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1 – 10 of 564The purpose of this paper is to analyze the consequences of the “safe harbor” provisions of the US Bankruptcy Code that were enacted from 1984 through 2005 and that protect…
Abstract
Purpose
The purpose of this paper is to analyze the consequences of the “safe harbor” provisions of the US Bankruptcy Code that were enacted from 1984 through 2005 and that protect certain financial contracts from standard bankruptcy procedures.
Design/methodology/approach
Qualitative methods are used to evaluate whether these provisions of the Bankruptcy Code were successful in their stated goal of reducing systemic risk in the financial system. A model of systemic risk is presented verbally in order to frame the discussion.
Findings
Recent evidence indicates that the “safe harbor” provisions, in fact, destabilized the financial system by encouraging collateralized interbank lending, discouraging careful analysis of the credit risk of counterparties and increasing the risk that creditors will run on a financial firm.
Practical implications
This paper indicates that the rewriting of the Bankruptcy Code to favor financial firms has had a profoundly destabilizing effect on the financial system. To put the financial system on more secure foundations, the author proposes that large complex financial institutions be prohibited from posting collateral on over the counter derivative transactions and that the repo‐related bankruptcy amendments passed in 2005 be repealed.
Originality/value
This paper proposes an original framework for understanding systemic risk which drives the results in the paper.
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Katherine Tyler and Edmund Stanley
In 1997, in this journal, Elizabeth Sheedy published a paper investigating exchange relationships in derivative markets. This paper was significant for two reasons. It was the…
Abstract
In 1997, in this journal, Elizabeth Sheedy published a paper investigating exchange relationships in derivative markets. This paper was significant for two reasons. It was the first article to consider the marketing of these important financial instruments. Second, her article set out a forceful argument that relationships in this context were breaking down, and that the advantages associated with a relationship model of exchange had not appeared, and indeed had to some extent facilitated the series of well publicised derivative disasters. In this paper, the authors respond to Sheedy’s call for further research through an empirical examination of the over‐the‐counter equity derivatives market in the USA and Britain, arguing that while relationships in this market do, to a limited degree, exhibit characteristics atypical of wider financial services contexts, the relationship paradigm continues to be relevant, and indeed inherent, to over‐the‐counter derivative exchange.
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Lixin Wu and Chonhong Li
The purpose of this paper is to provide a framework of replication pricing of derivatives and identify funding valuation adjustment (FVA) and credit valuation adjustments (CVA) as…
Abstract
Purpose
The purpose of this paper is to provide a framework of replication pricing of derivatives and identify funding valuation adjustment (FVA) and credit valuation adjustments (CVA) as price components.
Design/methodology/approach
The authors propose the notion of bilateral replication pricing. In the absence of funding cost, it reduces to unilateral replication pricing. The absence of funding costs, it introduces bid–ask spreads.
Findings
The valuation of CVA can be separated from that of FVA, so-called split up. There may be interdependence between FVA and the derivatives value, which then requires a recursive procedure for their numerical solution.
Research limitations/implications
The authors have assume deterministic interest rates, constant CDS rates and loss rates for the CDS. The authors have also not dealt with re-hypothecation risks.
Practical implications
The results of this paper allow user to identify CVA and FVA, and mark to market their derivatives trades according to the recent market standards.
Originality/value
For the first time, a line between the risk-neutral pricing measure and the funding risk premiums is drawn. Also, the notion of bilateral replication pricing extends the unilateral replication pricing.
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Zaminor Zamzamir@Zamzamin, Razali Haron and Anwar Hasan Abdullah Othman
This study investigates the impact of derivatives as risk management strategy on the value of Malaysian firms. This study also examines the interaction effect between derivatives…
Abstract
Purpose
This study investigates the impact of derivatives as risk management strategy on the value of Malaysian firms. This study also examines the interaction effect between derivatives and managerial ownership on firm value.
Design/methodology/approach
The study examines 200 nonfinancial firms engaged in derivatives for the period 2012–2017 using the generalized method of moments (GMM) to establish the influence of derivatives and managerial ownership on firm value. The study refers to two related theories (hedging theory and managerial aversion theory) to explain its findings. Firm value is measured using Tobin's Q with return on assets (ROA) and return on equity (ROE) as robustness checks.
Findings
The study found evidence on the positive influence of derivatives on firm value as proposed by the hedging theory. However, the study concludes that managers less hedge when they owned more shares based on the negative interaction between derivatives and managerial ownership on firm value. Hedging decision among managers in Malaysian firms therefore does not subscribe to the managerial aversion theory.
Research limitations/implications
This study focuses on the derivatives (foreign currency derivatives, interest rate derivatives and commodity derivatives) and managerial ownership that is deemed relevant and important to the Malaysian firms. Other forms of ownership such as state-/foreign owned and institutional ownership are not covered in this study.
Practical implications
This study has important implications to managers and investors. First is on the importance of risk management using derivatives to increase firm value, second, the influence of derivatives and managerial ownership on firm value and finally, the quality reporting on derivatives exposure by firms in line with the required accounting standard.
Originality/value
There is limited empirical evidence on the impact of derivatives on firm value as well as the influence of managerial ownership on hedging decisions of Malaysian firms. This study analyzes the influence of derivatives on firm value during the period in which reporting on derivatives in financial reports is made mandatory by the Malaysian regulator, hence avoiding data inaccuracy unlike the previous studies on Malaysia. This study therefore fills the gap in the literature in relation to the risk management strategies using derivatives in Malaysia.
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Xuan Shen and Valentina Hartarska
The purpose of this paper is to estimate the impact of financial derivatives on profitability in agricultural banks. Agricultural banks are new to the derivatives market and are…
Abstract
Purpose
The purpose of this paper is to estimate the impact of financial derivatives on profitability in agricultural banks. Agricultural banks are new to the derivatives market and are unlikely to use financial derivatives for risk speculation. Thus, the paper also provides evidence on the effectiveness of financial derivatives as a risk management tool in small commercial banks.
Design/methodology/approach
The authors use call report data from Federal Reserve Bank of Chicago for 2006, 2008 and 2010 to estimate an endogenous switching model to evaluate how profitability of derivatives user and non‐user agricultural banks is affected by different risk factors. This approach allows banks' endogenous choices to use financial derivatives to be accounted for, and to build a counterfactual analysis – what user banks' profitability would have been if they did not participate in the derivatives activities.
Findings
Results indicate that risk management through financial derivatives in agricultural banks is effective and profitability of derivatives user agricultural banks is less affected by credit risk and interest risk in the sample period. Derivatives' activities have improved agricultural banks' profitability and these impacts were increasing over years. In particular, in 2010 without use of derivatives, user banks would have had one‐third lower profitability.
Originality/value
This research is the first to study the role of derivatives in agricultural banks and also provides empirical evidence on the effectiveness of risk management through financial derivatives in agricultural banks.
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In response to the 2008 financial crisis, the European Union (EU) comprehensively restructured its derivative regulation. A key component of this new framework is a reporting…
Abstract
Purpose
In response to the 2008 financial crisis, the European Union (EU) comprehensively restructured its derivative regulation. A key component of this new framework is a reporting obligation for every derivative trade. As the reporting requirement does not involve public disclosure of the information, existing academic analysis on reporting regulations to-date, which focusses on public disclosure, is limited in predicting the effectiveness of the reform. This paper aims to assess whether the reform has been designed effectively based on the regulatory setup in the UK.
Design/methodology/approach
Framing the reporting regulation as a moral hazard problem with asymmetric information, this paper uses a game-theoretical approach to evaluate whether the new derivative reporting obligation effectively induces firm compliance. I also discuss potential extensions of the derivative reporting model, with particular emphasis on how the framework could account for heterogeneous firms and different regulatory tools.
Findings
Based on the theoretical analysis, this paper finds that while firms are unlikely to comply fully with derivative reporting requirements, it is possible to induce relatively high firm compliance. Although this does not mean we are immune from another financial crisis, the derivative reporting requirements should equip EU regulators to monitor a more transparent and secure derivatives market.
Originality/value
This paper provides a theoretical foundation for further study of post-crisis derivatives reforms. In particular, the implications of the model point to an empirical strategy to test the accuracy of the model.
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The aim of this paper is to study the impact of equity returns volatility of reference entities on credit‐default swap rates using a new dataset from the Japanese market.
Abstract
Purpose
The aim of this paper is to study the impact of equity returns volatility of reference entities on credit‐default swap rates using a new dataset from the Japanese market.
Design/methodology/approach
Using a copula approach, the paper models the different relationships that can exist in different ranges of behavior. It studies the bivariate distributions of credit‐default swap rates and equity return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula.
Findings
First, the paper emphasizes the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of equity returns volatility on credit‐default swap rates is higher for the lowest rating class. Second, the dependence structure is positive and asymmetric indicating that protection sellers ask for higher credit‐default swap returns to compensate the higher credit risk incurred by low rating class.
Practical implications
The paper has several practical implications that are of value for financial hedgers and engineers, loan market participants, financial regulators, government regulators, central banks, and risk managers.
Originality/value
The paper also illustrates the potential benefits of equity returns volatility of reference entities as a proxy of default risk. These simplifications could be lifted in future research on this theme.
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The purpose of this paper is to underline the (hidden) risks posed after the crisis by the exemption of non-financial operators, especially sovereigns, from the regulatory reforms…
Abstract
Purpose
The purpose of this paper is to underline the (hidden) risks posed after the crisis by the exemption of non-financial operators, especially sovereigns, from the regulatory reforms of over the counter (OTC) derivatives undertaken by G20 countries in the absence of accounting data on trading.
Design/methodology/approach
Recent financial regulatory improvements are reported to underline that the trading of OTC derivatives by sovereigns and local administrations does not take place under the new regulatory umbrella, because of the relative size of the institution, the lack of incentives to adhere to Centralized Counterparty Systems (CCPs) and most of all, the absence of proper accounting rules. Sovereigns and local administrations have the potential to undermine global financial stability.
Findings
The limited availability of accounting data on derivatives’ use by public administrations constitutes a barrier towards a full comprehension of risks involved. Sovereigns should be compelled to adhere to the CCPs and the collateralized system of trading; the short-term costs of adhering to CCPs are worth $20bn.
Research limitations/implications
The new regulatory system failed to explicitly consider the trading of sovereigns and this can reduce the effectiveness of regulation itself and can have negative impact on financial stability; in fact, omitting sovereigns from these regulations represent a significant risk oversight because they are systemically important players, although with a special political power.
Originality/value
Despite progress made in improving the transparency and resilience of OTC derivative markets after the subprime crisis, sovereigns and public administrations are exempted from the new regulation, posing severe risks to financial stability.
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Gordon Rausser, William Balson and Reid Stevens
Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper is to…
Abstract
Purpose
Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper is to outline the market microstructure necessary for such a clearing house.
Design/methodology/approach
The paper proposes using an request for quote platform with an active permissioning system that uses analytic approximations based on Monte Carlo simulation to estimate default risk and a two‐part pricing scheme to efficiently price that risk.
Findings
It is found that comprehensive clearing for complex and standardized derivatives is feasible using the clearing framework.
Research limitations/implications
This research is limited by the authors' ability to give empirical examples. The paper gives a short example with data, but given the constraints on length, cannot go into more detail.
Practical implications
This comprehensive clearing structure, in contrast to current proposed government regulations, will not drive out the “good” with the “bad” OTC derivative instruments.
Originality/value
This is the only paper the authors are aware of that outlines a detailed framework for clearing all OTC derivatives.
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Jonathan A. Batten and Niklas Wagner
In terms of notional value outstanding, derivatives markets declined in both over-the-counter and exchange-traded transactions during the 2007–2009 global financial crisis (GFC…
Abstract
In terms of notional value outstanding, derivatives markets declined in both over-the-counter and exchange-traded transactions during the 2007–2009 global financial crisis (GFC) period, as counterparty and credit concerns became pre-eminent. However, during the 2010–2011 second stage of the GFC, markets rebounded and by June 2011 outstandings reached new levels which highlight the importance these contracts continue to play in the day-to-day risk management and trading activities of corporations and financial intermediaries. The bulk of the contracts traded are interest rate-related instruments and are denominated in either US dollars or Euro. Credit-related instruments remain an important market segment, although outstandings remain at pre-crisis period levels. Of particular concern for regulators is the role of non-bank financial intermediaries, which are the main counterparty to derivatives transactions. While their share of the market remains unchanged over the last decade, outstandings overall have increased more than fourfold. The present volume considers the issues that participants face in today's derivatives markets including the potential impact of derivatives on economic stability, pricing issues, modelling as well as model performance and the application of derivatives for risk management and corporate control.
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