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Olivier De Jonghe Discussion of “A market-based measure of credit quality and Banks’ performance during the subprime crisis” By Martin Knaup Wolf Wagner
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
Credit quality • Default risk factor: • Yield difference between Baa and Aaa corporate bonds • Pros and Cons of your approach + High and Low riskCredit 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
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
Orthogonalization • Order of factors/shock (Choleski) • In this paper: • XO versus IG is irrelevant • Role of market factor Emerging scholars in Banking and Finance
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
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