Multi-Agent Financial Network (MAFN) Model of US Collateralized Debt Obligations (CDO): Regulatory Capital Arbitrage, Negative CDS Carry Trade and Systemic Risk Analysis

Simulation in Computational Finance and Economics: Tools and Emerging Applications, Alexandrova-Kabadjova B., S. Martinez-Jaramillo, A. L. Garcia-Almanza, E. Tsang, eds., IGI Global, August 2012

33 Pages Posted: 26 Feb 2013 Last revised: 26 Apr 2016

See all articles by Sheri M. Markose

Sheri M. Markose

University of Essex - Department of Economics

Bewaji Oluwasegun

University of Essex - Centre for Computational Finance and Economic Agents

Simone Giansante

University of Bath - School of Management

Date Written: August 12, 2012

Abstract

A database driven multi-agent model has been developed with automated access to US bank level FDIC Call Reports which yield data on balance sheet and off balance sheet activity, respectively, in Residential Mortgage Backed Securities (RMBS) and Credit Default Swaps (CDS). The simultaneous accumulation of RMBS assets on US banks’ balance sheets and also large counterparty exposures from CDS positions characterized the $2 trillion Collateralized Debt Obligation (CDO) market. The latter imploded by end of 2007 with large scale systemic risk consequences. Based on US FDIC bank data, that could have been available to the regulator at the time, we investigate how a CDS negative carry trade combined with incentives provided by Basel II and its precursor in the US, the Joint Agencies Rule 66 Federal Regulation No. 56914 which became effective on January 1, 2002, on synthetic securitization and credit risk transfer (CRT), led to the unsustainable trends and systemic risk. The resultant market structure with heavy concentration in CDS activity involving 5 US banks can be shown to present too interconnected to fail systemic risk outcomes. The simulation package can generate the financial network of obligations of the US banks in the CDS market. We aim to show how such a multi-agent financial network (MAFN) model is well suited to monitor bank activity and to stress test policy for perverse incentives on an ongoing basis.

Keywords: Credit Risk Transfer, Synthetic Securitization, Perverse Incentives, Credit Default Swaps, Collateralized Debt Obligation, Agent Based Modelling

JEL Classification: G01, G21, G15, G17, G32

Suggested Citation

Markose, Sheri M. and Oluwasegun, Bewaji and Giansante, Simone, Multi-Agent Financial Network (MAFN) Model of US Collateralized Debt Obligations (CDO): Regulatory Capital Arbitrage, Negative CDS Carry Trade and Systemic Risk Analysis (August 12, 2012). Simulation in Computational Finance and Economics: Tools and Emerging Applications, Alexandrova-Kabadjova B., S. Martinez-Jaramillo, A. L. Garcia-Almanza, E. Tsang, eds., IGI Global, August 2012, Available at SSRN: https://ssrn.com/abstract=2224157

Sheri M. Markose (Contact Author)

University of Essex - Department of Economics ( email )

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom
01206 87 2742 (Phone)

Bewaji Oluwasegun

University of Essex - Centre for Computational Finance and Economic Agents

Wivenhoe Park
Colchester, Essex CO4 3SQ
United Kingdom

Simone Giansante

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

HOME PAGE: http://people.bath.ac.uk/sg473/index.html

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
45
Abstract Views
523
PlumX Metrics