A threat to financial stability: risks in the capital market

The world benefits from financial stability. Vivian van Breemen, PhD student at Nyenrode Business University and supervisor at the European Central Bank^[1] and Dennis Vink, Professor of Finance & Investment at Nyenrode Business University, put together an international expert research team that focuses on analyzing systemic risks in the capital market. And with success: the research sheds light on numerous new risks that could pose a threat to financial stability.

Systemic risks are risks that threaten the financial system as a whole, as a result of which the economy can ultimately suffer considerable damage. In the capital market, they pose a possible threat to international financial stability. “The objective of our research was to highlight these risks, followed by making concrete recommendations to investors, regulatory authorities and other parties in the capital market”, explains Van Breemen. “With these new insights they can, for example, improve the effectiveness of their risk models, regulations and supervision”.

International research team

The research involved collaboration with experts from the US, Germany and the Netherlands. The international research team consisted of leading researchers from EDHEC Business School, the European Central Bank (ECB) and Nyenrode Business University. Together they conducted research into the European and American bond markets in the period 1995 to 2021. “We focused on these regions and time span, as they represent a large portion of the global market and were largely impacted by the 2008 financial crisis”, explains Vink. “For us, this was a unique setting to research the impact of the crisis on this market and the impact of new international laws and regulations after the crisis.”

Risks of credit rating

The research looked into credit ratings of financial products, such as bonds. A credit rating is an independent assessment of the creditworthiness of a financial product. This is issued by a credit rating agency, such as the American agencies Moody's and Standards & Poor's. The results of the research expose numerous previously unknown risks. For example, credit ratings do not always provide an accurate or complete picture of the credit risks in a financial product. This can create risks to investors, regulators and other market actors who rely on the opinion of credit rating agencies. “We show what causes these risks, such as competition between credit rating agencies, suboptimal legal frameworks and the way the market is structured”, explains Vink. “We recommend looking beyond the credit rating when determining the value of a financial product and in our research we provide concrete suggestions on how to do this”.

Wide audience with actual impact

The results of the research are widely distributed internationally. For example, the research team has sat down with regulators, academics, credit rating agencies and legislators. “Not only did this help with our own research, we were also able to distribute our insights quickly and effectively”, says Van Breemen. “In addition, regulatory authorities proactively reached out to us to discuss the implications of our research results for possible future regulations”. The research has also been presented several times at renowned conferences worldwide and has been published in various scientific journals and in the Working Paper Series of central banks.