Rainer Jankowitsch

Parsimonious Estimation of Credit Spreads

A method for compensating sliding temperature influences on workpieces during a dimensional measurement process. For this purpose, the workpiece temperature and the relative position of the workpiece in relation to the measuring apparatus are recorded at the start and at the end of the actual measurement. By use of the recorded values, the temperature of the workpiece can be calculated at each instant of the dimensional measurement and the relative position of the workpiece in relation to the measuring apparatus and therefore the corrected scanning point can thus be determined. Thus, in the dimensional measurement of workpieces, while taking into account the temperature influences, the temperature straight line in the time interval from the start of measurement to the end of measurement is divided by intermediate measurements into part intervals, within which interpolation can be carried out. For a further improvement of these values, the instants of coordinate measurement are made to coincide with the instants of temperature measurement.

Validation of Credit Rating Systems Using Multi-Rater Information

We suggest a new framework for the use of multi-rater information in the validation of credit rating systems, applicable in any validation process where rating information from different sources is available. As our validation framework does not rely on historical default information it appears to be particularly useful in situations where such information is inaccessible. We focus on the degree of similarity or - more generally - proximity of rating outcomes stemming from different sources and show that it is important to analyze three major aspects of proximity: agreement, association, and rating bias. We suggest using a weighted version of Cohens kappa to measure the agreement between two rating systems and we introduce a new measure for rating bias. In contrast to the existing literature we suggest tau-x as a measure of association which is based on the Kemeny-Snell metric and, opposed to other measures, is consistent with a set of basic axioms and should therefore be used in the context of multi-rater information. We provide an illustrative empirical example using rating information stemming from the Austrian Credit Register on partially overlapping sets of customers of 27 banks. Using a multi-dimensional scaling technique in connection with a minimal spanning tree we show that it is possible to consistently detect outliers, i.e., banks with a low degree of similarity to other banks. The results indicate that banks which are less diversified across the size of their loans are more likely to be outliers than others.

Secondary Market Liquidity and Security Design: Theory and Evidence from ABS Markets

We develop and empirically test a theory of optimal security design under adverse selection accounting for strategic trading by uninformed investors who will liquidate a security in secondary markets only if their idiosyncratic carrying costs exceed the securitys expected trading loss. Such investors demand primary market discounts equaling expected carrying costs borne plus trading losses incurred. Issuers minimize the total illiquidity discount by splitting cash-flow into tranched debt claims with liquidity predicted to increase with seniority, while the optimal number of tranches increases with underlying cash-flow risk. Empirical tests confirm our model predictions. Received November 7, 2013; accepted November 14, 2015 by Editor Itay Goldstein.

Transparency and Liquidity in the Structured Product Market

We analyze liquidity effects in the US fixed-income securitized product market using a unique data-set compiled by the Financial Industry Regulatory Authority (FINRA), containing all transactions between May 16, 2011 and February 29, 2012. We employ a wide range of liquidity proxies proposed in the academic literature that rely on various information sets. Our results show that the average transaction cost of a round-trip trade is around 66 bp in the securitized product market and that liquidity is quite diverse in the different market segments. In particular, we find that securities that are mainly institutionally traded, issued by a federal authority, or with low credit risk, tend to be more liquid. In addition, we discuss the relation between the measurement of liquidity and the disclosure of information, and provide evidence that transaction cost measures computed at a more aggregate level may still be reasonable proxies for liquidity. This finding is important for all market participants, but particularly for regulators, who need to decide on the level of detail of the transaction data to be disseminated to the market. JEL-Classification: G12, G14

The Manipulation Potential of Libor and Euribor

The London Interbank Offered Rate (Libor) and the Euro Interbank Offered Rate (Euribor) are two key market benchmark interest rates used in a plethora of financial contracts with notional amounts running into the hundreds of trillions of dollars. The integrity of the rate-setting process for these benchmarks has been under intense scrutiny ever since the first reports of attempts to manipulate these rates surfaced in 2007. In this paper, we analyze Libor and Euribor rate submissions by the individual panel banks and shed light on the underlying manipulation potential, by quantifying their effects on the final rate set (the “fixing”). We explicitly take into account the possibility of collusion between several market participants. Our setup allows us to quantify such effects for the actual rate-setting process that is in place at present, and compare it to several alternative rate-setting procedures. We find that such alternative rate fixings, particularly methodologies that eliminate outliers based on the median of submitted rates and the time-series of past submissions, could significantly reduce the effect of manipulation. Furthermore, we discuss the role of the sample size and the particular questions asked of the panel banks, which are different for Libor and Euribor, and examine the need for a transactions database to validate individual submissions.The London Interbank Offered Rate (Libor) and the Euro Interbank Offered Rate (Euribor) are two key market benchmark interest rates used in a plethora of financial contracts with notional amounts running into the hundreds of trillions of dollars. The integrity of the rate-setting process for these benchmarks has been under intense scrutiny ever since the first reports of attempts to manipulate these rates surfaced in 2007. In this paper, we analyze Libor and Euribor rate submissions by the individual panel banks and shed light on the underlying manipulation incentives by quantifying their potential effects on the final rate set (the “fixing”). Furthermore, we explicitly take into account the possibility of collusion between several market participants. Our setup allows us to quantify such effects for the actual rate-setting process that is in place at present, and compare it to several alternative rate-setting procedures. We find that such alternative rate fixings, and larger sample sizes, could significantly reduce the effect of manipulation. Furthermore, we discuss the role of the particular questions asked of the panel banks, which are different for Libor and Euribor, and examine the need for a transaction database to validate individual submissions.

The New Rules of the Rating Game: Market Perception of Corporate Ratings

We analyze the impact of credit rating changes on the pricing and liquidity of US corporate bonds, focussing on whether the informativeness of rating events varies in different economic environments, particularly after the Dodd-Frank Act. We find that the informativeness of rating changes is low before the crisis, particularly for financial bonds. However, after Dodd-Frank, rating changes lead to significantly stronger market reactions for non-financial bonds, and to weaker ones for financial bonds, indicating ambiguous effects of the new regulation. We link these findings to differences in the cost of information acquisition and underlying credit risk across securities by testing various hypotheses based on existing models of rating agency behavior.

Benchmarking Credit Rating Systems

The validation of credit rating systems has recently attracted particular interest both from banks and their supervisors as well as from academic research. Whereas the main interest has been focused on backtesting methods, alternative approaches such as benchmarking are of growing importance. Benchmarking methods make use of available multi-rater information, i.e. rating assignments about identical obligors stemming from different rating sources. Employing a unique data set provided by the Austrian central bank with rating information on European corporate obligors by nine major Austrian banks, we conduct a benchmarking analysis based on the framework suggested by Hornik et al. (2005) on both market specific and bank specific levels. It turns out that overall similarity among rating systems is remarkably lower for foreign markets compared to the domestic market. Transition economies and markets with a generally low involvement of Austrian banks show particularly dissimilar results. Differences in the overall similarity of rating systems are partly explained by different performance of some individual rating systems in the domestic and foreign markets.

The Manipulation Potential of Libor and Euribor: The Manipulation Potential of Libor and Euribor

The London Interbank Offered Rate (Libor) and the Euro Interbank Offered Rate (Euribor) are two key benchmark interest rates used in a plethora of financial contracts. The integrity of the rate‐setting processes has been under intense scrutiny since 2007. We analyse Libor and Euribor submissions by the individual banks and shed light on the underlying manipulation potential for the actual and several alternative rate‐setting procedures. We find that such alternative fixings could significantly reduce the effect of manipulation. We also explore related issues such as the sample size and the particular questions asked of the banks in the rate‐setting process.

Choice of Rating Technology and Loan Pricing in Imperfect Credit Markets

Accurate rating systems are of central importance for banks to price and manage their loan portfolios. A bank’s choice to invest in a more accurate rating technology is based on a trade-off: the better rating system usually comes at higher cost, but endows the bank with a competitive advantage, which includes potentially better access to funds. This paper models the rating technology choice of a bank as a two-stage game in an oligopolistic banking sector. In the first stage banks choose between two alternative rating technologies that provide estimates about a borrower’s default probability with varying precision. In the second stage banks set their loan prices based on estimated default probabilities in an imperfectly competitive loan market. While rating technology investment is lumpy and characterized by fixed costs, loan prices vary continuously with their markup over the risk-free rate of interest. The interaction of loan pricing and rating technology investment gives rise to the following predictions: equilibrium adoption of the new rating technology need not increase individual banks’ profits; identical banks in a symmetric banking sector might adopt the more accurate rating technologies sequentially rather than simultaneously; and increased competition in the banking sector slows investment in the new rating technology.

Choice of Rating Technology and Price Formation in Imperfect Credit Markets

Accurate rating systems are of key importance for banks to price and manage their loan portfolios. In this paper we analyze the choice of the rating technology in an oligopolistic banking sector. In our model the rating system estimates the probabilities of default for the individual borrowers and therefore provides important input for the pricing of the loans. We model the technology choice and the pricing as a two-stage game. In the first stage banks choose the rating technology and in the second stage banks choose their pricing policy given the imperfect (oligopolistic) market using a risk-based pricing approach. The presented probabilistic framework and the modeling of the technology choice is novel in the banking literature and can provide important insights. In a comparative static analysis we study the implications for a market with two banks, which can employ two different rating systems (low or high accuracy). We find that in equilibrium the rating technology choice critically depends on the cost structure. If the additional costs for the high accuracy system are large both banks will have no incentive to adopt this technology. If the additional costs are low equilibrium behavior of banks results in the implementation of the accurate technology. In this case credit spreads unambiguously decrease and credit volume increases. The use of the more accurate technology, however, does not necessarily result in higher profits for the banks. Only if the costs are sufficiently small the equilibrium behavior results in a Pareto improvement. This has important implications for banking regulation which aims to provide incentives to use high accuracy rating systems (e.g. Basel II regulation).