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Market-Based Credit Quality Measure in the Subprime Crisis

Discussing a study on a novel market-based credit quality measure and its impact on banks during the subprime crisis, exploring factors such as interest rate risk, default risk, and inflation. Evaluating the pros and cons of the proposed approach and its relevance in predicting economic downturns.

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Market-Based Credit Quality Measure in the Subprime Crisis

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  1. Olivier De Jonghe Discussion of “A market-based measure of credit quality and Banks’ performance during the subprime crisis” By Martin Knaup Wolf Wagner

  2. Bank asset prices • Information impounded in bank asset prices • Stock return decomposition: • Systematic risk (market beta) • Interest rate risk (Flannery and James, JF 1984) • Inflation (Dermine and Lajeri, JBF 1999) • Exchange rate risk • Term risk (Viale et al. , JBF 2009) • Default risk • … Emerging scholars in Banking and Finance

  3. Credit quality • Default risk factor: • Yield difference between Baa and Aaa corporate bonds • Pros and Cons of your approach + High and Low riskCredit risk indicator ( H/(H+L)) • Short time period • Only 35 substituents in cross-over index • CDS spreads vs bond spreads: are they cleaner? • may turn – into = Emerging scholars in Banking and Finance

  4. On the motivation “ Ourproposed credit risk indicator differsconceptuallyfromothermarket-basedmeasures , such as DtDor (bank) CDS spreads. While these measures focus on the currentriskiness of a bank, the CRI measures the perceivedexposure of a bank to aneconomicdownturn(in which high risk assetspresumablyperformworsethan low risk assets).” • Stilldependsonpredictinganeconomicdownturn • Time-varyingbetas (regime switches) • Tailbeta: extreme system(at)ic risk • Hartmann et al. (2006) • De Jonghe (JFI, forthcoming) Emerging scholars in Banking and Finance

  5. Orthogonalization • Order of factors/shock (Choleski) • In this paper: • XO versus IG is irrelevant • Role of market factor Emerging scholars in Banking and Finance

  6. Absolute price changes • Mapping between model and estimations • Model is in MVE= P*NOSH • ∆p= absolute change in bank’s share price • Not relative change, i.e. return • How did you normalize stock index? • Correspondence to return-based market models? • Market beta of 0.03 • What are loadings of CDSXO, CDSIG in return model? • Similar CRI? Emerging scholars in Banking and Finance

  7. Other comments • Is average CRI of 0.11 plausible? • Multiple regimes in CRI? Calm vs stress? • What is economic significance of XO and IG? To what extent does fit of regression increase? • Are bank-specific coefficients on XO and IG significant? INTERESTING PAPER! Emerging scholars in Banking and Finance

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