Moral Hazard Risk Research Articles

Just Round the Corner? Pros, Cons, and Implementation Issues of a Fiscal Union for the Euro Area

The experience of a number of successful monetary unions and economic theory suggest that the euro area would benefit from the establishment of a supranational fiscal capacity, provided its design keeps the risk of moral hazard at bay. Institutional reforms prompted by the crisis (e.g., the European Stability Mechanism and the banking union) are introducing - though to a limited extent - elements of crosscountry risk sharing. Nevertheless, among European institutions there is a broad consensus that further steps are needed. Proposals to create a sort of rainy-day fund present major practical difficulties - associated, inter alia, with the uncertainty characterising the identification of shocks in real time. A more appropriate solution, consistent with how risk sharing operates in existing federations, may be to centralize specific public functions. One often-discussed possibility is the introduction of a common unemployment benefit scheme. We argue that consideration could also be given to the creation of a euro-wide, notional defined-contribution pension scheme.

An endogenous structural credit risk model incorporating with moral hazard and rollover risk

In this paper, we embed optimal contracting between the manager and equity holders into Leland-Toft endogenous structural credit risk model to study the impact of moral hazard on the firm's credit risk with rollover debts. Our model quantitatively shows that the agency costs induced by the moral hazard can endogenously have significant impacts on credit spreads, besides the costs of rolling over the maturing debts of the firm. It originates from the conflicts that these two costs should be covered by equity holders while both the manager and maturing debt holders are still paid in full. The numerical results show that the credit spread with the agency costs of moral hazard is larger than the one without the agency costs. Thus, the moral hazard could be used to explain “credit spread puzzle” as an endogenous factor. The explicit formulae of the equity value, the debt value, and the endogenous default boundary are also given.

PENGARUH PENJAMINAN SIMPANAN, CAR, DAN NPL PADA TINGKAT DEPOSIT, RISIKO MORAL HAZARD, DAN NIM

Banking industry plays a very important role in Indonesian economy. Therefore, stability of banking system is considered substantial by the government. Bank Indonesia (BI), the central bank; Indonesia Deposit Insurance Corporation (LPS) and Financial Services Authority (FSA) seeks to preserve the stability of banking system using policy of capital adequacy ratio (CAR), the maximum limit of non-performing loan (NPL) and the obligations to become member of deposit insurance. This study wants to examine whether these regulations affect the level of deposits, moral hazard risk and the net interest margin (NIM) in Indonesian commercial banks in the period 2000-2012. Using a sample of 99 commercial banks with panel data regression method, the result demonstrate implementation of deposit insurance negatively but not significantly affect level of commercial bank deposits while variable CAR and NPL is giving negative and significant effect. Implementation of deposit insurance proved increasing moral hazard risk while variable CAR and NPL have negative and significant effect on the moral hazard risk. Other findings showed implementation of deposit insurance and CAR positively but insignificant affect NIM, but negatively and significant influenced by NPL.

Sharing Yet Caring

Abstract The quest for creating smart and sustainable cities entails various substantial challenges, such as environmental degradation and a shortage of space. To negotiate these hurdles, innovative approaches must be implemented. A key aspect in this regard is the shared use of resources via forms of access-based consumption. Owing to advances in the digitalization of contemporary societies, these concepts have recently attracted both consumer and scholarly interest. However, the digitally enabled separation of ownership and use brings along the risk of moral hazard by consumers using resources in careless or wasteful ways, which is detrimental to the sustainability of the overall system. In this study, the authors conceptualize and empirically investigate how these adverse effects can be mitigated by applying the potentials of connectivity and digital data to enable users to participate economically while acting favorably from a collective perspective. The results of the quasi-experimental research design, situated in a carsharing context and comprising data records of 2,983 bookings, indicate that this form of value co-capturing with consumers can significantly motivate users to alter their behavior. From these findings, the authors derive important implications for research on the sustainability of digital business eco-systems in the specific context of smart cities.

Enforcement quality and the use of earnouts in M&A transactions: International evidence

AbstractEarnouts are contractual agreements in merger and acquisition (M&A) deals that link part of the acquisition price to the future performance of the target company. These contracts seem to be a panacea for adverse selection and valuation risk issues in M&As. However, earnouts are not very popular. A likely reason for their limited diffusion is that earnouts have their origin in disagreement and in disagreement they may end: given the complexity of the verification of their outcome and the risk of moral hazard by the bidder, litigation at the time of their payout is far from uncommon. Absent effective legal protection for earnout holders, the potential benefits of these contracts could turn out to be empty promises, thus limiting incentives to include them in acquisition deals. Using an international sample of 37,228 deals completed between 2000 and 2015, we show that the inclusion of these contracts in M&As is significantly related to a country's enforcement quality. Furthermore, we show that a similar relation holds for the proportion of earnout payments with respect to total consideration. Our results hold after controlling for other determinants of earnout suggested by prior literature and for other institutional factors that could affect the use of earnouts.

Micro-Loans and Household Economies: Evidence in Indonesia

Micro-loans intended to improve household economies are a fascinating subject for research because a comparative analysis of before and after taking micro-loans would result in a bias selection. Households have different prior conditions from one another, so the difference found during the study is not entirely due to receiving micro-loans. There is a risk of moral hazard risk due to asymmetric information. This research adopts the double difference (DD) fixed effects method to estimate the extent of micro-loans’ impact. Results indicate that micro-loans are significantly influencing the household economies. The impact size was relatively small that it was not apparent during regression. As an implication, micro-loans intended for productive purposes can help improve household economic conditions. Effective and sustainable monitoring and counsel can minimize the risk of moral hazard.DOI: 10.15408/sjie.v7i1.5954

A Central Fiscal Stabilization Capacity for the Euro Area

This note outlines a concrete proposal for a euro area central fiscal capacity (CFC) that could help smooth both country-specific and common shocks. Specifically, it proposes a macroeconomic stabilization fund financed by annual contributions from countries that are used to build up assets in good times and make transfers to countries in bad times, as well as a borrowing capacity in case an exceptionally large shock exhausts the fund’s assets. To address moral hazard risks, transfers from the CFC—beyond a country’s own net contributions—would be conditional on compliance with the EU fiscal rules. The note also discusses several features aimed at avoiding permanent transfers between countries and making the CFC function as automatically as possible—to limit the scope for disputes over its operation—both of which are important points to make it politically acceptable.

Modeling Frost Losses: Application to Pricing Frost Insurance

ABSTRACTThe main objective of this article is to model the losses caused by frost events and use it to price frost insurance. Since the data on frost events are either unavailable or rarely available, we have chosen to obtain a model for frost losses based on temperature by using some fundamental agricultural engineering findings on frost damage. The main challenges in modeling frost loss variables are, first, the nonlinearity of the frost losses with respect to the temperature and, second, the fruit resistance to the first few hours of low temperature. We address both issues when introducing our frost loss variable. Then after finding the loss model, we use it to price frost insurance for a general family of insurance contracts that do not generate any risk of moral hazard. In particular, we will find the premiums of stop-loss policies for losses to citrus fruits using Value at Risk, Conditional Value at Risk, and Wang's premium based on temperature data from San Joaquin Drainage in California.

Moral hazard and default risk of SMEs with collateralized loans

This paper examines the failure of small- and medium-sized enterprises (SMEs) by considering both traditional financial ratios and other ratios proposed to capture ‘moral hazard effects’ in the presence of collateral, which lie in the principal-agent relationship between lender and borrower under conditions of asymmetric information. With a new Colombian database and by estimating default probability logit models, we measure the impact of these moral hazard effects on credit risk. We find that low effort and underinvestment variables have a significant impact on default risk and thus moral hazard has an effect on the failure of SMEs with collateralized obligations.

A Credit Scoring Model for SMEs Based on Accounting Ethics

Various types of government credit guarantee programs exist for small- and medium-sized enterprises (SMEs). The SMEs guaranteed by these programs can resolve their financial difficulties by obtaining loans from banks or being included in a pool for the issuance of primary collateralized bond obligations. However, the loan default rate for these supported firms is high owing to their moral hazard, which can be associated with unethical behavior in the accounting process. Since the stakeholders of credit guarantee programs initiated by the government include not only lenders and borrowers, but also taxpayers, the default risk of moral hazard must be minimized. Thus, an additional evaluation step is required to deal with accounting ethics, which has not thus far been considered in the literature. In this study, we propose an accounting ethics-based credit scoring model as a complementary approach, which can be used to select suitable borrowers. The proposed model is expected to reduce the default rate resulting from the moral hazard associated with unethical accounting behaviors in the supported firms.

Designing sound deposit insurances

Deposit insurances were blamed for encouraging the excessive risk taking behavior during the 2008 financial crisis. The main reason for this destructive behavior was “moral hazard risk”, usually caused by inappropriate insurance policies. While this concept is known and well-studied for ordinary insurance contracts, yet needs to be further studied for insurances on financial positions. In this paper, we set up a simple theoretical framework for a bank that buys an insurance policy to protect its position against market losses. The main objective is to find the optimal insurance contract that does not produce the risk of moral hazard, while keeping the bank’s position solvent. In a general setup we observe that an optimal policy is a multi-layer policy. In particular, we obtain a close form solution for the optimal insurance contracts when a bank measures its risk by either Value at Risk or Conditional Value at Risk. We show the optimal solutions for these two cases are two-layer policies.

State-Contingent Debt Instruments for Sovereigns

Background. The case for sovereign state-contingent debt instruments (SCDIs) as a countercyclical and risk-sharing tool has been around for some time and remains appealing; but take-up has been limited. Earlier staff work had advocated the use of growth-indexed bonds in emerging markets and contingent financial instruments in low-income countries. In light of recent renewed interest among academics, policymakers, and market participants—staff has analyzed the conceptual and practical issues SCDIs raise with a view to accelerate the development of self-sustaining markets in these instruments. The analysis has benefited from broad consultations with both private market participants and policymakers. The economic case for SCDIs. By linking debt service to a measure of the sovereign’s capacity to pay, SCDIs can increase fiscal space, and thus allow greater policy flexibility in bad times. They can also broaden the sovereign’s investor base, open opportunities for risk diversification for investors, and enhance the resilience of the international financial system. Should SCDI issuance rise to account for a large share of public debt, it could also significantly reduce the incidence and cost of sovereign debt crises. Some potential complications require mitigation: a high novelty and liquidity premium demanded by investors in the early stage of market development; adverse selection and moral hazard risks; undesirable pricing effects on conventional debt; pro-cyclical investor demand; migration of excessive risk to the private sector; and adverse political economy incentives.

Modeling Frost Losses: Application to Pricing Frost Insurances

The main objective of this paper is to model the losses caused by frost events and use it to price frost insurances. Since the data on frost events are either unavailable or rarely available, we have chosen to obtain a model for frost losses based on temperature by using some fundamental agricultural engineering findings on frost damages. The main challenges in modeling frost loss variables are first, the non-linearity of the frost losses with respect to the temperature and second, the fruit resistance to the first few hours of low temperature. We address both issues when introducing our frost loss variable. Then after finding the loss model, we use it to price frost insurances for a general family of insurance contracts that do not generate any risk of moral hazard. In particular, we will find the premiums of stop-loss policies for losses to citrus fruits using Value at Risk, Conditional Value at Risk and Wang's premium based on temperature data from San Joaquin Drainage County in California.

Incentives Compatible Constraints Pada Pembiayaan Mudharabah Bank Nagari Syariah

The realization of mudharabah financing in sharia banks is low than murabahah financing due to the high risk of moral hazard. This study proves that moral hazard risk of mudharabah financing can be reduced by incentive compatible constraints as risk mitigation. The findings of this study indicate that high moral hazard risk in mudharabah financing in Bank Nagari Shariah can be reduced by establishing several covenants at the beginning of the contract. Incentive compatible constraints were introduced by John R. Pressley and Session as the asymmetric risk mitigation of moral hazard information. The Nagari Bank Shariah identifies the moral hazard risk caused by internal and external factors of the bank, so that risk mitigation is also done internally and externally. Incentive compatible constraints as a mitigation of moral hazard risk and effective to reduce the occurrence of moral hazard risk for cooperative and institutional customers. The data mining process uses structured interviews with financing analysts and sharia risk management team of Bank Nagari Syariah. Documentation of bank financial statements, implementation guidelines of sharia financing and sustainability report 2014. The data obtained then analyzed by qualitative approach. Data analysis technique is done descriptively qualitative with incentive compatible constraints as an analytical tool.

What happened to global banking after the crisis?

PurposeLarge global banks were at the heart of the global financial crisis. In response to the crisis, the Financial Stability Board published an integrated set of policy measures, such as capital surcharges, to address the systemic and moral hazard risks associated with global systemically important banks (G-SIBs). Almost 10 years later, it is time to take stock of the impact of these measures. This paper answers three questions on what happened to the G-SIBs. First, have they shrunk in size? Second, are they better capitalised? Third, have they reduced their global reach?Design/methodology/approachThis paper looks at the individual G-SIBs and compares the situation before the crisis with the current situation. In this methodology, the differences because of changes at individual banks and changes in the ranking within the group (composition effect) are disentangled. Data have been collected on these banks from SNL Financial (banking database) and annual reports.FindingsFirst, a substantial increase in capital levels is seen, though the distribution is uneven. China and USA are leading the pact with leverage ratios (Tier 1 capital divided by total assets) of around 7 per cent for their large banks, whereas Europe and Japan are trailing behind with ratios between 4 and 5 per cent. Second, a strong composition effect is identified: a shift of business from the global European banks to the more domestic Asian banks, which are gradually increasing their global reach. The US banks keep their strong position. So, the decline in cross-border banking is largely because of a composition effect (i.e. a reshuffle of the global banking champions league) and far less due to a reduced global reach of individual banks.Research limitations/implicationsFrom the results on capital, recommendations are made on capital requirements (see below at social implications).Social implicationsIt is noted that the euro area, Japan, Sweden and Switzerland trail behind with a leverage ratio between 4 and 5 per cent. It is recommended these countries bring the leverage ratio of their largest banks more in line with international practice.Originality/valueThe effects of the reform after the global financial crisis on the large global banks have not been researched in detail. This paper split the results by country of incorporation (home country). This gives interesting differences, which the paper relates to specific policies (or lack of policies) in these countries.

Initial Conditions and the Private Debt Renegotiation Process

I investigate whether and how initial conditions around loan origination influence private debt renegotiation process. I model the renegotiation likelihood, and the conditional probability of multiple renegotiation rounds or multiple amended terms using a sequential logit model. I use a large sample of 15,000 loans on the European credit market. I find that contractual (covenants and collateral) and organizational (lenders pool size, reputation and relationship) mechanisms mitigating adverse selection and moral hazard risks have the largest and positive economic impacts. Lenders financial conditions (capitalization and credit portfolio exposure) and institutional arrangement aiming at creditors protection significantly impact the renegotiation process.

Bankarski rizik 56 - rizik moralnog hazarda

The exposure to moral hazard risk in business is present both in the economy and in the financial sector, and is manifested as a readiness of the contractual party to take unusual risks or not to enter contracts in good faith. The moral hazard risk in the financial sector may obtain a systemic dimension, hence the Financial Stability Board (FSB) launched an initiative towards G20 with the aim of mitigating the exposure to this risk, caused by systemically important institutions (SIFI). The final version of this initiative titled 'Key Attributes of Effective Resolution Regimes for Financial Institutions' was endorsed at the G20 Summit in Cannes, on 4 December 2011.

Contracting for technology transfer: patent licensing and know-how in Brazil

Using contract-level data, we study the relation between the inclusion of know-how in cross-border patent licensing agreements and the contractual terms used by firms to deal with moral hazard risks. We use official data on international technology contracts with patent licensing terms registered by affiliated and unaffiliated parties before the Department of Technology Transfer of the National Institute of Intellectual Property (INPI) in Brazil between 1996 and 2012. We find that contracts between unaffiliated parties involving know-how transfer show distinctive contractual and technology features compared to the rest: (i) they involve younger but lower quality technologies (compared to contracts without know-how); (ii) they are more prone to up front lump-sum payments than royalty or combined payments (royalty and fixed); and (iii) they are more likely to be accompanied by the licensing of other IPRs, in addition to patents, such as trademarks.

Evaluating credit rating prediction by using the KMV model and random forest

Purpose An increasing number of investors have begun using financial data to develop optimal investment portfolios; therefore, the public financial data shared in the capital market plays a critical role in credit ratings. These data enable investors to understand the credit levels of debtors from a bank perspective; this facilitates predicting the debtor default rate to efficiently evaluate investment risks. The paper aims to discuss these issues. Design/methodology/approach A credit rating model can be developed to reduce the risk of adverse selection and moral hazard caused by information asymmetry in the loan market. In this study, a random forest (RF) was used to evaluate financial variables and construct credit rating prediction models. Data-mining techniques, including an RF, decision tree, neural networks, and support vector machine, were used to search for suitable credit rating forecasting methods. The distance to default from the KMV model was then incorporated into the credit rating model as a research variable to increase predictive power of various data-mining techniques. In addition, four-level and nine-level classification were set to investigate the accuracy rates of various models. Findings The experimental results indicated that applying the RF in the variable feature selection process and developing a forecasting model was the most effective method of predicting credit ratings; the four-level and nine-level feature-selection settings achieved 95.5 and 87.8 percent accuracy rates, respectively, indicating that RF demonstrated outstanding feature selection and forecasting capacity. Research limitations/implications The experimental cases were based on financial data from public companies in North America. Practical implications Practical implication of this study indicates the most effective financial variables were dividends common/ordinary, cash dividends, volatility assumption, and risk-free rate assumption. Originality/value The RF model can be used to perform feature selection and efficiently filter numerous financial variables to obtain crediting rating information instantly.

Moral Hazard and Mispriced Systemic Risk in the Lead-Up to the 2007 Subprime Mortgage Crisis in the United States

This is the final version of the article. It first appeared from Illinois Wesleyan University via http://digitalcommons.iwu.edu/uer/vol12/iss1/17