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on Risk Management |
| By: | Jan Pieter Krahnen; Christian Wilde |
| Abstract: | This paper analyzes the risk properties of typical asset-backed securities (ABS), like CDOs or MBS, relying on a model with both macroeconomic and idiosyncratic components. The examined properties include expected loss, loss given default, and macro factor dependencies. Using a two-dimensional loss decomposition as a new metric, the risk properties of individual ABS tranches can directly be compared to those of corporate bonds, within and across rating classes. By applying Monte Carlo Simulation, we find that the risk properties of ABS differ significantly and systematically from those of straight bonds with the same rating. In particular, loss given default, the sensitivities to macroeconomic risk, and model risk differ greatly between instruments. Our findings have implications for understanding the credit crisis and for policy making. On an economic level, our analysis suggests a new explanation for the observed rating inflation in structured finance markets during the pre-crisis period 2004-2007. On a policy level, our findings call for a termination of the 'one-size-fits-all' approach to the rating methodology for fixed income instruments, requiring an own rating methodology for structured finance instruments. |
| Keywords: | credit risk, risk transfer, systematic risk |
| JEL: | G21 G28 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:fra:franaf:203&r=rmg |
| By: | O. DE JONGHE |
| Abstract: | This paper analyzes the relationship between banks’ divergent strategies toward specialization and diversification of financial activities and their ability to withstand a banking sector crash. We first generate market-based measures of banks’ systemic risk exposures using extreme value analysis. Systemic banking risk is measured as the tail beta, which equals the probability of a sharp decline in a bank’s stock price conditional on a crash in a banking index. Subsequently, the impact of (the correlation between) interest income and the components of non-interest income on this risk measure is assessed. The heterogeneity in extreme bank risk is attributed to differences in the scope of non-traditional banking activities: non-interest generating activities increase banks’ tail beta. In addition, smaller banks and better-capitalized banks are better able to withstand extremely adverse conditions. These relationships are stronger during turbulent times compared to normal economic conditions. Overall, diversifying financial activities under one umbrella institution does not improve banking system stability, which may explain why financial conglomerates trade at a discount. |
| Keywords: | diversification, non-interest income, financial conglomerates, banking stability, extreme value analysis, tail risk |
| JEL: | G12 G21 G28 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:09/579&r=rmg |
| By: | Judit Montoriol-Garriga; Evan Sekeris |
| Abstract: | The current financial crisis has given rise to a new type of bank run, one that affects both the banks' assets and liabilities. In this paper we combine information from the commercial paper market with loan level data from the Survey of Terms of Business Loans to show that during the 2007-2008 financial crises banks suffered a run on credit lines. First, as in previous crises, we find an increase in the usage of credit lines as commercial spreads widen, especially among the lowest quality firms. Second, as the crises deepened, firms drew down their credit lines out of fear that the weakened health of their financial institution might affect the availability of the funds going forward. In particular, we show that these precautionary draw-downs are strongly correlated with the perceived default risk of their bank. Finally, we conclude that these runs on credit lines have weakened banks further, curtailing their ability to effectively fulfill their role as financial intermediaries. |
| Keywords: | Bank assets ; Bank liabilities ; Financial crises ; Commercial credit |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbqu:qau09-4&r=rmg |
| By: | Andrea Beltratti; René M. Stulz |
| Abstract: | Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities. |
| JEL: | G15 G18 G21 G32 G34 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15180&r=rmg |
| By: | Frank Partnoy (University of San Diego School of Law) |
| Abstract: | The first part of the paper describes how over time credit rating agencies ceased to play the role of information intermediaries. Rating agencies did not provide information about the risk associated with the securitized instruments, but they simply enabled structurers to create and maintain tranches of these instruments with unjustifiably high credit ratings. The second part of the paper suggests how future policy may minimize overdependence on credit ratings, by removing regulatory licences and by implementing shock-therapy mechanisms to wean investors simple rating mnemonics. |
| Keywords: | Rating Agencies, Subprime Mortgages, Securitization |
| JEL: | G24 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:fem:femwpa:2009.27&r=rmg |
| By: | Michel Aglietta; Laurence Scialom |
| Abstract: | The global financial crisis has pinpointed the relevance and the virulence of systemic risk in modern innovative finance. It is grounded in the propensity of credit markets to drift to extremes in close correlation with asset price spikes and slumps. In turn, such a propensity is nurtured by the heuristic behaviour of market participants under severe uncertainty. While plagued by disaster myopia, market participants spread systemic risk. Such adverse conditions have been magnified by financial innovations that have made finance predatory and capable of capturing regulators to annihilate prudential policies. Malfunctioning in finance is so deep and disorders are so widespread that sweeping reforms are the order of the day, if financial stability is viewed as a primary public concern. In this paper we argue that macro prudential policy should be the linchpin of relevant reforms. Being a top-down approach, it impinges both upon monetary policy and micro prudential policy. Central banks should pursue a dual objective of price and financial stability. Bank supervisors should broaden their oversight on a much larger perimeter, encompassing all systematically important institutions. Counter cyclical capital provisions should be required and linked to the control of aggregate credit supply. Leveraged institutions without deposit base should be subject to incentives for a much stricter liquidity management. To stem regulatory capture, prompt corrective action should be enlarged in its scope and adapted to mark-to-market financial intermediaries. Implementing macro prudential policy entails institutional changes. Central banks, bank supervisors and other financial regulators need to work much closer than beforehand, because the spread of systemic risk is not deterred by institutional and geographical frontiers. The changes to make are particularly stringent in Europe, where national parochialism makes the resolution of orderly cross-border bank crisis all but impossible. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2009-29&r=rmg |
| By: | W. LAURIER; G. POELS |
| Abstract: | This paper provides an ontology-based set of Petri-nets for simulating the effect of business process changes on an organisation’s liquidity, and demonstrates that certain types of business process redesign can increase or reduce the amount of external funding that is required to prevent an organisation from defaulting on its debt. This debt defaulting may lead to proliferating liquidity constraints for subsequent supply chain partners. Consequently, this paper provides a proper toolkit for assessing and mitigating the propagation of liquidity constraints in supply chains. The paper uses the accounting-based Resource-Event-Agent ontology to create workflow patterns for modelling exchanges between supply chain partners and for the value chains that represent an organisation’s internal processes. Both the exchange and internal processes continuously convert money into resources and vice versa. These models for money to resource and resource to money conversions are then used for constructing supply chain models for liquidity modelling and analysis. |
| Keywords: | Resource-Event-Agent ontology, Petri-net, Simulation, Business Process Management, Workflow Model, Business Performance, Liquidity |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:09/574&r=rmg |