Essays on uncertainty and risk aversion

In the present paper fundamental changes in monetary policy strategy, especially in leading industrialized countries, from concentrating on development of the quantity of money to focusing strictly on developments of interest rates and interest rate levels is analysed in the case of the European Central Bank. The goal of research is to show that this change in monetary policy is one important reason for expansions of the European debt crisis since 2010. Within this new monetary policy regime, interest rate levels on the one hand and the transmission of interest rate policy measures to the interest rates of the other financial markets on the other hand, have become a very important role in central banking policies of today. For example to guarantee a sure and strict transmission of interest rate policy measures, which have its starting point on the short-term money market, and which should radiate to long-term interest rates on the capital market the ECB, if necessary, uses outright monetary transactions in secondary markets for sovereign bonds in the euro area. The main reason for acting in that manner is to avoid rising of long-term interest rates and to guarantee low levels of interest rate in the sovereign bonds markets. It is argued in the present paper that in focusing to guarantee low interest rate levels especially to overcome economic crisis you can find one important reason for expansions of the European debt crisis. This is so, because in view of current European economic policy rising interest rates in the European bonds markets above a level of 6 or 7 percent have become an unmistakeable proof of a severe debt problem.

In recent years, the importance of international capital flows has been increasing, which has significantly accelerated the integration process of the international financial system. After 2008, the central banks of major western developed economies implemented loose monetary policy, which led to a large amount of capital flowing into new market countries. However, international capital flowed out of new market countries after Federal Reserve Chairman Ben Bernanke said in 2013 that the Federal Reserve would gradually withdraw from quantitative easing.The great fluctuation of international capital has aroused the debate about monetary policy and macro-prudential policy. Rey (2015) believes that under any exchange rate system, only the control of international capital flows can maintain the independence of monetary policy. In view of the above findings, since 2016, the People’s Bank of China has established a macro-prudential regulatory mechanism for international capital flows to resist external financial shocks.By introducing domestic and international financial institutions, this paper brings the macro-prudential policy of foreign financial shocks and capital flows into the DSGE framework of small countries’ open economy. Domestic financial institutions can raise funds by absorbing the deposits of their own residents and foreign residents; international financial institutions buy and sell the creditor’s rights issued by various countries, so as to implement capital flows.It is found that under the impact of foreign interest rate increase, on the one hand, it will tighten the balance sheet of domestic financial institutions, and reduce the scale of corporate credit through bank incentives and constraints; on the other hand, it will cause the devaluation of domestic currency and international capital outflows, and affect the stability of the financial system. The macro-prudential management mechanism of capital flows can enhance the ability to resist external financial shocks. For China, the proportion of foreign debt is relatively low, and the policy effect is relatively mediocre for the counter cyclical tax adjustment mechanism of external borrowing of domestic financial structure; however, the counter cyclical adjustment mechanism for the capital flow of international financial institutions can significantly improve social welfare.This paper gives the following policy recommendations: Firstly, we should increase the significance of external financial risk prevention. In recent years, the rapid growth of international capital flows has brought new challenges to new economies. Secondly, we should strengthen the supervision of cross-border capital flows to resist external financial risks. In the process of further opening up of China’s financial market, the People’s Bank of China should improve the macro-prudential supervision of foreign exchange market, real estate market and credit market to prevent systemic financial risks. Finally, we should properly solve the financing problems of enterprises. For China, capital outflows will aggravate the already severe credit market pressure. Therefore, on the one hand, resist the external financial risk contagion through the macro-prudential supervision mechanism of capital flows; on the other hand, maintain the liquidity at a reasonable level through the flexible operation of monetary policy, in order to support economic growth.

While uncovered interest parity (UIP) fails unconditionally, UIP conditional on monetary policy actions remains a cornerstone of macroeconomic models used for monetary policy analysis. We posit that monetary policy actions are partially revealed by FOMC statements and propose a new identification strategy to uncover the degree to which such policy actions induce comovement in exchange rates and long-term interest rates consistent with uncovered interest parity. We reach three conclusions. First, there is evidence in favor of UIP at long horizons, conditional on monetary policy actions, for Dollar/Euro and Dollar/Yen exchange rates. Second, short-run movements in exchange rates following monetary policy surprises are consistent with the overshooting prediction of Dornbusch (1976), although our approach cannot test UIP at short horizons. Finally, we examine the degree to which monetary policy statements since the onset of the zero-lower bound (ZLB) on the short-term interest rate in the United States have engendered different comovement between long-term interest rates and exchange rates and find little evidence for a change in relationships.

Time-varying risk aversion and currency excess returns

Local government debt plays an important role in promoting economic development, but with the continuous expansion of the scale of local government debt, coupled with the opacity of financial and debt information, local debt risk may be directly transformed into financial risk. Therefore, the potential mechanism of local government debt risk inducing systemic financial risk is studied to strictly control local government debt and prevent it at present. It is of great practical significance to mitigate systemic financial risk. At present, the research on local government debt mainly focuses on the mechanism of local government debt to amplify economic fluctuations, while the potential mechanism of local government debt risk to induce systemic financial risk is relatively few. From the perspective of local government bonds and land finance, the innovation of this paper is to depict the Chinese elements such as the maturity of local government bonds, the opacity of debt and financial information, and to integrate local government debt, land finance and financial intermediaries into the framework of general equilibrium to analyze the potential mechanism of systemic financial risk induced by local debt risk. This study finds that when the economy is facing negative productivity shocks, the decline in total output will inhibit the land demand of households and enterprises, and the decline in land prices caused by the decline in demand will reduce the land-related fiscal revenue of local governments. On the one hand, the decline of land-related fiscal revenue will reduce government expenditure; on the other hand, it will increase the pressure on local governments to repay debt and the risk of debt, which will lead to the rise of bond interest rates and the decline of bond prices. Lower bond prices will affect the balance sheet of financial intermediaries, resulting in increased leverage and risk premium of financial intermediaries. Under the balance sheet constraints, financial intermediaries will shrink corporate credit, resulting in an increase in systemic financial risk. Rising interest rates and tightening credit will restrain enterprises’ investment and land demand, further reduce total output and land prices, increase the debt risk of local governments, and form a financial accelerator mechanism in the economy, which will lead to the mutual reinforcement of the debt risk and financial risk of local governments and form a vicious circle. In addition, when financial risk rises, the default risk of local government debt is lower. Based on the trade-off between risk and return, financial intermediaries will hold more local government bonds. Credit squeeze brought by asset allocation changes will further strengthen the financial accelerator mechanism and strengthen the interaction between debt risk and financial risk. Meanwhile, although extending the bond maturity can reduce the pressure of local governments to repay their debt in the short term, the longer the bond maturity is, the greater the financial shock and economic volatility caused by local government debt risk are. The paper indicates that: for resolving local government debt risk and reducing the probability of systemic risk, we firstly need to improve the local government bond market, diversify local government bond investors, and change the current situation dominated by commercial banks; secondly, we should strengthen budget constraints and control the scale of local government debt; thirdly, we should rationally design the maturity structure of local government bonds, strengthen the transparency of local government finance and debt information, and play the role of market constraints; finally, when financial risk rises, the central bank can adopt non-traditional monetary policy to intervene in the market, which can reduce financial risk and social welfare losses.

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.

Liquidity Risk and Performance of Banking System in Malaysia

Analyzing the nexus between financial risk and economic risk in India: Evidence through the lens of wavelet coherence and non-parametric approaches

We argue that women have long been involved in the financial sector, as investors and savers. As legislation gave married women equal rights to those of spinsters and widows by the end of the nineteenth century, and as low‐risk securities that appealed to women were increasingly offered to investors, so women increased in importance relative to men, outnumbering men by the 1950s. Whether out of necessity or preference, women took less financial risk than men. This difference in risk attitude has persisted to the present, whether in pension investment choice or in the substantial gap between the numbers of men and women who are employed in senior roles in the financial services sector, in the United Kingdom and the United States. Despite changes in women's activity over time, it seems that there is a persistent belief that women are innately different from men – in particular, more risk averse – in their financial ability and preferences.

[ACCESS RESTRICTED TO THE UNIVERSITY OF MISSOURI AT REQUEST OF AUTHOR.] The 2007-2009 economic events have renewed interests in the relationship between the financial sector and the macroeconomy and suggested that shocks originated in the financial sector may be a potential source of business cycle fluctuations. In this regard, this dissertation focuses on quantifying and assessing the role of shocks originated from the financial sector in driving business cycle fluctuations and how monetary policy could possibly respond from a welfare prospective. The dissertation consists of three chapters. The first chapter attempts to model the relationship between the financial sector and the macroeconomy theoretically. Specifically, I build a dynamic stochastic general equilibrium (DSGE) model by incorporating a financial sector with frictions between investors and banks. The existence of such frictions affect the healthiness of the financial sector and increase its riskiness, whereas would not affect those of the non-financial sector by much. I regard this type of frictions as supply-side financial shocks that are originated in the financial sector. Under this framework, the external finance premium in the financial sector can be determined endogenously. To study how the financial shocks would affect the dynamics of the model, impulse responses are used to show that the inclusion of those financial shocks yield larger amplification effects. Thus the model is able to generate higher volatility in aggregate outcomes, especially in the financial sector. This provides theoretical grounds to study the role of supply-side financial shocks for the next two chapters. Chapter two seeks to quantify empirically the effects of the financial shocks on the macroeconomy in a structural vector autoregression (SVAR) model. Based on the model implications derived from Chapter one, two types of financial shocks can be discriminated|the demand-side financial shock that comes from the entrepreneurial sector and the supply-side financial shock that comes from the financial sector. The identification strategy is that these two types of shocks affect the standards deviation of the equity returns in financial and entrepreneurial sectors in opposite directions. The overall SVAR results show that the effects of financial shocks on the real economic activities are non-trivial, although not major. In particular, the supply-side financial shocks originating from the financial sector explain a non-negligible part of the variabilities for the key macro variables; whereas for the financial variables, they are the main drivers, especially during the 2007-2009 crisis period. Chapter three studies how monetary policy should respond to this type of supplyside financial shocks from a prospective of social welfare. In particular, I consider a Taylor-type monetary policy rule augmented with a financial variable|the external finance premium. By doing so, it allows the central bank to react to the changes in the riskiness of the financial sector, in addition to the conventional output and inflation targets. The welfare results show that it is optimal for the central bank to respond to the financial variable. In other words, when there are shocks originated in the financial sector, the riskiness of the financial sector increases, and so do the external financing costs and the external finance premium in the financial sector. The banks' balance sheet conditions worsen and the central bank should cut its policy rate. The welfare analysis also implies that the inflation stabilization is still the most important target of the central bank, which in line with the literature that emphasizes the importance of inflation targeting.

The article examines the theoretical and methodological aspects of financial risk management, which is one of the key factors in ensuring the stability and effective functioning of enterprises in modern conditions of uncertainty. The main concepts of financial risk and approaches to its classification are highlighted, in particular, systemic and non-systemic risks are distinguished, internal and external factors of their occurrence are distinguished. The main types of financial risks are analyzed, including credit, interest, currency, operational, investment, inflation risks and liquidity risk. Their impact on the financial and economic activities of enterprises and factors that cause an increase or decrease in the level of financial risks are considered. Special attention is paid to political and macroeconomic aspects that can cause the emergence of new risks or exacerbate existing threats. The work systematizes scientific approaches to determining the essence of financial risk, and provides interpretations of this concept by various researchers. Key methods of financial risk management are identified, including diversification, insurance, hedging, limiting, creating reserves, using financial derivatives and avoiding excessively risky transactions. Mechanisms for assessing financial risks based on fundamental indicators, macroeconomic indicators, financial ratios and market multipliers are outlined. The main stages of financial risk management are considered, including identification, analysis, assessment, development and implementation of a risk minimization strategy, as well as constant monitoring and adjustment of risk strategies in response to changing market conditions. The importance of using financial regulations as a tool for controlling the level of risks, as well as the introduction of effective methods for predicting possible threats in the financial sector, is particularly emphasized. It is concluded that effective financial risk management contributes to strengthening the financial stability of enterprises, increasing their competitiveness and ensuring long-term development in an unstable market environment. A financial risk management model has been developed.

The most important feature of the last twenty years in the world economy is the digitalization of the social and economic field. This new trend is a process that can not be analyzed by unconventional methods, approaches, and techniques. This process is a dynamic mechanism that involves rapidly spreading effects. Therefore, digitalization has revealed an economic and social situation in which institutions are constantly transformed, innovations are applied very quickly, and are in demand. The most important problem in the studies to be carried out on this subject is the discussions about the measurement of digitalization and whether its numerical indicators are representative of the process or not. The extent of digitalization in the economy is Fintech applications in industry 4.0 money markets and financial markets in real terms. In today’s business world, the size of the relationship between production and the market changes in the digital economy. Achieving the accumulation of knowledge in the economy at lower costs with the effect of digitalization has led to the production of an important digital information. This accumulation of knowledge led to changes in economic behavior and preferences in business models. The economic area where the effect of this change is seen most rapidly is the financial area. Digitalization in the financial area is emerging as a new source of risk. In this respect, the increase in the volume of financial data with digitalization made the necessity of new analysis techniques necessary. Data sets resulting from the increase in the volume of data are defined as big data. In general, these big data have high frequency and real time or instant data feature in the financial system. The analysis of these data is a basic tool for measuring financial risks with systemic financial risks and the risk level of the markets. Digital economy is defined as a new economic structure as a result of changing the structure of the internet and communication systems. In this new structure, economic relations are created within the framework of the relationships established between the platforms. Establishing relationships between people, firms, and institutions through platforms reveal a lot of digitizable data. The continuous accumulation of this data online makes it necessary to carry out continuous analyzes according to each piece of information that is constantly received. The analysis of the information as well as the information turns into a product of economic value. The most important tool for this new transformation is artificial intelligence. Artificial intelligence and deep learning methods with machine learning, which are its tools, also cause changes in the financial and monetary relations of the new economy. The first major impact of this change was on the banking system. The changes in the banking system and the digital currencies and the developments that emerged with Facebook’s announcement on the issue of the Libra currency cause changes in the primary functions of the central banks and in the monetary transfer mechanism. The main reason for the change in the primary function of the Central Bank and the change in the monetary transmission mechanism is the differentiation in the property of the money. The differentiation in the feature and function of the central bank has to redefine its functions along with the monetary definitions of the central banks. Within the framework of this trend, the aim of this study is to analyze the change in the structure of central banks, the characteristics of money, and the functions of monetary policies, with the artificial intelligence and digitalization process.

Financial systemic risk – defined as the risk of collapse of an entire financial system vis-a-vis any one individual financial institution – is making inroads into academic research in the aftermath of the late 2000s Global Financial Crisis. We shed light on this new concept by investigating the value of various systemic financial risk measures in the corporate failure predictions of listed nonfinancial firms. Our sample includes 225,813 firm-quarter observations covering 8,604 US firms from 2000 Q1 to 2016 Q4. We find that financial systemic risk is incrementally useful in forecasting corporate failure over and above the predictions of the traditional accounting-based and market-based factors. Our results are stronger when the firm in consideration has higher equity volatility relative to financial sector volatility, the smaller size relative to the market, and more debts in current liabilities. The combined evidence suggests that systemic risk is a useful supplementary source of information in capital markets.

The increasing interconnectedness and digitalisation of the financial sector have exposed it to a new and pervasive threat: systemic cyber risk. Systemic cyber risk in finance refers to the potential for a cyber-attack or breach to cause widespread disruption and instability across financial systems and markets. This type of risk can arise from various sources, including hackers, insider threats, and technological failures. Financial institutions and policymakers can help safeguard the global economy and protect against potential disruptions and instability by addressing systemic cyber risk. To effectively mitigate systemic cyber risk, it is important to have a deep understanding of the potential threats and vulnerabilities within their systems. This requires ongoing analysis and study of the evolving nature of cyber threats and the latest technological advancements in cybersecurity. Ongoing analysis and study of cyber threats and advancements in cybersecurity are crucial to staying ahead of evolving risks and ensuring the financial system’s stability. In this context, Network analysis can be a valuable tool in studying systemic cyber risk in the financial domain since it is a powerful tool for understanding the interconnectedness of financial institutions and markets and the potential pathways for cyber risk to spread throughout the system. By mapping out these networks and identifying key nodes and vulnerabilities, institutions can better prepare for and respond to cyber-attacks.

Counter to the credit channel of monetary transmission, monetary policy tightening induces a rise in lending by two different types of non-bank financial institutions (NBFI): shadow banks and investment funds. A monetary DSGE model is able to replicate the empirical facts when augmented with interme- diaries that allow for regulatory arbitrage on the one hand, and household portfolio rebalancing on the other. Therefore NBFI reduce the effectiveness of the bank lending channel, which posits a decrease in bank lending following monetary tightening. Given the pending regulation of the fnancial system, I study how regulation of the shadow banking sector may affect the monetary transmission mechanism, especially during a zero lower bound (ZLB) episode. I find that bringing shadow banks back onto the balance sheets of commercial banks is beneficial for consumption smoothing. Alternatively, regulating them like investment funds results in a milder recession during, and a quicker escape from, the ZLB. This is because a large demand shock that moves the economy to the ZLB acts in a similar way to a monetary tightening due to the inability to lower the policy rate to the unconstrained level. Consequently, the bank lending channel becomes operational and its effectiveness can be reduced via less reliance on deposit funding.