We use a new bank-level dataset to study the FDI-versus-exports decision for German banks. We extend the literature on multinational firms in two directions. First, we simultaneously study FDI and the export of cross-border financial services. Second, we test recent theories on multinational firms which show the importance of firm heterogeneity [Helpman, E., Melitz, M.J., Yeaple, S.R., 2004. Export versus FDI. American Economic Review 94 (1), 300–316]. Our results show that FDI and cross-border services are complements rather than substitutes. Heterogeneity of banks has a significant impact on the internationalization decision. More profitable and larger banks are more likely to expand internationally than smaller banks. They have more extensive foreign activities, and they are more likely to engage in FDI in addition to cross-border financial services.

In this paper we develop a strongly stable (L-stable) and highly accurate method for pricing exotic options. The method is based on Padé schemes and also utilizes partial fraction decomposition to address issues regarding accuracy and computational efficiency. Due to non-smooth payoffs, which cause discontinuities in the solution (or its derivatives), standard A-stable methods are prone to produce large and spurious oscillations in the numerical solutions which would mislead to estimating options accurately. The proposed method does not suffer these drawbacks while being easy to implement on concurrent processors. Numerical results are presented for digital options, butterfly spread and barrier options in one and two assets. In addition, the methods are tested on the Heston stochastic volatility model.

A price process is scale-invariant if and only if the returns distribution is independent of the price measurement scale. We show that most stochastic processes used for pricing options on financial assets have this property and that many models not previously recognised as scale-invariant are indeed so. We also prove that price hedge ratios for a wide class of contingent claims under a wide class of pricing models are model-free. In particular, previous results on model-free price hedge ratios of vanilla options based on scale-invariant models are extended to any contingent claim with homogeneous pay-off, including complex, path-dependent options. However, model-free hedge ratios only have the minimum variance property in scale-invariant stochastic volatility models when price–volatility correlation is zero. In other stochastic volatility models and in scale-invariant local volatility models, model-free hedge ratios are not minimum variance ratios and our empirical results demonstrate that they are less efficient than minimum variance hedge ratios.

In this paper, we compare option contracts from a traditional derivatives exchange to bank-issued options, also referred to as covered warrants. While bank-issued option markets and traditional derivatives exchanges exhibit significant structural differences such as the absence of a central counterparty for bank-issued options, they frequently exist side-by-side, and the empirical evidence shows that there is significant overlap in their product offerings although options are not fungible between the two markets. The empirical analysis indicates that bid-ask spreads in either market are lowered by 1–2% due to competition from the other market, providing evidence that the benefits of competing market structures are available in the absence of fungibility.

We examine the determinants of Japanese regional bank pricing-to-market decisions and their impact on the intensity of depositor discipline, in the form of the sensitivity of deposit growth to bank financial conditions. To obtain consistent estimates, we first model and estimate the bank pricing-to-market decision and then estimate the intensity of depositor discipline after conditioning for that decision. We find that banks were less likely to adopt market price accounting the larger were their unrealized securities losses. We also find statistically significant evidence of depositor discipline among banks that elected to price to market. Our results indicate that depositor discipline was more intense for the subset of banks that adopted market price accounting.

Most bank merger studies do not control for hidden bailouts, which may lead to biased results. In this study we employ a unique data set of approximately 1000 mergers to analyze the determinants of bank mergers. We use undisclosed information on banks’ regulatory intervention history to distinguish between distressed and non-distressed mergers. Among merging banks, we find that improving financial profiles lower the likelihood of distressed mergers more than the likelihood of non-distressed mergers. The likelihood to acquire a bank is also reduced but less than the probability to be acquired. Both distressed and non-distressed mergers have worse CAMEL profiles than non-merging banks. Hence, non-distressed mergers may be motivated by the desire to forestall serious future financial distress and prevent regulatory intervention.

The evidence here indicates that sovereign debt rating and credit outlook changes of one country have an asymmetric and economically significant effect on the stock market returns of other countries over 1989–2003. There is a negative reaction of 51 basis points (two-day return spread vis-á-vis the US) to a credit ratings downgrade of one notch in a common information spillover around the world. Upgrades, however, have no significant impact on return spreads of countries abroad. Closeness (e.g., geographic proximity) and emerging market status amplify the effect of a spillover. Downgrade spillover effects at the industry level are more pronounced in traded goods and small industries.

Credit portfolios, as for instance Collateralized Debt Obligations (CDO’s) consist of credits that are heterogeneous both with respect to their ratings and the involved industry sectors. Estimates for the transition probabilities for different rating classes are well known and documented. We develop a Markov chain model, which uses the given transition probability matrix as the marginal law, but introduces correlation coefficients within and between industry sectors and between rating classes for the joint law of migration of all components of the portfolio. We have found a generating function for the one step joint distribution of all assets having non-default credit ratings and a generating function of the loss distribution. The numerical simulations presented here verify that the average number of defaults is not affected by the correlation coefficients, but the percentiles of the number of defaults are heavily dependent upon them. In particular, for strongly correlated assets, the distribution of the number of defaults follows a “cascade” pattern nesting in non-overlapping intervals. As a result, the probability of a large number of defaults is higher for correlated assets than for non-correlated ones.

In the financial engineering literature, stock-selling rules are mainly concerned with liquidation of the security within a short period of time. This is practically feasible only when a relative smaller number of shares of a stock is involved. Selling a large position in a market place normally depresses the market if sold in a short period of time, which would result in poor filling prices. In this paper, we consider the liquidation strategy for selling a large block of stock by selling much smaller number of shares over a longer period of time. In particular, we treat the selling rule problem by using a fluid model in the sense that the number of shares are treated as fluid (continuous) and the corresponding liquidation is dictated by the rate of selling over time. The objective is to maximize the expected overall return. The underlying problem may be formulated as a stochastic control problem with state constraints. Method of constrained viscosity solution is used to characterize the dynamics governing the optimal reward function and the associated boundary conditions. Numerical examples are reported to illustrate the results.

The price of defaultable or credit-risky bonds differs from the equivalent maturity price of a risk-free bond for a well identified number of factors: the positive probability of default prior to the bond maturity, the estimated loss given default, that depends on the adopted assumption on the recovery rate for that class, see Duffie and Singleton [Duffie, D., Singleton, K.J., 1999. Modeling term structures of defaultable bonds. Rev. Financ. Stud. 12, 687–720] for several models of recovery rates, the probability that the bond issuer will migrate from the current rating class to a lower class. In this study we apply two well-known modelling approaches, due to Jarrow et al. [Jarrow, R.A., Lando, D., Turnbull, S.M., 1997. A Markov model for the term structure of credit risk spreads. Rev. Financ. Stud. 10, 481–523] and Schönbucher [Schönbucher, P.J., 2002. A tree implementation of a credit spread model for credit. J. Comput. Finance 6 (2), 175–196] to price specifically two risk sources affecting the evolution of bond prices over time: the risk to move from a current risk class to a different one over the bond residual life, and the risk associated with comovements of the credit spread curves and the risk-free term structure. The former is referred to as transition risk, the latter as correlation risk. The analysis is conducted extending appropriately to a multinomial setting the classical discrete binomial model of the term structure formulated by Black et al. [Black, F., Derman, E., Toy, W., 1990. A one-factor model of interest rates and its application to treasury bond options. Financ. Analysts J. (January/February), 33–39], applied previously by Abaffy et al. [Abaffy, J., Bertocchi, M., Dupačová, J., Moriggia, V., 2000. On generating scenarios for bond portfolios. Bull. Czech Econom. Soc. 11, 3–27, and references ibidem] and many other authors in literature. The generalised model, with transition [by Jarrow et al.] and correlation risk [by Schönbucher], is applied to a large dataset of corporate spreads to evaluate the sensitivity of the isolated risk sources on the fair price of risky bonds traded in the Eurobond market.