Banking and financial intermediation
The crisis of 2007-2008 has revealed a deep lack of understanding of the sources of fragility in the financial system. For example, regulation of the banking sector was tailored to prevent isolated bank failures, while ignoring the impact of such regulation on aggregate markets. Similarly, there was a severe lack of understanding of other, unregulated parties offering financial intermediation services, such as credit rating agencies, hedge funds, etc. Now several years after the crisis, new financial intermediaries arise that largely depend on information technology and big-data (Fintech). Understanding whether these parties engage in regulatory arbitrage or provide meaningful new or more efficient services than existing banks will be important for the future of this sector. The same holds for, understanding how existing banks may respond to such competitive threats.
In this project, which is an umbrella for several potential projects, a number of alternative research problems are collected that provide additional insight into the role of banks and other financial intermediaries in the economy at large. Projects can be of theoretical or empirical nature. Projects at the boundary of financial intermediation and asset pricing or financial intermediation and corporate finance are also possible and even encouraged. Empirical projects can draw on the wide range of databases that is available at Erasmus University, including data on international stock prices, bank balance sheets, institutional ownership, mutual fund and hedge fund performance. Key questions are identified and investigated using appropriate and, where necessary, innovative econometric and/or micro-economic techniques. The first year of the project will be used to get acquainted with potential supervisors and to identify concrete research topics. During the entire project, three or four papers will be written, potentially with different supervisors, which jointly constitute the PhD thesis.
Banking, financial intermediation, financial crises, regulation, systemic risk
Precisely formulated research problems and questions are to be developed during the first year of the project, but in general can be expected to center around one of the following (interrelated) themes. The discussion of the themes contain various references to recent papers by ERIM finance faculty members, which gives an indication of the type of research that ERIM finance researchers specialize in.
Recent literature emphasizes the endogenous nature of liquidity. In particular, fire-sales at the side of constrained investors (such as banks, insurance companies or mutual funds) can lead to significant price discounts in financial markets (e.g., Coval and Stafford, 2007). An important insight of this take on financial markets is that the liquidity of an asset can depend on its ownership characteristics, in particular, whether investors are likely to be constrained or not (e.g., Wagner, 2011). On the other hand, illiquid assets may attract patient clienteles such as life insurers or pension funds (see e.g., Beber, Driessen and Tuijp, 2012). This has both implications for the pricing of assets, as well as desired portfolio holdings of agents in the financial system.
Information production, governance, and incentives
One function of financial intermediaries is to produce information. One can think about banks or credit rating agencies that screen and monitor borrowers or accountants that generate information that is crucial in ensuring proper conduct of business. Yet, the parties that produce such information may not have incentives that are perfectly aligned with those of their end-users (see e.g., Bongaerts, 2014). As a result, many of such parties are being regulated, but regulation by itself may induce improper behaviour such as regulatory arbitrage (Bongaerts et al., 2012). Several new mechanisms to induce proper behaviour, such as mandatory rotation, have been proposed or implemented in recent years. It is however unclear how effective these are and whether there are any unintended side-effects.
Incomplete markets and banking
It is well known that prices in incomplete markets are not uniquely determined. However, little attention has been paid to the question of how this should affect financial regulation. For one, if there is a wide range of potential prices, it is more likely that financial regulation that uses market prices (or balance sheet and income statement items with mark-to market accounting) as inputs will be inadequate. Multiplicity of prices can also create fragility in financial markets, which may by itself provide a rationale for regulation.
Diversity and the financial system
Diversity (heterogeneity) in the financial system is an important source of financial stability but has until recently been largely ignored by policy makers and academics. As an example, a financial system in which institutions follow different strategies, and are subject to different constraints, is likely to be more resilient than a system with homogenous players. A lack of diversity, by contrast, has shown to contribute to financial instability (Persaud, 2000, Khandani and Lo, 2011). A question of great importance for policy makers is which factors influence the diversity of a financial system, and also how one can measure diversity. Another question would be how to design policies that encourage diversity. One may consider policies that promote diversity indirectly, for example, capital surcharges for institutions that are deemed too similar to the rest of the system (Malherbe and Wagner, 2015). A more ambitious approach would be to consider actively encouraging variety in business models. This, in turn, relates to the question of how traditional banks should be regulated relative to new players (Harris, Opp and Opp, 2015, Ordonez 2015, Plantin, 2015).
Financial innovation and the real economy
The last two decades have witnessed a plethora of innovations in financial markets (e.g., Tufano, 2003). Two important examples from credit markets are credit derivatives and securitization products (and a very recent development is so called FinTech: innovations in the nexus of technology and finance that have the potential to disrupt traditional intermediation). There is a growing literature on the impact of financial innovation, focusing on the users of the innovation themselves. For instance, it has been shown that the usage of financial innovation affects the risk-taking of banks but also lending conditions (e.g., the pricing of loans) and the likelihood of borrower defaults. However, little is known on the implications for the overall economy. For instance, how does the usage of financial innovation affect risk sharing in the economy? Does it lead to a better allocation of capital across firms? And what about the cyclicality of the economy? For example, if these innovations reduce financial constraints, firms may respond more efficiently to shocks, with repercussions for economic fluctuations.
If empirical: Data collection and cleaning, using and combining existing financial databases. Employing and/or developing econometric methodology. Empirical analyses and interpretation.
If theoretical: Model-building using micro-economic theory. Preferably derive empirical implications, calibrate to data and test.
Candidates should have a strong background in finance, micro-economics, or econometrics. Especially for empirical projects experience with econometrics software and programming languages (e.g., Matlab, R, Ox) is highly recommended. Further, candidates should be fluent in English. Candidates should have a strong interest in finance, but not necessarily an MSc or MPhil degree in finance since the PhD program involves a thorough curriculum of finance courses.
The project will result in three to four articles, that will be targeted for publication in the top finance journals (ERIM P, P* list). In addition, a PhD thesis will be completed that combines these articles.
In general, this project can be expected to have important implications for both the academic literature and the asset management industry.
Ashcraft, Adam and João Santos: 2009, ‘Has the CDS market lowered the cost of corporate debt?’.
Beber, Alessandro, Joost Driessen, and Patrick Tuijp. "Pricing liquidity risk with heterogeneous investment horizons." Working Paper (2012).
Bertay, A., Gong, D. and W. Wagner “Securitization and Economic Activity: The Credit Composition Channel”, CEPR Discussion Paper No. DP10664, forthcoming Journal of Financial Stability.
Bongaerts, Dion. "Can alternative business models discipline credit rating agencies." Unpublished working paper (2014).
Bongaerts, Dion, K. J. Cremers, and William N. Goetzmann. "Tiebreaker: Certification and multiple credit ratings." The Journal of Finance 67.1 (2012): 113-152.
Coval, Joshua, and Erik Stafford. "Asset fire sales (and purchases) in equity markets." Journal of Financial Economics 86.2 (2007): 479-512.
Eisfeldt, Andrea: 2004, ‘Endogenous Liquidity in Asset Markets’. Journal of Finance 59(1), 1—30.
Holmström, Bengt and Jean Tirole: 2001, ‘LAPM: A Liquidity-Based Asset Pricing Model’. Journal of Finance 56, 1837—1867
Harris, M., C. Opp, and M. Opp (2014), Higher capital requirements, safer banks?, working paper.
Khandani, Amir and Andrew Lo (2008), “What Happened To The Quants In August 2007?: Evidence from Factors and Transactions Data”, NBER Working Paper No. 14465.
Keys, B. J., Mukherjee, T., Seru, A., & Vig, V. (2010). Did securitization lead to lax screening? Evidence from subprime loans. The Quarterly Journal of Economics, 125(1), 307-362.
Morris, Stephen and Hyun Song Shin: 2004, ‘Liquidity Black Holes’. Review of Finance 8, 1—18.
Nadauld, T. D., & Weisbach, M. S. (2012). Did securitization affect the cost of corporate debt?. Journal of Financial Economics, 105(2), 332-352.
Norden, L., Buston, C. S., & Wagner, W. (2014). Financial innovation and bank behavior: Evidence from credit markets. Journal of Economic Dynamics and Control, 43, 130-145.
Ordonez Guillermo (2015), "Sustainable Shadow Banking," NBER Working Papers 19022
Persaud, Avinash (2000), “Sending the herd off the cliff edge: the disturbing interaction between herding and market-sensitive risk management models”, Jacques de Larosiere Prize Essay, Institute of International Finance.
Plantin, Guillaume (2015), "Shadow Banking and Bank Capital Regulation", forthcoming Review of Financial Studies
Pulvino, Todd: 1998, ‘Do Asset Fire Sales Exist? An Empirical Investigation of Commercial Aircraft Transactions’. Journal of Finance 53, 939—978.
Rajan, Raguram, 2005."Has Financial Development Made the World Riskier?," NBER Working Papers 11728.
Tufano, P., 2003. Financial Innovation, in Handbook of the Economics of Finance (Volume 1a: Corporate Finance), George Constantinides, Milton Harris and Rene Stulz, eds. (Elsevier), 307-336.
Wagner, Wolf, 2011, Systemic Liquidation Risk and the Diversity-Diversification Trade-Off, Journal of Finance, Vol. 66, p. 1141-1175.
Wagner, Wolf, 2013, Performance Evaluation and Financial Market Runs, Review of Finance, vol. 17(2), pages 597-624.