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To assess risk, regulators need more data

To assess the extent of systemic risk in the financial markets, regulators should collect the information below from all participants, aggregate it into reports and make those reports public, perhaps on a web site.

This is the July 16, 2010, suggestion of economists Markus K. Brunnermeier at Princeton University, Gary Gorton at Yale University and Arvind Krishnamurthy at Northwestern University, in what they describe as a “very preliminary and incomplete” proposal. Their study is part of a movement among economists to develop data that can help spot the next financial crisis as it is brewing.

All financial institutions should regularly report the following information, according to the three economists:

(1) How the firm would fare if there were specified changes in:

• Interest rates (yields) on major government bonds (e.g., US, UK, Germany, Japan, China) bond rates for different maturities; also swap rates in LIBOR, FIBOR (Frankfurt), PIBOR (Paris), HIBOR (Hong Kong), etc. at different maturities;
• Credit spreads: Changes in major credit derivative indices (CDX, CMBX, LCDX) at different maturities;
• Exchange rates of major currencies;
• Stock prices, measured by major indices;
• Commodity prices, measured by sector and aggregate indices;
• Commercial real estate prices, e.g., the NCREIF property index;
• Residential house prices, e.g., Case-Shiller index;

(2) How the firm would fare in the following scenarios:

• Firms are unable to access the market to raise new cash for one month, three months, and six months.
• Repo haircuts on some asset classes rise.
• The syndicated loan market, or the securitization market, shuts down for some period.

(3) How the firm would fare if it encountered the following:

• Default by the largest of the firm’s counterparties, second largest counterparty, third largest;
• Default by largest supplier of bank lines;
• Default by a major clearing bank, or clearing system;
• Reputational event which prevents new security issuance for 6 months, 1 year;
• Inability to issue new securities for 1 month, 3 months, 6 months;
• Inability to clear for three days, 10 days;
• Rating downgrade of the senior unsecured debt of the company by 3 notches, 6 notches.

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