Earnings Management and Investor Protection: An International Comparison

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Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.

Default risk and income fluctuations in emerging economies

Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are
higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina
such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.

/pdf/default-risk-and-income-fluctuations-in-emerging-economies-3uwetnmpe6.pdf

Default Risk and Income Fluctuations in Emerging Economies

Aggregate and sectoral comovement are central features of business cycles, so the ability to generate comovement is a natural litmus test for macroeconomic models. But it is a test that most models fail. We propose a unified model that generates aggregate and sectoral comovement in response to contemporaneous and news shocks about fundamentals. The fundamentals that we consider are aggregate and sectoral total factor productivity shocks as well as investment specific technical change. The model has three key elements: variable capital utilization, adjustment costs to investment, and preferences that allow us to parameterize the strength of short-run wealth effects on the labor supply. (JEL

/pdf/can-news-about-the-future-drive-the-business-cycle-b482sd6shw.pdf

Can news about the future drive the business cycle

Government support to banks through the provision of explicit or implicit guarantees affects the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of bank data and government support to banks for the periods 2003-2004 and 2009-2010. We find that more government support is associated with more risk taking by banks, especially during the financial crisis (2009-10). We also find that restricting banks' range of activities ameliorates the moral hazard problem. We conclude that strengthening market discipline in the banking sector is needed to address this moral hazard problem.

https://www.imf.org/-/media/Websites/IMF/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1394.ashx

International Evidence on Government Support and Risk Taking in the Banking Sector

This paper documents a new type of cross-border bank lending channel A deepening of the European sovereign debt crisis in 2011 restrained the financial intermediation of European banks in the United States In this period, some of the US branches of European banks faced a dollar liquidity shock – due to their perceived risk reflecting the sovereign risk of their countries of origin – which in turn affected the branches’ lending to US entities We use a novel dataset to analyze the operations of branches of foreign banks in the United States Our results show that: (1) The US branches of foreign banks from countries with a greater increase in sovereign risk (mostly European banks) were less able to attract dollar funding from US money market funds (2) Instead, the branches with curtailed access to large time deposits relied more on funding from their own parent institutions, thus shifting from being net suppliers to being net receivers of dollar funding from their related offices (3) Since the additional funding received from parent institutions was not enough to offset the decreased access to US funding, such branches reduced their lending to US entities

/pdf/liquidity-shocks-dollar-funding-costs-and-the-bank-lending-3f9k8voz6j.pdf

Liquidity shocks, dollar funding costs, and the bank lending channel during the European sovereign crisis

https://www.federalreserve.gov/pubs/ifdp/2011/1020/ifdp1020r.pdf

Financial frictions, trade credit, and the 2008–09 global financial crisis☆

Government support to banks through the provision of explicit or implicit guarantees affects the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of rated banks and find that government support is associated with more risk taking by banks. More importantly, we find that restricting banks’ range of activities ameliorates the link between government support and bank risk taking. We conclude that, in the presence of moral hazard induced by government support, reducing bank complexity strengthens market discipline.

Government support, regulation, and risk taking in the banking sector

We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets. ; WP 10-04 replaces earlier versions listed as WP 09-13 and WP 06-11

Horacio Sapriza

Papers

International Evidence on Government Support and Risk Taking in the Banking Sector

Liquidity shocks, dollar funding costs, and the bank lending channel during the European sovereign crisis

Financial frictions, trade credit, and the 2008–09 global financial crisis☆

Government support, regulation, and risk taking in the banking sector

Quantitative properties of sovereign default models: solution methods matter