This paper investigates the effects of mortgage-backed securities (MBS) hedging activity on interest-rate volatility and proposes a model that takes these effects into account. An empirical examination suggests that the inclusion of information about MBS considerably improves model performance in pricing interest-rate options and in forecasting future interest-rate volatility. The empirical res...

In a general equilibrium model with risk neutral and risk averse agents, we show that if banks issue both demand deposits and equity, then free banking is run-proof and ecient. In particular, we obtain the ®rst best insurance solution if there is adequate risk neutral capital. If sucient risk neutral capital is unavailable, then a partial suspension of convertibility is optimal. In general, t...

There is a wide cross-country variation in the institutional structure of bank failure resolution, including the role of the deposit insurer. We use quantitative analysis for 57 countries and discussion of specific country cases to illustrate this variation. Using data for over 1,700 banks across 57 countries, we show that banks in countries where the deposit insurer has the responsibility of i...

Private banks often blame state guarantees to distort competition by giving public banks the advantage of lower funding costs. In this paper I show that if borrowers perceive the public bank as supporting economic development, private banks may be able to separate firms by self selection, enter the market, and obtain profits in equilibrium despite their cost disadvantage. The public bank’s comp...

Is market-based or bank-based financial system better for fostering technological innovation as an engine of growth? I present evidence that bank-based systems promote rapid technological progress in those industrial sectors that depend heavily on external finance for funding innovation by facilitating credit access to younger firms. On the other hand, I also find evidence of a general positive...

The Basel 2 Accord requires regulatory capital to cover stress tests, yet no coherent and objective framework for stress testing portfolios exists. We propose a new methodology for stress testing in the context of market risk models that can incorporate both volatility clustering and heavy tails. Empirical results compare the performance of eight risk models with four possible conditional and u...

Banks are growing ever larger compared to their national economies. We show that increases in relative bank size (measured as a bank’s liabilities divided by national GDP) are linked to banks displaying higher tail risk. This effect is not entirely due to risk channels that disproportionately expose relatively large banks to systematic tail risks, sovereign risks, or banking crises. Instead, we...

This paper develops a framework for stress-testing the credit risk of Chinese commercial banks to macroeconomic shocks. Using data over the period 1985-2008, this study establishes a vector auto-regression (VAR) model to describe the links between default rate and macroeconomic factors, and then designs three stress scenarios to implement the stress testing by Monte Carlo simulation. As a resul...

The objective of this paper is to analyse the network topology of the Italian segment of the European overnight money market through methods of statistical mechanics applied to complex networks. We investigate differences in the activities of banks of different sizes and the evolution of their connectivity structure over the maintenance period. The main purpose of the analysis is to establish t...

The magnitude and frequency of recent financial crises underscore the importance of understanding financial instability for the purpose of crisis prevention and crisis management. This paper brings together and adds structure to the theoretical literature on financial instability and the implications they carry for policy-makers. In addition to clarifying the theoretical underpinnings for study...