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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Volatile Capital Flows:
Monitoring Systemic Risks
Giampiero M. Gallo
DiSIA
Università di Firenze, Italy
[email protected]
South East Europe in an Environment of Volatile Capital Flows
CBBH Sarajevo June 6, 2014
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Concentrate on Potential Global Factors
• Main view: EMs (hence SEE) suffer from cascading
effects, possibly dominating domestic factors
• Domestic financing needs crucially depend on
international capital market conditions
• Government needs
• Market yields depend on evolution of risk premia (domestic –
debt, deficit, growth, inflation - and external factors)
• Financing needs for domestically operating financial
institutions (composition across equity, deposits, debt)
• Financing needs for the economy (credit, money and capital
markets – level of development of such markets?): recent
phenomenon of huge excess reserves by banks
• Lessons for regulations (e.g. carry trade)
CBBH – Sarajevo June 6, 2014
2
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Public and Corporate Debt Management in EM
• Overall improvement in the management of debt
•
•
•
•
Extend time to maturity
Reduce exposure in foreign currency
Reduce floating rate exposure
Better awareness of controlling public spending
• On the demand side: rising foreign participation
• Broader investment base (reduce funding costs, risk
diversification)
• Capital outflows related to reactions to global news
• Need to track
• Investors’ base and
• Systemic risks
CBBH- Sarajevo June 6, 2014
3
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Investors’ Base for Sovereigns
(Arslanap and Tsuda, 2014)
• Shifts in the composition of the investor base can
have implications for governments’ borrowing costs
• A rising share of foreign investors in the investor base
can make borrowers more sensitive to external
funding conditions
• A high share of domestic banks in the investor base
may jeopardize domestic financial stability
• A diverse investor base, reflecting different investor
characteristics in terms of risk tolerance and trading
motives, may increase the liquidity of government debt
securities in the secondary market (may be limited if
herding effects)
CBBH- Sarajevo June 6, 2014
4
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Monitoring Investors’ Base Composition
CBBH – Sarajevo June 6, 2014
5
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Different Compositions, Different Risks
CBBH – Sarajevo June 6, 2014
6
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
The Interdependences at Stake
CBBH – Sarajevo June 6, 2014
7
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Ingredients of a Monitoring System
Monitor what affects investors’ portfolio choices by type
of investor (leading indicators of impending shifts)
• Sovereign Bonds (yields, spreads and volatility)
• Corporate Bonds (yields, spreads and volatility)
• Equities (volatilities and spreads in volatilities)
• Correlations across asset classes
• Systemic Important Financial Institutions:
• Estimation of Marginal Expected Shortfall
• Capital Shortfall vs volatility
• Estimation of SRISK and ranking of SIFIs
CBBH – Sarajevo June 6, 2014
8
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
US Corporate Risk
7
6
5
4
3
2
1
0
2006
2007
2008
2009
2010
AAA
2011
2012
2013
2014
BAA
CBBH – Sarajevo June 6, 2014
9
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Country Risk
28
24
20
16
12
8
4
0
I
II III IV I
II III IV I
II III IV I
II III IV I
II III IV I
II III IV
2008
2009
2010
2011
2012
2013
GRE_GER
POR_GER
IRL_GER
SPA_GER
CBBH – Sarajevo June 6, 2014
ITA_GER
10
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Spillover Effects
CBBH – Sarajevo June 6, 2014
11
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Monitoring Systemic Risk
• Two main common features behind systemic risk:
• initial impairment to the financial system
• consequent spillover to the real economy
• Soundness of individual institutions is a necessary, but
not a sufficient condition to guarantee systemic
stability
• Monitoring market volatility as a potential source of
transmission channel but it is the joint distribution of
asset returns that matters, mainly the tail dependence.
CBBH – Sarajevo June 6, 2014
12
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
The Fear Index and the Fear Premium
CBBH – Sarajevo June 6, 2014
13
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Correlation across Asset Classes
CBBH – Sarajevo June 6, 2014
14
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Systemic Important Financial Institutions
Characteristics
• their big size,
• their scant substitutability as service providers, and
• their extremely high interconnectedness that greatly
contributes to spread out individual vulnerabilities
Relevance for the debate today
• Monitoring the SIFI’s risk dynamics has implications
for the volatility of Capital Flows
CBBH – Sarajevo June 6, 2014
15
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Beyond VaR
• The CoVaR (Adrian and Brunnermeier, is the VaR of
one financial institution conditional on the whole
system being in distress.
• The difference between the CoVaR and the
unconditional VaR of the financial system gives the
marginal contribution of that particular institution to
systemic risk.
• Key point: some institutions can have a low VaR, but a
high CoVaR. This is why the simple VaR is not a
sufficient measure to evaluate the systemic riskiness
of financial institutions.
• CoVar has complement in Marginal Expected Shortfall
CBBH – Sarajevo June 6, 2014
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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Acharya, Engle and Richardson (2012)
• Systemic risk should not be described in terms of a
financial firm’s failure per se but in the context of a
firm’s overall contribution to system‐wide failure.
• When only an individual financial firm’s capital is low,
the firm can no longer financially intermediate. This
has minimal consequences though because other
financial firms can fill in for the failed firm’s void.
• When capital is low in the aggregate, however, it is not
possible for other financial firms to step into the
breach. This breakdown in aggregate financial
intermediation is the reason there are severe
consequences for the broader economy.
CBBH – Sarajevo June 6, 2014
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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Capital Shortfall as a Source of Volatile Capital Flows
• Real systemic risk of a firm =
• Real social costs of a crisis per dollar of capital shortage times
• Probability of a crisis i.e., an aggregate capital shortfall times
• Expected capital shortfall of the firm in a crisis
• Expected capital shortfall captures in a single
measure many of the characteristics considered
important for systemic risk such as size, leverage, and
interconnectedness
• Alternative or complement to stress tests
CBBH – Sarajevo June 6, 2014
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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Methodology
• Market volatility and Firm’s Volatility
• Econometric models for volatility and correlations
CBBH – Sarajevo June 6, 2014
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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Evaluating Losses under Crisis Scenarios
• To calculate the systemic risk, this system first
evaluates the losses that an equity holder would face
if there is a future crisis.
• To do this, the system is simulated for six months into
the future many times.
• The most pessimistic scenarios for the market return
are treated as Crisis scenarios
• The expected loss of equity value of firm i is called the
Long Run Marginal Expected Shortfall or LRMES.
This is just the average of the fractional returns of the
firm’s equity in the crisis scenarios.
CBBH – Sarajevo June 6, 2014
20
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Construction of SRISK from Balance Sheets
• Capital shortfall with a prudential capital ratio of k
• If SRISK=0
CBBH – Sarajevo June 6, 2014
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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
SRISK for Deutsche Bank
CBBH – Sarajevo June 6, 2014
22
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Volatility for Deutsche Bank
CBBH – Sarajevo June 6, 2014
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DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Rankings as of May 30, 2014
CBBH – Sarajevo June 6, 2014
24
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
A Silver Lining?
CBBH – Sarajevo June 6, 2014
25
DiSIA
DIPARTIMENTO DI STATISTICA,
INFORMATICA, APPLICAZIONI
"GIUSEPPE PARENTI"
Implications for SEE
• Use the monitoring system to evaluate the relevance
of indicators for the specific domestic banking/capital
market dynamics
• Monitoring SRISK for major European SEFIs may
signal impending reversals in global strategies
• Compare differences across SEE countries to isolate
possible institutional differences
• Indications for regulatory scenarios
CBBH – Sarajevo June 6, 2014
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