A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy
Boston University - Department of Finance & Economics
Dale F. Gray
International Monetary Fund (IMF); MF Risk
Robert C. Merton
MIT Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit
October 10, 2006
HBS Finance Working Paper No. 936661
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.
Number of Pages in PDF File: 45
Keywords: macrofinancial risks, risk propagation, sovereign risk
JEL Classification: G2, E5, E6, H0working papers series
Date posted: October 11, 2006
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