Financial Market Structure and Financial Stability
This research group focuses on the role of financial market structures for financial stability. The recent financial crisis has revealed several new financial vulnerabilities that call for adequate regulatory responses. Sovereign solvency and bank default risk need to be made less interdependent by revising incentive structures propagating the transmission of these financial risks. Adequate regulatory treatment is needed for sovereign bond holdings of banks. The role of central bank transparency for international bank investment and financial stability needs to be understood. In a first workpackage, the impact of banking sector instability on sovereign default risk will be considered. The second workpackage analyses the performance of sovereign bond portfolio management of individual banks – by assessing both ex ante optimality of portfolio diversification as well as ex post risk adjusted returns. A third workpackage focuses on the role of central bank transparency for default risk and portfolio holdings of banks. Two aspects of central bank transparency will be considered: Transparency about monetary policy and transparency about macroprudential regulation.
Research ClusterFinancial Stability and Regulation
01.2017 ‐ 12.2020
The Role of Idiosyncratic and Systemic Bank Risks during the Euro Crisis
Regional Banking Instability and FOMC Voting
in: Journal of Banking & Finance, 2018
This study analyzes if regionally affiliated Federal Open Market Committee (FOMC) members take their districts’ regional banking sector instability into account when they vote. Considering the period 1979–2010, we find that a deterioration in a district's bank health increases the probability that this district's representative in the FOMC votes to ease interest rates. According to member-specific characteristics, the effect of regional banking sector instability on FOMC voting behavior is most pronounced for Bank presidents (as opposed to Governors) and FOMC members who have career backgrounds in the financial industry or who represent a district with a large banking sector.
Regional, Individual and Political Determinants of FOMC Members' Key Macroeconomic Forecasts
in: Journal of Forecasting, No. 1, 2018
We study Federal Open Market Committee members' individual forecasts of inflation and unemployment in the period 1992–2004. Our results imply that Governors and Bank presidents forecast differently, with Governors submitting lower inflation and higher unemployment rate forecasts than bank presidents. For Bank presidents we find a regional bias, with higher district unemployment rates being associated with lower inflation and higher unemployment rate forecasts. Bank presidents' regional bias is more pronounced during the year prior to their elections or for nonvoting bank presidents. Career backgrounds or political affiliations also affect individual forecast behavior.
How Do Political Factors Shape the Bank Risk-Sovereign Risk Nexus in Emerging Markets?
in: Review of Development Economics, No. 3, 2017
This paper studies the role of political factors for determining the impact of banking sector distress on sovereign bond yield spreads for a sample of 19 emerging market economies in the period 1994–2013. Using interaction models, I find that the adverse impact of banking sector distress on sovereign solvency is less pronounced for countries with a high degree of political stability, a high level of power sharing within the government coalition, a low level of political constraint within the political system, and for countries run by powerful and effective governments. The electoral cycle pronounces the bank risk–sovereign risk transfer.
Managerial Stability and the Pricing of New Equity Issuances: The Effects of State Enforcement of Noncompetition Agreements
in: International Review of Entrepreneurship, No. 2, 2017
In this paper, we empirically investigate the relationship between managerial stability induced by the legal enforcement of noncompetition agreements and the pricing of new equity issuances. Making use of the variation in the enforceability of noncompetition contracts across states in the U.S., we find that managerial stability is negatively related to underpricing and price revision for our sample of new equity issuing firms. Our results demonstrate that the stability of management is important for an issuing firm to convey its intrinsic value credibly to the market.
Central Bank Transparency and Cross-border Banking
in: Journal of International Money and Finance, 2017
We analyze the effect of central bank transparency on cross-border bank activities. Based on a panel gravity model for cross-border bank claims for 21 home and 47 destination countries from 1998 to 2010, we find strong empirical evidence that a rise in central bank transparency in the destination country, on average, increases cross-border claims. Using interaction models, we find that the positive effect of central bank transparency on cross-border claims is only significant if the central bank is politically independent and operates in a stable economic environment. Central bank transparency and credibility are thus considered complements by banks investing abroad.
What Drives the Commodity-Sovereign-Risk-Dependence in Emerging Market Economies?
in: IWH Discussion Papers, No. 23, 2019
Using daily data for 34 emerging markets in the period 1994-2016, we find robust evidence that higher export commodity prices are associated with higher sovereign bond returns (indicating lower sovereign risk). The economic effect is especially pronounced for heavy commodity exporters. Examining the drivers, we find, first, that commodity-dependence is higher for countries that export large volumes of volatile commodities and that the effect increases in times of recessions, high inflation, and expansionary U.S. monetary policy. Second, the importance of raw material prices for sovereign financing can likely be mitigated if a country improves institutions and tax systems, attracts FDI inflows, invests in manufacturing, machinery and infrastructure, builds up reserve assets and opens capital and trade accounts. Third, the concentration of commodities within a country’s portfolio, its government indebtedness or amount of received development assistance appear to be only of secondary importance for commodity-dependence.
Avoiding the Fall into the Loop: Isolating the Transmission of Bank-to-Sovereign Distress in the Euro Area and its Drivers
in: IWH Discussion Papers, No. 19, 2018
We isolate the direct bank-to-sovereign distress channel within the eurozone’s sovereign-bank-loop by exploiting the global, non-eurozone related variation in stock prices. We instrument banking sector stock returns in the eurozone with exposure-weighted stock market returns from non-eurozone countries and take further precautions to remove any eurozone crisis-related variation. We find that the transmission of instrumented bank distress, while economically relevant, is significantly smaller than the corresponding coefficient in the unadjusted OLS framework, confirming concerns on reverse causality and omitted variables in previous studies. Furthermore, we show that the spillover of bank distress is significantly stronger for countries with poorer macroeconomic performances, weaker financial sectors and financial regulation and during times of elevated political uncertainty.
Channeling the Iron Ore Super-cycle: The Role of Regional Bank Branch Networks in Emerging Markets
in: IWH Discussion Papers, No. 11, 2018
The role of the financial system to absorb and to intermediate commodity boom induced windfall gains efficiently presents one of the most pressing issues for developing economies. Using an exogenous increase in iron ore prices in March 2005, I analyse the role of regional bank branch networks in Brazil in reallocating capital from affected to non-affected regions. For the period from March 2004 to March 2006, I find that branches directly exposed to this shock by their geographical location experience an increase in deposit growth in the post-shock period relative to non-affected branches. Given that these deposits are not reinvested locally, I further show that branches located in the non-affected region increase lending growth depending on their indirect exposure to the booming regions via their branch network. Even tough, these results provide evidence against a Dutch Disease type crowding out of the non-iron ore sector, further evidence suggests that this capital reallocation is far from being optimal.
Time-varying Volatility, Financial Intermediation and Monetary Policy
in: IWH Discussion Papers, No. 19, 2016
We document that expansionary monetary policy shocks are less effective at stimulating output and investment in periods of high volatility compared to periods of low volatility, using a regime-switching vector autoregression. Exogenous policy changes are identified by adapting an external instruments approach to the non-linear model. The lower effectiveness of monetary policy can be linked to weaker responses of credit costs, suggesting a financial accelerator mechanism that is weaker in high volatility periods.
A Market-based Indicator of Currency Risk: Evidence from American Depositary Receipts
in: IWH Discussion Papers, No. 4, 2016
We introduce a novel currency risk measure based on American Depositary Receipts(ADRs). Using a multifactor pricing model, we exploit ADR investors’ exposure to potential devaluation losses to derive an indicator of currency risk. Using weekly data for a sample of 831 ADRs located in 23 emerging markets over the 1994-2014 period, we find that a deterioration in the fiscal and current account balance, as well as higher inflation, increases currency risk. Interaction models reveal that these macroeconomic fundamentals drive currency risk, particularly in countries with managed exchange rates, low levels of foreign exchange reserves and a poor sovereign credit rating.