Hedging Costs vs. Counterparty Risk: What Explains the Pricing of Structured Products During the 2007-2009 Financial Crisis?

2012 ◽  
Author(s):  
Stefan Petry
Keyword(s):  
Financial Crisis ◽  
Counterparty Risk ◽  
Structured Products

scholarly journals The Business Models of Large Interconnected Banks and the Lessons of the Financial Crisis

2012 ◽  
Vol 221 ◽  
pp. R31-R43 ◽  
Author(s):  
Adrian Blundell-Wignall ◽  
Paul E. Atkinson ◽  
Caroline Roulet
Keyword(s):  
Financial Crisis ◽  
Business Models ◽  
Conflicts Of Interest ◽  
Counterparty Risk ◽  
Too Big To Fail ◽  
Otc Derivatives ◽  
Derivatives Markets ◽  
Systemically Important Banks ◽  
Regulatory Reforms

This paper looks at the urgent and ongoing need to change the business models of global systemically important banks — particularly those that dominate the OTC derivatives markets which carry massive counterparty risk via collateralisation practices. It explores the three main lessons of the financial crisis: too big to fail, excess leverage and conflicts of interest. While regulatory reforms have been plentiful, none have adequately addressed the main source of the problems which lie in the very nature of the business models of large interconnected banks.

scholarly journals How Debt Markets Have Malfunctioned in the Crisis

2010 ◽  
Vol 24 (1) ◽  
pp. 3-28 ◽  
Author(s):  
Arvind Krishnamurthy
Keyword(s):  
Financial Crisis ◽  
Counterparty Risk ◽  
Real Economy ◽  
Risk Capital ◽  
Market Prices ◽  
Subprime Mortgage ◽  
The Real ◽  
Market Values ◽  
Debt Markets ◽  
Fundamental Values

The financial crisis that began in 2007 is especially a crisis in debt markets. A full understanding of what happened in the financial crisis requires investigation into the plumbing of debt markets. During a financial crisis, when funds often cannot be raised easily or quickly, the fundamental values for certain assets can become separated for a time from market prices, with consequences that can echo into the real economy. This article will explain in concrete ways how debt markets can malfunction, with deleterious consequences for the real economy. After a quick overview of debt markets, I discuss three areas that are crucial in all debt markets decisions: risk capital and risk aversion; repo financing and haircuts; and counterparty risk. In each of these areas, feedback effects can arise so that less liquidity and a higher cost for finance can reinforce each other in a contagious spiral. I will document the remarkable rise in the premium that investors placed on liquidity during the crisis. Next, I will show how these issues caused debt markets to break down; indeed, fundamental values and market values seemed to diverge across several markets and products that were far removed from the “toxic” subprime mortgage assets at the root of the crisis. Finally, I will discuss briefly four steps that the Federal Reserve took to ease the crisis and how each was geared to a specific systemic fault that arose during the crisis.

A Black Swan in the Money Market

2009 ◽  
Vol 1 (1) ◽  
pp. 58-83 ◽  
Author(s):  
John B Taylor ◽  
John C Williams
Keyword(s):  
Interest Rate ◽  
Financial Crisis ◽  
Money Market ◽  
Black Swan ◽  
Counterparty Risk ◽  
Federal Funds ◽  
No Arbitrage ◽  
Measures Of Risk ◽  
Recent Financial Crisis ◽  
Robust Evidence

The recent financial crisis saw a dramatic and persistent jump in interest rate spreads between overnight federal funds and longer-term interbank loans. The Fed took several actions to reduce these spreads including the creation of the Term Auction Facility (TAF). The effectiveness of these policies depends on the cause of the increased spreads such as counterparty risk, liquidity, or other factors. Using a no-arbitrage pricing framework and various measures of risk, we find robust evidence that increased counterparty risk contributed to the rise in spreads but do not find robust evidence that the TAF had a significant effect on spreads.

scholarly journals Considerations for the Design of a Central Counterparty for the Mexican Money Market

2011 ◽  
Vol 16 (31) ◽  
pp. 49-61
Author(s):  
Miguel de Lascurain M. ◽  
Keyword(s):  
Financial Crisis ◽  
Money Market ◽  
Counterparty Risk ◽  
Central Counterparties ◽  
Conceptual Designs ◽  
The Creation ◽  
Regulatory Institutions ◽  
Regulatory Failure ◽  
Derivatives Markets ◽  
Management Of Risk

The financial crisis has brought the problems of regulatory failure and unbridled counterparty risk to the forefront in financial discussions. In the last decade, central counterparties have been created in order to face those insidious problems. In Mexico, both the stock and the derivatives markets have central counterparties, but the money market has not. This paper addresses the issue of creating a central counterparty for the Mexican money market. Recommendations that must be followed in the design and the management of risk of a central counterparty, given by international regulatory institutions, are presented in this study. Also, two different conceptual designs for a central counterparty, appropriate for the Mexican market, are proposed. Final conclusions support the creation of a new central counterparty for the Mexican money market.

1 Introduction

2020 ◽  
Keyword(s):  
Financial Crisis ◽  
Financial Institutions ◽  
Global Financial Crisis ◽  
Counterparty Risk ◽  
Regulatory Requirements ◽  
High Quality ◽  
Normal Means ◽  
The One ◽  
The Global Financial Crisis

This introductory chapter provides a background and overview of financial collateral. One of the most significant changes in which financial markets have functioned since the global financial crisis is the 'flight to security'. Both the need for secured lending as well as regulatory requirements to reduce credit risk have contributed to the increased need for collateral, i.e. for liquid, high-quality assets that may be used as collateral. On the one hand, increasing concerns about counterparty risk have meant that secured borrowing and lending have become the normal means by which funding is accessed, largely replacing unsecured finance. On the other hand, the Basel III framework - and the need for better capitalization and liquidity of financial institutions - has made it more important for banks to hold a greater stock of high-quality securities. The global financial crisis and the resulting regulatory responses have thus profoundly affected the supply of, and demand for, financial collateral in that financial collateral has become much scarcer and more important. This book focuses on collateral in international finance transactions. It provides practitioners and academics with a comprehensive handbook on the various aspects of financial collateral and its use. The chapter then describes the terms finance, credit, security, and collateral.

scholarly journals Credit rating agencies and moral hazard

2011 ◽  
Vol 58 (2) ◽  
pp. 219-227 ◽  
Author(s):  
Milos Bozovic ◽  
Branko Urosevic ◽  
Bosko Zivkovic
Keyword(s):  
Financial Crisis ◽  
Moral Hazard ◽  
Credit Risk ◽  
Credit Rating ◽  
Global Financial Crisis ◽  
Credit Rating Agencies ◽  
Rating Agencies ◽  
Structured Products ◽  
The Global Financial Crisis ◽  
Financial Securities

The failure of credit rating agencies to properly assess risks of complex financial securities was instrumental in setting off the global financial crisis. This paper studies the incentives of companies and rating agencies and argues that the way the current rating market is organized may provide agencies with intrinsic disincentives to accurately report credit risk of securities they rate. Informational inefficiency is only enhanced when rating agencies function as an oligopoly or when they rate structured products. We discuss possible market and regulatory solutions to these problems.

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