NYU Stern

Derivatives

Featured Piece

"Bruce TuckmanAmending Safe Harbors to Reduce Systemic Risk in OTC Derivatives Markets" by Professor Bruce Tuckman.

The recent financial crisis has raised concerns that the failure of a significant derivatives’ counterparty and the liquidation of its positions might surprise and disrupt markets to the extent of threatening the viability of otherwise solvent institutions. To reduce this systemic risk, a policy consensus seems to have emerged around two objectives. One, ensure that positions held in derivatives markets are transparent to regulators and, in some aggregated form, to the public. Two, channel as many derivatives trades as practicable through clearing houses...Read More

In the Media


"Taking the L-I-E Out of LIBOR," by Professors Kermit Schoenholtz and Lawrence White, Bloomberg, July 26, 2012.

“Derivatives Compromise All About Enforcement,” Heather Landy/American Banker, June 30, 2010.

"OTC Derivatives Don't Need Fixing", by Professor Menachem Brenner, Forbes.com, May 12, 2010.

“Scope remains to circumvent derivatives bill,” by Professor Robert Engle, Financial Times, October 21, 2009.

“Geithner’s Plan for Derivatives: The Devil is in the Details,” Stephen Figlewski, Roy C. Smith, Ingo Walter, Forbes.com, May 18, 2009.

“Derivatives Trades Should All be Transparent,” by Professors Viral Acharya, Robert Engle, The Wall Street Journal, May 15, 2009.

“Time to Lift the Veil: A Clearinghouse for Credit Derivatives Trading,” by Professors Viral Acharya, Marti Subrahmanyam, Forbes.com, November 13, 2008.

“Credit Default Swaps are Good for You,” Stephen Figlewski, Roy C. Smith, Forbes.com, October 20, 2008.


Papers

“A Transparency Standard for Derivatives,” Viral Acharya, in Systemic Risk and Macro Modeling, 2012.

ABSTRACT (Click Here for Paper)
Derivatives exposures across large financial institutions often contribute to - if not necessarily create - systemic risk. During a crisis, lack of adequate understanding of such exposures often compromises regulatory ability to unwind an institution, inducing large-scale backstops and counterparty bailouts. It is often argued - in spite of the massive assistance that was provided in this crisis to deal with derivatives exposures - that derivative contracts are well collateralized so that counterparty risk is not a significant issue (on derivatives exposures). While this may have been true in some cases, evidence suggests otherwise in many important cases that contributed to the crisis.2 Equally importantly, documenting such evidence beyond reasonable doubt is currently infeasible due to the poor quality of derivatives disclosures by financial institutions to regulators and to the public at large. Furthermore, a lack of standardization of existing disclosures aggravates the problem of obtaining any consistent inference across institutions.

“Amending Safe Harbors to Reduce Systemic Risk in OTC Derivatives Markets,” Bruce Tuckman, Center for Financial Stability Policy Paper, (April 22, 2010).

ABSTRACT (Click Here for Paper)
The recent financial crisis has raised concerns that the failure of a significant derivatives' counterparty and the liquidation of its positions might surprise and disrupt markets to the extent of threatening the viability of otherwise solvent institutions. To reduce this systemic risk, a policy consensus seems to have emerged around two objectives. One, ensure that positions held in derivatives markets are transparent to regulators and, in some aggregated form, to the public. Two, channel as many derivatives trades as practicable through clearing houses. The implementation of these objectives, however, is far from straightforward. Exactly which positions have to be reported and cleared? What are the consequences of inaccurate or incomplete reporting or of failing to clear trades? Exactly which services constitute “clearing”? Existing legislative and regulatory initiatives do not answer these questions satisfactorily, partly because the broad policy objectives have not been thought through in the context of particular markets and partly because of a reflexive preference to rely on mandates rather than incentives. This paper recommends implementing the transparency and clearing objectives by narrowing the safe harbor for derivatives (i.e., the right to close-out derivative trades with counterparties that have declared bankruptcy) to include only those trades that are cleared, where “clearing” is meant to mandate only third-party pricing and collateral management.

“Viewing the Financial Crisis from 20,000 Feet Up,” Stephen Figlewski, Journal of Derivatives, (Spring 2009).

ABSTRACT (Click Here for Paper)
The U.S. economic crisis is systemic but the system is so complicated that commentators, policy makers, and the general public are focusing on details rather than on the big picture. This article offers a different perspective: An overview of the whole system, as if from 20,000 feet above it, that allows us to see the systemic nature of the crisis without being distracted by its complex details. The primary focus is on the problems with subprime mortgages, and I suggest a general approach to defuse that major driver of the crisis. But conditions have worsened so quickly since September 2008 that actions, which might have arrested the decline at that time, are now inadequate. However, one central message that it will be hard to get the financial system back on its feet without resolving the problems in the mortgage market still holds, and our general approach of government intervention at the point where the real economy risk connects to the financial system still offers a way to do that. And while real estate remains the largest and most disrupted sector of the economy, the principles outlined in this article are potentially applicable to other areas, as well.