The impacts of monetary policies and the risks of carry trade speculation

The main objective of my research is to show the high level of interconnection between central banks' monetary policies, banking system and corporate sectors with the aim of studying to what extent possible policies arising in one entity can stimulate effects on some others and vice versa a possible contagion arising from the corporate sector can propagate to the banking sector, resulting in high threat of systemic risk. Particularly, considering the increase in banks' lending to less creditworthy customers during periods of low monetary policy rates, I will explain the reasons behind the expected increase in carry trade speculation and the effects of this practice on firms' capital structure. Eventually, the threat of systemic risk arising from the corporate sectors' increase in default probability and the contagion of the banking one will be assessed.

As anticipated in the second section of this chapter, the contribution of the literature on the topic will be used to identify "best practices" that would effectively allow the analysis. The required data will be collected on Bloomberg and WRDS, two extensive platforms containing a comprehensive amount of both micro and macro data. Specifically, the initial tests will be implemented following the approach used by Ioannidou et al. (2014). The contractual characteristics of the individual loans made to listed emerging markets' firms will be analysed during both periods of standard and non-standard monetary policy using expost data. In the analysis, the ex-post default probability of these loans will be used as a proxy for risk to assert the effects of monetary policies on risk appetite. Afterwards, considering the change in default probability and in loans expected return in the two states, the analysis will use this test to spot the moral hazard behaviour of banks. Finally, the research will assess the impact of carry trade by running two empirical models. The first one will rely on the regression of the carry trade - expressed as the difference between the average interest rate of FXI25 firms' corporate bonds and the fed fund rate - against corporate related variables. This test will enable the understanding of the potential risks arising from investment and shadow banks' speculation and affecting emerging countries firms' capital structure. The second one considers carry trade as the difference between emerging markets foreign currency bonds and fed fund rate. Carry trade, this time, will be regressed against macro variables to assess its impact on the overall countries' economy. Some of these variables are: (1) inflation; (2) investment growth; (3) assets growth; (4) indebtedness. Successively, a sector analysis will be carried forward with the purpose of highlighting changes in listed firms' capital structure. This will be done by exploiting Bloomberg to observe the companies' main financial ratios, hence to use a financial valuation framework to detect relevant evidences of concern. Changes in assets prices and financial ratios will be analysed instead with the aim of computing the probability of default of these companies under changing economic variables. By using financial ratios to make projections of free cash flows and by making reasonable assumptions over the future cost of capital, the future value of the firms' assets and residual claims on them will be visible. These results will be used to conclude on the impact of monetary policy on corporations' risk. Finally, the research will adopt the method used by Rajan & Zingales to understand sectors' external financial dependence. Using a percentile approach, it will be possible to observe the correlation between the just mentioned external financial dependence and the changes in capital structure. Then, a conclusion will be draft on the effects of a change in monetary policy (and consequently of investments) on different sectors' risk, according to their exposure.