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We analyze holdings of public bonds by over 20,000 banks in 191 countries, and the role of these bonds in 20 sovereign defaults over 1998-2012. Banks hold many public bonds (on average 9% of their assets), particularly in less financially-developed countries. During sovereign defaults, banks increase their exposure to public bonds, especially large banks and when expected bond returns are high. At the bank level, bondholdings correlate negatively with subsequent lending during sovereign defaults. This correlation is mostly due to bonds acquired in pre-default years. These findings shed light on alternative theories of the sovereign default-banking crisis nexus.
Most short-term interest rates in the Euro area are below the European Central Bank deposit facility rate, the rate at which the central bank remunerates banks’ excess reserves. This unexpected development coincided with the start of the Public Sector Purchase Program (PSPP). In this paper, we explore empirically the interactions between the PSPP and repo rates. We document different channels through which asset purchases may affect them. Using proprietary data from PSPP purchases and repo transactions for specific (“special") securities, we assess the scarcity channel of PSPP and its impact on repo rates. We estimate that purchasing 1 percent of a bond outstanding is associated with a decline of its repo rate of 0.78 bps. Using an instrumental variable, we find that the full effect may be up to six times higher.
This paper reviews empirical and theoretical work on the links between banks and their governments (the bank-sovereign nexus). How significant is this nexus? What do we know about it? To what extent is it a source of concern? What is the role of policy intervention? The paper concludes with a review of recent policy proposals.
This paper introduces a new dataset on the composition of the investor base for government securities in the G20 advanced economies and the euro area. During the last decades, investors from abroad have increased their presence in government bond markets. The financial crisis broke this trend. Domestic financial institutions allocated a larger share of government securities in their portfolios, as Japan has done since its crisis in the 1990s. Increases in the share held by institutional investors or non-residents by 10 percentage points are associated with a reduction in yields by about 25 or 40 basis points, respectively. The data show a varied lead-lag relationship between bond yields and investor holdings. Portfolio balance estimates suggest that a change in statutory or regulatory holdings of government securities to the tune of 10 percent of the outstanding stock causes expected returns to decline by 7 to 25 basis points.
"The process by which securities are traded is very different from the idealized picture of a frictionless and self-equilibrating market offered by the typical finance textbook. This book offers a more accurate and authoritative take on this process. The book starts from the assumption that not everyone is present at all times simultaneously on the market, and that participants have quite diverse information about the security's fundamentals. As a result, the order flow is a complex mix of information and noise, and a consensus price only emerges gradually over time as the trading process evolves and the participants interpret the actions of other traders. Thus, a security's actual transaction price may deviate from its fundamental value, as it would be assessed by a fully informed set of investors. The book takes these deviations seriously, and explains why and how they emerge in the trading process and are eventually eliminated. The authors draw on a vast body of theoretical insights and empirical findings on security price formation that have come to form a well-defined field within financial economics known as "market microstructure." Focusing on liquidity and price discovery, the book analyzes the tension between the two, pointing out that when price-relevant information reaches the market through trading pressure rather than through a public announcement, liquidity may suffer. It also confronts many striking phenomena in securities markets and uses the analytical tools and empirical methods of market microstructure to understand them. These include issues such as why liquidity changes over time and differs across securities, why large trades move prices up or down, and why these price changes are subsequently reversed, and why we observe temporary deviations from asset fair values"--
This paper analyses the determimants of emerging market sovereign bond spreads by examining the short and long-run effects of fundamental (macroeconomic) and temporary (financial market) factors on these spreads. During the current global financial and economic crisis, sovereign bond spreads widened dramatically for both developed and emerging market economies. This deterioration has widely been attributed to rapidly growing public debts and balance sheet risks. Our results indicate that in the long run, fundamentals are significant determinants of emerging market sovereign bond spreads, while in the short run, financial volatility is a more important determinant of sperads than fundamentals indicators.
A comprehensive guide to the current theories and methodologies intrinsic to fixed-income securities Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods. The book presents crucial topics of fixed income in an accessible and logical format. Emphasizing empirical research and real-life applications, the book explores a wide range of topics from the risk and return of fixed-income investments, to the impact of monetary policy on interest rates, to the post-crisis new regulatory landscape. Well organized to cover critical topics in fixed income, Handbook of Fixed-Income Securities is divided into eight main sections that feature: • An introduction to fixed-income markets such as Treasury bonds, inflation-protected securities, money markets, mortgage-backed securities, and the basic analytics that characterize them • Monetary policy and fixed-income markets, which highlight the recent empirical evidence on the central banks’ influence on interest rates, including the recent quantitative easing experiments • Interest rate risk measurement and management with a special focus on the most recent techniques and methodologies for asset-liability management under regulatory constraints • The predictability of bond returns with a critical discussion of the empirical evidence on time-varying bond risk premia, both in the United States and abroad, and their sources, such as liquidity and volatility • Advanced topics, with a focus on the most recent research on term structure models and econometrics, the dynamics of bond illiquidity, and the puzzling dynamics of stocks and bonds • Derivatives markets, including a detailed discussion of the new regulatory landscape after the financial crisis and an introduction to no-arbitrage derivatives pricing • Further topics on derivatives pricing that cover modern valuation techniques, such as Monte Carlo simulations, volatility surfaces, and no-arbitrage pricing with regulatory constraints • Corporate and sovereign bonds with a detailed discussion of the tools required to analyze default risk, the relevant empirical evidence, and a special focus on the recent sovereign crises A complete reference for practitioners in the fields of finance, business, applied statistics, econometrics, and engineering, Handbook of Fixed-Income Securities is also a useful supplementary textbook for graduate and MBA-level courses on fixed-income securities, risk management, volatility, bonds, derivatives, and financial markets. Pietro Veronesi, PhD, is Roman Family Professor of Finance at the University of Chicago Booth School of Business, where he teaches Masters and PhD-level courses in fixed income, risk management, and asset pricing. Published in leading academic journals and honored by numerous awards, his research focuses on stock and bond valuation, return predictability, bubbles and crashes, and the relation between asset prices and government policies.
Are Bunds special? This paper estimates the “Bund premium” as the difference in convenience yields between other sovereign safe assets and German government bonds adjusted for sovereign credit risk, liquidity and swap market frictions. A higher premium suggests less substitutability of sovereign bonds. We document a rise in the “Bund premium” in the post-crisis period. We show that there is a negative relationship of the premium with the relative supply of German sovereign bonds, which is more pronounced for higher maturities and when risk aversion proxied by bond market volatility is high. Going forward, we expect German government debt supply to remain scarce, with important implications for the ECB’s monetary policy strategy.
The first book-length study of the importance of collateral frameworks in monetary policy, focusing on the Eurozone and euro crisis.
A global look at the reasons behind the recent economic collapse, and the responses to it The speculative bubble in the housing market began to burst in the United States in 2007, and has been followed by ruptures in virtually every asset market in almost every country in the world. Each country proposed a range of policy initiatives to deal with its crisis. Policies that focused upon stabilizing the housing market formed the cornerstone of many of these proposals. This internationally focused book evaluates the genesis of the housing market bubble, the global viral contagion of the crisis, and the policy initiatives undertaken in some of the major economies of the world to counteract its disastrous affects. Unlike other books on the global crisis, this guide deals with the housing sector in addition to the financial sector of individual economies. Countries in many parts of the world were players in either the financial bubble or the housing bubble, or both, but the degree of impact, outcome, and responses varied widely. This is an appropriate time to pull together the lessons from these various experiences. Reveals the housing crisis in the United States as the core of the meltdown Describes the evolution of housing markets and policies in the run-up to the crisis, their impacts, and the responses in European and Asian countries Compares experiences and linkages across countries and points to policy implications and research lessons drawn from these experiences Filled with the insights of well-known contributors with strong contacts in practice and academia, this timely guide discusses the history and evolution of the recent crisis as local to each contributor's part of the world, and examines its distinctive and common features with that of the U.S., the trajectory of its evolution, and the similarities and differences in policy response.