A major lesson of the recent financial crisis is that the ability of banks to withstand liquidity shocks and to provide lending to one another is crucial for financial stability. This paper studies the functioning of the interbank lending market and the optimal policy of a central bank in response to both idiosyncratic and aggregate shocks. In particular, it considers how the interbank market affects a bank’s choice between holding liquid assets ex ante and acquiring such assets in the market ex post. The authors show that a central bank should use different tools to manage different types of shocks. Specifically, it should respond to idiosyncratic shocks by lowering the interest rate in the interbank market and address aggregate shocks by injecting liquid assets into the banking system. They also show that failure to adopt the optimal policy can lead to financial fragility.

The rapid growth of the credit default swap (CDS) market and the increased number of defaults in recent years have led to major changes in the way CDS contracts are settled when default occurs. Auctions are increasingly the mechanism used to settle these contracts, replacing physical transfers of defaulted bonds between CDS sellers and buyers. Indeed, auctions will now become a standard feature of recent CDS contracts. This paper examines all CDS auctions conducted to date and evaluates their efficacy by comparing the auction outcomes with the underlying bond prices in the secondary market. The auctions appear to have served their purpose, as the authors find no evidence of inefficiency: Participation is high, open interest is low, and auction prices are close to prices observed in the bond market before and after each auction. The authors qualify their conclusions by noting that relatively few auctions have taken place thus far.

In September 2008, a six-year-old article about the 2002 bankruptcy of United Airlines’ parent company resurfaced on the Internet and was mistakenly believed to be reporting a new bankruptcy filing by the company. The parent company’s stock price dropped by as much as 76 percent in just a few minutes, before NASDAQ halted trading. After the “news” had been identified as false, the price rebounded, but still ended the day 11.2 percent below the previous close. The authors use this natural experiment and a simple asset-pricing model to study the aftermath of this false news shock. They find that, after three trading sessions, the company’s stock was still trading below the two-standard-deviation confidence band implied by the model and that it returned to within one standard deviation only during the sixth session. On the seventh day after the episode, the stock was trading at exactly the level predicted by the model.

Many companies that privatized between 1990 and 2007 were fairly young public firms, often with the same management team making the crucial restructuring decisions both at the time of the initial public offering (IPO) and the buyout. Mehran and Peristiani investigate the determinants of the decision to go private over a firm’s public life cycle. Their evidence reveals that firms with declining growth in analyst coverage, falling institutional ownership, and low stock turnover were more likely to go private and opted to do so sooner. The authors argue that a primary reason behind the decision of IPO firms to abandon their public listing was a failure to attract a critical mass of financial visibility and investor interest. Consistent with earlier literature, they also find strong support for Jensen’s free-cash-flow hypothesis, which argues that these corporate restructurings are a useful tool in capital markets for mitigating agency problems between insiders and outside shareholders.

Global banks played a significant role in the transmission of the current crisis to emerging-market economies. Flows between global banks and emerging markets include both cross-border lending, which has long been recognized as responding significantly to shocks at home or abroad, and internal capital-market lending, which is the internal flow of funds within a banking organization (such as between the organization’s headquarters and its offices in foreign locations). Adverse liquidity shocks to developed-country banking, such as those that occurred in the United States in 2007 and 2008, have reduced lending in local markets through contractions in cross-border lending to banks and private agents and also through contractions in parent banks’ support of foreign affiliates. Because all these forms of transmission impinge on the lending channel in recipient markets, the ownership structure of emerging-market banks does not by itself provide sufficient basis for identifying the degree of shock transmission from abroad.