Using intraday data, we identify the intensity of private information flow in the U.S. Treasury market. Our results show that the intensity of private information flow is highly correlated with public information shocks and higher for longer maturity bonds. More importantly, we find that bond price changes associated with high intensity of private information flow tend to be persistent, whereas those associated with low intensity of private information flow are more likely reversed. While public information and private information are the main determinants of bond price variations on days with news announcements, private information and liquidity shocks are important determinants of bond price variations on days with no significant events. Finally, we show that the depth of limit order book is inversely related to the intensity of private information flow. Nevertheless, informed dealers do not seem to use hidden orders to disguise their trading intentions.

This work analyses the effect of accruals quality in the access of firms to bank debt in a panel data of SME Spanish firms. The results show a positive association between accruals quality and bank debt, even when controlling for other determinants of bank debt and for possible endogeneity between bank debt and accruals quality, which suggests that higher precision of earnings reduces information asymmetries with banks and favors the access of firms to bank loans.

International equity markets linkages are characterized by nonlinear dependence and asymmetries. We investigate shifts in long run comovements in stock markets by means of an ‘interrupted’ Markov switching cointegration specification. This flexible approach allow us to study to what extent documented changes in global integration are permanent, or whether market linkages are subject to changes. Using an illustrative sample from 1980 to 2012 for USA, UK and Hong Kong stock price indices, we find evidence of interrupted cointegration across these markets between May 1997 and April 2002, which is consistent with the decoupling of stock prices from fundamentals during the dot-com bubble.

Systemic risk among the network of international banking groups arises when financial stress threatens to crisscross many national boundaries and expose imperfect international coordination. To assess this risk, we consider three decades of data on the cross-border interbank market. We use Rosvall and Bergstrom’s (2008) information theoretic map equation to partition banking groups from 21 countries into modules that reveal the contagious capacity of the network. We show that in the late 1980s four important financial centers formed one large super cluster that was highly contagious in terms of transmission of stress within its ranks, but less contagious on a global scale. But the expansion leading to the 2008 crisis left more transmitting hubs sharing the same total influence as a few large modules had previously. We show that this greater entanglement meant the network was more broadly contagious, and not that risk was more shared. Thus, our analysis contributes to our understanding as to why defaults in US sub-prime mortgages spread quickly through the global financial system.

A broad stream of research shows that information flows into underlying stock prices through the options market. For instance, prior research shows that both the Put–Call Ratio (P/C) and the Option-to-Stock Volume Ratio (O/S) predict negative future stock returns. In this paper, we compare the level of information contained in these two commonly used option volume ratios. First, we find that P/C ratios contain more predictability about future stock returns at the daily level than O/S ratios. Second, in contrast to our first set of results, O/S ratios contain more predictability about future returns at the weekly and monthly levels than P/C ratios. In fact, our tests show that while P/C ratios contain predictability about future daily returns and, to some extent, future weekly returns, the return predictability in P/C ratios is fleeting. O/S ratios, on the other hand, significantly predict negative returns at all levels: daily, weekly, and monthly. While Pan and Poteshman (2006) show that signed P/C ratios, which require proprietary data, have predictive power, we find that unsigned P/C ratios, which do not require proprietary data, also have predictive power.

This paper presents a flexible, lattice-based structural credit risk model that uses equity market information and a detailed depiction of a financial institution’s liability structure to analyze default risk. The model is applied to examine the term structure of default probabilities for Lehman Brothers prior to its demise. The results indicate, as early as March, that the firm would likely lose access to external capital within two years. The model can be used as both a diagnostic tool for the early detection of financial distress and a prescriptive tool for addressing the sources of risk in large, complex financial institutions.

We examine contemporaneous jumps (cojumps) among individual stocks and a proxy for the market portfolio. We show, through a Monte Carlo study, that using intraday jump tests and a coexceedance criterion to detect cojumps has a power similar to the cojump test proposed by Bollerslev et al. (2008). However, we also show that we should not expect to detect all common jumps comprising a cojump when using such coexceedance based detection methods. Empirically, we provide evidence of an association between jumps in the market portfolio and cojumps in the underlying stocks. Consistent with our Monte Carlo evidence, moderate numbers of stocks are often detected to be involved in these (systematic) cojumps. Importantly, the results suggest that market-level news is able to generate simultaneous large jumps in individual stocks. We also find evidence of an association between systematic cojumps and Federal Funds Target Rate announcements.

We examine the relation between legal, extra-legal and political institutional factors and earnings quality of banks across countries. We predict that earnings quality is higher in countries with legal, extra-legal and political systems that reduce the consumption of private control benefits by insiders and afford outside investors greater protection. Using a sample of banks from 35 countries during the pre-crisis period from 1993 to 2006, we find that all five measures of earnings quality studied are higher in countries with stronger legal, extra-legal and political institutional structures. We also find that banks in countries with stronger institutions are less likely to report losses, have lower loan loss provisions, and higher balance sheet strength during the 2007–2009 crisis period. Our findings highlight the implications of country level institutional factors for financial reporting quality and are relevant to bank regulators who are considering additional regulations on bank financial reporting.

Robust portfolio optimization has been developed to resolve the high sensitivity to inputs of the Markowitz mean–variance model. Although much effort has been put into forming robust portfolios, there have not been many attempts to analyze the characteristics of portfolios formed from robust optimization. We investigate the behavior of robust portfolios by analytically describing how robustness leads to higher dependency on factor movements. Focusing on the robust formulation with an ellipsoidal uncertainty set for expected returns, we show that as the robustness of a portfolio increases, its optimal weights approach the portfolio with variance that is maximally explained by factors.

Common asset holdings are widely believed to have been the primary vector of contagion in the recent financial crisis. We develop a network approach to the amplification of financial contagion due to the combination of overlapping portfolios and leverage, and we show how it can be understood in terms of a generalized branching process. This can be used to compute the stability for any particular configuration of portfolios. By studying a stylized model we estimate the circumstances under which systemic instabilities are likely to occur as a function of parameters such as leverage, market crowding, diversification, and market impact. Although diversification may be good for individual institutions, it can create dangerous systemic effects, and as a result financial contagion gets worse with too much diversification. There is a critical threshold for leverage; below it financial networks are always stable, and above it the unstable region grows as leverage increases. Note that our model assumes passive portfolio management during a crisis; however, we show that dynamic deleveraging during a crisis can amplify instabilities. The financial system exhibits “robust yet fragile” behavior, with regions of the parameter space where contagion is rare but catastrophic whenever it occurs. Our model and methods of analysis can be calibrated to real data and provide simple yet powerful tools for macroprudential stress testing.