Towards an early warning system for sovereign defaults leveraging on machine learning methodologies

In this study, we address the topic of credit risk stemming from central governments from a technical point of view. First, we explore various econometric and machine learning techniques to build an enhanced sovereign rating system that effectively differentiates the risk of default among countries. Our empirical results indicate that the machine learning method of XGBOOST has a superior out-of-sample and out-of-time predictive performance. Then, we use the models developed to calibrate a sovereign rating system and provide useful insights into the set-up of a parsimonious early warning system. Our results provide a more concise view of the most robust method for classifying countries’ default risk with significant regulatory implications, given that the efficient assessment of sovereign debt is crucial for effective proactive risk measurement.     

Developing an alert system for local governments in financial crisis

This article presents a new model which will show whether a local authority is heading for financial trouble. The model is simple for national audit bodies to use and provides an early warning of financial tensions allowing corrective action to be taken before there is a crisis.     

Ability of accounting and audit quality variables to predict bank failure during the financial crisis

We examine the ability of selected accounting and audit quality variables measured in a period prior to the financial crisis (i.e., the four quarters of 2006), to predict banks that subsequently failed during the financial crisis. We employ two sets of samples from the US: a troubled banks sample that includes banks that failed in or after 2007 as well as banks classified as being troubled based on profitability, loan quality, and balance sheet position in 2007, and a full sample that includes all banks with available required data. Using the troubled banks sample, we identify six reliable predictors of bank failure: auditor type, auditor industry specialization, Tier 1 capital ratio, proportion of securitized loans, growth in loans, and loan mix. For the larger full sample of banks, we identify the following ten predictors of bank failure: auditor type, Tier 1 capital ratio, proportion of securitized loans, nonperforming loans, loan loss provisions, growth in commercial loans, growth in real estate loans, growth in overall loans, loan mix, and whether the bank is a public bank.     

Research on optimization of an enterprise financial risk early warning method based on the DS-RF model

The financial risk early warning process of enterprises faces problems such as uncertainty and complexity. In the big data environment, scholars and enterprises that continue to use traditional evaluation methods will face large challenges. It is essential for an enterprise's sustainable operation to combine artificial intelligence algorithms, dynamically monitor its financial risks, and carry out financial risk early warning processes accurately and effectively. This study proposes an early warning method for corporate financial risks based on the evidence theory-random forest (DS-RF) model. The classic algorithm of machine learning—random forest was introduced into the framework of evidence theory to construct a random forest model with four dimensions: profitability, asset quality, debt risk, and operating growth. While predicting the risk, the credibility of the evidence was determined, and then the D-S synthesis rule was used for information fusion. An example was analyzed, taking JS Reclamation Group as the study subject. The comparison with the early warning results of the random forest algorithm and the traditional model shows that the DS-RF model proposed in this paper has a higher early warning accuracy and the results are presented more comprehensively and systematically, which effectively improves the efficiency of enterprise financial risk early warning and helps managers to make relevant decisions efficiently and scientifically.     

Avocent集中管理解决方案助金融企业在危机中前行

随着金融业数据中心建设的升级,新旧IT基础设施及虚实系统并存,而且传统分散式管理的IT系统为金融企业带来了高昂的运维成本。如何从本地分散管理转变为远程集中管理,通过一间总控室完成对数据中心机房内所有服务器和网络设备的管理,以满足运维人员和业务人员对服务器访问、操作、信息收集等方面的不同需求,保障金融业务的连续和稳定,是当前金融危机环境下金融企业的迫切需求。     

The regulatory response to the financial crisis

There are numerous aspects concerning financial regulation which the current financial turmoil has high-lighted. These include: (1) the form of deposit insurance; (2) bank solvency regimes, ‘prompt corrective action’; (3) Central Banks’ money market operations; (4) commercial bank liquidity risk management; (5) procyclicality of CARs (and mark-to-market); lack of counter-cyclical instruments; (5) boundaries of regulation, conduits, SIVs and reputational risk; (6) crisis management: (a) within countries, e.g. UK Tripartite Committee; or (b) cross-border, how to allocate the burden of cross-border defaults? This paper describes how the crisis exposed regulatory failings, drawing largely on UK experience, and suggests remedies.     

应对金融危机,有关对策的特别关注与特别说法

全国人民代表大会一年一度例会,但今年的十一届全国人大二次会议是在金融危机的背景下召开的,因此聚焦了来自世界各地的关切目光.海内外媒体希望通过"两会"在更深的层面上获得中国政府应对金融危机对策的解读.3月13日中国总理温家宝在中外记者招待会上,阐述了中国政府应对国际金融危机的政策,表示在必要时将推出新的刺激经济政策,提振了国入的信心.     

金融系统紧耦合，风险互动与国际金融危机

现代金融危机破坏性之所以越来越强烈,一个重要的原因是金融市场的复杂性和紧耦合度越来越高,由此导致各类风险的相互作用、相互加强,并最终导致系统风险的形成。该文基于工程学视角描述了这一机制的演变过程及其在此次国际金融危机中的表现,并提出松弛金融系统紧耦合性的相应建议。     

The ADR shadow exchange rate as an early warning indicator for currency crises

We develop an indicator for currency crisis risk using price spreads between American Depositary Receipts (ADRs) and their underlyings. This risk measure represents the mean exchange rate ADR investors expect after a potential currency crisis or realignment. It makes crisis prediction possible on a daily basis as depreciation expectations are reflected in ADR market prices. Using daily data, we analyze the impact of several risk drivers related to standard currency crisis theories and find that ADR investors perceive higher currency crisis risk when export commodity prices fall, trading partners’ currencies depreciate, sovereign yield spreads increase, or interest rate spreads widen.     

Financial controller turnover: An early warning sign of deteriorating financial reporting quality

This study examines the relation between financial controller turnover and public firms’ financial reporting quality. Exploiting a special institutional setting in China, where financial controllers along with CEOs and CFOs are required to attest to the accuracy and completeness of firms’ annual reports, we find that: (a) financial controller turnover is negatively associated with financial reporting quality, (b) the negative relation between financial controller turnover and financial reporting quality is more pronounced in non-state-owned enterprises, in firms with weaker corporate governance, and in areas with higher regulatory enforcement intensity, and (c) financial controller turnover is not related to real earnings management. Further analyses show that financial controller turnover is associated with the incidence of subsequent financial report restatements and enforcement actions by the China Securities Regulatory Commission (CSRC). Financial controller turnover also precedes top executive turnover and can be viewed as an early warning sign of deteriorating financial reporting quality. Such information content is incremental to that of top executive turnover. Our analyses also show that firms with financial controller turnover have higher initial stock returns but underperform their counterparts in the long run.     

An early warning indicator system to monitor the unsecured interbank funds market

A core goal of regulators and financial authorities is to understand how market prices convey information on the financial health of its participants. From this viewpoint we build an Early-Warning Indicators System (EWIS) that allows for identifying those financial institutions perceived as risky counterparts by the participants of the interbank market. We use micro-level data from bilateral overnight unsecured loans performed in the interbank market between January 2011 and December 2014. The EWIS identifies those participants that systematically pay high prices for liquidity in this market. We employ coverage tests to estimate EWIS’ robustness and consistency. We find that financial institutions with an elevated frequency of signals tend to exhibit a net borrower liquidity position in the interbank market, hence suggesting they are facing recurrent liquidity needs. Those institutions also exhibit higher probability of insolvency measured by the Z-score indicator. Thus, our results support the existence of market discipline based on peer-monitoring. Overall, the EWIS may assist financial authorities in focusing their attention and resources on those financial institutions perceived by the market as those closer to distress.     

Resilience to the financial crisis in customer-supplier networks

Inspired by the Capital Asset Pricing Model (CAPM) beta, we construct customer and supplier betas to separately investigate potentially different properties of downstream and upstream linkages. With the adjacency matrix acting as a ‘filter’ to extract each company's return covariances with its trading partners, the cross-sectional dependence contained in the customer-supplier network is summarized by our betas. We explore how these two betas are related to a company's resilience to the financial crisis of 2008–2009. We observe that a higher customer beta is generally associated with more resilience during the crisis. Therefore, investors could construct the customer beta to gain insights into the relative negative impact of a potential crisis on a stock's performance.     

Monitoring the future. Building an early warning system for the Dutch Ministry of Justice

To determine the sustainability of the policy, an Early Warning System (EWS) has been developed for the Dutch Ministry of Justice. An EWS is used to monitor various developments and to place them within the perspective of future scenarios. Without actually predicting the future, this makes it possible to determine which scenario is the most relevant at any given moment, allowing the department to adapt its policies. Regular modifications to the EWS make it possible to monitor in the direction of which scenario society appears to be moving. This creates a path to the future with which the sustainability of (new) policies can be tested periodically.     

Responses by Australian auditors to the global financial crisis

We examine the impact of the global financial crisis (GFC) on auditor behaviour in Australia. Using a sample of listed companies, we examine whether the GFC impacted the propensity of auditors to issue going concern modifications and increased audit effort as reflected in audit fees and audit reporting lag. Controlling for client characteristics, we find an increase in the propensity to issue going concern opinions during the period 2008–2009 compared with the period 2005–2007 and that Big N auditors responded to the GFC earlier than non‐Big N auditors. In relation to audit effort, we find evidence of increased audit fees during the period 2008–2009 compared with the period 2005–2007. There is, however, no evidence of increased audit reporting lags during the GFC.     

Global financial crisis: The challenge to accounting research

Accounting practices are deeply implicated in the current financial crisis and in proposals for recapitalizing financial institutions and restoring stability to the global financial system. This essay discusses the methodological and theoretical gaps in accounting research that explain our failure to anticipate the crisis and limit our ability to analyze and respond to it.     

Has the financial system become safer after the crisis? The changing nature of financial institution risk

Six years after the collapse of Lehman Brothers, the question of whether the U.S. financial system has become less risky remains unanswered. On the one side, new regulations including Dodd-Frank and Basel III have made improvements by requiring higher bank capital, and financial institutions themselves have reduced risk-taking activities. On the other side, it has been argued that “the fundamental risks remained and the efforts of regulators and politicians were simply rearranging the deckchairs on the Titanic.” (Baily and Elliott, 2013) This paper highlights the changing nature of financial institution risk from 2005 to 2011. It finds that while these institutions have become less risky individually after the crisis, the financial market has become more vulnerable to systemic contagion. The causal inference that the crisis and the post-crisis legislation have gradually changed the nature of financial institution risk is drawn from a quasi-experimental design. This finding suggests that the ever more integrated financial system might experience more synchronized contractions in future crises, providing empirical support for the proposals of the inter-bank collective regulation of banks by Acharya (2009) in addition to the intra-bank collective regulations as in Froot and Stein (1998) and BIS (1996, 1999).     

SAFE: An early warning system for systemic banking risk

This paper builds on existing microprudential and macroprudential early warning systems (EWSs) to develop a new, hybrid class of models for systemic risk that incorporates the structural characteristics of the financial system and a feedback amplification mechanism. The models explain financial stress using both public and proprietary supervisory data from systemically important institutions, regressing institutional imbalances using an optimal lag method. The Systemic Assessment of Financial Environment (SAFE) EWS monitors microprudential information from the largest bank holding companies to anticipate the buildup of macroeconomic stresses in the financial markets. To mitigate inherent uncertainty, SAFE develops a set of medium-term forecasting specifications that gives policymakers enough time to take ex-ante policy action and a set of short-term forecasting specifications for verification and adjustment of supervisory actions. This paper highlights the application of these models to stress testing and policy.     

Access to capital,investment, and the financial crisis

During the recent financial crisis, corporate borrowing and capital expenditures fall sharply. Most existing research links the two phenomena by arguing that a shock to bank lending (or, more generally, to the corporate credit supply) caused a reduction in capital expenditures. The economic significance of this causal link is tenuous, as we find that (1) bank-dependent firms do not decrease capital expenditures more than matching firms in the first year of the crisis or in the two quarters after Lehman Brother's bankruptcy; (2) firms that are unlevered before the crisis decrease capital expenditures during the crisis as much as matching firms and, proportionately, more than highly levered firms; (3) the decrease in net debt issuance for bank-dependent firms is not greater than for matching firms; (4) the average cumulative decrease in net equity issuance is more than twice the average decrease in net debt issuance from the start of the crisis through March 2009; and (5) bank-dependent firms hoard cash during the crisis compared with unlevered firms.