Insolvency regimes and firms' default risk under economic uncertainty and shocks

One of the arguments often advanced for implementing a stronger insolvency and bankruptcy framework is that it enhances credit discipline among firms. Using a large cross-country firm-level dataset, we empirically test whether a stronger insolvency regime reduces firms' likelihood of defaulting on their debt. In particular, we examine whether it reduces default risk during increased economic uncertainty and various external shocks. Our results confirm that a stronger insolvency regime moderates the adverse effects of economic shocks on firms' default risk. The effects are more pronounced for firms in the top half of the size distribution. We also explore channels through which improved creditor rights influence firms' default risk, including dependence on external finance, corporate leverage, and managerial ethics. Our main results are robust to an alternative measure of default risk, inclusion of currency and sovereign debt crisis episodes, and alternative estimations.     

Decomposing financial (in)stability in emerging economies

The analysis of the build-up of risks in emerging economies have traditionally been scarce and focused mostly on external risks, despite the recent substantial development of their financial system. This paper builds an index of financial vulnerabilities tailored to emerging economies, grouping 32 indicators around four poles: valuation and risk appetite, imbalances in the non-financial sector, financial sector vulnerabilities, and global vulnerabilities. It adopts a model-free approach, purposely departing from early warning models or complex econometric constructs, and rely on data made already available by international organisations. Our index of financial vulnerabilities enables a granular mapping of where risk originates and how it spreads to other parts of the financial system. Using various data visualisation tools and benefitting from the flexibility of our index’s methodology, we are able build a narrative of the evolution of financial stability in emerging economies from 2005 to 2015. Finally, we also discuss the relation between our index and both the business cycle (proxied by GDP) and the credit cycle (proxied by the credit-to-GDP gap).     

Interenterprise Credit and Adjustment during Financial Crises: The Role of Firm Size

Small and medium‐sized enterprises (SMEs) suffered a sharp contraction in their borrowing from banks during the Great Recession. Analyzing a large firm‐level database for European countries, the paper shows that trade credit amplified the liquidity squeeze on SMEs, with adverse effects on their real activity. SMEs sharply increased their net trade credit and thus transferred financial resources to larger firms. Given the large weight of SMEs in the economy of European countries, the liquidity squeeze of SMEs likely contributed to the depth of the output fall and the slow recovery in Europe during the Great Recession.     

Political booms and currency crises

This paper shows evidence that political booms, defined as the rise in governments’ popularity, are associated with a higher likelihood of currency crises. The reasoning behind this finding is that prudent economic policies to address underlying weaknesses in the economy may be political costly for incumbent governments in the short-term. Hence, popularity-concerned governments may not have enough incentives to take such corrective actions in a timely manner. This approach, in turn, can deteriorate economic fundamentals and increase related risks in the economy which can eventually lead to crises. This paper sheds light on this phenomenon in the case of currency crises, suggesting that currency crises can be viewed as “political booms gone bust” events. Moreover, it finds that higher international reserves, higher exports, and a higher degree of financial openness alleviate the effect of political booms on currency crises.     

Failure to learn from failure: The 2008 mortgage crisis as a déjà vu of the mortgage meltdown of 1994

This article traces the developments in the market for residential mortgage-backed securities (MBS) during the period 1970–2008. Drawing on an analysis of trade publications, business press, and interviews with practitioners, it shows that an MBS market meltdown in 1994 provided clear signals of problems with MBS. The market participants did not re-evaluate their use of risk management tools or adjust security design in response to the 1994 crisis, suggesting a lack of understanding of the implications of the crisis. The 1994 meltdown showed that MBS were vulnerable to systematic risks and that these risks could precipitate an MBS market crash. Furthermore, the 1994 meltdown demonstrated that large-scale investment in MBS could affect the primary mortgage market, thereby rendering the MBS risks unpredictable. After 1994, MBS investment shifted to MBS backed by mortgages with default risk – a development that led to the crash of 2008. By drawing parallels between the 1994 and 2008 crises, this article shows how the MBS market failed to self-correct. The results suggest that financial market participants do not always incorporate relevant information in their decision-making and that market participants have difficulties in both foreseeing the effect of financial innovations on markets and interpreting these effects.     

Dynamic risk spillovers and portfolio risk management between precious metals and global foreign exchange markets

This study examines portfolio management and risk spillovers between four major precious metals (gold, silver, palladium and platinum) and 20 important U.S. exchange markets. To this end, we employ the multivariate DECO-GARCH model and the spillover index developed by Diebold and Yilmaz (2014, 2016) to examine the spillovers between those metal prices and the exchange rates and design portfolios and hedging strategies using different risk measures. The results show evidence of weak average conditional equicorrelations among the considered markets over time, excluding the turbulent 2008–2010 period. Furthermore, the precious metals (excluding platinum) and the currencies (with the exception of the Australian, Brazilian, Denmark, Euro, Mexican, Norwegian, New Zealand and Swedish currencies) are net receivers of shocks. Finally, the four precious metals provide strong risk and downside risk reductions, underscoring the usefulness of including precious metals in a traditional foreign exchange-dominated portfolio.     

On the predictability of the distribution of excess returns in currency markets

This paper investigates the predictability of foreign exchange (FX) volatility and liquidity risk factors on returns to the carry trade, an investment strategy that borrows in currencies with low interest rates and invests in currencies with high interest rates. Previous studies have suggested that this predictability could have been spuriously accounted for due to the persistence of the predictors. The analysis uses a predictive quantile regression model developed by Lee (2016) that allows for persistent predictors. We find that predictability changes remarkably across the entire distribution of currency excess returns. Predictability weakens substantially in the left tail once persistence is accounted for, implying a moderate negative predictive relation between FX volatility risk and carry trade returns. By contrast, it becomes stronger in the right tail. Furthermore, we provide evidence that FX volatility risk still dominates liquidity risk after controlling for persistence. These findings suggest that the persistence of the predictors needs to be taken into account when one measures predictability in currency markets. Finally, out-of-sample forecast performance is also presented.     

The South African Financial Cycle and its Relation to Household Deleveraging

This paper considers the extent to which South African households have deleveraged, since the global financial crisis of 2007/2008. We extend the official South African Reserve Bank business cycle methodology to date financial cycles, from which we identify the peaks and troughs of the South African financial cycle going back to 1966. Our composite financial cycle index peaks in April 1974, January 1984 and May 2007; it has bottomed out in July 1979 and February 1999. Thus, we still await the trough. We further compare and contrast the deleveraging process in the current downward phase to the experiences from previous financial cycles. We find that the average period of the financial cycle in South Africa is much longer (approximately 17.3 years) than that of the business cycle (approximately 5.8 years), and that deleveraging has not yet matched the degree of deleveraging seen in previous downward phases. Our results suggest that further deleveraging is necessary, before we can expect to turn the financial corner.     

Does more finance mean more inequality in times of crisis?

Many recent empirical studies show that both banking crises and financial development (FD) play an important role in understanding the dynamics of income inequality (IncI) over the last decades. However, so far no study has investigated the role of FD in the amplification of IncI following banking crises. This paper seeks to address this issue based on a sample of 69 banking crises in 54 countries over the 1977–2013 period. Our analysis suggests that FD is associated with a significant increase in IncI in the aftermath of banking crises. This result is robust to a broad range of alternative specifications and is unaffected by various potential sources of endogeneity. We also show that the relationship between FD and the redistributive consequences of banking crises is not subject to a threshold effect and is stronger for developing countries.     

HUMANITARIAN CRISES AND ADOLESCENT WELL-BEING: KNOWLEDGE,GAPS, AND PROSPECTS

Adolescence constitutes the second and final window of human growth and a period of specific vulnerabilities, such as early pregnancy, early marriage, HIV infection, suicide, violence, alcohol, and drugs. Only a limited body of research investigates the effects of humanitarian crises on the human capital and well-being of adolescents. The evidence focuses on the short-term effects of conflict and, to a lesser extent, natural disasters on education, physical health, and nutrition, but not on mental health. Most analyses examine the situations of individuals exposed in utero and young childhood, but rarely during adolescence. Typically missing are robust empirical identification strategies and estimates on heterogeneous effects across age or gender. The lack of quality data and challenges in defining adolescence, establishing causality, or ensuring ethical research explain the knowledge gaps. Possible ways to expand the evidence base include mixing georeferenced data on individual location with georeferenced data on crises, sharpening quasi-experimental analytical techniques, and reconsidering the current timing of demographic data collection, now spanning 4- or 5-year intervals. The failure to make such adjustments will end by ignoring specific vulnerabilities among adolescents and render sustainable progress in well-being globally, narrowing inequalities, and guaranteeing human rights to all more difficult to achieve.