Working Paper: NBER ID: w12637
Authors: Dale F. Gray; Robert C. Merton; Zvi Bodie
Abstract: The high cost of international economic and financial crises highlights the need for a comprehensive framework to assess the robustness of national economic and financial systems. This paper proposes a new comprehensive approach to measure, analyze, and manage macroeconomic risk based on the theory and practice of modern contingent claims analysis (CCA). We illustrate how to use the CCA approach to model and measure sectoral and national risk exposures, and analyze policies to offset their potentially harmful effects. This new framework provides economic balance sheets for inter-linked sectors and a risk accounting framework for an economy. CCA provides a natural framework for analysis of mismatches between an entity's assets and liabilities, such as currency and maturity mismatches on balance sheets. Policies or actions that reduce these mismatches will help reduce risk and vulnerability. It also provides a new framework for sovereign capital structure analysis. It is useful for assessing vulnerability, policy analysis, risk management, investment analysis, and design of risk control strategies. Both public and private sector participants can benefit from pursuing ways to facilitate more efficient macro risk accounting, improve price and volatility discovery, and expand international risk intermediation activities.
Keywords: macrofinancial risks; contingent claims analysis; sovereign credit risk; economic balance sheets
JEL Codes: E5; E6; G2; H0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Corporate sector shocks (E32) | Financial sector risk exposure (G21) |
| Financial sector risk exposure (G21) | Public sector risk exposure (H12) |
| Corporate assets decline (G32) | Implicit government guarantees to banking sector (G28) |
| Policies reducing mismatches between assets and liabilities (G19) | Lower overall economic risk (G19) |
| Analysis of balance sheets (G32) | Quantification of sovereign credit risk (F34) |
| Cumulative risk exposures (G22) | Risk of default (G33) |