Financial institutions have for many years sought measures which cogently summarise the diverse market risks in portfolios of financial instruments. This quest led institutions to develop Value-at-Risk (VaR) models for their trading portfolios in the 1990s. Subsequently, so-called filtered historical simulation VaR models have become popular tools due to their ability to incorporate information on recent market returns and thus produce risk estimates conditional on them. These estimates are often superior to the unconditional ones produced by the first generation of VaR models. This paper explores the properties of various filtered historical simulation models. We explain how these models are constructed and illustrate their performance, examining in particular how filtering transforms various properties of return distribution. The procyclicality of filtered historical simulation models is also discussed and compared to that of unfiltered VaR. A key consideration in the design of risk management models is whether the model’s purpose is simply to estimate some percentile of the return distribution, or whether its aims are broader. We discuss this question and relate it to the design of the model testing framework. Finally, we discuss some recent developments in the filtered historical simulation paradigm and draw some conclusions about the use of models in this tradition for the estimation of initial margin requirements.
{"title":"Filtered Historical Simulation Value-at-Risk Models and Their Competitors","authors":"Pedro Gurrola-Perez, David Murphy","doi":"10.2139/ssrn.2574769","DOIUrl":"https://doi.org/10.2139/ssrn.2574769","url":null,"abstract":"Financial institutions have for many years sought measures which cogently summarise the diverse market risks in portfolios of financial instruments. This quest led institutions to develop Value-at-Risk (VaR) models for their trading portfolios in the 1990s. Subsequently, so-called filtered historical simulation VaR models have become popular tools due to their ability to incorporate information on recent market returns and thus produce risk estimates conditional on them. These estimates are often superior to the unconditional ones produced by the first generation of VaR models. This paper explores the properties of various filtered historical simulation models. We explain how these models are constructed and illustrate their performance, examining in particular how filtering transforms various properties of return distribution. The procyclicality of filtered historical simulation models is also discussed and compared to that of unfiltered VaR. A key consideration in the design of risk management models is whether the model’s purpose is simply to estimate some percentile of the return distribution, or whether its aims are broader. We discuss this question and relate it to the design of the model testing framework. Finally, we discuss some recent developments in the filtered historical simulation paradigm and draw some conclusions about the use of models in this tradition for the estimation of initial margin requirements.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-03-06","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132235223","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using vector autoregressive models with either constant or time-varying parameters and stochastic volatility for the United States, we find that a contractionary monetary policy shock has a persistent negative impact on the asset growth of commercial banks, but increases the asset growth of shadow banks and securitisation activity. To explain this ‘waterbed’ effect, we propose a standard New Keynesian model featuring both commercial and shadow banking, and we show that the model comes close to explaining the empirical results. Our findings cast doubt on the idea that monetary policy can usefully ‘get in all the cracks’ of the financial sector in a uniform way.
{"title":"Do Contractionary Monetary Policy Shocks Expand Shadow Banking?","authors":"B. Nelson, Gábor Pintér, Konstantinos Theodoridis","doi":"10.2139/ssrn.2550820","DOIUrl":"https://doi.org/10.2139/ssrn.2550820","url":null,"abstract":"Using vector autoregressive models with either constant or time-varying parameters and stochastic volatility for the United States, we find that a contractionary monetary policy shock has a persistent negative impact on the asset growth of commercial banks, but increases the asset growth of shadow banks and securitisation activity. To explain this ‘waterbed’ effect, we propose a standard New Keynesian model featuring both commercial and shadow banking, and we show that the model comes close to explaining the empirical results. Our findings cast doubt on the idea that monetary policy can usefully ‘get in all the cracks’ of the financial sector in a uniform way.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"85 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-01-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128008668","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper argues that human capital depreciation during unemployment generates an externality in job creation: firms ignore how their hiring decisions affect the skill composition of the future unemployment pool, and hence the output produced by new hires. As a consequence, job creation is too low from a social point of view. But the extent to which it is too low varies over the cycle. The reason is that the increase in the expected productivity of a new hire from next period’s unemployment pool caused by hiring an additional worker today, depends on the pool’s composition, which varies over the cycle.
{"title":"The Cost of Human Capital Depreciation During Unemployment","authors":"Lien Laureys","doi":"10.2139/ssrn.2487796","DOIUrl":"https://doi.org/10.2139/ssrn.2487796","url":null,"abstract":"\u0000 This paper argues that human capital depreciation during unemployment generates an externality in job creation: firms ignore how their hiring decisions affect the skill composition of the future unemployment pool, and hence the output produced by new hires. As a consequence, job creation is too low from a social point of view. But the extent to which it is too low varies over the cycle. The reason is that the increase in the expected productivity of a new hire from next period’s unemployment pool caused by hiring an additional worker today, depends on the pool’s composition, which varies over the cycle.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"24 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-08-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127394490","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using a calibrated model of endogenous sovereign default, we explore how GDP-linked bonds can raise the maximum sustainable debt level of a government, and substantially reduce the incidence of default. The model explores both the costs (in particular the GDP risk premium) and the benefits of issuing GDP-linked bonds. It concludes that significant welfare gains can be achieved by indexing debt to GDP.
{"title":"GDP-Linked Bonds and Sovereign Default","authors":"D. Barr, Oliver Bush, A. Pienkowski","doi":"10.2139/ssrn.2388768","DOIUrl":"https://doi.org/10.2139/ssrn.2388768","url":null,"abstract":"Using a calibrated model of endogenous sovereign default, we explore how GDP-linked bonds can raise the maximum sustainable debt level of a government, and substantially reduce the incidence of default. The model explores both the costs (in particular the GDP risk premium) and the benefits of issuing GDP-linked bonds. It concludes that significant welfare gains can be achieved by indexing debt to GDP.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"31 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-01-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122464660","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper proposes an empirical model which can be used to estimate the impact of changes in the volatility of shocks to US real activity on the UK economy. The proposed empirical model is a structural VAR where the volatility of structural shocks is time varying and is allowed to affect the level of endogenous variables. Using this extended SVAR model we estimate that a one standard deviation increase in the volatility of the shock to US real GDP leads to a decline in UK GDP growth of 0.1% and a 0.1% increase in UK CPI inflation. We then use a non-linear small open economy New Keynesian business cycle model calibrated to US/UK economies to investigate what kind of stochastic volatility shocks can deliver such behaviour. We find that shocks that generate marginal cost uncertainty – such as foreign wage mark-up and productivity stochastic volatility shocks – can reproduce the macroeconomic aggregate responses obtained by the empirical model. An increase in uncertainty, associated with foreign demand shocks on the other hand has a negligible impact on the domestic economy.
{"title":"The International Transmission of Volatility Shocks: An Empirical Analysis","authors":"H. Mumtaz, Konstantinos Theodoridis","doi":"10.2139/ssrn.2158396","DOIUrl":"https://doi.org/10.2139/ssrn.2158396","url":null,"abstract":"This paper proposes an empirical model which can be used to estimate the impact of changes in the volatility of shocks to US real activity on the UK economy. The proposed empirical model is a structural VAR where the volatility of structural shocks is time varying and is allowed to affect the level of endogenous variables. Using this extended SVAR model we estimate that a one standard deviation increase in the volatility of the shock to US real GDP leads to a decline in UK GDP growth of 0.1% and a 0.1% increase in UK CPI inflation. We then use a non-linear small open economy New Keynesian business cycle model calibrated to US/UK economies to investigate what kind of stochastic volatility shocks can deliver such behaviour. We find that shocks that generate marginal cost uncertainty – such as foreign wage mark-up and productivity stochastic volatility shocks – can reproduce the macroeconomic aggregate responses obtained by the empirical model. An increase in uncertainty, associated with foreign demand shocks on the other hand has a negligible impact on the domestic economy.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"18 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-10-07","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134296234","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using publicly available data for a group of 20 OECD countries, we find that the cyclical volatility of the unemployment rate exhibits substantial cross-country and time variation. We then investigate empirically whether labour market institutions can account for this observed heterogeneity and find that the impact of various institutions on cyclical unemployment dynamics is quantitatively strong and statistically significant. The hypothesis that labour market institutions could increase the volatility of unemployment by reducing match surplus is not supported by the data. In fact, unemployment benefits, taxation and employment protection appear to reduce the volatility of unemployment rates. In addition, we find that the precise nature of union bargaining has important implications for cyclical unemployment dynamics, with union coverage and density having large and offsetting effects. Finally, we provide evidence suggesting that interactions between shocks and institutions matter for cyclical unemployment fluctuations. However, institutions only account for about one quarter of the explained variation, which implies that they are important but they are not the entire story.
{"title":"Labour Market Institutions and Unemployment Volatility: Evidence from OECD Countries","authors":"Renato Faccini, Chiara Rosazza Bondibene","doi":"10.2139/ssrn.2137592","DOIUrl":"https://doi.org/10.2139/ssrn.2137592","url":null,"abstract":"Using publicly available data for a group of 20 OECD countries, we find that the cyclical volatility of the unemployment rate exhibits substantial cross-country and time variation. We then investigate empirically whether labour market institutions can account for this observed heterogeneity and find that the impact of various institutions on cyclical unemployment dynamics is quantitatively strong and statistically significant. The hypothesis that labour market institutions could increase the volatility of unemployment by reducing match surplus is not supported by the data. In fact, unemployment benefits, taxation and employment protection appear to reduce the volatility of unemployment rates. In addition, we find that the precise nature of union bargaining has important implications for cyclical unemployment dynamics, with union coverage and density having large and offsetting effects. Finally, we provide evidence suggesting that interactions between shocks and institutions matter for cyclical unemployment fluctuations. However, institutions only account for about one quarter of the explained variation, which implies that they are important but they are not the entire story.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"7 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-08-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116622847","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper analyses the conduct of monetary policy in an environment where households’ desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of ‘policy bias’ is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.
{"title":"Time-Varying Volatility, Precautionary Saving and Monetary Policy","authors":"M. Hatcher","doi":"10.2139/ssrn.1951939","DOIUrl":"https://doi.org/10.2139/ssrn.1951939","url":null,"abstract":"This paper analyses the conduct of monetary policy in an environment where households’ desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of ‘policy bias’ is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"14 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-10-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130018305","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A large empirical literature has examined the transmission mechanism of structural shocks in great detail. The possible role played by changes in the volatility of shocks has largely been overlooked in vector autoregression based applications. This paper proposes an extended vector autoregression where the volatility of structural shocks is allowed to be time-varying and to have a direct impact on the endogenous variables included in the model. The proposed model is applied to US data to consider the potential impact of changes in the volatility of monetary policy shocks. The results suggest that while an increase in this volatility has a statistically significant impact on GDP growth and inflation, the relative contribution of these shocks to the forecast error variance of these variables is estimated to be small.
{"title":"Estimating the Impact of the Volatility of Shocks: A Structural VAR Approach","authors":"H. Mumtaz","doi":"10.2139/ssrn.1951934","DOIUrl":"https://doi.org/10.2139/ssrn.1951934","url":null,"abstract":"A large empirical literature has examined the transmission mechanism of structural shocks in great detail. The possible role played by changes in the volatility of shocks has largely been overlooked in vector autoregression based applications. This paper proposes an extended vector autoregression where the volatility of structural shocks is allowed to be time-varying and to have a direct impact on the endogenous variables included in the model. The proposed model is applied to US data to consider the potential impact of changes in the volatility of monetary policy shocks. The results suggest that while an increase in this volatility has a statistically significant impact on GDP growth and inflation, the relative contribution of these shocks to the forecast error variance of these variables is estimated to be small.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"12 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-10-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114418543","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We estimate structurally a model of the term structure of interest rates that is consistent with no arbitrage but allows for demand pressures. The term structure in our model is determined through the interaction of risk-averse arbitrageurs and preferred-habitat investors with preferences for specific maturities. The model is estimated on US real rates during the 2000s and allows for two factors: one corresponding to the short rate and one to preferred - habitat demand. We find that the puzzling drop in long rates during 2004-05 (Greenspan conundrum) is driven by the demand factor. International reserves, foreign official holdings of longer-term US Treasuries may all be proxies for the preferred - habitat demand factor. For example, foreign purchases in the year to July 2004 appear to have lowered the ten-year rate by about 100 basis points. Foreign purchases have larger effects following periods when arbitrageurs have lost money.
{"title":"Preferred - Habitat Investors and the US Term Structure of Real Rates","authors":"I. Kaminska, Dimitri Vayanos, Gabriele Zinna","doi":"10.2139/ssrn.1898069","DOIUrl":"https://doi.org/10.2139/ssrn.1898069","url":null,"abstract":"We estimate structurally a model of the term structure of interest rates that is consistent with no arbitrage but allows for demand pressures. The term structure in our model is determined through the interaction of risk-averse arbitrageurs and preferred-habitat investors with preferences for specific maturities. The model is estimated on US real rates during the 2000s and allows for two factors: one corresponding to the short rate and one to preferred - habitat demand. We find that the puzzling drop in long rates during 2004-05 (Greenspan conundrum) is driven by the demand factor. International reserves, foreign official holdings of longer-term US Treasuries may all be proxies for the preferred - habitat demand factor. For example, foreign purchases in the year to July 2004 appear to have lowered the ten-year rate by about 100 basis points. Foreign purchases have larger effects following periods when arbitrageurs have lost money.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"45 4","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-07-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132870105","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this paper, I estimate a dynamic stochastic general equilibrium (DSGE) model of the United Kingdom. The basic building blocks of the model are standard in the literature. The main complication is that there are three consumption goods: non-energy output, petrol and utilities; given relative prices and their overall wealth, consumers choose how much of each of these goods to consume in order to maximise their utility. Each of the consumption goods is produced according to a sector-specific production function and sticky prices in each sector imply sector-specific New Keynesian Phillips Curves. I show how this model, once estimated, could form a useful additional input within a policymaker’s ‘suite of models’ by considering its implications for the responses of various macroeconomic variables to different economic shocks and by decomposing recent movements of energy and non-energy output and inflation into the proportions caused by each of the shocks.
{"title":"An Estimated DSGE Model of Energy, Costs and Inflation in the United Kingdom","authors":"S. Millard","doi":"10.2139/ssrn.1898065","DOIUrl":"https://doi.org/10.2139/ssrn.1898065","url":null,"abstract":"In this paper, I estimate a dynamic stochastic general equilibrium (DSGE) model of the United Kingdom. The basic building blocks of the model are standard in the literature. The main complication is that there are three consumption goods: non-energy output, petrol and utilities; given relative prices and their overall wealth, consumers choose how much of each of these goods to consume in order to maximise their utility. Each of the consumption goods is produced according to a sector-specific production function and sticky prices in each sector imply sector-specific New Keynesian Phillips Curves. I show how this model, once estimated, could form a useful additional input within a policymaker’s ‘suite of models’ by considering its implications for the responses of various macroeconomic variables to different economic shocks and by decomposing recent movements of energy and non-energy output and inflation into the proportions caused by each of the shocks.","PeriodicalId":395566,"journal":{"name":"BOE: Working Paper Series (Topic)","volume":"10 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-07-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125440843","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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