Knowledge that Transforms

We consider a network of equity mutual funds characterized by different levels of compliance with Environmental, Social, and Governance (ESG) aspects. We measure the impact of portfolio liquidation in a stress scenario on funds with different ESG ratings. Fire-sales spillover from portfolio liquidation propagates from one fund to another through indirect contagion mediated by common asset holdings. The analysis is conducted quarterly from March 2016 through June 2018 using daily data from different sources at the fund and firm levels. Our estimation strategy relies on a network analysis where funds are not taken as stand-alone entities but are interconnected components of a unified system. We find evidence that the relative market value loss of the High ESG ranked funds is lower than the loss experienced by the Low ESG ranked counterparts in the time span with lower volatility. In the higher-volatility period there is not always a clear dominance of one class over another. Results are robust when controlling for size and for feedback effects, and for different model specifications. Our analysis offers new insights to both asset managers and policymakers to exploit the aggregate effect of portfolio diversification related to the system as a whole.

This paper investigates the role of external auditors in banking sector supervision from a theoretical, institutional and empirical perspective. We first present a simple principal-agent framework that highlights the importance of several institutional characteristics in determining the optimal involvement of external auditors in supervision. We then construct a new index that captures the degree of involvement of external auditors in the oversight of the banking sector in 115 countries. Consistent with our theoretical arguments, we find that countries that increase the role of central banks in supervision are also more likely to involve auditors, suggesting that the added complexity of a supervisory function is likely to benefit from the expertise of an external auditor. Having experienced a financial crisis is also associated with a higher use of auditors, particularly among central banks with an increasing role in supervision, which suggests some reputational concerns of the supervisor. Finally, we show that higher audit quality is associated with an increased involvement of auditors in supervision.

Using a sample of 27 countries between 1990 and 2014, we find that banks charge higher interest rates and adjust other contractual features of their loans when lending to firms facing more stringent environmental regulations. Our evidence suggests that lenders’ concerns about the increase in environmental liabilities resulting from regulations is driving the results. Specifically, we show that firms facing such regulations have fewer participants in their loan syndicates, higher bankruptcy risk, and lower credit ratings, despite reducing their leverage. Overall, our results indicate that the observed higher loan spread is the result of environmentally sensitive lending practices by banks.

We examine the response of a broad set of digital assets to US Federal Fund interest rate and quantitative easing announcements, specifically examining associated volatility spillover and feedback effects. We classify each digital asset into one of three categories: Currencies; Protocols; and Decentralised Applications (dApps). Currency-based digital assets experience idiosyncratic spillovers in the period immediately after US monetary policy announcements, while application or protocol-based digital assets are largely immune to policy volatility spillover and feedback. Mineable digital assets are found to be more susceptible to monetary policy volatility spillovers and feedback than non-mineable. Responses indicate a diverse market within which, not all assets are comparable to Bitcoin.

We study retail deposit withdrawals from commercial banks that were differentially exposed to distress during the 2007–2009 financial crisis. We show that the propensity of clients to withdraw deposits increases with the severity of bank distress. However, an exclusive pre-crisis bank-client relationship eliminates withdrawal risk. The mechanism through which strong bank-client relationships mitigate withdrawal risk relates to the transaction costs of switching accounts rather than informational rents or differentiated services. Our findings provide empirical support to the Basel III liquidity regulations that emphasize the role of well-established client relationships for the stability of bank funding.

Time-varying depreciation rates are estimated for research and development of the United States aggregate economy and innovation-intensive industries. Mean annual R&D depreciation rates are 31.5% for software, 41% for pharmaceuticals, 42% for semiconductors, and 30.4% for aggregate economy during 1978–2014. R&D depreciation rates vary across industries. R&D investment demand has separate elasticities in time-varying depreciation, interest rate and price growth, allowing for different rates of technology shifts across industries. Software R&D investment has the same magnitude of elasticities to depreciation, interest rate and price, supporting a user cost to apply. For pharmaceuticals and semiconductors, depreciation leads to more R&D investment that implies the effect of scale. For aggregate economy, depreciation reduces R&D investment more than interest rate, indicating obsolescence. Forecasting of R&D investment is improved at both industry and aggregate level. Forecastable time-varying depreciation, interest rate and price growth predict R&D investment based on the estimated demand function. The in-sample forecast comparison for 2015–2019 confirms the superiority to the alternative methods. Out-of-sample forecasts of R&D investment are carried out through 2025, and R&D capital stocks are constructed across industries and aggregate U.S. economy.

Shadow insurance is a regulatory loophole exploited by certain insurance groups to increase risk exposure, potentially destabilising the financial system. In this paper, we evaluate the contribution of shadow insurance to systemic risk of the global financial sector using a sample of 215 international insurance entities covering the 2004–2017 period. We detect shadow insurance by examining every reinsurance agreement on the Schedule S filings. Using both ΔCoVaR and SRISK measures, we find that the practice of shadow insurance is a significant driver of global systemic risk.

This study investigates whether deposit insurance affects bank payout policy. To overcome identification concerns, we use the US Emergency Economic Stabilization Act of 2008, which increased the maximum limit of deposit insurance coverage, leading to significant changes in the proportion of insured deposits to assets of some banks, while leaving others relatively unaffected. In line with the view that dividends convey information regarding financial health, we find that banks, which experience a substantial increase in insured deposits reduce dividends relative to others with a smaller increase in insured deposits. An extensive battery of further tests confirm that our results are not driven by events (such as capital injections due to participation in the Trouble Asset Relief Program, peer effects, state tax changes, deposit insurance pricing changes) that took place around the time of the increase in the maximum limit of deposit insurance coverage. Overall, the results of our empirical analysis suggest that banks holding fewer uninsured deposits pay less dividends.

This paper investigates the effectiveness of macroprudential policy to contain the systemic risk of European banks between 2000 and 2017. We use a new database (MaPPED) collected by experts at the ECB and national central banks with narrative information on a broad range of instruments which are tracked over their life cycle. Using a dynamic panel framework at a monthly frequency we assess the impact of macroprudential tools and their design on the banks’ systemic risk both in the short and the long run. We furthermore decompose the systemic risk measure in an individual bank risk component and a systemic linkage component. This is of particular interest because microprudential policy focuses on the tail risk of an individual bank while macroprudential policy targets systemic risk by addressing the interlinkages and common exposures across banks. In general, the announcements of macroprudential policy actions have a downward effect on bank systemic risk. On average, all banks benefit from macroprudential tools in terms of their individual risk. We find that credit growth tools and exposure limits exhibit the most pronounced downward effect on the individual risk component. However, we find evidence for a risk-shifting effect which is more pronounced for retail-oriented banks. The effects are heterogeneous across banks with respect to the systemic linkage component. Liquidity tools and measures aimed at increasing the resilience of banks decrease the systemic linkage of banks. Moreover, these tools appear to be most effective for distressed banks. Our results have implications for the optimal design of macroprudential instruments.

We analyse minute-level multi-dimensional information flows within and between bitcoin spot and derivatives. We show that perpetual swaps and futures traded on the unregulated exchanges Huobi, OKEx and BitMEX are much the strongest instruments for bitcoin price discovery and we examine potential determinants of their leadership strength. Prices on the regulated CME bitcoin futures and the US-based spot exchanges react to, rather than lead, price movements on the unregulated exchanges and they may do so relatively slowly. In a multi-dimensional setting including the main price leaders within futures, perpetuals and spot markets, the CME futures have a very minor effect on price discovery, even less than the spot exchanges Bitfinex, Bitstamp and Coinbase. Our findings highlight the persistent problems stemming from inconsistent regulation in bitcoin spot and derivatives markets, including insufficient price stability and lack of resistance to manipulative trading. We conclude that the SEC are correct to maintain such issues as their main concern for bitcoin ETF applications.