This document provides an overview of a macroeconomic model that examines debt-financed investment-led growth. Some key points:
- The model explores whether financial factors can provide stability to an otherwise unstable demand-constrained economy, and whether they can generate growth cycles.
- Investment is determined by a post-Keynesian accelerator function where the sensitivity of investment to capacity utilization depends on financial factors like the risk of default and interest rates.
- Debt dynamics are modeled, where borrowing, repayment, and the debt stock over time are determined. Financial fragility and creditworthiness indicators are also developed.
- Monetary policy follows a Taylor-type rule where the central bank adjusts interest rates in response
This document provides an overview of various credit default models, including:
- Merton's structural model, which uses Black-Scholes option pricing theory to estimate probability of default.
- Extensions to Merton's model, including the KMV model which maps "distance to default" to historical default rates.
- Ratings-based models that use credit rating migration probabilities provided by rating agencies.
- Multivariate factor models that model default dependence between firms using common factors like the economy.
The document discusses key aspects and assumptions of these different modeling approaches.
A framework to analyse the sovereign credit risk exposure of financial instit...Jide Lewis PhD, CFA, FRM
This paper develops an integrative dynamic framework to evaluate the exposure of banks to sovereign credit risk using stress tests. The framework is used to replicate the historical twin-crisis dynamics which ensues when stress tests are implemented on selected macro-financial variables, based on a perfect foresighting exercise for the case of Jamaica.
Credit risk refers to the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do. The risk is primarily that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial and can arise in a number of circumstances. For example:
• A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit, or other loan
• A company is unable to repay amounts secured by a fixed or floating charge over the assets of the company
• A business or consumer does not pay a trade invoice when due
• A business does not pay an employee's earned wages when due
• A business or government bond issuer does not make a payment on a coupon or principal payment when due
• An insolvent insurance company does not pay a policy obligation
• An insolvent bank won't return funds to a depositor
• A government grants bankruptcy protection to an insolvent consumer or business.
To reduce the lender's credit risk, the lender may perform a credit check on the prospective borrower, may require the borrower to take out appropriate insurance, such as mortgage insurance or seek security or guarantees of third parties, besides other possible strategies. In general, the higher the risk, the higher will be the interest rate that the debtor will be asked to pay on the debt.
Credit risk modeling helps estimate potential credit losses and determine how much capital is needed to protect against such risks. It is more complex than market risk modeling due to factors like limited data on defaults, illiquidity in credit markets, non-normal distributions of losses, and correlations between obligors that increase in downturns. The main approaches are default mode, which considers losses from defaults, and mark-to-market, which also incorporates losses from credit quality deterioration. Structural models link default to a firm's asset value while reduced form models view default as a random event. Correlations between probability of default, exposure at default, and loss given default are also important to consider.
This document discusses key concepts related to the time value of money including discounting, present and future value calculations for single and multiple cash flows. It also covers topics such as effective annual rate calculations, annuities, perpetuities, and cash flow additivity and equivalence principles. Formulas for net present value and internal rate of return are presented along with their use in capital budgeting decisions. Money market yields, portfolio return measurements, and discounted cash flow applications are also summarized.
This document discusses currency exchange rates and economic growth. It provides details on how exchange rates are determined between currencies, including factors that affect exchange rate spreads. It also outlines several economic theories related to what drives long-term economic growth, such as investment in physical and human capital, as well as productivity gains from technological development. Key growth accounting relationships are presented, linking output growth to contributions from capital deepening, increases in the labor force, and improvements in total factor productivity.
This document discusses three main approaches to modeling credit risk: structural, reduced form, and incomplete information. It provides details on the structural approach using the Merton and first passage models and the reduced form approach using a Poisson process for default. It also discusses extending these models to value bank loans, specifically comparing the structural KMV model and reduced form CreditRisk+ model. The critiques note limitations like non-observability of variables, lack of dynamics, and potential underestimation of risk.
This document discusses quantitative portfolio management of default risk. It introduces a model for measuring default risk of individual assets based on the market value and volatility of the underlying company's assets. It describes how to infer asset values from observable equity characteristics. It also discusses measuring portfolio diversification through correlations between asset values and quantifying the expected and unexpected loss from defaults. The goal is to apply modern portfolio theory to debt portfolios in order to minimize risk and maximize returns through diversification.
This document provides an overview of various credit default models, including:
- Merton's structural model, which uses Black-Scholes option pricing theory to estimate probability of default.
- Extensions to Merton's model, including the KMV model which maps "distance to default" to historical default rates.
- Ratings-based models that use credit rating migration probabilities provided by rating agencies.
- Multivariate factor models that model default dependence between firms using common factors like the economy.
The document discusses key aspects and assumptions of these different modeling approaches.
A framework to analyse the sovereign credit risk exposure of financial instit...Jide Lewis PhD, CFA, FRM
This paper develops an integrative dynamic framework to evaluate the exposure of banks to sovereign credit risk using stress tests. The framework is used to replicate the historical twin-crisis dynamics which ensues when stress tests are implemented on selected macro-financial variables, based on a perfect foresighting exercise for the case of Jamaica.
Credit risk refers to the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do. The risk is primarily that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial and can arise in a number of circumstances. For example:
• A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit, or other loan
• A company is unable to repay amounts secured by a fixed or floating charge over the assets of the company
• A business or consumer does not pay a trade invoice when due
• A business does not pay an employee's earned wages when due
• A business or government bond issuer does not make a payment on a coupon or principal payment when due
• An insolvent insurance company does not pay a policy obligation
• An insolvent bank won't return funds to a depositor
• A government grants bankruptcy protection to an insolvent consumer or business.
To reduce the lender's credit risk, the lender may perform a credit check on the prospective borrower, may require the borrower to take out appropriate insurance, such as mortgage insurance or seek security or guarantees of third parties, besides other possible strategies. In general, the higher the risk, the higher will be the interest rate that the debtor will be asked to pay on the debt.
Credit risk modeling helps estimate potential credit losses and determine how much capital is needed to protect against such risks. It is more complex than market risk modeling due to factors like limited data on defaults, illiquidity in credit markets, non-normal distributions of losses, and correlations between obligors that increase in downturns. The main approaches are default mode, which considers losses from defaults, and mark-to-market, which also incorporates losses from credit quality deterioration. Structural models link default to a firm's asset value while reduced form models view default as a random event. Correlations between probability of default, exposure at default, and loss given default are also important to consider.
This document discusses key concepts related to the time value of money including discounting, present and future value calculations for single and multiple cash flows. It also covers topics such as effective annual rate calculations, annuities, perpetuities, and cash flow additivity and equivalence principles. Formulas for net present value and internal rate of return are presented along with their use in capital budgeting decisions. Money market yields, portfolio return measurements, and discounted cash flow applications are also summarized.
This document discusses currency exchange rates and economic growth. It provides details on how exchange rates are determined between currencies, including factors that affect exchange rate spreads. It also outlines several economic theories related to what drives long-term economic growth, such as investment in physical and human capital, as well as productivity gains from technological development. Key growth accounting relationships are presented, linking output growth to contributions from capital deepening, increases in the labor force, and improvements in total factor productivity.
This document discusses three main approaches to modeling credit risk: structural, reduced form, and incomplete information. It provides details on the structural approach using the Merton and first passage models and the reduced form approach using a Poisson process for default. It also discusses extending these models to value bank loans, specifically comparing the structural KMV model and reduced form CreditRisk+ model. The critiques note limitations like non-observability of variables, lack of dynamics, and potential underestimation of risk.
This document discusses quantitative portfolio management of default risk. It introduces a model for measuring default risk of individual assets based on the market value and volatility of the underlying company's assets. It describes how to infer asset values from observable equity characteristics. It also discusses measuring portfolio diversification through correlations between asset values and quantifying the expected and unexpected loss from defaults. The goal is to apply modern portfolio theory to debt portfolios in order to minimize risk and maximize returns through diversification.
Opportunities for portfolio diversification GenePanasenko
The document discusses opportunities and risks associated with investing in public and private debt markets. It explains that individuals can invest in bonds, bond funds, and private loan funds, with each having different levels of liquidity and risk. It emphasizes the importance of understanding how factors like interest rates, duration, and the financial standing of borrowers can impact the performance of both public and private debt instruments.
This document discusses factors that affect the risk structure of interest rates. It introduces three theories of the term structure of interest rates: expectations theory, market segmentation theory, and liquidity premium theory. Expectations theory holds that long-term interest rates equal the average expected short-term rates. Market segmentation theory sees bond markets as completely separate. Liquidity premium theory combines features of the first two theories, asserting long rates equal expected short rates plus a liquidity premium to compensate for less liquidity of long bonds. It best explains the empirical facts about how short and long rates typically move together and yield curve slopes.
This document discusses various financial risk concepts and instruments. It defines value at risk as a technique to measure financial risk over a time period. It also discusses credit value adjustment, liquidity risk, market risk, different types of financial instruments including money market funds, commercial paper, certificates of deposit, treasury bills, derivatives, yield curves, counterparty risk, and Basel regulations. It provides definitions and examples of these terms.
This document discusses quantitative finance topics including bond duration and immunization. It provides an example showing how duration and convexity can be used to approximate changes in bond prices from changes in yields. The document also discusses how to construct a bond portfolio with a target duration and convexity. Finally, it briefly defines interest rate swaps, bond options, interest rate caps, and floors.
This chapter discusses several factors that influence interest rates: marketability, liquidity, default risk, call privileges, prepayment risk, convertibility, and taxation. It explains how each of these factors affects the promised and expected yields on different types of financial assets. The risk-free interest rate underlies all other interest rates, which are scaled upward depending on their degree of additional risk factors like default risk or prepayment risk.
The prospect of rising interest rates continues to pose a risk to bond investors, but how a rise
in interest rates impacts investors depends on multiple factors.
This document discusses the reasons why firms engage in risk management through hedging activities. It provides examples of how hedging can reduce a firm's risk exposure and lower cash flow volatility. Specifically, hedging can reduce costs of financial distress, make attractive investments more likely, and allow firms to utilize tax deductions in the years they are incurred rather than carrying them forward. The document also notes some of the accounting, legal and tax issues related to corporate hedging activities.
The document discusses debt sustainability analysis (DSA) and its practice in the Turkish Treasury. DSA aims to estimate future debt levels and test debt sustainability under adverse scenarios. The Turkish Treasury uses several models for DSA, including the conventional accounting approach (CAA), debt indicators module (DIM), and Turkish debt simulation model (TDSM). The TDSM is a stochastic model that generates forward-looking scenarios and assesses tail risks, providing a more robust analysis than CAA. Results are reported regularly to management and published to promote transparency.
The document discusses various topics related to bond yields and interest rates:
1) Bond yields are determined by risk-free rates plus credit risk premiums. The Fed uses tools like open market operations and reserve requirements to implement monetary policy.
2) Treasury securities include bills, notes, bonds, and inflation-protected bonds. Treasuries have little credit risk but are still exposed to interest rate and other risks.
3) The Treasury yield curve shows the relationship between Treasury yields and maturities. Factors like on-the-run status, liquidity, and reinvestment risk complicate this relationship.
4) Yield spreads measure differences in bond yields and are used to assess credit risk, liquidity
Kang Tae Soo -- Riksbank Macroprudential Conference Stockholm, Sweden, Nove...Macropru Reader
Kang Tae Soo -- Riksbank Macroprudential Conference Stockholm, Sweden, November 2014
....
http://www.riksbank.se/en/Financial-stability/Macroprudential-Policy-Conference-November-2014/
Macroprudential Policy Conference, November 2014
Sveriges Riksbank and the International Monetary Fund are jointly hosting the conference Macroprudential Policy - Implementation and Interaction with other Policies in Stockholm on 13-14 November.
The conference will bring together representatives of national authorities and international organizations to share their knowledge and experience in the evolving field of macroprudential policy.
The financial crisis showed that ensuring the health of individual components of the financial system is not sufficient to guarantee overall financial stability. Macroprudential policy recognizes the importance of systemic risk and the need to develop regulations that address systemic risk and help to build resilience in the entire financial system.
This document provides an overview of key concepts in credit risk management, including:
1) Credit risk arises from factors like a borrower's ability to repay, economic conditions, specific events, and regional factors. It is the risk of financial loss if a counterparty fails to meet contractual obligations.
2) Banks assess probability of default, exposure at default, and loss given default to measure and manage credit risk. Transition matrices track how probabilities of default change over time.
3) Credit risk arises in both a bank's trading book (exchange traded and OTC derivatives) and banking book (loans and off-balance sheet commitments). Credit ratings and market prices help estimate probability of default.
It is not difficult to find situations of marked change in variables and with unpredictable event risk implies estimation problems. E.g.,
Credit spreads in 2008 rise to levels that could never have been forecast based upon previous history. The subprime crisis of 2007/8: credit spreads & volatility rise to unseen levels & shift in debtor behavior (delinquency patterns)
E.g., estimating the volatility from data in a calm (turbulent) period implies under (over) estimation of future realized volatility
Investors are flocking to safe assets like US and German sovereign bonds despite negative real returns, due to increased disaster risk and economic uncertainty. This behavior, called "disaster economics", has consequences for monetary policy as central banks must work to reduce fear and build confidence. While low rates are partly due to central bank actions, the flight to safety suggests investors prioritize capital preservation over returns. If this psychology persists, it signals challenges for stimulating growth and could portend a prolonged period of low rates.
Modified duration is a measure of how much a bond's price will fluctuate with interest rate changes. It is calculated by dividing the expected price change of a bond by the change in interest rates. A bond with higher modified duration means the price will fluctuate more in response to interest rate changes compared to a bond with lower modified duration. The document provides an example of how modified duration can be understood by relating it to holding excess winter clothing inventory, where the price would need to be adjusted more if inventory is high (like high modified duration) compared to if inventory is low.
[EN] Strategy Brief / Global Convertible Opportunities / December 2015NN Investment Partners
The document provides information on the NN (L) Global Convertible Opportunities fund including:
1) The fund invests in a portfolio of global convertible bonds with the objective of outperforming its benchmark index by 2% annually.
2) It uses a theme-based approach to security selection focused on mixed convertibles with downside protection and equity upside potential.
3) In December 2015, the fund returned -1.47% compared to the benchmark return of -1.44%, underperforming by 0.03%. Key detractors were positions in Taiyo Yuden and Iconix.
This document discusses various aspects of credit risk management. It defines different types of credit like trade credit, export credit, and consumer credit. It describes the roles and responsibilities of a credit manager in evaluating risk, monitoring performance, and collecting payments. It also provides details on credit evaluation processes, credit policies, credit limits, and methods to control and mitigate credit risk.
This document provides an overview of credit risk in banking. It defines credit risk as the risk of losses from a counterparty failing to meet obligations. Credit risk makes up 50-70% of banking risks. The document outlines various debt instruments like loans and bonds that expose banks to credit risk. It discusses macro assessments of credit risk through metrics like non-performing loans and credit growth at the country level. It also covers micro assessments using tools like credit registers, ratings, scoring models and other quantitative credit risk models.
This document discusses the consolidation hypothesis, which proposes that for theoretical purposes the treasury and central bank can be viewed as a single consolidated government sector. It argues that under this view, the government cannot run out of money and faces no risk of default. It acknowledges critiques of this hypothesis for oversimplifying institutional realities. However, it maintains the hypothesis provides theoretical insights and that central banks and treasuries cooperate in practice to circumvent self-imposed constraints. Overall the consolidation hypothesis frames policy debates around real economic limits rather than perceived financial constraints.
Inequality, Jobs, Growth: The postwar experience in the U.S.pkconference
This document discusses trends in inequality and unemployment in the postwar U.S. economy. It shows that income growth has disproportionately benefited the top 10% and top 1% of families. It also analyzes rising long-term unemployment, slower payroll recovery, declining wage share of GDP, and falling labor force participation. The author argues for rethinking conventional countercyclical stabilizers like unemployment insurance and instead implementing a job guarantee program to provide stable employment and income. Overall, the document analyzes how inequality has increased as unemployment outcomes have worsened, and calls for policies to stabilize incomes through full employment.
Opportunities for portfolio diversification GenePanasenko
The document discusses opportunities and risks associated with investing in public and private debt markets. It explains that individuals can invest in bonds, bond funds, and private loan funds, with each having different levels of liquidity and risk. It emphasizes the importance of understanding how factors like interest rates, duration, and the financial standing of borrowers can impact the performance of both public and private debt instruments.
This document discusses factors that affect the risk structure of interest rates. It introduces three theories of the term structure of interest rates: expectations theory, market segmentation theory, and liquidity premium theory. Expectations theory holds that long-term interest rates equal the average expected short-term rates. Market segmentation theory sees bond markets as completely separate. Liquidity premium theory combines features of the first two theories, asserting long rates equal expected short rates plus a liquidity premium to compensate for less liquidity of long bonds. It best explains the empirical facts about how short and long rates typically move together and yield curve slopes.
This document discusses various financial risk concepts and instruments. It defines value at risk as a technique to measure financial risk over a time period. It also discusses credit value adjustment, liquidity risk, market risk, different types of financial instruments including money market funds, commercial paper, certificates of deposit, treasury bills, derivatives, yield curves, counterparty risk, and Basel regulations. It provides definitions and examples of these terms.
This document discusses quantitative finance topics including bond duration and immunization. It provides an example showing how duration and convexity can be used to approximate changes in bond prices from changes in yields. The document also discusses how to construct a bond portfolio with a target duration and convexity. Finally, it briefly defines interest rate swaps, bond options, interest rate caps, and floors.
This chapter discusses several factors that influence interest rates: marketability, liquidity, default risk, call privileges, prepayment risk, convertibility, and taxation. It explains how each of these factors affects the promised and expected yields on different types of financial assets. The risk-free interest rate underlies all other interest rates, which are scaled upward depending on their degree of additional risk factors like default risk or prepayment risk.
The prospect of rising interest rates continues to pose a risk to bond investors, but how a rise
in interest rates impacts investors depends on multiple factors.
This document discusses the reasons why firms engage in risk management through hedging activities. It provides examples of how hedging can reduce a firm's risk exposure and lower cash flow volatility. Specifically, hedging can reduce costs of financial distress, make attractive investments more likely, and allow firms to utilize tax deductions in the years they are incurred rather than carrying them forward. The document also notes some of the accounting, legal and tax issues related to corporate hedging activities.
The document discusses debt sustainability analysis (DSA) and its practice in the Turkish Treasury. DSA aims to estimate future debt levels and test debt sustainability under adverse scenarios. The Turkish Treasury uses several models for DSA, including the conventional accounting approach (CAA), debt indicators module (DIM), and Turkish debt simulation model (TDSM). The TDSM is a stochastic model that generates forward-looking scenarios and assesses tail risks, providing a more robust analysis than CAA. Results are reported regularly to management and published to promote transparency.
The document discusses various topics related to bond yields and interest rates:
1) Bond yields are determined by risk-free rates plus credit risk premiums. The Fed uses tools like open market operations and reserve requirements to implement monetary policy.
2) Treasury securities include bills, notes, bonds, and inflation-protected bonds. Treasuries have little credit risk but are still exposed to interest rate and other risks.
3) The Treasury yield curve shows the relationship between Treasury yields and maturities. Factors like on-the-run status, liquidity, and reinvestment risk complicate this relationship.
4) Yield spreads measure differences in bond yields and are used to assess credit risk, liquidity
Kang Tae Soo -- Riksbank Macroprudential Conference Stockholm, Sweden, Nove...Macropru Reader
Kang Tae Soo -- Riksbank Macroprudential Conference Stockholm, Sweden, November 2014
....
http://www.riksbank.se/en/Financial-stability/Macroprudential-Policy-Conference-November-2014/
Macroprudential Policy Conference, November 2014
Sveriges Riksbank and the International Monetary Fund are jointly hosting the conference Macroprudential Policy - Implementation and Interaction with other Policies in Stockholm on 13-14 November.
The conference will bring together representatives of national authorities and international organizations to share their knowledge and experience in the evolving field of macroprudential policy.
The financial crisis showed that ensuring the health of individual components of the financial system is not sufficient to guarantee overall financial stability. Macroprudential policy recognizes the importance of systemic risk and the need to develop regulations that address systemic risk and help to build resilience in the entire financial system.
This document provides an overview of key concepts in credit risk management, including:
1) Credit risk arises from factors like a borrower's ability to repay, economic conditions, specific events, and regional factors. It is the risk of financial loss if a counterparty fails to meet contractual obligations.
2) Banks assess probability of default, exposure at default, and loss given default to measure and manage credit risk. Transition matrices track how probabilities of default change over time.
3) Credit risk arises in both a bank's trading book (exchange traded and OTC derivatives) and banking book (loans and off-balance sheet commitments). Credit ratings and market prices help estimate probability of default.
It is not difficult to find situations of marked change in variables and with unpredictable event risk implies estimation problems. E.g.,
Credit spreads in 2008 rise to levels that could never have been forecast based upon previous history. The subprime crisis of 2007/8: credit spreads & volatility rise to unseen levels & shift in debtor behavior (delinquency patterns)
E.g., estimating the volatility from data in a calm (turbulent) period implies under (over) estimation of future realized volatility
Investors are flocking to safe assets like US and German sovereign bonds despite negative real returns, due to increased disaster risk and economic uncertainty. This behavior, called "disaster economics", has consequences for monetary policy as central banks must work to reduce fear and build confidence. While low rates are partly due to central bank actions, the flight to safety suggests investors prioritize capital preservation over returns. If this psychology persists, it signals challenges for stimulating growth and could portend a prolonged period of low rates.
Modified duration is a measure of how much a bond's price will fluctuate with interest rate changes. It is calculated by dividing the expected price change of a bond by the change in interest rates. A bond with higher modified duration means the price will fluctuate more in response to interest rate changes compared to a bond with lower modified duration. The document provides an example of how modified duration can be understood by relating it to holding excess winter clothing inventory, where the price would need to be adjusted more if inventory is high (like high modified duration) compared to if inventory is low.
[EN] Strategy Brief / Global Convertible Opportunities / December 2015NN Investment Partners
The document provides information on the NN (L) Global Convertible Opportunities fund including:
1) The fund invests in a portfolio of global convertible bonds with the objective of outperforming its benchmark index by 2% annually.
2) It uses a theme-based approach to security selection focused on mixed convertibles with downside protection and equity upside potential.
3) In December 2015, the fund returned -1.47% compared to the benchmark return of -1.44%, underperforming by 0.03%. Key detractors were positions in Taiyo Yuden and Iconix.
This document discusses various aspects of credit risk management. It defines different types of credit like trade credit, export credit, and consumer credit. It describes the roles and responsibilities of a credit manager in evaluating risk, monitoring performance, and collecting payments. It also provides details on credit evaluation processes, credit policies, credit limits, and methods to control and mitigate credit risk.
This document provides an overview of credit risk in banking. It defines credit risk as the risk of losses from a counterparty failing to meet obligations. Credit risk makes up 50-70% of banking risks. The document outlines various debt instruments like loans and bonds that expose banks to credit risk. It discusses macro assessments of credit risk through metrics like non-performing loans and credit growth at the country level. It also covers micro assessments using tools like credit registers, ratings, scoring models and other quantitative credit risk models.
This document discusses the consolidation hypothesis, which proposes that for theoretical purposes the treasury and central bank can be viewed as a single consolidated government sector. It argues that under this view, the government cannot run out of money and faces no risk of default. It acknowledges critiques of this hypothesis for oversimplifying institutional realities. However, it maintains the hypothesis provides theoretical insights and that central banks and treasuries cooperate in practice to circumvent self-imposed constraints. Overall the consolidation hypothesis frames policy debates around real economic limits rather than perceived financial constraints.
Inequality, Jobs, Growth: The postwar experience in the U.S.pkconference
This document discusses trends in inequality and unemployment in the postwar U.S. economy. It shows that income growth has disproportionately benefited the top 10% and top 1% of families. It also analyzes rising long-term unemployment, slower payroll recovery, declining wage share of GDP, and falling labor force participation. The author argues for rethinking conventional countercyclical stabilizers like unemployment insurance and instead implementing a job guarantee program to provide stable employment and income. Overall, the document analyzes how inequality has increased as unemployment outcomes have worsened, and calls for policies to stabilize incomes through full employment.
Connecting approaches in heterodox economicspkconference
This document summarizes the key points of a session discussing connecting heterodox economics traditions and the contributions of Fred Lee. The session will honor Fred Lee's work, discuss defining heterodox economics and identifying heterodox economists, examine pluralism and sectarianism within heterodox economics, and address how Post Keynesian economics and Fred Lee's contributions furthered heterodox economics. Fred Lee advocated for a broad-tent approach to heterodox economics and connecting different traditions, though he and the author disagreed on markup pricing models.
Fiscal and monetary policy rules in an unstable economypkconference
This document summarizes a paper on fiscal and monetary policy rules in an unstable economy. It begins by outlining Harrodian instability and consumption/investment behavior. It then examines different policy rules, finding that a Taylor rule is not stabilizing when debt is high, while a "Keynesian policy rule" where government consumption stabilizes employment is stabilizing. An "austerity policy rule" aiming to keep debt ratios constant is destabilizing and aggravates Harrodian instability. The document concludes that automatic stabilizers are insufficient and policy is needed to remove instability, with the paper extending the analysis to interactions of fiscal and monetary policy rules.
Implications of Complex Behavioral Economics for Post Keynesian Economicspkconference
This document discusses the implications of complex behavioral economics for Post Keynesian economics. It argues that many models based on concepts like black swan events, Knightian uncertainty, and complexity economics do not assume an ergodic system and thus allow for non-epistemological uncertainty. It reviews how Keynes described bounded rational economic agents using heuristics and conventions. It also discusses concepts from behavioral economics like loss aversion, hyperbolic discounting, and herd behavior. Finally, it concludes that complexity can provide an ontological foundation for uncertainty and bounded rationality, with evolutionary adaptation in such a world.
A SFC Model of the US Economy with a Special Emphasis on Explaining Sectoral ...pkconference
The document discusses using a sector financial balances (SFB) model to explain aggregate demand (AD). It reviews criticism of using financial balances to directly measure growth contributions. While SFBs don't directly impact GDP components, they can impact alternative AD definitions. The model presented is essentially the IS model without interest rates. The document concludes that connecting the SFB model to stock-flow consistent (SFC) models of credit could strengthen it by tying financial balances to long-run equilibrium conditions when debt levels stabilize. A modified SFB model could serve as a good introductory model for explaining AD.
Innovation, Demand, and Finance in an Agent-Based Stock-Flow Consistent Modelpkconference
This document discusses a research project that combines agent-based modeling with stock-flow consistent modeling. The project was funded by three institutions and involved three researchers. It resulted in an agent-based stock-flow consistent model of innovation, demand, and finance. The model conceives of the economy as a complex system emerging from the interaction of heterogeneous and adaptive agents. It incorporates financial stocks and flows in a way that ensures consistency.
Bounded rationality refers to the idea that human decision-making is limited by cognitive blinders that prevent people from considering all relevant information. Herbert Simon proposed that people are only rational to a limited extent and can be emotional or irrational when making important decisions. They have limitations in processing complex information. A major source of bounded rationality is opportunistic behavior, which refers to taking self-interested actions with guile, such as misleading others or withholding beneficial information. Opportunistic behavior can happen before or after agreements and allows one party to avoid consequences. While not everyone acts this way, opportunism is costly to prevent. Tools like laws, contracts, transparency, and risk management can help mitigate opportunistic tendencies and
This document discusses fiscal policy in Latin American countries. It notes that international institutions traditionally advocated fiscal consolidation through austerity measures. However, some South American governments in the 2000s abandoned neoliberal policies in favor of growth with stable public policies. Data shows that these "Pink" countries experienced higher economic growth and declining public debt compared to other Latin American nations, though inequality remained an issue. While these governments had more autonomy, international credit markets still imposed conditions that limited their fiscal policy sovereignty.
Price Stability and Debt Stability: A Wicksell-Lerner-Tinbergen Framework for...pkconference
This document discusses a framework for coordinating monetary and fiscal policy to achieve both price stability and debt stability. It presents the IS curve equation showing combinations of interest rates and budget balances compatible with price stability, and the DS curve equation showing combinations compatible with a stable debt-GDP ratio. It argues that adjusting each policy instrument independently based on its target can produce endogenous policy cycles, but jointly targeting both goals can maintain potential output and a stable debt ratio. Historical estimates of these loci are provided for several decades to validate the framework.
Attheir creation, the rating agencies were like the news agencies because they published newsletters and were paying by contributions subscribers. That method of remuneration then evolved, and these are the debtors who have paid the agencies. Meanwhile, rating methods have gradually evolved to take into account the use of increasingly important to companies called sophisticated financial products such as structured products. Although the method of compensation has evolved, the activity of agencies has not changed and their responsibilities have remained for a long timethose news agencies, that is to say protected by freedom of expression. Thus, for years, they have enjoyed a special status allowing them to express opinions without any legal constraint weighs on them. Indeed, unlike, for example, an auditor who certified the accounts and give "reasonable assurance" of their quality based on professional standards of practice; no methodology stress weighs on agencies. However, their responsibilities have been initiated for the first time in the history of the rating, after the crisiss structured products. We see in this article how the agencies evaluate the risk of industrial and commercial companies (corporate) and financial institutions, as well as before ages and limitations of the current methodology used by credit rating agencies.
Chap 18 risk management & capital budgetingArindam Khan
The document discusses key concepts related to risk and capital budgeting. It defines risk as the range of possible outcomes of a decision where the probabilities are known. Strategies are plans to achieve goals, while states of nature are future conditions that impact strategy success. Outcomes are gains/losses from strategy-state combinations. Capital budgeting refers to planning, raising funds, and allocating capital to projects expected to generate returns over multiple years. Projects are evaluated using techniques like payback period, IRR, and NPV to determine if they increase firm value.
ch21 - Econ 442 - financial markets Par 1 of 2 (1).pdfjgordon21
The chapter discusses bond pricing and interest rate theory. It covers different types of bonds like government, corporate, municipal, and mortgage bonds. It also defines various interest rates used in bond valuation like spot rates, yield to maturity, current yield, and forward rates. Spot rates refer to the yield on zero-coupon bonds for different time periods. Forward rates represent the expected future interest rates for new loans committed today. The timing and definitions of cash flows and interest rates are important for accurately pricing and comparing bonds.
Optimal Policy Response to Booms and Busts in Credit and Asset PricesSambit Mukherjee
This document summarizes a model investigating the optimal policy response to booms and busts in credit and asset prices. The model shows how an externality can emerge from decentralized borrowing decisions, potentially leading to overborrowing. The laissez-faire level of borrowing is analyzed and found to differ from the socially optimal level due to agents not internalizing the externality. The analysis suggests that imposing a tax on borrowing could achieve the socially optimal level of borrowing by addressing this externality. However, the magnitude and direction of the optimal tax rate are found to differ from previous findings.
Chapter 24_Risk Management in Financial InstitutionsRusman Mukhlis
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Understanding Ponzi Schemes
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On 12 June 2024 the Institute for Economic Research and Policy Consulting (IER) held an online event “Economic Trends from a Business Perspective (May 2024)”.
During the event, the results of the 25-th monthly survey of business executives “Ukrainian Business during the war”, which was conducted in May 2024, were presented.
The field stage of the 25-th wave lasted from May 20 to May 31, 2024. In May, 532 companies were surveyed.
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✅ More survey results in the presentation.
✅ Video presentation: https://youtu.be/4ZvsSKd1MzE
Economic trends from a business point of view (May 2024)
Macrodynamics of Debt-Financed Investment-Led Growth with Interest Rate Rules
1. Macrodynamics of Debt-financed Investment-led
Growth with Interest Rate Rules
Soumya Datta
Faculty of Economics,
South Asian University,
New Delhi, INDIA
The 12th International Post-Keynesian Conference
Kansas City, Missouri
September 24-28, 2014
2. Introduction: Objectives of Study
This study attempts to answer the following primary questions:
Can financial considerations provide endogenous bounds to an
otherwise unstable demand-constrained closed economic systems?
In other words, does the financial sector play a stabilizing role?
Can these considerations give rise to persistent growth cycles, or
cyclical patterns in the growth rates of macroeconomic variables?
Can these cycles break down to more complex dynamical
possibilities?
How effective is a monetary policy, in the form of interest rate rules,
in achieving its desired objectives?
3. A Preview of the Model
We explicitly model the possibilities of borrowers defaulting on
payment commitments. This encourages lenders to discriminate
between borrowers, leading to credit rationing and red-lining.
During the upward phase of business cycle, financial variables
deteriorate due to credit expansion (Fisher, Minsky). Two kinds of
credit expansion: credit deepening and credit widening.
We provide an alternative macroeconomic story to Minsky’s
arguments.
To keep dimension low, at the moment we do not include income
distribution considerations. Prices remain constant. Hence,
monetary policy (Taylor Rule) is suitably modified – with capacity
utilization as a proxy for inflation.
4. Basic Model
A simple continuous time model of closed economy with no
government.
Two social classes: workers earning wages (W) and capitalists
earning profits (P).
National income by income method: Y (t) = W (t) + P (t).
Workers do not save. Capitalists save a fraction sp of profits. Hence
consumption, C (t) = W (t) + (1 − sp) P (t).
Price is a fixed-up markup over wage costs of production. Hence
P (t) = Y (t), where is the share of profits in national income.
Aggregate demand consists of consumption and investment:
AD (t) = C (t) + I (t).
Investment is financed either internally out of retained earnings, or
externally out of debt or equity.
7. : fixed output capital
ratio given by existing technology. Availability of the capital is the
binding constraint on production.
Actual level of output: Y (t) = min [AD (t) , Y⋆ (t)]. For all
AD Y ⋆, aggregate demand acts as the main constraint on
production. In this case output is determined by aggregate demand.
Rate of capacity utilization, u (t) =
Y (t)
Y ⋆ (t)
2 ]0, 1[.
Rate of investment, g (t)
I (t)
K (t)
8. Goods Market Equilibrium Investment Function
Goods market equilibrium: Level of output measured by income
method equals aggregate demand, i.e.
W (t) + P (t) = C (t) + I (t)
) Y (t) =
1
sp
I (t)
and g (t) = sp
9. u (t)
Post-Keynesian investment function:
g⋆ (t) = ¯
+
(t) u (t)
) g⋆ (t) = ¯
+
(t) g (t)
sp
10. where
is the sensitivity of desired rate of investment to capacity
utilization and is endogenously determined by financial factors. ¯
is
the exogenous component of investment (Dum´enil L´evy 1999).
11. Financial sector
In our model, we primarily examine debt as the main financial variable.
Debt dynamics affect the real sector via investment through two possible
routes:
By directly affecting the cost of financing investment.
Through various forms of risks associated with debt, for instance,
the possibility of the borrower defaulting on its payment
commitments.
12. Dynamics of Debt
The total outstanding debt commitment in period, t given by a
history of borrowing, B, at a rate of interest, r , and repayment, R:
D (t) =
t
Z
τ=0
(B () − R ()) er(t)(t−τ)d
) ˙D(t) = B (t) − R (t) + r (t)D (t)
Define macroeconomic index of financial fragility:
(t) =
(q + r (t))D (t)
P (t)
=
k (q + r (t)) spd (t)
g (t)
where d (t)
D (t)
K (t)
and g (t)
I (t)
K (t)
13. Dynamics of Debt (Cont’d)
Repayment of debt
Let the actual repayment in period t be a fraction (t) of the
outstanding debt commitment, i.e. R (t) = (t)D (t).
(t) depends on
1 Ability of firms to repay, given by the level of retained profits,
P. Higher retained profits would enable borrowers to repay
larger fraction of outstanding debt commitments without
altering its capital structure.
2 Index of financial fragility, . Higher would be associated
with a borrower profile where the firms have higher gearing
ratios. Hence, they would be forced to repay back a higher
fraction of outstanding debt commitments.
We adopt above in a simple multiplicative form:
(t) = mP (t) (t)
Substituting from the values of P and :
(t) = m(q + r (t)) d (t)
14. Dynamics of Debt (Cont’d)
Borrowing Financial Structure
In any period, t, let a fraction a (t) of the total investment I (t)
made by the firm sector be financed by fresh borrowing, i.e.
B (t) = a (t) I (t), where the fraction a (t) will be determined by the
financial structure of the firm.
For a given level of profits, we expect a higher rate of
investment to result in a higher proportion of investment
financed by outside sources.
Between two sources of external finance, there might be an
increasing preference for debt as the rate of investment
increases.
An increase in the level of financial fragility, , might
necessitate financing a higher proportion of the cost of
investment through debt.
) a (t) = a (g (t) , (t)) ; ag 0, aλ 0. With a simple
multiplicative form, we have
a (t) =
k (q + r (t)) s
d (t)
15. Creditworthiness and Borrower Profile
Consider the process of loan application by lenders. Broadly, the
quantitative factors determining the creditworthiness of a loan
application might be categorized into two classes:
1 Idiosyncratic factors: A preliminary assessment consisting of
factors which remain unchanged across various stages of a
business cycle, e.g. credit history, long-term repayment records,
reputation etc. Based on these factors, the lending institutions
might assign a credit rating or score to each loan applicant,
classifying them as prime or sub-prime.
2 Systemic factors: For a final decision, the lending institutions
take into account additional criteria, including the current
income of the loan applicants, evaluation of their proposed
projects in terms of their expected future income and risk
associated. These factors would depend on the specific stage
of business cycle one is in.
16. Creditworthiness and Borrower Profile (Cont’d)
We formalize the first by introducing 2 [0, 1], an indicator of the
proportion of borrowers with a high perceived risk of default (i.e.
the sub-prime borrowers) in the macroeconomic distribution of debt.
Periods of prosperity accompanied with a gradual worsening of the
profile of borrowers, leading to inclusion of borrowers with higher
perceived risk of default (sub-prime borrowers). This might happen
because:
During periods of prosperity, greater number of loan applicants
will qualify a given set of prudential norms.
In addition, typically prosperity leads to a relaxation of
prudential norms, both directly as well as indirectly from
financial innovation and predatory lending practices of
organized lenders, leading to emergence of new financial
instruments.
Formalizing this: (t) = gg (t) ; g 2 ]0, 1/gmax]
17. Creditworthiness and Borrower Profile (Cont’d)
Cumulative Index of Risk of Default
Construct a cumulative index of risk of default:
(t) = η (t) + λ (t)
where η and λ represent the sensitivity of to and .
The cumulative index of risk of default, , consist of two separate
risk components, and , emerging from two different kinds of risk
involved in credit expansion:
1 Credit widening, or inclusion of new borrowers with lower
credit rating, captured by .
2 Credit deepening, or an increase in the gearing ratio of existing
borrowers. captures a combination of both credit widening
and credit deepening.
This makes a more comprehensive macroeconomic indicator of
the risk of default than some of the more conventional indicators.
18. Financial Determinants of Investment
Risk of default negatively affects the sensitivity of the rate of
investment to capacity utilization,
.
Managers are concerned with risk of default, since in case of a
default, a firm might face a change in ownership through a
hostile takeover, threatening the job of managers. Thus, an
increase in would make them cut back on investment.
Lenders are concerned with risk of default, and might resort to
rationing and red-lining of credit if increases to unacceptable
levels. While this will affect only a section of borrowers, all
borrowers will cut back on investment in order to avoid getting
credit rationed or red-lined.
19. Financial Determinants of Investment (Cont’d)
The rate of interest negatively affects the sensitivity of the rate of
investment to capacity utilization,
.
Rate of interest directly affects the cost of servicing debt for
both past and new loans. This increases the cost of financing
investment.
An increase in the rate of interest increases the possibility of
adverse selection of risky projects. This might prompt lending
institutions to increase credit rationing and red-lining.
Formalizing:
(t) = ¯μ − ˆμ (t) − r (t)
where is the sensitivity of the accelerator to the rate of interest,
and ˆμ is the sensitivity of the accelerator to the cumulative risk of
default, .
20. Monetary Policy
Modified version of Taylor-type interest rate rule, which, instead of
targeting the inflation or the output gap, targets the rate of
capacity utilization as a proxy for the level of economic activity.
The Central Bank adjusts the rate of interest as a response to the
gap between the desired and the actual rate of capacity utilization,
i.e.
˙ r (t)
r (t)
= l [u (t) − u⋆]
where u⋆ 2 ]0, 1[ is the rate of capacity utilization desired by the
Central Bank.
21. Dynamics of Investment
Let the rate of investment be continuously adjusted so as to meet a
fraction, h, of the gap between the actual and the desired rate of
investment, i.e.
g˙ (t)
g (t)
= h (g⋆ (t) − g (t))
where h represents the speed of adjustment of the actual investment
to the desired level by the investors.
With suitable substitutions:
g˙ (t) =
¯μ
sp
35. − u
⋆
r (t)
˙d
(t) =
kqs
− 1
g (t) +
ks
d (t)
g (t) r (t) − mqd (t) − mr (t) d (t) + r (t)
These dynamics resemble the generalized predator-prey class of
models with two predators and one prey. Both r and d are
analogous to the predators, whereas g is analogous to prey.
Underlying such an analogy with ecological models, however, there
is a complex interaction of several macroeconomic feedback effects.
36. Macroeconomic Feedback Effects
Multiplier-Accelerator Relationship:
g
multiplier
−−−−−−! Y −! u
accelerator
−−−−−−! g
⋆ −! g
Financial Feedback I:
g
multiplier
−−−−−−! Y −! u
Taylor rule
−−−−−−! r
investment function
−−−−−−−−−−−! g
⋆ #−! g #
Financial Feedback II:
g −! −!
investment function
−−−−−−−−−−−! g
⋆ #−! g #
Financial Feedback III:
g −! B −! d −! −!
investment function
−−−−−−−−−−−! g
⋆ #−! g #
Secondary Financial Feedback:
(a) g
multiplier
−−−−−−! Y −! u
Taylor rule
−−−−−−! r −! −!
investment function
−−−−−−−−−−−! g
⋆ #−! g #
(b) g
multiplier
−−−−−−! Y −! u
Taylor rule
−−−−−−! r −! B −! d −!
−!
investment function
−−−−−−−−−−−! g
⋆ #−! g #
37. Summary of Results
The dynamical system has only one economically meaningful steady
state. The steady state rate of investment:
¯g = sp
38. u⋆
Note that the steady state rate of investment is completely
determined by the monetary policy of the Central Bank.
Steady state is stable provided l ˆl
, i.e. monetary policy is
sufficiently passive.
For a wide range of numerical values
@ˆl
/@u⋆ 0 8 u⋆ 2 ]0, 1[ : Targeting a higher rate of capacity
utilization will affect the effectiveness of monetary policy.
@ˆl
/@h 2 ]0,1[ 8 h 2 ]−1,1[: Faster adjustment by private
investors will leave more room for central bank to conduct
monetary policy.
39. Summary of Results (Cont’d)
Comparative Dynamics
We note that the steady state rate of growth depends directly on
the propensity to save out of profits. In other words paradox of
thrift does not operate in long run.
Given that we begun with a post-Keynesian investment function,
this result might seem to be a departure from standard
post-Keynesian literature and more in line with Harrodian literature.
In fact, higher the target rate of capacity utilization by Central
Bank, closer is the steady state rate of growth to the classic
Harrod’s result.
However, unlike the Harrodian literature, the steady state of growth
does not stabilize at an exogenously given natural rate, but at the
rate targeted by the Central Bank.
40. Summary of Results (Cont’d)
Away from the steady state, depending on the values of the
parameters, dynamical possibilities include
convergence to steady state, or
divergence away from the steady state, or
emergence of stable/unstable limit cycles around the steady
state (from non-degenerate Hopf Bifurcation, using h as the
control parameter), or/and
emergence of invariant torus around Hopf bifurcation limit
cycles and its eventual breakdown, bifurcation of homoclinic
and heteroclinic Shil’nikov orbits etc.
41. Summary of Results (Cont’d)
Bifurcation
A variety of bifurcations are shown to be possible:
1 Codim 1 bifurcation: Non-degenerate Hopf-bifurcation, using h as
the control parameter, leading to emergence of stable/unstable limit
cycles.
2 Codim 2 bifurcation: Using h and l as the control parameters, it is
possible to derive:
Neimark-Sacker bifurcation leading to emergence of invariant
torus.
Saddle-node bifurcation, and disappearance of saddle-nodes
through Shil’nilov bifurcation, emergence of infinite number of
periodic orbits.
Fold-Hopf (Gavrilov-Guckenheimer) bifurcation, triggering off
appearance and bifurcation of Shil’nikov homoclinic and
hetroclinic orbits, appearance of invariant torus and its
breakdown leading to chaos.
Double-zero (Bogdanov-Takens) bifurcation.
42. Conclusions
Even a simple model of real-financial interaction in a
demand-constrained economy leads to a complex interaction of
macroeconomic feedback effects.
Depending on the strengths of these effects, and the lags in them, a
wide variety of complex dynamical possibilities exist.
Under certain conditions, financial factors can endogenously bound
a demand-constrained economic system.
Even a purely deterministic system can give rise to complex
dynamics, and be sensitive to initial conditions. This can have
computational implications.
Monetary policy in the form of interest rate rules can determine the
steady state in our model. This conclusion, however, comes with
several riders.
43. Limitations
Areas for future research
By holding prices and share of profits fixed, we do not explicitly
model income distribution considerations in this model. An
immediate extension of this model, therefore, could be to look into
the effect of the macroeconomic feedback effects discussed here on
the distribution of income between various social classes.
We do not include complications arising out of changes in asset
prices in our model. Hence, we miss an important area which has
received a considerable attention in the literature, involving asset
price dynamics leading to boom-bust cycles.
We note that large number of dynamical possibilities exist in this
model. It is difficult to symbolically impose restrictions on
parameters to restrict the set of outcomes. One possible extension,
therefore, might be to suitably calibrate the model with the help of
real world data.