamic factor model to decompose yield differentials in a country-specific and a common (or systemic) risk component. As the country-specific component dominates, purging yields from it produces much smaller measures of bond market segmentation than conventional ones for the crisis period. We also investigate how the home bias of banks’ sovereign portfolios – a quantity-based measure of segmentation – is related to yield differentials, by estimating a vector error-correction model on 2008-12 monthly data. We find that the sovereign exposures of banks in most euro-area countries respond positively to increases in yields, especially in periphery countries. When yield differentials are decomposed in their country-risk and common-risk components, we find that: (i) in the periphery, banks respond to increases in country risk by increasing their domestic exposure, while in core countries they do not; (ii) in contrast, in most euro-area countries banks respond to an increase in the common risk factor by raising their domestic exposures. Finding (i) hints at distorted incentives in periphery banks’ response to changes in their own sovereign’s risk. Finding (ii) indicates that, when systemic risk increases, all banks tend to increase the home bias of their portfolios, making the euro-area sovereign market more segmented.
    JEL: C32 C51 C58 G11 G15
    Date: 2013–04
  24. By: Werner Roeger (European Commission); Robert Kollmann (ECARES, Université Libre de Bruxelles a); Marco Ratto (European Commission); Jan in 't Veld (European Commission)
    Abstract: A key dimension of fiscal policy during the financial crisis was massive government support for the banking system. The macroeconomic effects of that support have, so far, received little attention in the literature. This paper fills this gap, using a quantitative dynamic model with a banking sector. We estimate the model for a Euro area quarterly dataset. The GDP multiplier of state aid to banks is in the same range as conventional fiscal spending multipliers. Our results suggest that state aid for banks may have a strong positive effect on real activity. Bank state aid multipliers are in the same range as conventional fiscal spending multipliers. Support for banks has a positive effect on investment, while a rise in government purchases crowds out investment.
    Date: 2012
  25. By: Steven Laufer
    Abstract: Using a property-level data set of houses in Los Angeles County, I estimate that 30% of the recent surge in mortgage defaults is attributable to early home-buyers who would not have defaulted had they not borrowed against the rising value of their homes during the boom. I develop and estimate a structural model capable of explaining the patterns of both equity extraction and default observed among this group of homeowners. In the model, most of these defaults are attributable to the high loan-to-value ratios generated by this additional borrowing combined with the expectation that house prices would continue to decline. Only 30% are the result of income shocks and liquidity constraints. I use this model to analyze a policy that limits the maximum size of cash-out refinances to 80% of the current house value. I find that this restriction would reduce house prices by 14% and defaults by 28%. Despite the reduced borrowing opportunities, the welfare gain from this policy for new homeowners is equivalent to 3.2% of consumption because of their ability to purchase houses at lower prices.
    Date: 2013
  26. By: Zhu Wang
    Abstract: This paper studies unintended consequences of price cap regulation in the presence of demand externalities in the context of payment cards. The recent U.S. debit card regulation was intended to lower merchant card acceptance costs by capping the maximum interchange fee. However, small-ticket merchants found their fees instead higher after the regulation. To address this puzzle, I construct a two-sided market model and show that card demand externalities across merchant sectors rationalize card networks’ pricing response. Based on the model, I study socially optimal card fees and an alternative cap regulation that may avoid the unintended consequence on small-ticket merchants.
    Keywords: Financial markets ; Payment systems ; Law and legislation
    Date: 2013
  27. By: Xiao, Tim
    Abstract: Tim Xiao: This paper argues that the reduced-form jump diffusion model may not be appropriate for credit risk modeling. To correctly value hybrid defaultable financial instruments, e.g., convertible bonds, we present a new framework that relies on the probability distribution of a default jump rather than the default jump itself, as the default jump is usually inaccessible. The model is quite accurate. A prevailing belief in the market is that convertible arbitrage is mainly due to convertible underpricing. Empirically, however, we do not find evidence supporting the underpricing hypothesis. Instead, we find that convertibles have relatively large position gammas. As a typical convertible arbitrage strategy employs delta-neutral hedging, a large positive gamma can make the portfolio high profitable, especially for a large movement in the underlying stock price.
    Keywords: jump diffusion model, hybrid financial instrument, convertible bond, convertible underpricing, convertible arbitrage, default time approach, default probability (intensity) approach, asset pricing, credit risk modeling.
    JEL: G12 G13 G32
    Date: 2013–05–21
  28. By: Alexander Schaefer (hair of International Macroeconomics, Johannes Gutenberg-Universitaet Mainz, Germany); Isabel Schnabel (Chair of Financial Economics, Johannes Gutenberg-Universitaet Mainz, Germany); Beatrice Weder di Mauro (Chair of International Macroeconomics, Johannes Gutenberg-Universitaet Mainz, Germany)
    Abstract: We analyze the reaction of stock returns and CDS spreads of banks from Europe and the United States to four major regulatory reforms in the aftermath of the subprime crisis, employing an event study analysis. In contrast to the public perception that nothing has happened, we find that financial markets indeed reacted to the structural reforms enacted at the national level. All reforms succeeded in reducing bail-out expectations, especially for systemic banks. However, banks’ profitability was also affected, showing up in lower equity returns. The strongest effects were found for the Dodd-Frank Act (especially the Volcker rule), whereas market reactions to the German restructuring law were small.
    Keywords: Financial sector reform, financial stability, Dodd-Frank Act, Volcker rule, Vickers reform, German restructuring law, Swiss too-big-to-fail regulation, event study
    JEL: G21 G28
    Date: 2013–05–24

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