Endogenous risk and macroprudential risk management

Standard risk management tools – whether VaR, expected shortfall or portfolio insurance methods such delta hedging – are based on partial equilibrium analyses. These assume that price processes are exogenous to agents’ behaviour.

While the partial equilibrium approximation seems reasonable when supply and demand are stable, it breaks down when economic factors shift supply or demand; in these cases, general equilibrium effects on prices may be significant. 1987’s Black Monday and September 2008 are both cited as examples of the failure of PE risk management (Shin, 2010, Risk and Liquidity, OUP). Thus, PE risk management seems to fail when it is most needed.

However, general equilibrium risk measures capable of capturing price impact remain extremely restricted due to their additional technical complications (q.v. Csóka, Herings and Kóczy, 2007, J. Banking & Finance).

This project seeks to reduce the gap between PE's tractability and GE's realism, both from the perspective of market agents and regulators.

Questions of interest to it include: when are GE effects strongest? Can intermediate classes of risk measures, combining PE’s tractability with GE’s realism, be developed? What does macroprudential regulation look like (q.v. Hanson, Kashyap and Stein, 2011, JEP)? Can GE considerations improve options pricing and portfolio insurance?

Early application is advised. You are recommended to send a draft research proposal and CV to the supervisors prior to making a formal application. No applications will be considered after 0900UTC Monday 9th January 2012.