Did the Market Signal Impending Problems at Northern Rock? An Analysis of Four Financial Instruments
AbstractThe academic literature has regularly argued that market discipline can support regulatory authority mechanisms in ensuring banking sector stability. This includes, amongst other things, using forward-looking market prices to identify those credit institutions that are most at risk of failure. The paper's key aim is to analyse whether market investors signalled potential problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities at the Bank of England in September 2007. A further aim of the paper is to examine the signalling qualities of four financial market instruments (credit default swap spreads, subordinated debt spreads, implied volatility from options prices and equity measures of bank risk) so as to explore both the relative and individual qualities of each. Therefore, the paper's findings contribute to the market discipline literature on using market data to identify bank risk-taking and enhancing supervisory monitoring. Our analysis suggests that private market participants did signal impending financial problems at Northern Rock. These findings lend some empirical support to proposals for the supervisory authorities to use market information more extensively to improve the identification of troubled banks. The paper identifies equities as providing the timeliest and clearest signals of bank condition, whilst structural factors appear to hamper the signalling qualities of subordinated debt spreads and credit default swap spreads. The paper also introduces idiosyncratic implied volatility as a potentially useful early warning metric for supervisory authorities to observe.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by HAL in its series Working Papers with number hal-00547736.
Date of creation: 17 Dec 2010
Date of revision:
Note: View the original document on HAL open archive server: http://hal.archives-ouvertes.fr/hal-00547736/en/
Contact details of provider:
Web page: http://hal.archives-ouvertes.fr/
Bank regulation ; bank failures ; market discipline ; early-warning signals;
Other versions of this item:
- Maximilian J. B. Hall & Paul Hamalainen & Adrian Pop & Barry Howcroft, 2008. "Did the market signal impending problems at Northern Rock? An analysis of four financial instruments," Discussion Paper Series 2008_11, Department of Economics, Loughborough University, revised Oct 2008.
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-01-03 (All new papers)
- NEP-BAN-2011-01-03 (Banking)
- NEP-FMK-2011-01-03 (Financial Markets)
You can help add them by filling out this form.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (CCSD).
If references are entirely missing, you can add them using this form.