Theoretische achtergronden van de financiële crisis HOVO College 3.

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Theoretische achtergronden van de financiële crisis HOVO College 3

Hoofdverklaringen Financiële Crisis Financiële alchemie en de sub-prime hypotheekmarkt. Perverse prikkels in de financiële sector (en meer algemeen de opkomst van de markteconomie). Macro-economische onbalans en kapitaalstromen.

Diversification Suppose that there are two countries A and B. Both have one industry. Citizens in each county can invest in their own industry or, when capital mobility is possible, in the other country. There are two possible states of the world ‘normal’ and ‘bad’. The chance on normal is p=¾, and for bad is 1-p= ¼. When it is normal, returns are 100, and when bad 0. Hence, expected returns when citizens invest in home only are ¾ *100 + ¼ *0 = 75. When citizens invest 50% of their portfolio in home (A) and 50% in foreign (B), expected returns are: ¼ * ¼ *0+ ¼ * ¾ *2 *50 + ¾ * ¾ * 100 = 75 However, when citizens are risk averse, they choose international diversification. This is also the reason why banks exist: there is arbitrage between risk neutral institutions and risk averse individuals.

Risk aversion X 5010075 People put positive value on obtaining a certainty equivalent. This is a role for banking.

Optimal portfolio 45 0 A B Risk Return Capital allocation line Risk free r f The big question: how specific is the risk to the asset? How systematic is the risk across assets?

Structured Debt Transfornation Bond X \$1 (B)Bond Y \$1(B) CDO \$2 Senior Tranche AAA Junior Tranche BBB Two bond with default probability P d. Two tranches: Senior bears first dollar loss Junior bears second dollar loss

Diversification Bond X \$1 (B)Bond Y \$1(B) CDO \$3 Senior Tranche \$2 AAA Junior T \$1 BBB BOND Z \$1 By pooling more reserves, a larger share of the CDO can be sold as AAA

CDO 2 Bond X \$1 (B)Bond Y \$1(B) CDO \$3 ST \$2 AAA JT \$1 BBB BOND Z \$1 CDO \$3 JT \$1 BBB CDO 2 ST AAA (!)Junk Bond

The Financial System Own capital Deposits Money markets Mortgages Loans to firms Securitization CDSCDO Commercial BankInvestment Bank Value At Risk (VAR): -Own portfolio -Combined with structured products -Portfolio theories and stress tests -Non-linear default risk -Non-linear conter parties risk Concentrated insurance risk Rating agencies moral hazard risk

Transformation in the financial system Institutional investors Investment Banks Commercial Banks Savers Fix for Flex Subsidizing mortgage actors (Fanny May) CDO Rating agencies Information moral hazard Moody’s, S&P, Fitch Individual to Pooled

Incentive problemen in het bankwezen De bonuscultuur: – Op zich zijn bonusregelingen efficiënt in verband met ‘moral hazard’. – Maar, bij banken is de ‘leverage’ met andermans geld zo groot dat het niet reëel is. Banken hebben ‘private kennis’ van hun eigen onderliggende assets, wat kan leiden tot adverse selection: – De markt voor tweedehands auto’s. – Het libor schandaal.

The Balance of Payments Money flows inMoney flows out uit Exports Sell domestic assets Decrease in reserves Imports Buy foreign assets Increase in reserves

Source: The Economist

Global Imbalances: The US Import Buying assets Increase reserves Export Selling assets Decrease reserves Consumption Investment (!) Gov. Spending Global savings glut: - China - Oil exporters Domstic imbalances - Loose monetary policy - Rising asset prices - Financial innovation - Increased government spending US Balance of Payments

Global Imbalances: China Import Buying assets Increase reserves Export Selling assets Decrease reserves Investment Sources: - Outsourcing - Low prices - Undervalued exchange rate (?) - Supporting the fixed exchange rate - Sterilizing money supply effects China Balance of Payments - Growth - FDI

Export led growth AsiaChina’s fixed exchange rate Surplus oil exporters Macroeconomic Financial Imbalances US savings rateUS government deficit Unbalanced Europe

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