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Working Paper
Empirical analysis of corporate credit lines
Since bank credit lines are a major source of corporate funding and liquidity, we examine the determinants of credit line usage with a database of Spanish corporate credit lines. A line's default status is the primary factor driving its usage, which increases as a firm approaches default. Several lender characteristics suggest an important role for bank monitoring in firms' usage decisions. Credit line usage is found to be inversely related to macroeconomic conditions. Overall, while several factors influence corporate credit line usage, our analysis suggests that default and supply-side ...
Discussion Paper
Alternative measures of the Federal Reserve banks' cost of equity capital
The Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the twelve Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are ?woefully? and ?unavoidably? imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the Capital Asset Pricing Model (CAPM) and compare them using econometric and materiality criteria. Our results ...
Journal Article
Methods for evaluating value-at-risk estimates
Since 1998, U.S. commercial banks with significant trading activities have been required to hold capital against their defined market risk exposure. Under the "internal models" approach embodied in the current regulatory guidelines, the capital charges are a function of banks' own value-at-risk (VaR) estimates. VaR estimates are simply forecasts of the maximum portfolio loss that could occur over a given holding period with a specified confidence level. Clearly, the accuracy of these VaR estimates is of concern to both banks and their regulators. ; To date, two hypothesis-testing methods ...
Working Paper
How does competition impact bank risk-taking?
A common assumption in the academic literature and in the actual supervision of banking systems worldwide is that franchise value plays a key role in limiting bank risk-taking. As the underlying source of franchise value is assumed to be market power, reduced competition has been considered to promote banking stability. Boyd and De Nicolo (2005) propose an alternative view where concentration in the loan market could lead to increased borrower debt loads and a corresponding increase in loan defaults that undermine bank stability. Martinez-Miera and Repullo (2007) encompass both approaches by ...
Working Paper
Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement
Insurance companies and pension funds have liabilities far into the future and typically well beyond the longest maturity bonds trading in fixed-income markets. Such long-lived liabilities still need to be discounted, and yield curve extrapolations based on the information in observed yields can be used. We use dynamic Nelson-Siegel (DNS) yield curve models for extrapolating risk-free yield curves for Switzerland, Canada, France, and the U.S. We find slight biases in extrapolated long bond yields of a few basis points. In addition, the DNS model allows the generation of useful financial risk ...
Journal Article
Assessing supervisory scenarios for interest rate risk
A new proposal by the Basel Committee on Banking Supervision for setting the amount of capital banks must hold against potential losses from interest rate risk uses only a few, very stylized scenarios. Analysis shows the proposed scenarios are extremely unlikely to occur. While they may be appropriate for setting bank capital guidelines, they are much less relevant for everyday risk management. Instead, using a modeling framework with a plausible range of interest rate scenarios would be more relevant to help banks manage their interest rate risk.
Journal Article
Methods for evaluating value-at-risk estimates
This paper was presented at the conference "Financial services at the crossroads: capital regulation in the twenty-first century" as part of session 3, "Issues in value-at-risk modeling and evaluation." The conference, held at the Federal Reserve Bank of New York on February 26-27, 1998, was designed to encourage a consensus between the public and private sectors on an agenda for capital regulation in the new century.
Report
Regulatory evaluation of value-at-risk models
Beginning in 1998, commercial banks may determine their regulatory capital requirements for market risk exposure using value-at-risk (VaR) models; i.e., time-series models of the distributions of portfolio returns. Currently, regulators have available three statistical methods for evaluating the accuracy of VaR models: the binomial method, the interval forecast method, and the distribution forecast method. These methods test whether the VaR forecasts in question exhibit properties characteristics of accurate VaR forecasts. However, the statistical tests can have low power against alternative ...
Report
Exchange rate cointegration across central bank regime shifts
Foreign exchange rates are examined using cointegration tests over various time periods linked to regime shifts in central bank behavior. The number of cointegrating vectors seems to vary across these regime changes within the foreign exchange market. For example, cointegration is not generally found prior to the Plaza Agreement of September 22, 1985, but it is present after that date. The significance of these changes is evaluated using a likelihood ratio procedure proposed by Quintos (1993). The changing nature of the cointegrating relationships indicate that certain aspects of central bank ...
Journal Article
Measuring Interest Rate Risk in the Very Long Term
Insurance companies write policies to cover potential risks far into the future. Because the life of these contracts can extend well beyond the 30-year maturities for the longest U.S. Treasuries, it?s difficult to measure the interest rate risk involved. A new study describes how the long-term interest rates required to evaluate such long-lived liabilities can be extrapolated from shorter-maturity bond yields using a standard yield curve model. These extrapolations are a useful tool since they have very small errors relative to the yield curve variation typically considered for risk ...