This paper provides a theory of debt and hedging based on human capital. We distinguish human capital from physical capital in two ways: (1) human capital is inalienable and can exercise a one-sided option to leave the firm and (2) human capital is not perfectly replaceable. We show that a firm may reach the first best solution while issuing debt or equity to outsiders provided that either the insiders receive a senior claim or that the firm hedges. We then show that given asymmetric information concerning costs the only viable solution has the firm issuing debt to outsiders and hedging.

We examine how community banks respond to liquidity shocks created by natural disasters. We address community banks’ responses to liquidity shocks due to their focused geographic and economic presence, which coincide with their communities’ exposure to the disasters and the ability of the local banks to meet their needs. We find that community banks respond to liquidity shocks by managing their balance sheet, rather than any single balance sheet account. In particular, we find that they respond to the liquidity needs of their communities by increasing loans as deposits are withdrawn.

In November 2011, the Financial Stability Board, in collaboration with the International Monetary Fund, published a list of 29 "systemically important financial institutions" (SIFIs, now referred to as "globally systemically important banks" or G-SIBs), institutions whose failure, by virtue of "their size, complexity, and systemic interconnectedness", could have dramatic negative consequences for the global financial system. While "size" and "interconnectedness" have been the subject of much quantitative analysis, less attention has been paid to measuring "complexity." Yet without a consistent way to measure complexity, there is little guarantee that the designated SIFIs capture the complexity that the FSB is concerned about, and little hope of mitigating the consequences that the FSB warns of. In this paper we propose the structure of an individual firm's majority-control hierarchy as a proxy for institutional complexity. We demonstrate as a proof-of-concept how this method might be used by bank supervisors, particularly the Federal Reserve under its authority as consolidated supervisor, using a data set containing information on the majority-control hierarchies of many of the designated SIFIs. Our mathematical intrafirm network representation (and various associated metrics we propose) provides a uniform way to compare firms with often very disparate organizational structures – one that is distinct from a simple size comparison.

Using global data on syndicated loans, we show that any negative effect of stronger creditor rights on loan spreads, as identified in the prior literature (Qian and Strahan, 2007; Bae and Goyal, 2009), disappears once we include a single country characteristic: country size. This finding is robust to several identification methods, both global samples and within-country changes in creditor rights, different panel spans, and hundreds of control variables. We identify that key origins of the effect of country size on loan pricing are ethnic fractionalization and within-country heterogeneity in economic preferences, which create country risk.

Standard banking theory suggests that there exists an optimal level of credit risk that yields maximum bank profit. We identify the optimal level of risk-weighted assets that maximizes banks’ returns in the full sample of US banks over the period 1996–2011. We find that this optimal level is cyclical for the average bank, being higher than the realized credit risk in relatively stable periods with high profit opportunities for banks but quickly decreasing below the realized in periods of turmoil. We place this cyclicality into the nexus between bank risk and monetary policy. We show that a contractionary monetary policy in stable periods, where the optimal credit risk is higher than the realized credit risk, increases the gap between them. An increase in this gap also comes as a result of an expansionary monetary policy in bad economic periods, where the realized risk is higher than the optimal risk.

We analyze financial support for the entrepreneurial sector. State support can raise welfare by relaxing financial constraints, but it can also reduce lending standards if entrepreneurs substitute public sources of collateral for their own assets, if it encourages excessive entrepreneurial entry, or if it undermines bank monitoring incentives. We derive a “pecking order” for support schemes: support funds should be channeled first to credit guarantee schemes and then, when entrepreneurs start to substitute public for private collateral, to co-funding entrepreneurial projects. The optimal level of credit guarantee is diminishing in the costs of incentivising bank monitoring. We show in an extension that the long-term effect of public subsidies may be to impair the private sector’s initiative to uncover cost savings.

We construct a measure of systemic vulnerability in selected EU banking systems using an indirect, time-varying measure of the system covariance. Systemic vulnerability indicates the extent to which a banking system as a whole is sensitive to a negative shock. We proceed to examine to what extent the resulting measures of systemic vulnerability provide a convincing narrative of events during the period January 2000 to April 2016. The results provide evidence of: (i) rising vulnerability prior to the outbreak of the international financial crisis in 2007/08 in countries with banks exposed to toxic assets; (ii) vulnerability associated with the euro area sovereign debt crisis from 2009/10; and (iii) continued concerns from 2013 onwards regarding the need for euro area banks to improve their balance sheets and raise new capital at a time of sluggish profitability.

We quantify the linkages among banks’ equity performance and indicators of sovereign stress by using panel GMM to estimate a three-equation system that examines the impact of sovereign stress, as reflected in both sovereign spreads and sovereign ratings, on bank share prices. We use data for a panel of five euro-area stressed countries. Our findings indicate that a recursive relationship between sovereigns and banks operated during the euro-area crisis. Specifically, for the five crisis countries considered shocks to sovereign spreads fed-through to sovereign ratings, which affected commercial banks’ equity-prices. Our results also point to the importance of using levels of equity prices – rather than rates of return – in measuring banks’ performance. The use of levels allows us to derive the determinants of long-run equity prices.

We study an equilibrium risk and return model to explore the effects of the coronavirus crisis and associated skewness on the market price of risk. We derive the moment and equilibrium equations, specifying skewness price of risk as an additive component of the effect of variance on mean expected return. We estimate our model using the flexible skewed generalized error distribution, for which we derive the distribution of returns and the likelihood function. Using S&P 500 Index returns from January 1980 to mid-October 2020, our results show that the coronavirus crisis generated a deeply negative reaction in the skewness and total market price of risk, more negative even than the subprime and the October 1987 crises.

Do climate-oriented regulatory policies affect the flow of credit towards polluting firms? We match loan-level data to firm-level greenhouse gas emissions to assess the impact of the Paris Agreement. We find that, following this agreement, European banks reallocated credit away from polluting firms in relative terms. Specifically, euro area banks’ loan share to more polluting firms decreased by about 3percentage points compared to less polluting (or “green”) firms after the 2015 Paris Agreement (COP21). This result is stronger for banks that are well capitalized, have lower credit quality, and are less profitable.