Safe Assets Research Articles

Quantitative Easing and Safe Asset Scarcity: Evidence from International Bond Safety Premia

Through large-scale asset purchases, widely known as quantitative easing (QE), central banks around the world have reduced the available supply of safe assets. We examine the effects of the European Central Bank’s asset purchases in the 2015-2021 period on an international panel of bond safety premia from four highly rated countries: Denmark, Germany, Sweden, and Switzerland. We find statistically significant negative effects for all four countries. This points to a novel and important international spillover channel of QE programs to bond safety premia that operates via changes in the perceived relative scarcity of safe assets across international bond markets.

Stablecoins as the cornerstone in the linkage between the digital and conventional financial markets

Do stablecoins mean anything to risk management across financial markets? We answer this question by examining the interrelationships between stocks, treasuries, stablecoins, and cryptocurrencies in nonparametric quantile-causality-in-means and quantile-on-quantile regression models. Differently from previous studies of stablecoins’ price volatility, we focus on stablecoins’ trade volumes. The results extend the evidence on stablecoins’ responses to other crypto assets, whose declining returns, through the phenomena designated by us as “flight-to-cryptosafety”, fuel the stablecoins’ market capitalization. Issuance of new stablecoins, because of their backing by conventional safe assets, raises US Treasuries’ demand. And then, decaying Treasury yields cause “flight-to-safety” from stocks to Treasuries. Results from the quantile-based fixed-parameter models are robust to the dynamic connectedness metric based on the time-varying parameter vector auto-regression (TVP-VAR) framework.

A safe asset in early modern Castile, 1543–1714

AbstractThis article shows how public offices in the early modern period became investment assets in Castile (Spain). Moreover, it demonstrates that offices fulfilled all the conditions for being viewed as safe assets. In particular, through the combination of qualitative sources with a novel hand‐collected database, it shows that offices did not suffer from adverse selection, were traded in liquid secondary markets, and increased their value during periods of economic distress. This research is a pioneer in revealing the existence in early modern times of a haven asset, other than coins and public debt, and showing at the same time the private financial uses of offices.

Multivariate associations between dopamine receptor availability and risky investment decision-making across adulthood.

Enhancing dopamine increases financial risk taking across adulthood but it is unclear whether baseline individual differences in dopamine function are related to risky financial decisions. Here, thirty-five healthy adults completed an incentive-compatible risky investment decision task and a PET scan at rest using [11C]FLB457 to assess dopamine D2-like receptor availability. Participants made choices between a safe asset (bond) and a risky asset (stock) with either an expected value less than the bond ("bad stock") or expected value greater than the bond ("good stock"). Five measures of behavior (choice inflexibility, risk seeking, suboptimal investment) and beliefs (absolute error, optimism) were computed and D2-like binding potential was extracted from four brain regions of interest (midbrain, amygdala, anterior cingulate, insula). We used canonical correlation analysis to evaluate multivariate associations between decision-making and dopamine function controlling for age. Decomposition of the first dimension (r = 0.76) revealed that the strongest associations were between measures of choice inflexibility, incorrect choice, optimism, amygdala binding potential, and age. Follow-up univariate analyses revealed that amygdala binding potential and age were both independently associated with choice inflexibility. The findings suggest that individual differences in dopamine function may be associated with financial risk taking in healthy adults.

The Financial Origins of Non-Fundamental Risk

We formalize the idea that the financial sector can be a source of non-fundamental risk. Households' desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk-averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate nonfundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the demand for safe assets, through social insurance or by acting as a market maker of last resort.

The Secular Decrease in UK Safe Asset Market Power

We document the decline in market power of the U.K. in safe assets and quantify the resulting losses. We estimate an increasing elasticity of demand for U.K. public debt during the latter half of the 20th century. This is in sharp contrast to the U.S., which displays the opposite pattern with decreasing elasticities of demand during this time. We argue that the decline in market power of the U.K. in safe assets resulted in a sizable decline in seigniorage revenues.

The paradox of safe asset creation

Safe asset demand increases loan risk. This arises in a competitive model in which securitization vehicles create safe assets by pooling loan payoffs purchased from loan originators. Equity investors allocate their wealth between originators, who need skin-in-the-game due to moral hazard, and vehicles, who need loss-absorption capacity against aggregate risk. An increase in demand for safety fosters safe asset creation through a securitization boom: originators sell more of their loan payoffs to vehicles, equity is reallocated from originators to vehicles, and the two effects contribute to an increase in loan risk. The model is consistent with a broad set of facts in the run-up to the Global Financial Crisis.

INVESTMENTS IN TIMES OF UNCERTAINTY: FORMATION OF PORTFOLIOS USING RANDOM FOREST

Objective: based on a systematic approach using machine learning , this research aims to propose a model of selection and allocation of assets that allows for building profitable and safe portfolios, even in times of insecurity and low predictability. Methodology: we used the machine learning algorithm called random forest to associate the independent variables with a dependent one and learn the probability of positive returns in the month following the data collection. According to the probabilities, the stocks were allocated into long , short, or non-allocated portfolios . Finally, we allocated a share of gold, which is a protection asset much used in times of crisis and uncertainty. Results and contributions: the study reached its goal and demonstrated being possible to build profitable and safe investment portfolios, even in times of greater uncertainty and volatility, as in 2020 due to the Covid-19 pandemic. We found that the model is effective in moments of crisis and also of greater predictability, as in the period from 2016 to 2019 when the stock exchange has an uptrend. Relevance: the relevance of this study points to an unprecedented historical context in Brazil, where uncertainties regarding both the local and world economy have demanded advanced studies of prediction to minimize risks and contribute to results for investors. In addition, we highlight that following a short period of low Selic (2019 to 2021), the Central Bank increased the rate again, raising the interest more in profitable and safer assets than the investment in stocks. Impact on the area: the study has a positive impact on the finance area since studies in this field promote greater stability to investors and thus better capital flow for companies, which, in turn, contribute to society and the growth of the country.

TRADING AMBIGUITY: A TALE OF TWO HETEROGENEITIES

AbstractWe consider markets with heterogeneously ambiguous assets and heterogeneously ambiguity‐averse investors whose preferences are a parsimonious extension of the mean–variance framework. We study portfolio choice and trade upon arrival of public information, and show systematic departures from the predictions of standard theory, that occur in the direction of empirical regularities. In particular, our theory speaks to several phenomena in a unified fashion: the asset allocation puzzle, the observation that earnings announcements are followed by significant trading volume with small price change, and that increases in uncertainty are positively associated with increased trading activity and portfolio rebalancing toward safer assets.

The Role of Financial Risks and Financial Sustainability in the Iraqi Stock Markets during COVID-19 Pandemic

This paper compares the company's ability to sustain a diversified resource base for long-term service to its customers without need for external funding sources through two stressful systems of financial markets, the financial crisis aftermath 2008 and the COVID-19 epidemic. Our findings indicate that financial sustainability has been affected by disasters. Banks can impose significant risks on the economy, one of the main concerns about the causes of the current financial crisis is that banks engaged in excessive risk-taking, it has faced during the 2008 crisis liquidity and credit risks, while Through the 2020 crisis which is the COVID-19 pandemic crisis, the most significant financial risks that banks experienced were credit risks due to banks ’dependence on traditional, weak, safe assets, including the dollar, the Swiss franc, and other treasury bonds during the COVID-19 pandemic. This led to a lack of cash reserves held by banks, which led to weak investor tolerance towards financial risks, especially as the nature of crises is changing, as the results have proven that departures from riskiest directorships are more beneficial during the COVID-19 crisis because managers deal with the crisis in the same way as a crisis 2008 On the other hand, departures from riskiest directorships lead to higher administrative costs due to a lack of expertise.

Mutual fund asset allocation during COVID-19: evidence from an emerging market

ABSTRACT The paper examines the investment decisions of Indian equity mutual funds during various stages of the COVID-19 pandemic with monthly portfolio holdings. We find that funds favoured firms with lower risk, higher financial flexibility, and larger size during the early months of the pandemic. The preference for relatively low-risk firms, which reverses later, suggests a reallocation towards safer assets. Funds also preferred growth firms to value firms as the latter with greater invested capital are more vulnerable to the shock. Institutional investors also favoured group-affiliated firms throughout, reflecting their lower crisis vulnerability. We find that the stocks preferred by funds during the pandemic outperform others in the long run. The paper brings out key firm characteristics that impact mutual fund asset allocation during extreme uncertainty.

Banks, deposit rigidity and negative rates

Using loan level data for France, we show that the introduction of negative rates by the European Central Bank is associated with an expansion in lending by banks with greater reliance on deposits. The impact is driven by banks with larger shares of rigid deposits, i.e. deposits whose rate becomes inelastic when the policy rate falls below zero, such as short-term and households deposits. Consistent with risk-taking, negative rates appear to elicit reallocation away from safe assets, as banks increase exposure to smaller firms and corporate debt securities, as well as increase fee income. Finally, we document that these findings generalize to banks in the Euro Area. Our results suggest that negative rates encourage banks most reliant on deposits to engage in riskier activities to shield profitability, and that the composition of banks’ deposits plays a key role in the transmission of monetary policy rates below the zero lower bound.

Currency carry trades and global funding risk

We measure funding constraints in currency markets by deviations in the covered interest rate parity and funding risk by the standard deviation of the magnitude of the funding constraints. Empirically, funding risk is driven by financial sector conditions in the low interest rate countries, oil price, and the actions of the main central banks. Since 2008, funding risk has affected currency carry trading activity, carry trade returns, correlation between carry trade long and short currencies, relative equity returns, and the economic growth in the carry trade long and short countries. We develop a theory of currency markets under funding constraints to explain the phenomena. The model has additional testable implications: For instance, as funding constraints start to bind, it predicts that both the investment and the funding currencies crash relative to a safe asset. This result is observable empirically when we use gold to proxy for the safe asset.

The shortage of safe assets and China's housing boom

The shortage of safe assets and China's housing boom

‘Safe Assets’ during COVID-19: A Portfolio Management Perspective

The pandemic crisis of COVID-19 hit the financial markets like a shockwave on 16 March 2020. This paper attempts to capture which ‘safe assets’ asset managers could have fled during the first wave of the pandemic. From an investment manager’s perspective, candidate assets are stocks, bonds, exchange rates, commodities, gold, and (gold-backed) cryptocurrencies. Empirical tests of the ‘Safe-Haven’ hypothesis are conducted, upon which the selection of assets is performed. The methodological framework hinges on the Global Minimum Variance Portfolio with Monte Carlo simulations, and the routine is performed under Python. Other optimization techniques, such as risk parity and equal weighting, are added for robustness checks. The benchmark portfolio hits a yearly profitability of 7.2% during such a stressful event (with 3.6% downside risk). The profitability can be enhanced to 8.4% (even 14.4% during sub-periods) with a careful selection of ‘Safe assets’. Besides short- to long-term U.S. bonds, we document that investors’ exposure to Chinese, Argentinian, and Mexican stocks during COVID-19 could have been complemented with Swiss and Japanese currencies, grains, physical gold mine ETFs, or gold-backed tokens for defensive purposes.

Supranational Debt as Safe Asset: The Role of Repo

Supranational Debt as Safe Asset: The Role of Repo

The Safe Asset Shortage Conundrum and Why Gold is a Safe Asset

The Safe Asset Shortage Conundrum and Why Gold is a Safe Asset

The Secular Decrease in UK Safe Asset Market Power

The Secular Decrease in UK Safe Asset Market Power

Using the XGBoost classification algorithm and model interpretability techniques

Sovereign debt has traditionally been regarded a safe asset class. However, the picture has shifted in the last decade, with a significant increase in the number of sovereign defaults. The drivers of this increase are complex and as yet unexplored, but it is clear that factors other than traditional macroeconomic events are significantly underpinning these economies. Therefore, understanding how the drivers of sovereign credit risk have evolved beyond economic and fiscal issues, as well as the importance of additional drivers in sovereign credit risk assessment, is critical. This paper explains the strength of the effect of spillover effects from private sector risks on sovereign debt risk, as well as the impact of rising sustainability risks on sovereign credit risk and their underlying relationship, using the XGBoost classification algorithm and model interpretability techniques, namely Shapley additive explanations (SHAP) and local interpretable model-agnostic explanations (LIME). First, we discover that private sector risks contribute significantly to sovereign credit risk and that these factors must be considered alongside macroeconomic variables when modeling sovereign credit risk. Further, we find evidence that sustainability risks are financially material to sovereign creditworthiness. The relationship between sustainability risks and sovereign credit risk is complex, follows a nonmonotonic relationship and is highly dependent on country specificities, necessitating the integration of sustainability risk factors while accounting for interactions with the economic state of a country.

Bank Opacity and Safe Asset Moneyness

Bank Opacity and Safe Asset Moneyness