Times Of Financial Stress Research Articles

ERM strategies for navigating financial stress: Lessons from US commercial banks

This study explores the Enterprise Risk Management (ERM) strategies employed by U.S. commercial banks during times of financial stress, with a focus on the 2008 financial crisis and the COVID-19 pandemic. It investigates how ERM frameworks enable banks to make risk-adjusted decisions and effectively manage credit risk, ensuring both operational resilience and long-term value preservation. The research highlights the critical role of ERM in guiding banks through periods of market volatility, emphasizing the need for a structured approach to risk identification, assessment, and mitigation. Through a detailed analysis, the study examines how commercial banks have adjusted their risk appetite and governance structures in response to economic disruptions, balancing short-term stability with long-term growth objectives. Key ERM components such as capital adequacy, liquidity management, and stress testing are reviewed to demonstrate their effectiveness in safeguarding financial institutions. Additionally, the research discusses the importance of leadership and governance in enhancing risk oversight and fostering a culture of risk awareness across banking operations. The findings offer valuable lessons for financial institutions on how to navigate future financial stresses by leveraging robust ERM frameworks. By examining these strategies, the paper provides insights into the adaptability and resilience of U.S. commercial banks in maintaining financial stability and shareholder value in the face of uncertainty.. Keywords: Enterprise Risk Management (ERM), Financial Stress, Credit Risk Management, Operational Resilience, U.S. Commercial Banks, Governance Structures.

Portfolio performance implications of investment in renewable energy equities: Green versus gray

AbstractThe Sustainable Development Goals of the United Nation and interest by investors in Environmental, Social and Governance (ESG) investment strategies have caused a rapid shift to the green or renewable energy sector, from traditional or gray (oil, gas, and coal) energy companies. In this study, we examine whether and to what extent, financially speaking, there is a price to pay for investing in renewable energy sector equity. Moreover, we seek to determine whether green investments can be considered a hedge during times of financial stress. We find that alphas from investments in a portfolio of gray (overall energy sector) stocks and versus a portfolio of renewable energy equities during an exogenous, non‐financial shock—the COVID‐19 pandemic—and during non‐crisis periods did not differ statistically. However, the renewable energy index showed higher idiosyncratic volatility than the energy index, as expected. The results are robust to alternative model specifications. From a practical perspective, our results are informative in that they provide insights into the tradeoffs associated with renewable energy investments. In particular, risk‐adjusted returns to a renewable energy portfolio may be affected by greater idiosyncratic risk.

Multilayer networks in the frequency domain: Measuring extreme risk connectedness of Chinese financial institutions

We propose multilayer networks in the frequency domain, including the short-term, medium-term, and long-term layers, to investigate the extreme risk connectedness among financial institutions. Using the conditional autoregressive value at risk (CAViaR) tool to measure the extreme risk of financial institutions, we construct extreme risk networks and inter-sector extreme risk networks of 36 Chinese financial institutions through the proposed approach. We observe that the extreme risk connectedness across financial institutions is heterogeneous in the short-, medium-, and long-term. In general, the long-term connectedness among financial institutions rises sharply during times of financial stress, such as the 2015 Chinese stock market turbulence and the 2020 COVID-19 pandemic. Moreover, we note that the insurers are key players in driving the inter-sector extreme risk networks, because the inter-sector systemic importance of insurance institutions is dominant. Finally, our conclusions provide valuable information for regulators to prevent systemic risk.

The Credit Suisse CoCo wipeout: Facts, misperceptions, and lessons for financial regulation

The Credit Suisse CoCo wipeout: Facts, misperceptions, and lessons for financial regulation

The Moderating Role of Foreign Institutional Investors on Stock Market Volatility: Evidence from China

ABSTRACT Foreign shareholding can result in stock market volatility, especially in immature financial markets. With quarterly data from 1,348 listed companies held by Qualified Foreign Institutional Investors (QFIIs) from 2006 (Q1) to 2020 (Q4), we investigate the dynamic time-varying impact of QFII ownership on China A-share market volatility using an online support vector quantile regression. Our results indicate that QFIIs have an unsystematically destabilizing effect. This effect is asymmetric under different market conditions. QFIIs demonstrate more procyclicality during normal times, and less procyclicality during times of financial stress. The results of network density analysis confirm that volatility risk will stabilize as risk spill-over will decrease when QFIIs gradually expand their shareholdings and strengthen their interconnections in the China A-share market.

Assessing the impact of media sentiment on the returns of sukuks during the Covid-19 crisis

ABSTRACT The wavelet approach covering simultaneously the time and frequency domains is employed to study the impact of the Covid-19 coverage in mass media on the performance of the Dow Jones Sukuk investment grade total return indices. The overall coherence level for the media-coverage – sukuk pairs is found to increase with the investment horizon. Multiple time-frequency regions with low level of coherence, observable along the Covid-19 systemic crisis, imply attractive diversification attributes of investing in Islamic fixed-income securities especially in times of financial stress and turmoil. We investigate coherence and phase difference patterns, which differ for distinct maturity buckets of the Sukuk indices, further highlighting their potentiality for the downside risk hedge, workable under economic and financial distress.

Do long-term institutional investors contribute to financial stability? – Evidence from equity investment in Hong Kong and international markets

This study assesses whether long-term institutional investors help stabilise or destabilise stock markets, taking into account international spillovers arising from these investors’ portfolio rebalancing activities. Based on granular data of individual insurance companies and pension funds and their exposures to global markets, our results show that these investors notably change their fund flow dynamics among international markets in times of financial stress, during which the fund flows to developed economies overall are increasingly correlated with those to all other economies. Meanwhile, these long-term institutional investors, who stabilise declines in global stock markets during normal market conditions, destabilise stock markets in major developed economies during adverse market conditions. In view of such different impacts on stock markets, investors and regulators, as well as policymakers, should be mindful of any potential outcomes of the investment behaviour of these institutional investors during different market conditions.

Mitigating economic volatility: When building efficient financial markets should supersede conventional economic policy

The choice of instruments for mitigating economic volatility is a serious consideration for policymakers and important question in government and economics. Using a DSGE model with endogenous technology creation, we show that efficient financial markets are more effective than conventional economic policies, such as fiscal interventions, in reducing economic volatility. Our findings are consistent with data from the Chinese and the US economies who contrast in structure perfectly for the purpose of our comparison. The implication is that rather than focusing on conventional economic policies, a government should help establish efficient financial markets to allow producers a hedge into equity finance during times of financial stress.

Effective innovation via better management of firms: The role of leverage in times of crisis

The relationship between innovation activities and firm performance has been well established in the context of major economies. However, in the case of emerging economies, firms are more financially constrained, and they tend to suffer from weaker-management practices, which can be a drag on their performance despite greater innovation. Hence, whether better-managed firms benefit more effectively from innovation with greater access to finance remains unexplored. Using quarterly firm-level data during 1992–2015 from Turkey, this paper aims to uncover whether innovation intensity, in the traditional sense, namely R&D and intangibles, and better managerial practices, in the modern form, contribute to the performance of Turkish firms. By considering the financial constraints before and after the 2008 global financial crisis and by undertaking an impact evaluation of improved accounting regulation relating to disclosure on management practices, we find that all types of innovation activities boost profitability. In addition, R&D activities, with better management quality, help improve firm performance. Furthermore, although higher debt level, in general, is harmful, firms with better management quality make more effective use of innovative activities, along with higher financial leverage, in boosting their performance. Lastly, those better-managed firms in an emerging economy outperformed even during times of financial stress following the global financial crisis. The above findings survive a battery of robustness checks.

Cultivating Healthy Governance in Rural Programs.

Cultivating Healthy Governance in Rural Programs.

Is Renewable Energy a Luxury During Times of Financial Stress?

Is Renewable Energy a Luxury During Times of Financial Stress?

Export price and quality adjustment: The role of financial stress and exchange rate

This paper constructs a heterogeneous international trade model to investigate the impact of financial stress and exchange rate on credit-constrained exporting firms’ price and quality adjustments. Given that the elasticity of the cut-off cost is higher than the threshold, our model predicts that exporting firms would increase export prices and upgrade quality during times of financial stress or when foreign currency appreciates. Additionally, the incomplete pass-through of exchange rate to prices tends to be greater during times of financial stress. Our predictions on the adjustment effects of export price and quality are broadly confirmed by the trade data of China and its major trading partners from 2001 to 2011.

Different in Nature, Common in Style: View Commonality of Single Hedge Funds and Funds of Hedge Funds

Using style analysis, the authors show the common factor exposures of single hedge funds and funds of hedge funds (FoHFs). Despite the different nature and characteristics of the two categories, there are significant style similarities through the different business cycles. The authors argue that in general, FoHFs use substantially more leverage than single hedge fund strategies and found a positive trade-off between leverage and style exposure for the former and a negative one for the latter. Furthermore, the style in both category changes according to the business cycle, with single hedge fund strategies having more flexibility in allocation and aggressive style drifts. However, the similarities in style exposure increase in times of financial turmoil. Additionally, the exposure in equity and bond-related factors are significant and identify style drifts from the past. Finally, the authors found that both categories engage most in equity markets related factors—Betting Against Beta factors (BAB), High minus Low (HML) portfolios sorted by book-to-market to indicate value, Small minus Big (SMB) portfolios sorted by market-cap to indicate size, and Conservative minus Aggressive (CMA) portfolios. <b>TOPICS:</b>Real assets/alternative investments/private equity, portfolio construction, factor-based models, performance measurement <b>Key Findings</b> • In spite of their different natures, single funds and FoHFs show striking style similarity with significant exposure to the equity markets. Their style is largely determined by dynamically shifting between long and short exposure to the factors HML, SMB, and BAB. • FoHFs have much stronger absolute factor exposure, which is partly determined by the large amounts of leverage used. • The similar style exposure spikes in times of financial stress. However, single strategies show larger advantages in exploiting business cycles, flexible factor allocation, and excess returns.

Financial contagion and the role of firm characteristics

Using the Borsa Istanbul sector indices, this study shows that the bi-directional interactions between banking sector and non-financial corporate sectors intensify in high-volatility periods. The findings differ across sub-sectors. For example, during times of financial stress, banks have more interaction with the sectors that produce to the domestic market and that have less access to international finance, as opposed to the exporting sectors and sectors with external integration. Taking into account firm-level balance sheet characteristics, further suggest that, FX balance sheet mismatch, low export ratio, high leverage ratio and trade debt strengthen the degree of financial contagion.

Cheap Talk and Strategic Rounding in LIBOR Submissions

Abstract Interbanking rates were, until recently, based on judgmental estimates of borrowing costs. We interpret this as a cheap-talk game that allowed banks to communicate nonverifiable information about their opportunity cost to potential counterparties. Under normal market conditions there is a welfare maximizing equilibrium where banks truthfully disclose their borrowing cost, but, in times of financial stress, only “coarse” equilibria survive. We take this prediction to the data and show that banks round more frequently if the risk of the bank increases. Rounding is also more frequent for the more liquid short-term rates and certain benchmark maturities. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Central Banks and the Future of Money

Policymaking circles and central banks around the world are now giving serious consideration to the pros and cons of making central bank digital currencies (CBDCs) available to the general public. While the consensus view remains that such a move would be premature, opinion appears to be shifting. Indeed, developments in a number of advanced and emerging economies indicate that the CBDC model is receiving more serious consideration than it has in the past. The numerous speeches and research papers coming from central banks are testament to this growing interest. Moreover, some countries and central banks have moved beyond talking and have taken active steps to push the initiative further. Proponents view the introduction of CBDCs as a potentially positive development rather than a purely defensive reaction. Indeed, they believe CBDCs could materially improve the role of central bank money in the financial system by providing a more stable unit of account, a more efficient medium of exchange and a more secure store of value. Moreover, the potential benefits go well beyond these traditional central bank money functions. Proponents suggest that CBDCs could temper financial instability, improve the implementation and transmission of monetary policy, raise productivity, help finance government deficits, reduce tax evasion and discourage a number of other costly and illegal activities. These positive claims have not gone unchallenged. The most common concern raised is the destabilizing effect that CBDCs might have on the economy in times of financial stress. As a safe and convenient alternative to commercial bank deposits and other types of private financial assets, CBDCs might act as a dangerous accelerant in the context of a bank run, transforming an isolated concern about one bank’s solvency into a system-wide crisis. Another source of concern is the disruptive effect that CBDCs would likely have on the competitive position of commercial banks, other financial institutions and key financial market infrastructures. In the end, the best way forward for Canada and other countries may not involve the introduction of a CBDC. Some active government engagement now would nevertheless seem advisable to ensure the most promising ways forward are not precluded. Simply leaving it to the market to sort out would be very risky. The disruption caused by any policy reversals that might be contemplated at a later stage could prove insurmountable, leaving us in a place we would rather not be. It is important to understand that maintaining the status quo is unlikely to be a practicable option, given the shifting financial landscape. The question is not whether central banks will need to react, but how they should react to these tectonic technological shocks.

Diversification role of currency momentum for carry trade: Evidence from financial crises

The main objective of this paper is to investigate the diversification role of currency momentum for carry trade crashes during the turbulent periods surrounding the 1997–1998 Asian financial crisis and the 2007–2008 global financial crisis. The motivation is to use an important tendency of momentum strategy to yield statistically and economically significant profits during crisis periods that are far higher than the crashes commonly experienced with the carry trade. I use an empirical heterogeneous agent model to design a new trading strategy which combines carry trade and momentum signals where the relative weight given to both signals is based on their past performance. The main finding is that the combined strategy is a good hedge with desirable diversification merits in times of financial stress. This evidence has important implications for the practices of currency portfolio management during times of heightened financial uncertainty.

Muddying the Waters: Who Induces Volatility in an Emerging Market?

Do all investor types contribute equally to volatility formation? Although stock volatility should ideally originate only from fundamental innovations, it is embedded into prices through the trading process. We compare the relative contributions of trading by local institutions, local individuals and foreign institutions to the volatility of individual stocks, using a proprietary dataset and a battery of robust measures. Overall, neither local nor foreign institutions are the major drivers of volatility, not even during times of financial stress. Individuals consistently appear to induce more of the volatility and liquidity, behaving as the archetypical noise traders but also as liquidity providers.

Cheap Talk and Strategic Rounding in Libor Submissions

This paper constructs a model of directed search in the interbank market and tests its empirical implications with data from the Libor benchmark setting process. Interbanking rates were until recently based on judgmental estimates of borrowing costs published by a panel of banks. We interpret this as a cheap talk game that allowed banks to communicate non-verifiable information about their borrowing costs to potential counterparties. Under normal market conditions there is a welfare maximizing equilibrium where banks truthfully disclose their borrowing cost even if misstating costs is not penalized, but, in times of financial stress, only coarse equilibria survive, in which submissions are partially revealing of the bank's true borrowing rate. We take this prediction to the data and show that, indeed, the precision of the panel banks' individual estimates is chosen strategically. Banks round more frequently if the perceived riskiness of the bank increases. Rounding is also more frequent for the more liquid short term rates and for certain benchmark maturities. We discuss the implications of our results for the design of benchmark setting mechanisms and the ongoing Libor lawsuits.

The state dependent impact of bank exposure on sovereign risk

Abstract The theoretical literature remains inconclusive on whether changes in bank exposure to the domestic sovereign have an adverse effect on the sovereign risk position through a diabolic loop in the sovereign-bank nexus, or reduce perceived default risk by acting as a disciplinary device for the sovereign. In this paper we empirically analyze the impact of exogenous changes in bank exposure on the risk position of the sovereign within a Markov switching structural vector autoregressive in heteroscedasticity (MSH-SVAR) framework for a set of EMU countries. We add to the methodological literature by allowing for regime dependent shock transmissions according to the volatility state of the financial system. Finding support for both, a stabilizing and a destabilizing effect, we document a clear clustering among the country sample: rising bank exposure increased default risk for the EMU periphery, but decreased credit risk for the core EMU countries during times of financial stress.