From the onset of the 2008–2009 financial crisis to the subsequent European sovereign debt crisis, credit rating agencies have been assigned considerable blame. Reforming the credit rating industry has hence become an important policy issue. In addition to the regulatory efforts in the context of accepting the for-profit business model of ratings, there is a growing realization that credit ratings bear the characteristics of a public good. Financial market participants need reliable, transparent and independent assessment of credit risks. Credit ratings are therefore better viewed as an infrastructure matter. However, the proposed regulations seem to have missed this point. This paper introduces a new approach to credit ratings undertaken by the Risk Management Institute at the National University of Singapore that is predicated on the provision of credit ratings as a public good. With a public good alternative in place, the currently predominant for-profit business model may be counterbalanced.

Existing research on executive stock options mainly focuses on total risk when studying risk incentives. In this study, we use a GARCH option pricing framework to show that the incentive effects of executive stock options depend on the composition of risk. Controlling for total risk, the value of executive stock options increases with systematic risk and this effect is stronger when the total risk is low. Thus, when firms grant standard or non-indexed options, CEOs will have incentives to increase systematic risk even when the total risk remains constant. In contrast, indexed options will provide CEOs with incentives to reduce systematic risk. We therefore conclude that an optimal mix of indexed and non-indexed option grants will provide CEOs with incentives to take the desired level of systematic risk.

This paper investigates how well the Hang Seng Index options, the most important class of option contracts traded in Hong Kong, are priced using the GARCH approach. We calibrated the GARCH parameters using the call and put option data and used them to price options in the subsequent weeks. We found the GARCH model performs very well in comparison with the Black–Scholes model even after allowing for a smile/smirk adjustment. Its superior performance was also evident both before and during the recent Asian financial turmoil.

A multiperiod model is developed to measure the costs posed to the guaranty fund in a setting that incorporates risk-based capital regulations, interest rate risk and the possibility of catastrophic losses. The guaranty contract is modeled as a put option on the asset of the insurance company with a stochastic strike price and an uncertain maturity. The impacts of the key factors of this model are examined numerically and shown to make material differences in the costs to the guaranty fund.

We propose a multiperiod deposit insurance pricing model that simultaneously incorporates the capital standard and the possibility of forbearance. The model employs the recently developed GARCH option pricing technique in determining the deposit insurance value. Our model offers two distinctive advantages. First, it explicitly considers the implications of the strict enforcement on capital standard as stipulated in FDIC Improvement Act of 1991. Second, the use of the GARCH model allows us to capture many robust features exhibited by financial asset returns. By the GARCH option pricing theory, the value of a contingent claim is a function of the asset risk premium. This unique feature is found to be prominent in determining the bank's deposit insurance value. We also examine the effects of capital forbearance and moral hazard behavior in this multiperiod deposit insurance setting.

We estimate the term structures of the default probabilities for private firms using data consisting of 1759 default events from 29,894 firms between 1999 and 2014. Each firm’s default likelihood is characterized by a forward intensity model employing macro risk factors and firm-specific attributes. As private firms do not have traded stock prices, we devise a methodology to obtain a public-firm equivalent distance-to-default by projection that references the distance-to-defaults of public firms with comparable attributes. The fitted model provides accurate multi-period forecasts of defaults, leading to both economically and statistically significant benefits over benchmark models. The reported interest rates charged to private firms are reflective of the estimated default term structure.