A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy

45 Pages Posted: 11 Oct 2006

See all articles by Zvi Bodie

Zvi Bodie

Boston University

Dale F. Gray

International Monetary Fund (IMF); MF Risk

Robert C. Merton

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

Multiple version iconThere are 2 versions of this paper

Date Written: October 10, 2006

Abstract

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.

Keywords: macrofinancial risks, risk propagation, sovereign risk

JEL Classification: G2, E5, E6, H0

Suggested Citation

Bodie, Zvi and Gray, Dale F. and Merton, Robert C., A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy (October 10, 2006). HBS Finance Working Paper No. 936661, Available at SSRN: https://ssrn.com/abstract=936661 or http://dx.doi.org/10.2139/ssrn.936661

Zvi Bodie

Boston University ( email )

12 Salisbury Road
Brookline, MA
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617 306 5556 (Phone)

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

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

Robert C. Merton (Contact Author)

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

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

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

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

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