Contributions published at Banking (Jean-Charles Rochet)

In this study, we consider the statistical arbitrage definition given in Hogan, S, R Jarrow, M Teo and M Warachka (2004). Testing market efficiency using statistical arbitrage with applications to momentum and value strategies, Journal of Financial Economics, 73, 525–565 and derive the statistical arbitrage condition in the multi-asset Black–Scholes economy building upon the single asset case studied in Göncü, A (2015). Statistical arbitrage in the Black Scholes framework. Quantitative Finance, 15(9), 1489–1499. Statistical arbitrage profits can be generated if there exists at least one asset in the economy that satisfies the statistical arbitrage condition. Therefore, adding a no-statistical arbitrage condition to no-arbitrage pricing models is not realistic if not feasible. However, with an example we show that what excludes statistical arbitrage opportunities in the Black–Scholes economy, and possibly in other complete market models, is the presence of uncertainty or stochasticity in the model parameters. Furthermore, we derive analytical formulas for the expected value and probability of loss of the statistical arbitrage portfolios and compute optimal boundaries to sell the risky assets in the portfolio by maximizing the expected return with a constraint on the probability of loss.

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We develop a simple macroeconomic model with extreme financial frictions (no credit markets) and show that poverty traps can emerge even in the absence of leverage. In our model, farmers produce fruit by renting land from landlords. Crops are exposed to aggregate shocks (weather risk). To guarantee themselves a positive consumption level even after a bad crop, farmers store fruit as precautionary savings and adjust their scale of activity to the level of these savings. The land that is not rented to farmers is cultivated by landlords, who are less productive. We show that there is a unique Markov competitive equilibrium, in which the rental price of land increases with the level of farmers’ savings. A decline in savings, caused by a bad crop, may bring the economy into a ”poverty trap”, even in the absence of any leverage. Fluctuations of output are caused by productivity shocks and amplified by fluctuations in the level of activity of farmers. The simplicity of our model allows us to study analytically why the long run behavior of the economy may differ markedly from the one predicted by the steady state paradigm. Specifically, we show that when the risk-adjusted productivity of farmers is high and the elasticity of the land supply is low, using the steady state paradigm leads to serious mis-estimations of the long run average state of the economy.

The short-term debt markets have been believed to be in the epicenter of the financial crisis of 2007-2008. The repurchase agreement market is one of the biggest short-term debt markets. By analyzing data from 57'783 repurchase agreement transactions between 2003 and 2015, I do not find evidence of a "run" on the repo market apart from a contraction of private asset-backed securities and corporate debt used as collateral. Although haircuts and notional amounts of repo funding did not show any signs of distress, the sharp contraction of the use of specific asset classes as collateral may have severely impacted the shadow banking system. The hypothesis, however, that there was a systemic run on the repo market in the context of soaring haircut margins and sharp decline of cash offered, cannot be supported by this study.

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The thesis provides evidence that the capital structure of the 100 largest publicly-traded U.S. and European commercial banks and bank-holding companies during 2004 to 2014 can be mostly explained with standard cross-sectional determinants of non-financial firms' leverage. The model composition and the extension follow the structure of Gropp and Heider (2010). However, adding risk to the model increases the significance of the model. In addition, there is evidence that deposit insurance coverage has an impact on banks' capital structure. Since the sample period contains the global financial crisis and there is an effect on the overall estimations, to overcome this issue the entire sample pe­ riod is divided into three sub-periods: before the global fmancial crisis (2004-2006), dur­ ing the crisis (2007-2010) and after the crisis (2011-2014). The estimations show that there is a significant bias on the estimates across the entire sample period. The crisis sub­ period strongly affects the estimations of the entire sample period, whereas the after-crisis period has a weaker effect. The best model fit is reached with data before the crisis period.

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The private banking industry is facing numerous challenges pertaining to low interest rate environment, shrinking margins, waves of regulatory measures, and digitalization. But, none ofthese will determine the future course of action as strongly as the changing investor behavior. This master's thesis contributes to the ongoing research in academia and industry on identifying the most important dimensions of investor behavior change and their implications for the industry. The aim of this thesis is to identify the changes and the differences in investors' behavior using the concept of source of wealth. To achieve this objective, an industry survey was done from wealth managers of some of the big private banks. The purpose of the survey was to obtain detailed information on investor behavior considering factors such as risk appetite, exposure, time horizon, and complexity across asset classes. To incorporate the concept of source of wealth, the wealth managers were asked questions for the four most common client categories - corporate executives, first generation entrepreneurs, inheritors, and retired individuals. The results of the study clearly indicate that across most of the investor dimensions considered, there is an observable behavioral difference demonstrated by the investment decisions. The granular analysis further established that the degree of such change can vary from one case to another. One important result of the study is that retired individuals are showing an overall tendency to decrease their risk appetite, whereas first generation entrepreneurs are probably the most demanding and risk seeking clients for the . banks. Overall, it appears that the source of wealth plays a key role in clients' investment decisions. The survey study also gave important strategic implications in the areas of digitalization, regulations, and others.

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Since the Global Crisis, sovereign debt levels have exploded in many OECD countries. This column presents a new measure of government debt – maximum sustainable debt. This measure takes account of the fact that a shortfall in growth naturally increases the probability of default, while allowing for the possibility of rollover. Applications to recent data suggest that without sufficient institutional constraints, governments will generally borrow up to a level close to the maximum that can be sustained.

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We analyze statistical arbitrage with pairs trading assuming that the spread of two assets follows a mean‐reverting Ornstein–Uhlenbeck process around a long‐term equilibrium level. Within this framework, we prove the existence of statistical arbitrage and derive optimality conditions for trading the spread portfolio. In the existence of uncertainty in the long‐term mean and the volatility of the spread, statistical arbitrage is no longer guaranteed. However, the asymptotic probability of loss can be bounded as a function of the standard error of the model parameters. The proposed framework provides a new filtering technique for identifying best pairs in the market. Backtesting results are given for some of the pairs of stocks that are studied in the literature.

We develop a novel dynamic model of banking showing that aggregate bank capital is an important determinant of bank lending. In our model commercial banks finance their loans with deposits and equity, while facing equity issuance costs. Because of this financial friction, banks build equity buffers to absorb negative shocks. Aggregate bank capital determines the dynamics of lending. Notably, the equilibrium loan rate is a decreasing function of aggregate capitalization. The competitive equilibrium is constrained inefficient, because banks do not internalize the consequences of individual lending decisions for the future loss-absorbing capacity of the banking sector. In particular, we find that unregulated banks lend too much. Imposing a minimum capital ratio helps tame excessive lending, which enhances stability of the banking system.

We develop a theory of "risky utilities", i.e., private firms that manage an infrastructure for public service and that may be tempted to engage in excessively risky activities, such as reducing maintenance expenditures (at the risk of provoking a breakdown of the system) or in speculation (at the risk of incurring massive losses it cannot bear). These risky utilities include financial utilities like exchanges, clearinghouses or payment systems, as well as standard utilities like electricity transmission networks. Continuation of service is essential, so risky utilities cannot be liquidated. The optimal regulatory contract minimizes the social cost among the contracts that steer the firm away from risky activities. It is simple and implemented with a capital (equity) adequacy requirement and a resolution mechanism when that requirement is breached. The social cost function is explicitly computed, and comparative statics can be simply derived.

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Money, against the opinion of the majority, is currently produced by commercial banks. This paper focuses on the money creation process by firstly providing a historical overview and an explanation of the different theories about money creation. Subsequently, the current process of money creation is described. As this process is dominated by profit maximizing commercial banks, and in light of the recent financial crisis, alternatives to this money creation mechanism are analysed. The main alternative suggested by this paper is the sovereign money theory. In particular, special focus is given to the sovereign money initiative currently running in Switzerland (''Vollgeld-Initiative"). Even though the findings of this paper are in favour of a monetary reform, it is not possible to provide a final answer to the question of whether the sovereign money initiative in Switzerland can truly stabilize the economy and reduce the risk of future financial crises. Thus, it is concluded that, as a sovereign money regime is not implemented in any jurisdiction, the uncertainty and risk as a first mover might be too high for Switzerland.

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