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Working Paper
Believe only what you see: credit rating agencies, structured finance, and bonds
This paper identifies rating verifiability as a key difference that explains why credit rating agencies (CRAs) failed to mitigate information asymmetries in the structured finance market but succeeded in the bond market. Two infinitely repeated models are analyzed. In the first, the rating is unverifiable, and there is no equilibrium where the CRA reveals its information. In the second, the rating is verified with some probability, and full information revelation is guaranteed for any verification probability, when the CRA is patient enough. The interaction between verification probability ...
Working Paper
Can Reputation Ensure Efficiency in the Structured Finance Market? Majority Voting: A Quantitative Investigation
In Elamin (2013), the credit rating agency (CRA) cannot credibly fully reveal its information about the quality of a rated structured finance project, when ratings are unverifiable. Can the fear of losing its reputation discipline the CRA? In this paper, there is incomplete information about the type of the CRA. With some probability, it can be a truthful type, always fully revealing its information. At every period, the (updated) probability that the CRA is of the truthful type is its reputation. With only two project types and when the CRA?s reputation is high enough, an informationally ...
Working Paper
On the non-optimality of a Diamond-Dybvig contract in the Goldstein-Pauzner environment
I show, under intuitive conditions on the risk-averse utility function, the nonoptimality of the Diamond and Dybvig (1983) contract in the Goldstein and Pauzner (2005) environment. If marginal utility at zero is low enough, then Goldstein and Pauzner (2005)?s claim about the optimality of the Diamond and Dybvig (1983) contract is true. When it is not, the optimal contract insures the patient depositor against a project default. The contract may exhibit risk-sharing with the impatient depositor. Unlike when Goldstein and Pauzner (2005)?s claim is correct, relative risk aversion greater than 1 ...
Working Paper
The Effect of Safe Assets on Financial Fragility in a Bank-Run Model
Risk-averse investors induce competitive intermediaries to hold safe assets, thereby lowering the probability of a run and reducing financial fragility. We revisit Goldstein and Pauzner (2005), who obtain a unique equilibrium in the banking model of Diamond and Dybvig (1983) by introducing risky investment and noisy private signals. We show that, in the optimal demand-deposit contract subject to sequential service, banks hold safe assets to insure investors against investment risk. Consequently, fewer investors withdraw prematurely, which reduces the probability of a bank run. Safe asset ...
Journal Article
Rising Interest Rate Risk at US Banks
Average interest rate risk in the banking system has been increasing since the end of the financial crisis and is almost back to its pre-recession level. But the increase has not occurred uniformly at large and small banks. At big banks, risk, while increasing, hasn?t yet reached its pre-recession high. It?s in small banks where we see a steep rise in interest rate risk. The big banks? exposure is being driven mainly by their liabilities. At small banks, it is coming from both their assets and liabilities.
Journal Article
Interest Rate Risk and Rising Maturities
Banks have been steadily increasing their exposure to interest rate risk since the end of the financial crisis, though large and small banks are doing so in different ways. This Commentary examines the maturity structure of assets and liabilities to identify the underlying factors responsible for the rise in interest rate risk and the differences between large and small banks.