Liquidity Coinsurance and Bank Capital

Size: px
Start display at page:

Download "Liquidity Coinsurance and Bank Capital"

Transcription

1 Liquidity Coinsurance and Bank Capital Fabio Castiglionesi y Fabio Feriozzi z Gyöngyi Lóránth x Loriana Pelizzon { March 2011 Abstract This paper analyzes whether banks use their capital to deal with liquidity uncertainty that cannot be coinsured in the interbank market. To the extent that the remuneration of capital is exible it can be adjusted to face such liquidity uncertainty. Hence, bank capital can have a risk-sharing role as it can be used to transfer bank liquidity risk to well diversi ed investors. Bank capital and the interbank market therefore can act as substitutes, implying a negative relationship between these variables. We show that banks tend to postpone the remuneration of capital when they are hit by liquidity shocks that cannot be coinsured in the interbank market. This mechanism generates a negative relationship between a bank s activity in the interbank market and its short-term variation in bank capital. We test these predictions in a large sample of US banks and nd support for the risk-sharing role of bank capital. Similar results also hold in a sample of European and Japanese banks taken from Bankscope. JEL Classi cation: G21. Keywords: Bank Capital, Interbank Markets, Liquidity Coinsurance. We thank Christa Bouwman, Fabio Braggion, Hans Degryse, Robert Hauswald, Enisse Kharroubi, Jose Jorge, Vasso Ioannidou and seminar participants at Deutsche Bundesbank Conference Liquidity and Liquidity Risk, ELSE-UCL Workshop in Financial Economics: Markets and Institutions, Frias-CEPR Conference Information, Liquidity and Trust in Incomplete Financial Markets, Fourth Swiss Winter Conference on Financial Intermediation (Lenzerheide) for helpful comments. We also thank Mario Bellia and Marcella Lucchetta for excellent research assistance. The usual disclaimer applies. y CentER, EBC, Department of Finance, Tilburg University. fabio.castiglionesi@uvt.nl. z CentER, Department of Finance, Tilburg University. f.feriozzi@uvt.nl. x University of Vienna and CEPR. gyoengyi.loranth@univie.ac.at. { Univeristy Ca Foscari of Venice. pelizzon@unive.it. 1

2 1 Introduction One of the fundamental roles of the banking system is to transform liquid liabilities into illiquid assets. A necessary consequence of this function is that banks face a substantial amount of liquidity risk. 1 Banks can coinsure one another against the idiosyncratic liquidity shocks by lending to each other in the interbank market. However, the interbank market is unlikely to eliminate completely this uncertainty. This occurs mainly for two reasons. First, part of this liquidity risk is likely to be systematic and, by de nition, not possible to coinsure. Second, interbank markets are typically over the counter markets and based on a limited number of pre-established connections. So an idiosyncratic shock may be impossible to coinsure in the absence of such pre-established connections. 2 When a bank is unable to obtain resources in the interbank market, the occurrence of a liquidity shock might become problematic, and ultimately force the bank to liquidate some of its assets at a re sale price. To avoid this outcome, banks can use their capital to absorb the liquidity shock by postponing the payouts to their equityholders. The possibility for banks to transfer part of their liquidity uncertainty to their investors creates a risk-sharing role for bank capital. This form of liquidity risk sharing is indeed desirable if investors are well diversi ed, and it might represent an important function of bank capital. 3 Following Gale [17], we analyze a theoretical model of bank capital as risk-sharing device and derive empirical predictions that are tested in a sample of US, European and Japanese banks. The ndings are by and large consistent with the risk-sharing role of bank capital. We model an economy with two banks that collect deposits from risk-averse depositors and capital from risk-neutral investors. 4 Banks have access to two investment opportunities: A short-term liquid asset (a storage technology) and a long-term illiquid asset. The 1 Indeed banks are subject to liquidity risk on both side of their balance sheet. On the liability side, banks face uncertain withdrawals from depositors and, more generally, the risk of rolling over short-term debt. On the asset side, banks liquidity risk can be represented by delays in the repayment of granted loans. 2 Another reason why interbank markets might o er limited coinsurance opportunities is the presence of moral hazard or adverse selection problems (see Bhattacharya and Gale [5]) 3 Alternatively, bank capital can represent a bu er to protect against solvency shocks a ecting the asset side of banks balance sheet. Or it can mitigate the incentives to take excessive risk by banks shareholders (see, among the others, Brusco and Castiglionesi [7], and Morrison and White [23]). 4 We assume away any contractual imperfection and allow banks to o er fully contingent contracts to both depositors and investors. Among other things, this assumption prevents any role for bank capital as a bu er to prevent insolvency and it clari es its role as risk-sharing device for liquidity risk. 2

3 two banks have di erent depositor bases and face uncertain liquidity needs. Most of the time their liquidity shocks are idiosyncratic, but they also face some probability of receiving a symmetric liquidity shock. The two banks participate in an interbank market which allows them to coinsure against idiosyncratic liquidity shocks. However, the interbank market is of little help in case of a symmetric shock. We refer to liquidity risk that cannot be coinsured in the interbank market as undiversi able (liquidity) risk. The presence of undiversi able liquidity uncertainty creates a scope for the use of bank capital as a risksharing device. That is, some of the undiversi able risk can be transferred to risk-neutral investors. We assume that collecting resources from risk-neutral investors is costly, so that banks would have no capital were the liquidity uncertainty purely idiosyncratic. Clearly, the optimal level of capital crucially depends on the level of liquidity uncertainty that cannot be coinsured in the interbank market. We show by means of examples that this relationship might not be monotonic. In fact, while we would expect the optimal level of bank capital to decrease when the undiversi able uncertainty reduces, this only happens for some parameters con gurations. This is due to the fact that a reduction in undiversi able uncertainty also has an e ect on a bank s portfolio choices. In particular, a lower level of undiversi able uncertainty induces banks to reduce the investment in the liquid asset and, as in Castiglionesi et al. [8], this can produce higher consumption volatility for depositors. In this case, the optimal level of bank capital can increase because it helps moderate this volatility by transferring it to risk-neutral investors. An interesting insight that can be derived from this analysis is that the amount of liquidity uncertainty that a bank cannot insure in the interbank market can be an important determinant of bank capital. To the extent that such risk is a persistent bank characteristic, it might be responsible for at least some of the large explanatory power that bank xed e ects have in regressions explaining banks capital structure (Gropp and Heider [19]). Unfortunately it is di cult to empirically measure the bank-level undiversi able liquidity risk. Therefore, to obtain testable empirical predictions, we make use of the following general insight of the model. Bank capital should not be remunerated in states of the world where the marginal utility of consumption for depositors is high. In particular, when an undiversi able liquidity shock hits and liquidity needs are high in both banks, depositors per-capita consumption tends to be low and its marginal utility high. Hence, it is optimal to postpone bank capital remuneration when interbank markets activity is low. 3

4 The decision about when to remunerate bank capital clearly a ects the short-term value of bank capital and its short-term variation. Namely, when bank capital is remunerated, its short-term value tends to drop, both for an accounting reason and because it results in a lower remuneration in the future. The postponement of bank capital remuneration instead means higher future payouts to investors, and the short-term value of bank capital should increase as a consequence. Because the remuneration of bank capital occurs (is postponed) when the activity in the interbank market is high (low), the model predicts that a bank s activity in the interbank market has a negative correlation with (i) the short-term value of bank capital and (ii) the short-term change in bank capital. In the empirical part of the paper we test predictions (i) and (ii) and we nd support for both of them. The main results are obtained in a sample of 2,954 commercial banks in the US. We use their Call Reports to build a quarterly panel dataset spanning from the rst quarter of 2005 till the third quarter of In particular, for these banks we obtain information on their balance sheet items as well as on their activity in three di erent interbank markets: (a) Unsecured interbank lending and borrowing, (b) Repos and Reverse Repos with maturity longer than one day, and (c) Lending and borrowing on the overnight Federal Funds market. We consider the sum of the absolute value of the net positions in (a) as our main measure of interbank market activity. However, our results also hold when we add the absolute values of the net position in (b) and (c) to (a). As for capital, we adopt a broad de nition including book values of equity and reserves, as well as subordinated debt and hybrid capital. In this way we intend to include any source of funding with a long maturity and no collateral, whose remuneration is exible enough to be potentially used to absorb non diversi able liquidity shocks. To test prediction (i) we use a regression panel approach that allows us to estimate the conditional correlation between a bank s interbank market activity and its capital, including standard controls as well as bank xed e ects. We nd evidence of a negative and signi cant relationship, with both our measures of interbank activity. To test prediction (ii) we instead regress the quarterly variation of bank capital on our measures of interbank activity. We use standard controls also in these regressions as well as instrumental variables to address potential endogeneity issues. Again, we nd evidence of a negative and signi cant relationship which is robust to the choice of the measure of a bank s interbank market activity. Overall we consider this evidence as strongly supportive of the risk-sharing role of bank capital. We also perform a similar analysis in a sample of 877 large European 4

5 and Japanese commercial banks, obtaining yearly data from 2005 to 2009 from Bankscope. Also in this case results support the risk-sharing role of bank capital. These ndings would be di cult to rationalize if bank capital mainly had an incentive function. Indeed, if the main role of bank capital were to provide incentive to avoid excess risk taking then more capital would translate into lower bank insolvency risk. At the same time more capital results in easier access to the interbank market and larger interbank market activity. This in turn would imply a positive relationship between the level of bank capital and interbank activity. Even if our paper does not directly address normative issues, our results have important implications for regulation. Theoretically, we highlight the degree of undiversi able liquidity risk that each bank faces as an important determinant of bank capital. Moreover, we provide evidence that is consistent with this insight. The current debate on bank capital regulation emphasizes its role as incentive function (see Squam Lake Report, "Stanford" view ect.). We clearly do not want to dismiss this important role, but our results point to the fact that the role of bank capital as risk sharing device has been overlooked. We suggest, that when determining capital requirements, regulators may focus on identifying measures that indicate how much undiversi able risk a bank is subject to. Otherwise, any intervention to regulate bank capital will likely a ect the functioning of the markets in which banks coinsure their liquidity risk in a non-trivial way. Our paper is related to both theoretical and empirical works in banking. On the theory side, the paper closest to ours is Gale [17]. He also considers the risk-sharing role of bank capital but, contrary to us, his analysis focuses on regulatory aspects. For this purpose, Gale [17] considers spot markets as a way to co-insure against the liquidity shocks. By modeling the interbank market as a device to decentralize the social planner solution, our framework is similar to Allen and Gale [3]. However, following Castiglionesi et al. [8], we assume that aggregate uncertainty is perfectly anticipated by economic agents. More importantly, we analyze the relationship between the liquidity insurance provided by the interbank market and by bank capital, which is outside the scope of the two previous contributions. 5 5 There is also an extensive theoretical literature on capital regulation based on the incentive function of bank capital. The results are not conclusive since while bank capital requirements usually decrease risk taking the reverse is also possible (see, Kim and Santomero [22], Furlong and Keeley [16], Gennotte and Pyle [18], Rochet [24], Besanko and Kanatas [6] and Hellman et al. [21]). Among the recent contributions, Diamond and Rajan [11] rationalize bank capital as the trade o between liquidity creation, costs of bank 5

6 On the empirical side, our paper relates to two strands of the literature: The rst one on bank capital and the second on interbank markets. Flannery and Rangan [12] and Gropp and Heider [19] look at the determinants of banks capital holding. Flannery and Rangan [12] argue that the main cause of capital build-up of large US banks in the 1990s was an increased market discipline due to legislative and regulatory changes, resulting in the withdrawal of implicit government guarantees. Gropp and Heider [19] study the determinants of banks capital structure and address the questions of whether these determinants di er from those of non- nancial rms. While they do not nd evidence on the di erences, they argue that the most important determinants of banks capital structure are time-invariant bank xed e ects. Moreover, deposit insurance and capital regulation do not seem to have a signi cant impact on banks capital structure. Regarding the interbank market, Fur ne ([13], [14] and [15]) analyzes banks screening and monitoring activity in the Federal Funds market, and the behavior of this market during Russia sovereign default. Cocco et al. [9] look at the importance of relationships as an important determinant of banks ability to access the Portuguese interbank market. In a recent contribution, Afonso et al. [1] examine the impact of the nancial crisis of 2008, speci cally the bankruptcy of Lehman Brothers, on the functioning of the Federal Funds market. They argue that while banks became more restrictive in which counterparties they lent to, the nancial crisis did not lead to a complete collapse of the Fed Funds market. The novelty of our approach is to look at the co-determination of banks capital holding and their interbank market participation. To the best of our knowledge this relationship has not been explicitly addressed both in the theoretical and in the empirical banking literature. The remainder of the paper is organized as follows. Section 2 presents the model. Section 3 analyzes the optimal risk-sharing allocation chosen by a social planner. Section 4 shows how the e cient allocation can be decentralized by the presence of interbank markets. Section 5 characterizes the e cient allocation and it analyzes how the participation in the interbank market a ects bank capital and short-term changes in bank capital. Section 6 presents the data we used to test the model s predictions and the results of our regressions. Sections 7 concludes. The Appendix contains the proofs. distress and the ability to force borrower repayments. Allen, Carletti and Marquez [2] analyze the role of market discipline as a rationale to hold bank capital. 6

7 2 The Model The basic model is similar to Gale [17], and provides a rationale for the use of bank capital based on risk sharing. Consider a three-date economy (t = 0; 1; 2) with a single good available at each date for both consumption and investment. There are two assets: a short-term or liquid asset that matures in one period with a return of one, and a long-term or illiquid asset that requires two periods to mature and delivers a return R > 1. The short asset represents a storage technology (one unit of the good invested at t = 0; 1 produces one unit at t + 1), while the long asset captures long-term productive opportunities (one unit invested at t = 0 produces R units at t = 2, and nothing at t = 1). Clearly, the choice of a portfolio of assets re ects a trade-o between returns and liquidity. There are two banks i = A; B in the economy, and two groups of agents. The rst group is a continuum of risk-neutral agents that we call investors. They are endowed with a large amount of the consumption good at t = 0 and nothing at t = 1; 2. Investors cannot consume a negative amount at any time, and their utility is 0 c c 1 + c 2 ; where 0 > R, and 0 > 1 > 1: The second group is given by risk-averse agents that we call depositors. They are endowed with 1 unit of the consumption good at t = 0, and nothing at t = 1; 2. Following Diamond and Dybvig [10], depositors can be of two types, early consumers who only value consumption at t = 1, or late consumers who only value consumption at t = 2. The type of an agent is not known at t = 0. When consumption is valuable, the agent s utility is u(c), where u : R +! R is continuously di erentiable, strictly increasing and concave, and satis es the Inada condition lim c!0 u 0 (c) = 1. We assume that each bank has a unitary mass of depositors. The uncertainty about the preference shocks for the second group of agents is resolved in period 1 as follows. First, a liquidity shock is realized, which determines the fraction! i of early consumers in each bank i = A; B. Then, preference shocks are randomly assigned to the consumers in each bank so that! i agents become early consumers. The preference shock is privately observed by consumers, while the aggregate shocks! i are publicly observed. The bank shock! i takes the two values! H and! L, with! H >! L. We assume that with probability p > 1=2 the two banks have opposite shocks, that is, when a bank has 7

8 high liquidity needs (i.e.,! i =! H ), the other bank has low liquidity needs with probability p. In this case there is in principle room for trading on an interbank market to diversify away the liquidity shock. However, with probability 1 p both banks face high liquidity needs and the interbank market is of little help. The economy is therefore characterized by three possible states of the world S 2 S = fhh; LH; HLg. In state HH both banks have high liquidity needs, while in states LH and HL they are hit by di erent shocks. Table 1 summarizes the probability distribution of the liquidity shocks. Table 1: Banks liquidity shocks State S A B Probability HH! H! H (1 p) LH! L! H p=2 HL! H! L p=2 Notice that in states LH and HL, the average fraction of early consumers is constant and equal to! M =! H +! L ; 2 whereas it is clearly! H in state HH. Hence, there is some aggregate uncertainty on liquidity needs that is maximum when p = 1=2. 6 Notice that, as we assume p 1=2, any increase in p represents a reduction in aggregate uncertainty on liquidity needs. Agents cannot trade directly with one another, but the banking sector makes up for the missing markets. In particular, the activity of each bank develops as follows. At t = 0 each bank collects the initial endowment of its depositors and an amount e 0 of resources from investors. Therefore, the amount e will henceforth be referred to as bank capital. The bank invests an amount y in the short asset and an amount 1 + e y in the long asset; then, in period 1, after the aggregate shock S is publicly observed, the consumer reveals his preference shock to the bank and receives the consumption vector c S 1 ; 0 if he is an early consumer and the consumption vector 0; c S 2 if he is a late consumer. Similarly, 6 In fact, the aggregate liquidity shock can be measured by the average fraction of early consumers in the economy, and it can either be! M with probability p, or! H with probability 1 of this binary random variable is maximum when p = 1=2. p. Clearly, the variance 8

9 after the state S has been revealed, investors receive the consumption vector (d S 1 ; d S 2 ) 0: 7 Therefore, a risk sharing contract, also called an allocation, o ered by the bank is fully described by an array fy; e; c S t ; d S t g: S2S;t=1;2 As in Allen and Gale (2000), the existence of di erent groups of banks with di erent liquidity needs can capture di erent level of aggregation. Each bank in the model could indeed correspond to a speci c nancial institution, or to the representative bank in a speci c banking sector, a geographical region, etc. For our purposes, the economy represents a set of banks connected through an interbank market (to be explicitly introduced in section 4) together with their depositors and investors. In this sense, the parameter p represents a measure of the deepness of the interbank market, as it gives the probability of nding a bank with di erent liquidity needs to, potentially, trade with. In what follows we are interested in studying the e ects of the interbank market on the incentives to hold bank capital. Since our focus will be on an interbank market able to decentralize the rst-best allocation, we start in the next section to characterize optimal risk sharing and we will introduce the interbank market in section 4. 3 Optimal Risk Sharing In this section we abstract from the interbank market and consider the problem faced by a planner that chooses an allocation to maximize the sum of ex-ante expected utilities of depositors, maintaining investors at their reservation utility (i.e., the utility they can obtain by consuming their endowment at t = 0). The planner is unable to observe the preference shock of individual depositors but can observe banks aggregate liquidity shocks. Notice that total liquidity needs in the economy are the same in states HL and LH, and it is therefore optimal for the planner to move resources from one bank to the other to make the agents consumption plans constant in this case (i.e., c HL t t = 1; 2). = c LH t and d HL t = d LH t With a slight abuse of notation we can de ne a new state space S 0 = fh; Mg with the understanding that M = fhl; LHg and H = fhhg. An allocation can now be described 7 Agents are in a symmetric position ex-ante, and we assume that they are treated equally, that is, risk averse agents are all given the same contingent consumption plan, summarized by c S t similarly, risk neutral agents are all given the same contingent consumption plan d S t S2S;t=1;2. 9 for S2S;t=1;2 and,

10 by an array fy; e; fc s t; d s tg s2s 0 ;t=1;2 g, and it is said to be feasible if for each s 2 S0 and t = 1; 2, we have e 0; d s t 0; and! s c s 1 + d s 1 y; (1) (1! s )c s 2 + d s 2 (1 + e y)r + y! s c s 1 d s 1; (2) p( 1 d M 1 + d M 2 ) + (1 p)( 1 d H 1 + d H 2 ) 0 e: (3) The rst two constraints guarantee that there are enough resources at t = 1 and t = 2 respectively, to deliver the planned amount of consumption in each state s. Whenever y! s c s 1 d s 1 > 0 we say that there is positive rollover in state s, that is, some resources are stored through the liquid asset between t = 1 and t = 2. In this case the ex-post social value of liquidity is clearly the lowest possible as it exceeds the needs in the economy. The third constraint guarantees that investors get at least their reservation utility. 8 The planner s problem is therefore to choose a feasible allocation to maximize p! M u(c M 1 ) + (1! M )u(c M 2 ) + (1 p)! H u(c H 1 ) + (1! H )u(c H 2 ) : (4) Notice that in state H each banks s consumption needs must be satis ed with the resources available within the bank. In fact, in state H, both banks have a total demand for liquidity (from both consumers and investors) equal to! H c H 1 + d H 1 and from (1) we see that the available amount of the short asset within each bank is in fact enough to satisfy the internal demand (i.e., y! H c H 1 + d H 1 ). Things are di erent in state M: In this case in order to implement the rst best, the planner has to move resources between the two banks. For example, with no rollover in state M, the amount of liquid resources available at t = 1 in both banks is! M c M 1 + d M 1. However, one bank has a fraction! H of early consumers so that its demand for liquidity is! H c M 1 + d M 1, which results in an excess demand of (! H! M ) c M 1. At the same time, the other bank has a fraction! L of early consumers so that its demand for liquidity is only! L c M 1 + d M 1, which results in an excess supply of (! M! L ) c M 1. Given that (! H! M ) = (! M! L ) = (! H! L ) =2; 8 Notice that we are not explicitly considering the incentive contraints c s 1 c s 2 that prevent late consumers from pretending to be early consumers. This omission is however immaterial as the solution to the planner s problem automaticaly sati es such incentives constraints. This means that the rst-best allocation is also incentive e cient (see Proposition 1). 10

11 the excess demand can be cleared up with and excess supply at t = 1. At t = 2, resources move in the opposite direction in state M to clear up the bank excess demand and excess supply, while in states H each bank must satisfy its own demand with its own resources. 4 Interbank Deposit Market Consider now the decentralized economy in which each bank directly o ers a risk-sharing contract to its depositors and investors. We would like to know whether optimal risk sharing can also be achieved in this case. In the decentralized economy an allocation can only be achieved if it is feasible for each bank, separately. The rst-best consumption levels would not entail any feasibility problem in state H as, in this case, each bank demand for consumption is entirely satis ed using internal resources. 9 However, in state M both at t = 1 and t = 2, one bank has an excess demand for consumption while the other bank has an excess supply of exactly the same amount. One way to overcome this problem is to allow banks to exchange deposits at t = 0. To verify if this is feasible, assume that each bank o ers the rst-best allocation and deposits the amount! H! M with the other bank, under the same conditions applied to individual depositors. This means that when the fraction of early consumers in bank i is! H, bank i will behave as an early consumer and withdraw its interbank deposit at t = 1. In this case the bank obtains nothing at t = 2; while at t = 1 it gets (! H! M ) c M 1 if the fraction of early consumers in the other bank is! L (i.e., if the state is M), and (! H! M ) c H 1 otherwise (i.e., if the state is H). If the fraction of early consumers in bank i is! L, bank i will behave as a late consumer by holding its interbank deposit until t = 2, when it will nally withdraw it. In this case the bank obtains zero at t = 1 while at t = 2 it gets (! H! M ) c M 2 as the fraction of early consumers in the other bank is! H (i.e., the state is M for sure). We can now verify that the rst-best allocation is feasible in the decentralized economy 9 Notice that the rst-best allocation assigns a contingent consumption stream to the agents in each region. In state H both regions have a large fraction of early consumers but there is no liquidity shortage as the promised level of consumption in this case, c H 1, is the lowest possible (see proposition 1). We also allow for contingent consumption plans in the decentralized economy and we therefore abstract from problems of nancial distress and default. In any case, the state H represents a situation of economic distress at t = 1, with a strong pressure for immediate consumption, which however nds a frictionless (and e cient) solution in a reduction of per-capita consumption levels. 11

12 with interbank markets. To this end, notice that at t = 0 the net ow of funds between the two banks is zero so that the rst-best level of capital e and liquidity y are still compatible with the rst-best level of investment in the long asset given by 1 + e y. Thereafter, at t = 1 in state H the two banks withdraw their deposits at the same time so that the net ow of funds between banks is zero at both t = 1 and t = 2. First-best consumption levels are feasible within each bank in state H and will therefore remain so also in the presence of the interbank deposits market. In state M the two banks receive asymmetric liquidity shocks so that one bank will withdraw its interbank deposit at t = 1 (the bank with the high shock), while the other will withdraw at t = 2 (the bank with the low shock). For concreteness, let A be the bank with the high liquidity shock. In this case in both banks the amount of the short asset at t = 1 is y! M c M 1 + d M 1 but bank A needs! H c M 1 + d M 1 at t = 1 to cover its withdrawals and pay the promised amount to investors. Bank A redeems its interbank deposit at t = 1 and receives the amount (! H! M ) c M 1. Therefore it is able to satisfy its budget constraint:! H c M 1 + d M 1 =! M c M 1 + d M 1 + (! H! M ) c M 1 y + (! H! M ) c M 1 : Bank B faces withdrawals from both its depositors and from bank A, and pays d M 1 investors. Hence, the total amount of resources needed at t = 1 by bank B is to! L c M 1 + d M 1 + (! H! M ) c M 1 : However, it is also able to satisfy its budget constraint:! L c M 1 + d M 1 + (! H! M ) c M 1 =! M c M 1 + d M 1 y: Budget constraints are also satis ed at t = 2; and the case in which bank B receives the high liquidity shock is similar. Let m s 1 = (! H! M ) c s 1 and m s 2 = (! H! M ) c s 2 denote the amount that banks can withdraw in state s 2 fh; Mg at t = 1 and at t = 2, respectively. Table 2 below summarizes the net ow of funds between banks, as well as their net interbank positions, denoted by s t at time t and state s. A bank net position is positive when it is a net borrower (a debtor), and negative when it is a net lender (a creditor). 10 Notice that the interbank net position can only be di erent from zero at t = 1. Indeed, interbank deposits capture a market for liquidity at t = 1 and we will mainly refer to s 1 in what follows. 10 Notice that at t = 0 the two banks exchange exactly the same amount of resources and, therefore, the net interbank ows and positions are both equal to zero. 12

13 Table 2: Net interbank ows and positions State A B S S 0 ows s t=1 s 1 ows s t=2 s 2 ows s t=1 s 1 ows s t=2 s 2 HH H m H 1 m H 1 = m H 1 m H 1 = HL M m M 1 m M 1 m M 2 0 m M 1 m M 1 m M 2 0 LH M m M 1 m M 1 m M 2 0 m M 1 m M 1 m M First-Best Allocation In this section we further characterize the rst-best allocation and we study how both bank capital and interbank deposit markets play a role in achieving the optimal risk sharing. In a nutshell, interbank markets can only work when bank liquidity needs are asymmetric, that is in state M, but are of little help when both banks are hit by the high liquidity shock. The existence of undiversi able liquidity uncertainty (i.e., the possibility of liquidity shocks that cannot be diversi ed away through the interbank market) creates a scope for bank capital. In fact, by raising bank capital part of this undiversi able risk can be transferred to the risk-neutral investors. We now have Proposition 1 Assume p < 1 and consider the rst-best allocation. We have c H 1 < c M 1 c M 2 < c H 2 : Moreover, d M 1 d H 1 = 0; d H 2 d M 2 = 0; and positive rollover either occurs in state M, in which case c M 1 = c M 2, or it never occurs, in which case c M 1 < c M 2. This result is proved in the appendix and clari es that as bank capital is costly, undiversi able uncertainty makes it impossible for banks to o er full insurance to risk-averse depositors. In particular, rst-period (second-period) consumption tends to decrease (increase) with the overall fraction of early consumers. Risk-neutral investors can bear the uncertainty more e ciently. Banks can partially transfer the undiversi able uncertainty to investors by collecting part of their resources at t = 0, in the form of bank capital, in exchange for a contingent payout at t = 1; 2. The optimal way of arranging this form of risk sharing is to avoid any bank capital remuneration (i.e., payout to investors) when the 13

14 marginal utility of depositors is high, that is, in state H at t = 1, and in state M at t = 2. In principle, banks could raise enough capital to completely insure depositors against the liquidity uncertainty, but this turns out to be suboptimal because the use of bank capital is costly, in the sense that investors have a strong preference for time-zero consumption. In fact, when c H 2 = c M 2, the marginal value of insurance is zero but the marginal cost of capital is positive, as investors incur a marginal cost 0 > R to postpone consumption to t = 2; and a marginal cost 0 = 1 > 1 to postpone consumption to t = 1. In any case, the cost of capital is higher than the returns of the available investment opportunities (see Allen and Gale [4]) and this makes the use of bank capital costly. To conclude this section notice that we cannot exclude that the rst-best level of capital is zero. This trivial case emerges for example if 0 is too large with respect to 1, and bank capital becomes too costly to be used for risk-sharing purposes. In what follows we therefore abstracts from this case. 5.1 Bank Capital The optimal amount of bank capital clearly depends on the scope of the interbank market as measured by p. Let us use the notation e(p) to make this relationship explicit. The parameter p can be interpreted in a variety of ways. (1) At the level of a single nancial institution, p re ects the degree of connectedness to the overall interbank network; (2) At the country level, p is a ected by the external position of the banking system; (3) at the level of the overall economy, it re ects the relative importance of regional (and diversi able) shocks versus systemic shocks. Intuitively, if p increases, the interbank market can be used more often to smooth the liquidity shocks and, as a consequence, the incentive to raise bank capital should be smaller. This intuition is indeed correct when we consider the extreme case of p = 1. In this case, an allocation can be simply thought of as an array (y; e; c M 1 ; c M 2 ; d M 1 ; d M 2 ), as whatever happens in state H has zero probability and is therefore irrelevant. In this case, the optimal allocation has e 0, d M t 0; and solves max! M u(c M 1 ) + (1! M )u(c M 2 ) (5) subject to! M c M 1 + d M 1 y; (6) (1! M )c M 2 + d M 2 (1 + e y)r + y! M c M 1 d M 1 ; (7) 1 d M 1 + d M 2 0 e: (8) 14

15 Notice that (6)-(8) must all bind at the solution, and it is possible to verify that the rst-order conditions imply e(r 0 )u 0 (c M 2 ) = 0: (9) Clearly, as 0 > R and u 0 (c M 2 ) > 0, (9) implies that e = 0. Hence, with no aggregate uncertainty, the interbank market is su cient to smooth away liquidity shocks, and there is no need for bank capital. A continuity argument now immediately implies Proposition 2 If p 0 > p and p 0 is su ciently close to one, whenever e(p) > 0 we also have e(p 0 ) < e(p). In other words, whenever there is some scope for bank capital for risk-sharing purposes, a substantial reduction in undiversi able uncertainty also reduces the optimal level of bank capital. Figure 1 shows a numerical example in which bank capital is decreasing for all values of p 1=2, not only for su ciently high values. The example assumes R = 1:8, 0 = 2, 1 = 1:75,! H = 0:6,! L = 0:4, and depositors have constant relative risk aversion = 2. From panel (a) we can see that bank capital over total asset is indeed decreasing for all values of p 1=2. Panel (b) shows that investors receive a payout at t = 2 in state H for any p 2 (1=2; 1), while a payout at t = 1 in state M is only realized when p is below approximately [FIGURE 1] The negative relationship between the level of bank capital and p is not a general property of the model though. Indeed, Castiglionesi et al., [8] show that under general conditions a reduction in undiversi able liquidity uncertainty (i.e., here an increase in p beyond its minimum level of 1=2) can induce higher consumption volatility due to a reduction in the bank liquidity ratio. The same e ect shows up in this case and can induce banks to increase their amount of bank capital when p increases. Clearly, bank capital eventually decreases with p as it approaches one (i.e., as the overall liquidity uncertainty tends to vanish). Figure 2 shows a numerical example with R = 1:2, 0 = 1:35, 1 = 1:30;! H = 0:6,! L = 0:4, and in which depositors have constant relative risk aversion = 2. From panel 15

16 (a) we can see that bank capital is indeed slightly increasing until about p = 0:65 and decreasing thereafter. Panel (b) shows that the liquidity ratio, de ned as y=(1 + e), is everywhere decreasing in p, both when bank capital is optimally set to the levels shown in panel (a), and when it is forced to zero. Panels (c) and (d) show the volatility of rstperiod and, respectively, second-period consumption both with (left scale) and without (right scale) bank capital. [FIGURE 2] Notice that in the absence of bank capital, consumption volatilities are higher. This con rms that bank capital is used to partially insure depositors against liquidity uncertainty. Notice also that, in the absence of bank capital, the consumption volatility both in the rst and in the second period increases with p, for values of p below some threshold. This e ect depends on the reduced liquidity ratio documented in panel (b), and induces banks to increase their capital ratio to deal with the tendency toward an increased consumption volatility. In the example of Figure 2, anytime that the undiversi able liquidity uncertainty decreases (i.e., p increases) the use of (possibly increasing levels of) bank capital allows banks to reduce the volatility of consumption in the second period (but not always in the rst period). 5.2 Short-Term Capital Variation and Interbank Markets The relationship between bank capital and p is intuitive but di cult to study empirically because of the unobservability of p. What we do observe is a bank s activity in the interbank market at t = 1 which is captured by s 1, the net interbank position at t = 1. As we are mainly interested in the level of liquidity coinsurance provided by the interbank market, it does not matter whether s 1 is positive or negative (i.e., whether a bank is a net lender or borrower). Hence, we take its absolute value as a measure of interbank activity. In order to develop a testable prediction of the model we can consider what happens to the value of bank capital at t = 1, thought of as the value of (expected) future payouts to investors. We interpret the change in the value of capital at t = 1 as short term, as it materializes on the same time horizon as liquidity shocks. Notice that, after the observation of the state s at t = 1, the uncertainty about future payouts is completely resolved, and the 16

17 value of bank capital (in terms of t = 1 consumption) equals the expected payout at t = 2 divided by 1. In this sense, the state s determines the change in bank capital between t = 0 and t = 1, which is denoted by Cap s. Recall that the state s also determines banks net position in the interbank market (see Table 2). 11 Table 3 displays the t = 1 net positions in the interbank market in absolute value j s 1j together with the value of the changes in bank capital Cap. Both variables are a function of the state. It also reports the optimal payout policy to investors established in Proposition 1. Since the net position in the interbank market is in absolute values, the distinction between bank A and B is immaterial. Table 3: Change in bank capital and net interbank position State Cap s t=0 Cap s t=1 Cap s j s 1j H e d H 2 = 1 0 d H 2 = 1 e 0 M e d M 2 = 1 = 0 d M 2 = 1 e m M 1 > 0 We are interested in the relationship that the net position in the interbank market at t = 1 has with the value of bank capital at t = 1, and with its short-term variation between t = 0 and t = 1. Clearly, as Cap and Cap t=1 only di er by a constant, they have the same relationship with j 1 j. In fact, from Table 3 it is immediate to obtain E [Cap s t=1 j j 1 j > 0] E [Cap s t=1 j j 1 j = 0] = d H 2 = 1 ; E [Cap s j j 1 j > 0] E [Cap s j j 1 j = 0] = d H 2 = 1 : which are clearly both negative. These results can be summarized in the following Proposition 3 The net position in the interbank market at t = 1, measured by j 1 j, has a negative relationship with (i) the level of bank capital at t = 1, and (ii) with the short-time change in bank capital, measured by Cap. We now turn to the empirical section of the paper where we use the testable predictions contained in Proposition 3 to investigate whether the risk-sharing role of bank capital described in this section is indeed a relevant concern for banks. 11 Notice that the value of capital at t = 0 is expressed in terms of t = 0 consumption. To obtain its value in terms of consumption at t = 1 we should simply multiply it by 0 = 1, but this would clearly not alter in any ways the results in proposition 3. 17

18 6 Empirical Analysis 6.1 Data The interbank market is an Over the Counter market and its volume is not publicly available. A database that provides a proxy for the volume in this market is the quarterly Federal Financial Institutions Examination Council (FFIEC) Reports of Condition and Income (Call Reports), which all regulated commercial banks le with their primary regulator. We consider the Call Reports for banks with foreign o ces (FFIEC031) and for banks with domestic o ces only (FFIEC041). Call Reports contain detailed on-balance and o -balance-sheet information for all banks 12. Speci c to our study, we collect information on the amounts a given bank lends to, and borrows from other banks. This information comes from bank balance-sheets and has a quarterly frequency. This means that it does not allow to observe all the interbank ows throughout the quarter, nor it allows to distinguish interbank loans of di erent maturities 13, or the positions towards individual banks. Nonetheless, it gives a picture of the overall position a bank has vis-a-vis other banks at the time of the quarterly balance-sheet closure, that we take as a proxy of the interbank participation during the quarter. We build a quarterly panel dataset spanning from the rst quarter of 2005 to the third quarter of 2010 that includes 2954 commercial banks that report information about their interbank lending and borrowing positions. In order to measure a bank s activity on the interbank market we take the di erence of what a given bank lends to and borrows from other banks. We concentrate our analysis on three di erent types of borrowing: (a) Unsecured interbank lending and borrowing with more than one day maturity (Deposit from and Due to banks); (b) Securities purchased under agreements to resell and securities sold under agreements to repurchase, i.e., Repos and Reverse Repos with more than one day maturity; (c) Lending and borrowing on the one-day Federal Funds market 14 (Fed Funds sold and purchased). We take the absolute value of the di erence between lending and borrowing normalized by total assets as the empirical counterpart of j 1 j, that is, as a measure of activity in the interbank markets. We use the absolute value since we are rather interested in the 12 Call Report data are publicly available on the website of the Federal Reserve Bank of Chicago. 13 We could however distinguish between overnight versus longer maturities. 14 The accounting rules include also Overnight Repo in this cathegory. 18

19 overall bank s exposure to the interbank market than whether a bank is a net lender or a net borrower. As for capital, we consider a broad de nition that includes equity and reserves as well as subordinated debt and hybrid capital. Our model does not capture all the peculiarities and the di erent roles that bank capital may have. Instead, it focuses on its role as a bu er against liquidity shocks. For this reason any source of funding with a long maturity and no collateral could be considered as a good proxy for the capital variable included in our model. We consider bank capital in book values rather than in market values because of the liquidity bu er role bank capital plays in our model. We exclude banks from the sample that do not report interbank market exposure or capital. Proposition 3 (i) in Section 5 predicts a contemporaneous negative relationship (correlation) between a bank s activity in the interbank markets (henceforth referred to as interbank market participation) and bank capital. To test this relationship, we include a series of balance-sheets variables normalized by total assets as control variables. While the amount of liquid assets is endogenously determined in our model, we have no clear prediction on the contemporaneous relationship between interbank market participation and bank liquidity holdings. Bank liquidity holdings, which comprise cash and government securities and money deposited at the FED, however clearly a ects both the amount of bank capital and the interbank market exposure. Hence, we include it as a control variable in testing the relationship between the aforementioned variables. Earlier literature on bank regulation stressed the role of bank capital in increasing bank solvency. Hence, more capital leads to lower default risk. At the same time, the riskiness of the bank may also a ect its ability to borrow from the interbank market as shown by Afonso et al. [1]. Thus, to test the predicted substitution e ect between capital and interbank market exposure we need to control for bank risk characteristics. We consider two di erent variables: the amount of loans outstanding and risk weighted assets. The relationship between a bank s loan outstanding and its interbank market exposure in principle is ambiguous. A larger loan portfolio may result in a larger need to borrow in the interbank market. A larger loan portfolio may however render the borrower more risky, hence it may result in a lower supply of funds. As an additional control variable of bank risk we use the risk weighted assets reported by banks in the FFIEC report for determining capital requirements. To control for the impact of bank pro tability on the relation between capital and interbank market exposure we consider the return on assets (ROA). Pro tability clearly 19

20 a ects the need and the ability to participate in the interbank market, and at the same time the amount of bank capital a bank elects to hold. In our regression analysis, we also control for size of the bank that we measure with total assets. To capture the potential impact of the size of the interbank market that may a ect a bank s participation decision we also include as control variables two proxies of interbankmarket size. For each bank we calculate the total amount lent (borrowed) in the interbank market by other banks located in the same State and normalize this number by the total assets of these banks. The size of the interbank market could also be a ected by the amount of liquid assets held on the balance sheet of banks. For each bank we calculate the liquidity holdings by others banks located in the same State as the given bank and normalize it by total assets of these banks. Table 4 provides descriptive statistics for the main variables of interest and control variables we use in our empirical analysis. The sample exhibits considerable heterogeneity in the cross-section. We use two measures for a bank s interbank market activity. IabsTA1 is calculated as the absolute value of the di erence of unsecured interbank market lending and borrowing (Deposit from and Due to banks) normalized by total assets. IabsTA2 is de ned as the sum of unsecured interbank market lending and borrowing, Repos and FedFunds divided by total assets. The average interbank market exposure is 2.5% of total assets in our sample; this ratio is 5.93% if we also include Repo and FedFunds (IabsTA2), with a median of respectively 0.92% and 3.1%. However, the dispersion is rather signi cant. It ranges from 0.03% for the 5th percentile to 9.58% for the 95th percentile, and if we include Repos and FedFunds the dispersion is even larger (1.7% to 19.60%). The same applies to bank capital. On average bank capital is 10.99% of total assets but the standard deviation is 8.29%. [TABLE 4] Liquid assets, including cash and marketable securities, over total assets is on average 16.59%; bank balances at Federal Reserve Banks are on average 1.42%. Retail deposits and loans amount to 67.59% and 60.38% percent of total assets on average, respectively; risk weighted assets are 73.53%. The mean of the total book assets is US$ 5,59 billions and the median is US$ 549 million. The sample therefore includes both large, medium and small banks. The average 20

21 interbank market lending by the other banks in the same state is 1.11% (3.71% with Repo and FedFunds). The average interbank market borrowing by other banks in the same state is 0.58% (6.40% with Repo and FedFunds). The average liquidity holdings by banks located in the same state is 16.91% of total assets. Table 5 reports the pair-wise correlation between all the variables we consider. Correlations among the explanatory variables and control variables are not large, therefore we do not have to worry about collinearity in the analysis we perform. [TABLE 5] 6.2 Results The theoretical model presented in the previous section provides two testable implications. First, we predict a negative correlations between the level of capital banks choose to hold and their interbank market activity. Second, we predict a negative relationship between changes in bank capital and participation in the interbank market as banks delay remuneration to shareholders when the interbank market is less able to provide liquidity insurance as a consequence of banks facing common shocks First panel analysis: Interbank Markets We start by investigating the empirical relationship between a bank s interbank market activity and its level of capital. Our theoretical model does not predict any causality among these two variables but point to a negative relationship (Proposition 3 (i)). Therefore, our analysis is based on a regression panel approach that allows us to estimate the conditional correlation among these two variables. In fact, measuring a simple correlation among these variables would not be satisfactory as this correlation could be generated by other variables that contemporaneously a ect both interbank market participation and bank capital. In the model speci cation, interbank market participation is regressed on bank capital using the panel approach. We control for both rm xed e ects and time e ects so as to sweep out unobserved heterogeneity at the bank level as well as aggregate trends. The panel regression performed is: Y i;t = a + a i D i + a t D t + bcap i;t + cx + i;t, (10) 21

Liquidity Coinsurance, Moral Hazard and Financial Contagion

Liquidity Coinsurance, Moral Hazard and Financial Contagion Liquidity Coinsurance, Moral Hazard and Financial Contagion Sandro Brusco Universidad Carlos III de Madrid, SUNY at Stony Brook Fabio Castiglionesi Universitat Autónoma de Barcelona Outline Motivations

More information

Optimal insurance contracts with adverse selection and comonotonic background risk

Optimal insurance contracts with adverse selection and comonotonic background risk Optimal insurance contracts with adverse selection and comonotonic background risk Alary D. Bien F. TSE (LERNA) University Paris Dauphine Abstract In this note, we consider an adverse selection problem

More information

Interlinkages between Payment and Securities. Settlement Systems

Interlinkages between Payment and Securities. Settlement Systems Interlinkages between Payment and Securities Settlement Systems David C. Mills, Jr. y Federal Reserve Board Samia Y. Husain Washington University in Saint Louis September 4, 2009 Abstract Payments systems

More information

Do capital adequacy requirements reduce risks in banking?

Do capital adequacy requirements reduce risks in banking? Journal of Banking & Finance 23 (1999) 755±771 Do capital adequacy requirements reduce risks in banking? Jurg Blum * Institut zur Erforschung der wirtschaftlichen Entwicklung, University of Freiburg, D-79085

More information

Discussion of Self-ful lling Fire Sales: Fragility of Collateralised, Short-Term, Debt Markets, by J. C.-F. Kuong

Discussion of Self-ful lling Fire Sales: Fragility of Collateralised, Short-Term, Debt Markets, by J. C.-F. Kuong Discussion of Self-ful lling Fire Sales: Fragility of Collateralised, Short-Term, Debt Markets, by J. C.-F. Kuong 10 July 2015 Coordination games Schelling (1960). Bryant (1980), Diamond and Dybvig (1983)

More information

Lecture 2: The nature of financial intermediation:

Lecture 2: The nature of financial intermediation: Lecture 2: The nature of financial intermediation: The issue of why financial intermediaries exist is a puzzle for the complete markets paradigm of Arrow and Debreu. As we describe in this lecture, the

More information

4. Only one asset that can be used for production, and is available in xed supply in the aggregate (call it land).

4. Only one asset that can be used for production, and is available in xed supply in the aggregate (call it land). Chapter 3 Credit and Business Cycles Here I present a model of the interaction between credit and business cycles. In representative agent models, remember, no lending takes place! The literature on the

More information

CAPM, Arbitrage, and Linear Factor Models

CAPM, Arbitrage, and Linear Factor Models CAPM, Arbitrage, and Linear Factor Models CAPM, Arbitrage, Linear Factor Models 1/ 41 Introduction We now assume all investors actually choose mean-variance e cient portfolios. By equating these investors

More information

Corporate Income Taxation

Corporate Income Taxation Corporate Income Taxation We have stressed that tax incidence must be traced to people, since corporations cannot bear the burden of a tax. Why then tax corporations at all? There are several possible

More information

Should Banks Trade Equity Derivatives to Manage Credit Risk? Kevin Davis 9/4/1991

Should Banks Trade Equity Derivatives to Manage Credit Risk? Kevin Davis 9/4/1991 Should Banks Trade Equity Derivatives to Manage Credit Risk? Kevin Davis 9/4/1991 Banks incur a variety of risks and utilise different techniques to manage the exposures so created. Some of those techniques

More information

Central Bank Lending and Money Market Discipline

Central Bank Lending and Money Market Discipline Central Bank Lending and Money Market Discipline Marie Hoerova European Central Bank Cyril Monnet FRB Philadelphia November 2010 PRELIMINARY Abstract This paper provides a theory for the joint existence

More information

Mark-to-Market Accounting and Cash-in-the-Market Pricing

Mark-to-Market Accounting and Cash-in-the-Market Pricing Mark-to-Market Accounting and Cash-in-the-Market Pricing Franklin Allen Wharton School University of Pennsylvania allenf@wharton.upenn.edu Elena Carletti Center for Financial Studies University of Frankfurt

More information

Employee Stock Options, Financing Constraints, and Real Investment

Employee Stock Options, Financing Constraints, and Real Investment Employee Stock Options, Financing Constraints, and Real Investment Ilona Babenko Michael Lemmon Yuri Tserlukevich Hong Kong University of Science and Technology and University of Utah March 2009 Our goals

More information

Basel Committee on Banking Supervision. Frequently Asked Questions on Basel III s January 2013 Liquidity Coverage Ratio framework

Basel Committee on Banking Supervision. Frequently Asked Questions on Basel III s January 2013 Liquidity Coverage Ratio framework Basel Committee on Banking Supervision Frequently Asked Questions on Basel III s January 2013 Liquidity Coverage Ratio framework April 2014 This publication is available on the BIS website (www.bis.org).

More information

The Determinants and the Value of Cash Holdings: Evidence. from French firms

The Determinants and the Value of Cash Holdings: Evidence. from French firms The Determinants and the Value of Cash Holdings: Evidence from French firms Khaoula SADDOUR Cahier de recherche n 2006-6 Abstract: This paper investigates the determinants of the cash holdings of French

More information

How credit analysts view and use the financial statements

How credit analysts view and use the financial statements How credit analysts view and use the financial statements Introduction Traditionally it is viewed that equity investment is high risk and bond investment low risk. Bondholders look at companies for creditworthiness,

More information

The Real Business Cycle Model

The Real Business Cycle Model The Real Business Cycle Model Ester Faia Goethe University Frankfurt Nov 2015 Ester Faia (Goethe University Frankfurt) RBC Nov 2015 1 / 27 Introduction The RBC model explains the co-movements in the uctuations

More information

Discussion of Gertler and Kiyotaki: Financial intermediation and credit policy in business cycle analysis

Discussion of Gertler and Kiyotaki: Financial intermediation and credit policy in business cycle analysis Discussion of Gertler and Kiyotaki: Financial intermediation and credit policy in business cycle analysis Harris Dellas Department of Economics University of Bern June 10, 2010 Figure: Ramon s reaction

More information

Quality differentiation and entry choice between online and offline markets

Quality differentiation and entry choice between online and offline markets Quality differentiation and entry choice between online and offline markets Yijuan Chen Australian National University Xiangting u Renmin University of China Sanxi Li Renmin University of China ANU Working

More information

Adverse selection and moral hazard in health insurance.

Adverse selection and moral hazard in health insurance. Adverse selection and moral hazard in health insurance. Franck Bien David Alary University Paris Dauphine November 10, 2006 Abstract In this paper, we want to characterize the optimal health insurance

More information

Agency Con icts, Prudential Regulation, and Marking to Market

Agency Con icts, Prudential Regulation, and Marking to Market Agency Con icts, Prudential Regulation, and Marking to Market Tong Lu The University of Houston Haresh Sapra The University of Chicago June 20, 202 Ajay Subramanian Georgia State University Abstract We

More information

The Stock Market, Monetary Policy, and Economic Development

The Stock Market, Monetary Policy, and Economic Development The Stock Market, Monetary Policy, and Economic Development Edgar A. Ghossoub University of Texas at San Antonio Robert R. Reed University of Alabama July, 20 Abstract In this paper, we examine the impact

More information

I. Introduction. II. Financial Markets (Direct Finance) A. How the Financial Market Works. B. The Debt Market (Bond Market)

I. Introduction. II. Financial Markets (Direct Finance) A. How the Financial Market Works. B. The Debt Market (Bond Market) University of California, Merced EC 121-Money and Banking Chapter 2 Lecture otes Professor Jason Lee I. Introduction In economics, investment is defined as an increase in the capital stock. This is important

More information

On the Optimality of Financial Repression

On the Optimality of Financial Repression Discussion of On the Optimality of Financial Repression V.V. Chari Alessandro Dovis Patrick Kehoe Alberto Martin CREI, Universitat Pompeu Fabra and Barcelona GSE, IMF July 2014 Motivation Recent years

More information

Banks, Liquidity Management, and Monetary Policy

Banks, Liquidity Management, and Monetary Policy Discussion of Banks, Liquidity Management, and Monetary Policy by Javier Bianchi and Saki Bigio Itamar Drechsler NYU Stern and NBER Bu/Boston Fed Conference on Macro-Finance Linkages 2013 Objectives 1.

More information

Sharp and Diffuse Incentives in Contracting

Sharp and Diffuse Incentives in Contracting Risk & Sustainable Management Group Risk and Uncertainty Working Paper: R07#6 Research supported by an Australian Research Council Federation Fellowship http://www.arc.gov.au/grant_programs/discovery_federation.htm

More information

Capital markets, nancial intermediaries, and liquidity supply

Capital markets, nancial intermediaries, and liquidity supply Journal of Banking & Finance 22 (1998) 1157±1179 Capital markets, nancial intermediaries, and liquidity supply Paolo Fulghieri a,b, Riccardo Rovelli c, * a Finance Area, INSEAD, Boulevard de Constance,

More information

An Empirical Analysis of Insider Rates vs. Outsider Rates in Bank Lending

An Empirical Analysis of Insider Rates vs. Outsider Rates in Bank Lending An Empirical Analysis of Insider Rates vs. Outsider Rates in Bank Lending Lamont Black* Indiana University Federal Reserve Board of Governors November 2006 ABSTRACT: This paper analyzes empirically the

More information

Federal Reserve Bank of New York Staff Reports

Federal Reserve Bank of New York Staff Reports Federal Reserve Bank of New York Staff Reports Bank Liquidity, Interbank Markets, and Monetary Policy Xavier Freixas Antoine Martin David Skeie Staff Report no. 37 May 2009 Revised September 2009 This

More information

Credit monitoring and development: The impact of nancial integration

Credit monitoring and development: The impact of nancial integration Credit monitoring and development: The impact of nancial integration Lin Guo 1 Université de Paris I Panthéon Sorbonne March 31, 2010 1 CES-EUREQua, Maison des Sciences Economiques, 106-112, boulevard

More information

Aggregate Risk and the Choice Between Cash and Lines of Credit

Aggregate Risk and the Choice Between Cash and Lines of Credit Aggregate Risk and the Choice Between Cash and Lines of Credit Viral Acharya NYU Stern School of Business, CEPR, NBER Heitor Almeida University of Illinois at Urbana Champaign, NBER Murillo Campello Cornell

More information

Capital Adequacy Regulation: In Search of a Rationale

Capital Adequacy Regulation: In Search of a Rationale Financial Institutions Center Capital Adequacy Regulation: In Search of a Rationale by Franklin Allen Douglas Gale 03-07 The Wharton Financial Institutions Center The Wharton Financial Institutions Center

More information

The Role of Employee Stock Ownership Plans in Compensation Philosophy and. executive compensation arrangements

The Role of Employee Stock Ownership Plans in Compensation Philosophy and. executive compensation arrangements The Role of Employee Stock Ownership Plans in Compensation Philosophy and Executive Compensation Arrangements James F. Reda * Employee stock ownership plans, or ESOPs, have existed for more than 60 years

More information

HOUSEHOLD CREDIT DELINQUENCY: DOES THE BORROWERS INDEBTEDNESS PROFILE PLAY A ROLE?*

HOUSEHOLD CREDIT DELINQUENCY: DOES THE BORROWERS INDEBTEDNESS PROFILE PLAY A ROLE?* HOUSEHOLD CREDIT DELINQUENCY: DOES THE BORROWERS INDEBTEDNESS PROFILE PLAY A ROLE?* Luísa Farinha** Ana Lacerda** 1. INTRODUCTION The recent economic crisis, in a context of high households indebtedness

More information

9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle

9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle 9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle 9.1 Current Assets and 9.1.1 Cash A firm should maintain as little cash as possible, because cash is a nonproductive asset. It earns no

More information

Prof Kevin Davis Melbourne Centre for Financial Studies. Managing Liquidity Risks. Session 5.1. Training Program ~ 8 12 December 2008 SHANGHAI, CHINA

Prof Kevin Davis Melbourne Centre for Financial Studies. Managing Liquidity Risks. Session 5.1. Training Program ~ 8 12 December 2008 SHANGHAI, CHINA Enhancing Risk Management and Governance in the Region s Banking System to Implement Basel II and to Meet Contemporary Risks and Challenges Arising from the Global Banking System Training Program ~ 8 12

More information

Federal Reserve Bank of New York Staff Reports

Federal Reserve Bank of New York Staff Reports Federal Reserve Bank of New York Staff Reports Monetary Policy Implementation Frameworks: A Comparative Analysis Antoine Martin Cyril Monnet Staff Report no. 313 January 2008 Revised October 2009 This

More information

The recent turmoil in nancial markets has highlighted the need

The recent turmoil in nancial markets has highlighted the need Economic Quarterly Volume 100, Number 1 First Quarter 2014 Pages 51 85 A Business Cycle Analysis of Debt and Equity Financing Marios Karabarbounis, Patrick Macnamara, and Roisin McCord The recent turmoil

More information

The Financial Crises of the 21st Century

The Financial Crises of the 21st Century The Financial Crises of the 21st Century Workshop of the Austrian Research Association (Österreichische Forschungsgemeinschaft) 18. - 19. 10. 2012 Towards a Unified European Banking Market Univ.Prof. Dr.

More information

The International Certificate in Banking Risk and Regulation (ICBRR)

The International Certificate in Banking Risk and Regulation (ICBRR) The International Certificate in Banking Risk and Regulation (ICBRR) The ICBRR fosters financial risk awareness through thought leadership. To develop best practices in financial Risk Management, the authors

More information

Problem 1 (Issuance and Repurchase in a Modigliani-Miller World)

Problem 1 (Issuance and Repurchase in a Modigliani-Miller World) Problem 1 (Issuance and Repurchase in a Modigliani-Miller World) A rm has outstanding debt with a market value of $100 million. The rm also has 15 million shares outstanding with a market value of $10

More information

Moral Hazard. Itay Goldstein. Wharton School, University of Pennsylvania

Moral Hazard. Itay Goldstein. Wharton School, University of Pennsylvania Moral Hazard Itay Goldstein Wharton School, University of Pennsylvania 1 Principal-Agent Problem Basic problem in corporate finance: separation of ownership and control: o The owners of the firm are typically

More information

Unraveling versus Unraveling: A Memo on Competitive Equilibriums and Trade in Insurance Markets

Unraveling versus Unraveling: A Memo on Competitive Equilibriums and Trade in Insurance Markets Unraveling versus Unraveling: A Memo on Competitive Equilibriums and Trade in Insurance Markets Nathaniel Hendren January, 2014 Abstract Both Akerlof (1970) and Rothschild and Stiglitz (1976) show that

More information

Incentive Compensation for Risk Managers when Effort is Unobservable

Incentive Compensation for Risk Managers when Effort is Unobservable Incentive Compensation for Risk Managers when Effort is Unobservable by Paul Kupiec 1 This Draft: October 2013 Abstract In a stylized model of a financial intermediary, risk managers can expend effort

More information

THE FUNDAMENTAL THEOREM OF ARBITRAGE PRICING

THE FUNDAMENTAL THEOREM OF ARBITRAGE PRICING THE FUNDAMENTAL THEOREM OF ARBITRAGE PRICING 1. Introduction The Black-Scholes theory, which is the main subject of this course and its sequel, is based on the Efficient Market Hypothesis, that arbitrages

More information

Chapter 1: The Modigliani-Miller Propositions, Taxes and Bankruptcy Costs

Chapter 1: The Modigliani-Miller Propositions, Taxes and Bankruptcy Costs Chapter 1: The Modigliani-Miller Propositions, Taxes and Bankruptcy Costs Corporate Finance - MSc in Finance (BGSE) Albert Banal-Estañol Universitat Pompeu Fabra and Barcelona GSE Albert Banal-Estañol

More information

A note on the impact of options on stock return volatility 1

A note on the impact of options on stock return volatility 1 Journal of Banking & Finance 22 (1998) 1181±1191 A note on the impact of options on stock return volatility 1 Nicolas P.B. Bollen 2 University of Utah, David Eccles School of Business, Salt Lake City,

More information

Margin Requirements and Equilibrium Asset Prices

Margin Requirements and Equilibrium Asset Prices Margin Requirements and Equilibrium Asset Prices Daniele Coen-Pirani Graduate School of Industrial Administration, Carnegie Mellon University, Pittsburgh, PA 15213-3890, USA Abstract This paper studies

More information

Subordinated Debt and the Quality of Market Discipline in Banking by Mark Levonian Federal Reserve Bank of San Francisco

Subordinated Debt and the Quality of Market Discipline in Banking by Mark Levonian Federal Reserve Bank of San Francisco Subordinated Debt and the Quality of Market Discipline in Banking by Mark Levonian Federal Reserve Bank of San Francisco Comments by Gerald A. Hanweck Federal Deposit Insurance Corporation Visiting Scholar,

More information

Working Paper no. 37: An Empirical Analysis of Subprime Consumer Credit Demand

Working Paper no. 37: An Empirical Analysis of Subprime Consumer Credit Demand Centre for Financial Analysis & Policy Working Paper no. 37: An Empirical Analysis of Subprime Consumer Credit Demand Sule ALAN & Gyongyi LORANTH December 2010 The Working Paper is intended as a mean whereby

More information

RISK MANAGEMENT IN NETTING SCHEMES FOR SETTLEMENT OF SECURITIES TRANSACTIONS

RISK MANAGEMENT IN NETTING SCHEMES FOR SETTLEMENT OF SECURITIES TRANSACTIONS RISK MANAGEMENT IN NETTING SCHEMES FOR SETTLEMENT OF SECURITIES TRANSACTIONS A background paper for the 4th OECD/World Bank Bond Market Workshop 7-8 March 02 by Jan Woltjer 1 1 Introduction Settlement

More information

Deposit Insurance without Commitment by Russell Cooper and Hubert Kempf Discussion

Deposit Insurance without Commitment by Russell Cooper and Hubert Kempf Discussion Deposit Insurance without Commitment by Russell Cooper and Hubert Kempf Discussion Leopold von Thadden University of Mainz and ECB (on leave) Fiscal and Monetary Policy Challenges in the Short and Long

More information

Can Taxes Tame the Banks?

Can Taxes Tame the Banks? Capital structure responses to the post-crisis bank levies Michael Devereux (Oxford University) Niels Johannesen (University of Copenhagen) John Vella (Oxford University) May 13, 2013 Introduction Financial

More information

February 2013. Abstract

February 2013. Abstract Marking to Market and Ine cient Investments Clemens A. Otto and Paolo F. Volpin February 03 Abstract We examine how mark-to-market accounting a ects investment decisions in an agency model with reputation

More information

BIS Working Papers. Liquidity Squeeze, Abundant Funding and Macroeconomic Volatility. No 498. Monetary and Economic Department. by Enisse Kharroubi

BIS Working Papers. Liquidity Squeeze, Abundant Funding and Macroeconomic Volatility. No 498. Monetary and Economic Department. by Enisse Kharroubi BIS Working Papers No 498 Liquidity Squeeze, Abundant Funding and Macroeconomic Volatility by Enisse Kharroubi Monetary and Economic Department March 2015 JEL classification: D53, D82, D86 Keywords: Liquidity,

More information

Market Power, Forward Trading and Supply Function. Competition

Market Power, Forward Trading and Supply Function. Competition Market Power, Forward Trading and Supply Function Competition Matías Herrera Dappe University of Maryland May, 2008 Abstract When rms can produce any level of output, strategic forward trading can enhance

More information

The economics of sovereign debt restructuring: Swaps and buybacks

The economics of sovereign debt restructuring: Swaps and buybacks The economics of sovereign debt restructuring: Swaps and buybacks Eduardo Fernandez-Arias Fernando Broner Main ideas The objective of these notes is to present a number of issues related to sovereign debt

More information

Short-term Financial Planning and Management.

Short-term Financial Planning and Management. Short-term Financial Planning and Management. This topic discusses the fundamentals of short-term nancial management; the analysis of decisions involving cash ows which occur within a year or less. These

More information

Corporate Taxes and Securitization

Corporate Taxes and Securitization Corporate Taxes and Securitization The Journal of Finance by JoongHo Han KDI School of Public Policy and Management Kwangwoo Park Korea Advanced Institute of Science and Technology (KAIST) George Pennacchi

More information

The present and future roles of banks in small business nance

The present and future roles of banks in small business nance Journal of Banking & Finance 22 (1998) 1109±1116 The present and future roles of banks in small business nance Laurence H. Meyer Board of Governors of the Federal Reserve System, New York University Conference

More information

Monitoring and the acceptability of bank money

Monitoring and the acceptability of bank money Régis Breton Conference Bank liquidity, transparency and regulation Paris, 20/12/2013 The views expressed here are my own and should not necessarily be interpreted as those of the Banque de France or the

More information

LIQUIDITY RISK MANAGEMENT GUIDELINE

LIQUIDITY RISK MANAGEMENT GUIDELINE LIQUIDITY RISK MANAGEMENT GUIDELINE April 2009 Table of Contents Preamble... 3 Introduction... 4 Scope... 5 Coming into effect and updating... 6 1. Liquidity risk... 7 2. Sound and prudent liquidity risk

More information

Mark-to-Market Accounting and Liquidity Pricing

Mark-to-Market Accounting and Liquidity Pricing Mark-to-Market Accounting and Liquidity Pricing Franklin Allen Wharton School University of Pennsylvania allenf@wharton.upenn.edu Elena Carletti Center for Financial Studies University of Frankfurt carletti@ifk-cfs.de

More information

READING 14: LIFETIME FINANCIAL ADVICE: HUMAN CAPITAL, ASSET ALLOCATION, AND INSURANCE

READING 14: LIFETIME FINANCIAL ADVICE: HUMAN CAPITAL, ASSET ALLOCATION, AND INSURANCE READING 14: LIFETIME FINANCIAL ADVICE: HUMAN CAPITAL, ASSET ALLOCATION, AND INSURANCE Introduction (optional) The education and skills that we build over this first stage of our lives not only determine

More information

BIS Working Papers. Relationship and Transaction Lending in a Crisis. No 417. Monetary and Economic Department

BIS Working Papers. Relationship and Transaction Lending in a Crisis. No 417. Monetary and Economic Department BIS Working Papers No 417 Relationship and Transaction Lending in a Crisis by Patrick Bolton, Xavier Freixas, Leonardo Gambacorta and Paolo Emilio Mistrulli Monetary and Economic Department July 2013 JEL

More information

UNIVERSITY OF NOTTINGHAM. Discussion Papers in Economics THE CURRENCY DENOMINATION OF SOVEREIGN DEBT

UNIVERSITY OF NOTTINGHAM. Discussion Papers in Economics THE CURRENCY DENOMINATION OF SOVEREIGN DEBT UNIVERSITY OF NOTTINGHAM Discussion Papers in Economics Discussion Paper No. 06/0 THE CURRENCY DENOMINATION OF SOVEREIGN DEBT by Michael Bleaney January 006 DP 06/0 ISSN 1360-438 UNIVERSITY OF NOTTINGHAM

More information

CONTRACTUAL SIGNALLING, RELATIONSHIP-SPECIFIC INVESTMENT AND EXCLUSIVE AGREEMENTS

CONTRACTUAL SIGNALLING, RELATIONSHIP-SPECIFIC INVESTMENT AND EXCLUSIVE AGREEMENTS CONTRACTUAL SIGNALLING, RELATIONSHIP-SPECIFIC INVESTMENT AND EXCLUSIVE AGREEMENTS LUÍS VASCONCELOS y Abstract. I analyze a simple model of hold-up with asymmetric information at the contracting stage.

More information

DISCUSSION PAPER SERIES. No. 9037 GLOBALIZATION AND MULTIPRODUCT FIRMS. Volker Nocke and Stephen R Yeaple INTERNATIONAL TRADE AND REGIONAL ECONOMICS

DISCUSSION PAPER SERIES. No. 9037 GLOBALIZATION AND MULTIPRODUCT FIRMS. Volker Nocke and Stephen R Yeaple INTERNATIONAL TRADE AND REGIONAL ECONOMICS DISCUSSION PAPER SERIES No. 9037 GLOBALIZATION AND MULTIPRODUCT FIRMS Volker Nocke and Stephen R Yeaple INTERNATIONAL TRADE AND REGIONAL ECONOMICS ABCD www.cepr.org Available online at: www.cepr.org/pubs/dps/dp9037.asp

More information

Life Cycle Asset Allocation A Suitable Approach for Defined Contribution Pension Plans

Life Cycle Asset Allocation A Suitable Approach for Defined Contribution Pension Plans Life Cycle Asset Allocation A Suitable Approach for Defined Contribution Pension Plans Challenges for defined contribution plans While Eastern Europe is a prominent example of the importance of defined

More information

Policies for Banking Crises: A Theoretical Framework

Policies for Banking Crises: A Theoretical Framework Policies for Banking Crises: A Theoretical Framework Rafael Repullo CEMFI and CEPR September 2004 Abstract This paper analyzes the effects on ex ante risk-shifting incentives and ex post Þscal costs of

More information

CHAPTER 1: INTRODUCTION, BACKGROUND, AND MOTIVATION. Over the last decades, risk analysis and corporate risk management activities have

CHAPTER 1: INTRODUCTION, BACKGROUND, AND MOTIVATION. Over the last decades, risk analysis and corporate risk management activities have Chapter 1 INTRODUCTION, BACKGROUND, AND MOTIVATION 1.1 INTRODUCTION Over the last decades, risk analysis and corporate risk management activities have become very important elements for both financial

More information

BORROWING CONSTRAINTS, THE COST OF PRECAUTIONARY SAVING AND UNEMPLOYMENT INSURANCE

BORROWING CONSTRAINTS, THE COST OF PRECAUTIONARY SAVING AND UNEMPLOYMENT INSURANCE BORROWING CONSTRAINTS, THE COST OF PRECAUTIONARY SAVING AND UNEMPLOYMENT INSURANCE Thomas F. Crossley McMaster University Hamish W. Low University of Cambridge and Institute for Fiscal Studies January

More information

1 Present and Future Value

1 Present and Future Value Lecture 8: Asset Markets c 2009 Je rey A. Miron Outline:. Present and Future Value 2. Bonds 3. Taxes 4. Applications Present and Future Value In the discussion of the two-period model with borrowing and

More information

A Simple Model of Price Dispersion *

A Simple Model of Price Dispersion * Federal Reserve Bank of Dallas Globalization and Monetary Policy Institute Working Paper No. 112 http://www.dallasfed.org/assets/documents/institute/wpapers/2012/0112.pdf A Simple Model of Price Dispersion

More information

Federal Reserve Bank of New York Staff Reports. Banking with Nominal Deposits and Inside Money

Federal Reserve Bank of New York Staff Reports. Banking with Nominal Deposits and Inside Money Federal Reserve Bank of New York Staff Reports Banking with Nominal Deposits and Inside Money David R. Skeie Staff Report no. 242 March 2006 Revised May 2008 This paper presents preliminary findings and

More information

Decline in Federal Disability Insurance Screening Stringency and Health Insurance Demand

Decline in Federal Disability Insurance Screening Stringency and Health Insurance Demand Decline in Federal Disability Insurance Screening Stringency and Health Insurance Demand Yue Li Siying Liu December 12, 2014 Abstract This paper proposes that the decline in federal disability insurance

More information

Financial Institutions I: The Economics of Banking

Financial Institutions I: The Economics of Banking Financial Institutions I: The Economics of Banking Prof. Dr. Isabel Schnabel Gutenberg School of Management and Economics Johannes Gutenberg University Mainz Summer term 2011 V4 1/30 I. Introduction II.

More information

Credit Lines: The Other Side of Corporate Liquidity Filippo Ippolito Ander Perez March 2012

Credit Lines: The Other Side of Corporate Liquidity Filippo Ippolito Ander Perez March 2012 Credit Lines: The Other Side of Corporate Liquidity Filippo Ippolito Ander Perez March 2012 Barcelona GSE Working Paper Series Working Paper nº 618 Credit Lines: The Other Side of Corporate Liquidity Filippo

More information

Small business lending and the changing structure of the banking industry 1

Small business lending and the changing structure of the banking industry 1 Journal of Banking & Finance 22 (1998) 821±845 Small business lending and the changing structure of the banking industry 1 Philip E. Strahan a, *, James P. Weston b a Federal Reserve Bank of New York,

More information

The Bank of Canada s Analytic Framework for Assessing the Vulnerability of the Household Sector

The Bank of Canada s Analytic Framework for Assessing the Vulnerability of the Household Sector The Bank of Canada s Analytic Framework for Assessing the Vulnerability of the Household Sector Ramdane Djoudad INTRODUCTION Changes in household debt-service costs as a share of income i.e., the debt-service

More information

From Pawn Shops to Banks: The Impact of Banco Azteca on Households Credit and Saving Decisions

From Pawn Shops to Banks: The Impact of Banco Azteca on Households Credit and Saving Decisions From Pawn Shops to Banks: The Impact of Banco Azteca on Households Credit and Saving Decisions Claudia Ruiz UCLA January 2010 Abstract This research examines the e ects of relaxing credit constraints on

More information

FIN 683 Financial Institutions Management Liquidity Management and Deposit Insurance

FIN 683 Financial Institutions Management Liquidity Management and Deposit Insurance FIN 683 Financial Institutions Management Liquidity Management and Deposit Insurance Professor Robert B.H. Hauswald Kogod School of Business, AU Bank Runs Can arise due to concern about: Bank solvency

More information

t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3 MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

More information

the actions of the party who is insured. These actions cannot be fully observed or verified by the insurance (hidden action).

the actions of the party who is insured. These actions cannot be fully observed or verified by the insurance (hidden action). Moral Hazard Definition: Moral hazard is a situation in which one agent decides on how much risk to take, while another agent bears (parts of) the negative consequences of risky choices. Typical case:

More information

Financial Development and Macroeconomic Stability

Financial Development and Macroeconomic Stability Financial Development and Macroeconomic Stability Vincenzo Quadrini University of Southern California Urban Jermann Wharton School of the University of Pennsylvania January 31, 2005 VERY PRELIMINARY AND

More information

Credit Lectures 26 and 27

Credit Lectures 26 and 27 Lectures 26 and 27 24 and 29 April 2014 Operation of the Market may not function smoothly 1. Costly/impossible to monitor exactly what s done with loan. Consumption? Production? Risky investment? Involuntary

More information

What You Sell Is What You Lend? Explaining Trade Credit Contracts.

What You Sell Is What You Lend? Explaining Trade Credit Contracts. What You Sell Is What You Lend? Explaining Trade Credit Contracts. Mariassunta Giannetti Department of Finance, Stockholm School of Economics, CEPR and ECGI Mike Burkart Department of of Finance, Stockholm

More information

6. Budget Deficits and Fiscal Policy

6. Budget Deficits and Fiscal Policy Prof. Dr. Thomas Steger Advanced Macroeconomics II Lecture SS 2012 6. Budget Deficits and Fiscal Policy Introduction Ricardian equivalence Distorting taxes Debt crises Introduction (1) Ricardian equivalence

More information

Financial Intermediation and Credit Policy in Business Cycle Analysis. Mark Gertler and Nobuhiro Kiyotaki NYU and Princeton

Financial Intermediation and Credit Policy in Business Cycle Analysis. Mark Gertler and Nobuhiro Kiyotaki NYU and Princeton Financial Intermediation and Credit Policy in Business Cycle Analysis Mark Gertler and Nobuhiro Kiyotaki NYU and Princeton Motivation Present a canonical framework to think about the current - nancial

More information

Discussion of Capital Injection, Monetary Policy, and Financial Accelerators

Discussion of Capital Injection, Monetary Policy, and Financial Accelerators Discussion of Capital Injection, Monetary Policy, and Financial Accelerators Karl Walentin Sveriges Riksbank 1. Background This paper is part of the large literature that takes as its starting point the

More information

Bankruptcy, Finance Constraints and the Value of the Firm

Bankruptcy, Finance Constraints and the Value of the Firm Bankruptcy, Finance Constraints and the Value of the Firm By DOUGLAS GALE AND PIERO GOTTARDI We study a competitive model in which market incompleteness implies that debt-financed firms may default in

More information

Banks, Shadow Banking, and Fragility

Banks, Shadow Banking, and Fragility Banks, Shadow Banking, and Fragility Stephan Luck Paul Schempp May 2015 Preliminary please do not circulate! This paper studies a banking model of maturity transformation in which regulatory arbitrage

More information

René Garcia Professor of finance

René Garcia Professor of finance Liquidity Risk: What is it? How to Measure it? René Garcia Professor of finance EDHEC Business School, CIRANO Cirano, Montreal, January 7, 2009 The financial and economic environment We are living through

More information

Financial Research Advisory Committee Liquidity and Funding Working Group. August 1, 2013

Financial Research Advisory Committee Liquidity and Funding Working Group. August 1, 2013 Financial Research Advisory Committee Liquidity and Funding Working Group August 1, 2013 Executive Summary Overview The Liquidity and Funding Working Group of the FSRM focused its work efforts around the

More information

E cient Credit Policies in a Housing Debt Crisis

E cient Credit Policies in a Housing Debt Crisis Housing Credit E cient Credit Policies in a Housing Debt Crisis Janice Eberly and Arvind Krishnamurthy Kellogg School of Management, Northwestern University, and Stanford GSB May 2015 Housing Credit Introduction

More information

Apex Clearing Corporation

Apex Clearing Corporation Statement of Financial Condition (Unaudited) Apex Clearing Corporation is a member of FINRA, Securities Investor Protection Corporation (SIPC), NYSE MKT LLC, NYSE Arca, Inc., BATS Y Exchange, Inc., BATS

More information

EBA REPORT ON ASSET ENCUMBRANCE JUNE 2016

EBA REPORT ON ASSET ENCUMBRANCE JUNE 2016 EBA REPORT ON ASSET ENCUMBRANCE JUNE 2016 1 Contents List of figures 3 Executive summary 4 Analysis of the asset encumbrance of European banks 6 Sample 6 Scope of the report 6 Total encumbrance 7 Encumbrance

More information

Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869. Words: 3441

Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869. Words: 3441 Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869 Words: 3441 1 1. Introduction In this paper I present Black, Scholes (1973) and Merton (1973) (BSM) general

More information

Tools for Mitigating Credit Risk in Foreign Exchange Transactions 1

Tools for Mitigating Credit Risk in Foreign Exchange Transactions 1 Tools for Mitigating Credit Risk in Foreign Exchange Transactions November 2010 Introduction In November 2009, the Foreign Exchange Committee (FXC) and its Buy-Side Subcommittee released a paper that reviewed

More information

Determinants of Capital Structure in Developing Countries

Determinants of Capital Structure in Developing Countries Determinants of Capital Structure in Developing Countries Tugba Bas*, Gulnur Muradoglu** and Kate Phylaktis*** 1 Second draft: October 28, 2009 Abstract This study examines the determinants of capital

More information