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Working Papers

This series allows members of the OFR staff and their coauthors to disseminate preliminary research findings in a format intended to generate discussion and critical comments.

Papers in the series are works in progress and subject to revision. Views and opinions expressed are those of the authors and do not necessarily represent official positions or policy of the OFR or Treasury.

Contract as Automaton: The Computational Representation of Financial Agreements

Contract as Automaton: The Computational Representation of Financial Agreements

By Mark D. Flood and Oliver R. Goodenough

March 26, 2015

This paper shows that the fundamental legal structure of a well-written financial contract follows a logic that can be formalized mathematically as a "deterministic finite automaton." This allows, for example, automated reasoning to determine whether a contract is internally coherent and complete. The paper illustrates the process by representing a simple loan agreement as an automaton.

Market Liquidity and Heterogeneity in the Investor Decision Cycle

Market Liquidity and Heterogeneity in the Investor Decision Cycle

By Richard Bookstaber, Michael D. Foley, and Brian F. Tivnan

March 10, 2015

This paper presents a model of market liquidity in which those who need to sell come into the market with a greater need for immediacy than those who are willing to buy. This is a critical market dynamic behind the illiquidity that arises during market dislocations and crises, when some are in forced-selling mode while others are hesitant to come in and take the other side of the trade.

Are the Federal Reserve’s Stress Test Results Predictable?

Are the Federal Reserve’s Stress Test Results Predictable?

By Paul Glasserman and Gowtham Tangirala

March 03, 2015

This paper examines the results of four rounds of stress testing of the largest U.S. bank holding companies, starting in 2009. The data reveal a growing correlation in results from one year to the next, highlighting whether the stress tests in their current form may be losing some of their information value over time. The authors discuss the implications of these patterns and recommend greater diversity in the stress scenarios analyzed.

Process Systems Engineering as a Modeling Paradigm for Analyzing Systemic Risk in Financial Networks

Process Systems Engineering as a Modeling Paradigm for Analyzing Systemic Risk in Financial Networks

By Richard Bookstaber, Paul Glasserman, Garud Iyengar, Yu Luo, Venkat Venkatasubramanian, and Zhizun Zhang

February 11, 2015

This paper demonstrates the value of signed directional graphs, a modeling methodology used for risk detection in process engineering, in tracing the path of potential instabilities and feedback loops within the financial system. This approach expands the usefulness of network models of the financial system by including critical information on the direction of influence and the points of control between the various nodes of the network.

Concentrated Capital Losses and the Pricing of Corporate Credit Risk

Concentrated Capital Losses and the Pricing of Corporate Credit Risk

By Emil Siriwardane

December 22, 2014
Revised February 12, 2015

This paper uses proprietary credit default swap (CDS) data for 2010 to 2014 to show that capital fluctuations for sellers of CDS protection are an important determinant of CDS spread movements.

Effects of Limit Order Book Information Level on Market Stability Metrics

Effects of Limit Order Book Information Level on Market Stability Metrics

By Mark Paddrik, Roy Hayes, William Scherer, and Peter Beling

November 25, 2014

This paper uses an agent-based model of the limit order book to explore how the levels of information available to participants, exchanges, and regulators can be used for insights on the stability and resiliency of a market.

Hedging Market Risk in Optimal Liquidation

Hedging Market Risk in Optimal Liquidation

This paper discusses optimal strategies for financial institutions in selling large blocks of securities and in hedging the resulting market risk.

Structural GARCH: The Volatility-Leverage Connection

Structural GARCH: The Volatility-Leverage Connection

By Robert Engle and Emil Siriwardane

October 23, 2014

This paper proposes a new model of volatility featuring a "leverage multiplier" by which financial leverage amplifies equity volatility. The model estimates daily asset returns and asset volatility.

Design of Risk Weights

Design of Risk Weights

By Paul Glasserman and Wanmo Kang

August 19, 2014

This paper investigates the design of risk weights used in setting minimum levels of regulatory capital for banks and presents a formula for regulators to set those weights by analyzing bank portfolios.

An Agent-based Model for Financial Vulnerability

An Agent-based Model for Financial Vulnerability

By Rick Bookstaber, Mark Paddrik, and Brian Tivnan

July 29, 2014
Revised September 10, 2014

This paper develops an agent-based model that uses a map of funding and collateral flows to analyze the financial system’s vulnerability to fire sales and runs.

Attachment: Supplementary Material

Shadow Banking: The Money View

Shadow Banking: The Money View

This paper presents an accounting framework for measuring the sources and uses of short-term funding in the global financial system and introduces a dynamic map of global funding flows.

Attachment: Map of Money Flows in the Global Financial Ecosystem

A Map of Funding Durability and Risk

A Map of Funding Durability and Risk

By Andrea Aguiar, Rick Bookstaber, and Thomas Wipf

May 29, 2014

This paper features a funding map to illustrate the flow of funding from its initial providers through the bank/dealers to the end-users. In addition to showing the plumbing of the system, the paper also shows the processes for transforming funding liquidity, credit quality, and tenor. The paper then applies the funding map to track risk through various types of financial institutions, and to identify gaps in data needed for financial stability monitoring.

The Application of Visual Analytics to Financial Stability Monitoring

The Application of Visual Analytics to Financial Stability Monitoring

By Mark D. Flood, Victoria L. Lemieux, Margaret Varga, and B.L. William Wong

May 09, 2014
Revised October 07, 2014

This paper provides an overview of visual analytics - the science of analytical reasoning enhanced by interactive visualizations produced by data analytics software - and discusses potential benefits in monitoring financial stability.

Competition in Lending and Credit Ratings

Competition in Lending and Credit Ratings

This paper explores the relationship between the quality of corporate credit ratings and competition in lending between the public bond market and banks. It finds that the quality of credit ratings plays a role in financial stability because the behavior of rating agencies can reduce the impact of macroeconomic shocks.

Common Ground: The Need for a Universal Mortgage Loan Identifier

Common Ground: The Need for a Universal Mortgage Loan Identifier

By Matthew McCormick and Lynn Calahan

December 05, 2013

The U.S. mortgage finance system is a critical part of our nation’s financial system, representing 70 percent of U.S. household liabilities. The establishment of a single, cradle‐to‐grave, universal mortgage identifier that cannot be linked to individuals using publicly‐available data would significantly benefit regulators and researchers.

Cryptography and the Economics of Supervisory Information: Balancing Transparency and Confidentiality

Cryptography and the Economics of Supervisory Information: Balancing Transparency and Confidentiality

By Mark Flood, Jonathan Katz, Stephen Ong, and Adam Smith

September 04, 2013

This paper explores tradeoffs between transparency and confidentiality in financial regulation and discusses new techniques from the fields of secure computation and statistical data privacy that can facilitate the secure sharing of financial information.

Stress Tests to Promote Financial Stability: Assessing Progress and Looking to the Future

Stress Tests to Promote Financial Stability: Assessing Progress and Looking to the Future

By Rick Bookstaber, Jill Cetina, Greg Feldberg, Mark Flood, and Paul Glasserman

July 18, 2013

Stress testing of large bank holding companies in the United States - a valuable exercise used to determine regulatory capital and liquidity planning at these institutions - should be adapted to be made more useful for financial stability monitoring.

How Likely is Contagion in Financial Networks?

How Likely is Contagion in Financial Networks?

By Paul Glasserman and H. Peyton Young

June 21, 2013

This paper estimates how much interconnections among financial institutions - potential channels for contagion and amplification of shocks to the financial system - can increase expected losses from a wide range of shocks.

The History of Cyclical Macroprudential Policy in the United States

The History of Cyclical Macroprudential Policy in the United States

By Douglas J. Elliot, Greg Feldberg, and Andreas Lehnert

May 15, 2013

This paper presents a survey and historical narrative of policies to smooth the credit cycle in light of their potential future application as "macroprudential" policies to reduce the build-up of risks in U.S. financial markets.

Stress Scenario Selection by Empirical Likelihood

Stress Scenario Selection by Empirical Likelihood

By Paul Glasserman, Chulmin Kang, and Wanmo Kang

April 09, 2013

This paper develops a method for selecting and analyzing stress-testing scenarios for financial risk assessment.

Hedge Fund Contagion and Risk-adjusted Returns: A Markov-switching Dynamic Factor Approach

Hedge Fund Contagion and Risk-adjusted Returns: A Markov-switching Dynamic Factor Approach

By Ozgur (Ozzy) Akay, Zeynep Senyuz, and Emre Yoldas

March 13, 2013

This paper uses a flexible framework to analyze two important phenomena influencing the hedge fund industry - contagion and time variation in risk-adjusted return.

Systematic Scenario Selection: Stress Testing and the Nature of Uncertainty

By Mark D. Flood and George G. Korenko

February 07, 2013

This paper offers a technique for selecting multidimensional shock scenarios for use in financial stress testing. The technique uses a grid search of sparse, well distributed stress-test scenarios that are considered a middle ground between traditional stress testing and reverse stress testing.

CoCos, Bail-in, and Tail Risk

CoCos, Bail-in, and Tail Risk

By Nan Chen, Paul Glasserman, Behzad Nouri, and Markus Pelger

January 23, 2013

This paper develops a capital structure model of a bank to analyze the incentives created by contingent convertibles (CoCos) and bail-in debt, which convert to equity when a bank approaches insolvency. These two forms of contingent capital have been proposed as potential mechanisms to enhance financial stability.

Using Agent-Based Models for Analyzing Threats to Financial Stability

Using Agent-Based Models for Analyzing Threats to Financial Stability

By Richard Bookstaber

December 21, 2012

This paper discusses the concepts and research related to agent-based models and explores how the dynamics of a flock of birds in flight, a group of drivers in a traffic jam, or a panicked crowd of stampeding people might inform our analysis of threats to financial stability.

Forging Best Practices in Risk Management

Forging Best Practices in Risk Management

By Mark J. Flannery, Paul Glasserman, David K.A. Mordecai, and Cliff Rossi

March 26, 2012

This paper assesses risk management practices and how risk management can be improved. The paper approaches risk management from three perspectives: (1) risk measurement by individual firms, (2) governance and incentives, and (3) systemic concerns. The paper evaluates each approach separately and also discusses the importance of considering them as interrelated.

A Survey of Systemic Risk Analytics

By Dimitrios Bisias, Mark Flood, Andrew W. Lo, and Stavros Valavanis

January 05, 2012

The paper focuses on quantitative tools to assess threats to financial stability. It gives a broad overview of the state of the art in measuring systemic risk by focusing on a key set of 31 specific measurements outlined elsewhere in peer-reviewed articles or working papers.