A Macroeconomic Framework for Quantifying Systemic Risk. June 2012

Transcription

1 A Macroeconomic Framework for Quantifying Systemic Risk Zhiguo He Arvind Krishnamurthy University of Chicago & NBER Northwestern University & NBER June 212

2 Systemic Risk Systemic risk: risk (probability) of a state where financial intermediation is disrupted small fundamental shocks to financial intermediaries can have quantitatively large effects on macro economy Goal: Write down a non-linear macro model to assess systemic risk much of the time the link between financial intermediation and macro economy is small but in (crisis) states the effects are greatly amplified

3 Systemic Risk Systemic risk: risk (probability) of a state where financial intermediation is disrupted small fundamental shocks to financial intermediaries can have quantitatively large effects on macro economy Goal: Write down a non-linear macro model to assess systemic risk much of the time the link between financial intermediation and macro economy is small but in (crisis) states the effects are greatly amplified How well does the model match asymmetry (i.e. occasional effects of financial intermediation) in the data? How well can an intermediary shock channel explain patterns in 27-29? How likely is the economy, say unconditionally, to enter a systemic risk episode?

4 Innovation Relative to Much of Literature We study a model with occasionally binding financial constraint Typical models (e.g., Kiyotaki-Moore (1997),...) linearize around steady state where constraint binds. Cannot talk about 1) likelihood that intermediation is disrupted (its always disrupted...) and 2) how severely it is disrupted Our model solution has stochastic steady state, with fully solved equilibrium prices and policies Main drawback: need to reduce state variables Have to leave out some common DSGE elements Similar methodology to Mendoza (21) and Brunnermeier-Sannikov (211) Model elements adopted from He-Krishnamurthy (212), with real investment and housing

5 Preview of model result 6 Sharpe ratio.1 interest rate scaled intermediary reputation e investment I/K scaled intermediary reputation e scaled intermediary reputation e steady state distribution scaled intermediary reputation e

6 Preview of model result 6 Sharpe ratio.1 interest rate scaled intermediary reputation e investment I/K scaled intermediary reputation e scaled intermediary reputation e steady state distribution scaled intermediary reputation e Crisis: e crisis =.65, binding capital constraint Distress: e distress = 4 so that Pr (e e distress ) = 33% as in data

7 Strategy Crises are rare. How do we quantify model? Even if economy is currently not in a crisis state, the anticipation of a crisis affects decisions. 1. We match data on distress" (33% of data) and non-distress" periods (67% of data). 2. We extrapolate to a crisis and ask how well the model can match patterns from We compute conditional probabilities of triggering a crisis (measuring systemic risk" probabilities).

8 Evidence of Non-Linearity Excess bond premium (EBP): the risk premium part of credit spread (removing default part), Gilchrist and Zakrajsek (21). Correlates with measures of intermediary health. Use EBP to classify distress periods (33%) and non-distress periods (the rest) Distress Periods NBER Recessions 1973Q1-1975Q3 11/73-3/ Q2-1982Q4 7/81-11/ Q4-1987Q3 1988Q4-199Q1 7/9-3/ Q4-1993Q2 21Q2-23Q1 3/1-11/1 27Q3-29Q3 12/7-6/9

9 State-Dependent Covariances (1) Equity = Total market value of equity of finance, insurance and real estate sectors. (works as well if only include banks + broker/dealers) All variables are growth, except Sharpe ratio constructed from EBP Distress Non Distress Cov Corr Cov Corr Equity, Investment 1.31% Equity, Consumption.25% Equity, Sharpe -6.81% Equity, Landprice 4.6%

10 State-Dependent Covariances (2) All variables are growth, except Sharpe ratio constructed from EBP Distress Non Distress NBER+2 Excl-Crisis NBER+2 Excl-Crisis Equity, Investment.84% Equity, Consumption.13% Equity, Sharpe -7.57% Equity, Landprice 4.39% Note: Similar numbers if only use NBER dates, but distress sample is only 2% of observations.

11 VAR Evidence of Non-Linearity (3) VAR order: [intermediary equity, aggregate stock market, EBP, investment]. Coeffi cients depend on distress/non-distress state. Quarterly growth rates. PANEL A: DISTRESS PERIODS 25 Equity to Equity 2 Market to Equity EB (credit risk premium) to Equity 5 Investment to Equity PANEL B: NON DISTRESS PERIODS 2 Equity to Equity 12 Market to Equity.2 EB to Equity 2 Investment to Equity

12 Road Map of the Rest of Talk Model, mechanism, and solution Calibration Baseline parameters Prices and polices, comparative statics Matching data on distress and non-distress Systemic crisis Extrapolate to crisis state Uncover fundamental shocks in the recent crisis How likely are crises?

13 Agents and Technology Two classes of agents: households and bankers Households own the entire economy, but subject to frictions related to bankers who control intermediaries (next slide) Two types of capital: productive capital K t and housing capital H. Fixed supply of housing H 1 Price of capital qt and price of housing P t determined in equilibrium

14 Agents and Technology Two classes of agents: households and bankers Households own the entire economy, but subject to frictions related to bankers who control intermediaries (next slide) Two types of capital: productive capital K t and housing capital H. Fixed supply of housing H 1 Price of capital qt and price of housing P t determined in equilibrium Production Y = AK t, with A being constant Fundamental shocks: stochastic capital quality shock dz t dk t K t = i t dt δdt + σdz t Investment/Capital i t, quadratic adjustment cost Φ(i t, K t ) = i t K t + κ 2 (i t δ) 2 K t

15 Aggregate Balance Sheet Loans to Capital Producers i t Intermediary Sector Household Sector Capital q t K t Housing P t H Equity E t Debt W t E t Financial Wealth W t = q t K t + P t H

16 Aggregate Balance Sheet Loans to Capital Producers i t Intermediary Sector Aggregate bank reputation E t Household Sector Capital q t K t Housing P t H Equity E t Constraint: E t E t No constraint Debt W t E t Financial Wealth W t = q t K t + P t H

17 Single Bank/Banker Capital q t k t Housing P t h t Equity e t Debt d t Portfolio share in capital: α k t = q t k t e t Portfolio share in housing : α h t = P t h t e t Borrowing (no constraint): d t = q t k t + P t h t e t = (α k t + α h t 1)e t Return on bank equity: d R t = α k t drk t + α h t drh t (α k t + α h t 1)r t dt Banker (log preference) solves: max α k t,α h t E [d R t r t dt] m 2 Var t [d R t ]

18 Single Bank/Banker Capital q t k t Housing P t h t Equity e t Debt d t Properties (k, h) scales with e (k, h) increasing in E t [dr r] (k, h) decreasing in Var[dR] Portfolio share in capital: α k t = q t k t e t Portfolio share in housing : α h t = P t h t e t Borrowing (no constraint): d t = q t k t + P t h t e t = (α k t + α h t 1)e t Return on bank equity: d R t = α k t drk t + α h t drh t (α k t + α h t 1)r t dt Banker (log preference) solves: max α k t,α h t E [d R t r t dt] m 2 Var t [d R t ]

19 General Equilibrium (1) Intermediary Sector Household Sector Capital q t K t Equity E t Financial Wealth Housing p t H Debt W t E t Constraint: E t E t W t = q t K t + p t H Portfolio share in capital: α k t = q t K t E t Portfolio share in housing: α h t = P t H Et Given a particular state (K t, E t ), the portfolio shares are pinned down by GE Portfolio shares must also be optimally chosen by banks max α k t,αh t E t [d R t r t dt] m 2 Var t [d R t ]

20 General Equilibrium (2) Intermediary Sector Household Sector Capital q t K t Equity E t Financial Wealth Housing p t H Debt W t E t Constraint: E t E t W t = q t K t + p t H Portfolio share in capital: α k t = q t K t E t Portfolio share in housing: α h t = P t E t Prices (returns) have to adjust for optimality: Et [drt h r t dt], E t [drt k r t dt] equations for E t [dp t ], E t [dq t ] Rewrite to get ODEs for P(K, E) and q(k, E) Scale invariance: Define e E/K; then P = Kp(e) and q(e)

21 Capital Producers and Investment Capital goods producers (owned by households) undertake real investment Producers must sell the capital stock to intermediaries at price q t Risk averse intermediaries bear aggregate fundamental shocks Real investment is affected by financial condition of intermediaries to capture credit crunch Possible interpretations: Entrepreneurs raise capital from VC/PE at the price of qt Commercial banks makes collateralized loans Investment decision max i t q t i t K t Φ(i t, K t ) i t = δ + q t 1 κ

22 Capital Constraint Single bank has reputation ɛ t linked to intermediary performance (constant m) dɛ t ɛ t = m R t. Poor past returns reduce reputation Households invest a maximum of ɛ t dollars of equity capital with this banker

23 Capital Constraint Single bank has reputation ɛ t linked to intermediary performance (constant m) dɛ t ɛ t = m R t. Poor past returns reduce reputation Households invest a maximum of ɛ t dollars of equity capital with this banker Death rate η, and entry dψ t > of new bankers in extreme states (modeled later) E t : aggregate reputation. Identical banks, aggregate dynamics of E t de t E t = md R t ηdt + dψ t

24 Capital Constraint Single bank has reputation ɛ t linked to intermediary performance (constant m) dɛ t ɛ t = m R t. Poor past returns reduce reputation Households invest a maximum of ɛ t dollars of equity capital with this banker Death rate η, and entry dψ t > of new bankers in extreme states (modeled later) E t : aggregate reputation. Identical banks, aggregate dynamics of E t de t E t = md R t ηdt + dψ t Note: E t is like net worth" in many other models.

25 Households Problem (1) Choose consumption ct y and housing ct h to maximize [ ( ) ] E e ρt (1 φ) ln ct y + φ ln ch t dt Equilibrium rental price D t (housing asset dividend), FOC c h t D t φ = c y t 1 φ. In equilibrium (C h t = H = 1) D t = φ 1 φ C y t φ: expenditure share in housing, or the relative size of housing sector Households free to trade short-term debt. [ Interest rate r t = ρ + E t dc y t /Ct y ] [ Vart dc y t /Ct y ]

26 Households Problem (2) Representative household enters time t with financial wealth W t The household splits wealth: (1 λ) W t to equity households, λw t to bond households Equity households invest their portion of wealth as equity of intermediaries, subject to capital frictions Bond households invest in riskless bonds Once returns are realized, both members pool their wealth again (as in Lucas 199) The only role of bond households (i.e. parameter λ) is to introduce intermediary s leverage in normal time

27 Debt/Equity Ratio Loans to Capital Producers i t Intermediary Sector Aggregate bank reputation E t Household Sector Capital q t K t Housing P t H Equity E t Constraint: E t E t No constraint Debt W t E t Financial Wealth W t = q t K t + p t H (1 λ)w t λw t

28 Equity Capital Constraint Unconstrained capital structure: λw t of Debt, (1 λ)w t of Equity. Intermediary equity capital E t is given by E t = min [E t, (1 λ)w t ] How can capital constraint come to bind, beginning in a state where E t > (1 λ)w t? Suppose a 1% shock to real estate and price of capital, so that W t 1% (Household wealth = aggregate wealth) Reputation follows d E t than 1%: E t = md R t +... Two forces make E t more Equity is levered claim on assets: Return on equity = d R t < 1% m > 1 in our calibration.

29 Boundary Conditions When e =, E t > (1 λ) W t frictionless economy We solve for p( ), q( ) analytically As e, intermediaries portfolio volatility, i.e. Sharpe ratio, rises New bankers enter if e = e (Sharpe ratio hits γ, exogenous constant) Entry increases aggregate E but requires physical capital K at conversion rate of β e is a reflecting boundary Boundary conditions at the entry point e q (e) =, p (e) = p (e) β, and Sharpe_Ratio (e) = γ 1 + eβ

30 Calibration: Baseline Parameters Parameter Choice Target Panel A: Intermediation m Performance sensitivity 2.5 Average Sharpe ratio (38%) λ Debt ratio.5 Average intermediary leverage η Banker exit rate 13% Good model dynamics γ Entry trigger 5.5 Highest Sharpe ratio β Entry cost 2.35 Land price volatility Panel B: Technology σ Capital quality shock 5% Investment and Consumption volatilities δ Depreciation rate 1% Literature κ Adjustment cost 2 Literature A Productivity.14 Investment-to-capital ratio Panel C: Others ρ Time discount rate 2% Literature φ Housing share.5 Housing-to-wealth ratio

31 Equilibrium Prices and Policies (1) e crisis =.65: binding capital constraint e distress = 4 so that Pr (e e distress ) = 33% as in data.8 p(e), scaled housing price 1.1 q(e), capital price scaled intermediary reputation e scaled intermediary reputation e 1.5 return volatility of housing.535 return volatility of capital scaled intermediary reputation e scaled intermediary reputation e

32 Equilibrium Prices and Policies (2) e crisis =.65: binding capital constraint e distress = 4 so that Pr (e e distress ) = 33% as in data 6 Sharpe ratio.1 interest rate scaled intermediary reputation e scaled intermediary reputation e.15 investment I/K.35 steady state distribution scaled intermediary reputation e scaled intermediary reputation e

33 Matching State-Dependent Covariances: Baseline Distress Non Distress Data Baseline Data Baseline vol (Eq) 31.48% vol (I ) 8.5% vol (C ) 1.71% vol (LP) 21.26% vol (EB) 6.14% cov (Eq, I ) 1.31% cov (Eq, C ).25% cov (Eq, LP) 4.6% cov (Eq, EB) -6.81%

34 Matching State-Dependent Covariances: lower σ Distress Non Distress Data Baseline σ = 4% Data Baseline σ = 4% vol (Eq) 31.48% vol (I ) 8.5% vol (C ) 1.71% vol (LP) 21.24% vol (EB) 6.14% cov (Eq, I ) 1.31% cov (Eq, C ).25% cov (Eq, LP) 4.6% cov (Eq, EB) -6.81%

35 Matching State-Dependent Covariances: No Housing Distress Non Distress Data Baseline φ = Data Baseline φ = vol (Eq) 31.48% vol (I ) 8.5% vol (C ) 1.71% vol (LP) 21.24% vol (EB) 6.14% cov (Eq, I ) 1.31% cov (Eq, C ).25% cov (Eq, LP) 4.6% cov (Eq, EB) -6.81%

36 Uncovering Shocks in the Recent Crisis Data Model

37 Uncovering Shocks in the Recent Crisis Data Model Based on realized equity return we uncover fundamental shocks to K 7QIII 7QIV 8QI 8QII 8QIII 8QIV 9QI 9QII 9QIII 9QIV -3.77% Total -25%. Capital constraint binds after 8QII systemic crisis In the model (data), land price fall by 71% (55%)

38 Probability of Crisis 27Q2, Prob(crisis occurs in the next 2 years)=.9%, Prob(5 years) = 2.62%, Prob (1 years) = 1.5%

39 Probability of Crisis 27Q2, Prob(crisis occurs in the next 2 years)=.9%, Prob(5 years) = 2.62%, Prob (1 years) = 1.5% Conditional probability of hitting crisis (left) or distress (right).35 Probability of Capital Constraint Binding 1.1 Probability of Entering Distress States in next 5 years in next 1 years.8.7 in next 5 years in next 1 years Initial Condition e Initial C ondition: e init init Note: Probabilities are low, which suggests improved capital buffers would have limited effects.

40 VIX and Systemic Risk 2 e, scaled intermediary reputation time (quarters) prob. of capital constraint being constrained in next x years 1 next 1 year.5 next 5 years next 1 years time (quarters) housing price volatility time (quarters) Volatility in our model rises most sharply when the constraint binds Coincident indicator and no predictive content. What might work better? A VIX spread: Long-maturity VIX minus short-maturity VIX Other indicators...

41 Conclusion We develop a fully stochastic model of systemic crisis, with two major frictions: Equity capital constraint on intermediary sector Intermediaries have substantial holdings in real assets (physical capital or housing) We find that the model not only qualitatively delivers the nonlinearity observed in the data but also quantitatively matches the differential comovements in distress and non-distress periods Recent 7/8 crisis requires a cumulative negative shock around -25% Things we are working on: more on model-based measure of systemic risk