Ex Ante versus Ex Post Regulation of Bank Capital

The current debate on the new Basel Accord gives rise to a natural question about the appropriate form of capital regulation. We construct a general framework to study this issue. We show that ex ante regulation wastes the expertise of a bank in measuring its risk exposure, while an ex post regime makes full use of it. However, the latter is more vulnerable to the problem of unknown managerial risk preference. The results imply that the two regimes are complements, rather than substitutes. Further, under plausible conditions, an ex post regime emerges as the dominant element of the optimal combination. We use the results to shed light on current policy concerns.Ex Ante Regulation, Ex Post Regulation, Asymmetric Information, Safety Loss, Overportection, Loss, Safety Bias, Basel II

Predicting Agency Rating Migrations with Spread Implied Ratings

Investors traditionally rely on credit ratings to price debt instruments. However, rating agencies are known to be prudent in their approach to rating revisions, which results in delayed ratings adjustments to mutating credit conditions. For a large set of eurobonds we derive credit spread implied ratings and compare them with the ratings issued by rating agencies. Our results indicate that spread implied ratings often anticipate future movement of agency ratings and hence could help track credit risk in a more timely manner. This finding has important implications for risk managers in banks who, under the new Basel 2 regulations, have to rely more on credit ratings for capital allocation purposes, and for portfolio managers who face rating-related investment restrictions.credit rating, spread implied rating, credit risk