Research articles for the 2020-11-27

Debt Structure, Rollover Risk, and Payout Policy
Iwaki, Hiromichi,Saito, Junyu
This paper examines the effects of the rollover risk of debt on firms̢۪ payout policies, taking into account differences in the structure of debt. The results show that in the face of rollover risk, firms decrease dividends; in addition, they decrease the total payout given to shareholders including stock repurchases. However, these results only hold for the bank-dependent firms, not for firms with public debt. We find that the relationships between rollover risk and payout policy become weak for firms without any financing constraints. Our results imply that firms̢۪ payout policies can be attenuated when firms facing financial constraints need more financial flexibility.

Fair Value Opinion Shopping or Objective Valuation?
Koo, Minjae,Sivaramakrishnan, Shiva,Zhao, Yuping
With respect to fair value (FV) measurements of certain financial assets, the literature suggests that FV estimates derived from external third-party sources are more reliable than those from less-verifiable inputs that are subject to managerial discretion. However, using a sample of private insurance companies, we provide evidence that even verifiable FV estimates derived from external third-party sources are not immune to managerial opportunism. Insurers frequently change pricing sources of their fixed income securities to value a security at a higher level (i.e., an upward switch) or at a lower level (i.e., a downward switch) than in the previous period. We hypothesize that such source-switches could either be driven by managerial incentives to inflate FV estimate in order to avoid other-than-temporary impairment (OTTI) (i.e., FV opinion shopping) or to more faithfully report FV (i.e., objective valuation). We find that FV opinion shopping is the more dominant motive for source-switching by private Life insurers, and that source-switches on average lead to less accurate and more upwardly biased FV estimates. Moreover, FV opinion shopping is more prevalent among insurers with poor performance, for important securities, for securities with greater exposure to asset risk, and is mitigated by regulatory financial examinations. We also find that an upward switch reduces both the likelihood and magnitude of OTTI recognition, especially for high-impairment-risk securities. In sum, our evidence supports the narrative that opportunism with respect to source-switching potentially compromises the disciplining role of independent third parties in the valuation of fair-valued assets.

HVA: Fact and Friction
Burnett, Benedict
We develop a simple and generic expression for the impact of transaction costs on the value of a derivative portfolio, expressed as a 'Hedging Valuation Adjustment' (HVA). We provide expressions for the HVA in two cases: when it is included as part of the value to be hedged, and when it is left as an unhedged reserve. The hedged case shows an interesting feature we term 'imaginary volatility'. We show numerical results, and extend the formalism to the pricing of individual trades and to the multi-asset case.

Individualism, Formal Institutional Environment and Bank Capital Decisions
Bitar, Mohammad,Tarazi, Amine
We examine the effect of informal institutional environment on bank capital decisions worldwide as well as within the United States at the state level. Specifically, we focus on individualism and based on a sample of 7,034 banks in 68 countries, we establish three major findings: First, individualism is negatively and significantly associated with bank regulatory capital, an association which is independent of the influence of formal institutional environment per se. Second, effective legal enforcement magnifies the negative effect of individualism on bank regulatory capital. Finally, focusing on a single country, the United States, we also find that banks in individualistic states hold less regulatory capital than banks in collectivist states and the effect of individualism is magnified with effective legal enforcement at the state level. Our findings suggest that individualism serves as a constraint on regulators, as any given regulatory guidelines or formal institutional factors will operate very differently depending on the informal institutional environment.

Probability Performance Scenarios Are Better: An Efficient Disclosure of Higher Moments Information From No-Arbitrage Market Implied Distributions
Minenna, Marcello
The present work proposes a methodology for the representation of performance scenario in Packaged Retail and Insurance-based Investment Products (PRIIPS), by the means of a no-arbitrage probability table easy to understand for the retail investor. A statistical reconstruction via the method of moments allows to capture the main properties of the PRIIP market implied distribution by identifying the minimum number of descriptive moments needed. A reasonable quantile partition that is effective for representing to the retail investor the complex distributions of structured products characterized by non-linear pay-offs is then proposed.

The Operation of Supervisory Colleges in EU Banking Supervision: A Case Study of Soft Law Becoming Hard Law
Alford, Duncan
In this paper, I consider the case of supervisory cooperation among bank regulators where voluntary cooperation (soft law) over a period of 50 years has become hard law (regulations and directives) within the European Union. Driven by major international bank failures or financial crises, international standards for prudential supervisory cooperation among bank regulators have steadily developed and become more precise and defined since the early 1970s.