Net Exposures Research Articles

Credit default swaps and systemic risk

We present a network model for investigating the impact on systemic risk of central clearing of over the counter (OTC) credit default swaps (CDS). We model contingent cash flows resulting from CDS and other OTC derivatives by a multi-layered network with a core-periphery structure, which is flexible enough to reproduce the gross and net exposures as well as the heterogeneity of market shares of participating institutions. We analyze illiquidity cascades resulting from liquidity shocks and show that the contagion of illiquidity takes place along a sub-network constituted by links identified as ’critical receivables’. A key role is played by the long intermediation chains inherent to the structure of the OTC network, which may turn into chains of critical receivables. We calibrate our model to data representing net and gross OTC exposures of large dealer banks and use this model to investigate the impact of central clearing on network stability. We find that, when interest rate swaps are cleared, central clearing of credit default swaps through a well-capitalized CCP can reduce the probability and the magnitude of a systemic illiquidity spiral by reducing the length of the chains of critical receivables within the financial network. These benefits are reduced, however, if some large intermediaries are not included as clearing members.

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Novating a single asset class to a central counterparty (CCP) in an over-the-counter derivatives trading network impacts both the mean and variance of total net exposures between counterparties. When a small number of dealers trade in a relatively large number of asset classes, central clearing increases the mean and variance of net exposures, which may lead to increased counterparty risk and higher margin needs. There are intermediate cases where there is a tradeoff: The introduction of a CCP leads to an increase in expected net exposures but this increase is accompanied by a reduction in variance. We extend the work of Duffie and Zhu (2011) by considering general classes of network structures and focus on scale-free and core-periphery structures, which have been shown to be accurate models of real-world financial networks. We find that a CCP is unlikely to be beneficial when the link structure of the network relies on just a few key nodes. In particular, in large scale-free networks a CCP will always worsen expected netting efficiency. In such cases, CCPs can improve netting efficiency only if agents have some degree of risk aversion that allows them to trade off the reduced variance against the higher expected netted exposures. This may explain why, in the absence of regulation, traders in a derivatives network may not develop a CCP themselves.

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Novating a single asset class to a central counterparty (CCP) in an over-the-counter derivatives trading network impacts both the mean and variance of total net exposures between counterparties. When a small number of dealers trade in a relatively large number of asset classes, central clearing increases the mean and variance of net exposures, which may lead to increased counterparty risk and higher margin needs. There are intermediate cases where there is a trade-off: The introduction of a CCP leads to an increase in expected net exposures but this increase is accompanied by a reduction in variance. We extend the work of Duffie and Zhu (2011) by considering general classes of network structures and focus on scale-free and core-periphery structures, which have been shown to be accurate models of real-world financial networks. We find that a CCP is unlikely to be beneficial when the link structure of the network relies on just a few key nodes. In particular, in large scale-free networks a CCP will always worsen expected netting efficiency. In such cases, CCPs can improve netting efficiency only if agents have some degree of risk aversion that allows them to trade off the reduced variance against the higher expected netted exposures. This may explain why, in the absence of regulation, traders in a derivatives network may not develop a CCP themselves.

SUZAKUSTUDIES OF THE CENTRAL ENGINE IN THE TYPICAL TYPE I SEYFERT NGC 3227: DETECTION OF MULTIPLE PRIMARY X-RAY CONTINUA WITH DISTINCT PROPERTIES

The type I Seyfert galaxy NGC 3227 was observed by Suzaku six times in 2008, with intervals of $\sim1$ week and net exposures of $\sim50$ ksec each. Among the six observations, the source varied by nearly an order of magnitude, being brightest in the 1st observation with a 2-10 keV luminosity of $1.2\times10^{42}$~erg~s$^{-1}$, while faintest in the 4th with $2.9\times10^{41}$~erg~s$^{-1}$. As it became fainter, the continuum in a 2-45 keV band became harder, while a narrow Fe-K$\alpha$ emission line, detected on all occasions at 6.4 keV of the source rest frame, remained approximately constant in the photon flux. Through a method of variability-assisted broad-band spectroscopy (e.g., Noda et al. 2013), the 2-45 keV spectrum of NGC 3227 was decomposed into three distinct components. One is a relatively soft power-law continuum with a photon index of $\sim 2.3$, weakly absorbed and highly variable on time scales of $\sim5$ ksec; it was observed only when the source was above a threshold luminosity of $\sim6.6 \times10^{41}$ erg s$^{-1}$ (in 2-10 keV), and was responsible for further source brightening beyond. Another is a harder and more absorbed continuum with a photon index of $\sim 1.6$, which persisted through the six observations and varied slowly on time scales of a few weeks by a factor of $\sim2$. This component, carrying a major fraction of the broad-band emission when the source is below the threshold luminosity, is considered as an additional primary emission. The last one is a reflection component with the narrow iron line, produced at large distances from the central black hole.

Monitoring the European CDS Market Through Networks: Implications for Contagion Risks

Based on a unique data set referencing exposures on single name credit default swaps (CDS) on European reference entities, we study the structure and the topology of the European CDS market and its evolution from 2008 to 2012, resorting to network analysis. The structural features revealed show bilateral CDS exposures describing growing scale-free networks whose highly interconnected hubs constitute both a strength and weakness for the stability of the system. The potential "super spreaders" of financial contagion, identified as the most interconnected participants, consist mostly of banks. For some of them net notional exposures may be particularly large relative to their total common equity. Our findings also point to the importance of some non-dealer/non-bank participants belonging to the shadow banking system.

Credit Default Swaps and Systemic Risk

We present a network model for investigating the impact on systemic risk of central clearing of over the counter (OTC) credit default swaps (CDS). We model contingent cash flows resulting from CDS and other OTC derivatives by a multi-layered network with a core-periphery structure, which is flexible enough to reproduce the gross and net exposures as well as the heterogeneity of market shares of participating institutions. We analyze illiquidity cascades resulting from liquidity shocks and show that the contagion of illiquidity takes place along a sub-network constituted by links identified as 'critical receivables'. A key role is played by the long intermediation chains inherent to the structure of the OTC network, which may turn into chains of critical receivables.We calibrate our model to data representing net and gross OTC exposures of large dealer banks and use this model to investigate the impact of central clearing on network stability. We find that, when interest rate swaps are cleared, central clearing of credit default swaps through a well-capitalized CCP can reduce the probability and the magnitude of a systemic illiquidity spiral by reducing the length of the chains of critical receivables within the financial network. These benefits are reduced, however, if some large intermediaries are not included as clearing members.

Structure in the Italian overnight loan market

We analyze the Italian interbank loan market from 1999 until 2010. The analysis of net trade flows shows a high imbalance caused by a few large net borrowers in the market. The trading volume shows a significant drop starting in 2007, which accelerates with the Lehman default in late 2008. The interbank loan network is very dense. Hence, we try to identify strong links by looking for preferential lending relationships expressed by discounts in the loan rate. Furthermore, we estimate the dynamics of credit spreads for each bank and find that economically significant spreads for the overnight market developed only in 2010. The analysis of preferential loan relationships reveals that in the pre-Lehman era large net borrowers used to borrow at a slight discount. In the post-Lehman era borrowers with large net exposures paid more than the average market rate, which shows that the risk evaluation of market participants has changed considerably.

International banking during the Global Financial Crisis: U.K. and U.S. perspectives

We provide insights into international bank lending and borrowing, taken from the perspective of banks domiciled in the United Kingdom and the United States. Banks based in these countries are the major recipients and source of international bank lending and borrowing. We also show how these flows have been affected by the Global Financial Crisis. The results have particular interest for regulators, since much of the debate on the scale and scope of international banking concerns the absolute level of exposures, rather than net exposures.

The risk in hedge fund strategies: Theory and evidence from long/short equity hedge funds

Abstract Theory suggests that long/short equity hedge funds' returns come from directional as well as spread bets on the stock market. Empirical analysis finds persistent net exposures to the spread between small vs large cap stocks in addition to the overall market. Together, these factors account for more than 80% of return variation. Additional factors are price momentum and market activity . Combining two major branches of hedge fund research, our model is the first that explicitly incorporates the effect of funding (stock loan) on alpha. Using a comprehensive dataset compiled from three major database sources, we find that among the three thousand plus hedge funds with similar style classification, less than 20% of long/short equity hedge funds delivered significant, persistent, stable positive non-factor related returns. Consistent with the predictions of the Berk and Green (2004) model we find alpha producing funds decays to “beta-only” over time. However, we do not find evidence of a negative effect of fund size on managers' ability to deliver alpha. Finally, we show that non-factor related returns, or alpha, are positively correlated to market activity and negatively correlated to aggregate short interest . In contrast, equity mutual funds and long-bias equity hedge funds have no significant, persistent, non-factor related return. Expressed differently, L/S equity hedge funds, as the name suggests, do benefit from shorting. Besides differences in risk taking behavior, this is a key feature distinguishing L/S funds from long-bias funds.

Reliability of job-title based physical work exposures for the upper extremity: comparison to self-reported and observed exposure estimates

ObjectivesTo evaluate the agreement between job-title based estimates for upper extremity physical work exposures and exposure estimates from work observation and worker self-report.MethodsSelf-reported exposure questionnaires were completed by 972 workers,...

Interest Rate Cycles and Corporate Risk Management

We study the ability of US firms to manage interest rate risk during changes in monetary policy. From annual reports we extract interest rate derivative positions and analyze how they change with the cyclical movements in interest rates. Our hand-collected data follows firms' year-end positions in interest rate derivatives from 1990 through 2000, allowing us to evaluate their performance over time as well as in the cross-section. The 1990s constitute a unique period with pronounced interest rate cycles and with derivatives reporting requirements conducive to our analysis. We also investigate whether users of interest rate derivatives differ from non-users and whether those that appear to be speculating using interest rate derivatives differ from hedgers. In our sample, which is drawn from the Standard and Poor's 500 index, about 50% of the firms can be characterized using interest rate derivatives to hedge, about 33% of firms appear to use them to speculate and the remaining 17% do not use interest rate derivatives. Firms that use derivatives are larger, and appear to be more financially levered, have lower return on assets as well as lower market-to-book ratios than non-users. Despite attempting to separate firms that follow consistent hedging policies from those that opportunistically change net derivative exposures over time, we find no significant differences between those more likely to be hedgers and those that appear to be speculators based on standard proxies for financial distress costs and agency costs. However, the operating cash flows of hedgers are more sensitive to interest rate changes, suggesting differences between the underlying businesses of the two categories. We find no systematic evidence that firms categorized as speculators are able to correctly anticipate changes in interest rates.

Enterprise Risk Management: Theory and Practice

The Chief Risk Officer of Nationwide Insurance teams up with a distinguished academic to discuss the benefits and challenges associated with the design and implementation of an enterprise risk management program. The authors begin by arguing that a carefully designed ERM program—one in which all material corporate risks are viewed and managed within a single framework—can be a source of long‐run competitive advantage and value through its effects at both a “macro” or company‐wide level and a “micro” or business‐unit level.At the macro level, ERM enables senior management to identify, measure, and limit to acceptable levels the net exposures faced by the firm. By managing such exposures mainly with the idea of cushioning downside outcomes and protecting the firm's credit rating, ERM helps maintain the firm's access to capital and other resources necessary to implement its strategy and business plan.At the micro level, ERM adds value by ensuring that all material risks are “owned,” and risk‐return tradeoffs carefully evaluated, by operating managers and employees throughout the firm. To this end, business unit managers at Nationwide are required to provide information about major risks associated with all new capital projects—information that can then used by senior management to evaluate the marginal impact of the projects on the firm's total risk. And to encourage operating managers to focus on the risk‐return tradeoffs in their own businesses, Nationwide's periodic performance evaluations of its business units attempt to refl ect their contributions to total risk by assigning risk‐adjusted levels of “imputed” capital on which project managers are expected to earn adequate returns.The second, and by far the larger, part of the article provides an extensive guide to the process and major challenges that arise when implementing ERM, along with an account of Nationwide's approach to dealing with them. Among other issues, the authors discuss how a company should assess its risk “appetite,” measure how much risk it is bearing, and decide which risks to retain and which to transfer to others. Consistent with the principle of comparative advantage it uses to guide such decisions, Nationwide attempts to limit “non‐core” exposures, such as interest rate and equity risk, thereby enlarging the firm's capacity to bear the “information‐intensive, insurance‐ specific” risks at the core of its business and competencies.

Implications for Liquidity from Innovation and Transparency in the European Corporate Bond Market

This paper offers a new framework for the assessment of financial market liquidity and identifies two types: search liquidity and systemic liquidity. Search liquidity, i.e. liquidity in “normal” times, is driven by search costs required for a trader to find a willing buyer for an asset he/she is trying to sell or vice versa. Search liquidity is asset specific. Systemic liquidity, i.e. liquidity in “stressed” times, is driven by the homogeneity of investors - the degree to which one’s decision to sell is related to the decision to sell made by other market players at the same time. Systemic liquidity is specific to market participants’ behaviour. This framework proves fairly powerful in identifying the role of credit derivatives and transparency for liquidity of corporate bond markets. We have applied it to the illiquid segments of the European credit market and found that credit derivatives are likely to improve search liquidity as well as systemic liquidity. However, it is possible that in their popular use today, credit derivatives reinforce a concentration of positions that can worsen systemic liquidity. We also found that post-trade transparency has surprisingly little bearing on liquidity in that where it improves liquidity it is merely acting as a proxy for pre-trade transparency or transparency of holdings. We conclude that if liquidity is the objective, pre-trade transparency, as well as some delayed transparency on net exposures and concentrations, is likely to be more supportive of both search and systemic liquidity than post-trade transparency. JEL Classification: G14, G15, G18.

The Impact of Commodity Price Risk on Firm Value - An Empirical Analysis of Corporate Commodity Price Exposures

Commodity prices are more volatile than exchange rates and interest rates. Hence, a priori, commodity price risk represents a more important source of risk to corporations. This paper presents a comprehensive analysis of the economic commodity price exposure of a large sample of nonfinancial firms. The results indicate that corporations exhibit net exposures with regard to several commodity prices. Even though commodity prices are highly volatile, commodity price risk is, however, not found to be of greater importance than other financial risks. The results are consistent with few cash flows being affected by commodity price movements, and with corporate hedging of commodity price risk

Analysing Perceived Downside Risk: the Component Value‐at‐Risk Framework

Abstract Multinational companies face increasing risks arising from external risk factors, e.g. exchange rates, interest rates and commodity prices, which they have learned to hedge using derivatives. However, despite increasing disclosure requirements, a firm's net risk profile may not be transparent to shareholders. We develop the ‘Component Value‐at‐Risk (VaR)’ framework for companies to identify the multi‐dimensional downside risk profile as perceived by shareholders. This framework allows for decomposing downside risk into components that are attributable to each of the underlying risk factors. The firm can compare this perceived VaR, including its composition and dynamics, to an internal VaR based on net exposures as it is known to the company. Any differences may lead to surprises at times of earnings announcements and thus constitute a litigation threat to the firm. It may reduce this information asymmetry through targeted communication efforts.

Clinical and laboratory factors underlying refractoriness to platelet transfusions.

Of the spectrum of clinical and laboratory factors responsible for refractoriness to platelet transfusions, some are amenable to intervention, some to circumvention, and others only to acceptance and support for complications. Identification of the likely reason for refractoriness in a given individual patient is critical to determine the optimum management strategy. The blood bank or transfusion service can and perhaps should play a direct role in that strategy through the provision of single donor platelets collected by apheresis. Single donor platelets offer a number of real and theoretical advantages over random donor platelets, including the potential for crossmatching, reduction in net donor exposures, maintenance of ABO-compatibility, improved inventory management, and perhaps diminished rate of alloimmunization. The sole perceived benefits of random donor platelets are cost and availability. The cost differential, however, needs to take into account a variety of factors beyond the immediate concern of platelet collection and distribution, including many highly dependent upon local factors. The optimum management of the platelet refractory patient requires more appropriate use of single donor apheresis platelets coupled with platelet crossmatching when necessary. Data from outcomes studies presented indicates that increased reliance upon single donor apheresis platelets at the expense of pooled random donor units can improve the overall quality of transfusion practice by decreasing platelet utilization, resource consumption, donor exposures, and platelet wastage.

Clinical and laboratory factors underlying refractoriness to platelet transfusions

Of the spectrum of clinical and laboratory factors responsible for refractoriness to platelet transfusions, some are amenable to intervention, some to circumvention, and others only to acceptance and support for complications. Identification of the likely reason for refractoriness in a given individual patient is critical to determine the optimum management strategy. The blood bank or transfusion service can and perhaps should play a direct role in that strategy through the provision of single donor platelets collected by apheresis. Single donor platelets offer a number of real and theoretical advantages over random donor platelets, including the potential for crossmatching, reduction in net donor exposures, maintenance of ABO-compatibility, improved inventory management, and perhaps diminished rate of alloimmunization. The sole perceived benefits of random donor platelets are cost and availability. The cost differential, however, needs to take into account a variety of factors beyond the immediate concern of platelet collection and distribution, including many highly dependent upon local factors. The optimum management of the platelet refractory patient requires more appropriate use of single donor apheresis platelets coupled with platelet crossmatching when necessary. Data from outcomes studies presented indicates that increased reliance upon single donor apheresis platelets at the expense of pooled random donor units can improve the overall quality of transfusion practice by decreasing platelet utilization, resource consumption, donor exposures, and platelet wastage. © 1996 Wiley-Liss, Inc.