Oliver Entrop

The performance of investment grade corporate bond funds: evidence from the European market

This paper examines the risk-adjusted performance of mutual funds offered in Germany which exclusively invest in the ‘rather new’ capital market segment of euro-denominated investment grade corporate bonds. The funds are evaluated employing a single-index model and several multi-index and asset-class-factor models. In contrast to earlier studies dealing with (government) bond funds, we account for the specific risk and return characteristics of investment grade corporate bonds and use both rating-based indices and maturity-based indices, respectively, in our multi-factor models. In line with earlier studies, we find evidence that corporate bond funds, on average, under-perform the benchmark portfolios. Moreover, there is not a single fund exhibiting a significantly positive performance. These results are robust to the different models. Finally, we examine the driving factors behind fund performance. As well as examining the influence of several fund characteristics, particularly fund age, asset value under management and management fee, we investigate the impact of investment style on the funds’ risk-adjusted performance. We find indications that funds showing lower exposure to BBB-rated bonds, older funds, and funds charging lower fees attain higher risk-adjusted performance.

Quantifying the Interest Rate Risk of Banks: Assumptions Do Matter

This paper analyses the robustness of the standardised framework proposed by the Basel Committee on Banking Supervision (2004b) to quantify the interest rate risk of banks. We generalise this framework and study the change in the estimated level of interest rate risk if the strict assumptions of the standardised framework are violated. Using data on the German universal banking system, we find that estimates of the interest rate risk are very sensitive to the frameworks assumptions. We conclude that the results obtained using the standardised framework in its current specification should be treated with caution when used for supervisory and risk management purposes.

Estimating the Interest Rate Risk of Banks Using Time Series of Accounting-Based Data

This paper proposes a new method of estimating the interest rate risk of banks from the perspective of bank outsiders. The key innovation is the inclusion of time series of accounting-based data instead of using only the latest available reports to estimate the maturity structure of banks. Using regulatory accounting-based data, we estimate the model for more than 1,000 German universal banks and compare the results with a unique data set of bank-internal quantified interest rate risk. We find evidence that our model yields a significantly better fit of banks’ internally quantified interest rate risk than standard approaches that rely on one-point-in-time data.

Fristentransformation als Lösungsansatz für das Ertragsproblem von Banken

„Um unsere angespannte Ertragssituation auf Grund des Strukturwandels im Bankgewerbe in den Griff zu bekommen, mussen wir mehr denn je die Ertrags-potenziale der Fristentransforrnation ausschopfen.“ — So oder so ahnlich lauten haufig geauserte Statements des Managements vieler Kreditinstitute. Ungeachtet der verbundenen Messproblematik stellt der Ergebnisbeitrag aus der Fristentrans-formation bisher einen nicht unwesentlichen Teil des Gesamtergebnisses vieler Banken dar. Die zentrale Frage dieses Beitrags ist daher, ob und inwieweit eine Ausweitung der Fristentransforrnation zumindest einen Teil des Ertragsproblems der Banken losen kann. Oder sollten Banken kunftig gar auf die Fristentransformation verzichten?

Performance Measurement for Option Portfolios in a Stochastic Volatility Framework

Measuring the performance of stock portfolios that include options is challenging due to options’ nonlinearity in the underlying and their exposure to volatility risk. Our contribution to the literature is twofold: First, we provide a theoretically rigorous derivation of the time-variable factor loadings in a multi-factor model under stochastic volatility according to Heston (1993) when an option factor is included. We show that (i) any option factor is suitable if discrete returns are considered in instantaneous time and that (ii) the option factor’s loading equals the fraction of the volatility elasticities of the portfolio and of the option factor while the option factor’s underlying elasticity enters the factor loading of the underlying. Second, in applications however, time has to be discretized and factor loadings are usually estimated in a single regression over a certain time horizon, which regularly leads to a bias in performance measurement. We run a simulation analysis to analyze the size of this bias when different option factors from the common literature are used and propose a two-step procedure to keep the bias small.

'Exchange Rate Risk' within the European Monetary Union? Analyzing the Exchange Rate Exposure of German Firms

In this paper we show that inflation differentials among the countries in the European Monetary Union (EMU) are an economically significant risk to German firms, which make up the largest economy in the EMU. This risk can be interpreted as real “exchange rate exposure” resulting from trade within the euro area. Actually, we find that this EMU exposure is nearly as high as the standard exchange rate exposure caused by trade with non-EMU countries. Moreover, our analysis shows that many of the conventional factors that drive firm-specific exchange rate risk, such as size, debt ratio, asset turnover and foreign business activity, also determine EMU exposure in an economically meaningful way. However, EMU exposure challenges firms’ risk management, particularly as it cannot be reduced by standard financial hedging instruments such as currency derivatives.

Spread Risk Premia in Corporate Credit Default Swap Markets

The spread risk premium component of credit default swap (CDS) spreads represents a compensation demanded by protection sellers for future changes in CDS spreads caused by unpredictable fluctuations in the reference entity’s risk-neutral default intensity. This paper defines and estimates a measure of the spread risk premium component in CDS spreads of a sample of European investment-grade firms by using a stochastic intensity credit model. Our results show that, on average, investors demand a positive premium for such mark-tomarket risks. After controlling for CDS market conditions, like liquidity and supply/demand effects, a panel data analysis of the estimated spread risk premia reveals a positive impact of event risk captured by the overall stock market volatility and a negative impact of investors’ appetite for exposure to credit markets as reflected by the overall CDS market.

The Pricing Policy of Banks for Exchange-Traded Leverage Certificates: Interday and Intraday Effects

This paper analyzes the pricing policy of banks for retail exchange-traded leverage certificates. Based on a unique trade data set, we analyze the order flow induced by the investors and compare traded prices with corresponding theoretical fair product values. Our major results are: (i) Intraday effect: Traded leverage certificates are overpriced but the overpricing strongly depends on the time of day the trade is made. At the end of the underlying’s daily trading hours, issuers increase the prices. (ii) Interday effect: The overpricing decreases over the certificate’s lifetime. (iii) The intraday (interday) effect is more pronounced the more (less) likely a premature knock-out of the certificate is. (iv) Both effects are consistent with the investors’ order flow and the gap risk faced by issuers. Banks try to exploit systematic trading patterns of investors to increase their profits.

Non-maturing Deposits, Convexity and Timing Adjustments

One key driver of a bank’s total interest rate risk is the position of non-maturing deposits. Several papers such as [6], [8], and [7] value non-maturing deposits in an arbitrage-free framework and analyze their risk profile. All these models consist of three major components: first, the short rate process, i.e. the dynamics of the default-free interest rate term structure; second, the interest rate pass-through, i.e. the link between the development of the deposit rates and the development of default-free interest rates, in general the short rate; third, the development of the deposit volume over time. In this paper, we concentrate on the interest rate pass-through. We provide some term structure model-free results on the valuation of deposits, when the deposit rates are linearly linked to some long-term swap rate (rather than a short-term interest rate) as the reference rate with an unnatural time lag.

A New Methodology to Derive a Bank’s Maturity Structure Using Accounting-Based Time Series Information

While over the past few years both banking supervisors and researchers have focussed their attention on banks’ credit risk, the spotlight is now being turned again on interest rate risk. One reason for this is its character as a kind of systemic risk: there is evidence that a rise in interest rates affects most banks negatively. An historical example of a banking crisis caused by high interest rates is the ‘Savings and Loan Crisis’ which occurred in the USA during the 1980s.3 Between 1980 and 1988, 563 of the approximately 4,000 savings and loan institutions failed, while further failures were prevented by 333 supervisory mergers. The total costs of the crisis are estimated at USD160 billion. Recently, the Basel Committee on Banking Supervision published principles for the management and supervision of interest rate risk that go far beyond current practice.4 However, few data are available concerning banks’ interest rate risk exposure.