Risks of Financial Institutions
An NBER Conference on the Risks of Financial Institutions was held in Cambridge on November 10. Mark Carey; Federal Reserve Board. and Rene M. Stulz, NBER and Ohio State University, organized the meeting, at which the following papers were discussed:
Deborah Lucas, Northwestern University and NBER, and Robert McDonald, Northwestern University, "An Options-Based Approach to Evaluating the Risk of Fannie Mae and Freddie Mac"
Diana Hancock and Wayne Passmore, Federal Reserve Board, "Understanding Market Discipline in the Presence of Implicit Government Guarantees: An Analysis of Subordinated Bond and Stock Returns for GSEs and for Bank Holding Companies"
Discussant for both papers: Thomas Wilson, ING
Markus Brunnermeier, Princeton University, and Lasse Heje Pedersen, New York University, "Market Liquidity and Funding Liquidity" Discussant: Jeremy C. Stein, Harvard University and NBER
Gregory W. Brown, University of North Carolina, Chapel Hill; Sohnke M. Bartram, Lancaster University; and John E. Hund, University of Texas at Austin, "Estimating Systemic Risk in the International Financial System" Discussant: Anthony Saunders, New York University
Viral Acharya and Timothy Johnson, London Business School, "Insider Trading in Credit Derivatives" Discussant: Louis Scott, Morgan Stanley
Torben G. Andersen, Northwestern University and NBER; Tim Bollerslev, Duke University and NBER; and Francis X. Diebold, University of Pennsylvania and NBER, "Roughing It Up: Including Jump Components in the Measurement, Modeling, and Forecasting of Return Volatility"(NBER Working Paper No. 11775)
Discussant: Eric Ghysels, University of North Carolina, Chapel Hill
Samuel Hanson, Harvard University; M. Hashem Pesaran, University of Cambridge; and Til Schuermann, Federal Reserve Bank of New York, "Firm Heterogeneity and Credit Risk Diversification"
Discussant: David M. Lando, Copenhagen Business School
Sanjiv Das, Santa Clara University; Darrell Duffle, Stanford University and NBER; Nikunj Kapadia, University of Massachusetts; and Leandro Saita, Stanford University "Common Failings: How Corporate Defaults Are Correlated"
Discussant: David Li, Barclays Capital
Fannie Mae and Freddie Mac assume a significant amount of interest and prepayment risk and all of the credit risk for about half of the eight trillion dollar U.S. residential mortgage market. Their hybrid government-private status, and the perception that they are too big to fail, make them a potentially large, but mainly unaccounted for, risk to the federal government. Measuring the size and risk of this liability is technically difficult, but important for the debate over the appropriate regulation of these institutions. Lucas and McDonald take an options pricing approach to evaluating these costs and risks. Under the base case assumptions, the estimated value of the guarantees is $7.9 billion over ten years, with a combined 0.5 percent value at risk of $122 billion. The authors evaluate the sensitivity of these estimates to various modeling assumptions, and also to the regulatory regime, including forbearance policies and capital requirements. Their analysis highlights the benefits, but also the challenges, of taking on options-based approach to evaluating the value of federal credit guarantees.
When studying changes in the risks of large bank holding companies (BHCs) and government-sponsored enterprises (GSEs), researchers routinely argue that changes in the responsiveness of stock and subordinated bond returns to exogenous risk factors can be interpreted as reflecting changes in investors' views about the firm's expected losses. However, investors may perceive that these large firms have substantial implicit government guarantees. Hancock and Passmore show that these guarantees can confound the interpretation of stock and bond return responsiveness, making changes in the responsiveness of bond returns difficult to interpret. …