Laurent Clerc
- 17 September 2013
- OCCASIONAL PAPER SERIES - No. 4Details
- Abstract
- Over the past few years the CDS market’s role has evolved from mostly providing default protection towards credit risk trading. The first-ever credit event in a developed country’s sovereign CDS has further highlighted the importance of the CDS market from a macro-prudential perspective. Developments in the European sovereign CDS market are a part of the major structural shift in euro sovereign debt: in the market’s view, there has been a significant shift from sovereign debt as a (default-free) risk-free benchmark (i.e. bearing interest rate risk only) to sovereign debt as a credit risk asset. Therefore, a significant repricing of the entire asset category has taken place, with major implications ranging from asset allocation to risk management. This implies that some policy issues are not necessarily and exclusively related to the CDS market, but are part of broader developments in the EU financial system. This Occasional Paper aims to provide a comprehensive analysis of the CDS market from a macroprudential perspective. In order to so, a wide range of analytical approaches is applied: Structural analysis of the EU CDS market: description of the market structure, key segments, concentration and evolution over time. Network analysis of bilateral CDS exposures: description of the structure and resilience of the network at an aggregate level as well as of sub-samples. In particular, analysis is conducted on: (i) the aggregated CDS network; (ii) various sub-networks, such as the sovereign CDS network; and (iii) networks for particular CDS reference entities. In order to carry out this analysis, we applied the established literature on interbank and payment systems networks to the CDS exposures network. “Super-spreader” analysis: identification of key “too interconnected to fail” market participants, their activities in the CDS market and their risk-bearing capacity. Scenario analysis of sovereign credit risk: the impact of sovereign credit events on the EU banking system and their potential spillovers. Domino effects in the CDS market: estimation of default chain scenarios for major participants in the CDS market; again, following the literature on interbank networks, we analysed the network impact of the collapse of a major market participant. Comparison of market- and exposure-based assessments of contagion: systemic risk rankings based on market price estimates (e.g. CoVaR) are compared with the rankings obtained using confidential DTCC exposure data in order to understand to what extent market participants are aware of who is a systemically relevant trader in the CDS market and whether these measures of systemic risk are consistent.
- JEL Code
- G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G33 : Financial Economics→Corporate Finance and Governance→Bankruptcy, Liquidation
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
- 9 July 2015
- WORKING PAPER SERIES - No. 1827Details
- Abstract
- We develop a dynamic general equilibrium model for the positive and normative analysis of macroprudential policies. Optimizing financial intermediaries allocate their scarce net worth together with funds raised from saving households across two lending activities, mortgage and corporate lending. For all borrowers (households, firms, and banks) external financing takes the form of debt which is subject to default risk. This
- JEL Code
- E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
- 26 January 2016
- OCCASIONAL PAPER SERIES - No. 9Details
- Abstract
- An epidemiologist calculating the risk of a localised epidemic becoming a global pandemic would investigate every possible channel of contagion from the infected region to the rest of the world. Focusing on, say, the incidence of close human contact would underestimate the pandemic risk if the disease could also spread through the air. Likewise, calculating the quantity of financial system risk requires practitioners to understand all of the channels through which small and local shocks can become big and global. Much of the empirical finance literature has focused only on “direct” contagion arising from firms’ contractual obligations. Direct contagion occurs if one firm’s default on its contractual obligations triggers distress (such as illiquidity or insolvency) at a counterparty firm. But contractual obligations are not the only means by which financial distress can spread, just as close human contact is not the only way that many infectious diseases are transmitted. Focusing only on direct contagion underestimates the risk of financial crisis given that other important channels exist. This paper represents an attempt to move systemic risk analysis closer to the holism of epidemiology. In doing so, we begin by identifying the fundamental channels of indirect contagion, which manifest even in the absence of direct contractual links. The first is the market price channel, in which scarce funding liquidity and low market liquidity reinforce each other, generating a vicious spiral. The second is information spillovers, in which bad news can adversely affect a broad range of financial firms and markets. Indirect contagion spreads market failure through these two channels. In the case of illiquidity spirals, firms do not internalise the negative externality of holding low levels of funding liquidity or of fire-selling assets into a thin market. Lack of information and information asymmetries can cause markets to unravel, even following a relatively small piece of bad news. In both cases, market players act in ways that are privately optimal but socially harmful. The spreading of market failure by indirect contagion motivates policy intervention. Substantial progress has been made in legislating for policies that will improve systemic resilience to indirect contagion. But more tools might be needed to achieve a fully effective and efficient macroprudential policy framework. This paper aims to frame a high-level policy discussion on three policy tools that could be effective and efficient in ensuring systemic resilience to indirect contagion – namely macroprudential liquidity regulation; restrictions on margins and haircuts; and information disclosure.
- JEL Code
- G15 : Financial Economics→General Financial Markets→International Financial Markets
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation