Reverse stress testing: Scenario design for macroprudential stress tests

We propose a systematic algorithmic reverse-stress testing methodology to create “worst case” scenarios for regulatory stress tests by accounting for losses that arise from distressed portfolio liquidations. First, we derive the optimal bank response for any given shock. Then, we introduce an algorithm which systematically generates scenarios that exploit the key vulnerabilities in banks' portfolio holdings and thus maximize contagion despite banks' optimal response to the shock. We apply our methodology to data of the 2016 European Banking Authority (EBA) stress test, and design worst case scenarios for the portfolio holdings of European banks at the time. Using spectral clustering techniques, we group 10,000 worst-case scenarios into twelve geographically concentrated families. Our results show that even though there is a wide range of different scenarios within these 12 families, each cluster tends to affect the same banks. An “Anna Karenina” principle of stress testing emerges: Not all stressful scenarios are alike, but every stressful scenario stresses the same banks. These findings suggest that the precise specification of a scenario is not of primal importance as long as the most vulnerable banks are targeted and sufficiently stressed. Finally, our methodology can be used to uncover the weakest links in the financial system and thereby focus supervisory attention on these, thus building a bridge between macroprudential and microprudential stress tests.     

Integration and consumer protection: The case of Latin America

The author analyses Latin American attempts at creating a Common Market in which the free circulation of goods and services is guaranteed. He is concerned with the impact upon the emerging issues of consumer protection. The most promising project of economic integration has been initiated by the 1991 Asunción Treaty in which Argentina, Brazil, Paraguay, and Uruguay participate and which has the aim of creating a Southern Common Market (MERCOSUR). The author describes the institutional mechanisms set up in order to establish MERCOSUR by the end of 1994.The safeguard clauses allowing for restrictions on trade in the interest of consumer protection follow the model of the European Communities but are not controlled by an independent Court of Justice. Therefore, harmonisation of legislation is imperative but difficult. If such harmonisation is not feasible, goods may become banned in some Member States while circulating freely in others, and marketing practices may at the same time be forbidden in some and allowed in other Member States. This could eventually endanger both integration and consumer protection.

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Integration und Verbraucherschutz — das Beispiel Lateinamerika

Zusammenfassung Der Autor untersucht lateinamerikanische Bemühungen, einen Gemeinsamen Markt zu schaffen, wo der freie Verkehr von Waren und Dienstleistungen sichergestellt ist. Er beschÄftigt sich mit den Auswirkungen eines solchen Projektes auf den Verbraucherschutz. Die am weitesten gediehenen Initiativen sind 1991 durch den Abschlu\ des Asunción Vertrags bewerkstelligt worden, an dem Argentinien, Brasilien, Paraguay und Uruguay mitwirken, um einen Gemeinsamen Markt des Südens (Mercosur) zu errichten. Der Autor beschreibt die institutionellen Mechanismen, um Mercosur bis Ende 1994 zu vollenden.Schutzklausein erlauben eine EinschrÄnkung des Freihandels im Interesse des Verbraucherschutzes; sie folgen dem Modell der EuropÄischen Gemeinschaften, ohne jedoch von einem unabhÄngigen Gerichtshof kontrolliert zu werden. Deshalb ist die Angleichung der Gesetzgebung unerlÄ\lich aber schwierig. Wenn dies nicht möglich ist, könnten Waren in einem Staate verboten werden, aber in einem anderen frei zirkulieren, wÄhrend Handelspraktiken gleichzeitig verboten und erlaubt sind. Eine solche Folge würde Integration und Verbraucherschutz gleichzeitig gefÄhrden.

     

Efficient self-rationing of electricity revisited

In a recent issue of this Journal, Woo (1990) suggests a mechanism to improve on a pricing scheme initially proposed by Panzar and Sibley (1978). In this paper, we analyze Woo's mechanism. Woo claims that by activating rationing fuses only when total demand reaches system capacity, the problem of untimely curtailments is avoided. We show that this is trueonly if all consumers reach their subscribed capacity at the same temperature, which will not occur in general, and clarify the implications of this assumption on Woo's improvement of the Panzar-Sibley scheme. A slightly more complex self-rationing mechanism, which addresses the problems that we point out, is suggested.     

An option model approach to firm liquidity management

With an awareness of the famous Keynesian motives of demand for liquidity, we look at the cases of speculative and precautionary demand at the level of an individual firm. In countries like France, having alternative periods of large liquidity and credit squeeze, the firm's demand for liquidity is not only a transaction demand, but is also influenced by financial imperatives. The problem is to evaluate theoretically the amount of this demand and to elucidate the explicative variables. A valuation formula is derived from a comparison between a liquidity investment and a common stock call option. At this point, the now well-known theory of option pricing is used to obtain an explicit form of this valuation formula.     

The adoption of intensive monocrop horticulture in southern Cameroon

Results from a 1997 survey of 208 households in the humid forest zone of southern Cameroon indicate that African policy makers seeking to intensify agricultural production should focus attention on the horticultural sub‐sector. The survey, which gathered information on horticultural production practices, found that the average expenditure on agro‐chemical inputs by horticultural producers using monocrop production systems was 190US$/ha, which greatly exceeds the FAO reported national average expenditure of 6.50 US$/ha. A logit model of monocrop adoption indicated that the size of land holding per household had a negative effect on adoption, congruent with population‐driven technical change and that increases in unit transportation costs significantly decreased the probability of adoption. These findings suggest that policy makers should target horticultural intensification in areas of higher population density and promote investment in rural roads. The age of the household head had a significant negative and elastic effect on adoption, which in combination with an increase in the cohort of younger farmers in the rural population induced by macro‐economic events contributed to the spread of intensified horticulture. In the study area, roughly two‐thirds of rural households also produce cocoa and the quantity of cocoa produced was positively associated with adoption of intensive horticultural systems suggesting that export crop promotion indirectly facilitated diversification of agriculture. Women's participation in intensive monocrop production was limited and efforts to promote their greater involvement are recommended.