Essays in Financial Intermediation and Credit Risk
Pereira, Javier Marcelo
MetadataShow full item record
This dissertation focuses on issues in financial intermediation and sovereign credit risk. With the enactment of the Gramm-Leach-Bliley Act (GLBA) in 1999, the long-standing barriers between commercial and investment banking activities were formally removed. In chapter 1, I show that the increased competition, drastic reduction in underwriting fees and the increased issue complexity associated with the rapid entry of large commercial banks in securities underwriting lowered the screening incentives of top tier underwriters and led to deviations from the “underwriter certification hypothesis” (namely, that high-reputation underwriters should be associated with higher quality certification). Using data from the high-yield corporate bond market, I identify three patterns which are difficult to jointly reconcile within the standard reputation literature. First, evidence of increased credit rating variability reveals a structural change in the certification standards of prestigious underwriters after GLBA. This finding suggests that reputation concerns, a key source of discipline, did not prevent underwriters from lowering their screening standards. Second, the high yield bond market is dominated by high reputation underwriters. Hence, to account for such a behavior in a market dominated by prestigious institutions, a coordination device for poor certification would be necessary. Third, after accounting for issuer-underwriter matching, top tier underwriters still achieve lower at-issue yields post GLBA. Following poor certification, I show that market punishment through higher yields is confined to low reputation institutions. My findings suggest limitations of the reputation based disciplining mechanism. In chapter 2, I propose a theoretical framework to account for these patterns. In particular, I adopt the model of Ordonez (2013) to incorporate insights from the global game literature into the reputation mechanism to demonstrate that reputation equilibriums are fragile and can lead to a clustering of poor screening among high- and intermediate-reputation underwriters. My model suggests that the lack of a credible market-based punishment mechanism may indicate sticky priors about the reputation of prestigious underwriters. Finally, chapter 3 of my dissertation represents an exploratory work on the role of sovereign credit risk in the risk-adjusted uncovered interest parity condition (RA-UIP) and proposes the use of sovereign CDS spreads as a proxy for the time-varying risk premium necessary to explain the UIP puzzle. Recent literature suggests that sovereign risk contains a strong global component that is priced in currency markets. Using sovereign CDS spreads, I first corroborate whether changes in sovereign credit risk have a contemporaneous effect in currency prices for a set of 12 countries. In line with Della Corte et al. (2014), I find a strong contemporaneous relation between sovereign risk and currency prices. Then, I study whether sovereign credit risk contains a global credit risk component and whether the latter is priced in exchange rates. Using an equally weighted portfolio of sovereign CDS spreads as a proxy for global credit risk, I find that most of the information embedded in sovereign credit risk relevant for exchange rate returns seems to be global in nature. In light of these findings, I place my attention on the valuation channel proposed by Gourinchas and Rey (2007) and explore empirically the role of a country’s net foreign asset position (NFA) for the dynamics of global credit risk exposure and exchange rate returns. I find that net creditor countries exhibit a strong positive relationship between global credit risk and exchange rate appreciation. Empirical findings demonstrate promising supportive evidence of an economic linkage between exchange rates, sovereign credit risk and macro fundamentals that warrants further exploration.
- Economics