Financial contagion from the US structuredfinance market: evidence from internationalmarkets and asset pricing perspectives
Year: 2014
Type: dissertation
Abstract: Given the growing importance of securitisation to financial stability, it is surprising that empirical \nstudies on the role of the US structured finance market in the recent crisis have been relatively \nsparse. To fill this gap, this thesis studies the US structured finance market (tracked by the ABX \nindices) and addresses various important research questions specific to the recent 2007 to 2009 \nfinancial crisis. First, I contribute to the contagion literature by extending Longstaff’s (2010) \ninvestigation to an international market perspective. Evidence of contagion from the ABX indices \nto the G5 international equity and government bond markets via the funding illiquidity and credit \nrisk channels during the subprime crisis is documented. Second, I formulate a multifactor model \nwith crisis interaction effects and document significant increases in the ABX AAA factor loadings \nduring the subprime crisis, which is consistent with contagion. My cross-sectional pricing tests \nshow that the ABX AAA factor significantly explains the cross-section of expected returns during \nthe subprime crisis; that is, the impact of contagion on the US equity market was reasonably \nsystematic. I compute a simple statistic that gauges the degree of the stocks’ exposure to the \nABX innovations in each month and find that the exposure spiked in February, July and October \n2007 and in February, July and November 2008. Third, I investigate whether the US bank holding \ncompanies’ fundamental characteristics determine bank equity risks during the recent crisis. I \ndepart from prior studies and consider bank equity risks relating to the banks’ exposure to the \nABX innovations, the asset-backed money market and the market wide default risk in a variance \ndecomposition. My study establishes the link between the banks’ fundamental and equity risks, and \nshows that banks’ regulatory capital requirement is an effective means to limit banks’ exposure to \nsystemic risks in relation to funding illiquidity. Lastly, I document compelling evidence of quarterly \nbank stock return predictability based on variables relating to banks’ profitability, loan asset credit \nquality, capital adequacy and equity risks over the 2006 to 2011 period. By studying the turnover \nratios and order flows, I show that bank stocks with weaker fundamentals and smaller size were \ntraded more intensely in the following quarter while the higher trading activity was dominated by \nselling pressure. The evidence lends support to my ‘fire sale’ or ‘flight-to-safety’ hypothesis and \nreveals that the banks’ fundamental variables and size were the major criteria used by investors in \nformulating their ‘flight’ decisions during the recent crisis
Author: Woon Sau Leung
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W1962080133