I examine the relationship between a financial intermediary ("bank") and a borrowing firm in a three-period overlapping generations model. The model can accommodate two financing arrangements between the bank and the firm: one requires commitment to a long-term contract, the other does not....

The striking growth of credit derivatives suggests that market participants find them to be useful tools for risk management. I illustrate the value of credit derivatives with three examples. A commercial bank can use credit derivatives to manage the risk of its loan portfolio. An investment...

Firms active in OTC derivative markets increasingly use margin agreements to reduce counterparty credit risk. Making several simplifying assumptions, I use both a quasi-analytic approach and a simulation approach to quantify how margining reduces counterparty credit exposure. Margining reduces...

In the summer of 2000, central banks from the Group of Ten countries surveyed large international banks about their use of stress tests - a risk management tool that measures a firm's exposure to extreme movements in asset prices. The survey findings highlight the risks that most concern...

Correlations are crucial for pricing and hedging derivatives whose payoff depends on more than one asset. Typically, correlations computed separately for ordinary and stressful market conditions differ considerably, a pattern widely termed quot;correlation breakdown.quot; As a result, risk...

A forecast of the correlation between two asset prices is required to price or hedge an option whose payoff depends on both asset prices or to measure the risk of a portfolio whose return depends on both asset prices. However, a number of factors make it difficult to evaluate forecasts of...

Over the last several years, a combination of loan losses and regulatory barriers to equity issuance have left Japanese banks starved for capital. In September 1995, the Mitsubishi Bank was permitted to issue a complicated convertible security in a foreign market. The results of simulations of...

Does weakness in the banking sector adversely affect the real economy? If so, how large is the effect? In this article I answer these questions for Japan in 1991-92. I test whether a firm's investment is sensitive to the financial health of its main bank, controlling for stock market valuation...