Essays in Financial Economics

Rita Biswas, Michael Michaelides

• Publisher: Emerald Publishing Limited
• Year: 2019
• ISBN:
  9781789733914
• Topic: Business
• Subtopic: Finance
• Index: Business

This volume, dedicated to John W. Kensinger, explores a variety of topics in financial economics, including firm growth, investment risks, and the profitability of the banking industry. With its global perspective, Essays in Financial Economics is a valuable addition to the bookshelf of any researcher in finance.
Starting with a study examining the NYMEX Crude oil market, the first paper uses a no-arbitrage futures equilibrium cost-of-carry model that incorporates both the quality delivery option as well as the timing delivery option in the NYMEX contract. This is followed by two papers focusing on the growth of firms, one looking at a sample of S&P 500 firms in the US and one utilising a sample of firms from India's manufacturing sector.
The fourth paper compares the Fama-French (FF) five-factor model for firms on the Paris Bourse with the four-factor model, exploring how the fifth factor, investment risk premium, benefits the French stock market in comparison with the profitability factor (the fourth factor). The fifth paper examines the volatility of the Indian stock market, while the sixth looks at the Italian banking industry. Closing the volume is a paper that looks at the relationship between the US Dollar Index and several emerging stock market indices using Granger Causality tests.

ARE ITALIAN BANKS PROFITABLE BY USING DERIVATIVES? EVIDENCE FROM THE RECENT RECESSION OF ITALIAN ECONOMY

Mohamed Rochdi Keffala

ABSTRACT

The collapse of Italian economy has coincided with the global financial crisis to which derivatives are suspected to be responsible of its propagation. For this reason, this study aims to examine whether the use of derivatives affects the profitability of Italian banks during both the global financial crisis period and the recession period of Italian economy. To reach this goal an appropriate econometric procedure namely the dynamic Generalized Method of Moments system is applied using data from 22 Italian banks over the long period 2005–2017. A series of bank-specific indicators are used to explain the effect of overall derivatives and each derivative instrument separately on Italian banks’ profitability. The results of regressions panels indicate that in general derivatives as well as measured in the whole or splitting up in instruments specifically in forwards, options, and, in particular, swaps affect positively the profitability of Italian banks. The main conclusion is that – despite the episode of economic recession in Italy – Italian banks boost their profitability by using derivatives.

As practical contribution, policy-makers in Italy should throw out the assumption of the implication of derivatives in the fragility of the banking system. On the contrary, they should pave the way easily for Italian banks’ managers to deal with derivatives and look out for the real problems of the recent collapse of the Italian economy.

Keywords: Banks; derivatives; profitability; Italy; Generalized Method of Moments; global financial crisis

JEL Classifications: G01, G21, G32

1. INTRODUCTION

The global financial crisis that started in 2007 and continued in 2008 has shaken the world by destabilizing the economy of many countries such as Italy (Cucinelli, 2015). Indeed, Italian economy which is the ninth largest economy of the world and the third largest economy in the eurozone¹ has experienced a period of recession behind the crisis. (The annual percentage change of GDP is fallen from 2.199% in 2006 to 2.361% in 2009.)² The collapse of Italian economy is explained by many analysts due to many reasons especially the country’s uncertain political landscape and unclear economic reform plans. For these reasons, Fitch Ratings downgraded Italy’s sovereign debt from BBB+ to BBB because of the country’s unsolved economic problems particularly the fragility of banking system.³

The emergence of this crisis and the economic recession that followed as in Italy has raised several questions about the role of financial derivatives in such an incident.

Therefore, special attention has been given by several studies to the effect of derivatives on bank risk and performance in particular.

The lack of empirical papers on the effect of derivatives on bank profitability – as the central indicator of performance – calls for more specific attention. This is one of the issues behind the motivation of this study to examine specifically the profitability of Italian banks by using derivatives. The answer to this issue will be very important to realize the role of derivatives in the fragility of Italian banking system or even the slump of Italian economy behind the global financial crisis.

To reach this goal, we conduct dynamic panel regressions using Generalized Method of Moments (GMM) estimator technique as developed by Arellano and Bover (1995) on 22 Italian banks over the long period 2005–2017. The dependent variable is one of the reliable profitability measures defined by return on assets (ROA) and return on equity (ROE) which are largely used in the literature (Fayed, 2013; Titko, Skvarciany, & Jurevičienė, 2015) and proved their robustness and consistency especially in the study of Albulescu (2015). The independent variables are composed by one of the variable of interest (overall derivatives, forwards, options, swaps, and futures) and the control variables (leverage, capital adequacy, liquidity, risky assets, bank’s credit quality, and net interest margin). The separation between the variable of interests allows us to conclude about similaraties or differences in the results between the effect of derivatives in the whole and the effect of each derivative instrument. In fact, all the previous studies (Ghosh, 2017; Gitogo, 2012; Said, 2011; Shen & Hartarska, 2013) have investigated the effect of derivatives in the whole on banks’ profitability without separating between the instruments. Hence, this work will fulfill this gap in the literature by examining the effect of each derivative instrument on banks’ profitability additionally to the effect of derivatives in the whole. This also will lead us to assess more visibly the convergence or the divergence of results when separation between derivative instruments is made.

The first objective of this research is to investigate the effect of derivatives use on the profitability of Italian banks. The second objective of this study is to check-up whether derivatives are implicated in the recent collapse of the Italian economy.

This work provides several contributions as well as for related literature and also experts and policy-makers. First, this piece fulfills the gap in the literature investigating the effect of derivatives use on banks’ performance and profitability in particular. Second, it is one of very few researches focusing this issue on Italian banks. Third, this work is a pioneer to estimate individually each derivative instrument in order to make proof about the convergence or the divergence between the effect of overall derivatives and the effect of each instrument. Finally, this chapter offers evidence for Italian policy-makers as regards the role played by derivatives during the recent Italian economy crisis.

The main outcomes of this study reveal that using derivatives makes Italian banks more profitable.

The remaining of this piece is structured as follows Section 2 describes and shows statistics about the sample. In Section 3, after theoretical revised about profitability, the literature investigating the relationship between derivative use and profitability is reviewed. Section 4 explains the methodology applied. In Section 5, hypotheses are stipulated referring to the related literatur...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Contents
• List of Contributors
• Introduction
• Market Efficiency, Arbitrage, and Delivery Options in the Nymex Crude Oil Market
• Financial Decisions and Growth of the Firm Under High and Low Levels of Information Asymmetry
• Is Growth Risky? Evidence from India
• Detecting Profitability and Investment Risk Premiums in the French Stock Market
• Stock Market Volatility Modeling and Forecasting with a Special Reference to BSE Sensex
• Are Italian Banks Profitable by Using Derivatives? Evidence from the Recent Recession of Italian Economy
• The Impact of US Dollar Index on Emerging Stock Markets: A Simultaneous Granger Causality and Rolling Correlation Analysis