Knowledge that Transforms

Previous studies of consumer debt risk estimate low sensitivities to negative shocks, contradicting the historical data. This work proposes a heterogeneous agents model of household finances and credit risk. Families suffer labor income shocks and choose from a menu of loans contracts, defaulting on debt commitments when unable to finance minimum consumption standards. Using a variety of survey data I simulate household credit default for Chile over the last 20 years, replicating successfully the highs and lows of consumer delinquency. Some households are shown to be highly vulnerable to changes in interest rates, credit maturities and liquidity.

We study the sensitivity of banks’ credit supply to small and medium size enterprises (SMEs) in the UK with respect to the banks’ financial condition before and during the financial crisis. Employing unique data on the geographical location of all bank branches in the UK, we connect firms’ access to bank credit to the financial condition (i.e., bank health and the use of core deposits) of all bank branches in the vicinity of the firm for the period 2004–2011. Before the crisis, banks’ local financial conditions did not influence credit availability irrespective of the functional distance (i.e., the distance between bank branch and bank headquarters). However, during the crisis, we find that SMEs with banks within their vicinity that have stronger financial conditions faced greater credit availability when the functional distance is close. Our results point to a “flight to headquarters” effect during the financial crisis.

Using the test of Granger-causality in tail of Hong et al. (2009), we define and construct Granger-causality tail risk networks between 33 systemically important banks (G-SIBs) and 36 sovereign bonds worldwide. Our purpose is to exploit the structure of the Granger-causality tail risk networks to identify periods of distress in financial markets and possible channels of systemic risk propagation. Combining measures of connectedness of these networks with the ratings of the sovereign bonds, we propose a flight-to-quality indicator to identify periods of turbulence in the market. Our measure clearly peaks at the onset of the European sovereign debt crisis, signaling the instability of the financial system. Finally, we use the connectedness measures of the networks to forecast the quality of sovereign bonds. We find that connectedness is a significant predictor of the cross-section of bond quality.

Capturing financial network linkages and contagion in stress test models are important goals for banking supervisors and central banks responsible for micro- and macroprudential policy. However, granular data on financial networks is often lacking, and instead the networks must be reconstructed from partial data. In this paper, we conduct a horse race of network reconstruction methods using network data obtained from 25 different markets spanning 13 jurisdictions. Our contribution is two-fold: first, we collate and analyze data on a wide range of financial networks. And second, we rank the methods in terms of their ability to reconstruct the structures of links and exposures in networks.

This paper analyzes sovereign risk shift-contagion, i.e. positive and significant changes in the propagation mechanisms, using bond yield spreads for the major eurozone countries. By emphasizing the use of two econometric approaches based on quantile regressions (standard quantile regression and Bayesian quantile regression with heteroskedasticity) we find that the propagation of shocks in euro's bond yield spreads shows almost no presence of shift-contagion in the sample periods considered (2003–2006, Nov. 2008–Nov. 2011, Dec. 2011–Apr. 2013). Shock transmission is no different on days with big spread changes and small changes. This is the case even though a significant number of the countries in our sample have been extremely affected by their sovereign debt and fiscal situations. The risk spillover among these countries is not affected by the size or sign of the shock, implying that so far contagion has remained subdued. However, the US crisis does generate a change in the intensity of the propagation of shocks in the eurozone between the 2003–2006 pre-crisis period and the Nov. 2008–Nov. 2011 post-Lehman one, but the coefficients actually go down, not up! All the increases in correlation we have witnessed over the last years come from larger shocks and the heteroskedasticity in the data, not from similar shocks propagated with higher intensity across Europe. These surprising, but robust, results emerge because this is the first paper, to our knowledge, in which a Bayesian quantile regression approach allowing for heteroskedasticity is used to measure contagion. This methodology is particularly well-suited to deal with nonlinear and unstable transmission mechanisms especially when asymmetric responses to sign and size are suspected.

Whereas macroprudential policy has come to the fore since the Global Financial Crisis, with many regulators being given responsibility for such policy, the appropriate tools and the effectiveness of such tools remain open questions. We suggest that existing work on effectiveness of macroprudential policy may be vulnerable to bias due to omission of long run cointegration effects. This paper seeks to offer a fresh baseline for work in this area by adopting a cointegration framework which is robust to a variety of alternative techniques and compares favourably with non-cointegrated alternatives. We assess the impact of typical macroprudential policy interventions on house price and household credit growth in up to 19 OECD countries, using three datasets from the IMF and BIS, thus giving both a wider range of control variables and broader coverage of instruments than in most extant work. We find evidence that macroprudential polices remain effective in both short- and long-run at curbing house price and household credit growth even within a cointegration framework, albeit some tools are more effective than others. These include, in particular, taxes on financial institutions, general capital requirements, strict loan-to-value ratios and debt-to-income ratio limits.

Widespread bank losses during the financial crisis have raised concerns that equity-based compensation for bank CEOs causes excessive risk-taking. Debt-based compensation, so-called inside debt, aligns the interests of CEOs with those of external creditors. We examine whether inside debt induces CEOs to pursue less risky acquisitions. Consistent with this, we show that acquisitions announced by CEOs with high inside debt incentives are associated with a wealth transfer from equity to debt holders. After the completion of a deal, banks where acquiring CEOs have high inside debt incentives display lower market measures of risk and lower loss exposures for taxpayers.

This paper studies the effect of information disclosure on banks’ portfolio risk. We cast a simple banking system into a general equilibrium model with trading frictions. We find that the information disclosure lowers the expected risk-adjusted profits for a non-negligible fraction of banks. The magnitude of this effect depends on the structure of the banking system and, alarmingly, it is more pronounced for systemically important institutions. We connect these theoretical findings to the stress test procedure, where bank information is disclosed by the regulator. The 2011 and 2014 stress tests are used in an empirical study to further support our theoretical results.

A typical argument in the literature is that Corporate Social Responsibility (CSR) reduces the risk of conflicts with stakeholders. In accordance to this, we test whether: (i) domain specific CSR portfolios present pricing anomalies that could be captured by the introduction of risk factors accounting for exposition to stakeholder risk, (ii) this risk source is priced in the cross-section of stock returns. In doing so we are particularly cautious in disentangling the contributions of different CSR domains in generating the pricing anomalies. Our findings show the existence of pricing anomalies related to CSR, which vary in numbers across all the domains under analysis. Even if our domain-specific CSR risk factors are not able to capture all pricing anomalies, we find that they reduce their absolute value. Additionally, our results show that the stakeholder risk is priced in the cross-section of returns, and that such additional risk source presents different premiums for each domain.

This paper checks how international spillovers of shocks and policies are modified when banks are foreign owned. To this end we build a two-country macroeconomic model with banking sectors that are owned by residents of one (big and foreign) country. Consistently with empirical findings, in our model foreign ownership of banks amplifies spillovers from foreign shocks. It also strengthens the international transmission of monetary and macroprudential policies . We next use the model to replicate the financial crisis in the euro area and show how, by preventing bank capital outflow in 2009, the Polish regulatory authorities managed to reduce its contagion to Poland. We also find that under foreign bank ownership such policy is strongly preferred to a recapitalization of domestic banks. Finally, we check how foreign ownership of banks affects transmission of domestic shocks to find that it has a stabilizing effect.