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Financial Stability Research

Financial Stability Research. The Office of Financial Research: building a Research Community. Lehman Brothers Failure. Lehman Brothers Failure. Did they know what was going on?. Lehman Brothers Failure. Did they know what was going on? Did they have a choice?.

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Financial Stability Research

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  1. Financial Stability Research The Office of Financial Research: building a Research Community

  2. Lehman Brothers Failure

  3. Lehman Brothers Failure Did they know what was going on?

  4. Lehman Brothers Failure Did they know what was going on? Did they have a choice?

  5. “If this crisis has taught us anything, it has taught us that risk to our system can come from almost any quarter. We must be able to look in every corner and across the horizon for dangers and our system was not able to do that.” Secretary Geithner, opening remarks, testimony to Senate Banking Committee, June 18, 2009.

  6. National Academy of Science Workshop, Nov. 2009 • Sen. Jack Reed, adequacy of data and risk analysis systems for system-wide risks • We have good starting points, with regards to models; we need better data, not clear what data. • This will require a new approach to finance/economics research: • Large Science approach – large scale, multidisciplinary teams • Long-term sustained research effort that will iterate between better models and need for better or more refined data.

  7. Measuring Systemic RiskWhere are we?

  8. Black Swan Losses • Loss Distribution • Tail events are rare – very little data • Typically strong model assumptions

  9. Black Swan Losses We are not in Kansas anymore • Loss Distribution • Tail events are rare – very little data • Typically strong model assumptions • Liquidity Failures • Can’t hedge • No replicating portfolios • Mean & Variance • Game Theory

  10. Black Swan Losses • Loss Distribution • Tail events are rare – very little data • Typically strong model assumptions • Liquidity Failures • Scenario Analysis • Linkages – rights, obligations (Not Netting!) • Granular Macro Economics • Understanding Domino Risk

  11. Black Swan Losses • Loss Distribution • Tail events are rare – very little data • Typically strong model assumptions • Liquidity Failures • Scenario Analysis • Economic Impact • CaR – Credit at Risk • DoL – Distribution of Loss

  12. Monitoring Systemic Risk • Monitoring health of Economy • Regime shifting models • Summaries reflecting stress • Historical data • Derivatives data • Looking for Black Swans • Leverage measures • Concentrations, Bubbles • Liquidity capacity • Linkages and Transparency

  13. Current Risk SystemsSome of the Weaknesses • Not predicting cascading failures • Determine loss by counterparty • Do not predict probability of failure of counterparties • Do not account for Linkages

  14. U.S. Contribution to the Solution:The Office of Financial Research Proposed by concerned citizens Part of regulatory reform legislation Collect system-wide transaction data Develop analytic tools

  15. Lehman Brothers Failure Did they know what was going on? Did they have a choice? Can we afford to have this happen again?

  16. The Office of Financial Research • Office of the Comptroller of the Currency workshop, Feb. 2009 • Proposed National Institute of Finance (NIF) • Collect system-wide data, build analytic tools and monitor systemic-risk • Committee to Establish a NIF • Broad collection of concerned citizens • Legislative Response – OFR is now law

  17. Summary of LegislationDodd Frank Act 2010 • Office of Financial Research works for the Financial Stability Oversight Council • Better data and analysis tools • Long-term research • Regulatory Commons • Independent voice • Two components • Data Center • Research and Analysis Center

  18. Next Steps • Dodd Frank Act is law • Treasury sets up initial OFR • Key Initiatives • Reference data (Treasury’s current focus) • Common computing and data infrastructure • Build initial risk monitoring system • Key long-term research efforts • Investigate past crisis

  19. Opportunity to Help • Organize a Penn State Initiative • Key long-term research efforts • Conceptual models and mathematical models • Identifying important areas of collaboration • Seminar Series/Workshops • University Center, NSF Funding? • Potential Benefits • Future Funding • Back-up data center

  20. Opportunity to Help • Broader Initiatives (Other Universities and Industry partners) • Initial analytic systemic risk systems • Competitive Frameworks for comparison of systemic risk systems • Testing scenarios to prove how different technologies could apply • Cross-over of technologies that can be used for systemic risk • Maps of the financial system • Demonstration of prototypes and feasibility studies

  21. Future Issues • International Collaboration on Data • Common reporting requirements in key markets for market participants • OFR standards offer a point for building common standards • International Collaboration on Research • International body help coordinate and facilitate research across countries, in the public interest

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