New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability

32 Pages Posted: 27 Nov 2007  

Dale F. Gray

International Monetary Fund (IMF); MF Risk

Zvi Bodie

Boston University - Department of Finance & Economics

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit

Date Written: November 2007

Abstract

This paper proposes a new approach to improve the way central banks can analyze and manage the financial risks of a national economy. It is based on the modern theory and practice of contingent claims analysis (CCA), which is successfully used today at the level of individual banks by managers, investors, and regulators. The basic analytical tool is the risk-adjusted balance sheet, which shows the sensitivity of the enterprise's assets and liabilities to external "shocks." At the national level, the sectors of an economy are viewed as interconnected portfolios of assets, liabilities, and guarantees -- some explicit and others implicit. Traditional approaches have difficulty analyzing how risks can accumulate gradually and then suddenly erupt in a full-blown crisis. The CCA approach is well-suited to capturing such "non-linearities" and to quantifying the effects of asset-liability mismatches within and across institutions. Risk-adjusted CCA balance sheets facilitate simulations and stress testing to evaluate the potential impact of policies to manage systemic risk.

Suggested Citation

Gray, Dale F. and Bodie, Zvi and Merton, Robert C., New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability (November 2007). NBER Working Paper No. w13607. Available at SSRN: https://ssrn.com/abstract=1032862

Dale F. Gray

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

MF Risk

5921 Searl Terrace
Bethesda, MD 20816

Zvi Bodie

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Robert C. Merton (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Avenue
E62-634
Cambridge, MA 02139-4307
United States
617 715 4866 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6678 (Phone)

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