Multi-agent financial network (MAFN) model of US collateralized debt obligations (CDO): regulatory capital arbitrage, negative CDS carry trade, and systemic risk analysis

Sheri M. Markose, Bewaji Oluwasegun, Simone Giansante

Research output: Chapter in Book/Report/Conference proceedingChapter

1 Citation (Scopus)

Abstract

A database driven multi-agent model has been developed with automated access to US bank level FDIC Call Reports that yield data on balance sheet and off balance sheet activity, respectively, in Residential Mortgage Backed Securities (RMBS) and Credit Default Swaps (CDS). The simultaneous accumulation of RMBS assets on US banks' balance sheets and also large counterparty exposures from CDS positions characterized the $2 trillion Collateralized Debt Obligation (CDO) market. The latter imploded at the end of 2007 with large scale systemic risk consequences. Based on US FDIC bank data, that could have been available to the regulator at the time, the authors investigate how a CDS negative carry trade combined with incentives provided by Basel II and its precursor in the US, the Joint Agencies Rule 66 Federal Regulation No. 56914, which became effective on January 1, 2002, on synthetic securitization and Credit Risk Transfer (CRT), led to the unsustainable trends and systemic risk. The resultant market structure with heavy concentration in CDS activity involving 5 US banks can be shown to present too interconnected to fail systemic risk outcomes. The simulation package can generate the financial network of obligations of the US banks in the CDS market. The authors aim to show how such a Multi-Agent Financial Network (MAFN) model is well suited to monitor bank activity and to stress test policy for perverse incentives on an ongoing basis.

Original languageEnglish
Title of host publicationBanking, Finance, and Accounting
Subtitle of host publicationConcepts, Methodologies, Tools, and Applications, Vols. 1-3
Editors Information Resources Management Association
Place of PublicationHershey, U. S. A.
PublisherIGI Global
Chapter30
Pages561-590
Number of pages30
Volume1-3
ISBN (Electronic)9781466662698
ISBN (Print)9781466662681
DOIs
Publication statusPublished - 31 Jul 2014

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