Flight to Quality for Large Financial Institutions

Local correlation analysis is used to investigate flight to quality among large financial institutions before, during, and after the financial crisis of 2008-2009. While standard correlation captures general overall linear association, local correlation analysis more accurately captures changes in the associations in response to changing market conditions. Using raw, market-adjusted, and industry-adjusted stock returns of individual banks, we investigate the performance of troubled banks and the change in investing behavior. Investors react to noisy information from the financial difficulties encountered by banking institutions. This reaction results in flight to quality. While the traditional Pearson correlations capture general overall linear association, local correlation analysis captures changes in the association in response to changing market conditions. Thus, local correlation analysis more accurately measures changes in correlation where it matters most: in the loss tail of the distribution of financial returns; leading to more appropriate diversification, portfolio management, and within-industry implications

Mapping the State of Financial Stability

The paper uses the Self-Organizing Map for mapping the state of financial stability and visualizing the sources of systemic risks on a two-dimensional plane as well as for predicting systemic financial crises. The Self-Organizing Financial Stability Map (SOFSM) enables a two-dimensional representation of a multidimensional financial stability space and thus allows disentangling the individual sources impacting on systemic risks. The SOFSM can be used to monitor macro-financial vulnerabilities by locating a country in the financial stability cycle: being it either in the pre-crisis, crisis, post-crisis or tranquil state. In addition, the SOFSM performs better than or equally well as a logit model in classifying in-sample data and predicting out-of-sample the global financial crisis that started in 2007. Model robustness is tested by varying the thresholds of the models, the policymaker’s preferences, and the forecasting horizon.systemic financial crisis; systemic risk; self-organizing maps; visualisation; prediction; macroprudential supervision

The Core, Periphery, and Beyond: Stock Market Comovements among EU and Non-EU Countries

We thank conference participants at the 2016 Financial Management Association and our discussant Fernando Moreira, and two anonymous referees for immensely helpful comments. We also thank Andrew Patton and James P. LeSage for sharing their MATLAB codes for computing quantile dependence. The authors of this paper are responsible for any errors or omissions. The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the authors and do not necessarily reflect the views of the Commission or the authors\u27 colleagues on the staff of the Commission

Invited review: Epidemics on social networks

Since its first formulations almost a century ago, mathematical models for disease spreading contributed to understand, evaluate and control the epidemic processes.They promoted a dramatic change in how epidemiologists thought of the propagation of infectious diseases.In the last decade, when the traditional epidemiological models seemed to be exhausted, new types of models were developed.These new models incorporated concepts from graph theory to describe and model the underlying social structure.Many of these works merely produced a more detailed extension of the previous results, but some others triggered a completely new paradigm in the mathematical study of epidemic processes. In this review, we will introduce the basic concepts of epidemiology, epidemic modeling and networks, to finally provide a brief description of the most relevant results in the field.Comment: 17 pages, 13 figure

Illiquidity and all its Friends

The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macro-prudential policies.Liquidity, Contagion, Bailouts, Regulation

Can crude oil serve as a hedging asset for underlying securities? - Research on the heterogenous correlation between crude oil and stock index

In the increasingly frequent global financial turmoil, investors prefer to invest in stable assets to hedge risks. Crude oil naturally has dual use value as a general commodity and as a financial asset, which has attracted wide attention. In this paper, we adopt a wavelet coherence analysis to study the standard of crude oil as a hedging asset and analyze the dynamic correlation of crude oil and stock market price fluctuations in the four economies of the United States, Japan, China and Hong Kong at different frequencies. The empirical evidence shows that crude oil can be conditionally used as a hedging asset for underlying securities. From the perspective of space, crude oil is suitable for investors in China's stock market as a hedging asset, while for stock markets in the US, Japan and Hong Kong, the ability of crude oil to hedge risk has been greatly weakened. From the perspective of investment term, although crude oil cannot be regarded as a hedging asset for long-term investment, it can still play a hedging role in the short term. When the market is in a state of panic, the ability of oil to hedge risk is stronger

Thought and Behavior Contagion in Capital Markets

Prevailing models of capital markets capture a limited form of social influence and information transmission, in which the beliefs and behavior of an investor affects others only through market price, information transmission and processing is simple (without thoughts and feelings), and there is no localization in the influence of an investor on others. In reality, individuals often process verbal arguments obtained in conversation or from media presentations, and observe the behavior of others. We review here evidence concerning how these activities cause beliefs and behaviors to spread, affect financial decisions, and affect market prices; and theoretical models of social influence and its effects on capital markets. Social influence is central to how information and investor sentiment are transmitted, so thought and behavior contagion should be incorporated into the theory of capital markets.capital markets; thought contagion; behavioral contagion; herd behavior; information cascades; social learning; investor psychology; accounting regulation; disclosure policy; behavioral finance; market efficiency; popular models; memes

Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns

Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may be a channel allowing a bank default to spread to other banks. This paper analyzes how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures. Since information on bilateral exposures was not available in most previous studies, they assumed that banks spread their lending as evenly as possible among all the other banks by maximizing the entropy of interbank linkages. Based on the data available on actual bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims. The comparison indicates that, in line with the thesis prevailing in the literature, the maximum entropy method tends to underestimate the extent of contagion. However, this does not hold in general. Under certain circumstances, depending on the structure of the interbank linkages, the recovery rates of interbank exposures and banksÂ’ capitalization, the maximum entropy approach overestimates the scope for contagion.interbank market, financial contagion, systemic risk, maximum entropy

The Economics of Terrorism and Counter-Terrorism: A Survey (Part I)

This survey provides an in-depth analysis of existing research on the economic analysis of terrorism and counter-terrorist measures. First the existing evidence on the causes of terrorism is analyzed, then we consider the evidence of the consequences of terrorism and we demonstrate why it is important to regarding of the issue of counter-terrorism policy. Moreover the survey presents the existing knowledge on the interrelation between the economy and the issue of security and it incorporates analysis the level of knowledge about the causal chains between security and the economy. Also it focuses on perspective and methodologies from the discipline of economics but also refers to research from related disciplines (sociology, political science). It also assembles the knowledge on the impact of terrorism on the economy as reflected in macro-economic variables and its impact on specific sectors. Furthermore it assesses how potential an actual terrorist event determine consumer and producer behaviour, public policy, as well as terrorist responses to these policies. Finally a European perspective on the terrorism security annexes is discussed and here we analyze the causes of terrorism in Europe.risk, insecurity, survey, terrorism, counter-terrorism, security economics