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Lieven Hermans

16 May 2024
FINANCIAL STABILITY REVIEW - ARTICLE
Financial Stability Review Issue 1, 2024
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Abstract
Euro area private markets have grown significantly in recent years, providing alternative funding sources for companies and diversification benefits for investors. While private markets are currently small relative to public markets and bank lending in the euro area, continued strong growth, financial innovation and opaqueness in private markets could contribute to financial stability risks. Adverse economic shocks could result in rising defaults, valuation corrections and losses for private funds and their investors. Additionally, such shocks may be exacerbated by multiple layers of leverage at company, fund and investor level, or by liquidity mismatches for some open-ended private funds. For banks, risks could arise from lending exposures to these markets, as well as from rising competition with private funds, which could incentivise lower underwriting and credit standards.
JEL Code
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G24 : Financial Economics→Financial Institutions and Services→Investment Banking, Venture Capital, Brokerage, Ratings and Ratings Agencies
G30 : Financial Economics→Corporate Finance and Governance→General
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
30 March 2023
WORKING PAPER SERIES - No. 2803
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Abstract
We study the effects of low short-term interest rates on the optimal portfolio allocation in Markowitz portfolios and Risk parity portfolios. We propose a measure of Portfolio Instabil-ity, gauging the amount of optimal portfolio shifts needed to respond to exogenous shocks to the expected risk and return of the risky portfolio assets. Portfolio Instability, i.e. the selling pressure on riskier asset holdings, is found to be stronger the lower the risk-free interest rate. Heightened portfolio instability in the presence of low rates is found to emerge through two channels both of which incentivise the build-up of large and leveraged risky asset shares during calm periods which need to be unwound in the event of higher market volatility: first, low rates (mechanically) augment the excess return to be gained by investing in riskier assets and second, they are found to dampen volatility of riskier assets in the portfolio. The inverse relationship between portfolio instability and the risk-free rates is found to increase the closer the risk-free rate approaches the effective lower bound. Counterfactual analyses of the behaviour of optimal multi-asset portfolios demonstrate that the sell-off in riskier asset classes during the Covid crisis in March 2020 was more severe than would have been in the presence of higher short-term interest rates.
JEL Code
C58 : Mathematical and Quantitative Methods→Econometric Modeling→Financial Econometrics
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
24 May 2022
FINANCIAL STABILITY REVIEW - ARTICLE
Financial Stability Review Issue 1, 2022
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Abstract
The stellar growth, volatility and financial innovation currently seen in the crypto-asset ecosystem, as well as the rising involvement of institutional investors, show how important it is to gain a better understanding of the potential risks crypto-assets could pose to financial stability if trends continue on this trajectory. This special feature provides an update on crypto-asset market developments and a general overview of risks stemming from unbacked crypto-assets and decentralised finance, given the way in which they have evolved and their specific characteristics and risks. Systemic risk increases in line with the level of interconnectedness between crypto-assets and the traditional financial sector, the use of leverage and lending activity. It is important to close regulatory and data gaps in the crypto-assets ecosystem to mitigate such systemic risks.
JEL Code
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G19 : Financial Economics→General Financial Markets→Other
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G51 : Financial Economics
25 May 2020
FINANCIAL STABILITY REVIEW - BOX
Financial Stability Review Issue 1, 2020
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Abstract
Low financial market volatility in the years prior to the coronavirus outbreak increased the popularity of investment strategies based on targeting volatility. Low volatility across major asset classes and regions had been a key feature of global asset price developments until recently. Investments following strategies which are reliant on low market volatility have grown over recent years, with varying estimates. Globally, there may be funds with assets under management worth up to USD 2 trillion invested in some form of volatility strategies , with USD 300 billion invested in some 300 risk parity funds, a well-known hedge fund strategy for multi-asset funds. Additional leverage deployed in these funds raises their market-moving capacity.
29 November 2017
FINANCIAL STABILITY REVIEW - ARTICLE
Financial Stability Review Issue 2, 2017
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Abstract
The reduction in asset price volatility in recent years has taken place in tandem with investors lowering the premia required for lower-rated assets. The current favourable market sentiment could however change abruptly if, for instance, investors were to reassess the outlook for growth or monetary policy. Potential surges in asset price volatility could be amplified by: (i) investors selling off assets perceived as overvalued; (ii) the high levels of corporate leverage; and/or (iii) a rapid unwinding of market positions that benefit from low volatility. Low volatility in financial markets is therefore being closely monitored by financial stability authorities, as it may mask an underpricing of risks and a build-up of financial imbalances.
JEL Code
G00 : Financial Economics→General→General
27 June 2016
OCCASIONAL PAPER SERIES - No. 174
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Abstract
This paper first highlights the structural features of shadow banking in the euro area, focussing on investment funds. It then discusses the potential systemic risks that the recent expansion of the investment fund sector presents. While investment funds provide important intermediation services to the real sector, including market and liquidity risk-sharing and the bridging of information gaps, their rapid expansion may present systemic risks that need to be detected, monitored and managed. In particular, the risk of fund outflows and the possible negative impacts on the wider financial system have risen due to the rapid expansion of the investment fund sector, its growing involvement in capital markets, its use of synthetic leverage, and the inherent and growing maturity and liquidity mismatch arising from the demandable nature of fund share investments. While available data suggest that vulnerabilities within the investment fund sector are growing and links to the wider financial system and real economy have strengthened, data limitations prevent drawing a definitive conclusion on the sectors' contribution to systemic risk.
JEL Code
G01 : Financial Economics→General→Financial Crises
G20 : Financial Economics→Financial Institutions and Services→General
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation