New Economics Papers
on Financial Markets
Issue of 2012‒03‒21
ten papers chosen by

  1. Foreign holdings of U.S. Treasuries and U.S. Treasury yields By Daniel O. Beltran; Maxwell Kretchmer; Jaime Marquez; Charles P. Thomas
  2. The private premium in public bonds By Anna Kovner; Chenyang Wei
  3. A Note on Central Counterparties in Repo Markets By Hajime Tomura
  4. Pricing Synthetic CDOs Using a Three Regime Random-Factor-Loading Model By Philip Messow
  5. Bond Market Development in Asia : An Empirical Analysis of Major Determinants By Biswa Nath Bhattacharyay
  6. On Risk, Leverage and Banks: Do highly Leveraged Banks take on Excessive Risk? By Martin Koudstaal; Sweder van Wijnbergen
  7. The effect of TARP on bank risk-taking By Lamont Black; Lieu Hazelwood
  8. From Stress to CoStress: Stress Testing Interconnected Banking Systems By Rodolfo Maino; Kalin Tintchev
  9. Systemic Real and Financial Risks: Measurement, Forecasting, and Stress Testing By Gianni De Nicoló; Marcella Lucchetta
  10. Evaluating Asian Swap Arrangements By Joshua Aizenman; Yothin Jinjarak; Donghyun Park

  1. By: Daniel O. Beltran; Maxwell Kretchmer; Jaime Marquez; Charles P. Thomas
    Abstract: Foreign official holdings of U.S. Treasuries increased from $400 billion in January 1994 to about $3 trillion in June 2010. Most of this growth is accounted for by a handful of emerging market economies that have been running large current account surpluses. These countries are channeling their savings through the official sector, which is then acquiring foreign exchange reserves. Any shift in policy to reduce their current account surpluses or dampen the rate of reserves accumulation would likely slow the pace of foreign official purchases of U.S. Treasuries. Would such a slowing of foreign official purchases of Treasury notes and bonds affect long-term Treasury yields? Most likely yes, and the effects appear to be large. By our estimates, if foreign official inflows into U.S. Treasuries were to decrease in a given month by $100 billion, 5-year Treasury rates would rise by about 40-60 basis points in the short run. But once we allow foreign private investors to react to the yield change induced by the shock to foreign official inflows, the long-run effect is about 20 basis points.
    Date: 2012
  2. By: Anna Kovner; Chenyang Wei
    Abstract: This paper is the first to document the presence of a private premium in public bonds. We find that spreads are 31 basis points higher for public bonds of private companies than for bonds of public companies, even after controlling for observable differences, including rating, financial performance, industry, bond characteristics and issuance timing. The estimated private premium increases to 40-50 basis points when a propensity matching methodology is used or when we control for fixed issuer effects. Despite the premium pricing, bonds of private companies are no more likely to default or be downgraded than are public bonds. They do not have worse secondary market performance or higher credit default swap spreads nor are they necessarily less liquid. Bond investors appear to discount the value of privately held equity. The effect does not come only from the lack of a public market signal of asset quality, because very small public companies also pay high spreads.
    Keywords: Corporate bonds ; Investments ; Equity
    Date: 2012
  3. By: Hajime Tomura
    Abstract: The author introduces a central counterparty (CCP) into a model of a repo market. Without the CCP, there exist multiple equilibria in the model. In one of the equilibria, a repo market emerges as bond dealers and cash investors choose to arrange repos in an over-the-counter bond market. In another equilibrium, the repo market collapses due to aggregate cash shortage for dealers. Introducing a CCP into the repo market blocks the latter equilibrium. This stabilizing effect of a CCP is robust to idiosyncratic default risk of dealers and asymmetric information about the risk.
    Keywords: Payment, clearing, and settlement systems; Financial markets; Financial stability
    JEL: G24
    Date: 2012
  4. By: Philip Messow
    Abstract: Synthetic Collateralized Debt Obligations (CDOs) were among the driving forces of the rapid growth of the market for credit derivatives in recent years. Possibly the most popular model beside the Gaussian copula for pricing CDO tranches is the Random-Factor-Loading-Model of Andersen and Sidenius (2005). We extend this model by allowing more than two regimes of default correlations. The model is calibrated to market spreads at times of financial distress and during calm periods. For both points in time the model correlation skews are similar to the steep skews observed in the market and lead to an improvement to the standard Random-Factor-Loading-Model.
    Keywords: Collateralized debt obligation; random-factor-loading; pricing; financial dependence; factor model; default risk; correlated defaults
    JEL: C58 G13
    Date: 2012–02
  5. By: Biswa Nath Bhattacharyay (Asian Development Bank Institute (ADBI))
    Abstract: One of the reasons behind the financial crisis in 1997 was excessive dependence of Asian economies on commercial banks for domestic financing. Banks were the major source of corporate financing because the other major source, bond markets, was underdeveloped and small. On the other hand, the 2008 global financial crisis led to constraints in acquiring local currency and foreign currency liquidity in the corporate sector, as foreign banks withdrew investments from Asia. Furthermore, Asia needs large quantities of capital (US$750 billion per year for 2010–2020) to develop infrastructure connectivity within and across its economies. Local and regional capital can be channeled for long-term infrastructure projects and other productive investment through bond markets. At this juncture, to enhance bond financing, it is important to examine factors that promote effective development of bond markets. This study attempts to identity the major determinants of bond market development in Asian economies, through examining its relationship with selected key financial and economic factors, and to provide policy recommendations for further developing Asian bond markets. Major determinants for bond market development in Asia include the size of an economy, the stage of economic development, the openness of an economy, the size of the banking sector, and the interest rate spread.
    Keywords: domestic financing, Asian economies, bond market development
    JEL: F36 O16 G15 O53
    Date: 2011–06
  6. By: Martin Koudstaal (Double Effect); Sweder van Wijnbergen (Unversity of Amsterdam)
    Abstract: This paper deals with the relation between excessive risk taking and capital structure in banks. Examining a quarterly dataset of U.S. banks between 1993 and 2010, we find that equity is valued higher when more risky portfolios are chosen when leverage is high, and that more risk taking has a negative impact on valuation of the debt of highly leveraged banks. We find no evidence that deposit insurance is encouraging risk taking behaviour. We do find that banks with a more troubled loan portfolio take on more risk. Banks whose share price has slumped tend to gamble for resurrection by increasing the riskiness of their asset portfolios. The results suggest that incentives embedded in the capital structure of banks contribute to systemic fragility, and so support the Basel III proposals towards less leverage and higher loss absorption capacity of capital.
    Keywords: bank fragility; risk shifting; deposit insurance; gambles for resurrection
    JEL: G21 G28 G32
    Date: 2012–03–12
  7. By: Lamont Black; Lieu Hazelwood
    Abstract: One of the largest responses of the U.S. government to the recent financial crisis was the Troubled Asset Relief Program (TARP). TARP was originally intended to stabilize the financial sector through the increased capitalization of banks. However, recipients of TARP funds were then encouraged to make additional loans despite increased borrower risk. In this paper, we consider the effect of the TARP capital injections on bank risk taking by analyzing the risk ratings of banks’ commercial loan originations during the crisis. The results indicate that, relative to non-TARP banks, the risk of loan originations increased at large TARP banks but decreased at small TARP banks. Interest spreads and loan levels also moved in different directions for large and small banks. For large banks, the increase in risk-taking without an increase in lending is suggestive of moral hazard due to government ownership. These results may also be due to the conflicting goals of the TARP program for bank capitalization and bank lending.
    Date: 2012
  8. By: Rodolfo Maino; Kalin Tintchev
    Abstract: This paper presents an integrated framework for assessing systemic risk. The framework models banks’ capital asset ratios as a function of future losses and credit growth using a generalized method of moments to calibrate shocks to credit quality and credit growth. The analysis is complemented by a simple measure of systemic risk, which captures tail risk comovement among banks in the system. The main contribution of this paper is to advance a simple framework to integrate systemic risk scenarios that assess the impact of aggregate and idiosyncratic factors. The analysis is based on CreditRisk+, which uses analytical techniques—similar to those applied in the insurance industry - to estimate banks’ credit portfolio loss distributions, making no assumptions about the cause of default.
    Keywords: Banking systems , Credit expansion , Credit risk , Economic models , External shocks , Risk management ,
    Date: 2012–02–16
  9. By: Gianni De Nicoló; Marcella Lucchetta
    Abstract: This paper formulates a novel modeling framework that delivers: (a) forecasts of indicators of systemic real risk and systemic financial risk based on density forecasts of indicators of real activity and financial health; (b) stress-tests as measures of the dynamics of responses of systemic risk indicators to structural shocks identified by standard macroeconomic and banking theory. Using a large number of quarterly time series of the G-7 economies in 1980Q1-2010Q2, we show that the model exhibits significant out-of sample forecasting power for tail real and financial risk realizations, and that stress testing provides useful early warnings on the build-up of real and financial vulnerabilities.
    Keywords: Economic indicators , Financial risk , Forecasting models , Group of seven , Time series ,
    Date: 2012–02–28
  10. By: Joshua Aizenman (Asian Development Bank Institute (ADBI)); Yothin Jinjarak; Donghyun Park
    Abstract: Motivated by the unprecedented rise of swap agreements between the central banks of developed economies and their developing economy counterparts, this paper evaluates Asian swap arrangements and their association with the build-up of foreign reserves prior to the 2008–2009 global financial crisis. The evidence suggests that there is a limited scope for swaps to substitute for reserves. Furthermore, the selectivity of the swap lines indicates that only countries with significant trade and financial linkages can expect access to such ad hoc arrangements, on a case by case basis. Moral hazard concerns suggest that the applicability of these arrangements will remain limited. However, deepening swap agreements and regional reserve pooling arrangements may weaken the precautionary motive for reserve accumulation.
    Keywords: Swaps, swap agreements, central banks, Asia, foreign reserves, global financial crisis, dollar standards
    JEL: F15 F31 F32
    Date: 2011–07

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