Deposit insurance, bank incentives, and the design of regulatory policy

This paper was presented at the conference "Financial services at the crossroads: capital regulation in the twenty-first century" as part of session 6, "The role of capital regulation in bank supervision." The conference, held at the Federal Reserve Bank of New York on February 26-27, 1998, was designed to encourage a consensus between the public and private sectors on an agenda for capital regulation in the new century.Deposit insurance ; Bank investments ; Bank supervision ; Bank capital

Shortcomings of a Parametric VaR Approach and Nonparametric Improvements Based on a Non-Stationary Return Series Model

A non-stationary regression model for financial returns is examined theoretically in this paper. Volatility dynamics are modelled both exogenously and deterministic, captured by a nonparametric curve estimation on equidistant centered returns. We prove consistency and asymptotic normality of a symmetric variance estimator and of a one-sided variance estimator analytically, and derive remarks on the bandwidth decision. Further attention is paid to asymmetry and heavy tails of the return distribution, implemented by an asymmetric version of the Pearson type VII distribution for random innovations. By providing a method of moments for its parameter estimation and a connection to the Student-t distribution we offer the framework for a factor-based VaR approach. The approximation quality of the non-stationary model is supported by simulation studies

Environmental and Genetic Determinants of Colony Morphology in Yeast

Nutrient stresses trigger a variety of developmental switches in the budding yeast Saccharomyces cerevisiae. One of the least understood of such responses is the development of complex colony morphology, characterized by intricate, organized, and strain-specific patterns of colony growth and architecture. The genetic bases of this phenotype and the key environmental signals involved in its induction have heretofore remained poorly understood. By surveying multiple strain backgrounds and a large number of growth conditions, we show that limitation for fermentable carbon sources coupled with a rich nitrogen source is the primary trigger for the colony morphology response in budding yeast. Using knockout mutants and transposon-mediated mutagenesis, we demonstrate that two key signaling networks regulating this response are the filamentous growth MAP kinase cascade and the Ras-cAMP-PKA pathway. We further show synergistic epistasis between Rim15, a kinase involved in integration of nutrient signals, and other genes in these pathways. Ploidy, mating-type, and genotype-by-environment interactions also appear to play a role in the controlling colony morphology. Our study highlights the high degree of network reuse in this model eukaryote; yeast use the same core signaling pathways in multiple contexts to integrate information about environmental and physiological states and generate diverse developmental outputs

Testing for systemic risk using stock returns

Conditional value at risk (CoVaR) and marginal expected shortfall (MES) have been proposed as stock return based measures of the systemic risk created by individual financial institutions even though the literature provides no formal hypothesis test for detecting systemic risk. We address this shortcoming by constructing hypothesis test statistics for CoVaR and MES that can be used to detect systemic risk at the institution level. We apply our tests to daily stock returns data for over 3500 firms during 2006-2007. CoVaR (MES) tests identify almost 500 (1000) firms as systemically important. Both tests identify many more real-side firms than financial firms, and they often disagree about which firms are systemic. Analysis of the hypothesis tests' performance for plausible alternative hypotheses finds that return skewness can cause test rejections and, even when systemic risk imparts a strong signal in stock return distributions, hypothesis tests based on CoVaR and MES may fail to detect it. Our overall conclusion is that CoVaR and MES are not reliable measures of systemic risk

Policy uncertainty and bank stress testing

This paper highlights the policy uncertainty inherent in using stress tests, both to set minimum bank capital requirements and to assess the capital adequacy needed to maintain banking system stability

Inside the black box: The accuracy of alternative stress test models

Regulatory forecasts of bank performance over hypothetical multiyear stress scenarios are used to set financial institution minimum regulatory capital requirements in multiple jurisdictions, yet little is known about the accuracy of these supervisory stress test models.Updated January 201

Inflation targeting: How the Federal Reserve abandoned 'honest money' for a perpetual inflation tax

There was a time when the Federal Reserve believed that honest money—i.e., a stable price level— was essential for achieving full employment. Today, retired Fed officials are recommending that the Federal Open Market Committee (FOMC) target 3-percent inflation. They argue that a 3 percent inflation target would limit the risk of deflation and create large transitory reductions in unemployment and cumulative gains equal to 50 percent of GDP over a 15-year period. I review the evidence on deflation, the Phillips curve relationship that promises to deliver sizable output gains, the FOMC's historical experience with Phillips curve models, and how the FOMC's monetary strategy evolved from policy coordination, to price stability, to implicit, and finally to explicit inflation targeting. I analyze historically important factors that may prevent the realization of the hypothetical gains created by increasing the inflation rate target and summarize the literature that describes the costs and benefits of inflation. Finally, I provide estimates of the additional inflation tax revenue generated by increasing the FOMC's inflation target from 2 to 3 percent and show that, at a minimum, if the hypothetical gains were realized, more than 61 percent of the output gains would accrue to the Federal government. If output gains are not forthcoming, the change in the inflation target will still transfer trillions of dollars of inflation tax revenue from the public to the federal government and impose additional welfare costs that come with higher inflation

Statistical challenges of stress test financial stability assessments

Banking system stress tests are a key component of IMF/World Bank financial stability assessments