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In its capacity as debt issuer, the state has played a growing role in financial life over the last 30 years. To examine this role and connect it to shadow banking, the paper develops the concept of the ‘repo trinity’, which captures a set of policy objectives that central banks outlined after the 1998 Russian crisis, the first systemic crisis of collateral-based finance. The repo trinity connected financial stabilit…
ABSTRACT The repo market has been viewed as a potential source of financial instability since the 2007 to 2009 financial crisis, based in part on findings that margins increased sharply in a segment of this market. This paper provides evidence suggesting that there was no system‐wide run on repo. Using confidential data on tri‐party repo, a major segment of this market, we show that, the level of margins and the amou…
Using micro-level data, we construct a credit spread index with considerable predictive power for future economic activity. We decompose the credit spread into a component that captures firm-specific information on expected defaults and a residual component–– the excess bond premium. Shocks to the excess bond premium that are orthogonal to the current state of the economy lead to declines in economic activity and ass…
This paper attempts to explain the credit default swap (CDS) premium, using a novel approach to identify the volatility and jump risks of individual firms from high-frequency equity prices. Our empirical results suggest that the volatility risk alone predicts 48% of the variation in CDS spread levels, whereas the jump risk alone forecasts 19%. After controlling for credit ratings, macroeconomic conditions, and firms'…
We provide a model that links an asset's market liquidity (i.e., the ease with which it is traded) and traders' funding liquidity (i.e., the ease with which they can obtain funding). Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and margin requirements, depends on the assets' market liquidity. We show that, unde…
ABSTRACT We find that liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4,000 corporate bonds and spanning both investment grade and speculative categories, we find that more illiquid bonds earn higher yield spreads, and an improvement in liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond‐specific, firm‐spec…
ABSTRACT Using dealer's quotes and transactions prices on straight industrial bonds, we investigate the determinants of credit spread changes. Variables that should in theory determine credit spread changes have rather limited explanatory power. Further, the residuals from this regression are highly cross‐correlated, and principal components analysis implies they are mostly driven by a single common factor. Although …
ABSTRACT Most structural models of default preclude the firm from altering its capital structure. In practice, firms adjust outstanding debt levels in response to changes in firm value, thus generating mean‐reverting leverage ratios. We propose a structural model of default with stochastic interest rates that captures this mean reversion. Our model generates credit spreads that are larger for low‐leverage firms, and …
We study the implications of imperfect information for term structures of credit spreads on corporate bonds. We suppose that bond investors cannot observe the issuer’s assets directly, and receive instead only periodic and imperfect accounting reports. For a setting in which the assets of the firm are a geometric Brownian motion until informed equityholders optimally liquidate, we derive the conditional distribution …
ABSTRACT This article examines the optimal capital structure of a firm that can choose both the amount and maturity of its debt. Bankruptcy is determined endogenously rather than by the imposition of a positive net worth condition or by a cash flow constraint. The results extend Leland's (1994a) closed‐form results to a much richer class of possible debt structures and permit study of the optimal maturity of debt as …
Abstract We identify fixed-income mutual funds as an important contributor to the unusually high selling pressure in liquid asset markets during the COVID-19 crisis. We show that mutual funds experienced pronounced investor outflows amplified by their liquidity transformation. In meeting redemptions, funds followed a pecking order by first selling their liquid assets, including Treasuries and high-quality corporate b…
The search for a market design that ensures stable bank funding is at the top of regulators' policy agenda. This paper empirically shows that the central counterparty (CCP)-based euro interbank repo market features this stability. Using a unique and comprehensive data set, we show that the market is resilient during crisis episodes and may even act as a shock absorber, in the sense that repo lending increases with ri…
As the financial crisis deepened and unsecured interbank markets effectively shut down, repo market activity became increasingly concentrated in the very shortest maturities and against the highest-quality collateral. Repo rates for US Treasury collateral fell relative to overnight index swap rates, while comparable sovereign repo rates in the euro area and the United Kingdom rose. The different dynamics across marke…
1. INTRODUCTION During the financial crisis of 2007-09, particularly around the time of the Bear Stearns and Lehman Brothers failures, it became apparent that weaknesses existed in the design of the U.S. tri-party repo market, used by major broker-dealers to finance their inventories of securities. These design weaknesses had the potential to rapidly elevate and propagate systemic risk. Following the crisis, an indus…
Abstract Two intermediary-based factors—a corporate bond dealer inventory measure and a broad intermediary distress measure—explain more than 40$\%$ of the puzzling common variation in credit spread changes beyond canonical structural factors. A simple intermediary-based model with partial market segmentation accounts for intermediary factors’ explanatory power and delivers three further implications with empirical s…
Remarks at Brookings-Chicago Booth Task Force on Financial Stability (TFFS) meeting, panel on market liquidity (delivered via videoconference).
Over the last decade, the foreign exchange derivatives market has witnessed a collapse of covered interest parity (CIP). Not only does this collapse give rise to large deviations from CIP, it has unlocked a stream of exploitable arbitrage opportunities across currencies. In this paper, we introduce two new factors – inflation differential and relative economic performance – as potential drivers of deviations from CIP…
The desire of market participants to go long or short a portfolio of corporate credits led to the introduction of various types of indices of credit default swaps. In this article, we empirically investigate the relationships between the spreads of the North America CDX index and its tranches and their theoretical determinants. We find (1) support for a number of results predicted by the structural models used in cre…
Discount Window borrowing measures bank use of Federal Reserve emergency liquidity and serves as a signal of funding pressure and banking-sector strain.
Deposit outflow rate measures the pace at which deposits leave the banking system or individual banks, helping assess funding stability and confidence.
Regional Bank ETF performance helps track stress in smaller and mid-sized banks, especially around deposit stability, asset quality, and local credit conditions.
KBW Bank Index tracks the equity performance of major U.S. banks and provides insight into banking-sector health, credit transmission, and market confidence.
Bank CDS Index tracks the cost of insuring major bank credit risk and serves as a real-time indicator of banking-system stress and confidence.
Bank reserve balances reflect the quantity of reserves held by banks at the Federal Reserve and are central to understanding liquidity distribution and financial system stability.
LIBOR-OIS spread tracks the gap between unsecured bank funding rates and overnight indexed swap rates, historically serving as a benchmark for banking-system stress.
TED Spread measures the difference between interbank lending rates and short-term U.S. government bill yields, historically used as a gauge of credit and funding stress.
FRA-OIS spread measures the difference between interbank funding expectations and overnight indexed swap rates, often used as a gauge of banking and short-term funding stress.
Bank Capital Ratio — Loss-absorbing equity buffer determining lending capacity and dividend policy.
Liquidity Coverage Ratio — Regulatory high-quality liquid asset requirement for 30-day stress.
Net Stable Funding Ratio — Stable funding versus long-term assets — constrains maturity transformation.
Systemic Risk Indicator — Aggregate capital shortfall under stress — connects banking to macro hedges.
Shadow Banking Assets — Non-bank credit intermediation outside traditional capital rules.
NPL Ratio Banks — Non-performing loan share signaling late-cycle credit deterioration.
Bank Lending Standards (Banking).
Commercial Real Estate Stress (Banking).
Balance Sheet Constraint Dealer — Dealer SLR/balance-sheet limits reducing intermediation.
Supplementary Leverage Ratio (Banking).
GSIB Surcharge (Banking).
TLAC Requirement (Banking).
Resolution Planning (Banking).
Bail In Debt (Banking).
Deposit Insurance Limit (Banking).
Uninsured Deposit Share (Banking).
Held to Maturity Accounting — Accounting classification affecting AFS/HTM AOCI optics.
Available for Sale Securities (Banking).
AOCI Filter (Banking).
Unrealized Losses Banks — Mark losses on securities books in rising-rate regimes.
Duration Gap Banking (Banking).
Asset Liability Management (Banking).
Net Interest Margin (Banking).
Deposit Beta (Banking).
Beta of Liabilities (Banking).
Loan to Deposit Ratio (Banking).
Wholesale Funding Dependence — Reliance on market funding versus sticky deposits.
AFS AOCI ASEAN (Banking).
AFS AOCI Australia (Banking).
AFS AOCI broker-dealer (Banking).
AFS AOCI Canada (Banking).
AFS AOCI CEEMEA (Banking).
AFS AOCI China (Banking).
AFS AOCI EM Asia (Banking).
AFS AOCI Euro Area (Banking).
AFS AOCI GSIB (Banking).
AFS AOCI India (Banking).
AFS AOCI Japan (Banking).
AFS AOCI Korea (Banking).
AFS AOCI LatAm (Banking).
AFS AOCI Nordics (Banking).
AFS AOCI regional (Banking).
AFS AOCI trust bank (Banking).
AFS AOCI UK (Banking).
AFS AOCI US (Banking).
AML Transaction Monitoring (Banking).
AOCI Capital Filter — Treatment of unrealized AFS gains/losses in regulatory capital.
AOCI Filter (Banking).
Asset Liability Management (Banking).
Available for Sale Securities (Banking).
Bail In Debt (Banking).