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Seminars (SYR)

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Event When Speaker Title Presentation Material
SYR 22nd August 2014
09:00 to 09:45
Network structure and central clearing in the CDS market
We use an extensive data set of bilateral exposures on credit default swap (CDS) to estimate the impact on collateral demand of new margin and clearing practices and regulations. We decompose collateral demand for both customers and dealers into several key components, including the "velocity drag" associated with variation margin movements. We demonstrate the impact on collateral demand of more widespread initial margin requirements, increased novation of CDS to central clearing parties (CCPs), an increase in the number of clearing members, the proliferation of CCPs of both specialized and non-specialized types, and client clearing. Among other results, we show that system-wide collateral demand is increased significantly by the application of initial margin requirements for dealers, whether or not the CDS are cleared. Given these dealer-to-dealer initial margin requirements, however, mandatory central clearing is shown to lower, not raise, system-wide collateral demand, provided there is no significant proliferation of CCPs. Central clearing does, however, have significant distributional consequences for collateral requirements across various types of market participants.

Joint work with D Duffie and M Scheicher.
SYR 22nd August 2014
09:45 to 10:00
Discussion
SYR 22nd August 2014
10:00 to 10:45
The formation of a core periphery structure in heterogeneous financial networks
Recent empirical evidence suggests that financial networks exhibit a core periphery network structure. This paper aims at giving an economic explanation for the emergence of such a structure using network formation theory. Focusing on intermediation benefits, we find that a core periphery network cannot be unilaterally stable when agents are homogeneous. The best-response dynamics converge to a unique unilaterally stable outcome ranging from an empty to denser networks as the costs of linking decrease. A core periphery network structure can form endogenously, however, if we allow for heterogeneity among agents in size. We show that our model can reproduce the observed core periphery structure in the Dutch interbank market for reasonable parameter values.

Joint work with Daan in't Veld, Marco van der Leij, Cars Hommes
SYR 22nd August 2014
10:45 to 11:00
Discussion
SYR 22nd August 2014
11:30 to 12:15
Systemic risk through contagion in a core-periphery structured banking network
We contribute to the understanding of how systemic risk arises in a network of credit-interlinked agents. Motivated by empirical studies we formulate a network model which, despite its simplicity, depicts the nature of interbank markets better than a homogeneous model. The components of a vector Ornstein-Uhlenbeck process living on the vertices of the network describe the financial robustnesses of the agents. For this system, we prove a LLN for growing network size leading to a propagation of chaos result. We state properties, which arise from such a structure, and examine the effect of inhomogeneity on several risk management issues and the possibility of contagion.
SYR 22nd August 2014
12:15 to 12:30
Discussion
SYRW01 26th August 2014
09:00 to 09:30
A Lehar Why are Banks Highly Interconnected?
Joint with A. David

We study optimal interconnections between banks in alternative banking systems created using interbank loans and over-the-counter derivatives. Settlements on all interbank payments are renegotiated in the event of financial distress of a counterparty. A high degree of interconnectectness plays a positive role as it commits counterparties to renegotiate claims to reduce dead weight liquidation costs in the system. We show that the renegotiable interbank loans form the optimal interconnection to the joint risk management and asset quality problem faced by the banks. In addition, our analysis shows that systemic spillovers and the likelihood of financial crises are severely mismeasured when interbank renegotiations are not considered. The optimality of interbank loans is shown to hold in a wide range of institutional settings.
SYRW01 26th August 2014
09:45 to 10:15
Liquidity hoarding in the interbank market: Evidence from Mexican interbank overnight loan and repo transactions
Over The Counter (OTC) markets are an essential part of modern financial systems. However, there are some aspects which have placed them at the center of current regulatory efforts at the international level. Among these markets, the unsecured and secured (repo) interbank markets have received substantial attention from the academia and financial authorities as they represent two of the most direct sources of liquidity for banks. In this paper we investigate if trading relationships are established between banks in the unsecured and the repo market in Mexico and if such borrowing and lending relationships are important in terms of costs during different economic conditions. Unlike other related previous works, we are able to identify with full precision individual transactions between banks both in the unsecured and the repo market for a long period of time. In Mexico, there exist regulatory reports which provide us with daily data with an important level of detail for these two OTC markets. We find evidence of liquidity hoarding. A negative external funding shock lead banks to lend less at the interbank market, except to banks with which it holds a trading relationship. In particular, banks that highly depend on external funding lend less when they are affected by a shock. Authors: Marco van der Leij (U Amsterdam), Serafin Martinez-Jaramillo, José Luis Molina-Borboa, Fabrizio López-Gallo (Banco de México)
SYRW01 26th August 2014
11:00 to 11:30
Emergence of the EU Corporate Lending Network
Joint with U. Kochanska, C. Kok

This paper uses network formation techniques based on the theoretical framework of Halaj and Kok (2014) to construct networks of lending relationships between a large sample of banks and non-financial corporations in the EU. Networks of bank-firm lending relationships provide an alternative approach to studying real-financial linkages, which takes into account the heterogeneous characteristics of individual banks and firms on the propagation of shocks between the financial sector and the real economy. One particular strength of the model is related to the fact that the proposed framework provides an assessment not only of how banks are directly related to each other in the interbank market but also how they may be indirectly related (due to common exposures) via their corporate lending relationships. The model can be used to conduct counter-factual simulations of the contagion effects arising when individual or groups of banks and firms are hit by shocks. This could allow policy makers to gauge specific vulnerabilities in the financial system evolving around the lending relationships between banks and their (corporate) borrowers.
SYRW01 26th August 2014
11:45 to 12:15
Dynamics of the Leverage Cycle
We investigate the leverage cycle in the context of several different models, ranging from more realistic agent-based models to simple reduced form models with minimal assumptions. These models build on earlier work on the leverage cycle but in a more explicit dynamic context. They make it clear how managing a portfolio with a leverage target automatically gives rise to endogenous dynamics, coupling leverage and volatility and inducing chaotic oscillations driving clustered volatility and heavy tailed risk. As one moves from countercyclical to procyclical leverage, or from longer time horizons to shorter time horizons, volatility increases and stability decreases. Policies such as Basel II and III can have unintended consequences; while they can be effective for a single investor acting alone, when all investors use them they can be destabilizing. I will also discuss the relationship to the problem in the network context, where the same principle applies, i.e., diversification of risk by individuals often creates systemic risk. Finally, I will discuss possible stabilizing policies, such as impact-adjusted accounting.
SYRW01 26th August 2014
14:30 to 15:00
N Boyarchenko Intermediary Leverage Cycles and Financial Stability
We present a theory of financial intermediary leverage cycles within a dynamic model of the macroeconomy. Intermediaries face risk based funding constraints that give rise to procyclical leverage and a procyclical share of intermediated credit. The pricing of risk varies as a function of intermediary leverage, and asset return exposures to intermediary leverage shocks earn a positive risk premium. Relative to an economy with constant leverage, financial intermediaries generate higher consumption growth and lower consumption volatility in normal times, at the cost of endogenous systemic financial risk. The severity of systemic crisis depends on intermediaries' leverage and net worth. Regulations that tighten funding constraints affect the systemic risk-return trade-off by lowering the likelihood of systemic crises at the cost of higher pricing of risk. When the regulator’s tool-kit is expanded to include a liquidity ratio, liquidity requirements are preferable to capital requirements, as tightening liquidity requirements lowers the likelihood of systemic distress without impairing consumption growth. Finally, we show that in a model with two types of intermediaries – a “bank” facing risk-based constraints and a “fund” facing skin-in-the-game constraints – bank sector growth leads total financial sector asset growth, while growth of the fund sector does not, which is a feature we confirm in the data.
SYRW01 26th August 2014
15:15 to 15:45
Financial Networks, Systemic Risk and Macroprudential Policy
This talk will outline how a network approach to systemic risk which draws on epidemiological and ecological techniques can shed light on contagion in financial systems. Highlighting results from a few different models, it will explain how such an approach can be used to help understand the causes and dynamics of some aspects of the global financial crisis. And it will draw out lessons for policy, explaining how a macroprudential approach towards regulation may be important in containing systemic risk.
SYRW01 26th August 2014
16:15 to 16:45
Government Guarantees and Financial Stability
Joint with F. Allen, I. Goldstein, and A. Leonello

We analyze the trade-offs involved in the introduction of government guarantees in a context where panic and fundamental crises can occur, and both banks' and depositors' decisions are endogenously determined. A scheme against bank illiquidity eliminates panic runs and does not entail any disbursement for the government. By contrast, a scheme protecting depositors also against bank insolvency entails a disbursement for the government and leads to distortions both in the bank's choice of the optimal deposit contract and in government's choice of the optimal guarantees. Yet, we show that the latter scheme may achieve higher social welfare since it reduces significantly the probability of runs.
SYRW01 27th August 2014
09:00 to 09:30
M Farboodi Intermediation and Voluntary Exposure to Counterparty Risk
I develop a model of the financial sector in which endogenous intermediation among debt financed banks generates excessive systemic risk. Financial institutions have incentives to capture intermediation spreads through strategic borrowing and lending decisions. By doing so, they tilt the division of surplus along an intermediation chain in their favor, while at the same time reducing aggregate surplus. I show that a core-periphery network -- few highly interconnected and many sparsely connected banks -- endogenously emerges in my model. The network is inefficient relative to a constrained efficient benchmark since banks who make risky investments "overconnect", exposing themselves to excessive counterparty risk, while banks who mainly provide funding end up with too few connections. The predictions of the model are consistent with empirical evidence in the literature.
SYRW01 27th August 2014
09:45 to 10:15
TR Hurd Random Financial Networks and Locally Treelike Independence
Exact results in percolation theory on random graphs rely on a property known as the "tree ansatz'', which is known to be asymptotically true on the family on configuration graphs. More generally, the tree ansatz, also called mean field theory, can be used as the basis of approximations, which as numerous authors have remarked, can be surprisingly accurate. The question arises whether the tree ansatz can be useful for understanding financial systemic risk. In this talk, I will review the concepts underlying the tree ansatz, and explore how it can be embedded and used in models of financial contagion, such as the Eisenberg-Noe model and its alternatives. Along the way, I will propose definitions for "random financial network'' (RFN) and "locally treelike independence'' (LTI), and explore these definitions' mathematical consequences. In the end I will compare analytical approximations to Monte Carlo computations in some realistic network cascade examples, and show that there are indeed situations where the LTI approximation is "surprisingly" accurate. This provides some evidence that understanding of networks in other domains can help us in understanding financial networks.
SYRW01 27th August 2014
11:00 to 11:30
I van Lelyveld Motifs in International Banking Networks
The financial crisis clearly illustrated the importance of characterizing the level of 'systemic' risk associated with an entire credit network, rather than with single banks or banking systems. However, the interplay between financial distress and topological changes is still poorly understood. We build on earlier work where we analyzed interbank exposures among Dutch banks over the period 1998-2008, ending with the crisis. After controlling for the link density, we found that many topological properties display an abrupt change in 2008, providing a clear - but unpredictable - signature of the crisis. By contrast, if the heterogeneity of banks' connectivity is controlled for, the same properties show a gradual transition to the crisis, starting in 2005 and preceded by an even earlier period during which anomalous debt loops could have led to the underestimation of counter-party risk. These early-warning signals are undetectable if the network is reconstructed from partial bank-specific data, as routinely done. We now apply this methodology to cross border interbank linkages using confidential data collected by the Bank for International Settlements. Our aim is to 1) confirm our earlier results and 2) extend the methodology to handle weighted networks.
SYRW01 27th August 2014
11:45 to 12:15
S Battiston Market Procyclicality and Systemic Risk
We model the systemic risk associated with the so-called balance-sheet amplica- tion mechanism in a system of banks with interlocked balance sheets and with posi- tions in real-economy-related assets. Our modeling framework integrates a stochas- tic price dynamics with an active balance-sheet management aimed to maintain the Value-at-Risk at a target level. We nd that a strong compliance with capi- tal requirements, usually alleged to be procyclical, does not increase systemic risk unless the asset market is illiquid. Conversely, when the asset market is illiquid, even a weak compliance with capital requirements increases signicantly systemic risk. Our ndings have implications in terms of possible macro-prudential policies to mitigate systemic risk.
SYRW01 27th August 2014
14:30 to 15:00
A Tahbaz-Salehi Intermediation and Systemic Risk in the Repo Market
Joint with M. di Maggio

In this paper, we focus on the financial institutions' role as intermediaries between cash lenders (e.g. money market funds) and borrowers (e.g. hedge funds). We show that, by charging a haircut, lenders can discipline the investment choices of all the participants in the market-even those with whom they are not directly contracting. However, haircuts can also work as a propagation mechanism among financial institutions: idiosyncratic shocks can be amplified over the network of interbank relationships, up to the point that the market freezes and its intermediation capacity collapses.
SYRW01 27th August 2014
15:30 to 17:00
Central Clearing of OTC derivatives
Darrell Duffie (Stanford University)

George Handjinicolaou (ISDA)

Alexander Lipton (Bank of America) [to be confirmed]

Dennis McLaughlin (LCH Clearnet)

David Murphy (Bank of England)

This panel discussion will focus on systemic risk issues arising from the central clearing of over-the-counter derivatives. These issues may include default management resources and processes, the failure resolution of CCPs, planning for CCP service continuity or discontinuity, the liquidity of CCP default management resources, transparency of CCPs, supervision and regulation of CCPs (including cross-border issues), cross-CCP access by market participants, and a range of CCP risk management issues such as clearing membership requirements, voluntary and forced member resignations, criteria for approval of cleared products, initial margin requirements, and cross-silo risks. The panel includes experts from derivatives dealers, central clearing party operators, and financial regulators. An active discussion will include questions addressed to the panel from the floor.

SYRW01 28th August 2014
09:00 to 09:30
Systemic Risk and Central Counterparty Clearing
This paper studies financial networks in a stochastic framework. We apply a coherent systemic risk measure to examine the effects on systemic risk and liquidation losses of multilateral clearing via a central clearing counterparty (CCP). We find that a CCP always improves banks' surplus, and reduces banks' liquidation and shortfall losses. In return, the CCP introduces tail risk, which can lead to higher systemic risk. We provide sufficient conditions in terms of the CCP's fee and guarantee fund policy for a reduction of systemic risk. In a numerical example we find that feasible Pareto optimal fee and guarantee fund policies come along with reduced systemic risk. This is joint work with Hamed Amini and Andreea Minca.
SYRW01 28th August 2014
09:45 to 10:15
Risk-Sharing and Contagion in Networks
Joint with A. Cabrales & F. Vega-Redondo

We investigate the trade-off between the risk-sharing gains enjoyed by more interconnected firms and the costs resulting from an increased risk exposure. We find that when the shock distribution displays "fat tails," extreme segmentation into small components is optimal, while minimal segmentation and high density of connections are optimal when the distribution exhibits \thin" tails. For less regular distributions, intermediate degrees of segmentation and sparser connections are optimal. Also, if firms are heterogeneous, optimality requires perfect assortativity in a component. In general, however, a conflict arises between efficiency and pairwise stability, due to a "size externality" not internalized by firms.
SYRW01 28th August 2014
11:00 to 11:30
TM Eisenbach Fire-Sale Spillovers and Systemic Risk
Joint with F. Duarte

We construct a new systemic risk measure that quantifies vulnerability to firesale spillovers using detailed regulatory balance sheet data for U.S. commercial banks and repo market data for broker-dealers. Even for moderate shocks in normal times, fire-sale externalities can be substantial. For commercial banks, a 1 percent exogenous shock to assets in 2013-Q1 produces fire sale externalities equal to 19 percent of system capital. For broker-dealers, a 1 percent shock to assets in August 2013 generates spillover losses equivalent to almost 23 percent of system capital. Externalities during the last financial crisis are between two and three times larger. Our systemic risk measure reaches a peak in the fall of 2007 but shows a notable increase starting in 2004, ahead of many other systemic risk indicators. Although the largest banks and broker-dealers produce - and are victims of - most of the externalities, leverage and linkages of financial institutions also play important roles.
SYRW01 28th August 2014
11:45 to 12:15
Modeling Financial Systemic Risk- the Network Effect and the Market Liquidity Effect
Financial institutions are interconnected directly by holding debt claims against each other (the network channel), and they are also bound by the market liquidity in selling assets to meet debt liabilities when facing distress (the liquidity channel). The goal of our study is to investigate how these two channels of risk interact to propagate individual defaults to a system-wide catastrophe. We formulate the model as an optimization problem with equilibrium constraints and derive a partition algorithm to solve for the market- clearing equilibrium. The solutions so obtained enables us to identify two factors, the network multiplier and the liquidity amplifier, to characterize the contributions of these two channels to financial systemic risk, whereby we can acquire better understanding of the effectiveness of several policy interventions. The analysis behind the algorithm yields estimates for the contagion probability on the basis of the market value of the institutions' net worths, underscoring the importance of equity capital as a cushion against systemic shocks in the presence of the liquidity channel. The optimization formulation also provides more structural insights to allow us to extend the study of systemic risk to a system with debts of different seniorities, and meanwhile presents a close connection to the literature of stochastic networks. Finally, we illustrate the impacts of the network and the liquidity channels- in particular, the significance of the latter -in the formation of systemic risk with data on the European banking system.
SYRW01 28th August 2014
14:30 to 15:00
Efficiency and Stability of a Financial Architecture with Too-Interconnected-to-Fail Institutions
How to regulate large interconnected financial institutions has become a key policy question. To make the financial architecture more stable regulators have proposed to limit the size and connections of these institutions. I calibrate a network-based model of an over-the-counter market and infer the hidden financial architecture based on bilateral trades in the Federal funds market. A comparison of the calibrated architecture to nine counterfactual architectures reveals that that efficiency of liquidity allocation decreases and the risk of endogenous contagion increases non-monotonically as banks face limits on the number of trading partners. I also find that in a less concentrated architecture more banks trigger a large cascade of failures, and it is more difficult to identify these banks ex-ante. Overall, my results suggest it is not optimal to restrict the number of connections of too-interconnected-to-fail banks because it can result in a financial architecture that is less efficient, more fragile, and harder to monitor.
SYRW01 28th August 2014
15:15 to 15:45
An Agent-Based Model for Financial Vulnerability
This paper describes an agent-based model for analyzing the vulnerability of the financial system to asset- and funding-based fire sales. The model views the dynamic interactions of agents in the financial system extending from the suppliers of funding through the intermediation and transformation functions of the Bank/Dealer to the financial institutions that use the funds to trade in the asset markets, and that pass collateral in the opposite direction. The model focuses on the intermediation functions of the Bank/Dealers in order to trace the path of shocks that come from sudden price declines, as well as shocks that come from the various agents, namely funding restrictions imposed by the cash providers, erosion of the credit of the Bank/Dealers, and investor redemptions by the buy-side financial institutions. By building on a detailed mapping of the transformations and dynamics of the financial system, the agent-based model provides an avenue toward risk management that can trace out the pathways of key crisis dynamics such as fire sales and funding runs.
SYRW01 28th August 2014
16:15 to 16:45
S Weber Measures of Systemic Risk
Systemic risk refers to the risk that the financial system is susceptible to failures due to the characteristics of the system itself. The tremendous cost of this type of risk requires the design and implementation of tools for the efficient macroprudential regulation of financial institutions. The talk proposes a novel approach to measuring systemic risk.

Key to our construction is the philosophy that there is no distinction between risk and capital requirements, as recently described in Artzner, Delbaen & Koch-Medina (2009). Such an approach is ideal for regulatory purposes. The suggested systemic risk measures express systemic risk in terms of capital endowments of the financial firms. These endowments constitute the eligible assets of the procedure. Acceptability is defined in terms of cash flows to the entire society and specified by a standard acceptance set of an arbitrary scalar risk measure. Random cash flows can be derived conditional on the capital endowments of the firms within a large class of models of financial systems. These may include both local and global interaction. The resulting systemic risk measures are set-valued and allow a mathematical analysis on the basis of set-valued convex analysis.

We explain the conceptual framework and the definition of systemic risk measures, provide algorithms for their computation, and illustrate their application in numerical case studies - e.g. in the network models of Eisenberg & Noe (2001), Cifuentes, Shin & Ferrucci (2005), and Amini, Filipovic & Minca (2013).

This is joint work with Zachary G. Feinstein (Washington University in St. Louis) and Birgit Rudloff (Princeton University).

SYRW01 29th August 2014
09:00 to 09:30
M Elliott Financial Networks and Contagion
Joint with B. Golub and M. Jackson

We model financial contagions and cascades of defaults among organizations that have a network of cross holdings. We first identify a network-based measure that captures the impact of changes in one organization's value on other organizations' values. We use the measure to study both integration (the increasing of cross holdings) and diversification (the spreading out of cross holdings). We show that diversification initially increases the probability and extent of cascades as a network of interdependencies grows, and eventually the probability and extent of cascades decreases once organizations become less tied to specific other organizations. Integration also faces tradeoffs: increased dependence on other organizations versus less sensitivity to own investments. We briefly discuss incentives to seek bailouts, and associated moral-hazard issues. We also show that once an organization approaches a bankruptcy threshold, there are no trades of cross holdings or assets at fair prices that can lower the probability of its failure, and that unduly favorable trades for that organization and/or a direct injection of capital are necessitated. Finally, we illustrate some aspects of the model with European debt cross holdings.
SYRW01 29th August 2014
09:45 to 10:15
H Amini Default Cascades in Financial Networks
Propagation of balance-sheet or cash-flow insolvency across financial institutions may be modeled as a cascade process on a network representing their mutual exposures. We derive rigorous asymptotic results for the magnitude of contagion in a large financial network and give an analytical expression for the asymptotic fraction of defaults, in terms of network characteristics. Our results extend previous studies on contagion in random graphs to inhomogeneous directed graphs with a given degree sequence and arbitrary distribution of weights. We introduce a criterion for the resilience of a large financial network to the insolvency of a small group of financial institutions and quantify how contagion amplifies small shocks to the network. Our results emphasize the role played by 'contagious links' and show that institutions which contribute most to network instability in case of default have both large connectivity and a large fraction of contagious links. The asymptotic results show good agreement with simulations for networks with realistic sizes. This is joint work with Rama Cont and Andreea Minca.
SYRW01 29th August 2014
11:00 to 11:30
A Network View on Interbank Liquidity
Joint with S. Gabrieli

We use a novel dataset on all interbank money market transactions settled via the Eurosystem's payment system TARGET2 to study the liquidity allocation among European banks around the Lehman insolvency. We show that a freeze occured only in the term segment of the market. Using global and local network measures we characterize this freeze as a network shrinking process. We show that a bank's network position within the market has a significant impact on its lending and borrowing activity post-Lehman. Taking the network structure into account is therefore essential in understanding the reaction of the money market to adverse shocks.

SYRW01 29th August 2014
11:45 to 12:15
Control of interbank contagion under partial information
Co-authors: Hamed Amini (EPFL), Agnes Sulem (INRIA)

We consider a stylized core-periphery financial network in which links lead to the creation of projects in the outside economy but make banks prone to contagion risk. The controller seeks to maximize, under budget constraints, the value of the financial system defined as the total amount of external projects. Under partial information on interbank links, revealed in conjunction with the spread of contagion, the optimal control problem is shown to become a Markov decision problem. We find the optimal intervention policy using dynamic programming.

Our numerical results show that the value of the system depends on the connectivity in a non-monotonous way: it first increases with connectivity and then decreases with connectivity. The maximum value attained depends critically on the budget of the controller and the availability of an adapted intervention strategy. Moreover, we show that for highly connected systems, it is optimal to increase the rate of intervention in the peripheral banks rather than in core banks.

SYRW01 29th August 2014
13:30 to 14:00
P Young How Likely is Contagion in Financial Networks?
Joint with P. Glasserman

Interconnections among financial institutions create potential channels for contagion and amplification of shocks to the financial system. We estimate the extent towhich interconnections increase expected losses and defaults under a wide range of shock distributions. In contrast to most work on financial networks, we assume only minimal information about network structure and rely instead on information about the individual institutions that are the nodes of the network. The key node-level quantities are asset size, leverage, and a financial connectivity measure given by the fraction of a financial institution's liabilities held by other financial institutions. We combine these measures to derive explicit bounds on the potential magnitude of network effects on contagion and loss amplification. Spillover effects are most significant when node sizes are heterogeneous and the originating node is highly leveraged and has high financial connectivity. Our results also highlight the importance of mechanisms that go beyond simple spillover effects to magnify shocks; these include bankruptcy costs, and mark-to-market losses resulting from credit quality deterioration or a loss of confidence. We illustrate the results with data on the European banking system.
SYRW01 29th August 2014
14:15 to 16:00
Systemic Risk: Models and Mechanisms
C Rogers (University of Cambridge)

R Cont (Imperial College London/CNRS)

P Glasserman (Columbia University)

F Vega-Redondo (Bocconi University)

SYR 3rd September 2014
11:00 to 12:00
T Kobayashi Asset correlation and network fragility: How should we intervene?
The question of how to stabilize financial systems has attracted considerable attention since the global financial crisis of 2007-2009. Recently, Beale et al. (2011) demonstrated that higher portfolio diversity among banks would reduce systemic risk by decreasing the risk of simultaneous defaults at the expense of a higher likelihood of individual defaults. In practice, however, a bank default has an externality in that it undermines other banks' balance sheets. In this presentation, I focus on the interplay between the interbank network and asset correlation structure. I argue that regulator's intervention should be designed in a way that takes into account the mesoscopic features of financial markets.
SYR 9th September 2014
10:30 to 12:00
Over the Counter Markets (1)
Over-the-counter (OTC) markets for derivatives, credit derivatives and repurchase agreements played a significant role in the global financial crisis. Rather than being traded through a centralized institution such as a stock exchange, OTC trades are negotiated privately between market participants who may be unaware of prices that are currently available elsewhere in the market. In these relatively opaque markets, investors can be in the dark about the most attractive available terms and who might be offering them. This opaqueness exacerbated the financial crisis, as regulators and market participants were unable to quickly assess the risks and pricing of these instruments. These lecture by Prof. Duffie will provide a concise introduction to key modeling issues and techniques used for studying questions such as valuation, risk sharing and information transmission in OTC markets.
SYR 9th September 2014
14:00 to 15:30
Over the Counter Markets (2)
Over-the-counter (OTC) markets for derivatives, credit derivatives and repurchase agreements played a significant role in the global financial crisis. Rather than being traded through a centralized institution such as a stock exchange, OTC trades are negotiated privately between market participants who may be unaware of prices that are currently available elsewhere in the market. In these relatively opaque markets, investors can be in the dark about the most attractive available terms and who might be offering them. This opaqueness exacerbated the financial crisis, as regulators and market participants were unable to quickly assess the risks and pricing of these instruments. These lecture by Prof. Duffie will provide a concise introduction to key modeling issues and techniques used for studying questions such as valuation, risk sharing and information transmission in OTC markets.
SYR 10th September 2014
11:00 to 12:00
Systemic risk in large claims insurance markets with bipartite graph structure
We model a reinsurance market by using a bipartite graph structure. One group of nodes consists of insurance companies while the other one is formed by objects to be insured. The insurers choose to insure objects independently and with prespecified probabilities. In case of a damage the resulting claims are heavy-tailed random variables. Within the framework of regular variation, we specify the extremal dependence structure among the losses of the insurance companies and consider the influence of the market structure on several classical distribution-based risk measures such as Value-at-Risk, Expected Shortfall and conditional and multivariate versions of them. This is work in progress.
SYR 17th September 2014
14:00 to 15:00
The true cost of OTC derivatives
The true cost of OTC derivativesSince the breakdown in the early 70's of the postwar Bretton Woods fixed exchange rates and the achievements of Black, Scholes and Merton in obtaining a satisfactory theory of option pricing almost simultaneously, banking globally has undergone sweeping transformations at an ever increasing pace. After briefly surveying financial market developments from 1980 to the present, the role of structured over-the-counter derivatives in this advance will be examined in some detail. Previous extensive technical consultancy to leading banks on structured derivative products has been followed since the crisis by expert witness work for clients -- individual, commercial and governmental -- who have purchased these OTC products to their cost. This recent and ongoing experience has been an eye opener which I shall detail with numerous real examples. The presentation will go on to discuss our pricing methodology for these examples and close with some comments on the evolving global regulation of structured OTC derivatives.
SYRW02 22nd September 2014
11:30 to 12:15
P Hartmann Systemic Risk, Macroprudential Supervision and Regulation
The presentation will give a general overview of systemic risk, macroprudential supervision and regulation. It draws on more than 15 years of relevant experience in research and policy, including the results of the European System of Central Banks' Macroprudential Research Network (MaRs). The first part lays out some basic concepts needed for the analysis of systemic risk. The second part describes analytical tools for identifying the different forms of systemic risk and systemic financial instability. The third part reviews regulatory policy instruments that are discussed in the macroprudential policy debate. The various parts contain illustrations through research examples, in particular from the MaRs Network. The talk concludes with a discussion of research directions, which are particularly valuable from the angle of central banks and other macroprudential policy authorities.
SYRW02 22nd September 2014
14:00 to 14:45
When Micro Prudence increases Macro Risk: The Destabilizing Effects of Financial Innovation, Leverage, and Diversification
We propose a simple analytically tractable model showing how basic common practices of accounting and risk management are able to destabilize the financial market, when feedback effects and illiquidity are taken into account. Specifically our model considers financial institutions having capital requirements in the form of VaR constraint and following standard mark-to-market and risk management rules. They also face a diversification cost that prevent them to fully diversify their portfolio. We provide a full analytical quantification of the multivariate feedback effects between investment prices and bank behavior induced by portfolio rebalancing in presence of asset illiquidity and show how changes in the constraints of the bank portfolio optimization endogenously drive the dynamics of the balance sheet aggregate of financial institutions and creates systemic risk. The model shows that when financial innovation reduces the cost of diversification below a given threshold, the strength (due to higher leverage) and coordination (due to similarity of bank portfolios) of feedback effects increase. Under fairly general assumptions on the institution's expectations on future asset volatility and correlation, we observe that when the diversification cost is decreased or the VaR constraint is loosened, the dynamics of the system develops cycles and eventually display a chaotic behavior. Further decrease triggers a transition to a non stationary dynamics characterized by steep growths (bubbles) and plunges (bursts) of market prices. (in collaboration with F. Corsi, S. Marmi, P. Mazzarisi)
SYRW02 22nd September 2014
15:30 to 16:15
C Brownlees Bank Credit Risk Networks: Evidence from the Eurozone Crisis
Co-authors: Christina Hans (Universitat Pompeu Fabra), Eulalia Nualarte (Universitat Pompeu Fabra)

The European financial crisis has shown that the credit risk of large financial institutions is highly interconnected as a results of a number of linkages between entities like exposure to common assets and interbank lending. In this work we propose a novel methodology to study credit risk interdependence in large panels of financial institutions. We introduce a credit risk model in which bank defaults can be triggered both by systematic economy wide and idiosyncratic bank specific shocks. The idiosyncratic shocks are assumed to have a sparse conditional dependence structure that we call the bank credit risk network. An estimation strategy based on CDS data and Lasso-type regression allows to estimate the parameters of the model and to recover the bank credit risk network structure. We apply this technique to analyse the interdependence of large European financial institutions between 2006 and 2013. Results show that the credit risk network captures a substantial amount of de pendence on top of what can be explained by systematic factors.

SYRW02 22nd September 2014
16:30 to 17:15
Filling in the Blanks: Network Structure and Interbank Contagion
Co-authors : Kartik Anand (Bank of Canada), Ben Craig (Federal Reserve)

The network pattern of financial linkages is important in many areas of banking and finance. Yet bilateral linkages are often unobserved, and maximum entropy serves as the leading method for estimating counterparty exposures. This paper proposes an efficient alternative that combines information-theoretic arguments with economic incentives to produce more realistic interbank networks that preserve important characteristics of the original interbank market. The method loads the most probable links with the largest exposures consistent with the total lending and borrowing of each bank, yielding networks with minimum density. When used in a stress-testing context, the minimum density solution overestimates contagion, whereas maximum entropy underestimates it. Using the two benchmarks side by side defines a useful range that bounds the cost of systemic stress present in the true interbank network when counterparty exposures are unknown.

SYRW02 23rd September 2014
09:00 to 09:45
Systemic risk in derivatives markets: a pilot study using CDS data
Co-authors: Robleh Ali, Bank of England, Nick Vause, Bank of England and Filip Zikes, Bank of England

In this paper, we draw on network analysis and a sample of OTC derivatives data from a trade repository to demonstrate how the systemic importance of market participants in the derivatives markets may be measured. This is with a view to the trade repository data available to regulators becoming more comprehensive. We consider the importance of institutions both to the smooth functioning of OTC derivatives markets as well as their scope to spread financial distress, suggesting metrics from network analysis that effectively capture these two concepts. For some of these metrics, we find that direct counterparty positions or exposures serve as a good proxy for more comprehensive measures of systemic importance or risk that additionally take into account positions or exposures beyond those of immediate counterparties. This may be of interest to regulators who may only access counterparty data for firms that they regulate and may not collect data relating to the counterparties of those counterparties.

SYRW02 23rd September 2014
10:00 to 10:45
Systemic Risk and Centralized Clearing of OTC Derivatives: A Network Approach
We analyze the effect of central clearing of OTC derivatives on the financial system stability by means of network simulation approach. We build simple but realistic networks of financial firms, connected by bilateral links and via a single CCP. We simulate balance sheets of firms and introduce shocks to the system to simulate defaults. The default mechanism and shock absorption in presence of the CCP is modeled in the way that maximally reflects the reality. We run Monte Carlo simulations of the networks' evolution and obtain their default and contagion characteristics. We analyze the likelihood of the CCP's default and compare the stability of the financial network with and without the CCP for various network configurations and market scenarios.

We find that, for a homogeneous financial system, the presence of the CCP increases the network's stability and the probability of the CCP's failure is virtually zero. However, for non-homogeneous financial networks, we find the opposite effects: the presence of the CCP leads in this case to a disproportionately large probability of contagion defaults, especially for smaller financial firms. Furthermore, we find that the probability of the CCP failure is substantial in this case, regardless of the capitalization requirements. In all, we find that non-homogeneous networks exhibit greater instability and contagion in the presence of the CCP: a worrying fact, given that any real financial system is highly inhomogeneous in terms of size and concentration.

SYRW02 23rd September 2014
11:30 to 12:15
Margining with Multiple Central Counterparties
Co-authors: Paul Glasserman (Columbia University), Kai Yuan (Columbia University)

Spurred by regulatory efforts to mitigate systemic risk, many financial markets are shifting from a bilateral model of settlement towards central clearing. This is facilitated by a number of central counterparties (CCPs) that have recently emerged. We consider the issues that arise from the presence of multiple CCPs clearing a common set of financial products. In particular, we highlight a number of downstream consequences when such CCPs differ with respect to their margining policies.

SYRW02 23rd September 2014
14:00 to 14:45
Market diversity under Central Clearing
Co-authors: Allen Cheng (Johns Hopkins University), Sriram Rajan (Office of Financial Research)

We quantify the level of market concentration in a financial system where dealers hedge their operations by trading through a Central Counterparty (CCP). We partition individual dealer total assets into hedging and operating portfolios and model interactions of clearing entities with the CCP using Wright-Fisher diffusion dynamics.

We derive the unique Nash equilibrium attained when each dealer optimizes its hedge ratio. More specifically, we identify a relationship between the effectiveness of the clearing member's hedging portfolio transacted over the CCP and the volatility it experiences. As a consequence of this outcome and under optimal hedging, we show that market concentration tends to increase over time hence presenting systemic risk. We propose a self-financing tax and subsidy system that can effectively control market concentration. Using the margin model of Duffie, Scheicher and Vuillemey (2014), we calibrate our framework via an extensive dataset consisting of CDS bilateral exposures cleared through a US-based CCP. We analyze the calibrated model parameters and discuss implications for policy makers.

SYRW02 23rd September 2014
15:30 to 16:15
Capital Adequacy, Pro-cyclicality and Systemic Risk
VaR-based capital adequacy as specified by Basel II accords is subject to procyclical effects, potentially aggravating systemic risk, when it is supposed to mitigate it, as observed during 2008 crisis. Supposed improvements in Basel III, not only don’t resolve the problem, but introduce new sources of systemic risk. The method proposed here for computing the regulatory capital of financial institutions avoids the pitfalls of the Value-at-Risk. The computation is based on a generalized stress testing method, with the following principles: (i) market scenarios are defined by the regulator; (ii) institutions compute the impact of scenarios defined by the regulator and report them; (iii) the regulator not only counts the number of violations of the risk reporting but also their size; (iv) the regulatory capital is a multiple of the worst stress test, where the multiplier depends on the size and the frequency of the violations. By letting the institutions estimate their sensitivities to extreme market shifts, the regulator not only avoids a costly burden, but also keeps institutions responsible for their reporting. On the other hand, by keeping control on the list of stress tests involved in the computation of the capital, the regulator offers itself a very strong lever to prevent speculative bubbles, by making them costly in terms of capital requirements.
SYRW02 23rd September 2014
16:30 to 17:15
Assessing Measures of Order Flow Toxicity and Early Warning Signals for Market Turbulence
Co-authors: Oleg Bondarenko (University of Illinois at Chicago), Maria Gonzalez-Perez (CUNEF, Madrid)

Following the much publicized "flash crash" in the U.S. financial markets on May 6, 2010, much work has been done in terms of developing reliable warning signals for impending market stress. However, this has met with limited success, except for one measure. The VPIN, or Volume-synchronized Probability of INformed trading, metric is introduced by Easley, Lopez de Prado and O'Hara (ELO) as a real-time indicator of order flow toxicity. They find the measure useful in predicting return volatility and conclude it, indeed, may help signal impending market turmoil. The VPIN metric involves decomposing volume into active buys and sells. We use the best-bid-offer (BBO) files from the CME Group to construct highly accurate trade classification measures for the E-mini S&P 500 futures contract. Against this benchmark, the ELO Bulk Volume Classification (BVC) scheme is inferior to a standard tick rule based on individual transactions. Moreover, when VPIN is constructed from an accurate classification, it behaves in a diametrically opposite way to BVC-VPIN. We also find the latter to have forecast power for volatility solely because it generates systematic classification errors that are correlated with trading volume and return volatility. Controlling for trading intensity and volatility, the BVC-VPIN measure has no incremental predictive power for future volatility. We conclude that VPIN is not suitable for capturing order flow toxicity or signaling ensuing market turbulence. In an extension, we also explore high-frequency VIX measures as real-time indicators of market stress. We find it critical to control for confounding effects in the computation of the index. In particular, during stressful periods, when a "fear gauge" is most needed, VIX is least reliable. As an alternative, we construct a real-time "corridor" VIX measure. We document that this index performs vastly better during stressful episodes like the financial crisis and the flash crash.

SYRW02 24th September 2014
09:00 to 09:45
K Yuan Network Risk and Key Players: A Structural Analysis of Interbank Liquidity
Co-authors: Edward Denbee, Christian Julliard and Ye Li

We model banks' liquidity holding decision as a simultaneous game on an interbank borrowing network. We show that at the Nash equilibrium, the contributions of each bank to the network liquidity level and liquidity risk are distinct functions of its indegree and outdegree Katz-Bonacich centrality measures. A wedge between the planner and the market equilibria arises because individual banks do not internalize the effect of their liquidity choice on other banks' liquidity benefit and risk exposure. The network can act as an absorbent or a multiplier of individual banks' shocks. Using a sterling interbank network database from January 2006 to September 2010, we estimate the model in a spatial error framework, and find evidence for a substantial, and time-varying, network risk: in the period before the Lehman crisis, the network is cohesive and liquidity holding decisions are complementary and there is a large network liquidity multiplier; during the 2007-08 crisis, the network becomes less clustered and liquidity holding less dependent on the network; after the crisis, during Quantitative Easing, the network liquidity multiplier becomes negative, implying a lower network potential for generating liquidity. The network impulse-response functions indicate that the risk key players during these periods vary, and are not necessarily the largest borrowers.

SYRW02 24th September 2014
10:00 to 10:45
The Euro interbank repo market
Co-authors: Angelo Ranaldo (University of St. Gallen), Jan Wrampelmeyer (University of St. Gallen)

In the aftermath of the recent financial crisis, policy makers and regulators have initiated enormous efforts to reform financial markets in general and to stabilize banks' funding in particular. Is there a market design for short-term funding that ensures that banks can satisfy their liquidity needs even during severe crisis periods like the 2007-2009 financial crisis or the European sovereign debt crisis? Can a well-designed private market encourage lending even when aggregate risk is large and overall funding conditions tighten? This paper shows that such a private funding market already exists, namely the central counterparty (CCP)-based euro interbank repo market. Using a unique and comprehensive dataset, we provide the first systematic study of this important funding market and show that it is resilient during crisis episodes. If the CCP-based infrastructure is combined with very safe collateral, the market even acts as a shock absorber, in the sense that repo volume increases with risk, while spreads, maturities, and haircuts remain stable. Our results are consistent with banks trusting the CCP-based repo market to be a safe venue to hoard liquidity.

SYRW02 24th September 2014
11:30 to 12:15
J-C Heam Funding liquidity from a regulatory perspective
Co-author: Christian Gourieroux (CREST and University of Toronto)

In the Basel regulation, only the uncertainty on the asset price or on the default of borrowers is considered while the uncertainty about depositors’ or investors’ behaviors on the liability side is neglected. In contrast, we consider risks on both the asset and liability sides. We adapt usual risk measures, such as Value-at-Risk or Probability of Default, to disentangle the losses due to liquidity shortage from the losses due to a lack of solvency. Applied to US data, these additional terms are significant when shocks on prices and volumes are correlated. Consequently, the regulatory reserves for solvency risk cannot be set independently of the reserves for liquidity risk. We show how to set and manage jointly two reserve accounts to control the different risks.

SYRW02 24th September 2014
14:00 to 14:45
Liquidity spillovers in the German banking system
Co-author: Frank Heid (Deutsche Bundesbank)

This paper estimates spillover or contagion effects in bank liquidity for a panel of German banks. To estimate liquidity spillover effects, a spatial econometric approach is adopted, in which an economic distance is introduced that describes the connectedness between each pair of banks. This distance is constructed using interbank lending operations. Given this distance measure, the set of banks form a network, and spillover effects can be estimated in this network by employing the spatial autoregressive model. The results from the instrumental variable estimation indicate that there is a positive and significant liquidity spillover effect for the period of 2008 to 2013. Furthermore, spatial impulse response functions are estimated suggesting that shocks liquidity in this network are not very persistent over time since they do not diffuse over a horizon longer than one week.

SYRW02 24th September 2014
15:30 to 16:15
T Ota Measuring Systemic Illiquidity and Optimal Policy Options: A Dynamic Approach
Co-authors: Gerardo Ferrara (University of Turin), Sam Langfield (ECB), Zijun Liu (Bank of England)

This paper studies systemic liquidity risk in UK interbank system in a dynamic context. We estimate the daily network structures of banks’ short-term funding (up to 30 days) with various confidential datasets, and identify (1) banks that fall short of liquidity by themselves (individually illiquid banks); (2) banks that fall short of liquidity because the counterparties fail to repay their debts to the banks (systemically illiquid banks); and (3) the timing of these banks falling short of liquidity. In order to consider the timing of defaults, not only the number of defaults which normal contagion models focus on, we test a dynamic financial contagion model for the first time in the literature. This dynamic feature is important particularly when we discuss liquidity regulations such as LCR.

We obtain outcomes by the numerical simulations of the dynamic contagion model, with assumptions consistent with PRA’s micro-prudential liquidity monitoring schemes. The outcomes so far show the existence of significant systemic liquidity risk when banks do not have sufficient liquidity buffers. To the authors’ knowledge, this is the first paper in the literature studying interbank systemic liquidity risk with real datasets.

Based on the estimated systemic liquidity risk, we will consider the optimal liquidity provision policies to minimise the systemic liquidity risk, by solving a dynamic programming model.

SYRW02 24th September 2014
16:30 to 17:15
Quantifying contagion in funding markets: An application to stress-testing
In the aftermath of the financial crisis, stress-testing has become mandatory for banks. We propose a tractable model at the frontier of systemic risk stress-testing. Our theoretically-based stress-testing framework integrates credit risk, liquidity risk and contagion risk. We contribute to the literature in different ways. We first generalize the theoretical contagion results of Manz (2010) to an N-banks world, show the uniqueness and existence of an equilibrium in that context, and characterize the contagion dynamics. We then quantify the potential important contribution of information contagion to systemic risk and illustrates why ensuring that each bank is liquid when considered in isolation is not enough. Each bank must also be sufficiently liquid to resist to contagion effects. Finally, we illustrates how crucial are market participants' beliefs about an eventual central bank intervention in the unfolding of events when the financial system is in a fragile state.
SYRW02 25th September 2014
09:00 to 09:45
Vulnerable Banks
Based on joint work with David THESMAR (HEC) and Robin Greenwood (NBER).

When a bank experiences a negative shock to its equity, one way to return to target leverage is to sell assets. If asset sales occur at depressed prices, then one bank's sales may impact other banks with common exposures, resulting in contagion. We propose a simple framework that accounts for how this effect adds up across the banking sector. Our framework explains how the distribution of bank leverage and risk exposures contributes to a form of systemic risk. We compute bank exposures to system-wide deleveraging, as well as the spillover of a single bank's deleveraging onto other banks. We show how our model can be used to evaluate a variety of crisis interventions, such as mergers of good and bad banks and equity injections. We apply the framework to European banks vulnerable to sovereign risk in 2010 and 2011.

SYRW02 25th September 2014
10:00 to 10:45
Fire sales, endogenous risk and price-mediated contagion
Fire sales of assets during financial crises have been recognized as an important channel of contagion and amplification of losses We present a simple model of feedback and contagion through fire sales triggered by an initial macro-shock to a set of leveraged portfolios with common exposures and subject to leverage constraints. We show that the threshold nonlinearity inherent in the onset of fire sales plays a key role in the amplifying of shocks to portfolios, and investigate the role of portfolio constraints -leverage constraints and capital ratios- and the tradeoff between diversification and 'diversity' in determining the magnitude of contagion. The competition between contagion across portfolios and market impact of liquidation ('self-contagion') leads to a non-monotone dependence of the system-wide losses on parameters describing portfolio concentration, with different results depending on the severity of the stress scenarios considered. In particular, the model indicates that, for a given level of severity of the stress, the onset of contagion occurs when leverage is allowed to exceed a critical level, a criterion which can be used to calibrate regulatory constraints on leverage.
SYRW02 25th September 2014
11:30 to 12:15
Networks of Common Asset Holdings: Aggregation and Measures of Vulnerability
Co-author : Anton BRAVERMAN (Cornell)

This paper quantifies the interrelations induced by common asset holdings among financial institutions. A network representation emerges, where nodes represent portfolios and edge weights aggregate the common asset holdings and the liquidity of these holdings. As a building block, we introduce a simple model of order imbalance that estimates price impacts due to liquidity shocks. In our model, asset prices are set by a competitive risk-neutral market maker and the arrival rates for the buyers and sellers depend on the common asset holdings. We illustrate the relevance of our aggregation method and the resulting network representation using data on mutual fund asset holdings. We introduce three related measures of vulnerability in the network and demonstrate a strong dependence between mutual fund returns and these measures.

SYRW02 25th September 2014
14:00 to 14:45
System-wide risk and systemic importance: an incomplete review of metrics and data
I. Two major competing types of systemic-risk metrics are: (i) quantiles, e.g. VaR; and (ii) tail expectations, e.g. expected shortfall (ES). I.a. The choice of a risk metric is often motivated with: (i) properties of the metric’s estimator; (ii) computational convenience. But different metrics correspond to different economic concepts and thus to different policy objectives (e.g. to reduce system-wide risk vs. to build a war chest for a systemic crisis). Similar tension between alternative metrics exists in an investment portfolio context.

I.b. Given a metric for system-wide risk, the Shapley value offers a convenient prism for comparing alternative measures of the systemic importance of individual institutions. It also allows for deriving important properties of these measures and for identifying the policy contexts in which they should be used.

I.c. There is a subtle difference between the impact of an institution on system-wide risk and the presence of an institution in systemic events. Ignoring this difference could lead to grossly misleading conclusions as regards systemic importance.

II. Data availability shapes existing approaches to measuring system-wide risk and systemic importance. One approach builds on a structural model of system-wide risk and relies on balance sheet data and commercial vendors’ estimates of individual riskiness. Another approach builds on reduced-form models and relies on market-price data.

II.a. The first approach has revealed a material impact of the system's network structure on system-wide risk and the systemic importance of individual institutions. The scarcity of real-world data on such structures is thus a major problem in practical applications. II.b. The second approach makes it possible to study tail interdependence across institutions. Tools based on extreme-value theory deliver estimates of such interdependence, which contributes materially to measures of systemic importance.

Related Links: http://www.sciencedirect.com/science/article/pii/S1042957313000326 - "Measuring the systemic importance of interconnected banks" http://www.bis.org/publ/work308.htm - "Attributing systemic risk to individual institutions" http://www.bis.org/publ/qtrpdf/r_qt1306g.htm - "Looking at the tail: price-based measures of systemic importance"

SYRW02 25th September 2014
15:30 to 17:00
Monitoring systemic risk: indicators and data requirements
Laurent Clerc (Banque de France)

Robert Engle (NYU Stern)

Martin Summer (Austrian National Bank)

SYRW02 26th September 2014
09:00 to 09:45
Measuring and allocating systemic risk
Co-author: Markus Brunnermeier (Princeton)

This paper develops a framework for measuring, allocating and managing systemic risk. SystRisk, our measure of total systemic risk, captures the a priori cost to society for providing tail-risk insurance to the financial system. Our allocation principle distributes the total systemic risk among individual institutions according to their size-shifted marginal contributions. To describe economic shocks and systemic feedback effects we propose a reduced form stochastic model that can be calibrated to historical data. We also discuss systemic risk limits, systemic risk charges and a cap and trade system for systemic risk.

SYRW02 26th September 2014
10:00 to 10:45
Conditional Quantiles and Tail Dependence
Co-author: Claudia Czado

Conditional quantile estimation is a crucial step in many statistical problems. For example, the recent work on systemic risk relies on estimating risk conditional on an institution being in distress or conditional on being in a crisis (Adrian and Brunnermeier (2010), Brownlees and Engle (2011)). Specifically, the CoVaR systemic risk measure is based on a conditional quantile when one of the variable is in the tail of the distribution. In this paper, we study properties of conditional quantiles and how they relate to properties of the dependence. In particular, we provide a new graphical characterization of tail dependence and intermediate tail dependence from plots of conditional quantiles with normalized marginal distributions. A popular method to estimate conditional quantiles is the quantile regression (Koenker (2005), Koenker and Bassett (1978)). We discuss the properties and pitfalls of this estimation approach.

SYRW02 26th September 2014
11:30 to 12:15
R Engle The Prospects for Global Financial Stability
Nobel Prize-winning economist Robert F. Engle will present his thoughts on The Prospects for Global Financial Stability during the final session of Monitoring Systemic Risk: Data, Models and Metrics, the second workshop on the INI programme Systemic Risk: Mathematical Modelling and Interdisciplinary Approaches.

Prof Engle is the Michael Armellino Professor of Finance at the New York University Stern School of Business. He was awarded the 2003 Nobel Prize in Economics, which he shared with Prof Clive W. J. Granger of the University of California, San Diego, for his work developing new statistical models of volatility that captured the tendency of stock prices and other financial variables to move between high volatility and low volatility periods.

Amongst other achievements, he is also co-founding president of the Society for Financial Econometrics, a nonprofit group based at New York University. Prof Engle earned his doctorate in Economics and a Master of Science in Physics from Cornell University following his Bachelor of Science which he earned at Williams College. He taught economics at MIT and the University of California, San Diego before joining New York University in 2000.

SYR 1st October 2014
10:30 to 12:00
On some stochastic control problems arising in models of optimal portfolio liquidation: I
Traditional financial market models assume that asset prices follow an exogenous stochastic process and that all transactions can be settled without any impact on market prices. The assumption that all trades can be carried out at exogenous prices is appropriate for small investors who trade only a negligible proportion of the average daily trading volume. Due to lack of liquidity, it is not always appropriate, though, for institutional investors trading large blocks of shares over a short time span. p> The analysis of optimal liquidation problems has received considerable attention in the mathematical finance and stochastic control literature in recent years. From a control theoretic perspective the main characteristic of optimization problems arising within the framework of portfolio liquidation is a strong terminal state constraint, the liquidation constraint, which induces a singular terminal value of the value function. Optimal liquidation problems therefore naturally lead to PDEs, respectively, BSPDEs in the non-Markovian framework, with singular terminal conditions.

We review recent existence and uniqueness of solutions results for PDEs and BSPDEs with singular terminal value arising in models of optimal portfolio liquidation under price sensitive market impact. Our models are flexible enough to allow for simultaneous trading in regular exchanges and dark pools.

SYR 1st October 2014
14:00 to 15:30
On some stochastic control problems arising in models of optimal portfolio liquidation: II
Traditional financial market models assume that asset prices follow an exogenous stochastic process and that all transactions can be settled without any impact on market prices. The assumption that all trades can be carried out at exogenous prices is appropriate for small investors who trade only a negligible proportion of the average daily trading volume. Due to lack of liquidity, it is not always appropriate, though, for institutional investors trading large blocks of shares over a short time span.

The analysis of optimal liquidation problems has received considerable attention in the mathematical finance and stochastic control literature in recent years. From a control theoretic perspective the main characteristic of optimization problems arising within the framework of portfolio liquidation is a strong terminal state constraint, the liquidation constraint, which induces a singular terminal value of the value function. Optimal liquidation problems therefore naturally lead to PDEs, respectively, BSPDEs in the non-Markovian framework, with singular terminal conditions.

We review recent existence and uniqueness of solutions results for PDEs and BSPDEs with singular terminal value arising in models of optimal portfolio liquidation under price sensitive market impact. Our models are flexible enough to allow for simultaneous trading in regular exchanges and dark pools.

SYRW05 8th October 2014
09:00 to 10:30
Mean Field Games and Applications in Economics and Finance I
SYRW05 8th October 2014
11:00 to 11:30
P Degond A kinetic theory view of mean field games and applications to economics
We develop a kinetic theory framework for a games with a continuum of players where Nash equilibria play the role of thermodynamic equilibria. We discuss its connections with mean-field games. We consider the situation of time-scale separation where the slow evolution of the system is driven by the fast relaxation to Nash equilibria and apply it to a model of non-conservative economies.
SYRW05 8th October 2014
11:30 to 11:45
Discussion
SYRW05 8th October 2014
11:45 to 12:15
Price dynamics in limit order markets: a multi-scale stochastic model and its hydrodynamic limit
The advent of high frequency trading has changed the landscape of financial markets, leading to a heterogeneous environment where market participants with a wide range of trading frequencies interact through the limit order book. We propose a stochastic model for dynamics of price and order flow in a limit order market, which captures the coexistence of high frequency and low frequency order flow and examines the consequences of this heterogeneity on price dynamics, volatility and liquidity. We derive scaling limits of the model under different assumptions on the order flow : one variant yields as hydrodynamic limit the Lasry-Lions (2007) price formation model, providing a micro-structural foundation for this model, while another set of assumptions leads to a two-phase moving boundary problem.
SYRW05 8th October 2014
12:15 to 12:30
Discussion
SYRW05 8th October 2014
14:00 to 15:30
Mean Field Games and Applications in Economics and Finance II
SYRW05 8th October 2014
16:00 to 16:30
On a mean field model for knowledge growth
Lucas and Moll proposed a mean field model for knowledge growth, in which individuals can split their time between producing goods with their knowledge or increasing their knowledge level by meeting other individuals. These meetings are modeled by 'collisions', in which knowledge is exchanged. Hence the evolution of the knowledge distribution can by described by a Boltzmann type equation. The choice of how much time is spend on learning or producing goods, is determined by the overall production level. The resulting mean field model corresponds to an optimal control problem with a Boltzmann type constraint. We present first analytic results and discuss the existence of special equilibrium solutions. Furthermore we illustrate the behaviour of the model with numerical simulations.
SYRW05 8th October 2014
16:30 to 17:00
J Carrillo Optimal transport, mean field games and gradient flows
I will review how optimal transport can be seen as a mean field game via the Benamou-Brenier formula. Then I will show how Nash-Cournot equilibria are related to local minimizers of interaction energies or free energies penalized with the Wassertein distance. I will discuss briefly numerical schemes based on the optimal transportation viewpoint for the evolution PDEs obtained which are related to gradient flows of the free energy.
SYRW05 8th October 2014
17:00 to 17:15
Discussion
SYRW05 8th October 2014
17:15 to 17:45
R Carmona The Master Equation for large population equilibria
We use a simple N-player stochastic game with idiosyncratic and common noises to illustrate the introduction of the concept of Master Equation originally proposed by Lasry & Lions. We recast the Mean Field Game (MFG) paradigm in a set of coupled Stochastic Partial Differential Equations (SPDEs). The first one is a forward stochastic Kolmogorov equation giving the evolution of the conditional distributions of the states of the players given the common noise. The second is a form of stochastic Hamilton Jacobi Bellman (HJB) equation providing the solution of the optimization problem when the flow of conditional distributions is given. Being highly coupled, the system reads as an infinite dimensional Forward Backward Stochastic Differential Equation (FBSDE). Uniqueness of a solution and its Markov property lead to the representation of the solution of the backward equation (i.e. the value function of the stochastic HJB equation) as a deterministic function of the solution of the forward Kolmogorov equation, function which is usually called the \textit{decoupling field} of the FBSDE.

The (infinite dimensional) PDE satisfied by this decoupling field is identified with the master equation. We also show that this equation can be derived for other large populations equilibriums like those given by the optimal control of McKean-Vlasov stochastic differential equations.

SYR 15th October 2014
10:00 to 12:00
J-M Lasry Mean Field Games and Applications in Economics and Finance III
SYR 15th October 2014
14:00 to 15:00
Systemic Risk Modelling through SDEs in an Inhomogeneous Network
In this talk we discuss a multivariate Ornstein-Uhlenbeck model for interacting particles in an inhomogeneous network. Empirical studies and previous results suggest that such a model is well-suited to describe financial indicators of banks linked through interbanking lending. Under natural assumptions on the network structure, we prove, as the network size grows, a law of large number result that leads to a simpler limit model. The distinction between so-called core and periphery banks plays an important feature here. Further properties of the limit model are reported. This talk is based on joint work with Claudia Klüppelberg that is currently in progress and continues the work that she has presented at the INI on August 22nd.
SYR 15th October 2014
15:00 to 16:00
The Role of News in Commodity and Equity Markets
In this talk, I will give an overview of an exciting new field of research: creating news sentiment measures in financial markets (the so-called news analytics) and studying how various aspects of news influence asset prices. My main focus will be on commodity markets, but I will also touch upon equity-related news. I will illuminate how commodity and equity markets respond to news, in particular, to positive and negative news sentiment. I will utilize event studies, Granger causality tests and news-augmented volatility models to assess the effect of news on the returns, price jumps, volatilities, correlations and liquidity. I will show that there are significant statistical and economic news effects on asset prices, leading to potentially profitable trading strategies. For energy commodities, I will show a great asymmetry in the market's behavior: negative events are accompanied by much greater losses than the gains surrounding positive events. I propose a Local News Sentiment Level model for constructing a running series of news sentiment. Among other effects, I find strong evidence that news sentiment causes price jumps and conclude that market participants trade as some function of aggregated news. I augment volatility models (GARCH as well as high-frequency volatility models (HEAVY)) with news sentiment and show that including news sentiment measures in volatility models results in superior volatility forecasts and can improve the assessment of risk. Finally, I will discuss how news sentiments for various equities or commodities can be combined into a "news sentiment index" and how such index relates to well-know price indices.
SYR 22nd October 2014
10:30 to 11:30
Simple Macroeconomic Models with a Banking Sector: I
In parallel with the development of DSGE models with frictions, a series of papers have recently proposed to integrate banks within much simpler macro models. The objective is to develop simple calibrations allowing to assess in a transparent way the impact of bank capital regulation on growth and credit cycles. The aim of the tutorial is to present some of these models. Topic 1: Capital requirements and welfare: Van den Heuvel "the Welfare Cost of Bank Capital Requirements" Journal of Monetary Economics 2007 Nguyen, "Bank Capital requirements: A quantitative analysis" Wharton School 2013 de Nicolo, Gamba and Lucchetta "Microprudential regulation in a dynamic model of banking " IMF 2013
SYR 22nd October 2014
14:00 to 15:00
Simple Macroeconomic Models with a Banking Sector: II
In parallel with the development of DSGE models with frictions, a series of papers have recently proposed to integrate banks within much simpler macro models. The objective is to develop simple calibrations allowing to assess in a transparent way the impact of bank capital regulation on growth and credit cycles. The aim of the tutorial is to present some of these models. Topic 2: Countercyclical capital requirements and Credit Cycles: Aikman Haldane Nelson (2011) "Curbing the Credit Cycle" Bank of England, Gersbach Rochet (2013) "Capital Requirements and Credit Fluctuations" CEPR dp 9077
SYR 22nd October 2014
16:00 to 17:00
Large Bets and Stock Market Crashes
We use market microstructure invariance, as developed by Kyle and Obizhaeva (2011a), to examine the price impact and frequency of large stock market sales documented for the following stock market crash events: the stock market crash late of October 1929; the stock market crash of October 19, 1987; the sales of George Soros on October 22, 1987; the liquidation of Jerome Kerviel's rogue trades by Société Générale in January 2008; and the flash crash of May 6, 2010. Actual price declines are similar in magnitude to declines predicted based on parameters estimated from portfolio transitions data by Kyle and Obizhaeva (2011b). The two flash crash events had larger price declines than predicted, with immediate rapid V-shape recoveries. The slower moving 1929 crash had smaller price declines than predicted. Reconciling the predicted frequency of crashes to observed frequencies requires the distribution of quantities sold either to have fatter tails than a log-normal or a larger variance than estimated from portfolio transitions data. Using data available to market participants before these crash events, microstructure invariance leads to reasonable predictions of the impact of these systemic crash events.
SYR 23rd October 2014
11:00 to 12:00
Simple Macroeconomic Models with a Banking Sector: III
In parallel with the development of DSGE models with frictions, a series of papers have recently proposed to integrate banks within much simpler macro models. The objective is to develop simple calibrations allowing to assess in a transparent way the impact of bank capital regulation on growth and credit cycles. The aim of the tutorial is to present some of these models. Topic 3: Bank capital and growth Gersbach Rochet Scheffel "Solow, Ramsey and Banks"(2014) UZH dp, and "Financial Intermediation and Capital Accumulation"(2014) UZH dp
SYR 24th October 2014
10:00 to 12:00
Mod-Phi Convergence: precise asymptotics and local limit theorems for dependent random variables. I
We introduce a functional type of convergence from which one can deduce central limit theorem type results, as well as local limit theorems and precise large and moderate deviations estimates. In particular this provides us with a tool which predicts the scale up to which Gaussian approximation is valid and which explains quantitatively how a breaking of symmetry occurs at this scale. On our way, we also prove Berry-Esseen type estimates. We shall illustrate the methods with various examples:

#sums of dependent random variables with applications to the subgraph counts in the Erdos-Renyi random graph model;

#examples from random combinatorial structures;

#examples from number theory;

#examples from random matrix theory.

#examples from simple statistical mechanics models.

All these examples exhibit some dependence structure. Finally, we shall try to see how these ideas can apply to some simple financial
SYR 24th October 2014
14:00 to 16:00
Mod-Phi Convergence: precise asymptotics and local limit theorems for dependent random variables: II
We introduce a functional type of convergence from which one can deduce central limit theorem type results, as well as local limit theorems and precise large and moderate deviations estimates. In particular this provides us with a tool which predicts the scale up to which Gaussian approximation is valid and which explains quantitatively how a breaking of symmetry occurs at this scale. On our way, we also prove Berry-Esseen type estimates. We shall illustrate the methods with various examples:

#sums of dependent random variables with applications to the subgraph counts in the Erdos-Renyi random graph model;

#examples from random combinatorial structures;

#examples from number theory;

#examples from random matrix theory.

#examples from simple statistical mechanics models.

All these examples exhibit some dependence structure. Finally, we shall try to see how these ideas can apply to some simple financial
SYR 29th October 2014
11:00 to 12:30
Mod-Phi Convergence: precise asymptotics and local limit theorems for dependent random variables: III
We introduce a functional type of convergence from which one can deduce central limit theorem type results, as well as local limit theorems and precise large and moderate deviations estimates. In particular this provides us with a tool which predicts the scale up to which Gaussian approximation is valid and which explains quantitatively how a breaking of symmetry occurs at this scale. On our way, we also prove Berry-Esseen type estimates. We shall illustrate the methods with various examples:

#sums of dependent random variables with applications to the subgraph counts in the Erdos-Renyi random graph model;

#examples from random combinatorial structures;

#examples from number theory;

#examples from random matrix theory.

#examples from simple statistical mechanics models.

All these examples exhibit some dependence structure. Finally, we shall try to see how these ideas can apply to some simple financial
SYR 29th October 2014
14:00 to 15:30
Mod-Phi Convergence: precise asymptotics and local limit theorems for dependent random variables: IV
We introduce a functional type of convergence from which one can deduce central limit theorem type results, as well as local limit theorems and precise large and moderate deviations estimates. In particular this provides us with a tool which predicts the scale up to which Gaussian approximation is valid and which explains quantitatively how a breaking of symmetry occurs at this scale. On our way, we also prove Berry-Esseen type estimates. We shall illustrate the methods with various examples:

#sums of dependent random variables with applications to the subgraph counts in the Erdos-Renyi random graph model;

#examples from random combinatorial structures;

#examples from number theory;

#examples from random matrix theory.

#examples from simple statistical mechanics models.

All these examples exhibit some dependence structure. Finally, we shall try to see how these ideas can apply to some simple financial
SYR 3rd November 2014
10:00 to 11:00
Social coordination and social networks
SYR 3rd November 2014
14:00 to 15:00
Conflict in social networks
SYR 4th November 2014
14:00 to 15:00
Trading in networks
SYR 4th November 2014
15:00 to 16:00
Epidemics in networks
SYR 5th November 2014
10:00 to 11:00
S Weber Monetary Risk Measures - A Short Review
Banks and insurance companies typically use distribution-based risk measures for the evaluation of their downside risks. The talk reviews the theory of monetary risk measures including their statistical properties. Recently, some authors emphasized the significance of the elicitability of risk measures, a notion closely related to Huber's M-estimators and quantile regression. We characterize elicitable distribution-based risk measures and analyze the notion of generalized Hampel-robustness.
SYR 5th November 2014
14:00 to 15:00
S Weber Measures of Systemic Risk
The talk proposes a novel approach to measuring systemic risk. Key to our construction is the philosophy that there is no distinction between risk and capital requirements, as recently described in Artzner, Delbaen & Koch-Medina (2009). Such an approach is ideal for regulatory purposes. The suggested systemic risk measures express systemic risk in terms of capital endowments of the financial firms. These endowments constitute the eligible assets of the procedure. Acceptability is defined in terms of cash flows to the entire society and specified by a standard acceptance set of an arbitrary scalar risk measure. Random cash flows can be derived conditional on the capital endowments of the firms within a large class of models of financial systems. These may include both local and global interaction. The resulting systemic risk measures are set-valued and allow a mathematical analysis on the basis of set-valued convex analysis. We explain the conceptual framework and the definition of systemic risk measures, and provide an algorithm for their computation. The application of these risk measures is ilustrated in numerical case studies in the third talk.
SYR 5th November 2014
15:00 to 16:00
C Aymanns The dynamics of the leverage cycle
We present a simple agent-based model of a financial system composed of leveraged investors such as banks that invest in stocks and manage their risk using a Value-at-Risk constraint, based on historical observations of asset prices. We show that this leads to endogenous irregular oscillations, in which gradual increases in stock prices and leverage are followed by drastic market collapses, i.e. a leverage cycle. This phenomenon is studied using further simplified models. We introduce a flexible leverage regulation policy in which it is possible to continuously tune from pro-cyclical to countercyclical leverage. In order to identify the optimal parameters of this leverage policy we study the trade off between risk in the financial sector and bank leverage. Our results suggest that the optimal leverage policy is close to constant leverage while slightly countercyclical.
SYR 6th November 2014
10:00 to 11:00
S Weber An Integrated Model of Systemic Risk in Financial Networks
The talk presents a comprehensive model of a financial system that integrates network effects (cf. Eisenberg & Noe (2001)), bankruptcy costs (cf. Rogers & Veraart (2013)), cross- holdings (cf. Elsinger (2009)), and fire sales (cf. Cifuentes, Shin & Ferrucci (2005)). For the integrated financial market we prove the existence of a price-payment equilibrium and design an algorithm for the computation of the greatest and the least equilibrium. Systemic risk maesures and the number of defaults corresponding to the greatest price-payment equilibrium are analyzed in several comparative case studies. These illustrate the individual and joint impact of interbank liabilities, bankruptcy costs, cross-holdings and fire sales on systemic risk.
SYR 18th November 2014
11:00 to 12:00
Bank Runs, Deposit Insurance, and Liquidity: I
http://www.minneapolisfed.org/publications_papers/pub_display Talk will review original paper co-written with Doug Diamond.
SYR 19th November 2014
11:00 to 12:00
H Ku Option Replication and Valuation in Illiquid Markets
We first investigate replication of a contingent claim in discrete time under liquidity risk. We model liquidity costs as a stochastic supply curve with an underlying asset price depending on order flow. We use a partial differential equation to define a delta-hedging strategy and show that the payoff of this discrete replicating strategy converges to the payoff of the option. We then investigate the utility indifference pricing to option valuation for a large trader in the market. We consider trading actions in illiquid markets will incur liquidity costs, but at the same time, the trader can have influence on the stock price evolution and gain benefits from the permanent price impact by choosing the optimal strategy. Thus, the option price, in some sense, is determined by these two contradicting phenomena.
SYR 19th November 2014
14:00 to 15:00
Instabilities in economic network models: Is perfect rationality dynamically stable?
We study a dynamical model of interconnected firms which allows for certain market imperfections and frictions, restricted here to be myopic price forecasts and slow adjustment of production. Whereas the standard rational equilibrium is still formally a stationary solution of the dynamics, we show that this equilibrium becomes linearly unstable in a whole region of parameter space. When agents attempt to reach the optimal production target too quickly, coordination breaks down and the dynamics becomes chaotic. In the unstable, "turbulent" phase, the aggregate volatility of the total output remains substantial even when the amplitude of idiosyncratic shocks goes to zero or when the size of the economy becomes large. In other words, crises become endogenous. This suggests an interesting resolution of the "small shocks, large business cycles" puzzle.
SYR 24th November 2014
16:00 to 17:00
R May Systemic Risk in Ecological and Financial Systems: Early Warnings?
SYR 26th November 2014
11:00 to 12:00
Scenario Sets, Risk Measures and Stress Testing Part 1: Theory
We examine the relationship between multivariate scenarios sets and risk measures. Our interest is motivated by the use of scenario sets in the stress testing of banks and insurance companies whose portfolio values and solvency are dependent on changes in underlying financial risk factors. Although regulators suggest that financial institutions should consider extreme but plausible scenarios, there is no clear guidance on exactly how this should be done. We explain the connection between sets based on the notion of half-space depth (HD) and the Value-at-Risk risk measure. We then introduce general depth concepts related to coherent risk measures and show how these lead to scenario sets based on, for example, the expectile or the expected shortfall risk measure. The boundaries of these sets also have interesting interpretations in terms of capital allocation. Finally we explain how the sets might be used in ordinary (forward) stress testing and so-called reverse stress testing.
SYR 26th November 2014
14:00 to 15:00
Scenario Sets, Risk Measures and Stress Testing Part 2: Implementation
We consider the construction of multivariate scenario sets and the implementation of stress tests in practice. In the case of elliptically distributed risk factors, all of the depth-based scenario sets coincide with regions encompassed by the contours of the density function. The interest lies in skewed and/or heavy-tailed multivariate risk factor distributions, where the equivalence of depth contours and density contours does not hold in general. We analyse a number of example including generalized hyperbolic distributions and multivariate Bernoulli distributions. We also consider non-parametric estimation of scenario sets using empirical risk-factor change data.
SYR 2nd December 2014
15:00 to 16:00
Mathematical Aspects of Local vs. Global Risk Analysis: I
SYR 3rd December 2014
11:00 to 12:00
Mathematical Aspects of Local vs. Global Risk Analysis: II
SYR 3rd December 2014
14:00 to 15:00
Revealing information - or not - in financial trading
SYR 9th December 2014
11:00 to 12:00
Bank Runs, Deposit Insurance, and Liquidity: II
http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=800 Co-written with Doug Diamond. Talk will be about extension and current issues
SYR 9th December 2014
14:00 to 15:00
Backtesting and Elicitability Of Risk measures
With the suggested change to the use of expected shortfall for market risk measurement in the trading book of a bank, there has been renewed interest in the problem of backtesting expected shortfall. At the same time it has been suggested that there is a fundamental problem with backtesting expected shortfall due to its "non-elicitability" (Gneiting). Elicitable risk measures are functionals of distributions that minimise expected scores calculated using so-called consistent scoring functions; examples are Value-at-Risk and the expectile risk measure. We examine different ways in which scoring functions may be used in practical backtesting. While scoring functions offer new tools for comparing the effectiveness of banks' risk models, we concur with Acerbi and Szekely that they in no way undermine the potential use of expected shortfall as the main risk measure for the trading book.
SYR 9th December 2014
16:00 to 17:00
Rothschild Distinguished Visiting Fellow Lecture: Admitting Uncertainty: On the Role of Probability in Finance
Over the last decades, advanced probabilistic methods have played an increasing role in Finance, both in Academia and in the financial industry. In view of the recent financial crisis it has been asked to which extent the use of such methods has been part of the problem. We review some of the arguments and then focus on the pervasive issue of model uncertainty, or "Knightian uncertainty". This will be illustrated by the interplay between "historical measures" and "martingale measures" in the standard framework of Mathematical Finance, by strictly path-wise arguments that eliminate probabilistic arguments altogether, and by the quantification of financial risk in terms of monetary risk measures.
SYR 10th December 2014
10:00 to 11:00
M Dempster Financial Innovation and Backward Stochastic Difference Equations
We discuss the optimal design of new securities to cover currently untraded risks in an incomplete market environment.
SYR 10th December 2014
14:00 to 15:00
Endogenous network topology in the interbank lending market
SYRW03 15th December 2014
09:30 to 10:15
Intermediary Leverage Cycles and Financial Stability
Co-author: Nina BOYARCHENKO (Federal Reserve Bank of New York )

We develop a theory of financial intermediary leverage cycles in the context of a dynamic model of the macroeconomy. The interaction between a production sector, a financial intermediation sector, and a household sector gives rise to amplification of fundamental shocks that affect real economic activity. The model features two state variables that represent the dynamics of the economy: the net worth and the leverage of financial intermediaries. The leverage of the intermediaries is procyclical owing to risk-sensitive funding constraints. Relative to an economy with constant leverage, financial intermediaries generate higher output and consumption growth and lower consumption volatility in normal times, but at the cost of systemic solvency and liquidity risks. We show that tightening intermediaries’ risk constraints affects the systemic risk-return trade-off, by lowering the likelihood of systemic crises at the cost of higher pricing of risk. Our model thus represents a conceptual framework for cyclical macroprudential policies within a dynamic stochastic general equilibrium model.

SYRW03 15th December 2014
11:00 to 11:45
Endogenous Leverage and Asset Pricing in Double Auctions
Co-authors: Thomas Breuer (University of Applied Sciences, Vorarlberg), Hans-Joachim Vollbrecht (University of Applied Sciences, Vorarlberg), Martin Jandacka (University of Applied Sciences, Vorarlberg)

We study the exchange and pricing of leveraged assets in an agent based model of a continuous double auction. In this framework we validate recent results in general equilibrium theory about endogenous leverage and its consequences for asset pricing. We find that the institutional details of exchange are critical for a good match between the predictions of the theory and the outcome of the double auction. The outcome of the double auction is in particular sensitive with respect to the details of how markets for debt and collateral are coordinated and how collateral is cleared. These results delineate the scope of markets and financial instruments for which the equilibrium theory provides an appropriate perspective.

SYRW03 15th December 2014
13:30 to 14:15
M Marsili A Systemic Indicator for the Size of Shadow Banking
Co-authors: Davide Fiaschi (University of Pisa - Department of Economics), Imre Kondor (Parmenides Foundation), Valerio Volpati (Scuola Internazionale Superiore di Studi Avanzati (SISSA))

Using public data (Forbes Global 2000) we show that the asset sizes for the largest global firms follow a Pareto distribution in an intermediate range, that is "interrupted" by a sharp cut-off in its upper tail, where it is totally dominated by financial firms. Pareto distributions are generally traced back to a mechanism of proportional random growth, based on a regime of constant returns to scale. This makes our findings of an "interrupted" Pareto distribution all the more puzzling, because we provide evidence that financial firms in our sample should operate in such a regime. We claim that the missing mass from the upper tail of the asset size distribution is a consequence of shadow banking activity and that it provides an (upper) estimate of the size of the shadow banking system. This estimate -- which we propose as a shadow banking index -- compares well with estimates of the Financial Stability Board until 2009, but it shows a sharper rise in shadow banking activity after 2010. Finally, we propose a proportional random growth model that reproduces the observed distribution, thereby providing a quantitative estimate of the intensity of shadow banking activity.

SYRW03 15th December 2014
14:30 to 15:15
N Klimenko Tail Risk, Capital Requirements and the Internal Agency Problem in Banks
In this paper I show how to design capital requirements that would prevent the bank from manufacturing tail risk. In the model, the senior bank manager may have incentives to engage in tail risk. Bank shareholders can prevent the manager from taking on tail risk via the optimal incentive compensation contract. To induce shareholders to implement this contract, capital requirements should internalize its costs. Moreover, bank shareholders must be given incentives to comply with minimum capital requirements by raising new equity and expanding bank assets. Making bank shareholders bear the costs of compliance with capital regulation turns out to be crucial for motivating them to care about risk-management quality in their bank.
SYRW03 15th December 2014
16:00 to 16:45
E Faia Bank Networks: Contagion, Systemic Risk and Prudential Policy
Co-authors: Inaki Aldasoro (Goethe University Frankfurt), Domenico Delli Gatti (Catholic University Milan)

We present a network model of the interbank market in which optimizing risk averse banks lend to each other and invest in non-liquid assets. Clearing takes place through a price tâtonnement mechanism, while traded quantities ate obtained through three alternative matching algorithms: Maximum Entropy, Closest matching and Random matching. Contagion occurs through liquidity hoarding, interbank interconnections and fire sale externalities. The resulting network configurations exhibits core-periphery structure, dis-assortative behavior and low clustering coefficient. We measure systemic importance with network centrality and input-output metrics and systemic risk with Shapley values. Given the realm of our network we analyze the effects of prudential policies on the stability/efficiency trade-off. Liquidity requirements unequivocally decrease systemic risk but at the cost of lower efficiency (measured by aggregate investment in non-liquid assets); equity requirements tend to reduce risk (hence increase stability) without reducing significantly overall investment.

SYRW03 16th December 2014
09:00 to 09:45
A Kashyap How does macroprudential regulation change bank credit supply?
Co-authors: Alexandros Vardoulakis (Federal Reserve Board), Dimitrios Tsomocos (Oxford University)

We analyze a variant of the Diamond-Dybvig (1983) model of banking in which savers can use a bank to invest in a risky project operated by an entrepreneur. The savers can buy equity in the bank and save via deposits. The bank chooses to invest in a safe asset or to fund the entrepreneur. The bank and the entrepreneur face limited liability and there is a probability of a run which is governed by the bank’s leverage and its mix of safe and risky assets. The possibility of the run reduces the incentive to lend and take risk, while limited liability pushes for excessive lending and risk-taking. We explore how capital regulation, liquidity regulation,deposit insurance, loan to value limits, and dividend taxes interact to offset these frictions. We compare agents welfare in the decentralized equilibrium absent regulation with welfare in equilibria that prevail with various regulations that are optimally chosen. In general, regulation can lead to Pareto improvements but fully correcting both distortions requires more than one regulation.

SYRW03 16th December 2014
10:00 to 10:45
F Malherbe Opitmal Capital requirements over the Business and Financial Cycles
I propose a simple theory of intertwined business and financial cycles, where financial regulation both optimally responds to and influences the cycles. In this model, financial frictions lead to excessive aggregate lending by the financial sector. In response, the regulator sets capital requirements to trade off expected output against financial stability. The capital requirement that ensures investment efficiency depends on the state of the economy and, because of a general equilibrium effect, its stringency increases with aggregate banking capital. A regulation that fails to take this effect into account would exacerbate economic fluctuations and result in excessive aggregate lending during a boom. It would also allow for an excessive build up of risk in the financial sector, which implies that, at the peak of a boom, even a small adverse shock could trigger a banking sector collapse, followed by an excessively severe credit crunch.
SYRW03 16th December 2014
11:30 to 12:15
E Schaanning Fire sales, endogenous risk and price-mediated contagion: modeling, monitoring and prudential policy
Co-author: Rama CONT (Imperial College London)

Large-scale deleveraging of assets by distressed financial institutions have been recognized as an important channel for the contagion of losses during the recent financial crisis. We propose a model for analyzing the impact of fire sales on system-wide losses in a system with multiple financial institutions subject to a macroeconomic stress scenario affecting asset values. Our model emphasizes the nonlinear threshold nature of deleveraging, as a result of which the volume of deleveraging is a convex function of initial asset losses, and enables to quantify the magnitude of spillover effects due to price-mediated contagion in terms of liquidity-weighted overlaps of institutional asset holdings. We illustrate these observations on a dataset of European banks.

A key concept which emerges from the model is the notion of indirect exposure of a financial institution to an asset class: we show that, when the impact of of fire sales is taken into account, the effective exposure of an institution to an asset class may be found to be much larger than the apparent exposure as revealed by the portfolio holdings alone. We show that regulatory risk weights of asset classes may be used as a macroprudential tool for a a decentralized regulation of fire sales risk, by providing incentives to financial institutions to reduce their exposure to this contagion channel without revealing confidential information on institutional portfolio holdings.

SYRW03 16th December 2014
14:00 to 15:00
Macroprudential regulation
Tobias Adrian (New York Fed)

Philip Dybvig (Washington University)

Martin Hellwig (Max Planck Institute)

Dimitrios Tsomocos (University of Oxford)

SYRW03 16th December 2014
15:30 to 16:15
Financial regulations and bank credit to the real economy
Co-authors: Saqib Jafarey (City University London), James Porter (City University London), Giampaolo Gabbi (Sda Bocconi Milano)

We present an agent-based model focusing on the linkage between the interbank market and the real economy with a stylised central bank acting as lender of last resort. Using this model we address the tradeoff between stability and economic performance for different structures of the interbank market. We also explore the efficacy of recent regulatory reforms using our rich model. Our results suggest that the effects of regulatory leverage ratios on the banking sector?s performance can vary in a complex and non-monotonic way with the state of the economy, the degree of connectivity of the interbank market and the amount of information available to market participants on bank risks.

SYRW03 16th December 2014
16:15 to 17:00
Bank, Shadow Banking, and Fragility
Co-author: Paul Schempp (University of Bonn and Max Planck Insitute for Research on Collective Goods)

This paper studies a banking model of maturity transformation in which regulatory arbitrage induces the existence of shadow banking next to regulated commercial banks. We derive three main results: First, the relative size of the shadow banking sector determines the stability of the financial system. If the shadow banking sector is small relative to the capacity of secondary markets for shadow banks' assets, shadow banking is stable. In turn, if the sector grows too large, it becomes fragile: an additional equilibrium emerges that is characterized by a panic-based run in the shadow banking sector. Second, if regulated commercial banks themselves operate shadow banks, the parameter space in which a run on shadow banks may occur is reduced. However, once the threat of a crisis reappears, a crisis in the shadow banking sector spreads to the commercial banking sector. Third, in the presence of regulatory arbitrage, a safety net for banks may fail to prevent a banking crisis. Moreover, the safety net may be tested and may eventually become costly for the regulator.

SYRW03 17th December 2014
09:00 to 09:45
L Clerc Capital Regulation in a Macroeconomic Model with Three Layers of Default
Co-authors: Alexis Derviz (Czech National Bank), Caterina Mendicino (Banco de Portugal), Stephane Moyen (Deutsche Bundesbank), Kalin Nikolov (ECB), Livio Stracca (ECB), Javier Suarez (CEPR), Alexandros Vardoulakis (Federal Reserve Board of Governors,), ()

We develop a model which aims at providing a framework for the positive and normative analysis of macroprudential policies. The basic model incorporates optimizing fi…nancial intermediaries (“bankers”) who allocate their scarce wealth (“inside equity”) together with funds raised from saving households across two lending activities, mort- gage lending and corporate lending. External …financing for all borrowers (including banks) takes the form of external debt which is subject to default risk. The model shows the interplay of three interconnected net worth channels as well as distortions due to deposit insurance, and can be extended to analyse the implications of securitization and liquidity risk. The setup allows an explicit welfare analysis of macroprudential policies.

SYRW03 17th December 2014
10:00 to 10:45
Financial intermediaries in the theory of money
Co-author: Markus BRUNNERMEIER (Princeton)

A theory of money needs a proper place for financial intermediaries. Intermediaries create inside money and their ability to take risks determines the money multiplier. In downturns, intermediaries shrink their lending activity and re-sell their assets. Moreover, they create less inside money. As the money multiplier shrinks, the value of money rises. This leads to a Fisher disinflation that hurts intermediaries and all other borrowers. The initial shock is amplified, volatility spikes up and risk premia rise. An accommodative monetary policy in downturns, focused on the assets held by constrained agents, recapitalizes intermediaries and hence mitigates these destabilizing adverse feedback effects. A monetary policy rule that accommodates negative shocks and tightens after positive shocks, provides an ex-ante insurance, mitigates financial frictions, reduces endogenous risk and risk premia but it also creates moral hazard.

SYRW03 17th December 2014
11:30 to 12:15
Systemic Risk and Macroprudential regulation
SYRW03 17th December 2014
14:00 to 14:45
S Kapadia Taking uncertainty seriously: simplicity versus complexity in financial regulation
Co-authors: David Aikman (Bank of England), Mirta Galesic (Max Planck Institute for Human Development, Berlin), Gerd Gigerenzer (Max Planck Institute for Human Development, Berlin), Konstantinos Katsikopoulos (Max Planck Institute for Human Development, Berlin), Amit Kothiyal (Max Planck Institute for Human Development, Berlin), Emma Murphy (Bank of England), Tobias Neumann (Bank of England)

Distinguishing between risk and uncertainty, this paper draws on the psychological literature on heuristics to consider whether and when simpler approaches may outperform more complex methods for modelling and regulating the financial system. We find that: (i) simple methods can sometimes dominate more complex modelling approaches for calculating banks’ capital requirements, especially if limited data are available for estimating models or the underlying risks are characterised by fat-tailed distributions; (ii) simple indicators often outperformed more complex metrics in predicting individual bank failure during the global financial crisis; and (iii) when combining information from different indicators to predict bank failure, ‘fast-and-frugal’ decision trees can perform comparably to standard, but more information-intensive, regression techniques, while being simpler and easier to communicate.
SYRW03 17th December 2014
15:30 to 17:00
Regulating the financial network: the agenda for structural reform
Rama Cont (Imperial College London)

Laurent Clerc (Banque de France)

John Vickers (University of Oxford)

Sujit Kapadia (Bank of England)

SYRW03 18th December 2014
09:00 to 09:45
Illiquidty Component of Credit Risk
Co-author: Hyun Song Shin (Bank of International Settlements)

We describe and contrast three different measures of an institution's credit risk. "Insolvency risk" is the conditional probability of default due to deterioration of asset quality if there is no run by short term creditors. "Total credit risk" is the unconditional probability of default, either because of a (short term) creditor run or (long run) asset insolvency. "Illiquidity risk" is the difference between the two, i.e., the probability of a default due to a run when the institution would otherwise have been solvent. We discuss how the three kinds of risk vary with balance sheet composition. We provide a formula for illiquidity risk and show that it is (i) decreasing in the "liquidity ratio" -- the ratio of realizable cash on the balance sheet to short term liabilities; (ii) increasing in the "outside option ratio" -- a measure of the opportunity cost of the funds used to roll over short term liabilities; and (iii) increasing in the "fundamental risk ratio" -- a measure of ex post variance of the asset portfolio.

SYRW03 18th December 2014
10:00 to 10:45
Information Management in Banking Crises
Co-author: Joel Shapiro (University of Oxford)

A regulator resolving a bank faces two audiences: depositors, who may run if they believe the regulator will not provide capital, and banks, which may take excess risk if they believe the regulator will provide capital. When the regulator's cost of injecting capital is private information, it manages expectations by using costly signals: (i) A regulator with a low cost of injecting capital may forbear on bad banks to signal toughness and reduce risk taking, and (ii) A regulator with a high cost of injecting capital may bail out bad banks to increase confidence and prevent runs.

SYRW03 18th December 2014
11:30 to 12:15
Static Models of Central Counterparty Risk
Following the 2009 G-20 clearing mandate, international standard setting bodies (SSBs)have outlined a set of principles for central counterparty (CCP) risk management; they have also devised formulaic CCP risk capital requirements on clearing members for their central counterparty exposures. There is still no consensus among CCP regulators and bank regulators on how central counterparty risk should be measured coherently in practice. A conceptually sound and logically consistent definition of the CCP risk capital in the absence of a unifying CCP risk measurement framework is challenging. Incoherent CCP risk capital requirements may create an obscure environment disincentivizing the central clearing of over the counter (OTC) derivatives transactions. Based on novel applications of well-known mathematical models in finance, this paper introduces a risk measurement framework that coherently specifies all layers of the default waterfall resources of typical derivatives CCPs. The proposed framework gives the first risk sensitive definition of the CCP risk capital based on which less risk sensitive non-model-based methods can be evaluated.
SYRW03 18th December 2014
14:00 to 14:45
V Acharya Financial Sector Health Since 2007: A Comparative Analysis of the United States, Europe and Asia
This essay uses recent methodology for estimating capital shortfalls of financial institutions during aggregate stress to assess the evolution of financial sector health since 2007 in the United States, Europe and Asia. Financial sector capital shortfalls reach a peak in the end of 2008 and early 2009 for United States and Europe; however, they decline thereafter steadily only for the United States, with Europe reaching a similar peak in the Fall of 2011 during the southern periphery sovereign crises. In contrast, the financial sector in Asia had little capital shortfall in 2008-09 but the shortfall has increased steadily since then, notably for China and Japan. These relative patterns can be explained based on adequate regulatory responses in the United States, the lack thereof in Europe, economic stagnation in Japan, and the bank-leverage based fiscal stimulus in China.
SYRW03 18th December 2014
15:30 to 16:15
Geometry of Defaults
Co-author: Henry K. Schenck (University of Illinois at Urbana-Champaign)

We discuss some geometric considerations of defaults in networks of obligations. In particular, we use the clearing policies of Eisenberg and Noe and some ideas from geometry to compare counterparties.

SYRW03 18th December 2014
16:30 to 17:15
Do U.S. Financial Regulators Listen to the Public? Testing the Regulatory Process with the RegRank algorithm
Co-authors: Shawn Mankad (University of Maryland), George Michailidis (University of Michigan)

We examine the notice-and-comment process and its impact on influencing regulatory decisions by analyzing the text of public rule-making documents of the Commodity Futures Trading Commission (CFTC) and associated comments. For this task, we develop a data mining framework and an algorithm called RegRank, which learns the thematic structure of regulatory rules and public comments and then assigns tone weights to each theme to come up with an aggregate score for each document. Based on these scores we test the hypothesis that the CFTC adjusts the final rule issued in the direction of tone expressed in public comments. Our findings strongly support this hypothesis and further suggest that this mostly occurs in response to comments from the regulated financial industry. We posit that the RegRank algorithm and related text mining methods have the potential to empower the public to test whether it has been given the "due process" and hence keep government agencies in chec k.

SYRW03 19th December 2014
09:00 to 09:45
Networks, subnetworks and macroprudential capital requirements
Co-author: Jukka Isohätälä (Loughborouh University and University of Oulu)

This paper explores some of the consequences of network asymmetry for the transmission and containment of systemic financial risk. Before the global financial crisis network linkage was regarded as a source of stability, providing valuable diversification benefits to the most widely connected firms; since the crisis network linkages this view is widely questioned, is connectivity not a source of vulnerability and of potential transmission of systemic events? A related question is whether macroprudential capital requirements, set to protect the financial system against such systemic events, are better framed (for any given level of aggregate required capital) so as EITHER minimize the degree of transmission of shocks across the system i.e. focussed on the most connected firms; OR to maximize the ability of individual firms to withstand systemic disturbances i.e. focussed on the most specialized firms. These questions (connectivity as a source of protection or source of risk? f ocussing capital on connected or exposed firms) are only meaningful once allowance is made for network asymmetry and the presence of sub-networks (local connections and exposures within the financial system). We seek answers to these questions through simulation of a simple model of systemic financial risk, with a network and subnetworks loosely calibrated to UK experience during the financial crisis, with a focus on both exposure to property markets and extent of maturity mismatch.

SYRW03 19th December 2014
10:00 to 10:45
B Meller BSLoss– a comprehensive measure for interconnectedness
Co-authors: Kilian Fink (Deutsche Bundesbank), Ulrich Krueger (Deutsche Bundesbank), Lui-Hsian Wong (Deutsche Bundesbank)

We propose a measure for interconnectedness: BSLoss, the banking system loss which describes the increase in expected credit losses due to contagion risk. For this purpose, we construct an algorithm to model the transmission of credit risk in the interbank market via a multiple-round-process. Core to the algorithm is the simulation of how a deterioration of credit quality of debtor banks spills over to creditor banks via the interbank credit channel. The transmission of an exogenous shock to one or a group of banks is modeled on the basis of the empirical relationship between the Tier 1 capital ratio and the probability of default of banks. As a consequence of the contagion mechanism a devaluation of banks’ assets and an increase in credit losses can be observed. Compared to other measures for interconnectedness BSLoss comprises several merits: It is easy to interpret in economic terms (ie expressible in monetary units) and reacts sensitively even to small changes in cr edit risk (ie reflects a market value approach). The algorithm may be applied to analyze the effectiveness of systemic capital buffers to curb contagion risk in the banking system.

SYRW03 19th December 2014
11:30 to 12:15
Systemic Risk Measures for Financial Networks
Co-authors: Birgit Rudloff (Princeton University), Stefan Weber (Leibniz Universitat Hannover)

Systemic risk refers to the risk that the financial system is susceptible to failures due to the characteristics of the system itself. The tremendous cost of this type of risk requires the design and implementation of tools for the efficient macroprudential regulation of financial institutions. The talk proposes a novel approach to measuring systemic risk.

Key to our construction is the philosophy that there is no distinction between risk and capital requirements, as recently described in Artzner, Delbaen & Koch-Medina (2009). Such an approach is ideal for regulatory purposes. The suggested systemic risk measures express systemic risk in terms of capital endowments of the financial firms. These endowments constitute the eligible assets of the procedure. Acceptability is defined in terms of cash flows to the entire society and specified by a standard acceptance set of an arbitrary scalar risk measure. Random cash flows can be derived conditional on the capital endowments of the firms within a large class of models of financial systems. These may include both local and global interaction. The resulting systemic risk measures are set-valued and allow a mathematical analysis on the basis of set-valued convex analysis.

We explain the conceptual framework and the definition of systemic risk measures, provide algorithms for their computation, and illustrate their application in numerical case studies - e.g. in the network models of Eisenberg & Noe (2001), Cifuentes, Shin & Ferrucci (2005), and Amini, Filipovic & Minca (2013).

University of Cambridge Research Councils UK
    Clay Mathematics Institute London Mathematical Society NM Rothschild and Sons