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Story - antoq - 10/29/2010 - 07:50 - 0 comments - 0 attachments
The analysis of the efficient market hypothesis has attracted a great deal of interest in recent time. The efficient market hypothesis is based on the assumption that at any given time, prices of stocks fully reflect all the available information related to them. According to this, a stock market is seen as more efficient if market relevant information is incorporated into assets prices. Under fully efficient markets, past information should not affect returns in present period. In other words, the “efficient stock markets do not allow investors to earn more above-average returns without accepting above verage risks” (Malkiel 2003, p. 60). It is believed to be an application of rational expectation theory to the pricing of stocks.
A very important issue to be highlighted at this stage is that market efficiency does not mean that the market price of a stock should equal the true value of the stock. What it means is that errors in the market price, i.e. over or under valued of the true value, should be unbiased and randomly deviated. Based on this argument, the existence of random deviation prevents investors from finding those over or under valued stocks.
The availability of credit has been an issue of particular concern in Germany during the financial meltdown of 2008-2009. Lending to domestic non monetary financial institutions by banks in Germany has dampened since the summer of 2008. Contraction of loans, especially business loans, together with an ongoing recession led to a growing fear about an upcoming ”credit crunch” in Germany. In fact, a credit tightening is observed Euro-zone wide as well.
It is necessary to define a ”credit crunch” before attempting to identify if it exists or not. However, this term is used in an interchangeable way to describe different occasions. First of all, we have to make sure that anecdotal evidence of credit denials is hardly evidence of a credit crunch. Some borrowers could be too optimistic and far from evaluating the risks of their projects realistically; whereas some loan officers could be too skeptical. Such denials might occur simply due to incomplete information. Thus, it is essential to explore this concept more carefully. Bernanke and Lown (1991)(5) define a credit crunch as ”a significant leftward shift in the supply curve for bank loans, holding constant both the safe real interest rate and the quality of potential borrowers”. The definition of credit crunch that we adopt in this paper is brought up by Council of Economic Advisors (1991)(15) and follows ”a credit crunch is a situation in which the supply of credit is restricted below the range usually identified with prevailing market interest rates and the profitability of investment projects.” The reduction in the available supply of credit might be due to some funding problems of the lenders caused by disintermediation or strict regulation. It might also result from the weaknesses of lender’s balance sheet. In the literature, this mechanism is called bank lending channel. Bernanke and Gertler (1995)(4) enlighten the credit channel of monetary policy transmission and propose two possible linkages between credit markets and monetary policy: the first one is the above mentioned ”bank lending channel” and the second one is ”balance sheet channel”. The See Syron (1991)(17).
The question which factors determine sovereign yield spreads is of particular importance to borrowers and investors in international bond markets. Whereas the former wish to minimize the costs of international capital and seek appropriate policy recommendations, the latter are primarily interested in risk-adequate pricing.
The empirical literature on country risk in general and that on yield spread determination in particular is large and has offered important insights. However, in some cases the findings are controversial and their practical applicability is therefore limited. In order to resolve doubt it is desirable to conduct further research in this area.
