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New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability

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

Abstract

This paper proposes a new approach to improve the way central banks can analyze and manage the financial risks of a national economy. It is based on the modern theory and practice of contingent claims analysis (CCA), which is successfully used today at the level of individual banks by managers, investors, and regulators. The basic analytical tool is the risk-adjusted balance sheet, which shows the sensitivity of the enterprise's assets and liabilities to external "shocks." At the national level, the sectors of an economy are viewed as interconnected portfolios of assets, liabilities, and guarantees -- some explicit and others implicit. Traditional approaches have difficulty analyzing how risks can accumulate gradually and then suddenly erupt in a full-blown crisis. The CCA approach is well-suited to capturing such "non-linearities" and to quantifying the effects of asset-liability mismatches within and across institutions. Risk-adjusted CCA balance sheets facilitate simulations and stress testing to evaluate the potential impact of policies to manage systemic risk.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13607.

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Date of creation: Nov 2007
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Publication status: published as Rodrigo Alfaro (ed.) Financial Stability, Monetary Policy, and Central Banking, , chapter 05, pages 125-157, 2011.
Handle: RePEc:nbr:nberwo:13607

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  6. Dale F. Gray & Robert C. Merton & Zvi Bodie, 2006. "A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy," NBER Working Papers 12637, National Bureau of Economic Research, Inc.
  7. Gunnar Bårdsen & Kjersti-Gro Lindquist & Dimitrios P. Tsomocos, 2006. "Evaluation of macroeconomic models for financial stability analysis," Working Paper 2006/01, Norges Bank.
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  19. Zvi Bodie, 2006. "On asset-liability matching and federal deposit and pension insurance," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 323-330.
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