Week InReview

'An empirical assessment of the price of liquidity will also need to take into account the evolution of the attendant risks. This leads me to the topic of asset managers. Having gained in market presence post-crisis, asset managers and their activities are receiving much more attention because their business models can spur behaviour that amplifies market volatility. This is what we call leverage-like behaviour. Such behaviour sows the seeds of market liquidity risks.

'While dealers are scaling down the provision of market liquidity, asset managers continue to promise redemptions at short notice, thus encouraging their clients' liquidity illusion. As they may not be able to live up to their promises under financial stress, asset managers could exacerbate liquidity shortages at the wrong time.

'Prudential work is under way in this area, involving asset managers and supervisors. The former will need to internalise recent market changes in general and changes to the provision of liquidity services in particular. In turn, supervisors are stepping up the usage of stress tests.'

From a speech by 
Jaime Caruana
BIS General Manager
Lisbon, Portugal
May 10, 2016

Friday, May 20, 2016
Let's recap
In case you missed it . . .
G7 Japan 2016
Finance ministers & central bankers gather
(May 19)  Finance chiefs, including U.S. Treasury Secretary Jack Lew, and central bankers from the Group of Seven advanced economies arrived at a hot springs resort in Japan for meetings that stretch to Saturday.  The formal agenda for the G7 gathering on Kashiko Island in Sendai, in the northeastern part of Japan hit by the 2011 earthquake and tsunami, covers risks to the international economy, global financial architecture, sustainable and inclusive development, and cross-border financial flows.  The seven nations are also expected to discuss economic policy, climate change, cybersecurity, ways to revitalize global growth, the risk of Britain exiting the EU, boosting infrastructure investment, and a crack down on cross-border tax evasion; call for a system to share information on money laundering; and protest excessive Internet regulation in an apparent reference to China and Russia. Japanese Finance Minister Taro Aso warned of growing uncertainty in the global economy and said the G7 needs to play a leading role in providing stability.
Global pricing of stocks?
BIS poses question in working paper
(May 18) The Bank for International Settlements shows that in recent years global factor models have been catching up significantly with their local counterparts in terms of explanatory power (R 2 ) for international stock returns. This catch-up is driven by a rise in global factor betas, not a rise in factor volatilities, suggesting that the effect is likely to be permanent. Yet, there is no conclusive evidence for a global factor model catch-up in terms of pricing errors (alpha) or a convergence in country-specific factor premia. These findings suggest that global financial markets have progressed surprisingly little towards fully integrated pricing, different from what should be expected under financial market integration. They discuss alternative explanations for these patterns and assess implications for practice.
NY Fed on measuring liquidity
Investors may need new methods
(May 17)  Investors and policy makers may need 'new ways of measuring liquidity' due to structural changes that have taken place in the MBS and Treasury markets, Federal Reserve Bank of New York SVP Nathaniel Wuerffel stated at an industry conference .
  • Three 'important ongoing changes' have taken place in fixed income market's structure
    • Electronic and automated trading, bank regulation and risk management and public sector ownership
  • Data suggests that dealer-to-client market liquidity is different than that seen in highly automated markets
  • Regulation has combined with 'private decisions to manage risk more prudently post-crisis
  • FOMC now owns $2.5t in Treasuries and $1.7t in agency MBS; this has 'potential to increase or decrease liquidity in these markets'
    • FOMC owns ~30% of agency MBS outstanding, is largest single holder
    • Ownership base has shifted to those who do not hedge negative convexity
  • Despite 'notable amount of market commentary' regarding fall in liquidity 'it has been difficult to find compelling evidence' to support such claims using traditional liquidity measures
    • Liquidity 'can be a fairly abstract concept and there are numerous ways to define and measure it'
  • Treasury market ~$13t outstanding, agency MBS ~$6t; the former see $600b trade daily, the latter $200b
    • 90% of agency MBS trading occurs in TBA market
  • Treasury market liquidity measures present 'largely positive' picture
    • Agency MBS liquidity indicators 'like the Treasury market' have declined in recent years but are near long-run averages
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