Estimating defaults in organized security lending markets

Abstract

Purpose

This paper aims to analyze the dynamics of the security lending process and lending markets to identify the market-wide variables reflecting the characteristics of the stock borrowed and to measure the credit risk arising from lending contracts.

Design/methodology/approach

Using the data provided by Istanbul Settlement and Custody Bank on the equity lending contracts of Securities Lending and Borrowing Market between 2010 and 2012 and the data provided by Borsa Istanbul on Equity Market transactions for the same timeframe, this paper analyzes whether stock price volatility, stock returns, return per unit amount of risk and relative liquidity of lending market and equity market affect the defaults of lending contracts by using both linear regression and ordinary least squares regression for robustness and proxying the concepts of relative liquidity, volatility and return constructs by more than variable to correlate findings.

Findings

The results illustrate a statistically significant relationship between volatility and the default state of the lending contracts but fail to establish a connection between default states and stock returns or relative liquidity of markets.

Research limitations/implications

With the increasing pressure for clearing security lending contracts in central counterparties, it is imperative for both central counterparties and regulators to be able to precisely measure the risk exposure due to security lending transactions. The results gained from a limited set of lending transactions merit further studies to identify non-borrower and non-systemic credit risk determinants.

Originality/value

This is the first study to analyze the non-borrower and non-systemic credit risk determinants in security lending markets.

Citation

Osken, L.C., Onay, C. and Unal, G. (2016), "Estimating defaults in organized security lending markets", Journal of Financial Regulation and Compliance, Vol. 24 No. 3, pp. 343-362. https://doi.org/10.1108/JFRC-07-2015-0032