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A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy

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  • Dale F. Gray
  • Robert C. Merton
  • Zvi Bodie

Abstract

The high cost of international economic and financial crises highlights the need for a comprehensive framework to assess the robustness of national economic and financial systems. This paper proposes a new comprehensive approach to measure, analyze, and manage macroeconomic risk based on the theory and practice of modern contingent claims analysis (CCA). We illustrate how to use the CCA approach to model and measure sectoral and national risk exposures, and analyze policies to offset their potentially harmful effects. This new framework provides economic balance sheets for inter-linked sectors and a risk accounting framework for an economy. CCA provides a natural framework for analysis of mismatches between an entity's assets and liabilities, such as currency and maturity mismatches on balance sheets. Policies or actions that reduce these mismatches will help reduce risk and vulnerability. It also provides a new framework for sovereign capital structure analysis. It is useful for assessing vulnerability, policy analysis, risk management, investment analysis, and design of risk control strategies. Both public and private sector participants can benefit from pursuing ways to facilitate more efficient macro risk accounting, improve price and volatility discovery, and expand international risk intermediation activities.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12637.

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Date of creation: Oct 2006
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Handle: RePEc:nbr:nberwo:12637

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References

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  1. Yingbin Xiao & Dale F. Gray & Cheng Hoon Lim & Michael T. Gapen, 2004. "The Contingent Claims Approach to Corporate Vulnerability Analysis," IMF Working Papers 04/121, International Monetary Fund.
  2. Bodie, Zvi & Merton, Robert C., 2002. "International pension swaps," Journal of Pension Economics and Finance, Cambridge University Press, Cambridge University Press, vol. 1(01), pages 77-83, March.
  3. Dale F. Gray & Elena Loukoianova & Samuel W. Malone & Cheng Hoon Lim, 2008. "A Risk-Based Debt Sustainability Framework," IMF Working Papers 08/40, International Monetary Fund.
  4. Robert C. Merton & Zvi Bodie, 1992. "On the Management of Financial Guarantees," Financial Management, Financial Management Association, Financial Management Association, vol. 21(4), Winter.
  5. Brad Setser & Nouriel Roubini & Christian Keller & Mark Allen & Christoph B. Rosenberg, 2002. "A Balance Sheet Approach to Financial Crisis," IMF Working Papers 02/210, International Monetary Fund.
  6. Zvi Bodie, 2006. "On asset-liability matching and federal deposit and pension insurance," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jul, pages 323-330.
  7. Robert C. Merton, 1995. "A Functional Perspective of Financial Intermediation," Financial Management, Financial Management Association, Financial Management Association, vol. 24(2), Summer.
  8. Liliana Schumacher & Mario I. Bléjer, 2000. "Central Banks Use of Derivatives and Other Contingent Liabilities," IMF Working Papers 00/66, International Monetary Fund.
  9. Jorge A. Chan-Lau, 2003. "Anticipating Credit Events Using Credit Default Swaps, with An Application to Sovereign Debt Crises," IMF Working Papers 03/106, International Monetary Fund.
  10. William R. White, 2000. "Recent initiatives to improve the regulation and supervision of private capital flows," BIS Working Papers 92, Bank for International Settlements.
  11. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  12. Merton, Robert C. & Bodie, Zvi, 1993. "Deposit insurance reform: a functional approach," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 38(1), pages 1-34, June.
  13. Mario Draghi & Francesco Giavazzi & Robert C. Merton, 2003. "Transparency, Risk Management and International Financial Fragility," NBER Working Papers 9806, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Leonardo Luna & Dale F. Gray & Jorge Restrepo & Carlos Garcia, 2011. "Incorporating Financial Sector Risk Into Monetary Policy Models," IMF Working Papers 11/228, International Monetary Fund.
  2. Kalteier, Eva-Maria & Posch, Peter N., 2013. "Sovereign asset values and implications for the credit market," Review of Financial Economics, Elsevier, Elsevier, vol. 22(2), pages 53-60.
  3. Eduardo López E. & Víctor Riquelme P. & Ercio Muñoz S., 2011. "Long – Term Interest Rate and Fiscal Policy," Working Papers Central Bank of Chile, Central Bank of Chile 633, Central Bank of Chile.
  4. Amir E. Khandani & Andrew W. Lo & Robert C. Merton, 2009. "Systemic Risk and the Refinancing Ratchet Effect," NBER Working Papers 15362, National Bureau of Economic Research, Inc.
  5. Claudio Borio, 2011. "Rediscovering the macroeconomic roots of financial stability policy: journey, challenges and a way forward," BIS Working Papers 354, Bank for International Settlements.
  6. Surach Tanboon & Suchot Piamchol & Tanawat Ruenbanterng & Paiboon Pongpaichet, 2009. "Impacts of Financial Factors on Thailand's Business Cycle Fluctuations," Working Papers, Economic Research Department, Bank of Thailand 2009-01, Economic Research Department, Bank of Thailand.
  7. Claudio Borio & Claudio Mathias Drehmann, 2009. "Towards an operational framework for financial stability: "fuzzy" measurement and its consequences," BIS Working Papers 284, Bank for International Settlements.
  8. Angelo Baglioni & Umberto Cherubini, 2011. "Marking-to-Market Government Guarantees to Financial Systems.Theory and Evidence for Europe," DISCE - Quaderni dell'Istituto di Economia e Finanza, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE) ief0103, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  9. José Pablo Dapena, 2006. "Volatility of GDP, macro applications and policy implications of real options for structure of capital Markets," CEMA Working Papers: Serie Documentos de Trabajo., Universidad del CEMA 320, Universidad del CEMA.
  10. Agliardi, Elettra & Agliardi, Rossella & Pinar, Mehmet & Stengos, Thanasis & Topaloglou, Nikolas, 2012. "A new country risk index for emerging markets: A stochastic dominance approach," Journal of Empirical Finance, Elsevier, Elsevier, vol. 19(5), pages 741-761.
  11. Tiago Severo, 2012. "Measuring Systemic Liquidity Risk and the Cost of Liquidity Insurance," IMF Working Papers 12/194, International Monetary Fund.
  12. Edward I. Altman & Herbert A. Rijken, 2013. "Sovereign default risk assessment," International Journal of Banking, Accounting and Finance, Inderscience Enterprises Ltd, vol. 5(1/2), pages 6-27.
  13. Dale F. Gray & Robert C. Merton & Zvi Bodie, 2007. "New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability," NBER Working Papers 13607, National Bureau of Economic Research, Inc.
  14. Baglioni, Angelo & Cherubini, Umberto, 2013. "Within and between systemic country risk. Theory and evidence from the sovereign crisis in Europe," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(8), pages 1581-1597.

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