Alessandro Carboni

The Sovereign Credit Default Swap Market: Price Discovery, Volumes and Links with Banks' Risk Premia

This paper looks into the sovereign credit default swap (CDS) market from two perspectives. First, it analyses the relation between CDS and bond spreads. The results on a single-entity basis suggest that the CDS market leads the bond market in price discovery, especially during 2010, while both markets contribute during the pre-Lehman period and in 2009. Moreover, the inclusion of the EURIBOR-EUREPO 3-month spread helps to restore the long-run relation after the Lehman bailout. An event-study, which compares the reaction of sovereign CDS and bond markets to policy announcements in Europe, suggests that both markets react in the same way, especially after the release of bad news. As for the relation between prices and volumes of sovereign CDSs, estimates do not point to any stable relation. The second perspective is the relation between CDS spreads for sovereign and corporate entities. Our estimates on an aggregate and sector-wide basis point to a leading property of the former sector, even in 2009, while the banking sector increases its leading power during 2010.

From Taylor Rule to Money - Traditional and Unconventional Monetary Policies in the First Years of the Financial Crisis: Evidence from the United Kingdom, the USA and Europe

This work examines the role of the Federal Reserve, the Bank of England and the European Central Bank in managing traditional and unconventional tools of monetary policy especially during the first years of the financial crisis. For the traditional approach we estimate a Taylor-type reaction function, while we concentrate on the transmission mechanism by estimating a VAR system for the period January 1999 – September 2009. After describing the initial unconventional policies adopted, we concentrate on the impact on interest rates in two ways: we estimate a Nelson-Siegel (1987) term structure of interest rates and then we test for the link between Central Banks’ statements and ten-year Government bond yields. For the traditional measures, results confirm the respect of the Taylor principle, while the long-run analysis demonstrates a weakening of the interest rate channel. During financial crisis, the impact on interest rates suggests an increase in the uncertainty related to the medium-term representative curvature factor. Moreover if we look at longer term interest rates, we can see that sharp reductions are associated with specific statements’ date. Even if these statements produced desirable effects in the reduction of longer term interest rates, these ones are only temporary, as demonstrated by quasi-immediate upswings in the subsequent days.

Provisioning and Non-Performing Exposures During the Financial Crisis: Are Italian Banks Special?

Using a sample of 500 Italian banks over the period 2007 - 2014, our paper provides evidence on the hypothesis behind the management of credit risk provisions and non-performing exposures for the entire banking system and for different types of banks, clustered on dimension. We also study on the behavior of riskier banks and offer an interpretation of higher provisions during recent episodes of unconventional monetary measures. We summarize our main results in these points. First, provisions of Italian banks support the earnings management and the capital management hypothesis, reflecting their procyclicality. Second, the evidence shows that banks with different dimensions do not have the same response to selected determinants. In particular, macroeconomic variables affect provisioning only for medium and large banks, the capital management hypothesis holds for cooperative and small banks, while the earnings management is not validated for large banks. Third, non-performing loans are highly persistent for cooperative and small banks, while the hypothesis regarding efficiency, profitability and risk-taking are confirmed in relation to non-performing loans. Fourth, we also observe that banks with weaknesses in credit risk practices have insufficient provisions and therefore need more non-discretionary income to enlarge their coverage capacity. They also violate the capital management hypothesis. Finally, results show increased sensitivity of provisions to earnings in 2011 - 2013, due to unconventional measures.

An Analysis of Italian Bad Loans: Determinants, Forecasts and Transmission to the Real Economy

Since 2009 conditions in Italian credit market have been experiencing a dramatic worsening, reflecting the two most severe recessions since the Great Depression. Probability of default for non financial firms has reached unexpected values, while deterioration in credit portfolios has spread. This paper studies bad loans for Italian non financial firms during the last twenty years. We propose different linear and non-linear methodologies focusing on short and long-term determinants, forecasting properties and dynamic responses. Our empirical results suggest that macroeconomic and financial, but also, specified lenders and borrowers variables affect bad loans. Linear and non-linear models augmented with financial variables and asset prices produce better out-of-sample forecasts. A dynamic response analysis shows that default rates move with a cyclical pattern, falling after a positive shock in macroeconomic and financial variables. Moreover, a positive shock in bank credit or in default rate does not produce a clear feedback effect from credit to the real economy. In a non-linear framework, this happens only when the default rate is above a critical value, suggesting a possible breakdown in the transmission of credit to the real economy when credit quality is weak.

European Liquidity: What Matters Most? A Factor Model Analysis

We study European liquidity by extracting factors from a dataset of macroeconomic and financial variables for 26 countries. Liquidity is driven by three factors, called monetary policy, credit supply and credit demand obtained from rotated factors, after imposing theoretical restrictions. Liquidity is also determined by using banking variables. Our three findings are: monetary policy is the main driver for liquidity, even if European liquidity is not determined by only one factor. The first liquidity factor from banking could be used as banking sentiment indicator. Finally, the focus of the monetary policy of the ECB has switched from macroeconomic to financial sector since the beginning of the financial crisis.

An Empirical Investigation of Emerging Markets: What Does the Dynamics of Credit Risk Tell Us?

This paper looks into credit risk markets for Emerging economies. It analyzes the relation between credit default swap (CDS) and bond spreads in the post Lehman Brothers period by focusing on both short and long run relations. Equity and cost of funding are also considered in the study. On the one hand, the CDS market is able to forecast the bond market in 11 cases out of 15, while equity is a useful predictor of the CDS market in 8 cases out of 15. Evidence of a bidirectional relation holds for Asian countries. On the other, the CDS market moves ahead of the bond market and is the leader in terms of price discovery of credit risk. Adding equity and cost of funding to our VECM does improve the number of cases where cointegration holds, but does not change the price discovery results.

The Euro Area Yield Curve: An Analysis with Nelson-Siegel Type Models

We present Nelson-Siegel-type yield curves for the Euro Area, by studying the in-sample fit and the out-of sample forecasting properties. Moreover, we add macro variables (output gap, EONIA and HICP or alternatively Eurocoin) to estimate the interactions with yield curve factors (level, slope and curvature), following the rationale of Diebold et al (2006). We use a two step procedure as in Diebold and Li (2006) and we find three interesting results. The Svensson model has better in-sample fit properties with respect to the Nelson-Siegel model. There exist interactions among both the level and the curvature with macroeconomic variables, while on the other hand, the slope interacts with all macroeconomic variables. The addiction of a business cycle indicator like Eurocoin gives better results with respect to both yields-only and alterative yields-macro models, confirming the success of parsimonious models for out-of sample forecasting.

Exploring the Empirical Properties Among Different Credit Risk Indicators for EMU Corporate Index

This paper analyses the dynamic properties among different credit risk indicators, by using credit default swap (CDS) spreads, asset swap spread (ASWPS) and the option adjusted spread (OAS) for a sample of firms from the EMU Corporate index of Merrill Lynch, during both pre and post Lehman Brothers bailout. We find that credit risk indicators price equally in the long run for the first part of the sample, while the linkage is less robust for the second. Moreover we show that the estimated no-arbitrage relations differ from those suggested by the theory, reflecting other elements than credit risk into prices. In the short run, the dynamic relation suggest a two-way linkage among different markets for credit risk. Results from long term dynamic analysis suggest that both CDS and ASWPS contribute equally to price discovery, while OAS market moves ahead of the derivative market for the pre-Lehman period, especially for European firms. On the other hand, CDS market is the main forum for credit risk after Lehman bailout, irrespective of geographical areas.

Do Asset Price Developments Matter? Evidence for the United States and the Euro Area

There is an open debate about the role of asset prices in the conduct of monetary policy. The current crises and the burst of housing bubble give occasion to revisit this question. We present Generalized Method of Moments (GMM) estimates of the Taylor rule by using its classic version (Taylor, 1993), together with an augmented one with a proxy for asset price developments. We use data spanning from 1999:01 to 2009:06, for the United States and the Euro Area. Our estimations suggest three important results. The Taylor principle is respected when we estimate Taylor rules with output gap and inflation. The Fed seems react to developments in the financial sector, while there is no response to stock price movements by the ECB. Finally, Fed’s response to an asset price boom varies from 100 to 300 basis points, indicating a striking reaction against asset price developments.