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Elusive Safety: The New Geography of Capital Flows and Risk

by Laura Alfaro, Ester Faia, Ruth Judson, and Tim Schmidt-Eisenlohr

Examining motives and incentives behind the growing international flows of US-denominated securities, this study finds that dollar-denominated capital flows are increasingly intermediated by tax haven financial centers and nonbank financial institutions.

Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds

by Sergey Chernenko and Adi Sunderam

A key function of many financial intermediaries is liquidity transformation: creating liquid claims backed by illiquid assets. To date it has been difficult to measure liquidity transformation for asset managers. The study proposes a novel measure of liquidity transformation: funds’ cash management strategies. The study validates the measure and shows that liquidity transformation by asset managers is highly dependent on the traditional and shadow banking sectors.

Risky Business with Structured Finance

by Julia Hanna

How did the process of securitization transform trillions of dollars of risky assets into securities that many considered to be a safe bet? HBS professors Joshua D. Coval and Erik Stafford, with Princeton colleague Jakub Jurek, authors of a new paper, have ideas. Key concepts include: Over the past decade, risks have been repackaged to create triple-A-rated securities. Even modest imprecision in estimating underlying risks is magnified disproportionately when securities are pooled and tranched, as shown in a modeling exercise. Ratings of structured finance products, which make no distinction between the different sources of default risk, are particularly useless for determining prices and fair rates of compensation for these risks. Going forward, it would be best to eliminate any sanction of ratings as a guide to investment policy and capital requirements. It is important to focus on measuring and judging the system's aggregate amount of leverage and to understand the exposures that financial institutions actually have. Closed for comment; 0 Comments.