nep-ban New Economics Papers
on Banking
Issue of 2022‒09‒05
thirty papers chosen by
Sergio Castellanos-Gamboa, , Pontificia Universidad Javeriana

  1. Fighting Inflation in Challenging Times: a speech at the 2022 CEO & Senior Management Summit sponsored by the Kansas Bankers Association, Colorado Springs, Colorado, August 6, 2022 By Michelle W. Bowman
  2. Capital flows and monetary policy trade-offs in emerging market economies By Paolo Cavallino; Boris Hofmann
  3. Dimensional Reduction of Solvency Contagion Dynamics on Financial Networks By Gianmarco Ricciardi; Guido Montagna; Guido Caldarelli; Giulio Cimini
  4. Is globalization the root cause of declining inflation? By Juhana Hukkinen; Matti Viren
  5. Debt sustainability and monetary policy: the case of ECB asset purchases By Enrique Alberola-Ila; Gong Cheng; Andrea Consiglio; Stavros A. Zenios
  6. Till Debt Do Us Part: Strategic Divorces and a Test of Moral Hazard By Kim, Yeorim; Mastrogiacomo, Mauro; Hochguertel, Stefan; Bloemen, Hans
  7. Fiscal deficits and inflation risks: the role of fiscal and monetary policy regimes By Ryan Niladri Banerjee; Valerie Boctor; Aaron Mehrotra; Fabrizio Zampolli
  8. Incentive Fees with a Moving Benchmark and Portfolio Selection under Loss Aversion By Constantin Mellios; Anh Ngoc Lai
  9. Introducing New Forms of Digital Money: Evidence from the Laboratory By Gabriele Camera
  10. What drives repo haircuts? Evidence from the UK market By Christian Julliard; Gabor Pinter; Karamfil Todorov; Kathy Yuan
  11. Does DeFi remove the need for trust? Evidence from a natural experiment in stablecoin lending By Kanis Saengchote; Talis Putni\c{n}\v{s}; Krislert Samphantharak
  12. Contagion from market price impact: a price-at-risk perspective By Fukker, Gábor; Kaijser, Michiel; Mingarelli, Luca; Sydow, Matthias
  13. Clicking for Credit: Experiences of Online Lender Applicants from the Small Business Credit Survey By Barbara J. Lipman; Lucas Misera; Ann Marie Wiersch; Kim Wilson
  14. The Disciplining Effect of Supervisory Scrutiny in the EU-Wide Stress Test By Cosimo Pancaro; Christoffer Kok; Carola Müller; Steven Ongena
  15. Crypto Rewards in Fundraising: Evidence from Crypto Donations to Ukraine By Jane; Tan; Yong Tan
  16. Pre-Positioning and Cross-Border Financial Intermediation By Nicholas K. Tabor; Jeffery Y. Zhang
  17. Help in a Foreign Land: Internationalized Banks and Firms’ Export By Brancati, Emanuele
  18. Climate Change and Financial Policy: A Literature Review By Benjamin Dennis
  19. Towards the holy grail of cross-border payments By Bindseil, Ulrich; Pantelopoulos, George
  20. Risk capacity, portfolio choice and exchange rates By Boris Hofmann; Ilhyock Shim; Hyun Song Shin
  21. One-factor model of liquidity risk By Osadchiy, Maksim
  22. Should Bank Stress Tests Be Fair? By Paul Glasserman; Mike Li
  23. Interrogation of A Bubble in the Indian Market By Ganapathy G Gangadharan; N. Suresh
  24. The macroeconomic effects of Basel III regulations with endogenous credit and money creation By Li, Boyao
  25. FTPL and the Maturity Structure of Government Debt in the New Keynesian Model By Max Ole Liemen; Olaf Posch
  26. Individual Trend Inflation By Toshitaka Sekine; Frank Packer; Shunichi Yoneyama
  27. Bank of Japan's ETF purchase program and equity risk premium: a CAPM interpretation By Mitsuru Katagiri; Koji Takahashi; Junnosuke Shino
  28. Stress tests and capital requirement disclosures: do they impact banks' lending and risk-taking decisions? By Paul Konietschke; Steven Ongena; Aurea Ponte Marques
  29. The Term Structure of Interest Rates in a Heterogeneous Monetary Union By James Costain; Galo Nuño; Carlos Thomas
  30. Reflections on the Disinflationary Methods of Poincaré and Thatcher By James B. Bullard

  1. By: Michelle W. Bowman
    Date: 2022–08–06
  2. By: Paolo Cavallino; Boris Hofmann
    Abstract: We lay out a small open economy model incorporating key features of EME economic and financial structure: high exchange rate pass-through to import prices, low pass-through to export prices and shallow domestic financial markets giving rise to occasionally binding leverage constraints. As a consequence of the latter, a sudden stop with large capital outflows can give rise to a financial crisis. In the sudden stop, the central bank faces an intratemporal trade-off as output declines while inflation rises. In normal times, there is an intertemporal trade-off as the risk of a future sudden stop forces the central bank to factor financial stability considerations into its policy conduct. The optimal monetary policy leans against capital flows and domestic leverage. Macroprudential, capital flow management and central bank balance sheet policies can help to mitigate both intra- and intertemporal trade-offs. Fiscal policy also plays a key role. A higher level of public debt and a weaker fiscal policy imply greater leverage and hence greater tail risk for the economy.
    Keywords: capital flows, monetary policy trade-offs, emerging market economies
    JEL: E5 F3 F4
    Date: 2022–07
  3. By: Gianmarco Ricciardi; Guido Montagna; Guido Caldarelli; Giulio Cimini
    Abstract: Modelling systems with networks has been a powerful approach to tame the complexity of several phenomena. Unfortunately, such an approach is often made difficult by the large number of variables to take into consideration. Methods of dimensional reduction are useful tools to rescale a complex dynamical network down to a low-dimensional effective system and thus to capture the global features of the dynamics. Here we study the application of the degree-weighted and spectral reduction methods to an important class of dynamical processes on networks: the propagation of credit shocks within an interbank network, modelled according to the DebtRank algorithm. In particular we introduce an effective version of the dynamics, characterised by functions with continuous derivatives that can be handled by the dimensional reduction. We test the reduction methods against the full dynamical system in different interbank market settings: homogeneous and heterogeneous networks generated from state-of-the-art reconstruction methods as well as networks derived from empirical e-MID data. Our results indicate that, for proper choices of the bank default probability, reduction methods are able to provide reliable estimates of systemic risk in the market, with the spectral reduction better handling heterogeneous networks. Finally we provide new physical insights on the nature and working principles of dimensional reduction methods.
    Date: 2022–07
  4. By: Juhana Hukkinen (Monetary Policy and Research Department of Bank of Finland); Matti Viren (Monetary Policy and Research Department of Bank of Finland & Economics Department of University of Turku)
    Abstract: This paper examines the reasons for the declining path of inflation since the 1970s. In particular, it focusses on the role of globalization â covering both changes in the global market structure and technical and structural developments in trade and production. In addition, the paper deals with changes in the basic transmission mechanisms of price and wage inflation. The paper makes use of different data from individual countries and panel of countries. These data show that the dispersion of inflation and the behavior of relative prices follow a pattern that is consistent with several globalization indicators. Also estimation results show that these indicators are useful in tracing the developments of trend inflation after the 1960s. Moreover, it is shown that the basic relationships between prices and costs are nonlinear depending on the level of inflation.
    Keywords: Inflation, globalization, Phillips curve, trade unions
    JEL: E31 E52 E58 F02 F41 F42 F62
    Date: 2022–08
  5. By: Enrique Alberola-Ila; Gong Cheng; Andrea Consiglio; Stavros A. Zenios
    Abstract: We incorporate monetary policy into a model of stochastic debt sustainability analysis and evaluate the impact of unconventional policies on sovereign debt dynamics. The model optimizes debt financing to trade off financing cost with refinancing risk. We show that the ECB pandemic emergency-purchase programme (PEPP) substantially improves debt sustainability for euro area sovereigns with a high debt stock. Without PEPP, debt would be on an increasing (unsustainable) trajectory with high probability, while, with asset purchases, it is sustainable and the debt ratio is expected to return to pre-pandemic levels by about 2030. The improvement in debt dynamics extends beyond the PEPP and is larger for more gradual unwinding of the Central Bank balance sheet. Optimal financing under PEPP induces an extension of maturities reducing the risk without increasing costs. The analysis also shows that inflation surprises have relatively little impact on debt dynamics, with the direction and magnitude of the effect depending on the monetary policy response.
    Date: 2022–07
  6. By: Kim, Yeorim (Vrije Universiteit Amsterdam); Mastrogiacomo, Mauro (De Nederlandsche Bank); Hochguertel, Stefan (Vrije Universiteit Amsterdam); Bloemen, Hans (Vrije Universiteit Amsterdam)
    Abstract: We test whether households that face prospective home equity losses during a house price downturn use divorce to shed debt. We study the Dutch context, where qualifying homeowners can buy into a mortgage guarantee scheme that insures the lender against borrower default and transfers the risk to the public. Divorce is one of the major events that obliges the guarantor to repay outstanding residual debt after (foreclosure) sale. We argue in this paper that divorce is endogenous to holding underwater mortgages, and hence constitutes a choice that can be used for strategic use of the insurance. Using administrative data, we find a significant, 44% increase in the probability to divorce for households with an underwater mortgage. This effect is causal to being insured. The identification relies on a regression discontinuity design, that exploits the fact that the insurance is only available for properties with values below a legislated qualification threshold. The house price crisis (2008-2013) provides an unexpected shock to house values, leaving about 40% of owners with an underwater mortgage. Their home equity averages to about €-50.000. Couples with similar characteristics just above the qualification threshold experienced significantly less often a divorce than couples just below the threshold. We interpret this behavioral response as moral hazard, also because the induced divorcees reunite at a higher rate than other divorcees.
    Keywords: moral hazard, mortgage insurance, divorce
    JEL: D10 G21 G52 J12
    Date: 2022–07
  7. By: Ryan Niladri Banerjee; Valerie Boctor; Aaron Mehrotra; Fabrizio Zampolli
    Abstract: Using data from a panel of advanced economies over four decades, we show that the inflationary effect of fiscal deficits crucially depends on the prevailing fiscal-monetary policy regime. Under fiscal dominance, defined as a regime in which the government does not adjust the primary balance to stabilise debt and the central bank is less independent or puts less emphasis on price stability, the average effect on inflation of higher deficits is found to be up to five times larger than under monetary dominance. Under fiscal dominance, higher deficits also increase the dispersion of possible future inflationary outcomes, especially the probability of high inflation. Based on forecasts from our model, the high inflation experienced by many countries during the recovery from the Covid-19 pandemic appears more consistent with a regime of fiscal dominance than monetary dominance.
    Keywords: fiscal deficit, inflation, fiscal policy regime, monetary policy regime, monetary policy independence
    JEL: E31 E52 E62 E63
    Date: 2022–07
  8. By: Constantin Mellios (PRISM Sorbonne - Pôle de recherche interdisciplinaire en sciences du management - UP1 - Université Paris 1 Panthéon-Sorbonne); Anh Ngoc Lai (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - UNIV-RENNES - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper studies, in a unified and dynamic framework, the impact of fund managers compensation (symmetric and asymmetric fees including a penalty component) as well as their investment in the fund when managers exhibit a loss aversion utility function. Contrary to the vast majority of the existing literature, the benchmark portfolio, relative to which a fund's performance is measured, is risky. The optimal portfolio value comprises a call option and a term resembling the optimal value when the benchmark is riskless. The proportion invested in the risky security is a speculative position, while the fraction invested in the benchmark contains both a hedging addend and a speculative element. Our model and simulations show that (i) a risky benchmark substantially modifies the manager's allocation compared to a riskless benchmark; (ii) optimal positions are less risky when the manager is compensated by symmetric fees or faces a penalty; (iii) a relatively large manager's stake (30%) in the fund considerably reduces her risk-taking behaviour and results in an almost identical terminal portfolio value for the different fees schemes; (iv) optimal weights significantly react to different parameter values; (v) these results may have important implications on regulation.
    Abstract: L'objectif de cet article est d'étudier, dans un cadre unifié et dynamique, l'impact de la rémunération des gestionnaires de fonds (commission de performance symétrique ou non-symétrique avec potentiellement un malus), ainsi que leur propre investissement dans le fond lorsqu'ils sont caractérisés par une fonction d'utilité de type « aversion aux pertes ». Contrairement à la littérature existante, la performance du fond est appréciée par rapport à une référence (un indice, par exemple) risquée. Les principales conclusions de notre modèle et de nos simulations sont les suivantes : (i) une référence risquée modifie sensiblement l'allocation d'actifs ; (ii) les proportions optimales sont moins risquées dans le cas d'une commission de performance symétrique ; (iii) la détention par le gestionnaire d'une part relativement importante (30%) du fonds altère son comportement risqué et permet d'obtenir une valeur terminale du portefeuille quasi-identique quel que soit le type de rémunération ; (iv) les proportions optimales sont sensibles aux variations des valeurs des paramètres ; (v) ces résultats peuvent avoir des conséquences sur la régulation.
    Date: 2022
  9. By: Gabriele Camera (Economic Science Institute, Chapman University)
    Abstract: Central banks may soon issue currencies that are entirely digital (CBDCs) and possibly interest-bearing. A strategic analytical framework is used to investigate this innovation in the laboratory, contrasting a traditional “plain†tokens baseline to treatments with “sophisticated†interest-bearing tokens. In the experiment, this theoretically beneficial innovation precluded the emergence of a stable monetary system, reducing trade and welfare. Similar problems emerged when sophisticated tokens complemented or replaced plain tokens. This evidence underscores the advantages of combining theoretical with experimental investigation to provide insights for payments systems innovation and policy design.
    Keywords: digital currency, endogenous institutions, repeated games, CBDC
    JEL: C70 C90
    Date: 2022
  10. By: Christian Julliard; Gabor Pinter; Karamfil Todorov; Kathy Yuan
    Abstract: Using a unique transaction-level data, we document that only 60% of bilateral repos held by UK banks are backed by high-quality collateral. Banks intermediate repo liquidity among different counterparties and use central counterparties to reallocate high-quality collateral among themselves. Furthermore, maturity, collateral rating and asset liquidity have important effects on repo liquidity via haircuts. Counterparty types also matter: non-hedge funds, large borrowers, and borrowers with repeated bilateral relationships receive lower (or zero) haircuts. The evidence supports an adverse selection explanation of haircuts, but does not find significant roles for mechanisms related to lenders' liquidity position or default probabilities.
    Keywords: repurchase agreement, systemic risk, repo market, margin, haircut
    JEL: G01 G12 G21 G23
    Date: 2022–07
  11. By: Kanis Saengchote; Talis Putni\c{n}\v{s}; Krislert Samphantharak
    Abstract: Decentralized Finance (DeFi) is built on a fundamentally different paradigm: rather than having to trust individuals and institutions, participants in DeFi potentially only have to trust computer code that is enforced by a decentralized network of computers. We examine a natural experiment that exogenously stress tests this alternative paradigm by revealing the identities of individuals associated with a DeFi protocol, including a convicted criminal. We find that, in practice, DeFi does not (yet) fully remove the need for trust in individuals. Our findings suggest that that because smart contracts are incomplete, they are subject to run risk (Allen and Gale, 2004) and personal character and trust of individuals are still relevant in this alternative financial system.
    Date: 2022–07
  12. By: Fukker, Gábor; Kaijser, Michiel; Mingarelli, Luca; Sydow, Matthias
    Abstract: Overlapping portfolios constitute a well-recognised source of risk, providing a channel for financial contagion induced by the market price impact of asset deleveraging. We introduce a novel method to assess the market price impact on a security-by-security basis from historical daily traded volumes and price returns. Systemic risk within the euro area financial system of banks and investment funds is then assessed by considering contagion between individual institutions’ portfolio holdings under a severe stress scenario. As a result, we show how the bias of more homogeneous estimation techniques, commonly employed for market impact, might lead to loss estimates that are more than twice as large as losses estimated with heterogeneous price impact parameters. Another new feature in this work is the application of a price-at-risk measure instead of the average market price impact to evaluate the tail risk of possible market price movements in scenarios of different severity. Our results also show that system-level losses at the tail can be three times higher than average losses using the same scenario. JEL Classification: G01, G12, G17, G23, G32
    Keywords: fire sales, indirect contagion, overlapping portfolios, price impact, quantile regression
    Date: 2022–08
  13. By: Barbara J. Lipman; Lucas Misera; Ann Marie Wiersch; Kim Wilson
    Abstract: This report presents findings on the experiences of small businesses seeking credit from online lenders, based on data from the 2021 Small Business Credit Survey (SBCS). According to findings, firms that apply to online lenders are more likely to be newer and have fewer employees, lower revenues, and weaker credit scores. In addition, Black- and Hispanic-owned firms are more likely than white- and Asian-owned firms to report that they applied to an online lender. Furthermore, contrary to prior SBCS findings, online-lender applicants were less likely than bank applicants to be approved for the full amount of financing they sought. Generally, online-lender applicants reported lower overall satisfaction with their lenders than did bank applicants. Overall, approved applicants cited fewer challenges with their lender experiences than did applicants that were denied. The only exception was at online lenders, where approved applicants were more likely than denied applicants to cite challenges with high interest rates and unfavorable repayment terms.
    Keywords: small business; lenders
    Date: 2022–08–16
  14. By: Cosimo Pancaro (European Central Bank (ECB)); Christoffer Kok (European Central Bank (ECB)); Carola Müller (Center for Latin American Monetary Studies – CEMLA; Halle Institute for Economic Research); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR))
    Abstract: Relying on confidential supervisory data related to the 2016 EU-wide stress test, this paper presents novel empirical evidence that supervisory scrutiny associated to stress testing has a disciplining effect on bank risk. We find that banks that participated in the 2016 EU-wide stress test subsequently reduced their credit risk relative to banks that were not part of this exercise. Relying on new metrics for supervisory scrutiny that measure the quantity, potential impact, and duration of interactions between banks and supervisors during the stress test, we find that the disciplining effect is stronger for banks subject to more intrusive supervisory scrutiny during the exercise. We also find that a strong risk management culture is a prerequisite for the supervisory scrutiny to be effective. Finally, we show that a similar disciplining effect is not exerted neither by higher capital charges nor by more transparency and related market discipline induced by the stress test.
    Keywords: Stress Testing, Credit risk, Internal Models, Banking Supervision, banking regulation
    Date: 2022–08
  15. By: Jane (Xue); Tan; Yong Tan
    Abstract: Extrinsic incentives such as a conditional thank-you gift have shown both positive and negative impacts on charitable fundraising. Leveraging the crypto donations to a Ukrainian fundraising plea that accepts Ether (i.e., the currency of the Ethereum blockchain) and Bitcoin (i.e., the currency of the Bitcoin blockchain) over a seven-day period, we analyze the impact of crypto rewards that lasted for more than 24 hours. Crypto rewards are newly minted tokens that are usually valueless initially and grow in value if the corresponding cause is well received. Separately, we find that crypto rewards have a positive impact on the donation count but a negative impact on the average donation size for donations from both blockchains. Comparatively, we further find that the crypto rewards lead to an 812.48% stronger donation count increase for Ethereum than Bitcoin, given that the crypto rewards are more likely to be issued on the Ethereum blockchain, which has higher programmability to support smart contracts. We also find a 30.1% stronger decrease in average donation amount from Ethereum for small donations ( $250). Our study is the first work to look into crypto rewards as incentives for fundraising. Our findings indicate that the positive effect of crypto rewards is more likely to manifest in donation count, and the negative effect of crypto rewards is more likely to manifest in donation size.
    Date: 2022–07
  16. By: Nicholas K. Tabor; Jeffery Y. Zhang
    Abstract: The benefits of cross-border financial activity are wide-ranging, from greater competition and more efficient markets to broader and more stable access to capital. During normal economic times, the official sector and private sector share an incentive to foster such cross-border financial activities. During a financial crisis, however, the short-term alignment of official- and private-sector incentives can diverge—sometimes significantly. We present a game-theoretic model of the underlying trade-offs and discuss lessons for international financial regulators, placing them in the context of the 2008 financial crisis, when challenges in cross-border cooperation both channeled and amplified financial stress. We also discuss the critical unfinished business of post-crisis regulatory measures to improve oversight of internationally active financial institutions.
    Keywords: Bank Capital; Bank Liquidity; Cross-Border Finance; Market Fragmentation; Pre-Positioning
    JEL: F02 F59 F34 F00 F36 F30
    Date: 2022–08–09
  17. By: Brancati, Emanuele (Sapienza University of Rome)
    Abstract: The lack of information is a relevant obstacle to the export activity of small and medium enterprises. This paper analyzes whether banks can support firms’ export by reducing informational asymmetries about foreign markets. We exploit a large sample of Italian firms for which we merge custom data with information on their lender banks. We identify a shock exogenous to firms’ export decisions by relying on preexisting lending relationships and exploiting the acquisition of a firm’s domestic bank by an internationalized banking group. Our results show that, after the acquisition, firms have a significantly higher probability of starting export in countries where the consolidated bank has a foreign branch, which proxies for the amount of information accumulated that can be shared with client firms. Conversely, the effect on the intensive margins of previously-exporting companies is largely insignificant. We interpret these findings as evidence of information spillovers that mainly reduce firms’ fixed entry costs in a foreign market. The analysis also shows that other channels, such as bank credit availability or trade-finance supply, are unlikely to drive our results.
    Keywords: firms, export, informational barriers, banks
    JEL: F23 F14 G21 G00
    Date: 2022–07
  18. By: Benjamin Dennis
    Abstract: This article reviews the rapidly proliferating economic literature on climate change and financial policy. We find: (1) enduring challenges in estimating the statistical properties of a changed climate; (2) emerging evidence of financial markets pricing in climate-related risks; and (3) a range of significant institutional distortions preventing such pricing from being complete. Finally, we argue that geographic regions may be an especially fruitful unit of analysis for understanding the financial impact of climate change.
    Keywords: Climate change; Climate-finance; Climate-related risk
    JEL: G20 Q54 G10
    Date: 2022–07–29
  19. By: Bindseil, Ulrich; Pantelopoulos, George
    Abstract: The holy grail of cross-border payments is a solution allowing cross-border payments to be immediate, cheap, universal, and settled in a secure settlement medium. The search for such a solution is as old as international commerce and the implied need to pay. This paper describes current visions how to eventually find this holy grail within the next decade, namely through (i) modernized correspondent banking; (ii) emerging cross-border FinTech solutions; (iii) Bitcoin; (iv) global stablecoins; (v) interlinked instant payment systems with FX conversion layer; (vi) interlinked CBDC with FX conversion layer. For each, settlement mechanics are explained, and an assessment is provided on its potential to be the holy grail of cross-border payments. Several solutions are suitable for improving cross-border payments significantly, and some could even be the holy grail. JEL Classification: E42, E58, F31
    Keywords: bitcoin, CBDC, correspondent banking, cross-currency payments, interlinking, stablecoins
    Date: 2022–08
  20. By: Boris Hofmann; Ilhyock Shim; Hyun Song Shin
    Abstract: We lay out a model of risk capacity for global portfolio investors in which swings in exchange rates can affect their risk-taking capacity in a Value-at-Risk framework. Exchange rate fluctuations induce shifts in portfolio holdings of global investors, even in the absence of currency mismatches on the part of the borrowers. A currency appreciation for an emerging market borrower that is part of a broad-based appreciation of emerging market currencies leads to larger bond portfolio inflows than the equivalent appreciation in the absence of a broad-based appreciation. As such, the broad dollar index emerges as a global factor in bond portfolio flows. The empirical evidence strongly supports the predictions of the model.
    Keywords: bond spread, capital flow, credit risk, emerging market, exchange rate
    JEL: G12 G15 G23
    Date: 2022–07
  21. By: Osadchiy, Maksim
    Abstract: Credit and liquidity risks at the bank level depend on idiosyncratic and systematic (market) risks at the firm level. Portfolio effect transforms idiosyncratic risk into expected factor and leaves only systematic risk. Dependence only on market risk allows evaluating credit and liquidity risk using one-factor models. Since market risk is common to both credit risk and liquidity risk, it is useful to evaluate their joint distribution in a closed form. The one-factor Vasicek model was designed to evaluate credit risk – the probability distribution of the portfolio loss. The one-factor model proposed in the paper is designed to evaluate liquidity risk. Combination of credit risk and liquidity risk models is used to evaluate the joint distribution of credit and liquidity risks.
    Keywords: liquidity risk; credit risk; Vasicek model; barrier option; IRB
    JEL: G21 G32 G33
    Date: 2022–07–24
  22. By: Paul Glasserman; Mike Li
    Abstract: Regulatory stress tests have become the primary tool for setting capital requirements at the largest U.S. banks. The Federal Reserve uses confidential models to evaluate bank-specific outcomes for bank-specific portfolios in shared stress scenarios. As a matter of policy, the same models are used for all banks, despite considerable heterogeneity across institutions; individual banks have contended that some models are not suited to their businesses. Motivated by this debate, we ask, what is a fair aggregation of individually tailored models into a common model? We argue that simply pooling data across banks treats banks equally but is subject to two deficiencies: it may distort the impact of legitimate portfolio features, and it is vulnerable to implicit misdirection of legitimate information to infer bank identity. We compare various notions of regression fairness to address these deficiencies, considering both forecast accuracy and equal treatment. In the setting of linear models, we argue for estimating and then discarding centered bank fixed effects as preferable to simply ignoring differences across banks. We present evidence that the overall impact can be material. We also discuss extensions to nonlinear models.
    Date: 2022–07
  23. By: Ganapathy G Gangadharan; N. Suresh
    Abstract: Emerging markets such as India provide investors with returns far greater than those in developed markets; taking the average returns from the period 1995 to 2014 the returns are 4.714% to 3.276% of the developed market. The majority of emerging markets commenced joining with the capital market of the world, thus allowing a huge inflow of capital which in turn paved the path for economic growth. Even though the emerging markets provide high returns these may also be an indication of a bubble formation. Detection of a bubble is a tedious task primarily due to the fundamental value of the security being uncertain, and the randomness of the fundamentals of the market makes detecting bubbles an arduous task. Ratios that foretold the financial crisis of 2007- Market Capitalization to GDP, Price to Earnings Ratio, Price to Book Value, Tobins Q. Data is collected from 1999-2000 from various Indian indices such as NIFTY 50, NIFTY NEXT 50, NIFTY BANK, NIFTY 500 S and PBSE SENSEX, S and P BSE 100. The paper utilizes the ratios mentioned above to detect and backtrack various bubble episodes in the Indian market; the methodology used is the Philips et al 2015 right-tailed unit test. The paper is also inclined to take steps to mitigate the effects of a bubble by amending the financial policies and the monetary liquidity of the financial system.
    Date: 2022–07
  24. By: Li, Boyao
    Abstract: When banks create credit and money endogenously, how do Basel III regulations affect the macroeconomy? This study develops a simple monetary circuit model based on the stock-flow consistent framework. It analytically solves for the equilibrium where banks comply with the capital adequacy ratio or net stable funding ratio. The growth rates can decompose into the money creation processes. The primary component is lending, which depends on bank spreads (or profitability) and regulatory rules. Moreover, this study reveals a channel through which credit and money creation affect economic growth. Debt ratios of firms are related to their animal spirits and the economy’s growth rates, and this relationship implies conditions for firms using debt and going bankrupt. Finally, results reveal that regulations can transfer risk from banks to firms. These findings shed new light on banks’ macroeconomic roles and the effects of bank regulations.
    Keywords: Money creation; Basel III; Economic growth; Leverage; Banking macroeconomics
    JEL: E12 E51 G28
    Date: 2022–07–15
  25. By: Max Ole Liemen; Olaf Posch
    Abstract: In this paper, we revisit the fiscal theory of the price level (FTPL) within the New Keynesian (NK) model. We show in which cases the average maturity of government debt matters for the transmission of policy shocks. The central task of this paper is to shed light on the theoretical predictions of the maturity structure on macro dynamics with an emphasis on model-implied expectations. In particular, we address the transmission channels of monetary and fiscal policy shocks on the interest rate and inflation dynamics. Our results illustrate the role of the maturity of existing debt in the wake of skyrocketing debt-to-GDP ratios and increasing government expenditures. We highlight our results by quantifying the effects of the large-scale US fiscal packages (CARES) and predict a surge in inflation if the deficits are not sufficiently backed by future surpluses.
    Keywords: NK models, FTPL, government debt, maturity structure, CARES
    JEL: E32 E12 C61
    Date: 2022
  26. By: Toshitaka Sekine (Hitotsubashi University and CAMA); Frank Packer (Bank for International Settlements); Shunichi Yoneyama (Bank of Japan)
    Abstract: This paper extends the recent approaches to estimate trend inflation from the survey responses of individual forecasters. It relies on a noisy information model to estimate the trend inflation of individual forecasters. Applying the model to the recent Japanese data, it reveals that the added noise term plays a crucial role and there exists considerable heterogeneity among individual trend inflation forecasts that drives the dynamics of the mean trend inflation forecasts. Divergences in forecasts as well as moves in estimates of trend inflation are largely driven by a identifiable group of forecasters who see less noise in the inflationary process, expect the impact of transitory inflationary shocks to wane more quickly, and are more flexible in adjusting their forecasts of trend inflation in response to new information.
    Keywords: inflation forecast, disagreement, unobserved components model, noisy information, inflation target, quantitative and qualitative monetary easing, Bank of Japan
    JEL: E31 E52 E58
    Date: 2022–08
  27. By: Mitsuru Katagiri; Koji Takahashi; Junnosuke Shino
    Abstract: In this paper, we investigate the effects of the Bank of Japan's (BOJ) exchange-traded fund (ETF) purchase program on equity risk premia. We first construct a unique panel dataset for the amount of individual stock that the BOJ has indirectly purchased in the program. Then, utilizing the cross-sectional and time-series variations in purchases associated with the BOJ's policy changes, the empirical analysis reveals that: (i) the BOJ's ETF purchases instantaneously support stock prices on the days of purchases, and (ii) the instantaneous positive effects on stock prices, combined with the countercyclical nature of the BOJ's purchases, have decreased the market beta and coskewness of Japanese stocks, thus leading to an economically significant decline in risk premia.
    Keywords: large-scale asset purchases (LSAP), ETF purchase program, capital asset pricing model (CAPM), Bank of Japan
    JEL: E58 G12 G14
    Date: 2022–07
  28. By: Paul Konietschke (European Central Bank (ECB)); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR)); Aurea Ponte Marques (European Central Bank (ECB))
    Abstract: How do banks respond to changes in capital requirements as a result of the stress tests? Does the disclosure of stress test results matter? To answer these questions, we study the impact of European stress tests on banks' lending, their corresponding risk-taking, the ensuing effect on their profitability and the respective publication effect. Exploiting the centralised European stress tests in conjunction with two unique confidential databases containing (i) stress test information for the 2016 and 2018 exercises covering a total of 93 and 87 banks, respectively; and (ii) quarterly supervisory information on approximately 1,000 banks (stress-tested and non-tested), allow us to implement a dynamic difference-in-differences strategy for a comparable sample of banks. We find that banks participating in the stress tests reallocate credit away from riskier borrowers and towards safer ones in the household sector, making them in general safer but also less profitable. This is especially the case for the set of banks part of the Supervisory Review and Evaluation Process with undisclosed stress tests, which were also not disclosing their Pillar 2 Requirements voluntarily. Our results confirm that the publication of capital requirements can have a disciplinary effect since banks publishing their requirements tend to have more robust capital ratios, which improves market discipline and financial stability.
    Keywords: Stress-testing, Credit supply, Profitability, Financial stability, Market discipline
    JEL: E51 E58 G21 G28
    Date: 2022–08
  29. By: James Costain; Galo Nuño; Carlos Thomas
    Abstract: We build a no-arbitrage model of the yield curves in a heterogeneous monetary union with sovereign default risk, which can account for the asymmetric shifts in euro area yields during the Covid-19 pandemic. We derive an affine term structure solution, and decompose yields into term premium and credit risk components. In an extension, we endogenize the peripheral default probability, showing that it decreases with central bank bond-holdings. Calibrating the model to Germany and Italy, we show that a “default risk extraction” channel is the main driver of Italian yields, and that flexibility makes asset purchases more effective.
    Keywords: sovereign default, quantitative easing, yield curve, affine model, Covid-19 crisis, ECB, pandemic emergency purchase programme
    JEL: E50 G12 F45
    Date: 2022
  30. By: James B. Bullard
    Abstract: St. Louis Fed President Jim Bullard talked about the academic literature related to “credible” versus “incredible” disinflation and how that may apply to current conditions. He spoke before the Money Marketeers of New York University. Current inflation in the U.S. and the euro area (EA) is near 1970s levels, Bullard said. The disinflation under former Fed Chair Paul Volcker was costly, he added, but it was not credible initially—Volcker had to earn credibility. Nobel laureate and economist Thomas Sargent initiated a literature on costless disinflation (“soft landings”) that emphasized inflation expectations as the key variable, not the Phillips curve, Bullard noted. Subsequent literature illustrated how credibility might be earned in models that depart from rational expectations, he said. “The Fed and the ECB [European Central Bank] have considerable credibility compared with their 1970s counterparts, suggesting that a soft landing is feasible in the U.S. and the EA if the post-pandemic regime shift is executed well,” Bullard concluded.
    Keywords: inflation; disinflation; soft landings; costless disinflation
    Date: 2022–08–02

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