Table of Contents

Estimation of Value-at-Risk with Minimal Specification Error

Kian Guan Lim, Singapore Management University
Hao Cheng, Singapore Management University
Nelson Yap, Singapore Management University

Basel III Leverage Ratio Requirement and the Probability of Bank Runs

Jean Dermine, INSEAD - Finance

The Real Effects of a Manufactured Crisis: Money Market Funds and the Summer of 2011

Sean Collins, Investment Company Institute - Research
Emily Gallagher, Paris School of Economics (PSE), University of Paris 1 Pantheon-Sorbonne

What's the Value of a TBTF Guaranty? Evidence from the G-SII Designation for Insurance Companies

Kathryn L. Dewenter, University of Washington - Michael G. Foster School of Business
Leigh A. Riddick, American University - Kogod School of Business

Banks’ Non-Traditional Activities Under Regulatory Changes: Impact on Risk, Performance and Capital Adequacy

Alaa Guidara, Laval University
Jean-Pierre Gueyie, University of Quebec in Montreal-Department of Finance
Van Son Lai, Universite Laval
Issouf Soumaré, Laval University

Systemic Risk Oversight and the Shifting Balance of State and Federal Authority Over Insurance

Patricia A. McCoy, Boston College Law School

Reporting Regulatory Environments and Earnings Management: U.S. and Non-U.S. Firms Using U.S. GAAP or IFRS

Mark E. Evans, Wake Forest University
Richard W. Houston, University of Alabama
Michael F. Peters, University of Maryland
Jamie H. Pratt, Indiana University - Kelley School of Business - Department of Accounting


REGULATION OF FINANCIAL INSTITUTIONS eJOURNAL

"Estimation of Value-at-Risk with Minimal Specification Error" Free Download

KIAN GUAN LIM, Singapore Management University
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HAO CHENG, Singapore Management University
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NELSON YAP, Singapore Management University
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In this paper we provide a new statistical approach to estimate VaR with minimal specification error. In our approach we use current market information obtained from traded options to infer risk-neutral moments of the underlying asset returns over different horizons. For each horizon, the moments are fitted to a general 4-moment Variance Gamma risk-neutral probability distribution of future market prices. We also compute a Radon-Nikodym derivative and its probability distribution, and use this to transform the risk-neutral distribution of the underlying to its empirical distribution. The empirical distribution is then used to find the VaR. The novelty of our approach is that it avoids unnecessary mis-specification bias as we do not need to assume a particular empirical distribution of the underlying asset returns. As option prices trade frequently, the risk-neutral distribution can be updated frequently for transformation into the empirical distribution. This provides for timely updating of the VaR measures. The fitted risk-neutral Variance Gamma distribution is popular in finance due to its ability to model heavy tails and skewness. Our key contributions are in providing an alternative new approach to modeling VaR, and also in showing that underestimation of risk is largely not due to VaR itself but perhaps due to mis-specification errors which we minimize in our approach. We show that our method of measuring VaR clearly captures large tail risk in the empirical examples on S&P 500 index.

"Basel III Leverage Ratio Requirement and the Probability of Bank Runs" Free Download
Journal of Banking and Finance, Forthcoming

JEAN DERMINE, INSEAD - Finance
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A new argument for the Basel III leverage ratio requirement is proposed: the need to limit the risk of a bank run when there is imperfect information on the value of a bank’s assets. In addition to screening and monitoring borrowers, banks provide liquidity insurance with the supply of short-term deposits withdrawable on demand. The maturity mismatch creates the risk of a disorderly bank run which can be exacerbated by imperfect information about the value of bank assets. It is shown in a stylized Basel III framework that capital regulation should incorporate a liquidity risk component. Credit risk diversification and/or a reduced probability of loan default which lead to a reduction of Basel III regulatory capital will increase the probability of a bank run. The leverage ratio rule puts a floor on the Basel III risk-weighed capital ratio, allowing the limitation of such a risk.

"The Real Effects of a Manufactured Crisis: Money Market Funds and the Summer of 2011" Free Download
Midwest Finance Association Annual Meeting Paper, 2015

SEAN COLLINS, Investment Company Institute - Research
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EMILY GALLAGHER, Paris School of Economics (PSE), University of Paris 1 Pantheon-Sorbonne
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In the summer of 2011, U.S. prime money market funds (MMFs) significantly reduced their investments in short-term securities issued by eurozone banks. The summer also saw a drop in MMF assets. Some have attributed outflows from prime MMFs over the summer of 2011 to the eurozone crisis and, in particular, to prime funds’ investments in French banks exposed to Greek debt. This paper reexamines the evidence and finds more nuance in the factors influencing outflows. Our results indicate that the U.S. debt ceiling impasse was, arguably, the more important contributor to outflow over the summer of 2011. This may have public policy implications. Recurring debt ceiling crises could entail periods of abnormal outflows from prime and government MMFs, with their severity dependent on market perceptions of the probability and cost of a U.S. default.

"What's the Value of a TBTF Guaranty? Evidence from the G-SII Designation for Insurance Companies" Free Download

KATHRYN L. DEWENTER, University of Washington - Michael G. Foster School of Business
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LEIGH A. RIDDICK, American University - Kogod School of Business
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In July 2013, the Financial Stability Board classified nine global insurance firms as Global Systemically Important Insurers (G-SII). From the AIG bailout in 2008 through this announcement, we document average abnormal stock returns of 11.7% for these firms. These equity gains are not associated with drops in expected default probabilities, but are associated with an increase in expected asset risk and a loss to creditors. Over the same event window, the stock prices, CDS spreads, options and bond prices for other large insurance firms show no significant changes on average. Abnormal price responses for both sets of firms show significant cross correlations with measures of firm risk and with country-level measures of regulatory quality.

"Banks’ Non-Traditional Activities Under Regulatory Changes: Impact on Risk, Performance and Capital Adequacy" Free Download

ALAA GUIDARA, Laval University
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JEAN-PIERRE GUEYIE, University of Quebec in Montreal-Department of Finance
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VAN SON LAI, Universite Laval
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ISSOUF SOUMARÉ, Laval University
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Using the big six Canadian chartered banks quarterly financial statements and daily stock market data from 1982 to 2010, we examine the impact of non-interest income on Canadian banks’ risk, performance and capital under the different major regulatory changes made to the Bank Act of Canada. We document a significant increasing trend in non-interest income with a substitution effect between non-interest income and net interest margin following the 1987 amendment to the Bank Act allowing commercial banks to acquire (or merge with) investment dealers and brokerage firms. Our results show that Canadian banks’ expansion into non-traditional activities had resulted into decreased risk and increased performance benefitting from income diversification. Moreover, while adhering to capital adequacy regulation, reshuffling banks’ portfolio towards non-traditional activities did not reduce Canadian banks’ capital ratio, buttressing the effectiveness of capital adequacy regulation in Canada in linking banks capital allocation with their risk taking in spite of the re-regulation towards universal banking.

"Systemic Risk Oversight and the Shifting Balance of State and Federal Authority Over Insurance" Free Download
U.C. Irvine Law Review (2015 Forthcoming)

PATRICIA A. MCCOY, Boston College Law School
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The state-based model of U.S. insurance regulation has been remarkably enduring to date, in part because the traditional rationales for a greater federal role – efficiency, uniformity, and consumer protection – have not succeeded in displacing it. However, the 2008 financial crisis, the federal government’s unprecedented bailouts of parts of the insurance sector, and the need for a coordinated international approach radically shifted the debate about the proper allocation of power between the federal government and the states by supplanting traditional concerns about efficiency, uniformity, and consumer protection in insurance with a new federal mission to control systemic risk. Unprepared and ill-equipped to counter this shift, the states face the biggest threat to their domination of U.S. insurance regulation in years.

Already, the federal government has made inroads into insurance regulation for purposes of systemic risk oversight. That federal presence creates several openings for a broader federal role in insurance than just regulation of systemically important insurers. For instance, solvency regulation, which traditionally has been reserved to the states, increasingly could be subsumed under the rubric of systemic risk. Over time, other types of federal incursions could include higher reporting requirements for insurers, regulation of discrete, systemically risky activities (regardless of an insurer’s size), oversight of captive reinsurers, and greater consolidated supervision of insurance groups.

"Reporting Regulatory Environments and Earnings Management: U.S. and Non-U.S. Firms Using U.S. GAAP or IFRS" 
Accounting Review, Forthcoming
Kelley School of Business Research Paper No. 15-12

MARK E. EVANS, Wake Forest University
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RICHARD W. HOUSTON, University of Alabama
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MICHAEL F. PETERS, University of Maryland
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JAMIE H. PRATT, Indiana University - Kelley School of Business - Department of Accounting
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Based on data collected from 616 experienced financial officers who use U.S. GAAP or IFRS and are domiciled in the U.S., Europe, or Asia, we examine how reporting standards (U.S. GAAP vs. IFRS) and domicile (U.S. vs. non-U.S.) affect earnings management (real vs. accrual). U.S. firms using U.S. GAAP rely more heavily on real methods than non-U.S. firms that use either IFRS or U.S. GAAP, and U.S. firms using IFRS. U.S. firms using U.S. GAAP operate in an environment that encourages real over accruals methods; specifically, U.S. GAAP facilitates detection of earnings management and enforcement is more effective in the U.S. Further, the likelihood and amount of earnings management does not differ across conditions, suggesting that firms using less accruals earnings management tend to fully compensate by increasing real methods. So, stronger reporting environments do not necessarily reduce total earnings management, but instead encourage substitution of real for accruals methods.

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This eJournal distributes working and accepted paper abstracts covering regulatory and legal aspects of national and international financial institutions. The eJournal welcomes research that deals with legal aspects of depository institutions including banks, credit unions, trust companies, and mortgage loan companies. Topics also include regulation of insurance companies, brokers, underwriters, and investment funds.

Editors: G. William Schwert, University of Rochester, and Rene M. Stulz, Ohio State University (OSU)

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BANKING & FINANCIAL INSTITUTIONS EJOURNALS

MICHAEL C. JENSEN
Social Science Electronic Publishing (SSEP), Inc., Harvard Business School, National Bureau of Economic Research (NBER), European Corporate Governance Institute (ECGI)
Email: michael_jensen@ssrn.com

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Advisory Board

Regulation of Financial Institutions eJournal

EDWARD I. ALTMAN
Max L. Heine Professor of Finance and Vice Director, New York University (NYU) - Salomon Center, Max L. Heine Professor of Finance, New York University (NYU) - Department of Finance

DENNIS R. CAPOZZA
Professor of Finance and Dykema Professor of Business Administration, University of Michigan, Stephen M. Ross School of Business

DONALD CHEW
Morgan Stanley Investment Management

JOHN DAVID CUMMINS
Joseph E. Boettner Professor, Temple University - Risk Management & Insurance & Actuarial Science, Harry J. Loman Professor Emeritus, University of Pennsylvania - Insurance & Risk Management Department

DOUGLAS W. DIAMOND
Merton H. Miller Distinguished Service Professor of Finance, University of Chicago - Booth School of Business, National Bureau of Economic Research (NBER)

EUGENE F. FAMA
Robert R. McCormick Distinguished Service Professor of Finance, University of Chicago - Finance

STEPHEN FIGLEWSKI
Professor of Finance, New York University - Stern School of Business

STUART I. GREENBAUM
Bank of America Professor of Managerial Leadership, Washington University in St. Louis - Olin Business School

MICHAEL C. JENSEN
Co-Founder, Chairman, Managing Director and Integrity Officer, Social Science Electronic Publishing (SSEP), Inc., Jesse Isidor Straus Professor of Business Administration, Emeritus, Harvard Business School, Research Associate, National Bureau of Economic Research (NBER), Fellow, European Corporate Governance Institute (ECGI)

JONATHAN M. KARPOFF
Washington Mutual Endowed Chair in Innovation Professor of Finance, University of Washington - Michael G. Foster School of Business

KENNETH LEHN
Professor of Business Administration, University of Pittsburgh - Finance Group

STANLEY R. PLISKA
University of Illinois at Chicago - Department of Finance

CHARLES I. PLOSSER
President, Federal Reserve Bank of Philadelphia, National Bureau of Economic Research (NBER)

KATHERINE SCHIPPER
Duke University - Fuqua School of Business

ALAN SCHWARTZ
Sterling Professor of Law, Yale Law School

G. WILLIAM SCHWERT
Distinguished University Professor of Finance and Statistics, University of Rochester - Simon Business School, National Bureau of Economic Research (NBER)

RENE M. STULZ
Everett D. Reese Chair of Banking and Monetary Economics, Ohio State University (OSU) - Department of Finance, National Bureau of Economic Research (NBER), Fellow, European Corporate Governance Institute (ECGI)

ROSS L. WATTS
Erwin H. Schell Professor of Management, Massachusetts Institute of Technology (MIT) - Sloan School of Management