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Author:Schuermann, Til 

Journal Article
Hedge funds, financial intermediation, and systemic risk

Hedge funds, with assets under management approaching an estimated $1.5 trillion in 2006, have become important players in the U.S. and global capital markets. These largely unregulated funds differ from other market participants in their use of a variety of complex trading strategies and instruments, in their liberal use of leverage, in their opacity to outsiders, and in their convex compensation structure. These differences can exacerbate potential market failures stemming from agency problems, externalities, and moral hazard. Counterparty credit risk management (CCRM) practices, used by ...
Economic Policy Review , Volume 13 , Issue Dec , Pages 1-18

Journal Article
Horizon problems and extreme events in financial risk management

This paper was presented at the conference "Financial services at the crossroads: capital regulation in the twenty-first century" as part of session 3, "Issues in value-at-risk modeling and evaluation." The conference, held at the Federal Reserve Bank of New York on February 26-27, 1998, was designed to encourage a consensus between the public and private sectors on an agenda for capital regulation in the new century.
Economic Policy Review , Volume 4 , Issue Oct , Pages 109-118

Report
A general approach to integrated risk management with skewed, fat-tailed risks

The goal of integrated risk management in a financial institution is to measure and manage risk and capital across a range of diverse business activities. This requires an approach for aggregating risk types (market, credit, and operational) whose distributional shapes vary considerably. In this paper, we use the method of copulas to construct the joint risk distribution for a typical large, internationally active bank. This technique allows us to incorporate realistic marginal distributions that capture some of the essential empirical features of these risks-such as skewness and fat ...
Staff Reports , Paper 185

Report
Estimating probabilities of default

We conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD), using several analytical approaches from large-sample theory and bootstrapped small-sample confidence intervals. We do so for two different PD estimation methods-cohort and duration (intensity)-using twenty-two years of credit ratings data. We find that the bootstrapped intervals for the duration-based estimates are surprisingly tight when compared with the more commonly used (asymptotic) Wald interval. We find that even with these relatively tight confidence intervals, it is impossible ...
Staff Reports , Paper 190

Report
Macroprudential supervision of financial institutions: lessons from the SCAP

A fundamental conclusion drawn from the recent financial crisis is that the supervision and regulation of financial firms in isolation--a purely microprudential perspective--are not sufficient to maintain financial stability. Rather, a macroprudential perspective, which evaluates and responds to the financial system as a whole, seems necessary, and the ongoing discussions of regulatory reform in the United States underscore this view. The recently concluded Supervisory Capital Assessment Program (SCAP), better known as the bank "stress test," is one example of how the macro- and ...
Staff Reports , Paper 409

Report
Visible and hidden risk factors for banks

This paper examines the common factors that drive the returns of U.S. bank holding companies from 1997 to 2005. We compare a range of market models from a basic one-factor model to a nine-factor model that includes the standard Fama-French factors and additional factors thought to be particularly relevant for banks such as interest and credit variables. We show that the market factor clearly dominates in explaining bank returns, followed by the Fama-French factors. The bank-specific factors are not informative, particularly for the largest banks, which take advantage of protection in the form ...
Staff Reports , Paper 252

Report
Hedge funds, financial intermediation, and systemic risk

Hedge funds are significant players in the U.S. capital markets, but differ from other market participants in important ways such as their use of a wide range of complex trading strategies and instruments, leverage, opacity to outsiders, and their compensation structure. The traditional bulwark against financial market disruptions with potential systemic consequences has been the set of counterparty credit risk management (CCRM) practices by the core of regulated institutions. The characteristics of hedge funds make CCRM more difficult as they exacerbate market failures linked to agency ...
Staff Reports , Paper 291

Report
Understanding the securitization of subprime mortgage credit

In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies ...
Staff Reports , Paper 318

Report
Robust capital regulation

Banks? leverage choices represent a delicate balancing act. Credit discipline argues for more leverage, while balance-sheet opacity and ease of asset substitution argue for less. Meanwhile, regulatory safety nets promote ex post financial stability, but also create perverse incentives for banks to engage in correlated asset choices and to hold little equity capital. As a way to cope with these distorted incentives, we outline a two-tier capital framework for banks. The first tier is a regular core capital requirement that helps deter excessive risk-taking incentives. The second tier, a novel ...
Staff Reports , Paper 490

Report
Forecasting economic and financial variables with global VARs

This paper considers the problem of forecasting real and financial macroeconomic variables across a large number of countries in the global economy. To this end, a global vector autoregressive (GVAR) model previously estimated over the 1979:Q1-2003:Q4 period by Dees, de Mauro, Pesaran, and Smith (2007) is used to generate out-of-sample one-quarter- and four-quarters-ahead forecasts of real output, inflation, real equity prices, exchange rates, and interest rates over the period 2004:Q1-2005:Q4. Forecasts are obtained for 134 variables from twenty-six regions made up of thirty-three countries ...
Staff Reports , Paper 317

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