We study whether regulators should reveal stress test results which contain imperfect information about banks’ financial health. Although disclosure restores market confidence in banks, it misclassifies some healthy banks as risky. This encourages banks to choose portfolios that are deemed safe by regulators, leading to model monoculture and making the financial system less diversified. Optimal policy involves a commitment to reveal stress test results only when adverse selection problems are very severe or very mild. Where possible, stress tests should be designed to avoid predictable bias against particular portfolios, even at the cost of reducing average accuracy.
{"title":"Stress Tests and Model Monoculture","authors":"Keshav Dogra, Kee-Choon Rhee","doi":"10.2139/ssrn.3208233","DOIUrl":"https://doi.org/10.2139/ssrn.3208233","url":null,"abstract":"We study whether regulators should reveal stress test results which contain imperfect information about banks’ financial health. Although disclosure restores market confidence in banks, it misclassifies some healthy banks as risky. This encourages banks to choose portfolios that are deemed safe by regulators, leading to model monoculture and making the financial system less diversified. Optimal policy involves a commitment to reveal stress test results only when adverse selection problems are very severe or very mild. Where possible, stress tests should be designed to avoid predictable bias against particular portfolios, even at the cost of reducing average accuracy.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"13 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-07-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"133923269","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
By using unique hand-collected project-level investment data, we show that lengthy equity issuance regulation is positively related to the probability of subsequent project changes and a deterioration in project returns. The effects are more pronounced for firms in a highly competitive industry and with a comparative disadvantage. We further establish that this relationship is causal by exploiting the exogenous shock to approval delay caused by changes in the China Securities Regulation Commission chairman. In response, equity issuers mitigate the delay impact by temporarily increasing short-term debt. Finally, we show that the traditional firm-level investment data fail to detect such effects.
{"title":"Missing the Boat: Lengthy Regulatory Approval Diminishes Investment Opportunities at the Project Level","authors":"Qiaozhi Ye, Ronghong Huang, Kelvin Jui Keng Tan","doi":"10.2139/ssrn.3643380","DOIUrl":"https://doi.org/10.2139/ssrn.3643380","url":null,"abstract":"By using unique hand-collected project-level investment data, we show that lengthy equity issuance regulation is positively related to the probability of subsequent project changes and a deterioration in project returns. The effects are more pronounced for firms in a highly competitive industry and with a comparative disadvantage. We further establish that this relationship is causal by exploiting the exogenous shock to approval delay caused by changes in the China Securities Regulation Commission chairman. In response, equity issuers mitigate the delay impact by temporarily increasing short-term debt. Finally, we show that the traditional firm-level investment data fail to detect such effects.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"17 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-07-04","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122072135","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Central bank’s macroprudential supervisory activities have to fulfill three distinct tasks: (i) assessing the banking system’s vulnerability to exogenous adverse turbulence, (ii) evaluating the risk of systemic crisis originating from idiosyncratic shocks, and (iii) measuring financial market’s sensitivity to policy stimuli. Given that macroprudential stress tests are the centerpiece of this policy approach, it is important to establish whether they are up to the task. We study how the 2011–2018 European Banking Authority stress tests affected market risk perception and show that they provided agents with valuable information on the policy stances and the vulnerabilities of the banking system, carrying out the above tasks successfully, especially the second and third tasks.
{"title":"Macroprudential Supervision and Agents’ Information: What Stress Tests Really Tell the Markets","authors":"Fausto Pacicco, Luigi Vena, A. Venegoni","doi":"10.2139/ssrn.3630091","DOIUrl":"https://doi.org/10.2139/ssrn.3630091","url":null,"abstract":"Central bank’s macroprudential supervisory activities have to fulfill three distinct tasks: (i) assessing the banking system’s vulnerability to exogenous adverse turbulence, (ii) evaluating the risk of systemic crisis originating from idiosyncratic shocks, and (iii) measuring financial market’s sensitivity to policy stimuli. Given that macroprudential stress tests are the centerpiece of this policy approach, it is important to establish whether they are up to the task. We study how the 2011–2018 European Banking Authority stress tests affected market risk perception and show that they provided agents with valuable information on the policy stances and the vulnerabilities of the banking system, carrying out the above tasks successfully, especially the second and third tasks.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-06-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130559722","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2020-06-08DOI: 10.36639/MBELR.10.1.EQUITY
P. Mahoney
Over the past half century, the SEC’s regulations have become key determinants of the way in which stocks trade and the fees that exchanges charge for their services. The current equity market structure rules are contained primarily in the SEC’s Regulation NMS. The theory behind Regulation NMS is that a system of dispersed markets operating pursuant to SEC-mandated information and order routing links will provide the benefits of consolidation and competition simultaneously. This paper argues that Regulation NMS has failed in that quest. It has produced fragmented markets and created questionable incentives for market participants, possibly producing socially excessive investments in speed and secrecy. It discourages exchange innovation, provides insufficient incentives for traders to price orders aggressively, requires brokers to act against their customers’ interests, and forces the SEC to act as a price regulator. The paper contends that the SEC should replace Regulation NMS with three simple design principles—issuer choice, exchange autonomy, and regulatory consistency. These would allow market forces rather than regulatory mandates to determine the design and pricing of trading platforms and the trading strategies of broker-dealers. They would better align the private incentives of trading platforms with the social objectives of improving liquidity and price discovery.
{"title":"Equity Market Structure Regulation: Time to Start Over","authors":"P. Mahoney","doi":"10.36639/MBELR.10.1.EQUITY","DOIUrl":"https://doi.org/10.36639/MBELR.10.1.EQUITY","url":null,"abstract":"Over the past half century, the SEC’s regulations have become key determinants of the way in which stocks trade and the fees that exchanges charge for their services. The current equity market structure rules are contained primarily in the SEC’s Regulation NMS. The theory behind Regulation NMS is that a system of dispersed markets operating pursuant to SEC-mandated information and order routing links will provide the benefits of consolidation and competition simultaneously. \u0000 \u0000This paper argues that Regulation NMS has failed in that quest. It has produced fragmented markets and created questionable incentives for market participants, possibly producing socially excessive investments in speed and secrecy. It discourages exchange innovation, provides insufficient incentives for traders to price orders aggressively, requires brokers to act against their customers’ interests, and forces the SEC to act as a price regulator. \u0000 \u0000The paper contends that the SEC should replace Regulation NMS with three simple design principles—issuer choice, exchange autonomy, and regulatory consistency. These would allow market forces rather than regulatory mandates to determine the design and pricing of trading platforms and the trading strategies of broker-dealers. They would better align the private incentives of trading platforms with the social objectives of improving liquidity and price discovery.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-06-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115722478","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Abstract This paper investigates whether financial reforms promote entrepreneurship. Using a panel of 41 developed and developing countries from around the world, we find that financial sector reforms are positively associated with early-stage entrepreneurial activity. In a variety of robustness checks, including a falsification test, we fail to find the evidence that this relationship is driven due to the omission of unobserved, country-specific factors. Investigating the relationship between reforms in different dimensions of the financial sector and entrepreneurship, we find reforms in directed credit, credit controls, banking supervision, and international capital flows dimensions to be significantly associated with early-stage entrepreneurial activity.
{"title":"Do Financial Reforms Promote Entrepreneurship?","authors":"C. Jha, Rafiqul Bhuyan","doi":"10.2139/ssrn.3700246","DOIUrl":"https://doi.org/10.2139/ssrn.3700246","url":null,"abstract":"Abstract This paper investigates whether financial reforms promote entrepreneurship. Using a panel of 41 developed and developing countries from around the world, we find that financial sector reforms are positively associated with early-stage entrepreneurial activity. In a variety of robustness checks, including a falsification test, we fail to find the evidence that this relationship is driven due to the omission of unobserved, country-specific factors. Investigating the relationship between reforms in different dimensions of the financial sector and entrepreneurship, we find reforms in directed credit, credit controls, banking supervision, and international capital flows dimensions to be significantly associated with early-stage entrepreneurial activity.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"8 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-05-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122528634","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine the impact of interest rates benchmark reform and upcoming Libor transition on options markets. We address various modelling challenges the transition brings. We specifically focus on the impact of the clearing houses' discounting switch on swaptions, and the consequences of Libor transition on Libor-in-arrears swaps, caps, and range accruals as typical representatives of a very wide range of Libor derivatives.
{"title":"Interest Rates Benchmark Reform and Options Markets","authors":"Vladimir V. Piterbarg","doi":"10.2139/ssrn.3537925","DOIUrl":"https://doi.org/10.2139/ssrn.3537925","url":null,"abstract":"We examine the impact of interest rates benchmark reform and upcoming Libor transition on options markets. We address various modelling challenges the transition brings. We specifically focus on the impact of the clearing houses' discounting switch on swaptions, and the consequences of Libor transition on Libor-in-arrears swaps, caps, and range accruals as typical representatives of a very wide range of Libor derivatives.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"41 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-02-14","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114402973","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The European Union introduced Regulation 236/2012 in 2012 to address short selling and certain aspects of credit default swaps (CDS). Consequently, a uniform short position disclosure regime was developed, which is used in this paper to examine CDS spreads as a proxy for credit risk around public short sale announcements and evaluate the disclosure policy’s relevance from the debtholder’s perspective. Existing literature documents short selling regulations’ impacts on the stock market, but no evidence exists from the CDS market. Therefore, we first conduct an event study to examine the effects of different short sale events on corresponding firms’ CDS spreads between 2012 and 2018. Moreover, we use regression analyses to control for several credit risk determinants that may also affect CDS spreads. Our evidence suggests that opening and increasing short positions are perceived as negative information, and in this regard lead to higher CDS spreads. In contrast, CDS spreads tend to be lower if short positions decrease or close. Additionally, we find that negative information ceteris paribus more strongly affects CDS spreads than positive information. Finally, we investigate certain anticipatory reactions when negative news enters the CDS market.
{"title":"The European Union’s Short Selling Regulation and Its Impact on CDS Spreads","authors":"Denisa Lleshaj, Jannik Kocian","doi":"10.2139/ssrn.3574067","DOIUrl":"https://doi.org/10.2139/ssrn.3574067","url":null,"abstract":"The European Union introduced Regulation 236/2012 in 2012 to address short selling and certain aspects of credit default swaps (CDS). Consequently, a uniform short position disclosure regime was developed, which is used in this paper to examine CDS spreads as a proxy for credit risk around public short sale announcements and evaluate the disclosure policy’s relevance from the debtholder’s perspective. Existing literature documents short selling regulations’ impacts on the stock market, but no evidence exists from the CDS market. Therefore, we first conduct an event study to examine the effects of different short sale events on corresponding firms’ CDS spreads between 2012 and 2018. Moreover, we use regression analyses to control for several credit risk determinants that may also affect CDS spreads. Our evidence suggests that opening and increasing short positions are perceived as negative information, and in this regard lead to higher CDS spreads. In contrast, CDS spreads tend to be lower if short positions decrease or close. Additionally, we find that negative information ceteris paribus more strongly affects CDS spreads than positive information. Finally, we investigate certain anticipatory reactions when negative news enters the CDS market.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-01-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127209364","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Based on European RMBS deals with 24 million quarterly loan observations, we examine the effect of risk retention on bank behavior. Using OLS, propensity score matching, and instrumental variable regressions, we examine why retention deals perform better. Analyzing monitoring effort and the workout process, we find that the probability of rating updates or collateral revaluations is higher, and the rating quality is better. Retention loans have a lower probability of becoming non-performing, a lower delinquency amount, and a shorter time in arrears. Moreover, non-performing and defaulted retention loans are more likely to recover. We observe that total losses are lower for deals with retention, which are driven by lower default rates, lower exposures at default, and higher recovery rates. Overall, our results suggest that retention reduces moral hazard and incentivizes banks to exert higher effort, which results in superior securitized asset performance.
{"title":"The Impact of Skin in the Game on Bank Behavior in the Securitization Market","authors":"Martin Hibbeln, W. Osterkamp","doi":"10.2139/ssrn.3528090","DOIUrl":"https://doi.org/10.2139/ssrn.3528090","url":null,"abstract":"Based on European RMBS deals with 24 million quarterly loan observations, we examine the effect of risk retention on bank behavior. Using OLS, propensity score matching, and instrumental variable regressions, we examine why retention deals perform better. Analyzing monitoring effort and the workout process, we find that the probability of rating updates or collateral revaluations is higher, and the rating quality is better. Retention loans have a lower probability of becoming non-performing, a lower delinquency amount, and a shorter time in arrears. Moreover, non-performing and defaulted retention loans are more likely to recover. We observe that total losses are lower for deals with retention, which are driven by lower default rates, lower exposures at default, and higher recovery rates. Overall, our results suggest that retention reduces moral hazard and incentivizes banks to exert higher effort, which results in superior securitized asset performance.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"17 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-01-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123270604","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Underwriting is the most common allocation mechanism for IPOs. Despite its diffusion, underwriting suffers from underpricing which is ultimately “money left on the table” that negatively influences the health of a company. For this reason, capital markets have identified some tools to reduce underpricing. The lockup period provision is one of them. Notwithstanding its widespread use during IPOs, lockups are neither regulated nor fixed by any financial authorities. This paper investigates the reasons why financial regulators should make the lockup clause a compulsory requirement for listing and should extend its length further than the current average.
{"title":"Effects of a Long Mandatory Lockup Period on IPOs Underwriting","authors":"Riccardo Bazan","doi":"10.2139/ssrn.3514886","DOIUrl":"https://doi.org/10.2139/ssrn.3514886","url":null,"abstract":"Underwriting is the most common allocation mechanism for IPOs. Despite its diffusion, underwriting suffers from underpricing which is ultimately “money left on the table” that negatively influences the health of a company. For this reason, capital markets have identified some tools to reduce underpricing. The lockup period provision is one of them. Notwithstanding its widespread use during IPOs, lockups are neither regulated nor fixed by any financial authorities. This paper investigates the reasons why financial regulators should make the lockup clause a compulsory requirement for listing and should extend its length further than the current average.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-01-06","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126145814","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper proposes a novel approach to understand contagion of financial distress in the banking system, which takes into account the spatial nature of the phenomena. We use a Bayesian spatial autoregressive model that treats the likelihood of default of each bank as endogenous, and dependent on the network formed by all the other banks. Identification is achieved by controlling for bank fundamentals, latent macrofinancial and bank specific shocks that have similar consequences to contagion and act as confounding factors. Through the lens of a simulations exercise we study the importance of the structure of financial networks for financial stability, shedding light on the empirical adherence of important theoretical propositions that remain untested.
{"title":"Contagion, Not Only Interconnection: Measuring the Transmission of Financial Distress","authors":"Miguel C. Herculano","doi":"10.2139/ssrn.3849230","DOIUrl":"https://doi.org/10.2139/ssrn.3849230","url":null,"abstract":"This paper proposes a novel approach to understand contagion of financial distress in the banking system, which takes into account the spatial nature of the phenomena. We use a Bayesian spatial autoregressive model that treats the likelihood of default of each bank as endogenous, and dependent on the network formed by all the other banks. Identification is achieved by controlling for bank fundamentals, latent macrofinancial and bank specific shocks that have similar consequences to contagion and act as confounding factors. Through the lens of a simulations exercise we study the importance of the structure of financial networks for financial stability, shedding light on the empirical adherence of important theoretical propositions that remain untested.","PeriodicalId":414741,"journal":{"name":"Econometric Modeling: Financial Markets Regulation eJournal","volume":"22 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130122422","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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