OPUS 4 | CFS working paper series

2004, 25

The Basel II accord : internal ratings and bank differentiation (2004)

Eberhard Feess Ulrich Hege

The Basel Committee plans to differentiate risk-adjusted capital requirements between banks regulated under the internal ratings based (IRB) approach and banks under the standard approach. We investigate the consequences for the lending capacity and the failure risk of banks in a model with endogenous interest rates. The optimal regulatory response depends on the banks' inclination to increase their portfolio risk. If IRB-banks are well-capitalized or gain little from taking risks, then they will increase their market share and hold safe portfolios. As risk-taking incentives become more important, the optimal portfolio size of banks adopting intern rating systems will be increasingly constrained, and ultimately they may lose market share relative to banks using the standard approach. The regulator has only limited options to avoid the excessive adoption of internal rating systems. Klassifikation: K13, H41. December 2004.

2004, 24

The decline of activist stabilization policy : natural rate misperceptions, learning, and expectations (2004)

Athanasios Orphanides John C. Williams

We develop an estimated model of the U.S. economy in which agents form expectations by continually updating their beliefs regarding the behavior of the economy and monetary policy. We explore the effects of policymakers' misperceptions of the natural rate of unemployment during the late 1960s and 1970s on the formation of expectations and macroeconomic outcomes. We find that the combination of monetary policy directed at tight stabilization of unemployment near its perceived natural rate and large real-time errors in estimates of the natural rate uprooted heretofore quiescent in inflation expectations and destabilized the economy. Had monetary policy reacted less aggressively to perceived unemployment gaps, in inflation expectations would have remained anchored and the stag inflation of the 1970s would have been avoided. Indeed, we find that less activist policies would have been more effective at stabilizing both in inflation and unemployment. We argue that policymakers, learning from the experience of the 1970s, eschewed activist policies in favor of policies that concentrated on the achievement of price stability, contributing to the subsequent improvements in macroeconomic performance of the U.S. economy. Klassifikation: E52. April 2004.

2004, 23

Understanding the effects of government spending on consumption (2004)

Jordi Galí J. David López-Salidoz Javier Vallés

Recent evidence on the effect of government spending shocks on consumption cannot be easily reconciled with existing optimizing business cycle models. We extend the standard New Keynesian model to allow for the presence of rule-of-thumb (non-Ricardian) consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending. Klassifikation: E32, E62. First Draft: September 2002. This Draft: November 2003.

2004, 22

Monetary discretion, pricing complementarity and dynamic multiple equilibria (2004)

Robert G. King Alexander L. Wolman

In a plain-vanilla New Keynesian model with two-period staggered price-setting, discretionary monetary policy leads to multiple equilibria. Complementarity between the pricing decisions of forward-looking firms underlies the multiplicity, which is intrinsically dynamic in nature. At each point in time, the discretionary monetary authority optimally accommodates the level of predetermined prices when setting the money supply because it is concerned solely about real activity. Hence, if other firms set a high price in the current period, an individual firm will optimally choose a high price because it knows that the monetary authority next period will accommodate with a high money supply. Under commitment, the mechanism generating complementarity is absent: the monetary authority commits not to respond to future predetermined prices. Multiple equilibria also arise in other similar contexts where (i) a policymaker cannot commit, and (ii) forward-looking agents determine a state variable to which future policy respond. Klassifikation: E5, E61, D78. March 2004

2004, 21 r

The Basle securitisation framework explained : the regulatory treatment of asset securitisation (2004)

Andreas A. Jobst

The paper provides a comprehensive overview of the gradual evolution of the supervisory policy adopted by the Basle Committee for the regulatory treatment of asset securitisation. We carefully highlight the pathology of the new “securitisation framework” to facilitate a general understanding of what constitutes the current state of computing adequate capital requirements for securitised credit exposures. Although we incorporate a simplified sensitivity analysis of the varying levels of capital charges depending on the security design of asset securitisation transactions, we do not engage in a profound analysis of the benefits and drawbacks implicated in the new securitisation framework. Klassifikation: E58, G21, G24, K23, L51. Forthcoming in Journal of Financial Regulation and Compliance, Vol. 13, No. 1 . First version: January 12, 2004. This Version: 22 Sept. 2004. An revised ed. (march 2005): http://publikationen.ub.uni-frankfurt.de/volltexte/2005/1072/

2004, 20

The comovement of credit default swap, bond and stock markets : an empirical analysis (2004)

Lars Norden Martin Weber

This paper analyzes the empirical relationship between credit default swap, bond and stock markets during the period 2000-2002. Focusing on the intertemporal comovement, we examine weekly and daily lead-lag relationships in a vector autoregressive model and the adjustment between markets caused by cointegration. First, we find that stock returns lead CDS and bond spread changes. Second, CDS spread changes Granger cause bond spread changes for a higher number of firms than vice versa. Third, the CDS market is significantly more sensitive to the stock market than the bond market and the magnitude of this sensitivity increases when credit quality becomes worse. Finally, the CDS market plays a more important role for price discovery than the corporate bond market. Klassifikation: G10, G14, C32. First version: March 29, 2004. This Version: September 2, 2004.

2004, 19

Real-time price discovery in stock, bond and foreign exchange markets (2004)

Torben G. Andersen Tim Bollerslev Francis X. Diebold Clara Vega

We characterize the response of U.S., German and British stock, bond and foreign exchange markets to real-time U.S. macroeconomic news. Our analysis is based on a unique data set of high-frequency futures returns for each of the markets. We find that news surprises produce conditional mean jumps; hence high-frequency stock, bond and exchange rate dynamics are linked to fundamentals. The details of the linkages are particularly intriguing as regards equity markets. We show that equity markets react differently to the same news depending on the state of the economy, with bad news having a positive impact during expansions and the traditionally-expected negative impact during recessions. We rationalize this by temporal variation in the competing "cash flow" and "discount rate" effects for equity valuation. This finding helps explain the time-varying correlation between stock and bond returns, and the relatively small equity market news effect when averaged across expansions and recessions. Lastly, relying on the pronounced heteroskedasticity in the high-frequency data, we document important contemporaneous linkages across all markets and countries over-and-above the direct news announcement effects. Klassifikation: F3, F4, G1, C5 . July 2003. This Version: June 28, 2004.

2004, 18

Multiple-bank lending : diversification and free-riding in monitoring (2004)

Elena Carletti Vittoria Cerasi Sonja Daltung

This paper analyzes banks' choice between lending to firms individually and sharing lending with other banks, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending is optimal whenever the benefit of greater diversification in terms of higher monitoring dominates the costs of free-riding and duplication of efforts. The model predicts a greater use of multiple-bank lending when banks are small relative to investment projects, firms are less profitable, and poor financial integration, regulation and inefficient judicial systems increase monitoring costs. These results are consistent with empirical observations concerning small business lending and loan syndication. Klassifikation: D82; G21; G32. June 1, 2004.

2004, 17

Legality and venture governance around the world (2004)

Douglas Cumming Daniel Schmidt Uwe Walz

We analyze governance with a dataset on investments of venture capitalists in 3848 portfolio firms in 39 countries from North and South America, Europe and Asia spanning 1971-2003. We find that cross-country differences in Legality have a significant impact on the governance structure of investments in the VC industry: better laws facilitate faster deal screening and deal origination, a higher probability of syndication and a lower probability of potentially harmful co-investment, and facilitate board representation of the investor. We also show better laws reduce the probability that the investor requires periodic cash flows prior to exit, which is in conjunction with an increased probability of investment in high-tech companies. Klassifikation: G24, G31, G32. April 2004 .

2004, 16

Realized beta : persistence and predictability (2004)

Torben G. Andersen Tim Bollerslev Francis X. Diebold Jin Wu

A large literature over several decades reveals both extensive concern with the question of time-varying betas and an emerging consensus that betas are in fact time-varying, leading to the prominence of the conditional CAPM. Set against that background, we assess the dynamics in realized betas, vis-à-vis the dynamics in the underlying realized market variance and individual equity covariances with the market. Working in the recently-popularized framework of realized volatility, we are led to a framework of nonlinear fractional cointegration: although realized variances and covariances are very highly persistent and well approximated as fractionally-integrated, realized betas, which are simple nonlinear functions of those realized variances and covariances, are less persistent and arguably best modeled as stationary I(0) processes. We conclude by drawing implications for asset pricing and portfolio management. Klassifikation: C1, G1 . January 2003. This Draft/Print: March 1, 2004.

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