Academic literature on the topic 'The default price'

We derive analytical formulas for European call and put options on underlying assets that are exposed to double defaults risks which include exogenous counterparty default risk and endogenous default risk. The endogenous default risk leads the asset price to drop to zero and the exogenous counterparty default risk induces a drop in the asset price, but the asset can still be traded after this default time. A novel technique is developed to evaluate the European call and put options by first conditioning on the predefault and the postdefault time and then obtaining the unconditional analytic formulas for their price. We also compare the pricing results of our model with default-free option model and counterparty default risk option model.

In the present paper, we derive analytical formulas for barrier and lookback options with underlying assets exposed to multiple defaults risks which include exogenous counterparty default risk and endogenous default risk. The endogenous default risk leads the asset price drop to zero and the exogenous counterparty default risk induces a drop in the asset price, but the asset can still be traded after this default time. An original technique is developed to valuate the barrier and lookback options by first conditioning on the predefault and the afterdefault time and then obtaining the unconditional analytic formulas for their price. We also compare the pricing results of our model with the default-free option model and exogenous counterparty default risk option model.

The modeling of credit events is in effect the modeling of the times to default of various names. The distribution of individual times to default can be calibrated from CDS quotes, but for more complicated instruments, such as CDOs, the joint law is needed. Industry practice is to model this correlation using a copula/base correlation approach, which suffers significant deficiencies. We present a new approach to default correlation modeling, where defaults of different names are driven by a common continuous-time Markov process. Individual default probabilities and default correlations can be calculated in closed form. We provide semi-analytic formulas for the pricing of CDO tranches via Laplace-transform techniques which are both fast and easy to implement. The model calibrates to quoted tranche prices with a high degree of precision and allows one to price non-standard tranches in a consistent and arbitrage-free manner. The number of parameters of the model is flexible and can be adjusted to adapt to the set of market data one is calibrating to. More importantly, the model is dynamically consistent and can be used to price options on tranches and other exotic path-dependent products.

This paper presents a continuous‐time model of sovereign debt. In it, a relatively impatient sovereign government's hidden type switches back and forth between a commitment type, which cannot default, and an opportunistic type, which can, and where we assume outside lenders have particular beliefs regarding how a commitment type should borrow for any given level of debt and bond price. In any Markov equilibrium, the opportunistic type mimics the commitment type when borrowing, revealing its type only by defaulting on its debt at random times. The equilibrium features a “graduation date”: a finite amount of time since the last default, after which time reputation reaches its highest level and is unaffected by not defaulting. Before such date, not defaulting always increases the country's reputation. For countries that have recently defaulted, bond prices and the total amount of debt are increasing functions of the amount of time since the country's last default. For countries that have not recently defaulted (i.e., those that have graduated), bond prices are constant.

Default correlation is the key point for the pricing of multi-name credit derivatives. In this paper, we apply copulas to characterize the dependence structure of defaults, determine the joint default distribution, and give the price for a specific kind of multi-name credit derivative — collateralized debt obligation (CDO). We also analyze two important factors influencing the pricing of multi-name credit derivatives, recovery rates and copula function. Finally, we apply Clayton copula, in a numerical example, to simulate default times taking specific underlying recovery rates and average recovery rates, then price the tranches of a given CDO and then analyze the results.

Financial institutions form multilayer networks by engaging in contracts with each other and by holding exposures to common assets. As a result, the default probability of one institution depends on the default probability of all of the other institutions in the network. Here, we show how small errors on the knowledge of the network of contracts can lead to large errors in the probability of systemic defaults. From the point of view of financial regulators, our findings show that the complexity of financial networks may decrease the ability to mitigate systemic risk, and thus it may increase the social cost of financial crises.

This research examines the impact of defaults on product choice in sequential-decision settings. Whereas prior research has shown that a default can affect what consumers purchase by promoting choice of the preselected option, the influence of defaults is more nuanced when consumers make a series of related choices. In such a setting, consumer preferences may evolve across choices due to “spillover” effects from one choice to subsequent choices. The authors hypothesize that defaults systematically attenuate choice spillover effects because accepting a default is a more passive process than either choosing a nondefault option in the presence of a default or making a choice in the absence of a default. Three experiments and a field study provide compelling evidence for such default-induced changes in choice spillover effects. The findings show that firms’ setting of high-price defaults with the aim of influencing consumers to choose more expensive products can backfire through the attenuation of spillover. In addition to advancing the understanding of the interplay between defaults and preference dynamics, insights from this research have important practical implications for firms applying defaults in sequential choices.

This paper presents a numerical procedure for pricing collateralized bond obligations (CBO) and analyze the impact of default correlations for the prices of collateralized bond obligations. Specifically, we adopt default correlation model of Zhou (2001) and first passage time model of Black and Cox (1976). The model of Black and Cox is used for estimating the value of the firm and the volatility of the firm value which are unobservable variables. We find that the impact of default correlations on the prices of collateralized bond obligations is generally quite large. This can be tested by carrying out Monte-Carlo simulations for firm value processes, assuming first no default correlations and second modeling default correlations between the processes. We also compare the model prices and recently issued CBO market price and find that no default correlation model over prices the issued CBO and default correlation model under prices the issued CBO. These results in this paper emphasize that modeling default correlations is very important in analyzing CBO and a more complicated further analysis is required.

In this paper, we propose a Markov chain model to price basket credit default swap (BCDS) and basket credit-linked note (BCLN) with counterparty and contagion risks. Suppose that the default intensity processes of reference entities and the counterparty are driven by a common external shock as well as defaults of other names in the contracts. The stochastic intensity of the external shock is a Cox process with jumps. We derive recursive formulas for the joint distribution of default times and obtain closed-form premium rates for BCDS and BCLN. Numerical experiments are performed to show how the correlated default risks may affect the premium rates.

We derive a partial integro differential equation (PIDE) which relates the price of a calendar spread to the prices of butterfly spreads and the functions describing the evolution of the process. These evolution functions are the forward local variance rate and a new concept called the forward local default arrival rate. We then specialize to the case where the only jump which can occur reduces the underlying stock price by a fixed fraction of its pre-jump value. This is a standard assumption when valuing an option written on a stock which can default. We discuss novel strategies for calibrating to a term and strike structure of European options prices. In particular using a few calendar dates, we derive closed form expressions for both the local variance and the local default arrival rate.

Many risk factors exist in the commodity markets, especially those related to price and quantity. Recently, the risk of counterparty default has been increasing. The purpose of this study is to develop a portfolio-hedging model to hedge both price and default risks using exchange traded commodity futures and option contracts. Two approaches are taken to determine the optimal hedge ratios (HR) using futures and options: an analytical approach that mathematically derives closed-form mean-variance (E-V) maximizing solutions, and an empirical approach that uses stochastic optimization and Monte Carlo simulation under mean-value-at-risk (E-VaR) framework. Based on the analytical approach, we proved that utility-maximizing solutions exists. The empirical approach suggests that na?ve HR (HR of one) leads to a suboptimal result. The minimum-variance, E-V, and minimum VaR objective functions generated the same optimization results. Additionally, a copula is applied instead of a linear correlation, and resulted a higher put option HR.

Credit derivatives are very popular on financial markets in recent days.

The most liquid credit derivative is a credit default swap (CDS). In

this research we investigate methods for modeling and monitoring of the

price process of CDS. We study Hull and White model to calculate CDS

spread and have data for our analysis. We consider different methods for

monitoring of the price process of CDS. In particular we study CUSUM

method. And we calculate more commonly used perfomance measures

for this method.

This paper seeks to fill a gap in the literature regarding the consequences of banning ‘naked’ Credit Default Swaps (CDS). In particular, I use the European Union’s Ban on ‘naked” Sovereign CDS as an event study to evaluate the impact that banning such derivative products has on the price discovery process in the credit markets. Using both Granger Causality tests and a Vector Error Correction Model, I find that before November 1, 2012, CDS are the clear price leader in the credit markets. However, since the official date the regulation was put into effect, CDS’ price leadership was eroded. Moreover, after the ban, CDS and Bond Yield Spreads are no longer cointegrated in the long run, suggesting that different pricing mechanisms now exist between the two securities

This thesis comprises three empirical studies regarding information content of credit default swap (CDS). The first study provides further evidence of credit risk discovery between CDS and stock of the U.S. non-financial firms. Stock generally leads CDS in discovering credit risk information, with the exception of the stressful financial crisis period of 2008–2010. The CDS of investment-grade firms generally possesses higher informational efficiency than that of speculative-grade firms. High funding cost and central clearing counterparty hinder CDS from rapidly incorporating credit risk news. The second study investigates dynamics and determinates of credit risk transmission across the global systemically important financial institutions (G-SIFIs). The aggregate credit risk transmission across G-SIFIs dramatically increases from mid-2006 to mid-2008 and then fluctuates around 90% until 2014. Global systemically important banks (G-SIBs) and the U.S.–based G-SIFIs are major credit risk providers. More interbank loans, more non-banking income, higher extra loss absorbency requirement, and lower Tier 1 leverage ratio are positively related to a G-SIB’s role in credit risk transmission. Global systemically important insurers (G-SIIs) which have more non-traditional non-insurance activities, larger sizes, and more global sales tend to be credit risk senders. The final study examines the impact of sovereign credit rating and bailout events on sovereign CDS and equity index, especially their contemporaneous correlation, in the U.S., the U.K., and the Eurozone countries. The two assets are less negatively correlated at the arrivals of domestic rating events or surprises. Good and bad rating events present asymmetric effects on the asset correlation in Portugal, Netherlands, Ireland, Finland, and the U.S., while their symmetric effects are found in Spain, Italy, and Cyprus. Two assets become more negatively correlated on the announcement days of major bailouts. Bailout events have a stronger impact than domestic rating events. Greek rating news exerts spillover effect and generally has positive impact on the asset correlation in other economies.

This paper seeks to investigate the reaction of credit ratings and credit markets in response to accounting restatements. Accounting restatements can often be perceived as a precursor to fraudulent activity, which could lead to a more negative credit rating, or a heightened credit default swap (CDS) price. CDS prove to be a useful measuring tool as they adjust to changes relatively quickly; much more quickly than the assessment of a credit rating agency. My results suggest that restatements do indeed have an effect on credit rating. It does, however take longer for credit ratings to be updated after the restatement, but CDS quotes move faster and are just as, if not more accurate. I also find that credit default swaps do not anticipate restatements, showing that while the credit markets are beating the rating agencies, they do not appear to be beating the accountants.

Thesis advisor: Utku Unver
This dissertation consists of three essays in microeconomic theory: two focusing on insurance theory and one on matching theory. The first chapter is concerned with catastrophe insurance. Motivated by the aftermath of hurricane Katrina, it studies a strategic model of catastrophe insurance in which consumers know that they may not get reimbursed if too many other people file claims at the same time. The model predicts that the demand for catastrophe insurance can ``bend backwards'' to zero, resulting in multiple equilibria and especially in market failure, which is always an equilibrium. This shows that a catastrophe market can fail entirely due to demand-driven reasons, a result new to the literature. The model suggests that pricing is key for the credibility of catastrophe insurers: instead of increasing demand, price cuts may backfire and instead cause a ``race to the bottom.'' However, small amounts of extra liquidity can restore the system to stable equilibrium, highlighting the importance of a functioning reinsurance market for large risks. These results remain robust both for expected utility consumer preferences and for expected utility's most popular alternative, rank-dependent expected utility. The second chapter develops a model of quality differentiation in insurance markets, focusing on two of their specific features: the fact that costs are uncertain, and the fact that firms are averse to risk. Cornerstone models of price competition predict that firms specialize in products of different quality (differentiate their products) as a way of softening price competition. However, real-world insurance markets feature very little differentiation. This chapter offers an explanation to this phenomenon by showing that cost uncertainty fundamentally alters the nature of price competition among risk-averse firms by creating a drive against differentiation. This force becomes particularly pronounced when consumers are picky about quality, and is capable of reversing standard results, leading to minimum differentiation instead. The chapter concludes with a study of how the costs of quality affect differentiation by considering two benchmark cases: when quality is costless and when quality costs are convex (quadratic). The third chapter focuses on the theory of two-sided matching. Its main topic are inefficiencies that arise when agent preferences permit indifferences. It is well-known that two-sided matching under weak preferences can result in matchings that are stable, but not Pareto efficient, which creates bad incentives for inefficiently matched agents to stay together. In this chapter I show that in one-to-one matching with weak preferences, the fraction of inefficiently matched agents decreases with market size if agents are sufficiently diverse; in particular, the proportion of agents who can Pareto improve in a randomly chosen stable matching approaches zero when the number of agents goes to infinity. This result shows that the relative degree of the inefficiency vanishes in sufficiently large markets, but this does not provide a "cure-all'' solution in absolute terms, because inefficient individuals remain even when their fraction is vanishing. Agent diversity is represented by the diversity of each person's preferences, which are assumed randomly drawn, i.i.d. from the set of all possible weak preferences. To demonstrate its main result, the chapter relies on the combinatorial properties of random weak preferences
Thesis (PhD) — Boston College, 2012
Submitted to: Boston College. Graduate School of Arts and Sciences
Discipline: Economics

In this paper dependence between credit default swap (CDS) values and stock price movements of the largest European banking groups is examined and effectiveness of the usage of CDS contracts as a tool to hedge exposure to the price movements of the underlying stock during the pre-crisis and crisis periods is assessed. The effectiveness is evaluated by comparing estimated Value-at-Risk (VaR) and Expected Shortfall (ES) risk measures of portfolios consisting of stocks and CDS vis-à-vis portfolios consisting of only stocks. CDS are valued using mark-to-market approach. Marginal distributions of CDS value changes and stock returns are estimated using Kernel density estimate from historical time-series data of daily stock returns and CDS value changes. Dependence between marginal distributions is estimated using Gaussian, Gumbel and Student‟s t copulas. Random portfolio values are simulated using Monte Carlo Simulation from estimated copulas parameters and marginal distributions for daily, quarterly and yearly time horizons. VaR and ES with 90%, 95% and 99% confidence level are estimated from the simulated portfolio return distribution. The results show that there is a significant negative dependence between CDS values and stock prices during financial crisis while dependence is weak in the pre-crisis period. The main finding of the paper is that CDS added into the portfolio of stocks significantly reduces VaR and ES of a portfolio during the period of financial crisis while they... [to full text]
Šiame darbe tikrinama didţiausių Europos bankų grupių kredito rizikos apsikeitimo sandorių (CDS) ir akcijų kainų priklausomybė bei vertinamas CDS efektyvumas, jei jais draudţiamasi nuo akcijų kainų svyravimų prieš kriziniu ir kriziniu laikotarpiu. Efektyvumas yra įvertinamas lyginant apskaičiuotas rizikos vertes (VaR) ir tikėtinus vertės trūkumus (ES) dviejų portfelių: akcijų portfelio bei akcijų ir CDS portfelio. CDS vertinti yra naudojamas pagal rinką vertinimo būdas (mark-to-market approach). CDS verčių pasikeitimo ir akcijų grąţos ribiniai pasiskirstymai yra įvertinami, naudojant Kernel įvertinimą (Kernel Estimator) iš istorinių akcijų grąţų ir CDS verčių pokyčių duomenų. Priklausomybė tarp ribinių pasiskirstymų yra įvertinama naudojant Gauso, Gumbelio ir Studento t kopulas (copulas). Atsitiktinės portfelių vertės yra susimuliuojamos naudojant Monte Carlo simuliaciją, pritaikant kopulų parametrus bei kintamųjų ribinius pasiskirstymus vienos dienos, ketvirčio bei metų periodams. VaR ir ES su 90%, 95% ir 99% pasitikėjimo intervalais yra skaičiuojami iš susimuliuotų portfelio grąţų pasiskirstymo. Gauti rezultatai rodo, kad tarp akcijų kainų ir CDS verčių yra stipri priklausomybė krizės laikotarpiu, tuo tarpu prieš kriziniu laikotarpiu priklausomybė yra silpna. Pagrindinė darbo išvada yra ta, jog CDS įtraukti į akcijų portfelį reikšmingai sumaţina portfelio VaR ir ES kriziniu laikotarpiu, tačiau nesumaţina prieš kriziniu laikotarpiu. Portfelio rizika gali būti sumaţinta, jei... [toliau žr. visą tekstą]

Most farmers in South Africa use standard insurance to protect their crops against natural disasters such as hail or strong winds. However, no South African insurance contracts exist to compensate for too much or too little rain (although floods are covered), or which will pay out if temperatures were too high or too low for a certain period of time for the relevant crop. Weather derivatives - which farmers may employ to ensure crops against adverse temperatures - do exist, but these are mostly available in foreign markets in the form of Heating Degree Days contracts and Cooling Degree Day contracts and are used chiefly by energy companies. Some South African over-the-counter weather derivatives are available, but trading in these is rare and seldom used. The goal of this dissertation is to establish a pricing equation for weather derivatives specifically for use in the South African market. This equation will be derived using a similar methodology to that employed for credit default swaps. The premium derived will be designed to compensate grape farmers from losses arising from two different climatic outcomes - in this case temperature and precipitation. These derivatives will be region and crop specific and the formulation will be sufficiently flexible as to allow for further climatic possibilities (which may be added at a later stage). These weather derivative premiums will then be compared to standard crop insurance to establish economic viability of the products and recommendations will be made regarding their usage. The possibility of the simultaneous use of these derivatives and standard crop insurance for optimal crop coverage will also be explored and discussed.
Thesis (M.Com. (Risk management))--North-West University, Potchefstroom Campus, 2011.

Mestrado em Matemática Financeira
In this thesis we assess the real default probabilities of three groups of European sovereigns - peripheral, central and safe haven - in order to get a forward looking measure of the market sentiment about their default, as well as their evolution within the current European crisis. We follow Moody's CDS-implied EDF Credit Measures and Fair-Value Spreads methodology by extracting risk-neutral probabilities of default, assumed to be Weibull distributed, from CDS spreads and convert them into real probabilities of default, using an adaptation of the Merton model to remove the risk premium. We use CDS spreads data from 2008 to 2011 and country dependent market prices of risk as proxy for the risk premium based on the equity benchmark indices of each country. The obtained real default probabilities proved to be a suitable indicator to predict defaults according to the credit events. They have increased severely since 2009/2010, in particular for the peripheral economies - Greece, Ireland and Portugal. The Greece's 1-year probability of default reached 55% at the end of 2011 and a default took place in March 2012. These three countries had to request a bailout from the EU/IMF authorities, Greece and Ireland in 2010 and Portugal in April 2011. Spain and Italy, the central economies, have been a concern for investors, which is reected in their real probabilities of default that increased substantially during the second half of 2011. The safe haven sovereigns - Germany and France - were also not immune to the economic slowdown in Eurozone and its GDP started to shrink, however, the rise in the default probabilities was more limited.
Nesta tese apresentamos as probabilidades de incumprimento objectivas de três grupos de soberanos Europeus - periféricos, centrais e seguros - com o objectivo de captar antecipadamente o sentimento de mercado acerca dos mesmos, bem como analisar a evolução dessas probabilidades no contexto de crise europeia. Foi seguida a metodologia descrita em CDS-implied EDF Credit Measures and Fair-Value Spreads da Moody's, extraindo as probabilidades de incumprimento risco-neutrais, que se assume seguirem a distribuição Weibull, a partir dos preços dos CDS e convertendo-as em probabilidades de incumprimento objectivas, usando uma adaptação do modelo de Merton para expurgar o prémio de risco. Foram usados os preços dos CDS de 2008 a 2011 e os índices de Sharpe, variáveis com o país como proxy para o prémio de risco, baseados nos índices accionistas de referência de cada país. As probabilidades de incumprimento objectivas obtidas parecem ser indicadas para prever os incumprimentos de acordo com os acontecimentos reais. As probabilidades têm aumentado drasticamente desde 2009/2010, especialmente para os países periféricos - Grécia, Irlanda e Portugal. A probabilidade de incumprimento a um ano da Grécia era de 55% no final de 2011 e o incumprimento ocorreu efectivamente em Março de 2012. Estes três países tiveram de recorrer à ajuda financeira das autoridades União Europeia e do Fundo Monetário Internacional, a Grécia e a Irlanda em 2010 e Portugal em Abril de 2011. Espanha e Itália, as economias centrais, têm sido uma preocupação para os investidores, reflectida no aumento substancial das probabilidades de incumprimento no segundo semestre de 2011. Os soberanos seguros - Alemanha e França - também não ficaram imunes ao abrandamento económico na zona Euro e o seu PIB diminuiu, no entanto, o aumento das suas probabilidades de incumprimento foi mais limitado.

This thesis contributes to the strand of the financial literature on credit derivatives, in particular the credit default swaps (CDS) market. We present four inter-connected studies addressing CDS market efficiency, price discovery, informed trading and the systemic nature of the CDS market. The first study explores a specific channel through which informed traders express their views on the CDS market: mergers and acquisitions (M&A) and divestitures activities. We show that information obtained by major banks while providing these investment services is impounded by CDS rates prior to the operation announcement. The run-up to M&A announcements is characterized by greater predictability of stock returns using past CDS spread data. The second study evaluates the incremental information value of CDS open interest relative to CDS spreads using a large panel database of obligors. We find that open interest helps predict CDS rate changes and stock returns. Positive open interest growth precedes the announcement of negative earnings surprises, consistent with the notion that its predictive ability is linked to the disclosure of material information. The third study measures the impact on CDS market quality of the ban on uncovered sovereign CDS buying imposed by the European Union. Using panel data models and a difference-in-differences analysis, we find that the ban helped stabilize CDS market volatility, but was in general detrimental to overall market quality. Lastly, we investigate the determinants of open interest dynamics to uncover the channels through which CDS may endanger the financial system. Although we find information asymmetry and divergence of opinions on firms’ future performance as relevant drivers of open interest, our results indicate that systematic factors play a much greater influence. The growth of open interest for different obligors co-varies in time and is pro-cyclical. Funding costs and counterparty risk also reduce dealers’ willingness to incur inventory risk; Eficiência dos mercados de Credit Default Swaps Resumo: Esta tese investiga o mercado de derivados de crédito, e em particular o mercado de credit default swaps (CDS). São apresentados quatro estudos interligados abordando temáticas relacionadas com a eficiência informacional, a existência de negociação informada no mercado de CDS, e a natureza sistémica daquele mercado. O primeiro estudo analisa a existência de negociação informada no mercado de CDS antes de operações de aquisição, fusões ou venda de ativos relevantes. A nossa análise mostra uma reação dos prémios de CDS antes do anúncio daqueles eventos, sendo em alguns casos mais imediata do que a reação dos mercados acionistas. O segundo estudo avalia o conteúdo informativo das posições em aberto no mercado de CDS utilizando dados em painel de diferentes empresas ao longo do tempo. Os resultados indiciam que as posições em aberto podem ajudar a prever variações futuras dos prémios de CDS e retornos acionistas. Em acréscimo, verifica-se um aumento estatisticamente significativo das posições em aberto antes da divulgação de surpresas negativas nos resultados das empresas. O terceiro estudo mede os efeitos da proibição de posições longas em CDS sobre entidades soberanas pertencentes ao Espaço Único Europeu sem a detenção do ativo subjacente pelo comprador. A análise mostra um efeito negativo da proibição sobre a qualidade do mercado, pese embora se tenha assistido em simultâneo à redução da volatilidade. Por fim, são analisados os determinantes dos montantes associados a posições em aberto, com o intuito de compreender como o mercado de CDS pode influenciar o risco sistémico. Os resultados indicam que a assimetria de informação e a divergência de opiniões dos investidores influenciam aqueles montantes. Todavia, fatores sistemáticos como risco de contraparte, aversão ao risco e risco de re-financiamento parecem ser ainda mais relevantes por via do efeito que exercem no risco do balanço dos intermediários financeiros.

This chapter analyzes the growth of OTC derivatives before the global financial crisis of 2008 and the role of credit default swaps, in particular, in the near collapse of the global economy. It begins by exploring the basic characteristics of derivatives used as risk management instruments by investors to hedge against or exploit the volatility of asset prices. The analysis further reveals that the pre-crisis period was characterized by a broad-based consensus favoring deregulated markets and globally designed private rules. While not always unanimously supported, permissive public regulatory choices were often encouraged by interest group lobbying, the market-friendly views of many domestic authorities, and concerns about regulatory uncertainty and international competitiveness.

AbstractIn this chapter, the central bank is put aside and we review simple models of financial instability, which will be the basis for the subsequent chapter to explain the role of the central bank as lender of last resort. We first recall that financial instability is mostly triggered by a negative shock on asset prices, and thereby on the solvency of debtors, which in turn worsens access to credit and can set in motion a liquidity crisis with vicious circles. We develop the concepts of solvency “conditional” and “unconditional” on liquidity: a decline in asset prices can lead an unconditionally solvent debtor to become only conditionally solvent, such that sufficient liquidity becomes decisive for preventing its default. We then apply these concepts to the stability of bank funding and introduce the problem of bank runs. We subsequently show why asset liquidity in a dealer market deteriorates during a financial crisis (increased volatility and uncertainty increase the required bid-ask spread); how asymmetric information can lead to a freeze of credit markets in a simple adverse selection model; how declining and more volatile asset prices drive increases of haircut, and how these can force fire sales and defaults of borrowers. We finally discuss the interaction between these various crisis channels.

This chapter presents a case study that investigates the pricing of key contract provisions in Puerto Rican debt. It contributes to a body of research that asks whether investors price contract provisions and, if so, whether the pricing varies with credit risk. Contract provisions across different types of Puerto Rican bonds contain multiple sources of variation. Specifically, the chapter examines investor pricing of three key legal provisions of Puerto Rican debt; general obligation debt versus the secured bonds issued by the Puerto Rico Sales Tax Financing Corporation; debt issued under New York law versus Puerto Rican law; and finally impact of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) which retroactively enacted collective action clauses for Puerto Rican debt. In each instance, we find evidence consistent with the hypothesis that investors value specific contract provisions and legal protections and more so when credit risk is high, and restructuring becomes likely.

This chapter discusses the report of the Wall Street Journal about Stuyvesant Town, one of the biggest, most high-profile deals of the commercial real-estate boom, being in danger of imminent default. It explains how Tishman Speyer was stuck at $139 million rather than raising the net operating income up to $252 million by 2009, which MetLife had promised could be done. It also mentions RealPoint LLC, a credit-rating agency that estimated the property to only be worth $2.1 billion — less than half the purchase price from the time it has been purchased in 2006. The chapter focuses on the impacts of the recession to Tishman Speyer and all owners of real-estate, which had been precipitated by a collapse in the inflated housing market. It refers to apartment prices in Manhattan that had fallen sharply as 2009 wore on and prices that went down by 25 percent compared to 2008.

This chapter focuses on uncooperative supply chain inventory models when a supplier offers a credit period to the retailer for a fixed period of time. The models are studied with trade credit in Nash game and Supplier-Stackelberg game respectively. First, the authors have presented optimal results for centralized and decentralized decisions with selling price dependent demand and without trade credit. Second, the authors have obtained optimal results under the two games using classical optimization. The total joint profit of the supply chain is maximized with respect to initial lot size, selling price, and trade credit period. Numerical examples are provided to authenticate the proposed model and to provide some managerial insights. Also through sensitivity analysis, important model parameters are examined.

In the United States, concentrating solar power (CSP) is one of the most promising renewable energy (RE) technologies for reduction of electric sector greenhouse gas (GHG) emissions and for rapid capacity expansion. It is also one of the most price-competitive RE technologies, thanks in large measure to decades of field experience and consistent improvements in design. One of the key design features that makes CSP more attractive than many other RE technologies, like solar photovoltaics and wind, is the potential for including relatively low-cost and efficient thermal energy storage (TES), which can smooth the daily fluctuation of electricity production and extend its duration into the evening peak hours or longer. Because operational environmental burdens are typically small for RE technologies, life cycle assessment (LCA) is recognized as the most appropriate analytical approach for determining their environmental impacts of these technologies, including CSP. An LCA accounts for impacts from all stages in the development, operation, and decommissioning of a CSP plant, including such upstream stages as the extraction of raw materials used in system components, manufacturing of those components, and construction of the plant. The National Renewable Energy Laboratory (NREL) is undertaking an LCA of modern CSP plants, starting with those of parabolic trough design. Our LCA follows the guidelines described in the international standard series ISO 14040-44 [1]. To support this effort, we are comparing the life-cycle environmental impacts of two TES designs: two-tank, indirect molten salt and indirect thermocline. To put the environmental burden of the TES system in perspective, one recent LCA that considered a two-tank, indirect molten salt TES system on a parabolic trough CSP plant found that the TES component can account for approximately 40% of the plant’s non-operational GHG emissions [2]. As emissions associated with plant construction, operation and decommissioning are generally small for RE technologies, this analysis focuses on estimating the emissions embodied in the production of the materials used in the TES system. A CSP plant that utilizes an indirect, molten salt, TES system transfers heat from the solar field’s heat transfer fluid (HTF) to the binary molten salts of the TES system via several heat exchangers. The “cold tank” receives the heat from the solar field HTF and conveys it to the “hot tank” via another series of heat exchangers. The hot tank stores the thermal energy for power generation later in the day. A thermocline TES system is a potentially attractive alternative because it replaces the hot and cold tanks with a thermal gradient within a single tank that significantly reduces the quantity of materials required for the same amount of thermal storage. An additional advantage is that the thermocline design can replace much of the expensive molten salt with a low-cost quartzite rock or sand filler material. This LCA is based on a detailed cost specification for a 50 MWe CSP plant with six hours of molten salt thermal storage, which utilizes an indirect, two-tank configuration [3]. This cost specification, and subsequent conversations with the author, revealed enough information to estimate weights of materials (reinforcing steel, concrete, etc.) used in all components of the specified two-tank TES system. To estimate embodied GHG emissions per kilogram of each material, two life cycle inventory (LCI) databases were consulted: EcoInvent v2.0 [4], which requires materials mass data as input, and the US Economic Input-Output LCA database [5], which requires cost data as input. IPCC default global warming potentials (GWPs) give the greenhouse potential of each gas relative to that of carbon dioxide [6]. Where certain materials specified in Kelly [3] were not available in the LCI databases, the closest available proxy for those materials was selected based on such factors as peak process temperature, and similar input materials and process technology. The thermocline system was modeled using the two-tank system design as the foundation, from which materials were subtracted or substituted based on the differences and similarities of design [7]. Table 1 summarizes the results of our evaluation. Embodied emissions of GHGs from the materials used in the 6-hour, 50 MWe two-tank system are estimated to be 17,100 MTCO2e. Analogous emissions for the thermocline system are less than half of those for the two-tank: 7890 MTCO2e. The reduction of salt inventory associated with a thermocline design thus reduces both storage cost and life cycle greenhouse gas emissions. While construction-, operation- and decommissioning-related emissions are not included in this assessment, we do not expect any differences between the two system designs to significantly affect the relative results reported here. Sensitivity analysis on choices of proxy materials for the nitrate salts and calcium silicate insulation also do not significantly affect the relative results.

The Texas Interactive Power Simulator (TIPS) is an interactive analytical tool developed at the University of Texas at Austin for quantitatively comparing the first-order economic and environmental tradeoffs of different electricity production methods in Texas. The tool is designed for analysis of different power choices and is presented in an online format for use by students, the general public, and government decision-makers. The core electricity industry data are Texas-specific, but the flexibility of the framework, when combined with user supplied content, extends its applicability to the United States and world electricity markets. TIPS provides a method for assessing the tradeoffs of electricity generation technologies in terms of economic costs and environmental impacts. Economic costs include major factors such as the cost of capacity, fuel, operation and maintenance (O&M), as well as the costs of conservation programs and environmental impact mitigation technology. Environmental impacts include market externalities such as the environmental impacts on air, land, and water, and are normalized per kWh generated (for example, pounds of CO2 or NOx, acres of land, or gallons of cooling water consumed per kWh of generated electricity). Environmental impacts can further be associated with a cost, which is included in the overall levelized cost of electricity. Users can supply their own data for interactive experimentation, though peer-reviewed data are provided as default values. TIPS’ outputs include text, graphs, and pictograms showing the electricity output and environmental impact of the user’s selections, which allow the user to interpret the overall impact for different fuel mixes. Source data are incorporated from government sources and peer reviewed technical literature. The TIPS interactive interface allows the user to analyze a desired electricity mix according to the percentage breakdown of electricity production for each generation technology. The user input determines the overall direct and indirect costs of a unit of electricity according to the particular cost parameters associated with each generation technology. This manuscript discusses the methodology used in TIPS calculation and shares the results of using TIPS to analyze the cost and environmental impacts for a variety of illustrative and possible generation scenarios in Texas, including the following: high carbon prices, nuclear renaissance, and continuing wind market growth.

1.1 Macroeconomic summary Economic recovery has consistently outperformed the technical staff’s expectations following a steep decline in activity in the second quarter of 2020. At the same time, total and core inflation rates have fallen and remain at low levels, suggesting that a significant element of the reactivation of Colombia’s economy has been related to recovery in potential GDP. This would support the technical staff’s diagnosis of weak aggregate demand and ample excess capacity. The most recently available data on 2020 growth suggests a contraction in economic activity of 6.8%, lower than estimates from January’s Monetary Policy Report (-7.2%). High-frequency indicators suggest that economic performance was significantly more dynamic than expected in January, despite mobility restrictions and quarantine measures. This has also come amid declines in total and core inflation, the latter of which was below January projections if controlling for certain relative price changes. This suggests that the unexpected strength of recent growth contains elements of demand, and that excess capacity, while significant, could be lower than previously estimated. Nevertheless, uncertainty over the measurement of excess capacity continues to be unusually high and marked both by variations in the way different economic sectors and spending components have been affected by the pandemic, and by uneven price behavior. The size of excess capacity, and in particular the evolution of the pandemic in forthcoming quarters, constitute substantial risks to the macroeconomic forecast presented in this report. Despite the unexpected strength of the recovery, the technical staff continues to project ample excess capacity that is expected to remain on the forecast horizon, alongside core inflation that will likely remain below the target. Domestic demand remains below 2019 levels amid unusually significant uncertainty over the size of excess capacity in the economy. High national unemployment (14.6% for February 2021) reflects a loose labor market, while observed total and core inflation continue to be below 2%. Inflationary pressures from the exchange rate are expected to continue to be low, with relatively little pass-through on inflation. This would be compatible with a negative output gap. Excess productive capacity and the expectation of core inflation below the 3% target on the forecast horizon provide a basis for an expansive monetary policy posture. The technical staff’s assessment of certain shocks and their expected effects on the economy, as well as the presence of several sources of uncertainty and related assumptions about their potential macroeconomic impacts, remain a feature of this report. The coronavirus pandemic, in particular, continues to affect the public health environment, and the reopening of Colombia’s economy remains incomplete. The technical staff’s assessment is that the COVID-19 shock has affected both aggregate demand and supply, but that the impact on demand has been deeper and more persistent. Given this persistence, the central forecast accounts for a gradual tightening of the output gap in the absence of new waves of contagion, and as vaccination campaigns progress. The central forecast continues to include an expected increase of total and core inflation rates in the second quarter of 2021, alongside the lapse of the temporary price relief measures put in place in 2020. Additional COVID-19 outbreaks (of uncertain duration and intensity) represent a significant risk factor that could affect these projections. Additionally, the forecast continues to include an upward trend in sovereign risk premiums, reflected by higher levels of public debt that in the wake of the pandemic are likely to persist on the forecast horizon, even in the context of a fiscal adjustment. At the same time, the projection accounts for the shortterm effects on private domestic demand from a fiscal adjustment along the lines of the one currently being proposed by the national government. This would be compatible with a gradual recovery of private domestic demand in 2022. The size and characteristics of the fiscal adjustment that is ultimately implemented, as well as the corresponding market response, represent another source of forecast uncertainty. Newly available information offers evidence of the potential for significant changes to the macroeconomic scenario, though without altering the general diagnosis described above. The most recent data on inflation, growth, fiscal policy, and international financial conditions suggests a more dynamic economy than previously expected. However, a third wave of the pandemic has delayed the re-opening of Colombia’s economy and brought with it a deceleration in economic activity. Detailed descriptions of these considerations and subsequent changes to the macroeconomic forecast are presented below. The expected annual decline in GDP (-0.3%) in the first quarter of 2021 appears to have been less pronounced than projected in January (-4.8%). Partial closures in January to address a second wave of COVID-19 appear to have had a less significant negative impact on the economy than previously estimated. This is reflected in figures related to mobility, energy demand, industry and retail sales, foreign trade, commercial transactions from selected banks, and the national statistics agency’s (DANE) economic tracking indicator (ISE). Output is now expected to have declined annually in the first quarter by 0.3%. Private consumption likely continued to recover, registering levels somewhat above those from the previous year, while public consumption likely increased significantly. While a recovery in investment in both housing and in other buildings and structures is expected, overall investment levels in this case likely continued to be low, and gross fixed capital formation is expected to continue to show significant annual declines. Imports likely recovered to again outpace exports, though both are expected to register significant annual declines. Economic activity that outpaced projections, an increase in oil prices and other export products, and an expected increase in public spending this year account for the upward revision to the 2021 growth forecast (from 4.6% with a range between 2% and 6% in January, to 6.0% with a range between 3% and 7% in April). As a result, the output gap is expected to be smaller and to tighten more rapidly than projected in the previous report, though it is still expected to remain in negative territory on the forecast horizon. Wide forecast intervals reflect the fact that the future evolution of the COVID-19 pandemic remains a significant source of uncertainty on these projections. The delay in the recovery of economic activity as a result of the resurgence of COVID-19 in the first quarter appears to have been less significant than projected in the January report. The central forecast scenario expects this improved performance to continue in 2021 alongside increased consumer and business confidence. Low real interest rates and an active credit supply would also support this dynamic, and the overall conditions would be expected to spur a recovery in consumption and investment. Increased growth in public spending and public works based on the national government’s spending plan (Plan Financiero del Gobierno) are other factors to consider. Additionally, an expected recovery in global demand and higher projected prices for oil and coffee would further contribute to improved external revenues and would favor investment, in particular in the oil sector. Given the above, the technical staff’s 2021 growth forecast has been revised upward from 4.6% in January (range from 2% to 6%) to 6.0% in April (range from 3% to 7%). These projections account for the potential for the third wave of COVID-19 to have a larger and more persistent effect on the economy than the previous wave, while also supposing that there will not be any additional significant waves of the pandemic and that mobility restrictions will be relaxed as a result. Economic growth in 2022 is expected to be 3%, with a range between 1% and 5%. This figure would be lower than projected in the January report (3.6% with a range between 2% and 6%), due to a higher base of comparison given the upward revision to expected GDP in 2021. This forecast also takes into account the likely effects on private demand of a fiscal adjustment of the size currently being proposed by the national government, and which would come into effect in 2022. Excess in productive capacity is now expected to be lower than estimated in January but continues to be significant and affected by high levels of uncertainty, as reflected in the wide forecast intervals. The possibility of new waves of the virus (of uncertain intensity and duration) represents a significant downward risk to projected GDP growth, and is signaled by the lower limits of the ranges provided in this report. Inflation (1.51%) and inflation excluding food and regulated items (0.94%) declined in March compared to December, continuing below the 3% target. The decline in inflation in this period was below projections, explained in large part by unanticipated increases in the costs of certain foods (3.92%) and regulated items (1.52%). An increase in international food and shipping prices, increased foreign demand for beef, and specific upward pressures on perishable food supplies appear to explain a lower-than-expected deceleration in the consumer price index (CPI) for foods. An unexpected increase in regulated items prices came amid unanticipated increases in international fuel prices, on some utilities rates, and for regulated education prices. The decline in annual inflation excluding food and regulated items between December and March was in line with projections from January, though this included downward pressure from a significant reduction in telecommunications rates due to the imminent entry of a new operator. When controlling for the effects of this relative price change, inflation excluding food and regulated items exceeds levels forecast in the previous report. Within this indicator of core inflation, the CPI for goods (1.05%) accelerated due to a reversion of the effects of the VAT-free day in November, which was largely accounted for in February, and possibly by the transmission of a recent depreciation of the peso on domestic prices for certain items (electric and household appliances). For their part, services prices decelerated and showed the lowest rate of annual growth (0.89%) among the large consumer baskets in the CPI. Within the services basket, the annual change in rental prices continued to decline, while those services that continue to experience the most significant restrictions on returning to normal operations (tourism, cinemas, nightlife, etc.) continued to register significant price declines. As previously mentioned, telephone rates also fell significantly due to increased competition in the market. Total inflation is expected to continue to be affected by ample excesses in productive capacity for the remainder of 2021 and 2022, though less so than projected in January. As a result, convergence to the inflation target is now expected to be somewhat faster than estimated in the previous report, assuming the absence of significant additional outbreaks of COVID-19. The technical staff’s year-end inflation projections for 2021 and 2022 have increased, suggesting figures around 3% due largely to variation in food and regulated items prices. The projection for inflation excluding food and regulated items also increased, but remains below 3%. Price relief measures on indirect taxes implemented in 2020 are expected to lapse in the second quarter of 2021, generating a one-off effect on prices and temporarily affecting inflation excluding food and regulated items. However, indexation to low levels of past inflation, weak demand, and ample excess productive capacity are expected to keep core inflation below the target, near 2.3% at the end of 2021 (previously 2.1%). The reversion in 2021 of the effects of some price relief measures on utility rates from 2020 should lead to an increase in the CPI for regulated items in the second half of this year. Annual price changes are now expected to be higher than estimated in the January report due to an increased expected path for fuel prices and unanticipated increases in regulated education prices. The projection for the CPI for foods has increased compared to the previous report, taking into account certain factors that were not anticipated in January (a less favorable agricultural cycle, increased pressure from international prices, and transport costs). Given the above, year-end annual inflation for 2021 and 2022 is now expected to be 3% and 2.8%, respectively, which would be above projections from January (2.3% and 2,7%). For its part, expected inflation based on analyst surveys suggests year-end inflation in 2021 and 2022 of 2.8% and 3.1%, respectively. There remains significant uncertainty surrounding the inflation forecasts included in this report due to several factors: 1) the evolution of the pandemic; 2) the difficulty in evaluating the size and persistence of excess productive capacity; 3) the timing and manner in which price relief measures will lapse; and 4) the future behavior of food prices. Projected 2021 growth in foreign demand (4.4% to 5.2%) and the supposed average oil price (USD 53 to USD 61 per Brent benchmark barrel) were both revised upward. An increase in long-term international interest rates has been reflected in a depreciation of the peso and could result in relatively tighter external financial conditions for emerging market economies, including Colombia. Average growth among Colombia’s trade partners was greater than expected in the fourth quarter of 2020. This, together with a sizable fiscal stimulus approved in the United States and the onset of a massive global vaccination campaign, largely explains the projected increase in foreign demand growth in 2021. The resilience of the goods market in the face of global crisis and an expected normalization in international trade are additional factors. These considerations and the expected continuation of a gradual reduction of mobility restrictions abroad suggest that Colombia’s trade partners could grow on average by 5.2% in 2021 and around 3.4% in 2022. The improved prospects for global economic growth have led to an increase in current and expected oil prices. Production interruptions due to a heavy winter, reduced inventories, and increased supply restrictions instituted by producing countries have also contributed to the increase. Meanwhile, market forecasts and recent Federal Reserve pronouncements suggest that the benchmark interest rate in the U.S. will remain stable for the next two years. Nevertheless, a significant increase in public spending in the country has fostered expectations for greater growth and inflation, as well as increased uncertainty over the moment in which a normalization of monetary policy might begin. This has been reflected in an increase in long-term interest rates. In this context, emerging market economies in the region, including Colombia, have registered increases in sovereign risk premiums and long-term domestic interest rates, and a depreciation of local currencies against the dollar. Recent outbreaks of COVID-19 in several of these economies; limits on vaccine supply and the slow pace of immunization campaigns in some countries; a significant increase in public debt; and tensions between the United States and China, among other factors, all add to a high level of uncertainty surrounding interest rate spreads, external financing conditions, and the future performance of risk premiums. The impact that this environment could have on the exchange rate and on domestic financing conditions represent risks to the macroeconomic and monetary policy forecasts. Domestic financial conditions continue to favor recovery in economic activity. The transmission of reductions to the policy interest rate on credit rates has been significant. The banking portfolio continues to recover amid circumstances that have affected both the supply and demand for loans, and in which some credit risks have materialized. Preferential and ordinary commercial interest rates have fallen to a similar degree as the benchmark interest rate. As is generally the case, this transmission has come at a slower pace for consumer credit rates, and has been further delayed in the case of mortgage rates. Commercial credit levels stabilized above pre-pandemic levels in March, following an increase resulting from significant liquidity requirements for businesses in the second quarter of 2020. The consumer credit portfolio continued to recover and has now surpassed February 2020 levels, though overall growth in the portfolio remains low. At the same time, portfolio projections and default indicators have increased, and credit establishment earnings have come down. Despite this, credit disbursements continue to recover and solvency indicators remain well above regulatory minimums. 1.2 Monetary policy decision In its meetings in March and April the BDBR left the benchmark interest rate unchanged at 1.75%.

From this edition, the Financial Stability Report will have fewer pages with some changes in its structure. The purpose of this change is to present the most relevant facts of the financial system and their implications on the financial stability. This allows displaying the analysis more concisely and clearly, as it will focus on describing the evolution of the variables that have the greatest impact on the performance of the financial system, for estimating then the effect of a possible materialization of these risks on the financial health of the institutions. The changing dynamics of the risks faced by the financial system implies that the content of the Report adopts this new structure; therefore, some analyses and series that were regularly included will not necessarily be in each issue. However, the statistical annex that accompanies the publication of the Report will continue to present the series that were traditionally included, regardless of whether or not they are part of the content of the Report. In this way we expect to contribute in a more comprehensive way to the study and analysis of the stability of the Colombian financial system. Executive Summary During the first half of 2015, the main advanced economies showed a slow recovery on their growth, while emerging economies continued with their slowdown trend. Domestic demand in the United States allowed for stabilization on its average growth for the first half of the year, while other developed economies such as the United Kingdom, the euro zone, and Japan showed a more gradual recovery. On the other hand, the Chinese economy exhibited the lowest growth rate in five years, which has resulted in lower global dynamism. This has led to a fall in prices of the main export goods of some Latin American economies, especially oil, whose price has also responded to a larger global supply. The decrease in the terms of trade of the Latin American economies has had an impact on national income, domestic demand, and growth. This scenario has been reflected in increases in sovereign risk spreads, devaluations of stock indices, and depreciation of the exchange rates of most countries in the region. For Colombia, the fall in oil prices has also led to a decline in the terms of trade, resulting in pressure on the dynamics of national income. Additionally, the lower demand for exports helped to widen the current account deficit. This affected the prospects and economic growth of the country during the first half of 2015. This economic context could have an impact on the payment capacity of debtors and on the valuation of investments, affecting the soundness of the financial system. However, the results of the analysis featured in this edition of the Report show that, facing an adverse scenario, the vulnerability of the financial system in terms of solvency and liquidity is low. The analysis of the current situation of credit institutions (CI) shows that growth of the gross loan portfolio remained relatively stable, as well as the loan portfolio quality indicators, except for microcredit, which showed a decrease in these indicators. Regarding liabilities, traditional sources of funding have lost market share versus non-traditional ones (bonds, money market operations and in the interbank market), but still represent more than 70%. Moreover, the solvency indicator remained relatively stable. As for non-banking financial institutions (NBFI), the slowdown observed during the first six months of 2015 in the real annual growth of the assets total, both in the proprietary and third party position, stands out. The analysis of the main debtors of the financial system shows that indebtedness of the private corporate sector has increased in the last year, mostly driven by an increase in the debt balance with domestic and foreign financial institutions. However, the increase in this latter source of funding has been influenced by the depreciation of the Colombian peso vis-à-vis the US dollar since mid-2014. The financial indicators reflected a favorable behavior with respect to the historical average, except for the profitability indicators; although they were below the average, they have shown improvement in the last year. By economic sector, it is noted that the firms focused on farming, mining and transportation activities recorded the highest levels of risk perception by credit institutions, and the largest increases in default levels with respect to those observed in December 2014. Meanwhile, households have shown an increase in the financial burden, mainly due to growth in the consumer loan portfolio, in which the modalities of credit card, payroll deductible loan, revolving and vehicle loan are those that have reported greater increases in risk indicators. On the side of investments that could be affected by the devaluation in the portfolio of credit institutions and non-banking financial institutions (NBFI), the largest share of public debt securities, variable-yield securities and domestic private debt securities is highlighted. The value of these portfolios fell between February and August 2015, driven by the devaluation in the market of these investments throughout the year. Furthermore, the analysis of the liquidity risk indicator (LRI) shows that all intermediaries showed adequate levels and exhibit a stable behavior. Likewise, the fragility analysis of the financial system associated with the increase in the use of non-traditional funding sources does not evidence a greater exposure to liquidity risk. Stress tests assess the impact of the possible joint materialization of credit and market risks, and reveal that neither the aggregate solvency indicator, nor the liquidity risk indicator (LRI) of the system would be below the established legal limits. The entities that result more individually affected have a low share in the total assets of the credit institutions; therefore, a risk to the financial system as a whole is not observed. José Darío Uribe Governor