Credit Spread Widening Risk and its Effects on Banks' Economic Capital

Letizia, Aldo

doi:10.2139/ssrn.1800584

Cited by 2 publications

(2 citation statements)

References 5 publications

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“…OAS analysis incorporates credit risk and contingent cash flow risk, providing insight into the determinants of corporate bond spreads. Previous research has utilized OAS to study various aspects, including corporate bond spreads in emerging markets (Cavallo and Valenzuela 2010), dynamic behavior of credit spreads on corporate bond portfolios (Bierens et al 2003), mortgage spreads (Boyarchenko et al 2019), and assessment of bank capital adequacy considering market yield fluctuations and credit spread widening risk (Letizia 2012).…”

Section: Materials and Methodologymentioning

confidence: 99%

Risk Structure of Banks in Spain: Do BHCs Have Greater Cost of Debt?

Boliari,

Topyan,

Wang

2023

Risks

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Holding companies legally separate the assets and owners of a company creating a layer of liability protection. Theoretically, this feature lowers the risk attributable to holding companies, enabling them to offer lower-cost debts compared to stand-alone alternatives. However, no study has ever tested this hypothesis due to its technical and practical difficulties. Testing this hypothesis requires a separate classification of holding and stand-alone companies’ outstanding debts to compare their risk spreads, controlling the bonds’ risk ranking, maturities, and issue sizes. Further, a model is needed to make the callable bond spreads with unknown maturity dates comparable to non-callable bonds. This work is the first attempt to evaluate the risk spreads of stand-alone banks and bank holding companies in Spain by including all outstanding rated bonds offered by Spanish banks. In order to make callable bond spreads comparable with noncallable bond spreads, we obtained the option-adjusted spreads for the bonds using a lattice option-pricing model that treats the callable bonds as a bond with embedded options. We then regressed to option-adjusted spreads on control variables and ownership structure dummy to see if there exists a statistically and economically significant coefficient for the introduced dummy variable. We found that bank-holding company bonds have higher risk spreads compared to the stand-alone alternatives in Spain. This may be attributable to the characteristics of holding companies that introduce other risks that offset the gains obtained from the added layer of liability protection.

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Section: Materials and Methodologymentioning

confidence: 99%

Risk Structure of Banks in Spain: Do BHCs Have Greater Cost of Debt?

Boliari,

Topyan,

Wang

2023

Risks

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“…Option-adjusted spreads were used by several researchers in different contexts. Cavallo and Valenzuela (2010) used option-adjusted spreads in emerging markets, Bierens et al (2003) used the method for corporate bond portfolios, Boyarchenko et al (2019) used it for mortgage spreads, and finally Letizia (2012) used it for an assessment of bank capital adequacy. However, this study is the first one using it to compare the cost of the debts of US stand-alone banks and bank-holding companies.…”

Section: Fixed Income Securities and Their Returnsmentioning

confidence: 99%

Credit Risk Management and US Bank-Holding Companies: An Empirical Investigation

Topyan,

Wang,

Boliari

et al. 2024

JRFM

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This paper empirically evaluates the impact of ownership structure on the cost of credit in US banks. It does so by comparing their grouped option-adjusted credit spreads on the outstanding debt issues. As the overall risk of the creditors is reflected in the yield spread of the firms’ outstanding bonds, separately classifying bank-holding companies and stand-alone banks and controlling risk ratings, maturities, and issue sizes enables us to compare the yield spreads tied to ownership structure. After computing the option-adjusted yield spreads of outstanding operating and holding company bonds, we used these values in a master regression equation to test the statistical and economic significance of the binary variable separating the option-adjusted spreads of the two sets. Our work finds that when the S&P ranks and maturities are controlled, US bank-holding companies finances with higher cost of credit compared with stand-alone banks, although holding companies add a layer of liability protection due to the legal separation between the assets and the owners. This suggests that certain characteristics of US bank-holding companies, such as higher leverage and higher systematic risk levels, make them riskier compared with traditional stand-alone banks, offsetting the benefits of forming a holding company.

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Credit Spread Widening Risk and its Effects on Banks' Economic Capital

Cited by 2 publications

References 5 publications

Risk Structure of Banks in Spain: Do BHCs Have Greater Cost of Debt?

Risk Structure of Banks in Spain: Do BHCs Have Greater Cost of Debt?

Credit Risk Management and US Bank-Holding Companies: An Empirical Investigation

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