Network valuation in financial systems Barucca, Paolo; Bardoscia, Marco; Caccioli, Fabio ...
Mathematical finance,
October 2020, 2020-10-00, 20201001, Letnik:
30, Številka:
4
Journal Article
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Odprti dostop
We introduce a general model for the balance‐sheet consistent valuation of interbank claims within an interconnected financial system. Our model represents an extension of clearing models of ...interdependent liabilities to account for the presence of uncertainty on banks' external assets. At the same time, it also provides a natural extension of classic structural credit risk models to the case of an interconnected system. We characterize the existence and uniqueness of a valuation that maximizes individual and total equity values for all banks. We apply our model to the assessment of systemic risk and in particular for the case of stress testing. Further, we provide a fixed‐point algorithm to carry out the network valuation and the conditions for its convergence.
ABSTRACT
We study the effects of mark-to-market accounting (MTM) for banks following the originate-to-distribute lending model. Banks have expertise in originating loans, but it is costly for them to ...retain the loans on their books. We study how the accounting measurement of the retained loans affects the banks’ origination and retention decisions. We show that, relative to historic cost accounting (HC), MTM has three consequences. First, it improves the accuracy of loan measurement ex post. Second, it forces banks to retain more risk exposure on their own books. Finally, it can reduce ex ante origination efforts and lower the average quality of loans in the economy.
JEL Classifications: G01; G21; G30; M41.
When liquidity plays an important role as in financial crises, asset prices may reflect the amount of liquidity available rather than the asset's future earning power. Using market prices to assess ...financial institutions’ solvency in such circumstances is not desirable. We show that a shock in the insurance sector can cause the current market value of banks’ assets to fall below their liabilities so they are insolvent. In contrast, if values based on historic cost are used, banks can continue and meet all their future liabilities. We discuss the implications for the debate on mark-to-market versus historic cost accounting.
We develop a new model for solvency contagion that can be used to quantify systemic risk in stress tests of financial networks. In contrast to many existing models, it allows for the spread of ...contagion already before the point of default and hence can account for contagion due to distress and mark‐to‐market losses. We derive general ordering results for outcome measures of stress tests that enable us to compare different contagion mechanisms. We use these results to study the sensitivity of the new contagion mechanism with respect to its model parameters and to compare it to existing models in the literature. When applying the new model to data from the European Banking Authority, we find that the risk from distress contagion is strongly dependent on the anticipated recovery rate. For low recovery rates, the high additional losses caused by bankruptcy dominate the overall stress test results. For high recovery rates, however, we observe a strong sensitivity of the stress test outcomes with respect to the model parameters determining the magnitude of distress contagion.
Imperfect information aggregation in secondary markets of credit has significant consequences for economic cycles. As banks put more weight on mark-to-market gains, they find it optimal to refrain ...from revealing information about adverse shocks. Consequently, default risk is mispriced, and loan volumes, and thus investment, are not appropriately reduced. Overinvesment lowers the price of capital, leading households to increase consumption without decreasing labour supply, generating a boom. Due to mispricing, banks subsequently face bigger losses and capital depletion. Output then decreases sharply due to credit supply shortages. These instances of market dysfunction are crucial in amplifying credit cycles.
Were there fire sales in the RMBS market? Merrill, Craig B.; Nadauld, Taylor D.; Stulz, René M. ...
Journal of monetary economics,
September 2021, 2021-09-00, Letnik:
122
Journal Article
Recenzirano
•Prices of residential mortgage-back securities fell sharply during the global financial crisis.•These prices fell in part because of forced sales.•Risk-based capital requirements and mark-to-market ...accounting created incentives for forced sales.•Differences between transaction prices and predicted prices became large during the crisis but were small before and after the crisis.•As expected with forced sales, prices rebounded some after the crisis.
Many observers have argued that the fall in RMBS prices during the crisis was partly caused by fire sales. Using a unique dataset of RMBS transactions for insurance companies, we show evidence supportive of a role, at the transaction level, of forced sales that occurred at discounted prices relative to fundamentals, and find that the RMBS market behaved as a whole as would be expected in the presence of fire sales. We show that risk-sensitive capital requirements and mark-to-market accounting can jointly create incentives for financial institutions subject to adverse capital shocks to sell stressed securities.
ABSTRACT
Using laboratory markets where accounting regimes can be directly compared with equivalent economic parameters, we test whether and how two different accounting measurement bases—historical ...cost (HC) and mark-to-market (MTM)—influence trader perceptions and asset mispricing. Our results show that traders perceive otherwise equivalent assets differently by regime, consistent with accounting regimes imposing differential information processing costs. In the MTM regime, traders integrate market price information to a greater extent and integrate asset fundamental information to a lesser extent. We also observe that traders in the MTM regime express prospective preferences for information about future market prices, but in HC prefer information about future dividends. These individual-level effects correspond with greater market-level mispricing/bubbles under MTM. Our results suggest that accounting regimes can, on their own, contribute to price bubbles and their subsequent collapse.
Data Availability: Data are available on request.
We find that Treasury floating rate notes (FRNs) trade at a significant premium relative to the prices of Treasury bills and notes. This premium is directly related to the near-constant nature of FRN ...prices and is correlated with measures reflecting investor demand for safe assets. Money market funds are often the primary investors in FRNs, and the FRN premium is related to flows into funds with fixed net asset values, but not to flows into funds with variable net asset values. These results provide strong evidence that the FRN premium represents a convenience yield for the mark-to-market stability feature of FRNs.
Marking-to-Market: Panacea or Pandora's Box? PLANTIN, GUILLAUME; SAPRA, HARESH; SHIN, HYUN SONG
Journal of accounting research,
20/May , Letnik:
46, Številka:
2
Journal Article
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Financial institutions have been at the forefront of the debate on the controversial shift in international standards from historical cost accounting to mark-to-market accounting. We show that the ...trade-offs at stake in this debate are far from one-sided. While the historical cost regime leads to some inefficiencies, marking-to-market may lead to other types of inefficiencies by injecting artificial risk that degrades the information value of prices, and induces suboptimal real decisions. We construct a framework that can weigh the pros and cons. We find that the damage done by marking-to-market is greatest when claims are (1) long-lived, (2) illiquid, and (3) senior. These are precisely the attributes of the key balance sheet items of banks and insurance companies. Our results therefore shed light on why banks and insurance companies have been the most vocal opponents of the shift to marking-to-market.
Mark to market value at risk Chen, Yu; Wang, Zhicheng; Zhang, Zhengjun
Journal of econometrics,
January 2019, 2019-01-00, 20190101, Letnik:
208, Številka:
1
Journal Article
Recenzirano
Financial risk management has been overwhelmed by applications and research of value at risk (VaR) in daily practice mainly due to its simple form and easily interpretable feature. Yet, its serious ...drawback of underestimating an asset’s market risk has been noticed in numerous applications, and many alternative risk measures have been proposed in the literature. Among all existing alternative risk measures, it is hard to find one that a financial institution whose portfolio has multiple settlements before the end of holding period uses to internally perform risk assessment. We propose a new risk measure termed mark to market value at risk (MMVaR) for settlement being taken daily during the holding period. MMVaR is a natural alternative risk measure to VaR as it is a direct generalization of VaR. It not only maintains easily interpretable feature held by VaR, but also better computes an asset’s market risk in a financial institution having daily account settlements. We show that MMVaR is superior to VaR using simulation examples and real data. In real data analysis, we find that risks calculated using MMVaR are about 20% higher than risks calculated using classical VaR, which provides an evidence proof of Basel III’s new capital adequacy ratio requirement, and hence it can become an implementable daily risk measure.
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