Common Asset Holdings Research Articles

Research on systemic risk of China's bank-asset bipartite network

Systemic risk caused by banks due to common asset holdings serve as a significant contagion channel. In this study, we use empirical data from Chinese banks to construct a bank-asset bipartite network, employ the DebtRank algorithm for risk measurement, and incorporate asset price correlation into the DebtRank algorithm. Then we show the changes of the systemic risk in the Chinese banking system from 2018 to 2021. Furthermore, we analyze the systemic risk triggered by different types of banks and different industry assets and quantify the impact of each asset under different stress scenarios. We also conduct a validity analysis of asset price correlation, finding that the systemic risk considering asset price correlation is higher than that without considering asset price correlation. This study of financial systemic risk under the bank-asset bipartite network provides a new perspective for the regulation of systemic risk and is of significant importance for the prevention of systemic risk.

Common Asset Holdings as an Amplifier of Open-Ended Funds Liquidity Risk: Evidence from Global Fixed-Income Funds

Common Asset Holdings as an Amplifier of Open-Ended Funds Liquidity Risk: Evidence from Global Fixed-Income Funds

How vulnerable are interconnected portfolios of South African banks?

Price shocks that propagate through the financial system present a significant risk to financial system stability. This study was an evaluation of the vulnerability of South African banks’ portfolios to pricemediated contagion in the last decade. Using longitudinal data of balance sheet positions of the 10 largest banks from 2010 to 2020, the stress tests were triggered by price shocks on one marketable asset held by all banks: South African government bonds. Overall, the study found that second-order feedback effects from bank deleveraging are muted and that the concentrated structure of the South African banking system has a positive effect on shock absorption. However, a gradual trend towards more similar asset portfolios in the past 10 years has gradually increased exposure to the price-mediated contagion channel. Significance: The paper presents a novel modelling framework to study feedback price-effects in stress tests conducted on the South African banking system. A new data set shows the evolution of South African banks’ portfolio structure and vulnerability by computing two fragility metrics and a portfolio similarity measure. Using this data set, the relationship between banking sector vulnerability and portfolio similarity is tested empirically and it is shown how common asset holdings aggravate systemic risk to pricemediated contagion.

Climate policy and financial system stability: evidence from Chinese fund markets

ABSTRACT The impacts of climate policies on the global financial system have aroused wide attention all over the world. Fund markets are an important part of the financial system and play a crucial role in the stability of the financial system. In this paper, the impacts of climate policies on fund markets are evaluated from direct and indirect risk contagion channels using the data of Chinese ordinary stock funds and partial stock hybrid funds during 2007–2020. Risk contagion indicates that a fund's selling of stocks causes the stock price to fall, causing asset losses to other funds holding the same stocks. We construct a risk contagion model based on common asset holdings of funds. The analysis of direct risk exposure of funds to climate policy in China shows that five climate-policy-relevant sectors account for more than half of the total value of shareholdings. The climate risk stress-test indicates that ignoring the indirect risk contagion channel significantly underestimates the adverse effects of and climate policies on fund markets. More stringent, short-term climate targets and earlier implementation of climate policies helps to mitigate otherwise drastic changes required in energy markets in China to achieve a 2°C long-term target, and reduces the adverse effects of climate policies on the fund market. Furthermore, the impact of climate policies on different investment funds shows significant differences, leading to winners and losers. The losers are funds that adopt a high-carbon investment strategy, while winners are funds adopting a green investment strategy.

Mitigating Contagion Risk by ESG Investing

We study whether ESG investing may mitigate the risk of contagion among equity mutual funds. More precisely, we measure the impact of fire-sale spillover, propagating throughout the financial system, on funds ranked on ESG aspects. We compare the relative loss of capitalization experienced by high- and low-ranked funds. Contagion, which is indirect since funds are not exposed to counterparty risk, is modeled using a network structure. In cases of deleveraging from funds, fire-sale spillover propagates throughout the network because of common asset holdings among funds. We find that funds’ vulnerability to contagion decreases when the level of ESG compliance increases. Moreover, the average relative loss is lower for the high-ranked funds than for the low-ranked ones. The small-size funds mainly drive the result. Our findings indicate that contagion is less effective for high-ranked funds. From a macroeconomic perspective, ESG investing represents a new opportunity for diversification that makes the system more resilient to contagion.

ESG investing: A chance to reduce systemic risk

We consider a network of equity mutual funds characterized by different levels of compliance with Environmental, Social, and Governance (ESG) aspects. We measure the impact of portfolio liquidation in a stress scenario on funds with different ESG ratings. Fire-sales spillover from portfolio liquidation propagates from one fund to another through indirect contagion mediated by common asset holdings. The analysis is conducted quarterly from March 2016 through June 2018 using daily data from different sources at the fund and firm levels. Our estimation strategy relies on a network analysis where funds are not taken as stand-alone entities but are interconnected components of a unified system. We find evidence that the relative market value loss of the High ESG ranked funds is lower than the loss experienced by the Low ESG ranked counterparts in the time span with lower volatility. In the higher-volatility period there is not always a clear dominance of one class over another. Results are robust when controlling for size and for feedback effects, and for different model specifications. Our analysis offers new insights to both asset managers and policymakers to exploit the aggregate effect of portfolio diversification related to the system as a whole.

Herding in Open-end Funds: Evidence from China

This paper aims to detect the herding of Chinese open-end fund managers and examine the role that structural features of their industry play in their herding. The herding behaviour is investigated by employing the cross-sectional absolute deviation (CSAD) model, drawing on the Chinese open-end fund market for the 2007–2020 period.Our findings suggest that the presence of herding has been confirmed in all other types of funds except for income funds, with their herding being mainly driven by non-fundamental factors. Most types of funds show more pronounced herding when the market is rising and the fund flow is positive. Up markets foster positive fund flows, which promote herding to a certain extent. The structural characteristics of fund networks of common asset holdings produce an impact on the fund herding. Herding is observed in the network with larger centrality index and the disassortative network. Moreover, we also find that herding in most types of funds is more pronounced under conditions of high volatility and high economic policy uncertainty, and the fund herding tends to grow inversely with fund-size.

Higher-Order Exposures

Traditional exposure measures focus on direct to evaluate the losses an institution is exposed to upon the default of a counterparty. Since the Global Financial Crisis of '07/'08, indirect via common asset holdings are increasingly recognized too. Yet direct and indirect fail to capture the losses that result from shock propagation and amplification following the counterparty's default. In this paper, we introduce the concept exposures to refer to these spill-over losses and propose a way to formalize and quantify them. Using granular data of the South African financial system, we show that higher-order make up a significant part of – particularly during times of financial distress when matter most. We also show that higher-order cannot simply be extrapolated from direct or indirect exposures, since they depend strongly on the network structure and the robustness of individual institutions. Our findings suggest that higher-order should inform the design and calibration of those tools in the regulators' arsenal where matter -- including large exposure limits, capital requirement calibration, stress test design and resolution. Failure to do so may result in both lax ex-ante regulation and ill-informed ex-post handling of financial crises.

Systemic risk-efficient asset allocations: Minimization of systemic risk as a network optimization problem

Systemic risk is a multi-layer network phenomenon. Layers represent various types of direct financial exposure of various types, including interbank liabilities and derivative- or foreign exchange exposures. An important layer of systemic risk emerges through common asset holdings of financial institutions. Strongly overlapping portfolios lead to similar exposures that are caused by price movements of the underlying financial assets. Based on the knowledge of individual portfolio holdings of financial agents, we quantify the systemic risk of overlapping portfolios. We then present an optimization procedure whereby we minimize the systemic risk in a given financial market by optimally rearranging overlapping portfolio networks. The optimization is performed under the constraints that the expected returns and risk of the individual portfolios are unchanged. We explicitly demonstrate the power of the method on the overlapping portfolio network of sovereign exposure between major European banks, using data from the European Banking Authority stress test of 2016. Systemic risk can be reduced by more than a factor of two, without any detrimental effects for the individual banks. These results are confirmed by a simple simulation of fire sales in the government bond market. In particular, we show that the contagion probability is dramatically reduced in the optimized network. We comment on the efficiency of the network optimization approach in comparison to equity-injection-based ways to reduce systemic risk. To obtain the same risk levels that are obtained in the network optimization, it would be necessary to increase the actual available capital by two thirds. This shows the immense potential of network-based systemic risk management.

Common asset holdings and systemic vulnerability across multiple types of financial institution

One way systemic risk can crystallise is through fire sales of commonly held assets. This paper examines fire sale vulnerabilities across different types of financial institution, including non-banks. We undertake an in-depth empirical analysis of the interconnections between European open-ended investment funds and UK regulated banks and insurance companies through their common asset holdings. This research is the first to combine regulatory holding-level asset data for banks and insurers with private data for open-ended investment funds. Our results show the existence of a significant overlap between the equity and debt portfolios of different types of financial institution. We characterise financial institutions of different types in terms of their concentration profile, portfolio similarity and vulnerability to fire sales, providing evidence for the existence of a price-mediated channel of contagion between banks, insurance companies and investments funds.

ESG Investment Funds: A Chance to Reduce Systemic Risk

We consider a network of equity mutual funds characterized by different levels of compliance with Environmental, Social, and Governance (ESG) aspects. We measure the impact of portfolio liquidation in a stress scenario on funds with different ESG rates. Fire sales spillover from portfolio liquidation propagates from one fund to another because of indirect contagion mediated by common asset holdings. We find that the vulnerability of funds to contagion decreases with the level of ESG compliance. Contagion is less effective for higher ranked funds than for lower ranked ones. In particular, for different levels of portfolio liquidation, the relative market value loss of the highest ESG ranked funds is lower than the loss experienced by the lowest ESG ranked counterpart.

Competition and bank systemic risk: New evidence from Japan's regional banking

Bank competition and financial stability is a recurrent research issue, and researchers have begun to shed light on the effect of competition on systemic risk. In this paper, we first examine the empirical relationship between competition and systemic risk taking up the case of Japan's regional banking system. We find that competition undermines the system-wide financial stability. This result, however, sharply contrasts with those of earlier studies which utilize cross-country samples of large banking organizations. To this end, we perform a theoretical analysis focusing on the business profile of Japan's regional banks. We demonstrate that Japan's regional banks tend to diversify their portfolios toward non-core loans when the profitability of core loans declines as a result of competition. This diversification results in the build-up of systemic risk through increased common asset holdings.

Backtesting Macroprudential Stress Tests

In this paper, we consider models of price-mediated contagion in a banking networkof common asset holdings. For these models, the literature proposed two alternativeclasses of liquidation dynamics:threshold dynamics(banks liquidate their invest-ment portfolios only after they have defaulted), andleverage targeting dynamics(banks constantly rebalance their portfolios to maintain a target leverage ratio).We introduce a one-parameter family of non-linear liquidation functions that inter-polates between these two extremes. We then test the capability of these modelsto predict actual bank defaults (and survivals) in the United States for the years2008-10. We show that the model performance depends on the type of shock be-ing imposed (idiosyncratic versus systematic). We identify the two most relevantasset classes, for which the model has predictive power when these asset classes areexposed to an initial shock. In these cases, the model performs better than alter-native benchmarks that do not account for the network of common asset holdings,irrespective of the assumed liquidation dynamics. We also show how the best per-forming liquidation dynamics depend on the combination of the initial shock leveland the market impact parameter, on the cross-sectional variation in the marketimpact parameter, and on the number of asset liquidation rounds.

Modelling Fire Sale Contagion Across Banks and Non-banks

We study the impact of common asset holdings across different financial sectors on financial stability. In particular, we model indirect contagion via fire sales across UK banks and non-banks. Fire sales are triggered by different responses to a financial shock: banks and non unit-linked insurers are subject to regulatory constraints, while funds and unit-linked insurers are obliged to meet investor redemptions. We use our model to conduct a systemic stress simulation under different initial shock scenarios and institutions’ selling strategies. We find that performing a stress simulation that does not account for common asset holdings across multiple sectors can severely underestimate the fire sale losses in the financial system.We also show that a pro-rata liquidation strategy would result in a higher level of fire sale losses, but a waterfall strategy may produce a higher spill over effect for a passive institution (or a passive sector) that chooses not to liquidate any of its assets during distress.

Backtesting Macroprudential Stress Tests

In this paper, we consider models of price-mediated contagion in a banking network of common asset holdings. For these models, the literature proposed two alternative classes of liquidation dynamics: threshold dynamics (banks liquidate their investment portfolios only after they have defaulted), and leverage targeting dynamics (banks constantly rebalance their portfolios to maintain a target leverage ratio). We introduce a one-parameter family of non-linear liquidation functions that interpolates between these two extremes. We then test the capability of these models to predict actual bank defaults (and survivals) in the United States for the years 2008-10. We show that the model performance depends on the type of shock being imposed (idiosyncratic versus systematic). We identify the two most relevant asset classes, for which the model has predictive power when these asset classes are exposed to an initial shock. In these cases, the model performs better than alternative benchmarks that do not account for the network of common asset holdings, irrespective of the assumed liquidation dynamics. We also show how the best performing liquidation dynamics depend on the combination of the initial shock level and the market impact parameter, on the cross-sectional variation in the market impact parameter, and on the number of asset liquidation rounds.

Financial contagion in inter-bank networks with overlapping portfolios

By considering overlapping portfolios among financial institutions, we construct a financial contagion model for inter-bank networks with two channels of contagion: counter-party risk and common asset holdings risk. Based on the model, we verify the contribution of overlapping portfolios to systemic risk contagion and further analyse how the degree of diversification and initial shock affect the probability, extent and loss degree of contagion in different network structures. The results show that as the degree of diversification increases, the probability, extent and loss degree show overall inverted U-shaped tendencies. Different from the existing research that focuses only on a single channel of risk contagion, we find that the risk contagion is significant because of the combined effect of counter-party risk and common asset holdings risk, even though there is little portfolio overlap. Additionally, we study the core–periphery network to investigate the particularity of systematically important financial institutions and the feedback effect in financial networks when banks proactively reduce the exposure of depreciating assets.

Networks of common asset holdings: aggregation and measures of vulnerability

This paper quantifies the interrelations induced among financial institutions by common asset holdings. A network representation emerges in which nodes represent portfolios and edge weights aggregate the common asset holdings as well as the liquidity of these holdings. As a building block, we introduce a simple model of order imbalance that estimates price impacts caused by liquidity shocks. In our model, asset prices are set by a competitive risk-neutral market maker, and the arrival rates for buyers and sellers depend on the common asset holdings. We illustrate the relevance of our aggregation method and the resulting network representation using data on mutual fund asset holdings. We compare three related measures of vulnerability in the network and demonstrate a strong dependence between mutual fund returns and these measures.

Common Asset Holdings and Stock Return Comovement

A growing literature highlights the effect of common asset holdings on market dynamics. Focusing on relatively large stocks, Anton and Polk (2014) find that assets with many common investors comove more strongly in the future than otherwise similar stocks. In order to acknowledge the shift in institutional preferences over the last two decades we perform a similar analysis but also include small stocks in our sample. Our main findings are as follows: first, we document a strong increase in both institutional ownership and common asset holdings over the sample period, particularly so for the smallest stocks. Second, raw stock return correlations have also increased strongly over time, while the increase is much more modest for factor model residual correlations. Third, we confirm that common ownership is significantly related to future return correlations for relatively large stocks, but the relationship appears to become less important over time. For relatively small stocks the relationship is often insignificant, but the effect appears to become more important over time. Lastly, we find no evidence that institutional ownership Granger-causes return correlations for the subset of small stocks.

Are Specialists Speciall?

Common asset holdings have received a lot of attention recently, but little is known about how overlapping investors' portfolios are in the real world. Using data on U.S. institutional investors' stock portfolios for the period 1990–2014, we document a strong and significant overlap in the average pair of investors' portfolios. This strong portfolio overlap is the main reason for why it is difficult to detect institutions with superior performances. In fact, while specialized investors appear to emphasize certain stock-specific characteristics, their performances are not significantly different from those of diversified investors. Overall, these findings suggest that specialist investors are not very special.

Fire Sales, Indirect Contagion and Systemic Stress Testing

We present a framework for quantifying the impact of fire sales in a network of financial institutions with common asset holdings, subject to leverage or capital constraints. Asset losses triggered by macro-shocks may interact with one-sided portfolio constraints, such as leverage or capital constraints, resulting in liquidation of assets, which in turn affects market prices, leading to contagion of losses and possibly new rounds of fire sales when portfolios are marked to market. Price-mediated contagion occurs through common asset holdings, which we quantify through liquidity-weighted overlaps across portfolios. Exposure to price-mediated contagion leads to the concept of indirect exposure to an asset class, as a consequence of which the risk of a portfolio depends on the matrix of asset holdings of other large and leveraged portfolios with similar assets. Our model provides an operational stress testing method for quantifying the systemic risk arising from these effects. Using data from the European Banking Authority, we examine the exposure of the EU banking system to price-mediated contagion. Our results indicate that, even with optimistic estimates of market depth, moderately large macro-shocks may trigger fire sales which may then lead to substantial losses across bank portfolios, modifying the outcome of bank stress tests. Price-mediated contagion leads to a heterogeneous cross-sectional loss distribution across banks, which cannot be replicated simply by applying a macro-shock to bank portfolios in absence of fire sales. Unlike models based on `leverage targeting', which assume symmetric reactions to gains or losses, our approach is based on the asymmetric interaction of portfolio losses with one-sided constraints, distinguishes between insolvency and illiquidity and leads to substantially different loss estimates in stress scenarios.