Tag: risk

Quantifying the macroeconomic impact of geopolitical risk

Julian Reynolds

Policymakers and market participants consistently cite geopolitical developments as a key risk to the global economy and financial system. But how can one quantify the potential macroeconomic effects of these developments? Applying local projections to a popular metric of geopolitical risk, I show that geopolitical risk weighs on GDP in the central case and increases the severity of adverse outcomes. This impact appears much larger in emerging market economies (EMEs) than advanced economies (AEs). Geopolitical risk also pushes up inflation in both central case and adverse outcomes, implying that macroeconomic policymakers have to trade-off stabilising output versus inflation. Finally, I show that geopolitical risk may transmit to output and inflation via trade and uncertainty channels.

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Supply chain disruptions: shocks, links, and hidden exposure

Rebecca Freeman, Richard Baldwin and Angelos Theodorakopoulos

Supply chain disruptions are routinely blamed for things ranging from elevated inflation to shortages of medical equipment in the pandemic. But how should exposure to foreign supply chains be measured? Using a global input-output database, this post shows that the full exposure of US manufacturing to foreign suppliers (especially China) is much larger than face value measures indicate. Moreover, it argues that the big change in supply chain disruptions in recent years stems from changes in the nature of the shocks (from idiosyncratic to systemic), not the nature of the supply chains.

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Capitalising climate risks: what are we weighting for?

David Swallow and Chris Faint

Policymakers have been investing heavily, to an accelerated timeline, to better understand the financial risks from climate change and to ensure that the financial system is resilient to those risks. Against that background, some commentators have observed that the most carbon-intensive sectors may be subject to the greatest increase in transition risk. They argue that these risks are not currently included within risk weights in the banking prudential framework and that regulators should adjust the framework to include them. Conceptually, this argument sounds credible – so how might UK regulators approach whether to adjust the risk-weighted asset (RWA) framework to include potential increases in risks? This post updates on some of the latest thinking to help answer this question.

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The leverage ratio: a balance between risk and safety

Jonathan Smith

What was the root cause of the financial crisis? Ask any economist or banker and undoubtedly they will at some point mention leverage (see e.g. here, here and here). Yet when a capital requirement based on leverage — the leverage ratio requirement — was introduced, fierce criticism followed (see e.g. here and here). Drawing on the insights from a working paper, and thinking about the main criticism — that a leverage ratio requirement could cause excessive risk-taking — this seems not to have been the case.

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Bitesize: Premium Delirium II

Nicholas Vause

In a recent post, my co-author and I showed some charts suggesting that investors have been accepting less compensation for bearing credit risk. This type of risk can be very costly when it materialises, but the probability of that happening is typically very low. A similar risk is inherent in deeply out-of-the-money options. Here too, investors seem to be accepting less compensation for risk.

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Rational and Behavioural Drivers of Financial Markets: the case of ‘search for yield’

Silvia Pepino.

Rational and behavioural factors can coexist in financial markets. The ‘search for yield’ (or ‘reach for yield’) observed in financial markets in recent years is a striking manifestation of the interaction of rational and behavioural factors. During an extended period of low interest rates and volatility, market participants have displayed a tendency to seek higher returns by investing in securities that carry higher credit, liquidity or duration risk. This tendency to search for yield appears to have been motivated by a mix of rational fundamental considerations, business and regulatory constraints, and behavioural biases.

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