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 Cluster
Financial Stability and Regulation

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Professor Dr Stefan Eichler
Professor Dr Stefan Eichler
Mitglied - Department Financial Markets
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01.2017 ‐ 12.2020

The Role of Idiosyncratic and Systemic Bank Risks during the Euro Crisis


Professor Dr Stefan Eichler

Refereed Publications


Financial Stability and Central Bank Governance

Michael Koetter Kasper Roszbach G. Spagnolo

in: International Journal of Central Banking, No. 4, 2014


The financial crisis has ignited a debate about the appropriate objectives and the governance structure of Central Banks. We use novel survey data to investigate the relation between these traits and banking system stability focusing in particular on their role in micro-prudential supervision. We find that the separation of powers between single and multiple bank supervisors cannot explain credit risk prior or during the financial crisis. Similarly, a large number of Central Bank governance traits do not correlate with system fragility. Only the objective of currency stability exhibits a significant relation with non-performing loan levels in the run-up to the crisis. This effect is amplified for those countries with most frequent exposure to IMF missions in the past. Our results suggest that the current policy discussion whether to centralize prudential supervision under the Central Bank and the ensuing institutional changes some countries are enacting may not produce the improvements authorities are aiming at. Whether other potential improvements in prudential supervision due to, for example, external disciplinary devices, such as IMF conditional lending schemes, are better suited to increase financial stability requires further research.

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Forecast Dispersion, Dissenting Votes, and Monetary Policy Preferences of FOMC Members: The Role of Individual Career Characteristics and Political Aspects

Stefan Eichler Tom Lähner

in: Public Choice, No. 3, 2014


Using data from 1992 to 2001, we study the impact of members’ economic forecasts on the probability of casting dissenting votes in the Federal Open Market Committee (FOMC). Employing standard ordered probit techniques, we find that higher individual inflation and real GDP growth forecasts (relative to the committee’s median) significantly increase the probability of dissenting in favor of tighter monetary policy, whereas higher individual unemployment rate forecasts significantly decrease it. Using interaction models, we find that FOMC members with longer careers in government, industry, academia, non-governmental organizations (NGOs), or on the staff of the Board of Governors are more focused on output stabilization, while FOMC members with longer careers in the financial sector or on the staffs of regional Federal Reserve Banks are more focused on inflation stabilization. We also find evidence that politics matters, with Republican appointees being much more focused on inflation stabilization than Democratic appointees. Moreover, during the entire Clinton administration ‘natural’ monetary policy preferences of Bank presidents and Board members for inflation and output stabilization were more pronounced than under periods covering the administrations of both George H.W. Bush and George W. Bush, respectively.

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The Political Determinants of Sovereign Bond Yield Spreads

Stefan Eichler

in: Journal of International Money and Finance, No. 46, 2014


This paper analyzes the political determinants of sovereign bond yield spreads using data for 27 emerging markets in the period 1996 to 2009. I find strong evidence that countries with parliamentary systems (as opposed to presidential regimes) and a low quality of governance face higher sovereign yield spreads, while the degree of democracy and elections play no significant role. A higher degree of political stability and the power to implement austerity measures significantly reduce sovereign yield spreads particularly in autocratic regimes, while no significant effect is detected for democratic countries. Overall, political determinants have a more pronounced impact on sovereign bond yield spreads in autocratic and closed regimes than in democratic and open countries.

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Macroeconomic Factors and Microlevel Bank Behavior

Claudia M. Buch S. Eickmeier Esteban Prieto

in: Journal of Money, Credit and Banking, No. 4, 2014


We analyze the link between banks and the macroeconomy using a model that extends a macroeconomic VAR for the U.S. with a set of factors summarizing conditions in about 1,500 commercial banks. We investigate how macroeconomic shocks are transmitted to individual banks and obtain the following main findings. Backward-looking risk of a representative bank declines, and bank lending increases following expansionary shocks. Forward-looking risk increases following an expansionary monetary policy shock. There is, however, substantial heterogeneity in the transmission of macroeconomic shocks, which is due to bank size, capitalization, liquidity, risk, and the exposure to real estate and consumer loans.

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Devaluation Expectations Based on Cross-listed Stocks: Evidence for Financial Crises in Argentina Then and Now

Stefan Eichler

in: Applied Economics Letters, No. 10, 2014


I use the relative prices of American Depositary Receipts and their underlying stocks to derive devaluation expectations. I find that stockholders currently perceive an overvalued peso. Devaluation expectations are driven by the incentive of competitive devaluation and sovereign default risk.

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Working Papers


What Drives the Commodity-Sovereign-Risk-Dependence in Emerging Market Economies?

Hannes Böhm Stefan Eichler Stefan Gießler

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.

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Avoiding the Fall into the Loop: Isolating the Transmission of Bank-to-Sovereign Distress in the Euro Area and its Drivers

Hannes Böhm Stefan Eichler

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.

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Channeling the Iron Ore Super-cycle: The Role of Regional Bank Branch Networks in Emerging Markets

Helge Littke

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.

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Time-varying Volatility, Financial Intermediation and Monetary Policy

S. Eickmeier N. Metiu Esteban Prieto

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.

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A Market-based Indicator of Currency Risk: Evidence from American Depositary Receipts

Stefan Eichler Ingmar Roevekamp

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.

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