New Economics Papers
on Financial Markets
Issue of 2012‒12‒10
five papers chosen by

  1. Bank regulation and supervision around the world : a crisis update By Cihak, Martin; Demirguc-Kunt, Asli; Peria, Maria Soledad Martinez; Mohseni-Cheraghlou, Amin
  2. Dynamic Correlations of Sovereign Bond Yield Spreads in the Euro zone and the Role of Credit Rating Agencies' Downgrades By Antonakakis, Nikolaos
  3. Are CDS spreads predictable? An analysis of linear and non-linear forecasting models By Avino, Davide; Nneji, Ogonna
  4. CDS pricing under Basel III: capital relief and default protection By Chris Kenyon; Andrew Green
  5. Application of simplest random walk algorithms for pricing barrier options By M. Krivko; M. V. Tretyakov

  1. By: Cihak, Martin; Demirguc-Kunt, Asli; Peria, Maria Soledad Martinez; Mohseni-Cheraghlou, Amin
    Abstract: This paper presents the latest update of the World Bank Bank Regulation and Supervision Survey, and explores two questions. First, were there significant differences in regulation and supervision between crisis and non-crisis countries? Second, what aspects of regulation and supervision changed significantly during the crisis period? The paper finds significant differences between crisis and non-crisis countries in several aspects of regulation and supervision. In particular, crisis countries (a) had less stringent definitions of capital and lower actual capital ratios, (b) faced fewer restrictions on non-bank activities, (c) were less strict in the regulatory treatment of bad loans and loan losses, and (d) had weaker incentives for the private sector to monitor banks'risks. Survey results also suggest that the overall regulatory response to the crisis has been slow, and there is room to improve regulation and supervision, as well as private incentives to monitor risk-taking. Specifically, comparing regulatory and supervisory practices before and after the global crisis, the paper finds relatively few changes: capital ratios increased (primarily among non-crisis countries), deposit insurance schemes became more generous, and some reforms were introduced in the area of bank governance and bank resolution.
    Keywords: Banks&Banking Reform,Access to Finance,Emerging Markets,Debt Markets,Bankruptcy and Resolution of Financial Distress
    Date: 2012–12–01
  2. By: Antonakakis, Nikolaos
    Abstract: The European debt crisis that followed the global financial crisis, erupting first with Greece, then Ireland, Portugal, Italy and Spain, has threatened the very existence of the Euro zone. In this paper we examine the evolution of dynamic co-movements of sovereign bond yield spreads (BYS) in the Euro zone and the role of credit rating agency downgrades on those co-movements. Estimation results from a multivariate DCC-GARCH model on daily BYS data for nine Euro zone countries over the period 2007-2012 suggest an inverted U-shaped curve of BYS co-movements during the period of the financial and debt crisis. Credit rating downgrades by major rating agencies indicate rather idiosyncratic patterns of government bond yield spreads co-movements within and between the Euro zone periphery and the core.
    Keywords: Government bond yield spreads; credit rating agencies; dynamic conditional correlations; Euro zone sovereign debt crisis
    JEL: C32 E43 G12 G24
    Date: 2012
  3. By: Avino, Davide; Nneji, Ogonna
    Abstract: This paper investigates the forecasting performance for CDS spreads of both linear and non-linear models by analysing the iTraxx Europe index during the financial crisis period which began in mid-2007. The statistical and economic significance of the models’ forecasts are evaluated by employing various metrics and trading strategies, respectively. Although these models provide good in-sample performances, we find that the non-linear Markov switching models underperform linear models out-of-sample. In general, our results show some evidence of predictability of iTraxx index spreads. Linear models, in particular, generate positive Sharpe ratios for some of the strategies implemented, thus shedding some doubts on the efficiency of the European CDS index market.
    Keywords: Credit default swap spreads; iTraxx; Forecasting; Markov switching; Market efficiency; Technical trading rules
    JEL: C22 G20 G01
    Date: 2012–11–23
  4. By: Chris Kenyon; Andrew Green
    Abstract: Basel III introduces new capital charges for CVA. These charges, and the Basel 2.5 default capital charge can be mitigated by CDS. Therefore, to price in the capital relief that CDS contracts provide, we introduce a CDS pricing model with three legs: premium; default protection; and capital relief. If markets are complete, with no CDS bond basis, then CDSs can be replicated by taking short positions in risky floating bonds issued by the reference entity and a riskless bank account. If these conditions do not hold, then it is theoretically possible that the capital relief that CDSs provide may be priced in. Thus our model provides bounds on the CDS-implied hazard rates when markets are incomplete. Under simple assumptions we show that 20% to over 50% of observed CDS spread could be due to priced in capital relief. Given that this is different for IMM and non-IMM banks will we see differential pricing?
    Date: 2012–11
  5. By: M. Krivko; M. V. Tretyakov
    Abstract: We demonstrate effectiveness of the first-order algorithm from [Milstein, Tretyakov. Theory Prob. Appl. 47 (2002), 53-68] in application to barrier option pricing. The algorithm uses the weak Euler approximation far from barriers and a special construction motivated by linear interpolation of the price near barriers. It is easy to implement and is universal: it can be applied to various structures of the contracts including derivatives on multi-asset correlated underlyings and can deal with various type of barriers. In contrast to the Brownian bridge techniques currently commonly used for pricing barrier options, the algorithm tested here does not require knowledge of trigger probabilities nor their estimates. We illustrate this algorithm via pricing a barrier caplet, barrier trigger swap and barrier swaption.
    Date: 2012–11

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