Tests on the Accuracy of Basel II

Basel II rules allow qualified banks to assess the risk in their portfolio of credit exposures with a methodology based on the informational content of credit ratings and two crucial assumptions: (1) the credit risk of individual exposures is driven by one systematic risk factor only and (2) the portfolio is fully diversified. We test the accuracy of the credit risk measures obtained with the new rules by comparing them with benchmark measures derived with a popular ratings-based credit risk model which accounts for multiple risk factors and portfolio concentration. We find that the Basel II assumptions may have a substantial impact on risk assessments and produce deviations from the benchmark that may be economically significant.Basel II, credit rating, credit risk

Value at risk and precommitment: approaches to market risk regulation

This paper was presented at the conference "Financial services at the crossroads: capital regulation in the twenty-first century" as part of session 4, "Incentive-compatible regulations: views on the precommitment approach." The conference, held at the Federal Reserve Bank of New York on February 26-27, 1998, was designed to encourage a consensus between the public and private sectors on an agenda for capital regulation in the new century.Bank capital ; Risk

Admissions of International Graduate Students: Art or Science? A Business School Experience

International students are often well represented in graduate programmes in North America and Europe. Information on foreign countries' education systems and grading schemes is available but cross-country comparisons are often challenging and highly subjective. Therefore, universities have a clear need for calibrating admissions of international students to ensure a fair and cost effective selection process. By comparing the performance of international students in their host institution with their entry qualifications we devise a simple approach to detecting systematic biases in the perceived quality of the applicants and propose corrective actions. We find that by using public information on cross-country comparisons of academic qualifications, country selection biases can occur and produce a substantial impact on international students' performance and failure rates. Our model is based on admission data that are routinely collected by universities which should ensure its broad applicability.admissions, country bias, entry qualifications, failure probability

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 simple framework to analyze this issue. In our model the risk carried by a bank as well as managerial risk preference are a bank's private information. We show that ex ante constraints waste the superior risk information of a bank, while an ex post regime makes full use of it. However, the latter is more vulnerable to the problem of unknown managerial risk-aversion. 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. In particular, our results provides theoretical underpinning for the inclusion of pillar 2 alongside pillar 1 in Basel II.Ex Ante Regulation, Ex Post Regulation, Asymmetric Information, Safety Loss, Overprotection 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

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

Time varying price discovery

We show how multivariate GARCH models can be used to generate a time-varying “information share” (Hasbrouck, 1995) to represent the changing patterns of price discovery in closely related securities. We find that time-varying information shares can improve credit spread predictions

COVID-19 and fiscal policy in the euro area

In this chapter we document fiscal policy developments in the main euro area economies over the last two decades and highlight the dramatic changes triggered by the COVID-19 pandemic. We analyse how euro area yield curves respond to COVID-19 related expectations of fiscal expansion. We show how fiscal constraints may affect interest rates. Upward pressure on national yields from higher debt levels could compromise fiscal and financial stability in the long-term

Liquidity and shadow banking

Using a unique dataset of the detailed portfolio holdings of US money market funds, we study the behaviour of such funds in the context of the European sovereign debt crisis. These important players in the shadow banking sector were particularly vulnerable to liquidity shocks before the introduction of minimum liquidity requirements. We analyse the impact of these requirements and show that they have considerably increased the resilience of prime funds. We also see that prime funds increase their liquidity to counter expected investors’ redemptions in crisis periods. However, liquidity does not shelter risky funds from lower inflows