Bank Credit Risk, Common Factors, and Interdependence of Credit Risk in Money Markets: Naohiko Baba

Transcription

1 For presenaion a he fourh join cenral bank conference on risk managemen and sysemic risk held a he European Cenral Bank Bank Credi Risk, Common Facors, and Inerdependence of Credi Risk in Money Markes: Observed vs. Fundamenal Prices of Bank Credi Risk Naohiko Baba (naohiko.baba@boj.or.jp) Bank of Japan November 9, 2005

2 1 Conens 1. Moivaion 2. Mehodology o Decompose Risk Premiums 3. Empirical Resuls 4. Discussions: Policy Implicaions

3 2 1. Moivaion Brief Review: Wha is Japan Premium? I is ypically defined as (90-day) US Dollar-TIBOR minus US Dollar-LIBOR (Io and Harada [2004]) Yen-TIBOR minus Yen-LIBOR (Covrig, Low, and Melvin [2004]) Reference Banks of TIBOR and LIBOR Yen-TIBOR U.S. Dollar-TIBOR Yen-LIBOR U.S. Dollar-LIBOR Mizuho Bank, Sumiomo Misui Banking Co., JP Morgan Chase, he Bank of Tokyo Misubishi, Saiama Resona Bank, UFJ Bank, Shinsei Bank, he Chuo Misui Trus and Banking Co., he Misubishi Trus and Banking Co., he Sumiomo Trus and Banking Co., Mizuho Corporae Bank, Mizuho Trus and Banking Co., he Shoko Chukin Bank, UBS AG, Shinkin Cenral Bank, he Norinchukin Bank Sumiomo Misui Banking Co., he Bank of Tokyo Misubishi, UFJ Bank, Mizuho Corporae Bank, he Norinchukin Bank, he Misubishi Trus and Banking Co., he Sumiomo Trus and Banking Co., he Chuo Misui Trus and Banking Co., Ciibank NA, UBS AG Bank of America, Barclays Bank Plc, Ciibank NA, Deusche Bank AG, HSBC, JP Morgan Chase, Lloyds TSB Bank Plc, Rabobank, The Royal Bank of Scoland Group, UBS AG, Wesdeusche Landesbank AG, he Bank of Tokyo Misubishi, Sumiomo Misui Banking Co., Mizuho Corporae Bank, UFJ Bank, he Norinchukin Bank Abbey Naional Plc, Bank of America, Barclays Bank Plc, Ciibank NA, Credi Suisse Firs Boson, Deusche Bank AG, HBOS, HSBC, JP Morgan Chase, Lloyds TSB Bank Plc, Rabobank, The Royal Bank of Scoland Group, UBS AG, Wesdeusche Landesbank, he Bank of Tokyo Misubishi, he Norinchukin Bank

4 As a Signal of Bank Credi Risk Japan Premium: Two Banking Crises and Jus One Spike (%) Japan Premium Japan Premium (US dollar) Japan Premium (yen) Aug-92 Aug-93 Aug-94 Aug-95 Aug-96 Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug

5 4 Defaul Probabiliy Esimaed from Equiy Prices: Two Banking Crises and Two Spikes Defaul Probabiliies of Japanese Banks BTM SMBC MIZUHO UFJ Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Source: Ueno and Baba [2005]

6 5 Defaul Probabiliy Esimaed from CDS Spreads: Two Banking Crises and Two Spikes Defaul Probabiliies of Japanese Banks Recovery Raios of Japanese Banks 0.15 BTM MIZUHO SMBC UFJ Senior Subordinaed Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep BTM SMBC UFJ MIZUHO Source: Ueno and Baba [2005]

7 Japan Premium is no longer a bank credi signal? We decompose risk premiums consruced from TIBOR/LIBOR and quaniaively evaluae he fundamenal componens of bank credi risk. If no, hen wha facors move risk premiums? Price discovery funcioning of money marke ineres raes deerioraed? Wha properies he fundamenal prices of bank credi risk have in erms of he dynamic inerdependence? 6

8 2. Mehodology o Decompose Risk Premiums Defining Fundamenal Prices of Credi Risk Random-walk prices ha are specific o each bank group Preliminary Sep: Facor Analysis We derive common facors from four risk premiums, which play a role of conrol variables in a sae space model below. Second Sep: Sae Space Model We consruc a sae space model in which wo random-walk shadow prices are assumed o govern he fundamenal prices of bank credi risk in he yen and US dollar markes, respecively. Conrols for he effecs of common facors derived by facor analysis 7

9 Preliminary Sep: Facor Analysis Facor analysis successfully exraced wo common facors: (a) Global facor: equally common o all of he risk premiums (b) Currency facor: capures he difference beween he yen and dollar markes Facor Loadings Facor 1 JD JY FY FD Facor 2 FD FY JY JD Facor 3 FY JD FD JY Aug-92 Aug-92 Aug-92 Aug-93 Aug-93 Aug-93 Time Series of each Facor Aug-94 Aug-94 Aug-95 Aug-95 Aug-96 Aug-96 Facor 1 (Global Facor) Aug-97 Aug-98 Aug-99 Aug-00 Facor 2 (Curreny Facor) Aug-97 Aug-98 Aug-99 Aug-00 Facor 3 (Credi Facor) JY: yen-tibor-japanese TB rae JD: US dollar-tibor-us TB rae FY: yen-libor-japanese TB rae FD: US dollar-libor-us TB rae Aug-94 Aug-95 Aug-96 Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-01 Aug-01 Aug-02 Aug-02 Aug-02 Aug-03 Aug-03 Aug-03 Aug-04 Aug-04 Aug-04 8

10 Second Sep: Sae Space Model J*/F*: Shadow Prices of Japanese/Foreign Banks Credi Risk JY(FY)PRICE/JD(FD)PRICE: Fundamenal Prices in he yen and he US dollar markes, respecively Conrol Variables: Fg (Global Facor), Fc (Currency Facor) Japanese banks: JY = JYPRICE + a Fg + a Fc + g c e jy JD = JDPRICE + b Fg + b Fc + g c e jd Foreign banks: FY = FYPRICE + c Fg + c Fc + g c e fy g c fd FD = FDPRICE + d Fg + d Fc + e, where jy jy * jyprice 0 + a1 J e, JYPRICE = a + jd 0 jd 1 * JDPRICE = a + a J + e jdprice fy fy 1 * fyprice FYPRICE = a0 + a F + e, fd fd * fdprice 0 + a1 F e. 9 FDPRICE = a +

11 3. Empirical Resuls Sae Space Model Overall model fiing is good, and he sensiiviy of fundamenal prices o he shadow prices is significanly higher in he US Dollar marke han in he yen marke for boh bank groups. jy jy * jyprice 0 + a1 J e, JYPRICE = a + jd 0 jd 1 * JDPRICE = a + a J + e jdprice fy fy * fyprice 0 + a1 F e, FYPRICE = a + Parameer Sd. error Japanese Banks jy a *** 5.01E-07 jd a *** 9.47E-09 jy a *** jd a *** Foreign Banks fy a *** 3.49E-08 fd a *** 1.46E-05 fy a *** fd a *** Log likelihood Wald Tes Null Hypohesis (H0) 2 χ jd jy a 1 - a 1 =0 2.74E+10*** fd fd fd * fdprice 0 + a1 F e. FDPRICE = a + fy a 1 - a 1 =0 3.38E+07*** 10

12 11 To summarize, Yes, LIBOR/TIBOR conain relevan fundamenal prices of bank credi risk. However, he explanaory power of fundamenal prices is.. Major par of he variance is explained by he global and currency facor. Imporance of Componens: Proporion of he Toal Variance Explained by Each Componen Global Facor Currency Facor Fundamenal Price Three Facors JY JD FY FD JY: yen-tibor-japanese TB rae JD: US dollar-tibor-us TB rae FY: yen-libor-japanese TB rae FD: US dollar-libor-us TB rae

13 12 In erms of Japan Premiums In boh currencies, fundamenal Japan premiums experienced much smaller spikes during he banking crisis around In yen, Japan premium has been negaive since 1999, when he BOJ iniiaed zero ineres rae policy (ZIRP). Observed and Fundamenal Japan Premiums 1.2 US Dollar Marke 0.5 Yen Marke Aug-92 Aug-93 Aug-94 Aug-95 Japan Premium (US dollar) Fundamenal Japan Premium (US dollar) Aug-96 Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug Aug-92 Aug-93 Aug-94 Aug-95 Aug-96 Japan Premium (yen) Fundamenal Japan Premium (yen) Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04

14 13 4. Discussions: Policy Implicaions Then, why he imporance of Japan premium as a signal of credi risk was reduced? Three Hypoheses: Io and Harada [2004] and Baba e al. [2005] 1. Japanese banks have been required o pu up cash collaerals o raise dollars in he money markes since around I migh be he case, bu no confirmed. 2. Weaker banks have exied from he inernaional money markes. Then why CDS and equiy markes experienced a spike recenly? 3. Money markes gradually los price-discovery funcioning for bank credi risk in a very low ineres rae environmen, paricularly in he Japanese yen markes. Some furher evidence from he CD marke

15 Recen developmens of CD Ineres raes are likely o suppor he hird hypohesis. Dispersion of CD spreads across he issuing banks has almos vanished under he Quaniaive Moneary Easing Policy. Credi curves has flaed ou almos compleely. Sandard Deviaion of CD Ineres Raes Across Banks (Mauriy: Less han 30-day) Average of Sd Deviaion Banking Crisis ZIRP QMEP Sd Deviaion Credi Curves of CD Spreads /09/ /04/ /11/ /06/ /12/ /07/ /02/ /09/ /04/ /11/ /06/ /01/ /08/ /03/ /09/ /04/ /11/ A2 A3 Baa1 Baa2 Source: Baba e al. [2005b] 14

16 15 Quaniaive Moneary Easing Policy and Bank Credi Risk BOJ s QMEP exered a non-negligible effec on credi spreads paricularly in he money markes (Baba e al. [2005a,b]). Two Possibiliies 1. The policy package under he name of he QMEP subsanially reduced he risk ha banks fail o mee paymen obligaions in he near fuure, which makes he near-erm chance of a defaul much smaller. 2. The BOJ s policy jus paralyzed he marke funcioning. Which explanaion beer describes he realiy needs furher analysis.

17 16 References for his Presenaion Baba, N., S. Nishioka, N. Oda, M. Shirakawa, K. Ueda, and H. Ugai [2005a] Japan s Deflaion, Problems in he Financial Sysem, and Moneary Policy, Moneary and Economic Sudies, 23, pp Baba, N., M. Nakashima, Y. Shigemi, and K. Ueda [2005b] The Bank of Japan s Moneary Policy and Bank Risk Premiums in he Money Marke, forhcoming in Inernaional Journal of Cenral Banking. Covrig, V., B. Low, and M. Melvin [2004] A Yen is no a Yen: TIBOR/LIBOR and he Deerminans of he Japanese Premiums, Journal of Financial and Quaniaive Analysis, 39, pp Io, T., and K. Harada [2004] Credi Derivaives Premium as a New Japan Premium, Journal of Money, Credi, and Banking, 36, pp Ueno, Y., and N. Baba [2005] Defaul Inensiy and Expeced Recovery Implied by Term Srucure of CDS Spreads For Japanese Banks: How are Japanese Banks Subordinaed Bonds Priced in he CDS Marke? mimeo