THE CRISIS IN THE FOREIGN EXCHANGE
MARKET
Author: Michael Melvin (Barclays) & Mark Taylor (Barclays)
Presenters: Milana Jascuk, Lisa Nguyen, Murad
Ramazanov, Artiom Nicolaev
CONTENT
• Timeline of Financial Crisis & Brief Overview
Introduction
• 2007
• 2008
Overview of Important Events
& Their Implications for exchange Rates &
Market dynamics
• Can One Predict Costly Events Before
Occurrence?
Quantitative Measure For Comparison
• Summary
Conclusion
Introduction
TIME LINE LEADING UP TO THE FINANCIAL CRISIS
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August 2007, subprime- related turmoil
November 2007, credit restrictions
March 2008, The Bear Stearns Companies, Inc July 2008, JPMorgan Chase
& Co.
September 2008, failure of
Lehman Brothers.
Over View of Preceding Crisis
2007
OVER VIEW OF PRECEDING CRISIS 2007
First Stage of Unwind
• Deleveraging in currency
portfolios
• Implied
volatility from option prices
Exchange Rate Turbulence –
“carry trade”; 7.7%
change
Volatility period fell
over September &
October
NOVEMBER 2007: CREDIT, COMMODITIES AND DELEVERAGING
Perception
• Investors to increase carry trade exposures
2
ndBig Spike Volatility
• Credit concerns
• Difficulty getting money
• Chain reaction of investment funds
Hedge funds - primary brokers trigger
call
• “Flight to Quality”
Bear Stearns and Illiquidity
In early March 2008 rumors and its affect on Bear Stearns
by clients;
Federal Reserve: “too big to fail”
Takeover by JP Morgan Chase
Reasons for bankruptcy
Lehman Brothers and counterparty risk
Lehman Brothers was the fourth
biggest investment bank
in US till 2008 crises and its bankruptcy is the
biggest in US history.
In 2008 company faced with big losses in financial
markets.
TED spreads rose sharply after Lehman Brothers'
failure.
After failure bank's risk avoidance for giving credits The anecdote
about KfW 319 million euros
payment on September 15
EXCHANGE RATES WITHIN FINANCIAL CRISES
A GLOBAL FINANCIAL STRESS INDEX
List of countries:
• Australia, Austria, Belgium, Canada, Denmark, Finland,
France, Germany, Italy, Japan, Netherlands,
Norway, Spain, Sweden, Switzerland, the UK and the USA.
Essential
characteristics of a financial crisis:
• Large shifts in asset prices
• an abrupt increase in risk and uncertainty
• abrupt shifts in liquidity
• a measurable decline in
banking system health
indicators.
INDICATORS
Banking sector
The beta of banking sector stocks, constructed as the twelve-month rolling covariance of the year-over-year percent change of a country’s banking sector equity index and its overall stock market index, divided by the rolling twelvemonth variance of the year-over- year percent change of the overall stock market index.
The spread between interbank rates and the yield on Treasury Bills, i.e. the socalled TED spread that we discussed above: three-month LIBOR or commercial paper rate minus the government short-term rate.
The slope of the yield curve, or inverted term spread: the government shortterm Treasury Bill yield minus the
government long-term bond yield
Securities market
Corporate bond spreads: the corporate bond yield minus the long-term government bond yield.
Stock market returns: the monthly percentage change in the country equity market index.
Time-varying stock return volatility. This was calculated as the square root of an exponential moving average of squared deviations from an exponential moving average of national equity market returns. An exponential moving average with a 36-month half-life was used in both cases.
