The timing of default can greatly affect an individual’s wealth. This paper empirically studies the optimal stopping decision —default— where subjects have the alternative to stop paying a loan on the asset whose value is governed by the Brownian motion. The optimal policy is to stop when the asset value crosses the optimal threshold defined by a real deferral option, where the deferral option ...

This paper analyzes US interest rate swap spreads in relation to the sovereign crisis of the Euro zone. The results reveal that swap spreads of 5and 10-years incorporate default risk positively in accordance with the theory. According to Ito (2010) which analyzed the period of global financial crisis stemming from subprime loan problem in the US, the default risk is negatively incorporated in t...

In this paper we relate a bank’s choice between retail and wholesale liabilities to real economic uncertainty and the resulting volatility of bank loan volumes. We argue that since the volume of retail deposits is slow and costly to adjust to shocks in the volume of bank assets, banks facing more intense uncertainty and more volatile loan demand tend to employ more wholesale liabilities rather ...

One of the particular problems facing agribusiness firms is the relationship between commodity price risk (a source of business risk) and debt repayment ability (a source of financial risk). This study examines the use of commodity-linked loans applied to agricultural credits. A commodity-linked loan is a credit instrument whose payoff is contingent on the value of an underlying commodity or po...

The authors conduct a counterfactual simulation of the proposed rules under the new Basel Capital Accord (Basel II), including the revised treatment of expected and unexpected credit losses proposed by the Basel Committee in October 2003. When the authors apply the simulation to Canadian banking system data over the period 1984–2003, they find that capital requirements for banks will likely fal...

In Hong Kong, 35% of residential mortgage loans are adjustable rate mortgages with variable tenor (VRT). That is, with a change in interest rates, the loan adjusts its maturity and principal payment such that the monthly installment remains the same. In other words, instead of bearing a volatility on monthly payments as in a ®xed-tenor variable payment (VRP) mortgage, VRT mortgagors bear intere...

In adjustable interest loans the borrower assumes the risk of interest rate rising, which leads to the growth of loan annuities. Given the importance of this risk in both corporate and personal finance, it is a recurrent topic in economic and financial press. In this paper, we show that the duration of a loan with constant annuity and interest rate can be used to assess the sensitivity of payme...

This study examines bank risk by investigating the equity and loan portfolio characteristics of publicly-traded bank holding companies. Unlike the pattern for non-financial firms, equity betas of large banks are two to five times greater than those of small banks. In explaining this, we note that regulation imposes an effective cap on banks’ equity volatility. Because the portfolios of small ba...

We propose a new model of exchange rates, which yields a theory of the forward premium puzzle. Our explanation combines two ingredients: the possibility of rare economic disasters, and an asset view of the exchange rate. Our model is frictionless, has complete markets, and works for an arbitrary number of countries. In the model, rare worldwide disasters can occur and affect each country’s prod...