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Did the market signal impending problems at Northern Rock? An analysis of four financial instruments

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posted on 10.02.2009 by Paul Hamalainen, Adrian Pop, Maximilian Hall, Barry Howcroft
The academic literature has regularly argued that market discipline can support regulatory authority discipline to monitor 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 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. In addition, the paper tests for evidence of an implicit “too-big-to-fail” policy in UK banking. Our analysis suggests that private market participants did signal impending financial problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities. 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.

History

School

  • Business and Economics

Department

  • Economics

Publisher

© Loughborough University

Version

VoR (Version of Record)

Publication date

2008

Notes

This is a working paper. It is also available at: http://ideas.repec.org/p/lbo/lbowps/2008_11.html

ISSN

1750-4171

Language

en

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