Quantifying Systemic Risk and Reconceptualizing the Role of Finance for Economic Growth

Journal Of Investment Management (JOIM), Second Quarter 2010

Posted: 13 Jul 2010

See all articles by Dale F. Gray

Dale F. Gray

International Monetary Fund (IMF); MF Risk

Date Written: July 12, 2010

Abstract

Contingent claims analysis (CCA) has formed part of the core of modern financial theory since the early 1970s as basis for many credit risk measurement methods. The adaptation of CCA for the measurement and analysis of systemic risk that arises due to the cross-exposures of economic sectors is a new and promising area for applications of finance in the future. Finance tools can be adapted to analyze a wide range of macro issues including sovereign risk, economic output, and economy-wide risk transmission.Modern finance provides a way to unify macroeconomics, risk-adjusted balance sheets, and risk transmission.We demonstrate that the traditional macroeconomic accounts, in particular the flow-of-funds, can be derived as a special case of a risk-adjusted balance sheet of the economic sectors when asset volatility is ignored.We show that the CCA macroeconomic balance sheet can be used to identify the contribution of the financial sector to an important new measure of economic output value, which adjusts the traditional flow-based measures of GDP, and its components, for the level of risk. Systemic risk can be analyzed using a portfolio of implicit put options in the financial sector using a multivariate dependence structure. The systemic risk dynamics are interlinked with the new measures of risk-adjusted economic value via the CCA balance sheets and put-call parity relationships. In this way, the contribution of the financial sector to risk-adjusted economic output can be measured conditional on the public cost of the joint contingent claim of financial sector activity.

Keywords: Contingent claims analysis (CCA), debt guarantees, systemic risk, systemic CCA

JEL Classification: G00

Suggested Citation

Gray, Dale F., Quantifying Systemic Risk and Reconceptualizing the Role of Finance for Economic Growth (July 12, 2010). Journal Of Investment Management (JOIM), Second Quarter 2010. Available at SSRN: https://ssrn.com/abstract=1639094

Dale F. Gray (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

MF Risk

5921 Searl Terrace
Bethesda, MD 20816

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