Credit risk

About: Credit risk is a research topic. Over the lifetime, 18595 publications have been published within this topic receiving 382866 citations.

Trade Credit: Suppliers as Debt Collectors and Insurance Providers

Abstract: There are two fundamental puzzles about trade credit: why does it appear to be so expensive, and why do input suppliers engage in the business of lending money? This paper addresses and answers both questions analysing the interaction between the financial and the industrial aspects of the supplier-customer relationship. It examines how, in a context of limited enforceability of contracts, suppliers may have a comparative advantage over banks in lending to their customers because they hold the extra threat of stopping the supply of intermediate goods. Suppliers may also act as liquidity providers, providing insurance against liquidity shocks that may endanger the survival of their customer relationships. The relatively high implicit interest rates of trade credit result from the existence of insurance and default premia. The implications of the model are examined empirically using parametric and nonparametric techniques on a panel of UK firms.

The Credit Ratings Game

Abstract: The spectacular failure of top-rated structured …nance products has brought renewed attention to the con‡icts of interest of Credit Rating Agencies (CRAs). We model both the CRA con‡ict of understating credit risk to attract more business, and the issuer con‡ict of purchasing only the most favorable ratings (issuer shopping), and examine the eectiveness of a number of proposed regulatory solutions of CRAs. We …nd that CRAs are more prone to in‡ate ratings when there is a larger fraction of naive investors in the market who take ratings at face value, or when CRA expected reputation costs are lower. To the extent that in booms the fraction of naive investors is higher, and the reputation risk for CRAs of getting caught understating credit risk is lower, our model predicts that CRAs are more likely to understate credit risk in booms than in recessions. We also show that, due to issuer shopping, competition among CRAs in a duopoly is less e¢ cient (conditional on the same equilibrium CRA rating policy) than having a monopoly CRA, in terms of both total ex-ante surplus and investor surplus. Allowing tranching decreases total surplus further. We argue that regulatory intervention requiring upfront payments for rating services (before CRAs propose a rating to the issuer) combined with mandatory disclosure of any rating produced by CRAs can substantially mitigate the con‡icts of interest of both CRAs and issuers.

Structural Models of Corporate Bond Pricing: An Empirical Analysis

Abstract: This paper empirically tests five structural models of corporate bond pricing: Those of Merton (1974), Geske (1977), Leland and Toft (1996), Longstaff and Schwartz (1995), and Collin-Dufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capital structures during the period 1986-1997. The conventional wisdom is that structural models do not generate spreads as high as those seen in the bond market, and true to expectations we find that the predicted spreads in our implementation of the Merton model are too low. The compound option approach of Geske comes much closer to the spreads observed in the market, on average, but still underpredicts spreads. In contrast, the Leland and Toft model substantially overestimates credit risk on most bonds, and especially so for high coupon bonds. The Longstaff and Schwartz model modifies Merton to incorporate a stochastic interest rate and a correlation between interest rates and firm value. While the correlation and the level of interest rates have little effect, higher interest rate volatility leads to higher predicted spreads. However, this and other features of this model result in spreads that are often too high for risky bonds and too low for safe bonds. The target leverage ratio model of Collin-Dufresne and Goldstein helps to raise the spreads on the bonds that were considered very safe by the Longstaff and Schwartz model, but overall tends toward overestimation of credit risk. We conclude that structural models do not systematically underpredict spreads, as the previous literature implies, but accuracy is a problem. Moreover, some of the simplifications made to date lead to overestimation of credit risk on the riskier bonds while scarcely affecting the spreads of the safest bonds.

Financial Institutions Management: A Risk Management Approach

Abstract: Part I Introduction Ch. 1 Why Are Financial Institutions Special? Appendix 1A The Financial Crisis: The Failure of Financial Services Institution Specialness (online) Appendix 1B Monetary Policy Tools (online) Ch. 2 Financial Services: Depository Institutions Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework (online) Appendix 2B Commercial Banks' Financial Statements and Analysis (online) Appendix 2C Depository Institutions and Their Regulators (online) Appendix 2D Technology in Commercial Banking (online) Ch. 3 Financial Services: Finance Companies Ch. 4 Financial Services: Securities Brokerage and Investment Banking Ch. 5 Financial Services: Mutual Funds and Hedge Funds Ch. 6 Financial Services: Insurance Ch. 7 Risks of Financial Institutions Part II Measuring Risk Ch. 8 Interest Rate Risk I Appendix 8A The Maturity Model (online) Appendix 8B Term Structure of Interest Rates Ch. 9 Interest Rate Risk II Appendix 9A The Basics of Bond Valuation (online) Appendix 9B Incorporating Convexity into the Duration Model Ch. 10 Credit Risk: Individual Loan Risk Appendix 10A Credit Analysis (online) Appendix 10B Black-Scholes Option Pricing Model (online) Ch. 11 Credit Risk: Loan Portfolio and Concentration Risk Appendix 11A CreditMetrics Appendix 11B CreditRisk+ Ch. 12 Liquidity Risk Appendix 12A Sources and Uses of Funds Statement, Bank of America, March 2012 (online) Ch. 13 Foreign Exchange Risk Ch. 14 Sovereign Risk Appendix 14A Mechanisms for Dealing with Sovereign Risk Exposure Ch. 15 Market Risk Ch. 16 Off-Balance-Sheet Risk Appendix 16A A Letter of Credit Transaction (online) Ch. 17 Technology and Other Operational Risks Part III Managing Risk Ch. 18 Liability and Liquidity Management Appendix 18A Federal Reserve Requirement Accounting (online) Appendix 18B Bankers Acceptances and Commercial Paper as Sources of Financing (online) Ch. 19 Deposit Insurance and Other Liability Guarantees Appendix 19A Calculation of Deposit Insurance Premiums Appendix 19B FDIC Press Releases of Bank Failures (online) Appendix 19C Deposit Insurance Coverage for Commercial Banks in Various Countries (online) Ch. 20 Capital Adequacy Appendix 20A Internal Ratings-Based Approach to Measuring Credit Risk-Adjusted Assets Appendix 20B Methodology Used to Determine G-SIBs Capital Surcharge (online) Ch. 21 Product and Geographic Expansion Appendix 21A EU and G-10 Countries: Regulatory Treatment of the Mixing of Banking, Securities, and Insurance Activities and the Mixing of Banking and Commerce (online) Ch. 22 Futures and Forwards Appendix 22A Microhedging with Futures (online) Ch. 23 Options, Caps, Floors, and Collars Appendix 23A Black-Scholes Option Pricing Model (online) Appendix 23B Microhedging with Options (online) Ch. 24 Swaps Appendix 24A Setting Rates on an Interest Rate Swap Ch. 25 Loan Sales Ch. 26 Securitization Appendix 26A Fannie Mae and Freddie Mac Balance Sheets (online)

Islamic Banks and Financial Stability: An Empirical Analysis

Abstract: The relative financial strength of Islamic banks is assessed empirically based on evidence covering individual Islamic and commercial banks in 19 banking systems with a substantial presence of Islamic banking. We find that (a) small Islamic banks tend to be financially stronger than small commercial banks; (b) large commercial banks tend to be financially stronger than large Islamic banks; and (c) small Islamic banks tend to be financially stronger than large Islamic banks, which may reflect challenges of credit risk management in large Islamic banks. We also find that the market share of Islamic banks does not have a significant impact on the financial strength of other banks.