New Economics Papers
on Financial Markets
Issue of 2012‒05‒15
four papers chosen by

  1. Variation in Systemic Risk at US Banks During 1974-2010 By Armen Hovakimian; Edward J. Kane; Luc Laeven
  2. The impact of financial crises on the risk-return tradeoff and the leverage effect By Bent Jesper Christensen; Morten Ørregaard Nielsen; Jie Zhu
  3. Arbitrage, liquidity and exit: the repo and federal funds markets before, during, and emerging from the financial crisis By Morten L. Bech; Elizabeth Klee; Viktors Stebunovs
  4. Stock return comovement and systemic risk in the Turkish banking system By Binici, Mahir; Köksal, Bülent; Orman, Cüneyt

  1. By: Armen Hovakimian; Edward J. Kane; Luc Laeven
    Abstract: This paper proposes a theoretically sound and easy-to-implement way to measure the systemic risk of financial institutions using publicly available accounting and stock market data. The measure models credit risk of banks as a put option on bank assets, a tradition that originated with Merton (1974). We extend his contribution by expressing the value of banking-sector losses from systemic default risk as the value of a put option written on a portfolio of aggregate bank assets whose exercise price equals the face value of aggregate bank debt. We conceive of an individual bank’s systemic risk as its contribution to the value of this potential sector-wide put on the financial safety net. To track the interaction of private and governmental sources of systemic risk during and in advance of successive business-cycle contractions, we apply our model to quarterly data over the period 1974-2010. Results indicate that systemic risk reached unprecedented highs during the years 2008-2010, and that bank size, leverage, and asset risk are key drivers of systemic risk.
    JEL: G01 G21 G28
    Date: 2012–05
  2. By: Bent Jesper Christensen (Aarhus University and CREATES); Morten Ørregaard Nielsen (Queen?s University and CREATES); Jie Zhu (Shanghai University of Finance and Economics)
    Abstract: We investigate the impact of financial crises on two fundamental features of stock returns, namely, the risk-return tradeoff and the leverage effect. We apply the fractionally integrated exponential GARCH-in-mean (FIEGARCH-M) model for daily stock return data, which includes both features and allows the co-existence of long memory in volatility and short memory in returns. We extend this model to allow the financial parameters governing the volatility-in-mean effect and the leverage effect to change during financial crises. An application to the daily U.S. stock index return series from 1926 through 2010 shows that both ?financial effects increase significantly during crises. Strikingly, the risk-return tradeoff is significantly positive only during financial crises, and insignificant during non-crisis periods. The leverage effect is negative throughout, but increases significantly by about 50% in magnitude during ?financial crises. No such changes are observed during NBER recessions, so in this sense ?financial crises are special. Applications to a number of major developed and emerging international stock markets confirm the increase in the leverage effect, whereas the international evidence on the risk-return tradeoff is mixed.
    Keywords: FIEGARCH-M, financial crises, financial leverage, international markets, long memory, risk-return tradeoff, stock returns, volatility feedback.
    JEL: C22 G01
    Date: 2012–05–02
  3. By: Morten L. Bech; Elizabeth Klee; Viktors Stebunovs
    Abstract: This paper examines the link between the federal funds and repo markets, before, during, and emerging from the financial crisis that began in August 2007. In particular, the paper investigates the initial transmission of monetary policy to closely related money markets, pricing of risk, and liquidity effects, and then shows how these could interact if the Federal Reserve removes the substantial amount of liquidity currently in the federal funds market. The results suggest that pass-through from the federal funds rate to the repo deteriorated somewhat during the zero lower bound period, likely due to limits to arbitrage and idiosyncratic market factors. In addition, during the early part of the crisis, the pricing of federal funds, which are unsecured loans, indicated a marked jump in perceived credit risk. Moreover, the liquidity effect for the federal funds rate, or the change in the federal funds rate associated with an exogenous change in reserve balances, weakened greatly with the increase in supply of these balances over the crisis, implying a non-linear demand for federal funds. Using these analyses, the paper then shows simulations of the dynamic effects and balance sheet mechanics of liquidity draining on the federal funds and repo rates--a tool that might be used in an exit strategy to tighten monetary policy.
    Date: 2012
  4. By: Binici, Mahir; Köksal, Bülent; Orman, Cüneyt
    Abstract: This paper investigates the evolution of systemic risk in the Turkish banking sector over the past two decades using comovement of banks’ stock returns as a systemic risk indicator. In addition, we explore possible determinants of systemic risk, the knowledge of which can be a useful input into effective macroprudential policymaking. Results show that the correlations between bank stock returns almost doubled in 2000s in comparison to 1990s. The correlations decreased somewhat after 2002 and increased again as a result of the 2007-2009 financial crisis. Main determinants of systemic risk appear to be the market share of bank pairs, the amount of non-performing loans, herding behavior of banks, and volatilities of macro variables including the exchange rate, U.S. T-bills, EMBI+, VIX, and MSCI emerging markets index.
    Keywords: Stock returns; comovement; systemic risk; Turkish banking system
    JEL: G32 C22 G21 G01
    Date: 2012–05–01

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