How well do aggregate prudential ratios identify banking system problems?

Aggregate prudential ratios have become a mainstay of financial stability analysis. But how reliable are these indicators when it comes to distinguishing between strong and weak banking systems? We address this issue by analyzing the performance of aggregate prudential ratios in systemic banking crises, drawing upon a large cross-country dataset. We caution against sole reliance on these indicators, and advocate supplementing them with other tools and techniques. Nonetheless, our findings offer evidence that some of the ratios can help identify systemic banking problems.     

Financial investor sentiment and the boom/bust in oil prices during 2003–2008

From both theoretical and policy perspectives, it is important to understand if financial speculation contributes to the boom/bust in oil prices during 2003–2008. In this paper, we disentangle the effects of financial speculation from those of economic fundamentals by focusing on exogenous changes of financial speculation in oil markets identified by changes in financial investor sentiment. Furthermore, we focus on a quasi-experiment setting, and investigate both sentiment-driven overvaluation of oil prices and subsequent mispricing correction. Our findings suggest that financial speculation might have contributed to the 2003–2008 boom/bust in oil prices.     

Can CoCo-bonds mitigate systemic risk?

After the 2008 financial crisis, the idea of contingent convertible (CoCo) capital was revived as a means to stabilize individual banks, and hence the entire banking system. The purpose of this paper is to empirically test, whether CoCo-bonds indeed improve the stability of the banking system and reduce systemic risk. Using the broadly applied SRISK metric, we obtain contradicting results, which are based on the accounting of the CoCo-bond as debt or equity. This observation is problematic, as CoCo-bonds generally increase the loss-absorbing capacity of a bank. We remedy this shortcoming by proposing an adjustment to the original SRISK formula. Using empirical tests, we show that the undue disparity has been solved by our adjustment, and that CoCo-bonds reduce systemic risk, irrespective of their accounting. Our results are robust to different parametrizations and accounting standards, as well as issuance effects.     

Can unpredictable risk exposure be priced?

We study the link between beta predictability and the price of risk. An investor who desires exposure to a certain risk factor needs to predict what next period’s beta will be. We use a simple model to show that an ambiguity averse agent’s demand is lower when betas are hard to predict, leading to a reduction in risk premiums. We test the implications for downside betas and VIX betas. We find that they have economically and statistically small prices of risk once we account for the fact that an investor cannot observe ex-post realized betas when determining asset demand.     

Can we control health care costs?

The health care system will never go bankrupt, the author of this article asserts. But the expense of maintaining it is putting such a strain on our resources that bankruptcy sometimes seems not so far off. The controls and devices we use, like certificate-of-need requirements and health management organizations, obviously have not slowed the rise in costs. We need to focus our attention on three elements in the picture that can do the most about curbing expenditures: the health care administrator, the physician, and the business organization (the labor union as well as the corporation). The author offers suggestions for action from these quarters.     

Credit risk and the business cycle: What do we know?

We perform a meta-regression analysis to characterize the relationship between ex post credit risk, measured through non-performing loans and real GDP growth. Although the prior empirical literature reveals a statistically significant inverse association, the precise effect of growth performance to credit quality diverges and remains subject to several qualifications. Using estimates from 56 studies and applying a Bayesian meta-regression analysis we explore the systematic patterns of the heterogeneity in the reported estimates. According to our evidence, the specification form as well as features related to the type of data, and the sample period are factors that systematically influence the estimated results.     

Is it real? Can we win? Is it worth doing? Managing risk and reward in an innovation portfolio

Minor innovations make up most of a company's development portfolio, on average, but they never generate the growth companies seek. The solution, says Day--the Geoffrey T. Boisi Professor of Marketing and a codirector of the Mack Center for Technological Innovation at Wharton--is for companies to undertake a systematic, disciplined review of their innovation portfolios and increase the number of major innovations at an acceptable level of risk. Two tools can help them do this. The first, called the risk matrix, graphically reveals the distribution of risk across a company's entire innovation portfolio. The matrix allows companies to estimate each project's probability of success or failure, based on how big a stretch it is for the firm to undertake. The less familiar the product or technology and the intended market, the higher the risk. The second tool, dubbed the R-W-W (real-win-worth it) screen, allows companies to evaluate the risks and potential of individual projects by answering six fundamental questions about each one: Is the market real? Explores customers' needs, their willingness to buy, and the size of the potential market. Is the product real? Looks at the feasibility of producing the innovation. Can the product be competitive? and Can our company be competitive? Investigate how well suited the company's resources and management are to compete in the marketplace with the product. Will the product be profitable at an acceptable risk? Explores the financial analysis needed to assess an innovation's commercial viability. Last, Does launching the product make strategic sense? examines the project's fit with company strategy and whether management supports it.     

In search of a rational foundation for the massive IT boom in the Australian banking industry: Can the IT boom really drive relationship banking?

Information technology (IT) is meant to improve bank performance by lowering operational costs and improving the process of financial intermediation of banks. However, the empirical evidence has failed to reach a consensus on the precise effects of IT on bank performance as some find evidence to concur with the Solow Paradox, while others contradict this paradox. The heterogeneity in the quality of banking services is partly responsible for the inconsistency in the findings. To sidestep the issue of heterogeneity, we consider the top-tier Australian banks for which the quality of banking services is homogeneous. Applying the dynamic panel data methodology, i.e., panel autoregressive distributed lag (panel ARDL) and cross-sectionally augmented panel ARDL (CS-ARDL) models, we investigate the effect of IT on the cost and profit efficiency frontiers of the top-tier Australian banks during 2000–2019. We unequivocally establish that the frontiers of bank profits rise due to the adoption and diffusion of IT investment, contradicting the assumed failure of IT to adequately collect soft information in the banking industry. Furthermore, we find that the cost frontiers have risen, driven by the IT boom. Hence, there is evidence that despite increases in operational inefficiency, IT has shifted the profit frontiers up by enhancing relationship banking in Australia.     

Conditional portfolio allocation: Does aggregate market liquidity matter?

This paper investigates how aggregate liquidity influences optimal portfolio allocations across various US characteristic portfolios. We consider short-term allocation problems, with single and multiple risky assets, and use the nonparametric approach of Brandt (1999) to directly express optimal portfolio weights as functions of aggregate liquidity shocks. We find, first, that the effect of aggregate liquidity is positive and decreasing with the investment horizon. Second, at daily and weekly horizons, this effect is weaker on allocations in large stocks and gets stronger as we move toward small stocks, regardless of the other stock characteristics, suggesting that liquidity is the main concern of very short-term investors. Third, conditional allocations in risky assets decrease and exhibit shifts toward more liquid assets as aggregate liquidity worsens. Overall, conditioning on aggregate liquidity yields empirical results that are consistent with the so-called flight-to-safety and flight-to-liquidity episodes. Finally, we propose a simple tactical investment strategy and show how aggregate liquidity information can be exploited to enhance the out-of-sample performance of long-term strategies.     

Is ex-post credit risk affected by the cycles? The case of Italian banks

The objective of this research is to empirically examine if both credit and business cycle affect the ex-post credit risk (i.e. non-performing loans) in the banking system of Italy for the period 1995Q1–2014Q1. The increase in NPLs post-2008 has put into question the robustness of many European banks and the stability of the whole sector. It still remains a serious challenge, especially in Italy which is one of the countries that hit by the financial crisis. By employing fixed and random effects and a dynamic GMM estimation as econometric methodologies I find results that underline common causes for NPLs. Higher NPLs in Italy are mostly due to worse macroeconomic conditions (i.e. bad phase of business cycle) and due to excess credit. Through a Granger causality test, my arguments found even more support. Such findings can be helpful when designing macro-prudential as well as NPL resolution policies.     

Can extra-financial ratings serve as an indicator of ESG risk?

We examine whether extra-financial ratings are related to the probability of occurrence of adverse environmental, social and governance (ESG) events, and thus serve as an indicator of ESG-risk. We observe that a firm's global extra-financial performance is negatively related to its likelihood of dealing with adverse ESG-related events. However, for some CSR dimensions, the link between overall performance (strengths and concerns) and risk is positive, which is consistent with a compensation effect. We also observe an cross-dimensional effect whereby extra-financial performance in a specific CSR dimension can affect the probability of occurrence of adverse events associated with other dimensions. Results are robust to a number of tests.     

Re-examining the risk–return relationship in Europe: Linear or non-linear trade-off?

This paper analyzes the risk–return trade-off in Europe using recent data from 11 European stock markets. After relaxing the linear assumptions in the risk–return relationship by introducing a new approach that considers the current state of the market, we obtain significant evidence for a positive risk–return trade-off for low volatility states. However, this finding is reduced or even non-significant during periods of high volatility. Maintaining the linear assumption over the risk–return trade-off leads to non-significant estimations for all cases. These results are robust across countries despite the conditional volatility model used. These results also demonstrate that the inconclusive results in previous studies may be due to strong linear assumptions when modeling the risk–return trade-off. This previous research fails to uncover the global behavior of the relationship between return and risk.     

Asset pricing anomalies: Liquidity risk hedgers or liquidity risk spreaders?

We capture two distinct investing preferences – hedging against aggregate liquidity risk or betting on it – in the cross-section of stock returns. A three-factor model underpinned by exposures to changes in market liquidity, isolating two alternating patterns, is developed. Our results can be summarized in the following ways: one, the improved performance of recent asset-pricing models is driven by factors that mimic liquidity risk hedging and are linked to cross-sectional mispricing. Two, our model outperforms competing models in explaining time-series return variation across market states. Three, our parsimonious model enables an understanding of diverging return premia in the cross-section. Four, the estimated risk premiums in our model correspond to theoretical, economic, and statistical restrictions holistically across varied and complex anomaly structures. In this respect, the performance of the proposed model is even better than the risk premiums on factors in the model that have the largest cross-sectional r-squared values.     

Financial systemic risk: Taxation or regulation?

This paper describes financial systemic risk as a pollution issue. Free riding leads to excess risk production. This problem may be solved, at least partially, either by financial regulation or by taxation. From a normative viewpoint, taxation is superior in many respects. However, reality shows that financial regulation is adopted more frequently. This paper makes a positive, politico-economic argument. If the majority chooses regulation, the level is likely to be too harsh. If it chooses taxation, then the level is likely to be too low. Due to regressive effects, a tax on financial transactions receives low support from a majority of low polluting portfolio owners. The same kind of majority may strategically choose regulation in order to burden the minority with a larger share of the cost of reducing systemic risk.     

Scuba diving: how high the risk?

The host factors that represent the most risk for scuba-diving safety are poor fitness, overweight, chronic diseases, structural abnormalities of the heart and lungs, and multiple risk factors for CAD. Any of these factors, plus inexperience, a history of irresponsible behavior, or participation in technical diving should alert medical underwriting that a scuba diver has excess risk for fatal accidents.