The Office of Financial Research: building a Research Community.

The Office of Financial Research: building a Research

Community

Did they know what was going on?

Did they know what was going on? Did they have a choice?

“If this crisis has taught us anything, it has taught us that risk to our system can come from almost any quarter. We must be able to look in every corner and across the horizon for dangers and our system was not able to do that.” Secretary Geithner, opening remarks, testimony to Senate Banking Committee, June 18, 2009.

Sen. Jack Reed, adequacy of data and risk analysis systems for system-wide risks

We have good starting points, with regards to models; we need better data, not clear what data.

This will require a new approach to finance/economics research:• Large Science approach – large scale, multidisciplinary teams• Long-term sustained research effort that will iterate between

better models and need for better or more refined data.

Loss Distribution• Tail events are rare – very little data• Typically strong model assumptions

Loss Distribution• Tail events are rare – very little data• Typically strong model assumptions• Liquidity Failures

Can’t hedge No replicating portfolios Mean & Variance Game Theory

We are not in Kansas anymore

Loss Distribution• Tail events are rare – very little data• Typically strong model assumptions• Liquidity Failures• Scenario Analysis

Linkages – rights, obligations (Not Netting!) Granular Macro Economics Understanding Domino Risk

Loss Distribution• Tail events are rare – very little data• Typically strong model assumptions• Liquidity Failures• Scenario Analysis• Economic Impact

CaR – Credit at Risk DoL – Distribution of Loss

Monitoring health of Economy Regime shifting models Summaries reflecting stress

Historical data Derivatives data

Looking for Black Swans Leverage measures Concentrations, Bubbles Liquidity capacity Linkages and Transparency

Not predicting cascading failures

Determine loss by counterparty

Do not predict probability of failure of counterparties

Do not account for Linkages

Proposed by concerned citizens

Part of regulatory reform legislation

Collect system-wide transaction data

Develop analytic tools

Did they know what was going on? Did they have a choice?

Can we afford to have this happen again?

Office of the Comptroller of the Currency workshop, Feb. 2009• Proposed National Institute of Finance (NIF)• Collect system-wide data, build analytic

tools and monitor systemic-risk

Committee to Establish a NIF • Broad collection of concerned citizens• Legislative Response – OFR is now law

Office of Financial Research works for the Financial Stability Oversight Council • Better data and analysis tools• Long-term research• Regulatory Commons• Independent voice

Two components • Data Center• Research and Analysis Center

Dodd Frank Act is law

Treasury sets up initial OFR

Key Initiatives• Reference data (Treasury’s current focus)• Common computing and data infrastructure• Build initial risk monitoring system• Key long-term research efforts• Investigate past crisis

Organize a Penn State Initiative• Key long-term research efforts

Conceptual models and mathematical models Identifying important areas of collaboration Seminar Series/Workshops University Center, NSF Funding?

Potential Benefits• Future Funding• Back-up data center

Broader Initiatives(Other Universities and Industry partners)

Initial analytic systemic risk systems Competitive Frameworks for comparison of

systemic risk systems Testing scenarios to prove how different

technologies could apply Cross-over of technologies that can be used for

systemic risk Maps of the financial system Demonstration of prototypes and feasibility

studies

International Collaboration on Data• Common reporting requirements in key

markets for market participants• OFR standards offer a point for building

common standards

International Collaboration on Research• International body help coordinate and

facilitate research across countries, in the public interest