Low Interest Rate Environment Research Articles

Simulation of multidimensional diffusions with sticky boundaries via Markov chain approximation

In this study, we develop a novel method to simulate multidimensional diffusions with sticky boundaries for which the Euler scheme fails. We approximate the sticky diffusion process by a multidimensional continuous-time Markov chain (CTMC) that can be easily simulated. We provide two approaches to construct the CTMC. In the first approach, we approximate the infinitesimal generator of the sticky diffusion by finite difference using standard coordinate directions. In the second one, we match the local moments using the drift and the eigenvectors of the covariance matrix as transition directions. The first approach does not always guarantee a valid Markov chain, whereas the second one can. We show that both construction methods yield a first-order simulation scheme, which can capture the sticky behavior and is free from the curse of dimensionality. As applications, we use our method to simulate the limit of a queuing system with exceptional service policy and a multi-factor short rate model for low interest rate environment.

Are European commercial banks more profitable than cooperative banks? Evidence from a low interest rate environment

AbstractOur aim is to compare empirically the profitability of European cooperative and commercial banks in a low interest rate environment. We employ dynamic panel data methods on a data set of nearly 1000 banks from 11 European countries where both ownership structures compete on the same market. We observed different banking strategies during the 2009–2015 period, when market interest rates reached an all‐time low. Our analysis produced four main conclusions. First, we find that commercial banks maintain superior profitability over cooperative banks in an environment of low interest rates. Second, commercial banks unjustifiably decreased their loan loss provisioning in a low interest rate environment in order to maintain their profitability. This trend is not present in cooperative banks. Third, decreased provisioning is present mainly in smaller institutions. Fourth, cooperative banks are significantly more stable than commercial banks in terms of their Z‐score in a low interest rate environment. This finding is in line with existing findings during normal interest rates. In addition, the Z‐score of cooperative banks increased during the observation period, whereas the Z‐score of commercial banks remained stable. Our findings survive a battery of robustness checks. Our results also show differences in the strategies and priorities of both competing ownership types in a low interest rate environment: commercial banks focus on maintaining their profitability by decreasing loan loss provisions, whereas cooperative banks seek to increase their stability. Therefore, regulators pursuing stability in a low interest rate environment should focus on the credit risk management of small commercial banks.

Labour market reforms and employment hysteresis

Abstract This paper analyses the effects of deregulation of employment in an environment of low interest rates and economic uncertainty. For this purpose, we estimate a switching employment equation based on the play model of hysteresis. As a novel feature, the estimation allows for a possible change in the value of the switching parameter after the implementation of labour market reforms. We use Portuguese monthly industrial data spanning from January 2000 to October 2016. Portugal provides a good case study since it is a country where significant measures towards the deregulation of the labour market were applied after the recent financial crisis. The results show that these measures reduced the hysteresis effects in the dynamics of aggregate employment except in the period where uncertainty increased substantially, when the opposite happened.

Global Life Insurers during a Low Interest Rate Environment

Life insurers' business model has changed with the growth of insurance products with minimum return guarantees that are exposed to market and interest risks. The interest risk exposure of US and European insurers increased in the low-rate environments after the global financial crisis and the European sovereign debt crisis, respectively. The relative fragility of life insurers is highly persistent across the global financial crisis, the European sovereign debt crisis, and the COVID-19 crisis. European insurers with a higher share of liabilities with minimum return guarantees in 2016 had lower stock returns during the COVID-19 crisis.

Identifying countries at risk of fiscal crises: High‐debt developed countries

AbstractCrises in European countries in 2010 and beyond demonstrated that fiscal crises and sovereign default are not confined to emerging and developing countries. Advanced economies can sustain much larger debt‐to‐GDP ratios than emerging economies. But how much larger? Experience is heterogeneous both across countries and across time. What determines this heterogeneity? We show that a low growth‐adjusted interest rate, a large maximum value for the primary surplus and a strong surplus responsiveness to debt can support higher debt‐to‐GDP ratios without fiscal crisis. We use our estimates to assess fiscal crisis risk for nine high‐debt developed countries following the financial crisis in 2008. Our results imply that Ireland and Portugal lost access to financial markets because of the rise in growth‐adjusted interest rate, whereas Greece would have lost access regardless of the interest rate. Additionally, our results warn of potential future crises for Greece, Italy and Japan even if these countries remain in a low interest rate environment.

Corporate debt and unconventional monetary policy: The risk-taking channel with bond and loan contracts

We investigate the effects of unconventional monetary policies on corporate debt through the risk-taking channel using corporate bond and syndicated loan contracts from 2000 to 2016 in Japan. In this period, the policy rate remained fixed near the zero bound. Using the daily changes in the yield curve on monetary policy meeting days, we identify one call rate shock and two unconventional monetary policy shocks that do not affect short-term rates. We find that QE shocks, which move all medium-to-long-term rates, increase the maturity of debt contracts, especially for syndicated loans. In addition, such QE shocks decrease the size of corporate bonds with short maturity. On the other hand, QQE shocks, which raise medium-term rates and lower long-term rates, decrease the size of loans and corporate bonds with longer maturity. These effects imply the existence of the risk-taking channel of unconventional monetary policy: it stimulates investment in longer-maturity assets and decreases investment in assets with lower yields. Our findings show that unconventional policies affect debt contracts even in an extremely low interest rate environment.

Limitations of the framework to address value for money risk in the European unit-linked market

Savings in the unit-linked products are increasing across the European Union member-states. In environment of low interest rates and increased capital requirements for traditional life insurance products the supply of the unit-linked insurances is rapidly growing. The last year sold unit-linked life insurances in Bulgaria are four times more than five years earlier.
 Unit-linked life insurance consists of insurance part and asset management part. The investment result from the insurance is usually born by the insured. The investment performance is related to the performance of the financial markets.
 The growing acceptance of unit-linked products are posing questions of adequate information to consumers, the balance between the price and the benefits of the products, the related risks and the proper rights of the insured.
 All these specifics raise questions whether the insured are well informed when buying the insurance and whether the client’s needs and preferences are matched with the proposed product. These questions lead to the asking what value is receiving the client for the money spent – value for money effect and risks.
 In the European Union there is no common framework on the assessment of the effectiveness of the product. The European Insurance and Occupational Pensions Authority is proposing framework to address value for money risk in the European unit-linked market.
 The study finds out that the design of the product is of great importance for the value for money effect for the insured. The life insurance activity in the European Union follows strict and profound regulations both for the life insurance companies and for the life insurance products. That is why additional framework is not the most necessary step. The European Union needs Savings plan that encourages saving in the member states, increases the insurance coverage, increases the accumulated assets and improves the efficiency of the personal savings and investment products.

Nelson–Siegel decay factor and term premia in Japan

This study examines the low–interest rate environment in Japan from mid-1990 to the end of 2020, using a dynamic Nelson–Siegel framework emphasizing the role of the decay factor. A regime-switching model estimates that the regime with low decay factor and bond yield volatility (“low” regime) has persisted since the early years of Bank of Japan's quantitative and qualitative monetary easing (QQE) policy. A shift away from the low regime can instantly increase the 10-year government bond yield by over 50 basis points by increasing the term premiums with little changes in the expected short rate.

Black-scholes approximation of warrant prices: slight return in a low interest rate environment

Black-scholes approximation of warrant prices: slight return in a low interest rate environment

Interest rate risk and monetary policy normalisation in the euro area

A low interest rate environment is susceptible to sudden increases in policy rates and heightened interest rate risk (IRR). By using a sample of 81 euro area banks during the period 2014Q4-2018Q1 and a confidential supervisory measure of IRR, this paper identifies which bank-specific characteristics can amplify or weaken the impact of a 200 basis points positive shock in interest rates. We find that banks reliant on core deposits, that hold more floating-interest rate loans and that diversify their lending, either by sector or geography, are less exposed to a positive change in interest rates. Interestingly, we discover that banks that did not exploit the exceptional financing provided by the European Central Bank (ECB) reveal greater IRR exposure. These findings advance the debate on the impact of a possible return to a normalised monetary policy on the euro area banking sector.

Debt policies in the aftermath of COVID-19 — The SGP’s debt benchmark revisited

The post-COVID-19 period is likely to be characterised by an intensified stabilisation-sustainability trade-off. This paper revisits the design of the Stability and Growth Pact’s debt rule in the context of two debates on fiscal policies: first, the implications of the low interest environment for debt sustainability and the appropriate interaction of fiscal and monetary policies and, second, the reform of the EU fiscal governance framework. In both debates the choice of government debt anchor and the speed of adjustment take centre stage. The debt rule appears predestined to fulfil the role of debt anchor. However, our analysis shows that its existing design gives rise to a pro-cyclical bias that has hampered its implementation in a low-growth and inflation environment. We propose two parametric changes to better balance the objectives of macroeconomic stabilisation and debt sustainability: first, accounting for persistent deviations of inflation from the central bank’s target; and, second, a reduced speed of adjustment. Putting a reformed debt rule at the centre of the EU fiscal governance framework would allow reducing the latter’s complexity without the need to revise the EU Treaties.

High-frequency identification of monetary policy shocks in Japan.

We identify monetary policy shocks in Japan during the unconventional monetary policy period using high-frequency data for interest rate futures. Following the empirical strategy of Gürkaynak et al. (Int J Cent Bank 1: 55–93, 2005), we conduct an event-study analysis to estimate the effects of the monetary policy surprises on asset prices around the timing of policy announcements made by the Bank of Japan between 1999 and 2020. We find that a monetary policy shock can be described by two factors that have statistically significant effects on the financial market. A surprise monetary tightening has negative effects on stock returns and positive effects on government bond yields, even in the low-interest environment. We also find that the responses of the longer term yields tend to be larger than those of the shorter term yields. The response is the largest for the 10-year government bond yield, which has, in the last 2 decades, been effectively targeted by the Bank of Japan. This finding contrasts with those of previous studies of the conventional monetary policy period, in which responses are larger for the shorter term yields.

The unbearable lightness of equilibria in a low interest rate environment

Structural models with no solution are incoherent, and those with multiple solutions are incomplete. We show that models with occasionally binding constraints are not generically coherent. Coherency requires restrictions on the parameters or on the support of the distribution of the shocks. In presence of multiple shocks, the support restrictions cannot be independent from each other, so the assumption of orthogonality of structural shocks is incompatible with coherency. Models whose coherency is based on support restrictions are generically incomplete, admitting a very large number of minimum state variable solutions.

Firm Attributes and Value of Pension Fund Administrators in Nigeria

Value creation is a key objective of every firm and this is applicable to Pension Fund Administrators (PFAs) who seek to remain competitive and achieve superior corporate performance by taking advantage of certain firm attributes. Studies have shown that value of PFAs can impact the financial health of a significant number of individuals during their retirement years if their Retirement Saving Account (RSA) funds are well managed. This objective is scarcely achieved following the increasing challenge faced by the pension fund industry in the dimensions of dearth of investment, poor investment decision by PFAs, restrictions and investment limits by the regulator and the hunt for yield for its RSA contributors amid an environment of low interest rates. Studies that examined the combined effect of firm attributes of firm age, size, contribution density, number of contributors, board size, board quality and branch network on the value of PFAs are lean. This study investigated the effect of firm attributes on Value of Pension Fund Administrators (net asset value per unit) in Nigeria. The study employed <i>ex-post facto</i> research design. Purposive sampling technique was used to select a sample of fifteen (15) from 22 pension fund administrators which have been in existence for the past ten years (2011-2020). Data for this study were extracted from the published annual reports and accounts of the sampled companies which were validated by certification of external auditors and National Pension Commission (PenCom). Data were analysed using descriptive and inferential (multiple regression) statistics at α = 0.05 level of significance. The study found that firm attributes jointly exerted significant impact on net asset value per unit of pension fund administrators (<i>Adj</i>.R² = 0.9298, F(6, 143) = 254.96, p < 0.05). The study concluded that firm attributes enhanced the value of pension fund administrators in Nigeria. It was recommended that pension fund managers should make stakeholders’ interest (contributors and shareholders) a priority and use the selected firm attributes to their advantage to drive performance and create value.

Low Interest Rates, Market Power, and Productivity Growth

This study provides a new theoretical result that a decline in the long‐term interest rate can trigger a stronger investment response by market leaders relative to market followers, thereby leading to more concentrated markets, higher profits, and lower aggregate productivity growth. This strategic effect of lower interest rates on market concentration implies that aggregate productivity growth declines as the interest rate approaches zero. The framework is relevant for antitrust policy in a low interest rate environment, and it provides a unified explanation for rising market concentration and falling productivity growth as interest rates in the economy have fallen to extremely low levels.

Corporate Pension Risk-Taking in a Low Interest Rate Environment

Corporate Pension Risk-Taking in a Low Interest Rate Environment

Valuation of General Gmwb Annuities in a Low Interest Rate Environment

Valuation of General Gmwb Annuities in a Low Interest Rate Environment

Disproportionate Safety Preference and the Innovation of Fintech Shadow Banking

There has been a dramatic shift in financial intermediation in the last 10 - 15 years from traditional banks to shadow banks (non-depository institutions that rely on originate-to-distribute lending model). We link this rise to an emerging literature that shows that certain and uncertain utility functions are different with a disproportionate preference for certainty. We show that such a preference plays a role in diverting lending away from the traditional banking model to the shadow banking model. Furthermore, a low interest-rate environment emerges as the key contributing factor in the dramatic rise of shadow banking.

Peril or Promise—How the SME Banking Sector Will Perform in 2022 and beyond? Do We See an Overreliance on Recovery?

The study takes a specific look at the microstructure of banking lending to SMEs and the latent trials in maintaining a better balance between the loan demand and supply after the COVID-19 pandemic to upkeep the overall economic goals. The global “war” on the COVID-19 pandemic and related economic waves indeed have led to the worldwide recession. The COVID-19 crisis becomes the most extensive systemic-risk unification the world has ever comprehended in the commercial sense. More actions are needed to avoid falling these economies into life-support despite government initiatives regarding new regulations and stimulus packages. Unfortunately, the smallest business segment struggles and fails to claim essential funding through internal and external sources due to inherent weaknesses and poor business architecture. Historically, the SME funding gap was one of the critical areas of discussion and research. Before the current situation, accessing financial services, crucial for SMEs’ growth, severely constrained many economies. However, the problem has further deteriorated. The prolonged low-interest environment, high competition, and compressed interest margins made many banks under-priced SME risk, particularly after the previous financial crisis. Against this backdrop, the predominant SME lenders experience high NPL ratios, adversely affecting the entire banking system’s soundness and lending to the real economy.

Fiscal sustainability and low interest rates: what an indicator can(’t) tell

The indicator that is commonly used to assess the long-term fiscal sustainability of public finances in EU member states (“S2”) is also defined if government borrowing rates are assumed to be permanently lower than the growth rate of GDP. Under these circumstances, however, it no longer provides a reliable orientation for fiscal policy. I illustrate these findings based on simulations prepared for the Fifth Sustainability Report published by the German Federal Ministry of Finance. In addition, I discuss the interpretation of the indicator in a low-interest environment and the assumption that relevant interest rates may continue to be low if there are substantial challenges for fiscal sustainability, e.g., through demographic ageing.