Deferred Taxation Under Default Risk

This paper contributes to the burgeoning literature on the so-called “risk-taking channel” of monetary policy by constructing a partial equilibrium model of the commercial loan market, where conventional monetary policy influences bank lending standards and, by extension, the risk of bank default. In the model, borrower heterogeneity in terms of entrepreneurial abilities and project revenue results in optimal commercial bank lending standards. These standards take the form of a minimum ability requirement: only borrowers with abilities greater than or equal to the minimum threshold receive a loan; the rest are completely excluded from the loan market. After loans are made, a negative aggregate shock that lowers all borrowers’ project revenue results in unexpected loan losses for the bank that may push it into default. In the baseline model, lending standards loosen and the probability of bank default rises when the central bank’s policy rate falls, a result that suggests that asset quality and lending standards may play an important role in shaping the risk-taking channel of monetary policy. However, the relationship between bank default and the policy rate is sensitive to the extent of bank capitalization. While default risk and the policy rate are negatively correlated at relatively strongly capitalized banks, the risk of default at more weakly capitalized banks increases with the policy rate. Additionally, default risk at strongly capitalized banks is more responsive to changes in the policy rate than at weakly capitalized banks. This paper contributes to the literature on the risk-taking channel of monetary policy. First, the model enables analysis of the impact of monetary policy on risk-taking in a setting where both bank asset quality and leverage play a role in shaping the risk of bank default. Second, the model’s results on the role of bank capitalization imply that the tradeoff between financial stability and monetary policy depends crucially on bank capital ratios. This suggests that recent changes to bank capital requirements embodied in new post-2008 financial crisis regulations may impact the nature and size of the risk-taking channel.

Incremental Usefulness of the Parent-only Balance Sheet to Debt Holders: Evidence from Banks

In this study we present a comprehensive forward-looking portfolio simulation methodology for assessing the correlated impacts of market risk, private sector and Sovereign credit risk, and inter-bank default risk. In order to produce better integrated risk assessment for banks and systemic risk assessments for financial systems, we argue that reasonably detailed modeling of bank asset and liability structures, loan portfolio credit quality, and loan concentrations by sector, region and type, as well as a number of financial and economic environment risk drivers, is required. Sovereign and inter-bank default risks are increasingly important in the current economic environment and their inclusion is an important model extension. This extended model is demonstrated through an application to both individual Brazilian banks (i.e., 28 of the largest banks) and groups of banks (i.e., the Brazilian banking system) as of December 2004. When omitting Sovereign risk, our analysis indicates that none of the banks face significant default risk over a 1-year horizon. This low default risk stems primarily from the large amount of government securities held by Brazilian banks, but also reflects the banks' adequate capitalizations and extraordinarily high interest rate spreads. We note that none of the banks which we modeled failed during the very stressful 2007-2008 period, consistent with our results. Our results also show that a commonly used approach of aggregating all banks into one single bank, for purposes of undertaking a systemic banking system risk assessment, results in a misestimate of both the probability and the cost of systemic banking system failures. Once Sovereign risk is considered and losses in the market value of government securities reach 10% (or higher), we find that several banks could fail during the same time period. These results demonstrate the well known risk of concentrated lending to a borrower, or type of borrower, which has a non-zero probability of default (e.g., the Government of Brazil). Our analysis also indicates that, in the event of a Sovereign default, the Government of Brazil would face constrained debt management alternatives. To the best of our knowledge no one else has put forward a systematic methodology for assessing bank asset, liability, loan portfolio structure and correlated market and credit (private sector, Sovereign, and inter-bank) default risk for banks and banking systems. We conclude that such forward-looking risk assessment methodologies for assessing multiple correlated risks, combined with the targeted collection of specific types of data on bank portfolios, have the potential to better quantify overall bank and banking system risk levels, which can assist bank management, bank regulators, Sovereigns, rating agencies, and investors to make better informed and proactive risk management and investment decisions.

Accelerated Depreciation, Default Risk and Investment Decisions

In this article we focus on a representative firm that can decide when to invest under default risk. On the one hand, this firm can benefit from generous tax depreciation allowances, on the other hand it faces a default risk. Our aim is to study the effects of tax depreciation allowances in a risky environment. As will be shown in our numerical analysis, generous tax depreciation allowances lead to a decrease in a firm’s leverage and, in most cases, cause a reduction in default risk. This result has a strong policy implication, in that it shows that an investment stimulus pack is expected neither to increase the default risk nor to cause financial instability.

(ProQuest: ... denotes formulae omitted.)I. IntroductionThe purpose of this paper is to show that country fundamentals matter for the cross-section of currency excess returns. We include the variables reflecting macroeconomic fundamentals, such as interest rate, default risk, and foreign exchange rate regime. We also include the variables reflecting the degree of capital control and the size of capital market. We speculate that variations of country fundamentals may significantly affect the currency returns through increasing or decreasing the currency risks. For example, the adoption of more flexible exchange rate regime may increase the currency risks substantially. Our analysis shows that these variables do have explanatory power for the cross-section of currency excess returns.Some previous works also considered the country fundamentals as important determinants of currency returns. For example, Jorda and Taylor (2012) and Coudert and Mignon (2013) emphasize the relation of the real exchange rate and default risk with the currency returns, respectively. However, we consider a more extensive set of country fundamentals in this paper and adopt an empirical method basically different from the previous studies.This paper's empirical methodology is partly motivated both by Lustig et al. (2011), and Lustig and Verdelhan (2007). They explain the cross-section of currency returns with a single factor-the global carry profits in case of Lustig et al. (2011) and the global consumption growth in case of Lustig and Verdelhan (2007).We adopt the factor model framework of these authors, but we include new factors that are based on country fundamentals.1In a series of their highly original papers, Pojarliev and Levich (2008, 2010, 2011) build a multi-factor currency returns model from the popular currency strategies such as carry, value, trend following, and volatility. Pojarliev and Levich used the factor model to explain the performance of currency fund managers. We modify the work of Pojarliev and Levich in two directions. First, we construct factors from country fundamentals rather than from investment-style returns. Second, we use the factor model to explain the performance of currencies, rather than currency fund managers.Our main empirical results are based on monthly currency excess returns of 19 major currencies for the 10-year period between January 2001 and December 2010. The 19 currencies have been selected after dropping those currencies with inadequate fundamental data. Our main findings can be summarized as follows:First, when the currencies are sorted on the basis of forward premium, exchange rate regime, the degree of capital control, and the size of capital markets, there are persistent return differences between high-ranked and low-ranked currencies. When the currencies are sorted by default risk, the return differences between high-ranked and low-ranked currencies are not persistent. As far as forward premium is concerned, the pattern has been discussed extensively in the previous literature. The results regarding the other fundamental variables are original in this paper.Second, a parsimonious model with three factors-forward premium, default risk, and foreign exchange rate regime-explains a large part of the cross-section of currency excess returns.Also the zero-intercept restriction of the factor model is not rejected for 13 out of 19 currencies. In comparison, a factor model with three investment-style factors is rejected for 14 out of 19 currencies.In recent years, the persistent profits of so-called carry trades have drawn many authors' attention.2 Carry traders buy a high-yield currency and sell a low-yield currency, or, equivalently, take a long forward position in a high-yield currency against a low-yield currency. Such trades exploit the failure of the uncovered interest parity (UIP). If the UIP holds, the excess returns cannot be predicted by interest rate or forward premium. …

Default is an increasingly important issue for the Fall, as market stress builds in a weak economic and financial environment rally. The study seeks to investigate if financial tools such as hedging and working capital management can be used for a precaution against default risk in the textile sector of Pakistan. Furthermore, it provides us an analysis on how macroeconomic variables are managed reduces the risk of default. Several elements can potentially impact the likelihood of a corporation experiencing a default on its debt. Nevertheless, this research has only analyzed Working Capital Management, Hedging, and macroeconomic covariables. Data of 102 textile firms was collected for the time of 2015-2020. The objective of this analysis is to assess the influence of these variables on the likelihood of default. The present study employs a logical approach to inquiry. The deductive approach would be the most suitable to evaluate the hypothesis of causation in the study. Our study provides evidence of a strong and statistically significant negative relationship between working capital management and default risk. The importance of the impact of CPI and R&D Investment is observed at a significant level. The statistical significance of the relationship between GDP growth and the probability of default is acceptable. The statistical significance of the impact of interest rates on default likelihood is insignificant. This study offers significant theoretical contributions by incorporating well-established financial theories, including Credit Rationing Theory, to develop a complete framework for understanding default risk. This article examines how these ideas shed light on the behavior of lenders, conflicts of interest inside agencies, and the impact of free cash flow on corporate decision-making. Furthermore, this study investigates the often-overlooked aspect of working capital management and the role of hedging in risk management. This study offers practical insights for finance experts, corporate administrators, legislators, and investors.

The Aggregate Consequences of Default Risk: Evidence from Firm-Level Data

Financial reports report the activities carried out by the Company in an accounting period. The activities carried out are expressed in the form of numbers. The numbers in the financial statements become less meaningful if seen only from one side, the numbers in the financial reports can be more meaningful in assessing the performance of a company if they can be compared between one accounting post and another accounting post in the financial report which is called financial ratios. The purpose of this research is to find out how the financial performance of PT. Indofood Sukses Makmur, Tbk. based on financial ratio analysis consisting of liquidity, solvency and profitability ratios. The data analysis method used is a quantitative descriptive method using measurements of liquidity, solvency and profitability ratios. Based on the overall liquidity ratio, the company is in good condition and tends not to be able to maximize its working capital, which is indicated by the high liquidity ratio in 2022. Based on the profitability ratio, it is known that the company's funding structure tends to be balanced between funding sources from third parties and the company owner. The higher the solvency ratio, the higher the company's risk of default. In 2022, the company seeks to reduce its solvency ratio which is already quite high. Based on the profitability ratio, the company's performance can be said to be fluctuating, especially in 2022, there will be a decline in the company's profitability. This can be caused by the lack of optimal use of the company's resources to achieve profits.

This study empirically examines the impact of borrower, loan, and mortgage parameters on default risk in residential mortgage loans. Using 6743 individual housing loan accounts data from Housing Finance Institutions in Lebanon, we develop a comprehensive model using the multivariable binary logistic regression, best subset logistic regression, and stepwise regression analysis procedures to investigate the impact of 21 predictors and 29 sub-predictor parameters on log odds of default risk. In addition, the study conducted a model diagnosis using the Hosmer - Lemeshow Goodness of fit test, Likelihood Ratio Test, Model accuracy- Classification Table, Statistically Significant Test- ROC curve, and Pregibon Delta Beta Statistics. The study aims to assist financial institutions in managing and assessing the default risk more effectively and develop effective strategies to mitigate this risk. The empirical results suggest that the estimated probability of defaulting on a housing loan is approximately 3.8% when all predicted variables are set at their lowest value. In addition, marital status and the existence of dependence have a positive impact on default risk. The higher the number of dependents is, the higher the risk of default. Moreover, a widowed borrower has a higher log odd of default compared to single, married, and divorced borrowers. Furthermore, the results revealed that self-employed borrowers positively impact the risk of default due to the absence of a steady flow of income. In addition, there is an inverse relationship between the market price-to loan ratio and the log odds of default since the borrower’s equity will increase when the house price increases. However, log odds of default will increase when the loan value is higher than the mortgage market price. Moreover, the result shows that the nature of the borrower’s occupation has a positive relationship with log odds of default where borrowers working in real estate and construction sectors have lower default rates than borrowers working in other industries. In addition, a high interest rate increases the loan's monthly payment and therefore increases the probability of default. Furthermore, the loans granted for purchase and renovation purposes have a lower risk of default than the ones given for construction and under-construction. In addition, the model's overall accuracy was demonstrated by a 91.61 percent visible correct classification rate.

We develop a structural credit model to examine how interactions between default and liquidity affect corporate bond pricing. The model features debt rollover and bond-price-dependent holding costs. Over the business cycle and in the cross-section, the model matches average default rates and credit spreads in the data, and captures variations in bid-ask and bond-CDS spreads. A structural decomposition reveals that default-liquidity interactions can account for 10%–24% of the level of credit spreads and 16%–46% of the changes in spreads over the business cycle. Further, liquidity-related corporate bond financing costs amount to 6% of the total issuance amount from 1996 to 2015. Received July 12, 2015; editorial decision April 15, 2017 by Editor Andrew Karolyi. Authors have furnished an Internet Appendix, which is available on the Oxford University Press website next to the link to the final published paper online.

Puerto Rico's unique characteristics as a U.S. territory allow us to examine the transmission of quasi-sovereign default risk to the real economy.We document a negative relationship between increased default probabilities and employment growth in government-demand-dependent industries.The negative relationship strengthens when the government undertakes austerity measures.In addition, fiscal austerity reduces output growth via a local fiscal multiplier effect.Overall, we provide evidence for a novel demand-driven transmission mechanism of sovereign default risk that operates through austerity risk and government demand dependence.

This study aims to examine the impact of the net‐zero policy on forward default risk at the firm level within the energy sector of the US, spanning over the period 2007–2021. The research employs Panel Vector Autoregression (PVAR) modeling, as well as linear and non‐linear Autoregressive Distributed Lag (ARDL) models to investigate this relationship. The findings suggest that the implementation of net‐zero policy measures can have complex effects on firms' default risk in both the short and long run. The PVAR results confirm a unidirectional negative impact of net‐zero policies on forward default risk over 2, 3, and 5 years. The symmetric ARDL model results show a negative long‐run impact on the future probability of default, with short‐run impacts being positive across all time horizons. The asymmetric ARDL model findings indicate that positive net‐zero measures reduce the probability of default in the long run and increase it in the short run across all time horizons. Conversely, negative shocks of net‐zero measures lead to an increase in the forward probability of default in the long run. The differences in findings between the long and short run are attributed to the effects of capital expenditures on infrastructure expenses required to achieve net‐zero results. This study contributes to the literature on financial outcomes and the impact of adopting sustainable development and net‐zero goals. The policy implications suggest that a supportive institutional framework must be provided to reduce the financial default in energy sector firms, which will assist in capital and infrastructure expenditures in the short run.

An axiomatic approach to default risk and model uncertainty in rating systems

This paper represents an extension and integration of recent empirical and theoretical research on default risk and taxability. The purpose of the paper is to develop and test a model of interest rate spreads which incorporates both the effect of taxes and differences in default probabilities in a theoretically correct manner. There is an important fundamental difference between our approach to explaining yield spreads and the approach most commonly taken in literature. Unlike nearly all of the previous work, we do not begin with a yield spread model, i.e., one which begins by examining differences in yields, but rather begin with an expected return or pricing model, which can then be expressed in the yield spread format. This is a fundamental difference in approaches which we feel leads to a superior theoretical formulation which can then be tested empirically without many of the problems inherent in the alter- native approach. The theoretical model is a simple extension of earlier work on default by While there is a considerable literature that analyzes the effect of taxability on rate spreads, we are unaware of any previous study that considers tax conse- quences in the event of default, a rather surprising omission.