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...

This paper presents evidence that reductions in mortgage interest rates associated with prepayment penalties are greater for riskier borrowers, as measured by mortgage type, credit scores, and local incomes and education levels. This is consistent with an efficiency view that, by reducing the reclassification risk faced by lenders, prepayment penalties can be welfareimproving. Additional findin...

We assess the impact of the geographic expansion of bank assets on the cost of banks’ interestbearing liabilities. Existing research suggests that expansion can both intensify agency problems that increase funding costs and facilitate risk diversification that decreases funding costs. Using a newly developed identification strategy, we discover that the geographic expansion of banks across U.S....

We provide the first evidence that changes in risk-based capital requirements for banks affect the real economy through international trade. Using a natural experiment – mandatory Basel II adoption in its Standardized Approach by all banks in Turkey on July 1, 2012 – we investigate the impact of new risk-weights applied to commercial letters of credit (CLC) on that country’s exports to 174 coun...

The note is a review of the literature on the quantitative methods used to assess the vulnerabilities of financial systems to risks. In particular, the author focuses on the role of system-wide stress testing. He summarizes the recent developments in the literature, highlighting topics relevant for the Czech case. He presents the key concepts relating to systemwide stress tests, overviews the s...

Deposit insurance schemes and bank failure resolution systems are asked to fulfill conflicting public policy objectives: on the one hand, they are supposed to protect small depositors and prevent contagion risks from bank runs; on the other hand, they are supposed to minimize aggressive risk taking by banks. This paper discusses the incentive-compatible design and interaction of both components...

Instead of relying on accounting principles and illustrative accounting examples, this paper examines the rationale for ESO expensing from an economics perspective and has the following findings. In principle, while ESO expensing is justified under ESOs’ expense-postponing function, it is not under the employee-stimulating function. In practice, ESOs’ risk-sharing function poses a fundamental d...

This paper analyzes the application of the Markov-switching ARCH model (Hamilton and Susmel, 1994) in improving value-at-risk (VaR) forecast. By considering a mixture of normal distributions with varying variances over different time and regimes, we find that the “spurious high persistence” found in the GARCH model is adjusted. Under relative performance and hypothesis-testing evaluations, the ...

Shadow banking in China is mainly conducted by banks to evade the excessive credit control, which constitutes a dual-track approach to liberalize the country’s rigid interest rate policy. The market track of shadow banking can lead to efficiency gain by allowing credit resale to fund the more productive yet credit-deprived private enterprises (PEs). Pareto improvement can be achieved as the ban...

Previous comparative analyses of gross and net settlement have focused on the credit risk of the central counterparty in net settlement arrangements, and on the incentives for participants to alter the risk of the portfolio under net settlement. By modeling the trading economy that generates the demand for payment services, we are able to show some largely unexplored advantages of net settlemen...