nep-cba New Economics Papers
on Central Banking
Issue of 2018‒02‒26
25 papers chosen by
Maria Semenova
Higher School of Economics

  1. Extreme events and optimal monetary policy By Jinill, Kim; Ruge-Murcia, Francisco
  2. US Monetary Policy and International Bond Markets By Simon Gilchrist; Vivian Z. Yue; Egon Zakrajsek
  3. Nonlinear state and shock dependence of exchange rate pass through on prices By Hernán Rincón-Castro; Norberto Rodríguez-Niño
  4. Financial Vulnerability and Monetary Policy By Adrian, Tobias; Duarte, Fernando
  5. Oil Price Shocks, Monetary Policy and Current Account Imbalances within a Currency Union By Baas, Timo; Belke, Ansgar H.
  6. The dynamic impact of monetary policy on regional housing prices in the US: Evidence based on factor-augmented vector autoregressions By Manfred M. Fischer; Florian Huber; Michael Pfarrhofer; Petra Staufer-Steinnocher
  7. ECB interventions in distressed sovereign debt markets: The case of Greek bonds By Trebesch, Christoph; Zettelmeyer, Jeromin
  8. Sweden's Trilemma Trade-offs By Cortuk, Orcan
  9. Trade-offs in Bank Resolution By Giovanni Dell'Ariccia; Maria Soledad Martinez Peria; Deniz O Igan; Elsie Addo Awadzi; Marc Dobler; Damiano Sandri
  10. Temporary Price Changes, Inflation Regimes and the Propagation of Monetary Shocks By Alvarez, Fernando; Lippi, Francesco
  11. The “Too Big to Fail” Subsidy in Canada: Some Estimates By Patricia Palhau Mora
  12. Bank lending behavior and business cycle under Basel regulations: Is there a significant procyclicality? By Katsutoshi Shimizu; Kim Cuong Ly
  13. Modeling Your Stress Away By Niepmann, Friederike; Stebunovs, Viktors
  14. Effectiveness of unconventional monetary policies in a low interest rate environment By Andrew Filardo; Jouchi Nakajima
  15. Global factors and trend inflation By Güneş Kamber; Benjamin Wong
  16. Financial spillovers of international monetary policy: Six hypotheses on the Latin American case, 2010-2016 By Eijffinger, Sylvester C W; Malagon, Jonathan
  17. Flexible and mandatory banking supervision By Alessandro De Chiara; Luca Livio; Jorge Ponce
  18. Monetary Policy and Financial Conditions: A Cross-Country Study By Adrian, Tobias; Duarte, Fernando; Grinberg, Federico; Mancini-Griffoli, Tommaso
  19. The global financial cycle, bank capital flows and monetary policy. Evidence from Norway By Ragna Alstadheim; Christine Blandhol
  20. Financial Heterogeneity and the Investment Channel of Monetary Policy By Pablo Ottonello; Thomas Winberry
  21. Risk-Taking Channel of Monetary Policy By Adrian, Tobias; Estrella, Arturo; Shin, Hyun Song
  22. Risks and challenges of complex financial isntruments: an analysis of SSM banks By Rosario Roca; Francesco Potente; Luca Giulio Ciavoliello; Alessandro Conciarelli; Giovanni Diprizio; Lanfranco Lodi; Roberto Mosca; Tommaso Perez; Jacopo Raponi; Emiliano Sabatini; Antonio Schifino
  23. Can Technology Undermine Macroprudential Regulation? Evidence from Peer-to-Peer Credit in China By Braggion, Fabio; Manconi, Alberto; Zhu, Haikun
  24. Monetary Policy and Asset Valuation By Bianchi, Francesco; Lettau, Martin; Ludvigson, Sydney
  25. The Interplay Among Financial Regulations, Resilience, and Growth By Allen, Franklin; Goldstein, Itay; Jagtiani, Julapa

  1. By: Jinill, Kim; Ruge-Murcia, Francisco
    Abstract: This paper studies the implication of extreme shocks for monetary policy. The analysis is based on a small-scale New Keynesian model with sticky prices and wages where shocks are drawn from asymmetric Generalized Extreme Value distributions. A nonlinear perturbation solution of the model is estimated by the simulated method of moments. Under the Ramsey policy, the central bank responds nonlinearly and asymmetrically to shocks. The trade-off between targeting a gross inflation rate above 1 (or a net inflation rate above 0) as insurance against extreme shocks and targeting an average gross inflation at unity to avoid adjustment costs is unambiguously decided in favour of strict price stability.
    JEL: E4 E5
    Date: 2018–02–06
  2. By: Simon Gilchrist; Vivian Z. Yue; Egon Zakrajsek
    Abstract: This paper uses high-frequency data to analyze the effects of US monetary policy--during the conventional and unconventional policy regimes--on foreign government bonds markets in advanced and emerging market economies. The results indicate that an expansionary US monetary policy steepens the foreign yield curve--denominated in local currency--during a conventional US monetary policy regime and flattens the foreign yield curve during an unconventional policy regime. The passthrough of unconventional US monetary policy to foreign bond yields is, on balance, comparable to that of conventional policy. In addition a conventional US monetary easing leads to a significant narrowing of the credit spreads on dollar-denominated sovereign bonds that are issued by countries with a speculative-grade sovereign credit rating. However, during the unconventional policy regime, yields on speculative-grade sovereign debt denominated in dollars move one-to-one with yields on comparable-maturity US Treasury securities.
    Keywords: Conventional and unconventional US monetary policy ; Financial spillovers ; Sovereign yields and credit spreads
    JEL: E4 E5 F3
    Date: 2018–02–15
  3. By: Hernán Rincón-Castro; Norberto Rodríguez-Niño
    Abstract: This paper examines the nature of the pass-through of exchange rate shocks on prices along the distribution chain, and estimates its short and long-term path. It uses monthly data from a small open economy and a smooth transition auto-regressive vector model estimated by Bayesian methods. The main finding is that exchange rate pass-through is nonlinear and state and shock dependent. There are two main policy implications of these findings. First, models used by central banks for policymaking should take into account the nonlinear and endogenous nature of the pass-through. Second, a specific rule on pass-through for monetary policy decisions should be avoided.
    Keywords: exchange rate pass-through to prices, pricing along the distribution chain, statedependent, shock-dependent, LST-VAR, Bayesian estimation
    JEL: F31 E31 E52 C51 C52
    Date: 2018–01
  4. By: Adrian, Tobias; Duarte, Fernando
    Abstract: We present a microfounded New Keynesian model that features financial vulnerabilities. Financial intermediaries' occasionally binding value at risk constraints give rise to variation in the pricing of risk that generate time varying risk in the conditional mean and volatility of the output gap. The conditional mean and volatility are negatively related: during times of easy financial conditions, growth tends to be high, and risk tends to be low. Monetary policy affects output directly via the IS curve, and indirectly via the pricing of risk that relates to the tightness of the value at risk constraint. The optimal monetary policy rule always depends on financial vulnerabilities in addition to the output gap, inflation, and the natural rate. We show that a classic Taylor rule exacerbates deviations of the output gap from its target value of zero relative to an optimal interest rate rule that includes vulnerability. Simulations show that optimal policy significantly increases welfare relative to a classic Taylor rule. Alternative policy paths using historical examples illustrate the usefulness of the proposed policy rule.
    Keywords: Financial Stability; Macro-Finance; monetary policy
    JEL: E52 G10 G12
    Date: 2018–02
  5. By: Baas, Timo (University of Duisburg-Essen); Belke, Ansgar H. (University of Duisburg-Essen)
    Abstract: For more than two decades now, current-account imbalances are a crucial issue in the international policy debate as they threaten the stability of the world economy. More recently, the government debt crisis of the European Union shows that internal current account imbalances inside a currency union may also add to these risks. Oil price fluctuations and a contracting monetary policy that reacts on oil prices, previously discussed to affect the current account may also be a threat to the currency union by changing internal imbalances. Therefore, in this paper, we analyze the impact of oil price shocks on current account imbalances within a currency union. Differences in institutions, especially labor market institutions and trade result in an asymmetric reaction to an otherwise symmetric shock. In this context, we show that oil price shocks can have a long-lasting impact on internal balances, as the exchange rate adjustment mechanism is not available. The common monetary policy authority, however, can reduce such effects by specifying an optimum monetary policy target. Nevertheless, we also show that there is no single best solution. CPI, core CPI or an asymmetric CPI target all come at a cost either regarding an increase in unemployment or increasing imbalances.
    Keywords: current account deficit, oil price shocks, DSGE models, search and matching labor market, monetary policy
    JEL: E32 F32 Q43
    Date: 2017–12
  6. By: Manfred M. Fischer; Florian Huber; Michael Pfarrhofer; Petra Staufer-Steinnocher
    Abstract: In this study interest centers on regional differences in the response of housing prices to monetary policy shocks in the US. We address this issue by analyzing monthly home price data for metropolitan regions using a factor-augmented vector autoregression (FAVAR) model. Bayesian model estimation is based on Gibbs sampling with Normal-Gamma shrinkage priors for the autoregressive coefficients and factor loadings, while monetary policy shocks are identified using high-frequency surprises around policy announcements as external instruments. The empirical results indicate that monetary policy actions typically have sizeable and significant positive effects on regional housing prices, revealing differences in magnitude and duration. The largest effects are observed in regions located in states on both the East and West Coasts, notably California, Arizona and Florida.
    Date: 2018–02
  7. By: Trebesch, Christoph; Zettelmeyer, Jeromin
    Abstract: We study central bank interventions in times of severe distress (mid-2010), using a unique bond-level dataset of ECB purchases of Greek sovereign debt. ECB bond buying had a large impact on the price of short and medium maturity bonds, resulting in a remarkable "twist" of the Greek yield curve. However, the effects were limited to those sovereign bonds actually bought. We find little evidence for positive effects on market quality, or spillovers to close substitute bonds, CDS markets, or corporate bonds. Hence, our findings attest to the power of central bank intervention in times of crisis, but also suggest that in highly distressed situations, this power may not extend beyond those assets actually purchased.
    Keywords: Central Bank Asset Purchases; eurozone crisis; Market Segmentation; Securities Markets Programme; sovereign risk
    JEL: E43 E58 F34 G12
    Date: 2018–01
  8. By: Cortuk, Orcan
    Abstract: In this paper, we empirically examine the theoretical concept of “impossible trinity” (financial trilemma) for Sweden for the period of 2010-2017. While doing this, we modified the Aizenman, Chinn and Ito approach by adding an extra interaction term to the main regression which shows whether these three policies are implemented in harmony without creating any trade-offs. Similarly, this interaction term also reflects the effectiveness of all supportive policies (i.e. hoarding international reserves, liquidity policies etc.) in order to eliminate the trade-offs between the monetary independence, exchange rate stability and capital openness. Our results indicate that the standard ACI approach is not sufficient in explaining Sweden’s economic policies and adding an interaction term to the main trilemma regression is both necessary and critical. From the latter perspective, the interaction term has a negative contribution indicating that Sweden could achieve to relax the binding trilemma trade-offs in this period. Lastly, our analysis continues by exploring the implications of the interaction term for inflation in a VAR and Granger Causality analyses where we find that interaction term has certain decreasing impact on inflation.
    Keywords: Financial Trilemma, impossible trinity, Sweden's economy
    JEL: E44 E5 F4
    Date: 2018–02
  9. By: Giovanni Dell'Ariccia; Maria Soledad Martinez Peria; Deniz O Igan; Elsie Addo Awadzi; Marc Dobler; Damiano Sandri
    Abstract: This SDN revisits the debate on bank resolution regimes, first by presenting a simple model of bank insolvency that transparently describes the trade-off involved between bail-outs, bail-ins, and larger capital buffers. The note then looks for empirical evidence to assess the moral hazard consequences of bail-outs and the systemic spillovers from bail-ins.
    Keywords: Bank bailouts;Spillovers;bank insolvency, bail-outs, bail-ins, larger capital buffers, spillovers
    Date: 2018–02–09
  10. By: Alvarez, Fernando; Lippi, Francesco
    Abstract: We analyze a sticky price model where firms choose a price plan, namely a set of two prices. Changing the plan entails a "menu cost", but either price in the plan can be charged at any point in time. We analytically solve for the optimal policy and for the output response to a monetary shock. The setup rationalizes the coexistence of many price changes, most of which are temporary, with a modest flexibility of the aggregate price level. We present evidence consistent with the model implications using CPI data for Argentina across a wide range of inflation rates.
    Keywords: menu cost models; price flexibility; price plans; reference prices; sticky prices; temporary price changes
    JEL: E3 E5
    Date: 2018–01
  11. By: Patricia Palhau Mora
    Abstract: Implicit government guarantees of banking-sector liabilities reduce market discipline by private sector stakeholders and temper the risk sensitivity of funding costs. This potentially increases the likelihood of bailouts from taxpayers, especially in the absence of effective resolution frameworks. Estimates of “too big to fail” (TBTF) implicit subsidies are useful to understand bank agents’ incentives, measure potential resolution costs and assess the credibility of regulatory reform. Given the implicit nature of the subsidy, I propose a framework that adopts two empirical approaches to assess the quantum of the subsidies accruing to systemic banks in Canada. The first is based on credit rating agencies’ assessment of public support and the second relies on a contingent claims analysis. Results suggest more progress on resolution is needed, such as the implementation of a credible statutory bail-in regime for senior obligations, to increase market discipline and help address TBTF externalities. That said, Canada being an early adopter of Basel III might help explain the significant reduction in the government’s contingent liability since the peak years of the crisis.
    Keywords: Financial Institutions, Financial stability
    JEL: G13 G21 G28
    Date: 2018
  12. By: Katsutoshi Shimizu (Department of Economics, Nagoya University); Kim Cuong Ly (School of Management, Swansea University)
    Abstract: This paper re-examines the procyclical effect of risk{sensitive capital regulation on bank lending. The risk{sensitive requirement of the Basel II/III regulation affects procyclically the bank lending in European countries, but the actual requirements are indeed too risk-insensitive. However, the risk{sensitive capital regulation induces less lending than the risk-insensitive capital regulation. Furthermore, the introduction of Basel II has a negative impact on lending even under the risk{insensitive regulation.
    Keywords: Bank capital, Basel regulation, macro-prudential policy, business cycle, procyclicality, buffer capital, countercyclical buffer.
    JEL: G21 G28 G18 G14 G32
    Date: 2018–02–01
  13. By: Niepmann, Friederike; Stebunovs, Viktors
    Abstract: We investigate systematic changes in banks' projected credit losses between the 2014 and 2016 EBA stress tests, employing methodology from Philippon et al. (2017). We find that projected credit losses were smoothed across the tests through systematic model adjustments. Those banks whose losses would have increased the most from 2014 to 2016 due to changes in their exposures and supervisory scenarios-keeping the models constant-saw the largest decrease in losses due to model changes. Model changes were realistic and more pronounced for banks that rely more on the Internal Ratings-Based approach, and they explain the cross-section of market responses to the release of the 2016 results. Stock prices and CDS spreads increased more for banks with larger reductions in projected credit losses due to model changes, as investors apparently did not interpret lower loan losses as reflecting a decrease in credit risk but, instead, as a sign of lower capital requirements going forward.
    Keywords: credit risk models; financial institutions; regulation; stress tests
    JEL: G21 G28
    Date: 2018–01
  14. By: Andrew Filardo; Jouchi Nakajima
    Abstract: Have unconventional monetary policies (UMPs) become less effective at stimulating economies in persistently low interest rate environments? This paper examines that question with a time-varying parameter VAR for the United States, the United Kingdom, the euro area and Japan. One advantage of our approach is the ability to measure an economy's evolving interest rate sensitivity during the post-GFC macroeconomy. Another advantage is the ability to capture time variation in the "natural", or steady state, rate of interest, which allows us to separate interest rate movements that are associated with changes in the stance of monetary policy from those that are not.
    Keywords: lending rate, quantitative easing, time-varying parameter VAR model, unconventional monetary policy
    JEL: E43 E44 E52 E58
    Date: 2018–01
  15. By: Güneş Kamber; Benjamin Wong
    Abstract: We develop a model to empirically study the influence of global factors in driving trend inflation and the inflation gap.We apply our model to five established inflation targeters and a group of heterogeneous Asian economies. Our results suggest that while global factors can have a sizeable influence on the inflation gap, they play only a marginal role in driving trend inflation. Much of the influence of global factors in the inflation gap may be reflecting commodity price shocks. We also find global factors have a greater influence on inflation, and especially trend inflation, for the group of Asian economies relative to the established inflation targeters. A possible interpretation is that inflation targeting may have reduced the influence of global factors on inflation, and especially so on trend inflation.
    Keywords: trend inflation, foreign shocks, Beveridge-Nelson decomposition
    JEL: C32 E31 F41
    Date: 2018–01
  16. By: Eijffinger, Sylvester C W; Malagon, Jonathan
    Abstract: This paper aims to determine if there is a differential incidence between conventional and unconventional monetary policy of developed economies in Latin American financial markets, evaluating six hypotheses that can be extracted from the economic literature. Financial spillovers are considered on two dimensions: financial asset prices (fixed income and equity markets) and interest rates (monetary policy rate and loans rates). The main finding is that both conventional and unconventional monetary policies in US and Eurozone have a significant and direct incidence on Latin American fixed income markets, although the effect of unconventional monetary policy is low. In contrast, only unconventional monetary policy has a significant effect on Latin American equity markets. On the other hand, regardless of the exchange rate pass-through of Latin American economies, the conventional monetary policy of the United States and Eurozone has a low but significant incidence on both monetary policy rates and lending interest rates in Latin America, while the unconventional monetary policies have no incidence. As anticipated, US conventional and unconventional monetary policy have a higher incidence on Latin American financial markets with respect to the monetary policy decisions in Eurozone and Japan. Finally, free trade agreements between developed economies and Latin American economies do not have a significant impact on the relationship between international monetary policy and Latin American financial markets.
    Keywords: central banking; financial asset prices; financial globalization; Financial spillovers; Latin America; monetary policy
    JEL: E40 E43 E50 E52 E58
    Date: 2018–02
  17. By: Alessandro De Chiara; Luca Livio; Jorge Ponce
    Abstract: The implementation of tighter regulation and more powerful supervision may impose large social costs due to the strong reliance on supervisory information that requires direct assessment by a supervisor (i.e. Mandatory Supervision). We show that by introducing a Flexible Supervision contract, which is designed to be chosen by those banks that have incentives to capture the supervisor and allows them to bypass Mandatory Supervision, the most efficient regulation under asymmetric information may be implemented. Benevolent regulators should introduce Flexible Supervision regimes for the less risky, more capitalized and transparent banks in addition to the traditional Mandatory Supervision regime.
    Keywords: Banking supervision; Regulatory capture
    Date: 2018–02
  18. By: Adrian, Tobias; Duarte, Fernando; Grinberg, Federico; Mancini-Griffoli, Tommaso
    Abstract: Loose financiall conditions forecast high output growth and low output volatility up to six quarters into the future, generating time varying downside risk to the output gap which we measure by GDP-at-Risk (GaR). This finding is robust across countries, conditioning variables, and time periods. We study the implications for monetary policy in a reduced form New Keynesian model with financial intermediaries that are subject to a Value at Risk (VaR) constraint. Optimal monetary policy depends on the magnitude downside risk to GDP, as it impacts the consumption-savings decision via the Euler constraint, and the financial conditions via the tightness of the VaR constraint. The optimal monetary policy rule exhibits a pronounced response to shifts in financial conditions for most countries in our sample. Welfare gains from taking financial conditions into account are shown to be sizable.
    Keywords: financial conditions; Financial Stability; monetary policy
    JEL: E52
    Date: 2018–02
  19. By: Ragna Alstadheim (Norges Bank (Central Bank of Norway)); Christine Blandhol (University of Chicago and Statistics Norway)
    Abstract: We investigate the importance of a global financial cycle for gross capital inflows based on monthly balance sheet data for Norwegian banks. The VIX index has been interpreted as an “investor fear gauge” and associated with a global financial cycle. This index has also been found to impact real activity. We include both a global activity variable and the VIX index in our structural VAR model of capital inflows. We find that when global activity falls, banks’ foreign funding share falls. Our results suggest that global real activity rather than a global financial cycle is a main driver behind the volume of bank capital inflows. We also study domestic monetary policy and implications for capital flows. Domestic monetary policy helps absorb VIX shocks and there is no indication of procyclical (“carry trade”) effects on funding. Monetary policy affects activity and inflation in a standard fashion, and the exchange rate acts as a buffer when shocks hit the economy.
    Keywords: Bank Capital flows, Uncertainty-shocks, Structural VAR
    JEL: E32 E44 F32 G15
    Date: 2018–02–19
  20. By: Pablo Ottonello; Thomas Winberry
    Abstract: We study the role of heterogeneity in firms' financial positions in determining the investment channel of monetary policy. Empirically, we show that firms with low leverage or high credit ratings are the most responsive to monetary policy shocks. We develop a heterogeneous firm New Keynesian model with default risk to interpret these facts and study their aggregate implications. In the model, firms with high default risk are less responsive to monetary shocks because their marginal cost of external finance is high. The aggregate effect of monetary policy therefore depends on the distribution of default risk across firms.
    JEL: D22 E22 E44 E52
    Date: 2018–01
  21. By: Adrian, Tobias; Estrella, Arturo; Shin, Hyun Song
    Abstract: One of the most robust stylized facts in macroeconomics is the forecasting power of the term spread for future real activity. We propose a possible causal mechanism for the forecasting power of the term spread, deriving from the balance sheet management of financial intermediaries and the risk-taking channel of monetary policy. Monetary tightening leads to the flattening of the term spread, reducing net interest margin and credit supply. We provide empirical support for the risk-taking channel.
    Keywords: risk taking channel of monetary policy
    Date: 2018–02
  22. By: Rosario Roca (Bank of Italy); Francesco Potente (Bank of Italy); Luca Giulio Ciavoliello (Bank of Italy); Alessandro Conciarelli (Bank of Italy); Giovanni Diprizio (Bank of Italy); Lanfranco Lodi (Bank of Italy); Roberto Mosca (Bank of Italy); Tommaso Perez (Bank of Italy); Jacopo Raponi (Bank of Italy); Emiliano Sabatini (Bank of Italy); Antonio Schifino (Bank of Italy)
    Abstract: We investigate the valuation risk affecting financial instruments classified as L2 and L3 for accounting purposes. These are instruments that are not directly traded in active markets and are often relatively complex, opaque and illiquid. There is a huge volume of L2 and L3 instruments in the balance sheets of SSM banks (around €6.8 trillion worth, considering both assets and liabilities). We argue that the complexity and opacity of these instruments create substantial room for discretionary accounting and prudential choices by financial intermediaries, which have incentives to use this discretion to their advantage. The current regulatory reporting standard is not sufficient to make a comprehensive assessment of the overall risks stemming from L2 and L3 instruments. We highlight that these instruments share some characteristics with NPLs (illiquidity, opacity), and argue that the risk they pose might also be comparable.
    Keywords: fair value accounting, level 2 instruments, L3 instruments, prudential regulation
    JEL: G21 G28 G32 M41
    Date: 2017–12
  23. By: Braggion, Fabio; Manconi, Alberto; Zhu, Haikun
    Abstract: We study whether and to what extent peer-to-peer (P2P) credit helps circumvent loan-to-value (LTV) caps, a key macroprudential tool to contain household leverage. We exploit the tightening of mortgage LTV caps in a number of cities in China in 2013 as our testing ground, in a difference-in-differences setting, and we base our tests on a novel, hand-collected database covering all lending transactions at RenrenDai, a leading Chinese P2P credit platform. P2P loans increase at the cities affected by the LTV cap tightening relative to the control cities, consistent with borrowers tapping P2P credit to circumvent the regulation. The granularity of our data allows us to separate credit demand from credit supply effects, with a fixed effects strategy. Our results also indicate that P2P lenders do not adjust their pricing and screening to the influx of new borrowers after 2013, despite the fact that their loans ex post have higher delinquency and default rates. Symmetric effects are associated with a loosening of mortgage LTV caps in 2015. Our test provides empirical evidence on the capacity of P2P credit to undermine LTV caps. More broadly, our analysis informs the debate on the challenges posed by the interaction between FinTech and credit regulation.
    Keywords: peer-to-peer credit; household leverage; macroprudential regulation; loan-to-value caps
    JEL: G01 G23 G28
    Date: 2018–01
  24. By: Bianchi, Francesco; Lettau, Martin; Ludvigson, Sydney
    Abstract: This paper presents evidence of infrequent shifts, or regimes,in the mean of the consumption-wealth variable cay that are strongly associated with low frequency fluctuations in the real value of the Federal Reserveís primary policy rate, with low policy rates associated with high asset valuations, and vice versa. By contrast, there is no evidence that infrequent shifts to high asset valuations and low policy rates are associated with higher economic growth or lower economic uncertainty; indeed the opposite is true. Additional evidence shows that low interest rate/high asset valuation regimes coincide with significantly lower equity market risk premia.
    JEL: G10 G12 G17
    Date: 2018–01
  25. By: Allen, Franklin (Imperial College London); Goldstein, Itay (The Wharton School of the University of Pennsylvania); Jagtiani, Julapa (Federal Reserve Bank of Philadelphia)
    Abstract: Interconnectedness has been an important source of market failures, leading to the recent financial crisis. Large financial institutions tend to have similar exposures and thus exert externalities on each other through various mechanisms. Regulators have responded by putting more regulations in place with many layers of regulatory complexity, leading to ambiguity and market manipulation. Mispricing risk in complex models and arbitrage opportunities through regulatory loopholes have provided incentives for certain activities to become more concentrated in regulated entities and for other activities to move into new areas in the shadow banking system. How can we design an effective regulatory framework that would perfectly rule out bank runs and TBTF (too big to fail) and to do so without introducing incentives for financial firms to take excessive risk? It is important for financial regulations to be coordinated across regulatory entities and jurisdictions and for financial regulations to be forward looking, rather than aiming to address problems of the past.
    Keywords: financial reform; capital regulations; liquidity regulations; too big to fail; living wills; Dodd–Frank Wall Street Reform and Consumer Protection Act; financial stability; interconnectedness
    JEL: G12 G18 G21 G28
    Date: 2018–02–16

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