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...

This paper proposes a method for constructing a volatility risk premium, or investor risk aversion, index. The method is intuitive and simple to implement, relying on the sample moments of the recently popularized model-free realized and option-implied volatility measures. A small-scale Monte...

Synthetic collateralized debt obligations, or synthetic CDOs, are popular vehicles for trading the credit risk of a portfolio of assets. Following a brief summary of the development of the synthetic CDO market, I draw on recent innovations in modeling to present a pricing model for CDO tranches...

The quot;Big Bangquot; deregulation of Japanese financial markets focuses on financial modernization. I argue that financial modernization is of secondary importance for improving the performance of the Japanese economy. A key long-term issue facing Japan is to maintain its high level of per...

Event risk is the risk that a portfolio's value can be affected by large jumps in market prices. Event risk is synonymous with quot;fat tailsquot; or quot;jump riskquot;. Event risk is one component of quot;specific riskquot;, defined by bank supervisors as the component of market risk not...