Times Of Financial Distress Research Articles

Dynamic interactions between Central European currencies and the euro

We argue that the non-euro EU currencies of Central European countries have moved increasingly together with the euro in foreign exchange markets. To prove this point, we examine the dynamics of cross-elasticity between selected Central European currencies (the Czech koruna, Polish zloty, and Hungarian forint) and the euro exchange rates in U.S. dollar terms using daily data for the January 4, 2000 to April 5, 2019 sample period. We adopt the cross-elasticity model originally proposed and tested for the EU currencies by Orlowski (2016). To test the currency co-movements over time, we employ the Bai-Perron multiple breakpoint regression and two-state Markov switching tests. We find evidence of increasing co-movements between the Central European currencies and the euro that become particularly pronounced in times of financial distress. Co-movements of local exchange rates with the euro are also more pronounced during the euro-periphery sovereign debt crisis.

Directors’ Duty of Care in Times of Financial Distress Following the Global Epidemic Crisis

The global COVID-19 pandemic is causing the large-scale end of life and severe human suffering globally. It is the most massive public health crisis in modern living memory, which created a significant economic crisis. This dramatic change is reflected in a significant recession of global production and the collapse of confidence in the functions of markets. Corporations and boards of directors around the world are required to design specific strategies to tackle the negative consequences of the crisis. This is especially true for small and medium-sized enterprises (SMEs) that suffered tremendous economic loss, and their continued existence as ongoing concern is questionable. Given these uncertain financial times, this Article is devoted to exploring directors' duty of care from a global perspective. In particular, I argue that the current crisis will underline the importance of the advisory role of the board of directors rather than the monitoring function, and further regulatory reforms that strengthen such capacity are expected to emerge. Furthermore, I maintain that the civil law rather than the Anglo-American law on directors' duty of care provides boards with a more expansive scope of discretion to confront the unusual challenges associated with the COVID-19 because these governance regimes are tailored to the unique features of companies and markets. I apply this novel argument in different types of SMEs, mainly in the family business and venture capital-backed firms.

Stock price related financial fragility and growth patterns

Abstract The total output of an economy usually follows cyclical movements which are accompanied by similar movements in stock prices. The common explanation relies on the demand side. It points out that stock market wealth drives consumption which triggers production afterwards. This paper focuses on influences via the supply side of the economy. The aim of the paper is to explore channels where stock price patterns influence the amount of credit taken by firms. The author examines trend and volatility cycles on the stock market. There are three channels addressed: the stock market valuation as piece of information for the assessment of a firm’s creditworthiness, the influence on restructuring prospects in times of financial distress and the stock market related remuneration of the top management affecting capital demand. The author ask to which extent a channel may contribute to the stock price - output relation when there is mutual feedback. A model à la Delli Gatti et al. (A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility, 2005) drives the results. Firms take credit to finance their production which determines their financial fragility. If their stochastic revenue is too low, they are bankrupt and leave the economy. The capital loss hurts the bank’s equity base and future credit supply is diminished. This causes business cycles. Results show that if the bank assesses creditworthiness according to the stock price then idiosyncratic stock price fluctuations have only a slight effect as they disturb selection and hinder growth. If stock market optimism matters for bankruptcy ruling the level of stock owners’ influence does not matter. If optimism is wide spread among stock investors however, investment behaviour is also correlated through the stock prices and this results in huge real economy cycles without any long-term growth. If volatility is considered in the decision of managers they act more prudently and this fosters growth.

Financial market risk and macroeconomic stability variables: dynamic interactions and feedback effects

This study investigates dynamic interactions and feedback effects between financial market risk proxied by VIX and key macroeconomic stability variables that include the rate of unemployment, headline inflation and market-based inflation expectations reflected by the breakeven inflation. We argue that market risk should play a stronger role in macroeconomic modeling and forecasting than it has been recognized thus far in the literature. We employ vector autoregression with impulse response functions, as well as two-state Markov switching tests to examine these interactions on the longest available US monthly data. The empirical tests show that the association between market risk and macroeconomic fundamentals is predominantly neutral at normal, predictable economic conditions. It becomes very pronounced at times of financial distress, in the environment of elevated market risk coupled with uncertain expectations for macroeconomic variables. Shocks in VIX have a longer impact on macroeconomic stability than that generally claimed in the prior literature. The Markov switching tests for CPI and breakeven inflation indicate that households and businesses are concerned primarily about episodes of increasing inflation, while bond market participants worry mainly about declining inflation and deflation.

Practical Applications of Volatility as an Asset Class: Holding VIX in a Portfolio

<h3>Practical Applications Summary</h3> In <b>Volatility as an Asset Class: <i>Holding VIX in a Portfolio</i></b> from the Fall 2018 issue of <b><i>The Journal of Alternative Investments</i></b>, authors <b>Jason Berkowitz (St. John’s University)</b> and <b>R. Jared DeLisle (Utah State University)</b> explore whether investors can diversify their stock portfolios by adding assets linked to the Chicago Board Options Exchange’s Volatility Index (VIX). Diversification is increasingly difficult to achieve because asset classes that have historically moved in opposite directions during times of financial distress now tend to all fall in value during such crises. However, the VIX tends to go up when the S&amp;P 500 Index (SPX) goes down—so theoretically, a small position in the VIX should provide a small hedge in an SPX-based portfolio. Unfortunately, the VIX itself is not a traded asset that can be purchased like a stock. Because the only VIX-related products currently available for investment are derivatives, the authors studied whether investors can diversify an SPX-based portfolio by investing in VIX futures and call options, as well as SPX put options and straddles. They found that all of these assets are costly and have negative returns—and that all the hypothetical portfolios containing them underperform a 100% SPX portfolio. Therefore, diversifying by investing in the VIX is not possible in the real world. <b>TOPICS:</b>Real assets/alternative investments/private equity, analysis of individual factors/risk premia, portfolio construction

Distributive Justice and Resistance to Change in Cutback Management: Evidence from a Survey Experiment and a Longitudinal Field Study

Cutback management may invoke perceptions of distributive (in)justice, potentially shaping how employees respond to change. Using a survey experiment and a longitudinal field study, this article examines how two standards of distributive justice—equality and equity—affect resistance to change in response to cutbacks. The results indicate that distributive justice negatively affects resistance to change, and that distributive equality and distributive equity may have differential effects during cutback management. By signaling distributive justice, public managers may be able to reduce resistance and maintain the organization’s capacity for change and innovation in times of financial distress.

Dynamic relations between oil and stock market returns: A multi-country study

We study the relation between the BRENT and seventeen stock market indexes of important oil-dependent economies. We focus on connectedness between these markets and characterize the dynamics of transmission and reception. We use LASSO methods to shrink, select, and estimate the high dimensional network linking these markets between August, 1999 and March, 2018. This methodological innovation allows the inclusion of a significantly larger number of markets in the network, providing finer results regarding connectedness in the oil-stock market nexus. We show that transmission runs mainly from stock markets to the BRENT. Connectedness varies considerably over time, reaching peaks during times of financial distress. Dynamic predictive causality tests show evidence of time-varying bidirectional causality. Causality from stock markets to the BRENT is detected mostly for the last part of the sample period. This finding indicates that the impact of stock market developments on oil markets is growing over time.

Central Bank Digital Currency: Benefits and Drawbacks

Prompted by technological advances and a decline in cash usage, many Central Banks are investigating whether it would be possible to issue a digital complement to cash, a so-called Central Bank Digital Currency (CBDC). Despite ongoing research and occasional pilots, Central Banks have shied away from introducing a CBDC for public use. Even though CBDCs would have the potential to counteract some of the problems that could arise for the payment system in the future when the use of cash is rapidly declining, they also present significant risks for financial stability. This article contributes to the discussion by setting out a CBDC framework and formulating broad design principles for CBDC in line with the central bank´s function as Lender of last Resort (LOLR). The attributes and functionality of a CBDC are highly determinative of the architectural design and technical solution chosen, particularly in the context of LOLR. Therefore, we argue in favour of a solid coin for e-emergency liquidity assistance, available 24 hours a day and seven days per week, anonymous, interest-bearing and unlimited, to prevent bank runs and restore financial stability in times of financial distress.

Do Firms Hedge During Distress?

Firms are less likely to use financial derivatives as they approach distress, even though theory predicts risk management is more valuable in these situations. By expanding the definition of hedging to include purchase obligations (POs) - non-cancelable forward contracts with suppliers – we are able to understand how firms hedge and whether hedging matters. We provide the first evidence that firms rely on POs during distress, often switching from derivatives to these contracts. Firms also initiate POs in response to liquidity shocks. Moreover, compared to hedging with derivatives, hedging with POs enables higher investment levels during times of financial distress. Firms adjust – but do not cease - hedging near distress and this mitigates underinvestment.

Oil prices, unemployment and the financial crisis in oil-importing countries: The case of Spain

The aim of this paper is to analyse the effect of oil price shocks on unemployment in an oil-importing country such as Spain to determine whether they affect unemployment differently in times of financial distress. In order to do so, we use Bayesian methods to estimate a SVAR model with endogenous oil shocks. According to our results, the response of unemployment to oil shocks is clearly different in the pre-crisis compared to the crisis period. Asymmetries are also an important feature of the data: positive oil shocks contributed negatively to the evolution of employment in Spain after the outbreak of the crisis, while any decreases had less of an effect in terms of a recovery in the employment rate.

Labor Market and Financial Shocks: A Time‐Varying Analysis

AbstractWe estimate a time‐varying VAR model to analyze the effects of a financial shock on the U.S. labor market. We find that a tightening of financial conditions is highly detrimental to the labor market. We show that while negative financial shocks have been responsible for increases in unemployment, our model does not find significant contributions of financial shocks during periods of expansion. The source of this asymmetry is the time‐varying standard deviation of the identified shock, which is higher in times of financial distress; on the other hand, we find that the transmission mechanism does not significantly change over time.

Does Diversification of Share Classes Increase Firm Value?

Firms can issue stocks classified in many ways. They can be classified in respect to voting rights, dividend rights, redemption rights, conversion rights, and many others. In this study, we ask if it is desirable to give greater freedom to firms in their choices of class shares. Making use of the 2011 Commercial Act amendment that significantly relaxed the regulation on class shares in Korea, we study the motivation and the effect of adopting two newly emerged class shares – preferred stocks convertible to voting stocks at the discretion of management and preferred stocks redeemable at the discretion of investors. We find that firms adopt the former for managerial entrenchment purpose and destroy firm value by doing so. As for the latter, we find that firms adopt them in times of financial distress but fail to stop the downfall in firm value by doing so.

Forecasting the UK economy: Alternative forecasting methodologies and the role of off-model information

How did DSGE model forecasts perform before, during and after the financial crisis, and what type of off-model information can improve the forecast accuracy? We tackle these questions by assessing the real-time forecast performance of a large DSGE model relative to statistical and judgmental benchmarks over the period from 2000 to 2013. The forecasting performances of all methods deteriorate substantially following the financial crisis. That is particularly evident for the DSGE model’s GDP forecasts, but augmenting the model with a measure of survey expectations made its GDP forecasts more accurate, which supports the idea that timely off-model information is particularly useful in times of financial distress.

Identifying relationship lending in the interbank market: A network approach

Relationship lending is broadly interpreted as a strong partnership between a lender and a borrower. Nevertheless, we still lack consensus regarding how to quantify the strength of a lending relationship, while simple statistics such as the frequency and volume of loans have been used as proxies in previous studies. Here, we propose statistical tests to identify relationship lending as a significant tie between banks. Application of the proposed method to the Italian interbank networks reveals that the fraction of relationship lending among all bilateral trades has been quite stable and that the relationship lenders tend to impose high interest rates at the time of financial distress.

Intangible Asset Reallocation and Financial Frictions

I develop and estimate a novel dynamic model of the secondary market trading of intangible assets in an environment where financial market frictions interfere with firm investment. Intangible asset trading (IAT) not only serves as an alternative means of financing but also reallocates investment opportunities to firms in better positions to exploit them. Estimation of the model uncovers high trading frictions, but the option to trade still leads to significant efficiency gains. These gains stem both from IAT's direct effect on relaxing firms' financial constraints and especially from ex ante changes in firms' expectations, which influence their investment choices. I also show that the impact of financial frictions depends largely on the ease with which firms can trade intangibles. Finally, I present corroborating reduced-form evidence that firms sell a particular type of intangible asset, patents, during times of financial distress and their financial conditions appear to improve after these sales.

Labor Market and Financial Shocks: A Time Varying Analysis

Motivated by the events of the Great Recession, we estimate a time-varying structural VAR model to analyze the effects of a financial shock on the labor market, focusing on the US. Our results indicate that a tightening of financial conditions is highly detrimental to the labor market. Moreover, we show that financial shocks have affected the unemployment rate asymmetrically in the last three decades, an implication that a standard VAR cannot capture: while negative financial shocks have been responsible for increases in unemployment, our model does not find significant contributions of financial shocks during periods of expansion. The source of this asymmetry is the time-varying standard deviation of the identified shock, which is higher in times of financial distress; on the other hand, we find the transmission mechanism is almost constant over time.

Effects of Monetary Policy during Financial Market Crises and Regime Changes: An Empirical Evaluation Using a Nonlinear Vector Autoregression Model

Using monthly data for Korea, this study examines nonlinear effects of monetary policy in association with financial market distress. The study uses a nonlinear vector autoregression model and finds that monetary policy becomes ineffective for addressing huge demand contractions in times of financial market turmoil or severe economic downturn, implying a structural change from a non‐Keynesian to a Keynesian regime, such as a liquidity trap. Monetary contractions have stronger output effects than monetary expansions, particularly in times of financial distress. We found no evidence in favor of asymmetric effects of monetary shocks of different sizes. Finally, we also found financial shocks to have stronger effects on the real economy in times of financial distress than in normal times. The results have important policy implications for periods of financial turmoil or economic crisis.

Elasticity of Medicaid Access with Respect to State Financial Distress

In 2016, total Medicaid spending, $574.2 billion, represented one-third of state budgets. Descriptive studies indicate that state policymakers adjust social welfare programs during times of financial distress, particularly Medicaid. The challenge of formally estimating this effect is that macroeconomic shocks increase Medicaid enrollment and state-level financial stress. We use an exogenous measure of Medicaid generosity to estimate the elasticity of Medicaid generosity with respect to financial conditions. We find Medicaid generosity is not adjusted during periods of fiscal distress, whether anticipated or not. Instead, we find a counter-cyclical Medicaid effect with generosity increasing with increases in the unemployment rate.

Bank loyalty, social networks and crisis

In this paper, we consider how the intensity and channels of the relation between social networks and bank loyalty vary according to the state of the economy. We analyze bank exit over the period 2005–2012 for over 300,000 retail clients of a commercial bank that experienced a bank run in 2008 due to a shock in solvency risk. The unique and rich data we constructed in close collaboration with the bank enables us to distinguish different sorts of family networks from neighborhood networks, while controlling for a wide range of client-level and branch-level characteristics and events. Using a proportional hazards model, we show the importance of family networks. In times of financial distress, family networks become even more important and retail clients take weaker, less direct social relationships into account.

Does a central clearing counterparty reduce liquidity needs?

This study investigates whether and how central clearing influences the overall liquidity needs in a network of financial obligations. Utilizing the approach of flow network theory, we show that the effect of adding a central clearing counterparty (CCP) is decomposed into two effects: central routing, and central netting effects. Each effect can produce different liquidity needs according to different liquidity scenarios. The analysis indicates that adding a CCP in times of financial distress successfully reduces the overall liquidity needs if and only if the netting efficiency of the CCP is sufficiently high. Furthermore, once the economy is no longer in financial distress, higher netting efficiency of the CCP could conversely increase the overall liquidity needs. The results have implications for the effectiveness of CCPs in mitigating systemic risk in times of financial distress, and their operating costs once the distress has passed.