Credit derivatives, the liquidity of bank assets and banking stability

The emerging markets for credit derivatives have improved the liquidity of bank assets by providing banks with various new possibilities for selling and hedging their risks. This paper examines the consequences for banking stability. In a simple model where liquidation of bank assets is costly, we show that increased asset liquidity benefits stability by encouraging a representative bank to reduce the risks on its balance sheet. Stability is further enhanced because the bank can now liquidate assets in a crisis more easily. However, we find that these stability effects are counteracted by increased risk-taking by the bank. Overall, stability actually falls because the improved possibilities for liquidating assets in a crisis make a crisis less costly for the bank. The bank therefore takes on an amount of risk that more than offsets the initial positive impact on stability

Aggregate liquidity shortages, idiosyncracic liquidity smoothing and banking regulation

This paper develops a model of banking fragility driven by aggregate liquidity shortages. Inefficiencies arise because liquidity smoothing across banks breaks down when there is such a shortage, causing unnecessary and value-reducing transfer of assets between banks. We find that a Lender of Last Resort policy is ineffective in restoring efficiency as it leads to offsetting changes in the banks’ supply of liquidity. In contrast, subsidizing the purchase of assets from troubled banks increases welfare by improving the banks’ liquidity holdings. The first best, however, is achieved by redistributing liquidity from healthy to troubled banks in a crisis

Credit risk transfer and financial sector performance

In this paper we study the impact of credit risk transfer (CRT) on the stability and the efficiency of a financial system in a model with endogenous intermediation and production. Our analysis suggests that with respect to CRT, the individual incentives of the agents in the economy are generally aligned with social incentives. Hence, CRT does not pose a systematic challenge to the functioning of the financial system and is generally welfare enhancing. However, we identify issues that should be addressed by the regulatory authorities in order to minimize the potential costs of CRT. These include: ensuring the development of new methods of CRT that allow risk to be more perfectly transferred, setting regulatory standards that reflect differences in the social cost of instability in the banking and insurance sector; promoting CRT instruments that are nor detrimental to the monitoring incentives of banks

The marketability of bank assets and managerial rents: implications for financial stability

Ongoing financial innovation and greater information availability increase the tradability of bank assets and reduce banks' dependence on individual bank managers as private information in the lending process declines. In this paper we argue that this has two effects on banks, with opposing implications for banking stability. First, the hold-up problem between bank managers and shareholders becomes less severe. Consequently, banks' capital structure needs to be less concerned with disciplining the management. Deposits -the most effective disciplining device- can be reduced, increasing banks' resilience to adverse return shocks. However, limiting the hold-up problem also diminishes bank managers' rents, reducing their incentives to properly monitor and screen borrowers, with adverse implications for asset quality. Thus, even though the improved marketability of bank assets allows banks to adopt a safer capital structure, the default risk of banks does not necessarily decline. --Marketability,Incentives,Financial Innovations,Financial Stability

Credit Derivatives and Sovereign Debt Crises

Credit derivatives allow for buying protection on corporate debt, but also on sovereign debt. In this paper we examine the implications for sovereign debt crises. We show that the availability of credit protection lowers ex-ante debtor moral hazard by allowing a bondholder to improve his bargaining position in negotiations with the sovereign, thus forcing the sovereign to internalize more of the costs of a crisis. When bondholders use credit protection strategically, we additionally find that credit derivatives do not hinder an efficient resolution of crises. Crisis resolution may even be improved by facilitating conditionality. When protection is not chosen strategically, however, credit protection may also be detrimental to crisis resolution by making restructuring more difficult. In either case we identify a role for government policy as bondholders' choice of protection is not necessarily socially efficient.credit derivatives, sovereign debt crisis, moral hazard

The Feasible Gains from International Risk Sharing

We argue that since there are several impediments to international risk sharing, the welfare gains from full international risk sharing, which have been the object of analysis in the previous literature, are not suggestive. Instead, we study the gains from feasible risk sharing and find that they are considerable (0:5% increase inpermanent consumption). Marginal benefits from further risk sharing are low, which indicates that feasible risk sharing can achieve most of the benefits from internationalrisk sharing. Surprisingly, we find that sharing short term consumption risk lowers welfare. On the basis of the results we make suggestions on how to improve existing international risk sharing systems.International risk sharing, welfare gains

Taxation if Capital is not Perfectly Mobile: Tax Competition versus Tax Exportation.

This paper analyzes the tax competition and tax exporting effect of financial integration. On the one hand, financial integration increases capital mobility and thus the incentive for countries to compete for capital. On the other hand, financial integration increases foreign ownership of firms and capital and allows for exportation of source taxes. Both effects have contrary implications for capital taxes. Allowing for imperfectly mobile capital, our analysis suggests that currently the tax exportation effect is dominating, which implies excessive capital taxation. From studying the benchmark of full financial integration we find that capital taxes are likely to increase from current levels. We further examine the tax exportation effect empirically and find that is significant as well as quantitatively important for the U.S.

Inter-observer variability for cardiac ultrasound measurements in cats repeated at different time points in early adult life

Abstract A high degree of accuracy is required when using echocardiography to diagnose hypertrophic cardiomyopathy (HCM) in cats, as variation in measurements of 0.5 mm may affect classification of individuals as ‘abnormal’. This study in adult cats examined at different time points inter-observer variability between two Board certified echocardiographers in veterinary cardiology. Twenty-four female European shorthair cats were examined at 12, 18 and 24 months of age by observer 1. Two dimensional (2D) echocardiographic images were collected in conscious cats to measure left ventricular, aortic and left atrial dimensions. Measurements were repeated by observer 2 on stored images, and analyzed for effect of time, observer and time-observer interaction. Based on end-diastolic left ventricular wall thickness, cats were diagnosed as ‘normal’ or 'abnormal'. Linear mixed models (generalized when appropriate) were performed. A significant difference between observers was found for all septal (IVSd) and free wall (LVFWd) thickness measurements and left ventricular internal diameters but not for aortic or left atrial measurements. All measurement coefficients of variation (CV) were 5 mm in cats >6 kg bodyweight) was significantly different between observers for IVSd but not LVFWd. Caution is warranted when diagnosing as ‘abnormal’ or interpreting small changes based on IVSd, due to significant inter-observer differences in this measurement

How to regulate international banks

The practice of banking supervision has been thrust very firmly into the spotlight since the great global financial crisis began to unfold over a decade ago. In that time it has been the subject of endless debate and much disagreement