MARKET DISCIPLINING OF THE DEVELOPING COUNTRIES' SOVEREIGN GOVERNMENTS

In this article, we contribute to the current literature on market disciplining of the sovereign governments of the developing countries by distinguishing both sides of the market discipline hypothesis by adopting three‐stage least square estimation to incorporate the contemporaneous feedback effects between primary structural budget balances and the country's default‐risk premiums. We provide empirical evidence of a unidirectional causal relationship between a country's default‐risk premium and primary structural budget balances with the direction flowing from primary structural budget balances to country's risk premium in 40 developing countries over the period 1975–2008. We also employ the Arellano‐Bond dynamic panel generalized methods of moments estimation to control for this joint determination of primary structural budget balances and the country's default‐risk premium, and find supportive evidence of undisciplined sovereign governments and of nonlinearly behaving well‐functioning financial markets in the sample countries. (JEL C5, G1, G3)     

BANK COMPETITION AND FINANCIAL STABILITY: LIQUIDITY RISK PERSPECTIVE

We study whether competition affects banks' liquidity risk‐taking, which was at the heart of the 2008 financial crisis. We find that banks with greater market power take more liquidity risk, implying that decreased competition leads to financial fragility. During a financial crisis, however, the effect of market power on liquidity risk varies across bank size. Small banks with greater market power reduce liquidity risk while large banks with greater market power do not change their liquidity risk‐taking behavior. This suggests that enhanced charter values due to reduced competition lowers small banks' risk‐shifting incentives when their default risk significantly increases during a crisis. (JEL G21, G28)     

Measuring and Optimizing Portfolio Credit Risk: A Copula‐based Approach*

In this work, we present a methodology for measuring and optimizing the credit risk of a loan portfolio taking into account the non‐normality of the credit loss distribution. In particular, we aim at modelling accurately joint default events for credit assets. In order to achieve this goal, we build the loss distribution of the loan portfolio by Monte Carlo simulation. The times until default of each obligor in portfolio are simulated following a copula‐based approach. In particular, we study four different types of dependence structure for the credit assets in portfolio: the Gaussian copula, the Student's t‐copula, the grouped t‐copula and the Clayton n‐copula (or Cook–Johnson copula). Our aim is to assess the impact of each type of copula on the value of different portfolio risk measures, such as expected loss, maximum loss, credit value at risk and expected shortfall. In addition, we want to verify whether and how the optimal portfolio composition may change utilizing various types of copula for describing the default dependence structure. In order to optimize portfolio credit risk, we minimize the conditional value at risk, a risk measure both relevant and tractable, by solving a simple linear programming problem subject to the traditional constraints of balance, portfolio expected return and trading. The outcomes, in terms of optimal portfolio compositions, obtained assuming different default dependence structures are compared with each other. The solution of the risk minimization problem may suggest us how to restructure the inefficient loan portfolios in order to obtain their best risk/return profile. In the absence of a developed secondary market for loans, we may follow the investment strategies indicated by the solution vector by utilizing credit default swaps.     

Fire sales by euro area banks and funds: What is their asset price impact?

The assets under management of investment funds have soared in recent years, triggering a debate on their possible implications for financial stability. We contribute to this debate assessing the asset price impact of fire sales in a novel partial equilibrium model of euro area funds and banks calibrated over the period between 2008 and 2017. An initial shock to yields causes funds to sell assets to address investor redemptions, while both banks and funds sell assets to keep their leverage constant. These fire sales generate second-round price effects. We find that the potential losses due to the price impact of fire sales have decreased over time for the system. The contribution of funds to this impact is lower than that of banks. However, funds’ relative contribution has risen due to their increased assets under management and banks’ lower leverage and rebalancing towards loans. Should this trend continue, funds will become an increasingly important source of systemic risk.     

DETERMINANTS OF FINANCIAL DISTRESS IN LARGE FINANCIAL INSTITUTIONS: EVIDENCE FROM U.S. BANK HOLDING COMPANIES

We investigate determinants of financial distress in large financial institutions based on the Distance‐to‐Default and Z‐Scores measures. Using data of U.S. bank holding companies (BHCs), we find that the housing price index is a consistently significant factor across all BHCs and the non‐performing loan ratio is the most powerful indicator for financial distress. Short‐term wholesale funding is also a reliable default risk indicator. We additionally find that all the three regulatory capital requirements are very important for controlling default risk, particularly in the post‐crisis period. (JEL C53, G14, G21, G28)     

TROUGH TO PEAK: A NOTE ON RISK‐TAKING IN THE PACIFIC NORTHWEST'S BANKING SECTOR, 2001–2007

Using a cohort of 157 Federal Deposit Insurance Corporation insured banks based in the Pacific Northwest, this paper examines regional bank risk‐taking over the 2001–2007 economic expansion. The focus is on on‐balance sheet assets that carry a 100% risk weighting in the calculation of regulatory capital ratios. This study finds that Pacific Northwest banks significantly increased their share of 100% risk‐weighted assets between 2001 and 2007, largely through commercial real estate lending. Asset size, market concentration, age, metropolitan statistical area‐location, and balance sheet capacity for risk‐taking are statistically significant predictors of the change in the share of 100% risk‐weighted assets over the period of interest. (JEL G21, R11)     

Acquisition of Information and Share Prices: An Empirical Investigation of Cognitive Dissonance

Abstract. This paper deals with the determinants of agents' acquisition of information. Our econometric evidence shows that the general index of Italian share‐prices and the series of Italy's financial newspaper sales are cointegrated, and the former series Granger‐causes the latter, thereby giving support to the cognitive dissonance hypothesis: (non‐professional) agents tend to buy the newspaper when share prices are high and not to buy it when share prices are low. Instead, we do not find support for the hypothesis that the agents acquire information in order to trade in the stock market: we find no relationship between quantities exchanged in the market and newspaper sales, nor between stock market volatility and newspaper sales.     

EFFECTS OF THE SUNDAY SHOPPING RESTRICTION IN KOREA

We examine the effectiveness of Korea's Sunday superstore shopping regulation, whose purpose is to protect small‐ and medium‐sized retailers as well as traditional markets. Applying a two‐way random‐effects regression model to the daily sales data of four megastores and four super supermarkets, we find the net sales decrease of superstores is on average 5.61% of daily sales after taking into account sales increases due to consumers' switching to weekdays. Only about 17%–19% of the reduced superstore sales are transferred to traditional markets. Based on these estimates, the compensating variation per year is predicted to be 2.4–2.5 trillion Korean won (around US $2.1–2.2 billion). (JEL L51, L88)     

Collateral rehypothecation,safe asset scarcity,and unconventional monetary policy

We build a mark-to-market model where commercial banks can enlarge their balance sheets, repledging the available collateral several times to exchange liquidity through the interbank market. In bad times, the fall of risky asset price disrupts the length of the repledging chain due to the increase of the haircut and the decrease of external assets' value. In such a scenario, the central bank can intervene implementing unconventional monetary policies by purchasing a fraction of the banking system's external assets, both safe treasury bonds, and risky asset-backed securities, to inject liquidity. Our results show that a quantitative easing policy that purchases only safe assets is highly ineffective in restoring the intermediation activity to the pre-crisis level due to its inability to sustain the risky asset price and the repledging chain of collateral. Instead, focusing on risky assets only, the monetary authority can sustain risky asset prices, avoiding the freezing of the money market.     

DO PSYCHOLOGICAL SHOCKS AFFECT FINANCIAL RISK TAKING BEHAVIOR? A STUDY OF U.S. VETERANS

Traditional economic theories assume that individuals are endowed with certain risk preferences that are unaltered by experiences. However, recent evidence indicates that macroeconomic shocks do have an effect on an individual's willingness to take financial risks. In the context of investment decisions, we examine empirically whether an individual's risk preferences are affected by other types of traumatic life experiences. Using a unique proprietary data set, we investigate whether personal traumatic experiences—such as the combat experiences of veterans—have long‐term effects on financial risk‐taking behavior. We find that having experienced combat decreases the probability of investing in risky assets. Key policy implications are noted. (JEL G11, D14)     

Sovereign Default Risk and Recovery Rates: What Government Bond Markets Expect for Greece

Bond market data on sovereign bond yields is used to estimate sovereign default risk and the amount of the expected “hair‐cut” for Greece between 2008 and 2011. Using a structural pricing model that relies on compound option theory short‐term and long‐term default probabilities and their dependencies can be inferred. Thereby bond yield spreads for different maturities are integrated. In addition, a reduced form model is applied to infer the recovery rate expected by bond market participants. The paper shows that sovereign default risk and recovery rate dynamics reflect events that are important for Greece's repayment capacity.     

Tipping the (Im)balance: Capital inflows,financial market structure,and banking crises

An emerging consensus among scholars and policy‐makers identifies foreign capital inflows as one of the primary determinants of banking crises in developed countries. We challenge this view by arguing that external imbalances are destabilizing only when banks face substantial competition from securities markets in the process of financial intermediation. We assemble a dataset of banking crises covering the advanced industrialized countries from 1976 to 2011 and find evidence of a conditional relationship between capital inflows, a well‐developed securities market, and the incidence of banking crises. We further explore the impact of capital inflows on banks’ actual risk taking as indicated by their capital adequacy levels and measures of insolvency risk. Our results demonstrate that prudential capital cushions tend to decline with the combination of capital inflows and prominent securities markets. We highlight the political decisions—often made during the early days of a country's financial development—that determine the relative prominence of banks vs. non‐bank financial institutions and conclude with policy recommendations.     

PARTICIPATION IN WORKPLACE EMPLOYER‐SPONSORED TRAINING IN CANADA: ROLE OF FIRM CHARACTERISTICS AND WORKER ATTRIBUTES

In this work, we study the role of firm characteristics and worker attributes in determining participation in workplace employer‐sponsored training in Canada using the Workplace and Employee Survey (WES) of Statistics Canada. We attempt to answer the following questions using the rich information of firms that are available in WES data: Does firms' provision of workplace training encourage workers' participation in Canada? How do changes in market competition, organizational changes, and technological innovation affect workers' participation in workplace training in Canada? We find that firms' training provision significantly affects workers' participation in Canada. We also find that increased international competition, organizational changes, and technological innovation are significantly correlated with workers' training participation at workplaces. We note that workers in some sectors and in smaller firms have lower workplace training incidence and older, part‐time, production and marketing/sales workers and workers with preschool children participate less in workplace training. (JEL J080, J240, J290)     

Non‐Neutrality of the Proposed Resource Super Profits Tax

I explain my disagreement with Professor Lund regarding the non‐neutrality of the proposed Resource Super Profits Tax. I find that, when assets are sold by a firm to another firm or when an exit decision is made between shutting down or selling the project, that distortions from the Resource Super Profits Tax occur. Previous analysis of cash flow taxes did not analyse the effects of assets sales under uncertainty.     

Risk Diversification on the Polish Capital Market

The basics of portfolio management theory and methods of efficient selection of assets and their financing have been created by Markowitz and Sharpe. They propose that risk diversification consists, generally speaking, of the increase in the number of securities in a portfolio. So, authors try to answer the question of how many securities have to be bought on a given market to assure a well-diversified portfolio, where the increase in the number of securities does not lead to a significant decrease in portfolio risk. To evaluate such a purpose on the Polish capital market, 20 companies were surveyed that are included in the WIG20 index in the period January 2–October 10, 2001. The returns were estimated on a weekly basis. The research shows that a portfolio of securities constructed, according to the Sharpe Model, has a wide application to the Polish capital market.*University of Szczecin—Poland. This paper was presented at the Fifty-Eighth InternationalAtlantic Economic Conference, October 6Y9, 2005, Chicago, U.S.A.     

EFFICIENCY AND BARGAINING POWER IN THE INTERBANK LOAN MARKET

Using detailed transactions‐level data on interbank loans, we examine the efficiency of an overnight interbank lending market and the bargaining power of its participants. Our analysis relies on the equilibrium concept of the core, which imposes a set of no‐arbitrage conditions on trades in the market. For Canada's Large Value Transfer System, we show that although the market is fairly efficient, systemic inefficiency persists throughout our sample. The level of inefficiency matches distinct phases of both the Bank of Canada's operations as well as phases of the 2007–8 financial crisis. We find that bargaining power tilted sharply toward borrowers as the financial crisis progressed and (surprisingly) toward riskier borrowers.     

Corporate Debt,Hybrid Securities,and the Effective Tax Rate

Effective tax rates (ETRs) are useful tools to make comparisons between different tax systems. However, the existing ETR measures are based on rather simplifying assumptions. In particular, they disregard the existence of different kinds of debt and hybrid securities. In this paper, we use contingent‐claim analysis to calculate the ETR. We will therefore deal with both pure debt and two of the most well‐known hybrid securities, that is, convertible and reverse convertible bonds. We will show that effective taxation crucially depends on the characteristics of debt and that the existing measures of ETR can be dramatically biased, since they account neither for default risk nor for the ability to convert debt into equity.     

Investors' Personality Influences Investment Decisions: Experimental Evidence on Extraversion and Neuroticism

The authors analyze the impact of individuals' degree of extraversion and neuroticism on their decision making in an experimental asset market. To establish this link between research on experimental asset markets and social psychology the authors use a unique approach that combines a questionnaire designed to assess individuals' degree of extraversion and neuroticism and an experimental asset market to assess individual financial decision making. The dataset combines 364 undergraduate business students' questionnaire responses and their trading behavior in the asset market. The authors find that extraversion and neuroticism significantly influence individuals' behavior in the experimental asset market. Specifically, more extraverted individuals pay higher prices for financial assets and they buy more financial assets when assets are overpriced than less extraverted individuals do. More neurotic individuals hold less risky assets in their financial portfolios than less neurotic individuals do. Although a large part of the explanatory power appears to be driven by gender differences, the authors still find significant impact of extraversion and neuroticism after controlling for gender effects. The study findings suggest that further research on financial markets could benefit from including personality of market participants as a crucial explanatory factor.     

THE EFFECT OF FORWARD MARKETS ON MULTINATIONAL FIRMS

This paper presents a model of a risk averse multinational firm under exchange rate risk. The firm, which owns and controls assets in two countries, is engaged in production, sales and forward contracting whenever forward markets exist. First, we investigate the effects of exchange rate uncertainty without any risk sharing markets. It is shown that the firm internalizes missing hedging markets by increasing foreign production and lowering foreign sales. Therefore the firm hedges by repatriating foreign profits in the form of goods. Second, the implications of the existence of forward markets of global market decisions are discussed. It is shown that a separation theorem holds. This does not imply that the multinational firm shifts all the risk into the forward exchange market.     

Counterparty effects on capital structure decision in incomplete market

This paper builds a static contingent-claim model that allows for examining the optimal capital structure with the joint arguments of counterparty default risk and market incompleteness. A first-passage-time model with jump default barrier is adopted to capture the counterparty effects on the pricing of defaultable claims. Following the framework of Jarrow and Yu (2001), the jump in primary firm's bankruptcy barrier is designed as the loss on capital resulted from secondary firm's bankruptcy. The relevance of market incompleteness in the context of claim-pricing is considered using “good-deal asset price bound” method by Cochrane and Saa-Requejo (2000). We show that the effects of counterparty's default clearly diminish the uses of debt, which indirectly explains the so-called under-leveraged puzzle. We further find that counterparty effects on capital structure are sensitive to market incompleteness and firm's characteristics, such as tax rate and bankruptcy cost rate.