Did Subjectivity Play a Role in CDO Credit Ratings?

Analyzing 916 collateralized debt obligations (CDOs), we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to increasingly larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model‐implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA‐rated CDOs only comply with the credit rating agency's own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that on average AAA tranches were structured to BBB support levels.     

Trade Credit or Financial Credit? An International Study of the Choice and Its Influences

Trade credit financing has usually been assumed to be an expensive source of funds. Recent studies, however, suggested that it can be available at either low or no cost. Using an international panel of firms, we provide an empirical answer to this matter. We analyze the type of firms and financial environments that are associated with a relatively more intense use of financial credit and, consistent with the mainstream literature, we find that trade credit financing is chosen by firms that have more restricted access to financial credit. These results appear to be stronger for firms located in emerging markets.     

Did institutions herd during the internet bubble?

We examine the trading behavior of institutional investors during the internet bubble and crash of 1998–2001, and its impact on stock prices. Similar to some recent findings concerning the trading behavior of hedge funds and NASDAQ 100 stocks, we find that during the bubble all types of institutions herded with great intensity into internet stocks for a comprehensive sample of institutional investors and internet stocks. In addition to this, we present three entirely new results. First, institutional herding was much greater than what can be explained by momentum trading. Second, institutions as a group continued to increase their holdings of internet stocks for two quarters past the market peak during the first quarter of 2000, and three quarters past the peak for individual stock prices, suggesting that institutions were unable to time the price peaks. Finally and most importantly, we find positive abnormal returns contemporaneous with institutional herding and negative abnormal returns (reversals) at the point that herding ceased. This finding suggests that institutions’ trading created temporary price pressures, and may have contributed to the bubble.     

Did the value premium survive the subprime credit crisis?

We provide evidence that value stocks significantly underperformed growth stocks during the subprime credit crisis, despite a positive value premium before the crisis. The reversal in the value premium concentrates in financially constrained firms, suggesting it was due to the adverse influence of the crisis rather than confounding effects. These findings are robust to alternative financial constraint proxies and asset pricing models. The observation that value stocks are vulnerable to losses during extreme downturns like the crisis is consistent with them being riskier than growth stocks. Our findings have implications for the academic debate on the underlying cause of the value premium and for investors on the profitability of value investing strategies.     

Credit risk modeling strategies: the road to serfdom?

This paper aims at presenting some practical issues in modeling default risk of a single commercial credit counterparty from the perspective of a large retail bank. We define default risk as the probability that a counterparty’s intrinsic credit quality deteriorates within a given time horizon such that contractual agreements cannot be honored. This work gives an insight into using scoring/rating models in a credit environment of a large European bank. Contrary to many banks, we did not define the segments in a first step with a view to developing the rating tools in a second step. Our approach has, to some extent, followed a different path. Iteratively, we both defined the borders for a particular segment and selected an appropriate rating tool. More particularly, customer segmentation has been carried out on the basis of various rating tools’ goodness-of-fit criteria. The topics cover customer segmentation using goodness-of-fit measures, data measurement levels and optimization algorithms, rating tool calibration to the central default tendency and communication to the end user. Copyright © 1999 John Wiley & Sons, Ltd.     

Who Transfers Credit Risk? Determinants of the Use of Credit Derivatives by Large US Banks

Abstract

Credit derivatives enable banks to transfer selected credit risks to third parties. An empirical model is developed for the motivation for bank participation in credit derivative markets and, conditional on participation, the factors that determine the volume of business transacted. Participation appears to be closely related to bank size, but there is only limited evidence that entry barriers related to franchise value or past experience in dealing in derivatives are important. There is evidence that banks use credit derivatives as part of their overall risk management strategy. However, the use of credit derivatives does not appear to be influenced by the extent of managerial share ownership.     

Did the rating standard for banks change after the crisis?

Review of Quantitative Finance and Accounting - Did rating agencies tighten their rating standard after the overwhelming critique on their generous ratings before 2008? This study aims to examine...     

Did securitization affect the cost of corporate debt?

This paper investigates whether the securitization of corporate bank loan facilities had an impact on the price of corporate debt. Our results suggest that loan facilities that are subsequently securitized are associated with a 17 basis point lower spread than that of facilities that are not subsequently securitized. We consider facility characteristics that are associated with the likelihood of securitization and estimate the extent to which these characteristics are related to spreads. We document that Term Loan B facilities, facilities of B-rated firms, and facilities originated by banks that originate CLOs are securitized more frequently than other facilities. Spreads on facilities estimated to be more likely to be subsequently securitized have lower spreads than otherwise similar facilities. The results are consistent with the view that securitization caused a reduction in the cost of capital.     

Did Hayek and Robbins Deepen the Great Depression?

Contrary to some accounts, the Hayek–Robbins ("Austrian") theory of the business cycle did not prescribe a monetary policy of "liquidationism" in the sense of passive indifference to sharp deflation during the early years of the Great Depression. There is no evidence that Hayek or Robbins influenced any "liquidationist" in the Hoover administration or the Federal Reserve System. Federal Reserve policy during the Great Depression was instead influenced by the real bills doctrine, which (despite some apparent similarities) was diametrically opposed in key respects to Hayek's norms for central bank policy.     

Credit risk interconnectedness: What does the market really know?

We analyze the relation between market-based credit risk interconnectedness among banks during the crisis and the associated balance sheet linkages via funding and securities holdings. For identification, we use a proprietary dataset that has the funding positions of banks at the bank-to-bank level for 2006–2013 in conjunction with investments of banks at the security level and the credit register from Germany. We find asymmetries both cross-sectionally and over time: when banks face difficulties to raise funding, the interbank lending affects market-based bank interconnectedness. Moreover, banks with investments in securities related to troubled classes have a higher credit risk interconnectedness. Overall, our results suggest that market-based measures of interdependence can serve well as risk monitoring tools in the absence of disaggregated high-frequency bank fundamental data.     

Did bank distress stifle innovation during the Great Depression?

We find a negative relationship between bank distress and the level, quality and trajectory of firm-level innovation during the Great Depression, particularly for R&D firms operating in capital intensive industries. However, we also show that because a sufficient number of R&D intensive firms were located in counties with lower levels of bank distress, or were operating in less capital intensive industries, the negative effects were mitigated in aggregate. Although Depression era bank distress was associated with the stifling of innovation, our results also help to explain why technological development was still robust following one of the largest shocks in the history of the U.S. banking system.     

Did the crisis induce credit rationing for French SMEs?

This paper focuses on the access of independent French SMEs to bank lending and analyzes whether the observed evolution of credit to SMEs over the recent period was “demand driven” as a result of the decrease in firms’ activity and investment projects or was “supply driven” with an increase in credit “rationing” stemming from a more cautious behavior of banks. Based on a sample of around 60,000 SMEs, we come to the conclusion that, despite the stronger standards used by banks when granting credit, French SMEs do not appear to have been strongly affected by credit rationing since 2008. This result goes against the common view that SMEs suffered from a strong credit restriction during the crisis but is perfectly in line with the results of several surveys about the access to finance of SMEs recently conducted in France.     

Did CDS trading improve the market for corporate bonds?

Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error), and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002–2008, we find that the advent of CDS was largely detrimental. Bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specifications of our tests.     

Which Credit Unions are Acquired?

Recent years have witnessed a wave of consolidation amongst US credit unions. Through hazard function estimations, this paper identifies the determinants of acquisition for credit unions during the period 2001-06. The hazard of acquisition is inversely related to both asset size and profitability, and positively related to liquidity. Growth-constrained credit unions are less attractive acquisition targets. Institutions with low capitalization and those with small loans portfolios relative to total assets are susceptible to acquisition. The investigation presents unique empirical evidence of a link between technological capability and the hazard of acquisition. During the period 2001-06, when there was sustained growth in the use of internet technology, credit unions with no website were at the highest risk of acquisition.     

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.     

Did amakudari undermine the effectiveness of regulator monitoring in Japan?

The principal–agent problem between the regulator, regulated banks, and taxpayers is critical to the viability of the financial system’s safety net. There exists the danger that the regulator will collude with regulated banks to pursue their benefits at the expense of taxpayers, thereby reducing effectiveness of financial supervision. This paper proposes that the human relationship prevailing between the regulatory authorities and private banks referred to as “amakudari” is a form of collusion between the regulator and banks that endangers the safety net mechanism in Japan. Statistical analysis of data on regional banks shows that those banks accepting post-retirement officials from the Ministry of Finance have reduced capital adequacy levels and increased non-performing loans. Thus, the statistical result supports the hypothesis proposed in this paper.     

Did capital infusions enhance bank recovery from the great recession?

This paper investigates the long-run recovery experience of US banks that received capital infusions under the Capital Purchase Program (CPP), a part of the Troubled Asset Relief Program (TARP). Based on a dynamic recovery model, our results show that recovering CPP banks tended to be in better financial condition than other CPP banks. Long-run event study analyses of common stock prices reveal that, in the quarter after repayment of TARP funds, CPP banks experienced economically large and significant buy-and-hold wealth gains of 14%, equivalent to approximately $329 billion. We conclude that TARP was successful in fostering bank financial and stock price recovery.     

Did the Federal Reserve's MBS purchase program lower mortgage rates?

On November 25, 2008, the Federal Reserve announced it would purchase mortgage-backed securities (MBS). This program affected mortgage rates through three channels: (1) improved market functioning in both primary and secondary mortgage markets, (2) clearer government backing for Fannie Mae and Freddie Mac, and (3) anticipation of portfolio rebalancing effects. We use empirical pricing models for MBS yields and for mortgage rates to measure relative importance of channels: The first two were important during the height of the financial crisis, but the effects of the third depended on market conditions. Overall, the program put significant downward pressure on mortgage rates.     

How Did the 2003 Dividend Tax Cut Affect Stock Prices?

We test the hypothesis that the 2003 dividend tax cut boosted US stock prices and thereby lowered the cost of equity capital. Using an event‐study methodology, we attempt to identify an aggregate stock market effect by comparing the behavior of US common stock prices with that of foreign equities and the equities of real estate investment trusts (REITs). We also examine the relative cross‐sectional response of prices of high‐ and low‐dividend‐paying stocks. We do not find any imprint of the dividend tax cut news on the value of the aggregate US stock market. On the other hand, high‐dividend stocks outperformed low‐dividend stocks by a few percentage points over the event windows, suggesting that the tax cut may have induced asset reallocation within equity portfolios. Finally, the positive abnormal return on nondividend paying US stocks in 2003 does not appear to be tied to tax cut news.