Macrofinancial Risk Analysis

by Gray, Dale; Malone, Samuel

• ISBN13: 9780470058312
• ISBN10: 0470058315
• Edition: 1st
• Format: Hardcover
• Copyright: 2008-04-28
• Publisher: Wiley

Summary

Macrofinancial risk analysis Dale Gray and Samuel Malone Macrofinancial Risk Analysis provides a new and powerful framework with which policymakers and investors can analyze risk and vulnerability in economies, both emerging market and industrial. Using modern risk management and financial engineering techniques applied to the macroeconomy, an economic value can be placed on the risks posed by inter-linkages between sectors, the risk of default of different sectors on their outstanding debt obligations quantified, and the value ex-ante of guarantees to private sector entities by the government calculated. This book guides the reader through the basic macroeconomic and financial models necessary to understand the framework, the core analytical tools, and more advanced contributions that will be of interest to researchers. This unique synthesis of ideas from finance and macroeconomics offers several original contributions to the theory of financial crises, as well as a range of new policy options for governments interested in achieving a better tradeoff between economic growth and macro risk.

Author Biography

Dr. DALE GRAY is the Senior Risk Expert in the Monetary and Capital Markets Department of the International Monetary Fund (IMF). He is founder and President of Macro Financial Risk, Inc. (Mf Risk) a pioneer in the application of risk management tools to economies (board members include Robert Merton and Zvi Bodie). He has worked for investment banks, hedge funds, Moody’s Investors Service, IMF, World Bank, IFC as well as advising governments on macro risk analysis, management of sovereign wealth funds, and the design of risk mitigation strategies. He has worked on over thirty countries, is a frequent lecturer with numerous publications. He has a Ph.D. from MIT, MS from Stanford and is a certified Financial Risk Manager.

Dr. SAMUEL W. MALONE is a professor of finance at the IESA, a business school in Caracas, and director of ProAlea, Inc., a risk and strategy consultancy based in Latin America.  He holds a doctorate in economics from the University of Oxford, UK, and undergraduate degrees in mathematics and economics from Duke University, where he graduated Phi Beta Kappa with summa cum laude Latin honors. Elected to attend Oxford as a Rhodes Scholar representing the United States, Malone is also a four-time winner of the international Mathematical Contest in Modeling, an intensive problem-solving competition in which participants devise and write up solutions to real-world problems chosen by experts in government and industry. Author of several articles in applied mathematics and economics, he has consulted for the International Monetary Fund and the Inter-American Development Bank in Washington, DC.

Table of Contents

Foreword

Preface

Introduction

Overview Of Finance, Macroeconomics, And Risk Concepts

A Brief History of Macroeconomics, and Why the Theory of Asset Pricing and Contingent Claims Should Shape its Future

A brief history of macroeconomics

How uncertainty is incorporated into macroeconomic models

Missing components in macro models: balance sheets with risk, default and (nonlinear) risk exposures

Asset pricing theory, financial derivatives pricing and contingent claims analysis

Autoregression in economics vs. random walks in finance

Asset price process related to a threshold or barrier

Relating finance models and risk analytics to macroeconomic models

Toward macrofinancial engineering

Summary

References

Macroeconomic Models

The Hicks-Hansen IS-LM model of a closed economy

The Mundell-Fleming model of an open economy

A dynamic, stochastic, five-equation small open economy macro model

Summary

References

Stochastic Processes, Asset Pricing, and Option Pricing

Stochastic processes

Ito's lemma

Asset pricing: Arrow-Debreu securities and the replicating portfolio

Put and call option values

Pricing the options using the Black-Scholes-Merton formula

Market price of risk

Implications of incomplete markets for pricing

Summary

Primer on relationship of put, call, and exchange options

Physics, Feynman, and finance

References

Balance Sheets, Implicit Options, and Contingent Claims Analysis

Uncertain assets and probability of distress or default on debt

Probability of distress or default

Debt and equity as contingent claims

Payoff diagrams for contingent claims

Understanding why an implicit put option equals expected loss

Using the Merton model and Black-Scholes-Merton formula to value contingent claims

Measuring asset values and volatilities

Estimating implied asset value and asset volatility from equity or junior claims

Risk measures

Summary

References

Further Extensions and Applications of Contingent Claims Analysis

Extensions of the Merton model

Applications of CCA with different types of distress barriers and liability structures

Risk adjusted and actual probabilities using the market price of risk, Sharpe ratios, and recovery rates

Moody's-KMV's approach

CCA using skewed asset distributions modeled with a mixture of lognormals

Maximum likelihood methods

Incorporating stochastic interest rates and interest rate term structures into structural CCA balance sheet models

Other structural models with stochastic interest rates

Summary

Calculating parameters in the Vasicek model

References

The Macrofinance Modeling Framework

The Macrofinance Modeling Framework: Interlinked Sector Balance Sheets

Contingent claim balance sheets for sectors

Measuring asset values and volatilities

Measuring risk exposures

Linkages in a simple four-sector framework

Integrated value and risk transmission between sectors

Policy effectiveness parameters in implicit options

Advantages of an integrated balance sheet eiskapproach

Summary

References

The Macrofinance Modeling Framework: A Closer Look at the Sovereign CCA Balance Sheet

CCA balance sheet for the government and monetary authorities

Sovereign distress

Calculat

Table of Contents provided by Publisher. All Rights Reserved.