In recent years, subprime lending has grown substantially as an important sector of the credit markets. This paper is concerned with the risk management of subprime loan portfolios and the importance of default correlation in measuring that risk. Using a large portfolio of residential subprime loans from an anonymous subprime lender, we show that default correlation is substantial for this lender. In particular, the significance of default correlation increases as the internal credit rating declines. Our results suggest that lenders and regulators would be well served investing in the understanding of default correlation in subprime portfolios.

The existing literature reports insignificant `total' exposure for multinational or exporting firms, where total exposure incorporates both firm-specific and macroeconomic effects. We propose a dual-effect hypothesis to explain this result which seemingly contradicts conventional wisdom. According to our proposed hypothesis, firms are affected by both the domestic economy and foreign markets. These effects are at least partially offsetting for exporters and additive for importers. The resulting predictions of insignificant total exposure for exporters and positive total exposure for importers are borne out in our tests. The literature also reports insignificant `residual' exposure for multinationals or exporting firms, where residual exposure estimates the firm-specific exposure. This result is explained by biases in the residual exposure estimates introduced by the choice of the value-weighted market index as the control portfolio. We propose an equally-weighted portfolio of purely domestic firms as an alternative portfolio to reduce such biases and report significantly negative exposure for exporters and significantly positive exposure for importers, as predicted by theory.

This paper studies the influence of the state of the business cycle on credit ratings. In particular, we assess whether rating agencies are excessively procyclical in their assignment of ratings. Our analysis is based on a model of ratings determination that takes into account factors that measure the business and financial risks of firms, in addition to indicators of macroeconomic conditions. Utilizing annual data on all US firms rated by Standard & Poor’s, we find that ratings do not generally exhibit excess sensitivity to the business cycle. In addition, we document that previously reported findings of a secular tightening of ratings standards are not robust to a more complete accounting of systematic changes to measures of risk.

The lead–lag relationship in both returns and volatilities between spot and futures markets has been investigated extensively in the financial economics literature. Only a limited number of such studies have appeared on forward markets, primarily due to the lack of easy access to empirical data. This paper uses a unique database in over-the-counter Forward Freight Agreements (FFA) to investigate the issue. The underlying commodity is non-storable, being that of a shipping service, with the additional feature of transactions costs being higher in the spot market in comparison to the forward market. These features have interesting implications for the markets. At the practical level, the better understanding of the mean and variance dynamics can improve risk management and budget planning decisions.