nep-fmk New Economics Papers
on Financial Markets
Issue of 2013‒11‒14
five papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Regulatory-Compliant Derivatives Pricing is Not Risk-Neutral By Chris Kenyon; Andrew Green
  2. How stressed are banks in the interbank market? By Abbassi, Puriya; Fecht, Falko; Weber, Patrick
  3. Are European sovereign bonds fairly priced? The role of modeling uncertainty By Leo de Haan; Jeroen Hessel; Jan Willem van den End
  4. Credit Rating Agency Announcements and the Eurozone Sovereign Debt Crises By Christopher F. Baum; Margarita Karpava; Dorothea Schäfer; Andreas Stephan
  5. Low Income Countries, Credit Rationing and Debt Relief: Bye bye international financial market? By Marc Raffinot; Baptiste Venet

  1. By: Chris Kenyon; Andrew Green
    Abstract: Regulators clearly believe that derivatives can never be risk free. Regulators have risk preferences and by imposing costly actions on banks they have made derivatives markets incomplete. These actions have idiosyncratic effects, for example the stress period for Market Risk capital is determined at the bank level, not at desk level. Idiosyncratic effects mean that no single measure makes assets and derivatives martingales for all market participants. Hence the market has no risk-neutral measure and Regulatory-compliant derivatives pricing is not risk-neutral. Market participants have idiosyncratic, multiple, risk-neutral measures but the market does not. Practically, we show that derivatives desks leak PnL (profit-and-loss) even with idealized markets providing credit protection contracts and unlimited liquidity facilities (i.e. repos with zero haircuts). This PnL leak means that derivatives desks are inherently risky as they must rely on competitive advantages to price in the costs of their risks. This strictly positive risk level means that Regulatory-required capital must also have strictly positive costs. Hence Regulatory-compliant derivatives markets are incomplete. If we relax our assumptions by permitting haircuts on repos the situation is qualitatively worse because new Regulatory-driven costs (liquidity buffers) enter the picture. These additional funding costs must be met by desks further stressing their business models. One consequence of Regulatory-driven incomplete-market pricing is that the FVA debate is resolved in favor of both sides: academics on principles (pay for risk); and practitioners on practicalities (desks do pay). As a second consequence we identify appropriate exit prices.
    Date: 2013–11
  2. By: Abbassi, Puriya; Fecht, Falko; Weber, Patrick
    Abstract: We use a unique data set that comprises each bank's bids in the Eurosystem's main refinancing operations and its recourse to the LOLR facility (a) to derive banks' willingness-to-pay for liquidity through a one-week repo and (b) to show that a bank's willingness-to-pay is a good indicator for the probability that this bank draws on the LOLR facility. Our results suggest (i) that banks' willingness-to-pay for liquidity indeed reflects refinancing conditions in the interbank market and (ii) that the willingness-to-pay can serve as an early warning indicator for banking distress. --
    Keywords: banks,liquidity,LOLR facility,repos,money markets,frictions
    JEL: D44 E42 E58 G21
    Date: 2013
  3. By: Leo de Haan; Jeroen Hessel; Jan Willem van den End
    Abstract: This paper examines the extent to which large swings of sovereign yields in euro area countries during the sovereign debt crisis can be attributed to fundamentals. We focus on the inherent uncertainty in bond yield models, which is often overlooked in the literature. We show that the outcomes are strongly affected by modeling choices with regard to i) the confidence bands for the model prediction, ii) the assumption whether the model coefficients are similar across countries or not, iii) the sample selection, iv) the inclusion of financial variables and v) the choice of time-varying coefficients. These choices affect the explanatory power of macro fundamentals and the extent of mispricing. We find substantial misalignment compared to fundamentals for Greek yields, in most specifications also for Portugal and Ireland, but for the other EMU countries, including Spain and Italy, the evidence is less clear cut. This calls for modesty in interpreting bond yield models and for cautiousness when using them in policymaking.
    Keywords: Sovereign bond; Interest rate; Risk premium
    JEL: E43 E44 F34 G15
    Date: 2013–10
  4. By: Christopher F. Baum (Boston College; DIW Berlin); Margarita Karpava (MediaCom London); Dorothea Schäfer (DIW Berlin; Jönköping International Business School); Andreas Stephan (Jönköping International Business School; DIW Berlin)
    Abstract: This paper studies the impact of credit rating agency (CRA) announcements on the value of the Euro and the yields of French, Italian, German and Spanish long-term sovereign bonds during the culmination of the Eurozone debt crisis in 2011-2012. The employed GARCH models show that CRA downgrade announcements negatively affected the value of the Euro currency and also increased its volatility. Downgrading increased the yields of French, Italian and Spanish bonds but lowered the German bond's yields, although Germany's rating status was never touched by CRA. There is no evidence for Granger causality from bond yields to rating announcements. We infer from these findings that CRA announcements significantly influenced crisis-time capital allocation in the Eurozone. Their downgradings caused investors to rebalance their portfolios across member countries, out of ailing states' debt into more stable borrowers' securities.
    Keywords: Credit Rating Agencies, Euro Crisis, Sovereign Debt, Euro Exchange Rate
    JEL: G24 G01 G12 G14 E42 E43 E44 F31 F42
    Date: 2013–11–01
  5. By: Marc Raffinot (LEDa, UMR DIAL-Paris-Dauphine); Baptiste Venet (PSL, Université Paris-Dauphine, LEDa, UMR DIAL)
    Abstract: (english) Low Income Countries (LICs) have a very limited access to international financial markets. Since the 90's, LICs have been granted debt relief by bilateral creditors and by international financial institutions. Did those debt relief initiatives send a negative message to the lenders, deterring them to lend to the LICs? For assessing this we use a new extended concessionality rate of financing flows. We assess the impact of debt relief on this concessionality rate implementing a Granger causality test using panel data, a methodology perfected by Hurlin (2004, 2005), Hurlin and Venet (2004) and Dumitrescu and Hurlin (2012). We show that for the 28 LICs of our panel, there is a robust causal relationship from debt relief to the concessionality rate of financing flows (either positive or negative). The reverse causality is also significant, but to a lesser extent. _________________________________ (français) Les pays à faible revenu (PFR) ont un accès très limité au marché financier international. Depuis la fin des années 90, la plupart des PFR ont bénéficié de réductions de dette de la part de leurs créanciers bilatéraux et multilatéraux. Ces réductions de dette ont-elles envoyé un signal négatif aux prêteurs, qui les auraient détournés de prêter à ces pays, ou, au contraire, un message positif d’accroissement de la capacité à rembourser ? Pour analyser ceci, nous utilisons un nouveau taux de concessionalité élargi, et une nouvelle base de données sur les réductions de dette en termes d’encours. Nous effectuons un test de Granger en panel, une méthode mise au point par Hurlin (2004, 2005), Hurlin et Venet (2004) et Dumitrescu et Hurlin (2012). Nous montrons que pour les 28 PFR de notre panel, les réductions de dette ont un impact significatif (positif ou négatif) sur le taux de concessionalité élargie. La causalité inverse est aussi significative, mais dans une moindre mesure.
    Keywords: Debt relief, Low Income countries, Causality in panels, Access to the financial market, concessionality, Réduction de dette, Pays à faible revenu, causalité en panel, accès au marché financier,concessionalité.
    JEL: C23 F34
    Date: 2013–03

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