ANDREA CESARE RESTI
Projects / working papers
Do Investors care about Credit Ratings? An Analysis through the Cycle
Joint with Giuliano Iannotta and Giacomo Nocera
Paper presented at the 2010 FMA Academic Meeting Las Vegas
Status: submitted Journal of Money Credit and Banking - download paper here
In this paper we analyze the effects on bond pricing of changes in market opaqueness and in the information content of ratings. The idea is simple: if the information content of ratings is poorer, bond investors should invest more in additional information, hence ratings and any other easy-to-observe issue characteristics should lose the ability to explain bond credit spreads.
Using a simple model of the credit assessment process under uncertainty, we verify that the incentive to invest in additional information becomes stronger when the information content of ratings is poorer. The impact of ratings on bond spreads across the credit cycle is then empirically investigated. The data are from Dealogic DCM Analytics, which reports information on issuers (nationality, industry, etc.) and issues (spread at issuance, Moody’s, S&P and Fitch ratings, maturity, size, currency, etc.). We find that unexplained dispersion increases for bonds issued during phases of market turmoil, supporting the hypothesis that investors collect and impound additional information into spreads as a consequence of higher market-wide uncertainty.
Investigating Price Determinants of Structured Finance Issues at Launch: Evidence from the European Market
Joint with Barbara Mento
Status: first draft ready
The aim of this paper is to empirically investigate the determinants of primary market spreads in European structured finance securities over the 1999-2008 period. In particular, using the reduced-form multiplicative heteroskedastic regression model suggested by Harvey, the analysis has been conducted on two separate equations, with the aim of testing both the spread level and its precision.
Empirical evidence demonstrates the crucial importance of credit ratings as major pricing factors for structured finance transactions at launch. However, it shows the consistent significance of some deal- and tranche- specific characteristics in affecting not only the level of launch spreads but also their unexplained dispersion. This suggests that the degree of accuracy of a ratings-based pricing model and the ability of investors to price hidden information varies across different types of securitizations.
Do news decrease or increase market uncertainty? The case of the banking sector in 2005-2008
Joint with Mascia Bedendo
Status: database ready
Our project analyses a vast sample of news releases concerning the world’s top 100 banks by total assets over the period 2005-2008 (which includes both a quiet subperiod and the hectic market environment of late 2007 and 2008). We assess the impact of market-wide and idiosyncratic news on various measures of firm-specific uncertainty such as stock volatility, dispersions in analysts’ forecasts, stock liquidity. In particular, we aim at investigating under what circumstances news which are expected to increase the degree of transparency on banks’ activities and future performance in fact lead to a reduction in the idiosyncratic uncertainty. We test the extent of this impact both in good times and in times of market stress, when we expect new information to be more valuable.
Our sample includes the top 100 banks in Western Europe, North America and Japan by total assets as of year-end 2007. News releases are collected from a number of sources (including e.g. the Dow Jones Newswire, Reuters News, the Financial Times) through the Factiva database.
Bank interconnectedness and systemic risk
Joint with Andrea Sironi
Status: validating database and running preliminary regressions
This research project is divided in two parts. In the first part, we estimate a measure of bank interconnectedness - based on the above mentioned financial statement ratios - aimed at capturing the degree of interconnectedness of one bank with the other financial institutions. We do this for a sample of large banks both from USA and Europe. We plan to use data from the Bankscope database and from quarterly and annual individual financial statements.
In the second part, we study the relationship between an individual bank degree of interconnectedness, as measured by its degree of interdependence to other banks (interbank deposits, OTC derivatives trading, etc.), and the market price of its debt capital, as proxied by the credit default swap (CDS) spread. We also empirically investigate if this relationship has changed before and after the start of the recent financial crisis. We plan to run multivariate regressions (panel) where the CDS spread of individual banks is regressed against the degree of entangleness of each one of them and a number of control variables such a capital (tier 1 and total capital ratio), asset risk (loan loss provisions over total assets, asset volatility), size (log of total assets), profitability (average return on assets).
The quality of Tier 1 Capital for large European banks and the impact of the Basel 3 regulations
Joint with Giuliano Iannotta
Status: data base ready, first draft to be publicly presented in October 2010
During the last 20 years banks have increasingly resorted to hybrid or innovative capital instruments, that is, to funding instruments which lie in-between equity capital and debt (e.g., they have no voting rights and entail a fixed coupon, like bonds, but interest payments may deferred or cancelled, depending on the bank’s current profits, and even the principal may be slashed against losses on a going concern basis). However, hybrid and innovative capital instruments were plagued by an intrinsic ambiguity: while regulators were willing to consider them as capital (although within some quantitative limits), investors were confident that banks would in the end treat them as plain debt, and would refrain to avoid reputational costs and future squeezes on funding.
The Basel Committee is currently envisaging a new regulation on hybrid instruments to curb down excesses and ensure that an adequate share of a bank’s capital consists of plain vanilla common equity. In short, it will be considerably more difficult for banks to resort to hybrid or innovative instruments.
In light of the above , our research project aims at compiling a map of the innovative capital instruments used by European banks throughout the last 10-15 years, highlighting the most common characteristics and clauses and at assessing the impact of the new regulations on the availability and cost of bank capital. To this aim, we have set up a unique database, covering the first 25 European banking groups and including details on all hybrid and innovative capital instruments. The paper will also include a limited number of case studies on innovative capital instruments recently issued in the banking industry (including contingent liabilities) and the effects (both intended and unintended) they may have on future bank stability.
Joint with Giuliano Iannotta and Giacomo Nocera
Paper presented at the 2010 FMA Academic Meeting Las Vegas
Status: submitted Journal of Money Credit and Banking - download paper here
In this paper we analyze the effects on bond pricing of changes in market opaqueness and in the information content of ratings. The idea is simple: if the information content of ratings is poorer, bond investors should invest more in additional information, hence ratings and any other easy-to-observe issue characteristics should lose the ability to explain bond credit spreads.
Using a simple model of the credit assessment process under uncertainty, we verify that the incentive to invest in additional information becomes stronger when the information content of ratings is poorer. The impact of ratings on bond spreads across the credit cycle is then empirically investigated. The data are from Dealogic DCM Analytics, which reports information on issuers (nationality, industry, etc.) and issues (spread at issuance, Moody’s, S&P and Fitch ratings, maturity, size, currency, etc.). We find that unexplained dispersion increases for bonds issued during phases of market turmoil, supporting the hypothesis that investors collect and impound additional information into spreads as a consequence of higher market-wide uncertainty.
Investigating Price Determinants of Structured Finance Issues at Launch: Evidence from the European Market
Joint with Barbara Mento
Status: first draft ready
The aim of this paper is to empirically investigate the determinants of primary market spreads in European structured finance securities over the 1999-2008 period. In particular, using the reduced-form multiplicative heteroskedastic regression model suggested by Harvey, the analysis has been conducted on two separate equations, with the aim of testing both the spread level and its precision.
Empirical evidence demonstrates the crucial importance of credit ratings as major pricing factors for structured finance transactions at launch. However, it shows the consistent significance of some deal- and tranche- specific characteristics in affecting not only the level of launch spreads but also their unexplained dispersion. This suggests that the degree of accuracy of a ratings-based pricing model and the ability of investors to price hidden information varies across different types of securitizations.
Do news decrease or increase market uncertainty? The case of the banking sector in 2005-2008
Joint with Mascia Bedendo
Status: database ready
Our project analyses a vast sample of news releases concerning the world’s top 100 banks by total assets over the period 2005-2008 (which includes both a quiet subperiod and the hectic market environment of late 2007 and 2008). We assess the impact of market-wide and idiosyncratic news on various measures of firm-specific uncertainty such as stock volatility, dispersions in analysts’ forecasts, stock liquidity. In particular, we aim at investigating under what circumstances news which are expected to increase the degree of transparency on banks’ activities and future performance in fact lead to a reduction in the idiosyncratic uncertainty. We test the extent of this impact both in good times and in times of market stress, when we expect new information to be more valuable.
Our sample includes the top 100 banks in Western Europe, North America and Japan by total assets as of year-end 2007. News releases are collected from a number of sources (including e.g. the Dow Jones Newswire, Reuters News, the Financial Times) through the Factiva database.
Bank interconnectedness and systemic risk
Joint with Andrea Sironi
Status: validating database and running preliminary regressions
This research project is divided in two parts. In the first part, we estimate a measure of bank interconnectedness - based on the above mentioned financial statement ratios - aimed at capturing the degree of interconnectedness of one bank with the other financial institutions. We do this for a sample of large banks both from USA and Europe. We plan to use data from the Bankscope database and from quarterly and annual individual financial statements.
In the second part, we study the relationship between an individual bank degree of interconnectedness, as measured by its degree of interdependence to other banks (interbank deposits, OTC derivatives trading, etc.), and the market price of its debt capital, as proxied by the credit default swap (CDS) spread. We also empirically investigate if this relationship has changed before and after the start of the recent financial crisis. We plan to run multivariate regressions (panel) where the CDS spread of individual banks is regressed against the degree of entangleness of each one of them and a number of control variables such a capital (tier 1 and total capital ratio), asset risk (loan loss provisions over total assets, asset volatility), size (log of total assets), profitability (average return on assets).
The quality of Tier 1 Capital for large European banks and the impact of the Basel 3 regulations
Joint with Giuliano Iannotta
Status: data base ready, first draft to be publicly presented in October 2010
During the last 20 years banks have increasingly resorted to hybrid or innovative capital instruments, that is, to funding instruments which lie in-between equity capital and debt (e.g., they have no voting rights and entail a fixed coupon, like bonds, but interest payments may deferred or cancelled, depending on the bank’s current profits, and even the principal may be slashed against losses on a going concern basis). However, hybrid and innovative capital instruments were plagued by an intrinsic ambiguity: while regulators were willing to consider them as capital (although within some quantitative limits), investors were confident that banks would in the end treat them as plain debt, and would refrain to avoid reputational costs and future squeezes on funding.
The Basel Committee is currently envisaging a new regulation on hybrid instruments to curb down excesses and ensure that an adequate share of a bank’s capital consists of plain vanilla common equity. In short, it will be considerably more difficult for banks to resort to hybrid or innovative instruments.
In light of the above , our research project aims at compiling a map of the innovative capital instruments used by European banks throughout the last 10-15 years, highlighting the most common characteristics and clauses and at assessing the impact of the new regulations on the availability and cost of bank capital. To this aim, we have set up a unique database, covering the first 25 European banking groups and including details on all hybrid and innovative capital instruments. The paper will also include a limited number of case studies on innovative capital instruments recently issued in the banking industry (including contingent liabilities) and the effects (both intended and unintended) they may have on future bank stability.
Last change 07/07/2010