Talk Titles and Abstracts
Viral Acharya (NYU Stern)
Measuring Systemic Risk
We present a simple model of systemic risk and show how each
nancial institution's contribution to systemic risk can be measured.
An institution's contribution, denoted systemic expected shortfall
(SES), is its propensity to be undercapitalized when the system
as a whole is under-capitalized, which increases in the institution's
marginal expected shortfall, MES, i.e., its losses in the tail
of the aggregate sector's loss distribution, and in its leverage.
Institutions internalize their externality if they are \taxed"
based on their SES. We demonstrate empirically the ability of
components of SES to predict emerging systemic risk during the
nancial crisis of 2007-2009, in particular, (i) the outcome of
stress tests performed by regulators; (ii) the decline in equity
valuations of large nancial rms in the crisis; and, (iii) the
widening of their credit default swap spreads.
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Rama Cont (Columbia University IEOR)
Measuring Contagion and Systemic Risk
We propose a quantitative approach for assessing the systemic
impact of the failure of a financial institution, based on a simple
model of default contagion in a banking system. Our approach takes
into account both volatility and correlation of market factors
and contagion effects due to counterparty exposures: we argue
that neglecting either of these aspects leads to a severe underestimation
of systemic risk. By contrast to "backward-looking"
indicators of systemic risk, our approach, based on exposures,
is a forward-looking approach based on the simulation of future
contagion scenarios. We discuss some theoretical properties of
our proposed measure of systemic risk and show how it can be estimated
in practice using a database of interbank exposures obtained from
the Brazilian central bank. The analysis reveals the importance
of network properties when modeling contagion and systemic risk
and leads to some recommendations for the macro-prudential regulation
of systemic risk.
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Jon Danielsson (London School of Economics)
Risk Appetite and Endogenous Risk
Risk is endogenous. Equilibrium risk is the fixed point of the
mapping that takes perceived risk to actual risk. When risk-neutral
traders operate under Value-at-Risk constraints, market conditions
exhibit signs of fluctuating risk appetite and amplification of
shocks through feedback effects. Correlations in returns emerge
even when
underlying fundamental shocks are independent. We derive a closedform
solution of equilibrium returns, correlation and volatility by
solving the fixed point problem in closed form. We apply our results
to stochastic volatility and option pricing.
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Erkko Etula (Federal Reserve Bank of New York)
Risk
Appetite and Exchange Rates
We present evidence that the funding liquidity of U.S. financial
intermediaries forecast U.S. dollar exchange rate growth---at
weekly, monthly, and quarterly horizons, both in-sample and out-of-sample,
and against a large set of foreign currencies. We provide a theoretical
foundation for a funding liquidity channel in a simple asset pricing
model where the effective risk aversion of dollar-funded intermediaries
fluctuates with the tightness of their risk constraints. We estimate
prices of risk using a cross-sectional asset pricing approach
and show that U.S. dollar funding liquidity forecasts exchange
rates because of its association with time-varying risk premia.
Our empirical evidence shows that this channel is separate from
the more familiar "carry trade" channel.
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Kay Giesecke (Stanford MSE)
Systemic
Risk: What Defaults Are Telling Us
This paper defines systemic risk as the conditional probability
of failure of a large number of financial institutions, and develops
maximum likelihood estimators of the term structure of systemic
risk in the U.S. financial sector. The estimators are based on
a new dynamic hazard model of failure timing that captures the
influence of time-varying macro-economic and sector-specific risk
factors on the likelihood of failures, and the impact of spillover
effects related to missing/unobserved risk factors or the spread
of financial distress in a network of firms. In- and out-of-sample
tests demonstrate that the fitted risk measures accurately quantify
systemic risk for each of several risk horizons and confidence
levels, indicating the usefulness of the risk measure estimates
for the macro-prudential regulation of the financial system.
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Itay Goldstein (Wharton)
Self-Fulfilling Credit Market Freezes
This paper develops a model of a self-fulfilling credit market
freeze and uses it to study alternative governmental responses
to such a crisis. We study an economy in which operating firms
are interdependent, with their success depending on the ability
of other operating firms to obtain financing. In such an economy,
inefficient credit market freeze may arise in which banks abstain
from lending to operating firms with good projects because of
their self-fulfilling expectations that other banks will not be
lending. Our model enables us to study the effectiveness of alternative
measures for getting an economy out of an inefficient credit market
freeze. In particular, we study the effectiveness of interest
rate cuts, infusion of capital into financial institutions, direct
lending to operating firms by the government, and infusion of
capital into financial firms under lending commitment.
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Jennifer Huang (University of Texas at Austin)
Optimal Liquidity Policy
This paper presents a simple model of liquidity demand and supply.
We show that competitive market forces fail to lead to efficient
supply of liquidity. The market provision of liquidity is generally
too low when the probability of liquidity event is small and is
too high when the probability of liquidity event is large. Moreover,
we show that different policy interventions have different efficiency
consequences under different market conditions. For example, while
subsidizing liquidity providers ex ante (e.g., designated market
makers) is generally efficient, the market liquidity might be
too high especially when the probability of liquidity event is
small; while subsidizing sellers in the spot market (e.g., relaxing
capital requirements, subsidizing loan modifications, or purchasing
of toxic assets) can reduce the cost of immediate default, it
reduces the incentives of other market participants to provide
liquidity, both ex ante and ex post, and generally reduces welfare.
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Wei Xiong (Princeton University)
Heterogeneous Beliefs and Short-term Credit Booms
We study the financing of speculative asset-market booms in a
standard framework with heterogeneous beliefs and short-sales
constraints. Cash-constrained optimists use their asset holdings
as collateral to raise debt financing from less optimistic creditors.
Through state-contingent refinancing, short-term debt allows the
optimists to reduce debt payment in upper states which they assign
higher probabilities to, but at the expense of greater rollover
risk if the asset fundamental deteriorates at the debt maturity.
In contrast, long-term debt allows the optimists to hedge their
financing cost in downturns. Our model identifies distinctive
effects of initial and future belief dispersion in driving a short-term
credit boom, and shows that the optimists' debt-maturity and leverage
choices can directly affect the asset market equilibrium.
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Hao Zhou (Federal Reserve Board)
Assessing the Systemic Risk of a Heterogeneous
Portfolio of Banks during the Recent Financial Crisis
This paper measures the systemic risk of a banking sector as
a hypothetical distress insurance premium, identifies various
sources of financial instability, and allocates systemic risk
to individual financial institutions. The systemic risk measure,
defined as the insurance cost to protect against distressed losses
in a banking system, is a summary indicator of market perceived
risk that reflects expected default risk of individual banks,
risk premia as well as correlated defaults. An application of
our methodology to a portfolio of twenty-two major banks in Asia
and the Pacific illustrates the dynamics of the spillover effects
of the global financial crisis to the region. The increase in
the perceived systemic risk, particularly after the failure of
Lehman Brothers, was mainly driven by the heightened risk aversion
and the squeezed liquidity. Further analysis, which is based on
our proposed approach to quantifying the marginal contribution
of individual banks to the systemic risk, suggests that “too-big-to-fail”
is a valid concern from a macroprudential perspective of bank
regulation.
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