New Framework for Managing Macrofinancial Risk
A new paper* published by the Harvard Business School proposes that central banks use contingent claims analysis (CCA) to analyze and manage national financial risks. CCA is successfully used today at the level of individual banks by managers, investors, and regulators.
The basic analytical tool of the proposal is the risk-adjusted balance sheet, which shows the sensitivity of the enterprise’s assets and liabilities to external “shocks.”
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, the authors write. “Risk-adjusted CCA balance sheets facilitate simulations and stress testing to evaluate the potential impact of policies to manage systemic risk. The time pattern of CCA balance sheet components, risk indicators, and sensitivity parameters can be integrated with macroeconomic models.”
*New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability by Dale F. Gray (Sr. Risk Expert, Monetary and Capital Markets Department
International Monetary Fund), Robert C. Merton (John and Natty McArthur University Professor Harvard Business School) and Zvi Bodie (Norman and Adele Barron Professor of Management Boston University School of Management).
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