Browsing by Subject "Systemic risk"

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Monetary policy and systemic risk on financial markets : concepts, transmission channels and policy implications
(2016) Scheffknecht, Lukas; Spahn, Peter
The present thesis explores the issue of systemic risk on financial markets and its interplay with monetary policy. Systemic risk is defined as the risk of experiencing a severe financial crisis. It is inefficiently high in the absence of appropriate regulation due to the presence of systemic externalities, which arise if financial institutions do not internalize the consequences of their actions for systemic stability. More specifically, such behavior may lead to vulnerable financial networks, poor diversification, fire sales, inefficient distribution of liquidity as well as to breakdowns of markets characterized by incomplete information. Macroprudential regulation aiming at systemic stability should therefore focus on the mitigation of systemic externalities. However, a critical assessment of the current state of financial regulation reveals that several important drivers of systemic risk remain unaddressed. Insufficient containment of systemic risk poses a challenge for monetary policy. First, financial crises have adverse effects on macroeconomic stability. Second, monetary policy itself has the potential to affect the evolution of systemic risk. It is subsequently tried to shed light on potential transmission channels running from an expansive policy stance to an increase in systemic risk. On a theoretical basis, it is found that a monetary expansion tends to induce higher leverage as well as credit risk and less stable refinancing in the intermediation sector. An empirical analysis of the US economy based on vector autoregressions supports this “risk-taking channel.” Moreover, the analysis of a simple macro-financial model shows that procyclical risk-taking behavior of financial intermediaries produces additional macroeconomic volatility. Optimal policy consists of a combination of strict capital requirements and an interest rate rule featuring an explicit reaction to credit dynamics. In a final step, I discuss implications for monetary policy. If macroprudential regulation is not strict enough, it is advisable to embark on a strategy of preemptive interest rate hikes in an environment of rising systemic risk. Its implementation could be achieved by a slight modification of the existing two-pillar strategy of the European Central Bank. Alternatively, central banks could rely on output gap measures which take financial conditions into account. However, such a strategy can increase short-term macroeconomic volatility. Hence, monetary policy faces the additional trade-off of balancing medium-term financial stability against macroeconomic stability in the short run. Moreover, monetary policy and macroprudential regulation should be carefully coordinated to deliver welfare-maximizing outcomes.
The effect of central counterparties on counterparty risk, liquidity and systemic risk of Over-the-Counter markets
(2020) Schönemann, Gregor H.; Gehde-Trapp, Monika
The introduction of central clearing on formerly bilaterally cleared derivatives markets has been one of the biggest changes in the landscape of financial markets during the last decade. The studies in this thesis examine this landmark in financial markets regulation by analyzing its effect on three relevant areas of financial market stability: counterparty risk, market liquidity and systemic risk. The studies in this dissertation examine the effect of central clearing on these three areas empirically on the market for Credit Default Swaps (CDS) by using data from the Depository Trust & Clearing Corporation (DTCC). The results show that the option to clear trades with an arguably very creditworthy Central Clearing Counterparty (CCP) leads to varying effects depending on the risk profile of the CDS contracts. In chapter 2, we show that the introduction of central clearing decreases the netting efficiency of CDS contracts and leads to a higher fragmentation of CDS positions. This negative effect is concentrated in CDS contracts that were relatively efficiently netted in bilateral markets. The netting efficiency of ex-ante less efficiently netted CDS contracts, however, is not decreased by the introduction of central clearing. In chapter 3, I use a regression discontinuity design to show that central clearing affects market liquidity of CDS contracts positively. This effect, however, is concentrated in CDS contracts with high fundamental risk and high liquidity risk. Furthermore, I show that the positive liquidity effect can be explained by a lower sensitivity of market liquidity to counterparty risk and lower regulatory costs. In chapter 4, we use different time series techniques in order to show that the default dependencies among the dominant CDS market participants decrease with the introduction of central clearing. All in all, the results show the potentially stabilizing effect of CCPs on the financial market architecture of derivatives markets. However, this effect depends on the contracts that are made eligible for central clearing by CCPs. High-risk contracts exhibit by far the highest benefits from the central clearing option. For CCPs, however, low-risk contracts of high liquidity and high trading volumes may be most attractive to make eligible for central clearing as they maximize revenues and minimize risk management costs. This shows the conflict between regulators and regulated entities and the necessity of bespoke financial markets regulation.