http://repub.eur.nl/res/concept/jel-G28/ Recent publications classified by JEL Code G28 en http://repub.eur.nl/static-eur/img/logo.png http://repub.eur.nl http://repub.eur.nl/res/pub/23653/ 2011-05-02T00:00:00Z Standard risk metrics tend to underestimate the true risks of hedge funds because of serial correlation in the reported returns. Getmansky et al. (2004) derive mean, variance, Sharpe ratio, and beta formulae adjusted for serial correlation. Following their lead, adjusted downside and global measures of individual and systemic risks are derived. We distinguish between normally and fat tailed distributed returns and show that adjustment is particularly relevant for downside risk measures in the case of fat tails. A hedge fund case study reveals that the unadjusted risk measures considerably underestimate the true extent of individual and systemic risks. Di Cesare, A. Stork, Ph.A. Vries, C.G. de http://repub.eur.nl/res/pub/34943/ 2011-05-01T00:00:00Z Abstract: This paper is one chapter of the volume “Regulation and Economics” of the second edition of the Encyclopedia of Law and Economics. The authors review the economics of banking and financial markets and the regulatory response to market failure. Market failure in finance depends on problems of information and externalities. Regulation addresses these problems through conduct of business rules and prudential requirements. This approach has recently proved insufficient to prevent financial crises. Governments and central banks had to step in with massive safety nets in order to prevent financial meltdown. Although the appropriate regulatory response to the global financial crisis is still to be discovered, this chapter tries to draw a few lessons for financial regulation and supervision. First, prudential regulation and supervision should monitor, and possibly limit, competition between banks and non-banks in order to identify timely new sources of systemic risk. Second, financial stability policies need to strike a difficult balance between ex-ante strictness and ex-post leniency in order to deal with non-quantifiable risks. Moral hazard is not the only determinants of systemic instability; knightian uncertainty also determines instability by suddenly curtailing market and funding liquidity. Third, all financial institutions falling within the regulatory perimeter should have good corporate governance. However, what is good governance for non-financial firms is not necessarily efficient for financial firms due to the quality and quantity of externalities involved. Finally, because systemic externalities are cross-jurisdictional in modern financial markets, at least coordination among monetary and supervisory authorities of different countries is warranted. Pacces, A.M. Heremans, D. http://repub.eur.nl/res/pub/21681/ 2010-12-01T00:00:00Z We analyze the impact of (alliance) network exposure on the speed and extent of adoption of the business model as being one explanatory factor for diffusion controlling for actor specific characteristics and embeddedness in the network. In order to explain how existing national regulation moderated this relationship and whether it succeeded in its risk-limiting mission by moderating global adoption patterns and risk-bearing behavior among financial institutions we estimate various history event analysis model i.e. standard Cox and extended frailty models. We find strong support for the role of network exposure rather than social learning, the impact of regulatory effort on patterns of adoption and the role of country clusters for diffusion in the financial sector. Cuntz, A.N. Blind, K. http://repub.eur.nl/res/pub/34945/ 2010-01-01T00:00:00Z Abstract This article analyzes the last financial crisis focussing on the recurrent dynamics of externalities in banking. It shows that two major determinants of the crisis were the uncertainty of a new form of financial intermediation and the failure of regulation to cope with its externalities. Differently from more standard explanations, which are based on opportunism and/or irrationality of financial institutions, this analysis suggests that regulation has not just been insufficient. Regulation has contributed to financial instability too, supporting fragile conventions to handle uncertainty and encouraging regulatory arbitrage through financial innovation. Three implications are derived from this analysis and contrasted with the ongoing reforms of financial regulation in the US and in the EU. First, regulatory arbitrage is better dealt with by protecting banking from disintermediation than by extending prudential regulation to non-banks. Maturity transformation should be defined functionally and reserved to banks. Second, a major danger with ratings is that they support false conventions of safety. To avoid this outcome, the relevance of ratings for regulatory purposes should be reduced and rating agencies should be deterred from rating without firm knowledge. Third, in order to reduce short-termism, regulation of banks’ corporate governance should rather question than reinforce managerial accountability to shareholders. Pacces, A.M. http://repub.eur.nl/res/pub/23434/ 2009-07-01T00:00:00Z Regulatory capital requirements for European banks have been put forward in the Basel II Capital Framework and subsequently in the capital requirements directive (CRD) of the EU. We provide a detailed discussion of the capital requirements for private equity investments under different approaches. For the internal model approach we present a structural model that we calibrate to a proprietary dataset. We modify the standard Merton structural model to make it applicable in practice and to capture stylized facts of private equity investments. We also implement the early default feature with a fast simulation algorithm. Our results support capital requirements lower than in Basel II, but not as low as in CRD, thereby giving adverse incentives to banks for using advanced risk models. A sensitivity analysis shows that this finding is robust to parameter uncertainty and stress scenarios. Bongaerts, D.G.J. Charlier, E. http://repub.eur.nl/res/pub/12372/ 2006-01-01T00:00:00Z Paper prepared for the NBER project on “Risks of Financial Institutions”. We benefited from suggestions and criticism by many participants in the NBER project on “Risks of financial institutions”, in particular by the organizers Mark Carey (also involving Dean Amel and Allen Berger) and Rene Stulz, by our discussant Tony Saunders and by Patrick de Fontnouvelle, Gary Gorton, Andy Lo, Jim O’Brien and Eric Rosengren. Furthermore, we are grateful for comments we received at the 2004 European Finance Association Meetings in Maastricht, in particular by our discussant Marco da Rin and by Christian Upper, at the 2004 Ottobeuren seminar in economics, notably the thoughts of our discussant Ernst Baltensberger, of Friedrich Heinemann and of Gerhard Illing, as well as at seminars of the Max Planck Institute for Research on Collective Goods, the Federal Reserve Bank of St. Louis, the ECB and the University of Frankfurt. Gabe de Bondt and David Marques Ibanez supported us enormously in finding yield spread data, Lieven Baele and Richard Stehle kindly made us aware of pitfalls in Datastream equity data. Very helpful research assistance by Sandrine Corvoisier, Peter Galos and Marco Lo Duca as well as editorial support by Sabine Wiedemann are gratefully acknowledged. Any views expressed only reflect those of the authors and should not be interpreted as the ones of the ECB or the Eurosystem. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research. This paper derives indicators of the severity and structure of banking system risk from asymptotic interdependencies between banks’ equity prices. We use new tools available from multivariate extreme value theory to estimate individual banks’ exposure to each other (“contagion risk”) and to systematic risk. Moreover, by applying structural break tests to those measures we study whether capital markets indicate changes in the importance of systemic risk over time. Using data for the United States and the euro area, we can also compare banking system stability between the two largest economies in the world. Finally, for Europe we assess the relative importance of cross-border bank spillovers as compared to domestic bank spillovers. The results suggest, inter alia, that systemic risk in the US is higher than in the euro area, mainly as cross-border risks are still relatively mild in Europe. On both sides of the Atlantic systemic risk has increased during the 1990s. Hartmann, P. Straetmans, S. Vries, C.G. de http://repub.eur.nl/res/pub/7426/ 2005-12-07T00:00:00Z We study the dependence between the downside risk of European banks and insurers. Since the downside risk of banks and insurers differs, an interesting question from a supervisory point of view is the risk reduction that derives from diversification within large banks and financial conglomerates. We discuss the limited value of the normal distribution based correlation concept, and propose an alternative measure which better captures the downside dependence given the fat tail property of the risk distribution. This measure is estimated and indicates better diversification benefits for conglomerates versus large banks. Slijkerman, J.F. Schoenmaker, D. Vries, C.G. de http://repub.eur.nl/res/pub/7132/ 2005-11-30T00:00:00Z Latvian employees have to choose a pension fund for the second-pillar of the Latvian pension system. These pension funds invest about 85% in domestic assets. In this paper, we address the question why this strong home bias might exist. Firstly, we conclude that the Latvian pension law is strict on international diversification. However, not to the extent that it can fully explain the home bias. Secondly, our empirical analysis suggests that international diversification lowers investment risks for Latvian (pension) investors. Thus, it seems hard to explain the home bias of Latvian pension funds by lack of diversification benefits. Thirdly, Latvian pension fund managers might have more (private) information about Latvian companies than international companies. Therefore, they might prefer to invest more domestically to add more value for their clients. Finally, Latvian employees might have a strong preference to invest in companies they are familiar with. Since we are not aware of any research on the latter two topics, we can only speculate that currently many investment policies are suboptimal for Latvian employees saving for retirement. We expect the Latvian pension industry to develop new products that reduce risk by allowing for more diversification. In addition, we recommend Latvian employees to pay attention to the investment policy of their pension fund and think carefully about the rewards, risks, and costs that are involved. Swinkels, L.A.P. Vejina, D. Vilans, R. http://repub.eur.nl/res/pub/12375/ 2005-04-01T00:00:00Z Banks are linked through the interbank deposit market, participations like syndicated loans and deposit interest rate risk. The similarity in exposures carries the potential for systemic breakdowns. This potential is either strong or weak, depending on whether the linkages remain or vanish asymptotically. It is shown that the linearity of the bank portfolios in the exposures, in combination with a condition on the tails of the marginal distributions of these exposures, determines whether the potential for systemic risk is weak or strong. We show that if the exposures have marginal normal distributions the potential for systemic risk is weak, while if e.g. the Student distributions apply the potential is strong. Vries, C.G. de http://repub.eur.nl/res/pub/12383/ 2002-07-30T00:00:00Z Under the new Capital Accord, banks choose between two different types of risk management systems, the standard or the internal rating based approach. The paper considers how a bank's preference for a risk management system is affected by the presence of supervision by bank regulators. The model uses a principal–agent setting between a bank's owner and its risk management. The main conclusion is that previously unregulated institutions can be expected to switch to the lower quality standard approach subsequent to becoming regulated, i.e., the presence of regulation may induce a bank to decrease the quality of its risk management system. Danielsson, J. Jorgensen, B.N. Vries, C.G. de