Knowledge that Transforms

In recent years, mergers, acquisitions and organic growth have meant that some of the largest and most complex financial groups have come to transcend national boundaries and traditionally defined business-lines. As a result, they have become a potential channel for the cross-border and cross-market transmission of financial shocks. This paper analyses the degree of comovement in the equity prices of a selected group of large complex financial institutions (LCFIs), and assesses the extent to which movements are driven by common factors. A relatively high degree of commonality is found for most LCFIs although there are still noticeable divisions between sub-groups of LCFIs, both according to geography and to a lesser extent primary business-line.

In the literature on currency and banking crises it has become the standard procedure to distinguish pure currency crises, pure banking crises and combined (“twin”) currency and banking crises. We show theoretically and empirically that a similar differentiation should be chosen with regard to currency and debt crises. Twin currency and debt crises differ from both pure currency and pure debt crises in their determinants, course of events, and economic consequences. We find that each type of crises has a unique set of macroeconomic causes. We also identify internal contagion and selection bias effects, which may lead to biased empirical estimates if twin crises are not treated as a specific type of crises. Such a separation allows in significantly improving the efficiency of early warning systems especially for debt and twin crises.

Outright bank failures without prior indication of financial instability are very rare. In fact, banks can be regarded as troubled to varying degrees before outright closure. But failure studies usually neglect the ordinal nature of bank distress. We distinguish four different kinds of increasingly severe events on the basis of the distress database of the Deutsche Bundesbank. Only the worst distress event entails a bank to exit the market. Since the four categories of hazard functions are not proportional, we specify a generalized ordered logit model to estimate respective probabilities of distress simultaneously. We find that the likelihood of ordered distress events changes differently in response to given changes in the financial profiles of banks. Consequently, bank failure studies should account more explicitly for the different shades of distress. This allows an assessment of the relative importance of financial profile components for different degrees of bank distress.

This paper provides a detailed descriptive analysis of multiple-plan Chapter 11 reorganizations and an empirical study of the determinants of multiple-plan adoption. In the presence of imperfect and asymmetric information multiple plans are a result of extended bargaining that facilitates the convergence of beliefs and resolution of incentives. The longer time in bankruptcy leads to costs that concern all claimants and affect recovery rates and deviations from absolute priority rules. The delay to reach a settlement is mainly due to firm valuation uncertainty, creditor coordination problems, shareholders receiving some consideration in the first plan, and presence of DIP financing.

This paper investigates the use of exit consents in a sample of bond exchange offers during 1986–1997. We find that exit consents are common, approximately 56% of the exchange offers in our sample have them and 60% of the exit consents are by non-financially distressed firms. Using a probit model, we find that a set of variables that proxy for holdout problems is able to significantly explain the use of exit consents. Reducing holdouts is necessary for timely and efficient debt restructurings and achieving financial stability particularly in sovereign debt markets.

Although IMF support is supposed to benefit a country, it might be bad news that the IMF believes intervention is necessary. This paper analyzes a bank run model in which both the liquidity effect and the signalling effect of the intervention occur. The IMF strategically provides liquidity support to facilitate market functioning. When the IMF intervenes and has large resources, it uses the signalling to aim for a “half run” and off-sets the negative consequences with the liquidity support. For small IMF resources, the negative signalling effect might not be off-set and the IMF presence can be distorting.

Large bank failures are often handled differently to other firm failures because suddenly closing a large bank and consequently freezing otherwise liquid claims raises financial stability concerns. As a result, substantial public funds are often used as part of the resolution process, which can undermine market discipline and longer-term financial stability. We propose a resolution scheme that enables the good portion of creditors’ claims to be quickly made available to them in way that maintains market discipline while managing the liquidity effects of large bank failures. We report on a New Zealand study into making the scheme work in practice.

In the dynamic model of banking, a bank's option to hide its loan losses by rolling over non-performing loans is shown to worsen moral hazard. Contrary to the classic theory, moral hazard may arise even when a bank cannot seek a correlated risk for its loans. The loans seem to be performing and the bank makes a profit although it is de facto insolvent. When the bank's balance sheet includes hidden non-performing loans, the bank may optimally shrink lending or gamble for resurrection by growing aggressively. To eliminate this type of moral hazard, which is broadly consistent with evidence from emerging economies, a few regulatory implications are suggested.

We estimate probabilities of bankruptcy for 5784 industrial firms in the period 1988–2002 in a model where common equity is viewed as a down-and-out barrier option on the firm's assets. Asset values and volatilities as well as firm-specific bankruptcy barriers are simultaneously backed out from the prices of traded equity. Implied barriers are significantly positive and monotonic in the firm's leverage and asset volatility. Our default probabilities display better calibration and discriminatory power than the ones inferred in a standard Black and Scholes [Black, F., Scholes, M., 1973. The pricing of options and corporate liabilities. J. Pol. Econ. 81, 637–659]/Merton [Merton, R.C., 1974. On the pricing of corporate debt: the risk structure of interest rates. J. Finance 29, 449–470] and KMV frameworks. However, accounting-based measures such as Altman Z- and Z″-scores outperform structural models in 1-year-ahead bankruptcy predictions, but lose relevance as the forecast horizon is extended.