Each depositor insured to at least $250,000 per insured bank

How Well Does the Vasicek-Basel AIRB Model Fit the Data? Evidence from a Long Time Series of Corporate Credit Rating Data - PDF 517 KB (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-10
Paul H. Kupiec


November 2009

ABSTRACT
I develop methods that produce consistent estimates of the Vasicek-Basel IRB (VAIRB) credit risk model parameters. I apply these methods to Moody's data on corporate defaults over the period 1920–2008 and assess the model fit and construct hypothesis tests using bootstrap methods. The results show that the VAIRB does not capture the variability in Moody's default data: there are numerous episodes in which obligors default with much greater frequency than predicted. This pattern is consistent with a missing common factor that affects default correlation only intermittently—a missing factor similar to the frailty covariate in Duffie et al. (2009). Unlike Lopez (2004), I find the VAIRB correlation parameter to be larger for lower-rated credits. I use estimates of the VAIRB error distribution to construct capital allocations for model risk and find that the capital buffers for model risk are substantial, especially for lower-graded credits. VAIRB common factor estimates exhibit positive autocorrelation and thus long time series are usually necessary to produce reliable model estimates. Alternatively, I use common factor and correlation parameter estimates from the 1920-2008 data to control for common factor realizations when estimating unconditional default rates (PDs) from short samples. I estimate PDs and confidence intervals using default data for Moody's alpha-numeric rating grades (1998-2008). After correcting for common factor effects, sample average default rates are shown to overstate the PD for most credit grades in this sample period.

Keywords: Portfolio Credit Risk Measurement, Corporate Ratings, Basel II, Vasicek Credit Risk Model, Economic Capital Allocation

JEL codes: C31, C33, C51, C52, C53, G13, G21, G28, G32, G33

More Powerful Unit Root Tests with Non-normal Errors - PDF 893 KB (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-9
Kyung So Im, Junsoo Lee, Margie Tieslau


November 2009

ABSTRACT
This paper proposes new unit root tests that are more powerful when the error term follows a non-normal distribution. The improved power is gained by utilizing the additional moment conditions embodied in non-normal errors. Specifically, we follow the work of Im and Schmidt (2008), using the framework of generalized methods of moments (GMM), and adopt a simple two-step procedure based on the "residual augmented least squares" (RALS) methodology. Our RALS-based unit root tests make use of non-linear moment conditions through a computationally simple procedure. Our Monte Carlo simulation results show that the RALS-based unit root tests have good size and power properties, and they show significant efficiency gains when utilizing the additional information contained in non-normal errors---information that is ignored in traditional unit root tests.

Keywords: Unit root test, Generalized methods of moments (GMM), Residual augmented least squares (RALS), Non-normality.

JEL codes: C22, C12, C13.

Speculation and Recent Volatility in the Price of Oil - PDF 934 KB (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-8
James Einloth


October 2009

ABSTRACT
As the price of crude oil doubled from June 2007 to June 2008, suspicion grew that price was being driven higher by speculation rather than fundamental supply and demand. After having seen the price drop 70 percent from its peak, this explanation may appear more plausible than ever. This paper introduces a new methodology that uses convenience yield – imputed from futures prices – to detect the influence of speculation on the spot price of a storable commodity. The paper finds the evidence inconsistent with speculation having played a major role in the rise of price to $100 per barrel in March 2008. However, the evidence suggests that speculation did play a role in its subsequent rise to $140. Finally, the analysis finds that the collapse in price was caused by an unanticipated decline in demand rather than by speculators unloading their positions. This implies that, absent the discovery of vast new sources of energy, high oil prices will return with the recovery of the global economy.

Keywords: oil, petroleum, futures price, speculation, convenience yield, bubble

JEL codes: G13, Q33, Q40

The Effect of Bank Account Ownership on Credit, Consumption, and Savings: Evidence from the United Kingdom - PDF 1.03MB (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-7
Katie Fitzpatrick


September 2009

ABSTRACT
I use an electronic transfer mandate in the UK Child Benefit program, a transfer received by virtually all families with children, to estimate the effect of bank account ownership on the financial behavior of less educated families with children. With the mandate increasing account ownership by as much as 29 percent for less educated families with children, it provides an exogenous increase in account ownership to examine the causal effect of bank account ownership on access to credit, purchase of household durable goods, vehicle ownership, vehicle purchase, and accumulation of financial assets. When a less educated family becomes an owner of a bank account, I find a 71 percentage point increase in the probability of owning a credit card, an increase of 1.4 household durable goods, and no change in vehicle ownership or purchase. Although I find that bank account ownership does not affect the mean level of financial assets, I do find evidence suggestive of an increase in the top half of the financial asset distribution which indicates that there may be heterogeneity in the savings response to owning a bank account. Overall, my findings suggest that the most important benefit of owning a bank account is access to credit and requiring lower income families to own a bank account will not reverse their low average savings levels in the short run.

Keywords: Consumer Finance, Savings, Consumer Credit, Household Finance, Unbanked

JEL Classification: D6, D14, G21, H3

Bank Failures and the Cost of Systemic Risk: Evidence from 1900-1930 2,017k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-6
Paul Kupiec and Carlos Ramirez


April 2009

ABSTRACT
This paper investigates the effect of bank failures on economic growth using data from 1900 to 1930, a period that predates active government stabilization policies and includes periods of banking system distress that are not coincident with recessions. Using both VAR and a difference-in-difference methodology that exploits the reactions of the New York and Connecticut economies to the Panic of 1907, we estimate the effect of bank failures on economic activity. The results indicate that bank failures reduce subsequent economic growth. Over this period, a 0.14 percent (1 standard deviation) increase from the mean value of the liabilities of the failed depository institutions results in a reduction of 17 percentage points in the growth rate of industrial production and a 4 percentage point decline in real GNP growth. The reductions occur within three quarters of the initial bank failure shock and can be interpreted as an important component of the cost of systemic risk in the banking sector.

Keywords: bank failures; systemic risk; financial accelerator, vector auto regressions; Panic of 1907; non-bank commercial failures

JEL Classification: N11, N21, E44, E32

Implied Recovery - PDF 249k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-05
Sanjiv R. Das and Paul Hanouna


November 2008

ABSTRACT
In the absence of forward-looking models for recovery rates, market participant tend to use exogenously assumed constant recovery rates in pricing models. We develop a exible jump-to-default model that uses observables: the stock price and stock volatility in conjunction with credit spreads to identify implied, endogenous, dynamic functions of the recovery rate and default probability. The model in this paper is parsimonious and requires the calibration of only three parameters, enabling the identification of the risk-neutral term structures of forward default probabilities and recovery rates. Empirical application of the model shows that it is consistent with stylized features of recovery rates in the literature. The model is exible, i.e., it may be used with different state variables, alternate recovery functional forms, and calibrated to multiple debt tranches of the same issuer. The model is robust, i.e., evidences parameter stability over time, is stable to changes in inputs, and provides similar recovery term structures for different functional specifications. Given that the model is easy to understand and calibrate, it may be used to further the development of credit derivatives indexed to recovery rates, such as recovery swaps and digital default swaps, as well as provide recovery rate inputs for the implementation of Basel II.

Keywords: Implied, Recovery, Loss-Given-Default, Credit Default Swaps

JEL Classification: G0, G1.

Do Financial Counseling Mandates Improve Mortgage Choice and Performance? Evidence from a Natural Experiment - PDF 3,335 KB (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-04
Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet, and Douglas D. Evanoff

ABSTRACT
We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a natural experiment in which the State of Illinois required ‘high-risk’ mortgage applicants acquiring or refinancing properties in 10 specific zip codes to submit loan offers from state-licensed lenders to review by HUD-certified financial counselors. We document that the legislation led to declines in both the supply of and demand for credit, with statelicensed lenders and lower-quality borrowers disproportionately exiting the affected area. Controlling for the salient characteristics of the remaining borrowers and lenders, we find that the legislation succeeded in reducing ex post default rates among counseled borrowers by close to 4 percentage points (about 35% decline). We attribute this result to actions of lenders responding to the presence of external review and, to a lesser extent, to counseled borrowers renegotiating their loan terms. We also find that the legislation nudged some borrowers to choose less risky loan products in order to eschew counseling.

Keywords: Financial literacy, Lax screening, Subprime crisis, Household finance

JEL Classification: D14, D18, L85, R21

Pay for Performance?CEO Compensation and Acquirer Returns in BHCs - PDF 905k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2009-03
Kristina Minnick, Haluk Unal, Liu Yang


December 2008

ABSTRACT
We examine the impact of managerial incentives on acquisitions in the banking industry. We find that banks whose CEOs have higher pay-for-performance sensitivity (PPS) are less likely to engage in value- reducing acquisitions. Conditional on engaging in acquisitions, those higher-PPS banks have significantly better announcement returns: on average these banks outperform the acquires in the lower-PPS group by 1.2% in a three-day window around the announcement. The positive market reaction can be rationalized by long-term performance. Following acquisitions, banks with high PPS experience greater improvement in their operating performance as measured by ROA.

Keywords: Keywords: Pay-for-Performance Sensitivity, CEO Compensation, Acquirer Returns, Bank Mergers

JEL classification: G34, G21

The $700 Billion Bailout: A Public-Choice Interpretation 691K (Word Help)

FDIC Center for Financial Research Working Paper No. 2009-01
Carlos D. Ramírez
January 2009

Abstract
On September 29, 2008, the House of Representatives voted to reject HR 3997 (known as the original $700 Billion Bailout Bill). On October 3, the House reversed course and voted to approve the Emergency Economic Stabilization Act of 2008 (EESA). This paper applies a political voting model to these two House votes—the rejection of the bill on September 29 and its passage on October 3. Both economic conditions and PAC contributions matter in explaining the two votes, but their effect is attenuated by legislator's power. PAC contributions from the American Bankers Association appear to matter for explaining the legislators who switched. The role of ideology in explaining either the September 29 or October 3 vote is limited.

Keywords:

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