Knowledge that Transforms

Against the backdrop of the Great Recession, investigating the differences in institutional frameworks became important to explain the heterogeneity in the market perception about the credit quality and default risk of banks in different countries. Using data for 118 banks of 30 countries over the period 2004–2011, we find that an improvement of the quality of economic and legal institutions can help in reducing banks' CDS spreads, as banks operating in countries where the regulatory quality is stronger tend to be less affected by spikes in financial stress of 2008–2009. Considering a series of indicators of the financial structure of the banking system, our results reveal that more concentration of the banking sector, a stronger presence of foreign banks, a deterioration of the banking sector health or the lack of alternative means of finance is associated with higher CDS spreads of banks. We also show that the dynamics of bank CDS spreads accrue to: (i) the quality of banks’ balance sheet; (ii) (il)liquidity of banks’ assets; (iii) how profitable banks’ operations are; and (iv) the banks’ leverage ratios. Finally, higher CDS spreads of banks tend to be associated with periods of high inflation and low GDP growth.

Using dynamic conditional correlations and network theory, this study brings a novel interdisciplinary framework to define the integration and segmentation of emerging countries. The individual EMBI+ spreads of 13 emerging countries from January 2003 to December 2013 are used to compare their interaction structure before (phase 1) and after (phase 2) the global financial crisis. Accordingly, the unweighted average of dynamic conditional correlations between cross country bond returns significantly increases in phase 2. At first glance, the increased co-movement degree suggests an integration of the sample countries after the crisis. However, using correlation based stable networks, we show that this is not enough to make such a strong conclusion. In particular, we reveal that the increased average correlation is more likely to be caused by clusters of countries that exhibit high within-cluster co-movement but not between-cluster co-movement. Potential reasons for the post-crisis segmentation and important implications for international investors and policymakers are discussed.

In light of the renewed challenge to construct effective “Early Warning Systems” for sovereign debt crises, we empirically evaluate the predictive power of econometric models developed so far across developed and emerging country regions. We propose a different specification of the crisis variable that allows for the prediction of new crisis onsets as well as duration, and develop a more powerful dynamic-recursive forecasting technique to generate more accurate out-of-sample warning signals of sovereign debt crises. Our results are shown to be more accurate compared to the ones found in the existing literature.

Using an international panel of 104 countries over the period 1995–2012, we analyze the relationship between country-level securitization and economic activity. Our findings suggest that securitization is negatively related to various proxies of economic activity – even prior to the crisis of 2007–2009. We explain this finding as the results of securitization spurring consumption at the expense of investment and capital formation. Consistent with this, we find that securitization of household loans is negatively associated with economic activity, whereas business securitization displays a weak positive association with it, and that household securitization increases an economy's consumption-investment ratio. Our results inform recent initiatives aimed at reviving securitization markets, as they indicate that the impact of securitization crucially depends on the underlying collateral.

This paper explores the determinants for the leverage decision of financial institutions via the channels of bank-specific characteristics, peer bank behavior, and economic policy uncertainties, which are critical to appropriately control the risk of the financial system and explain the cross-sectional heterogeneity in risk-taking behavior among financial institutions. Our results indicate that bank-specific characteristics are the most influential one among the three channels for leverage decision of financial institutions, while the other two channels also exhibit significant effects on the leverage decision. We further note that economic policy uncertainty may affect their leverage decisions through the channels of their shifting lending behavior and risk-taking capacity.

Risk assessment in the banking sector has been a prominent topic in the banking literature and has gained attention especially since the recent financial crises. In particular, the European crisis, which was the first since the formation of the Eurozone, underlined a number of significant problems and increased concerns on the tail or crash risk of banks. In the present study, we seek to examine whether information asymmetry, the importance of banks in the financial system and systemic risk play significant roles in the evolution of stock crashes in the banking sector. Information asymmetry is proxied by opacity, the importance of a bank in a financial network is proxied by network centrality, and systemic risk is proxied by clustering. The research framework considers a number of regulatory, reporting and financial market factors that have also been determined to relate to stock crashes and shows that all of the above factors are related to (idiosyncratic) stock crash risk under specific conditions.

This paper exploits the Financial Accounts of the United States to derive long time series of bank and nonbank credit to different sectors, and to examine the cyclical behavior of these series in relation to (i) the long-term business cycle, (ii) recessions and recoveries, and (iii) systemic financial crises. We find that bank and nonbank credit exhibit different dynamics throughout the business cycle. We also examine the role of bank and nonbank credit in the creation of financial interconnections and illustrate a method to conduct macro-financial stability assessments.

Each year, millions of dollars are reported lost due to terrorist attacks around the world. In this paper, we conduct a systematic examination of the impact of terrorist attacks on financial markets. We specifically explore the relationship between world stock market indices and large-scale terrorist incidents. We consider sixteen incidents outside the U.S. and thirty-three incidents in the U.S. We use several indices in our analysis, including the S&P 500, the 10-year US Treasury bond yield, gold prices, and several other domestic and international stock market indices. Given the physical asset losses and the psychological impact on citizens, our expectation was to see a strong correlation between terrorist incidents and financial market valuations. However, to our surprise, with the exception of the September 11, 2001 terrorist attacks, our results show that acts of terrorism do not have a significant or lasting economic effect on stock and bond market returns. Contrary to our starting hypothesis, we find no evidence of ‘flight to safety’ behavior in any of the markets.

We provide evidence that the impact of the investment horizon of institutional investors on the credit risk of U.S. industrial firms is both statistically and economically significant. Ceteris paribus, a one percent point increase in the ownership by short-term (long-term) institutions leads to a 0.188 (.046) percentage point decrease (increase) of a firm’s credit spread during 2001–2011. However, during the financial crisis period of 2007/08, long-term institutional investors tend to reduce a firm’s credit risk, especially when a firm’s risk profile is high. Hence, long-term institutions play an important role in enhancing financial stability during the crisis period by mitigating risk.

We examine whether the prevailing national culture has been material in determining bank performance during the recent financial crisis. In this paper, we focus on three particular national culture dimensions: uncertainty avoidance, individualism/collectivism, and power distance. We expect banks from high uncertainty avoidance and power distance societies to perform relatively better during the recent financial crisis. On the other hand, banks in individualistic (collectivist) societies are likely to perform worse (better) during the crisis. Using an international sample of 3438 banks from 48 countries, we find support for our main conjectures. Specifically, we establish that uncertainty avoidance, collectivism, and power distance have a first order impact on bank performance during the crisis. Our results are robust to a battery of additional checks, including additional variables, alternative samples, and correcting for potential endogeneity.