may I have your attention ladies and
gentlemen we will commence the program
in a very short while from now you are
requested to kindly be seated and please
turn your cellphone's to the silent mode
so as to avoid disturbances during the
proceedings if you require any
assistance feel free to contact any of
the support staff thank you
a very good evening everybody
good evening on behalf of NSC it gives
me mana see immense delight in extending
a hearty welcome to all of you
especially the honorable guests esteem
dignitaries and all you invitees for
this extremely special event the Dr.
RH Patil Memorial Lecture in keeping
with the Indian tradition we will
commence by lighting the official
ceremonial lamp, i request the Nobel
prize-winning economist professor Robert
Engle to kindly do us the honors I also
request MD and CEO of NSE Mr. Vikram
Limaye to please join in sir
in Sanskrit translates the lamp is
luminous its radiance grants victory
it's light in paths Dharma artha kama
and Moksa
that is righteousness prosperity
pleasure
and finally emancipation
this is the significance of lighting a
lamp and hence a lamp should be lit lamp
as we know is also a symbol of knowledge
the lamb being lit we will take a nice
picture which will be treasured in
memories thank you gentlemen you may
please take your seats
ladies and gentlemen this year is very
special for NSE as the National Stock
Exchange of India is celebrating its
silver jubilee NSE has an important role
to play in fulfilling the aspirations of
India becoming a five trillion US dollar
economy we will now play a short film
dedicated to all NSE partners kindly
take a look at the screen it has an aura
it radiates energy and it is India's
symbol of prosperity you see it
everywhere in homes in bundles at
inaugurations at companies
the Marigold it announces personal
unions and corporate partnerships
the one flower that says here is someone
celebrating a success but joy
a journey
besides lemare cold there's yet another
Indian symbol of prosperity that spread
across India National Stock Exchange of
India Limited NSE the marigold and NSE
two icons of India
one symbolizes prosperity
the other enables it the year 1994 India
was ready the winds of economic
liberalisation were flowing across India
it now required an engine of growth
taking a landscape changing step the
government using SEBI as a pivot roped
in key institutions to set up the
National Stock Exchange barriers had
been demolished India had finally
connected to India entrepreneurs could
easily raise capital Indians across
India could now invest in stock markets
in its domestic role it is India's
largest stock exchange and amongst the
largest exchanges growing for
international markets and investors it
is the gateway to India's growth story
NSE today is a symbol of national pride
the nifty 50 the de facto symbol of the
direction of the Indian economy is
India's most well-known global financial
brand NSE AFSC a gift City Gujarat is
yet another initiative from the
Government of India and NSE to bring
international clothes to India
beyond achievements putting purpose
before profit how by making the markets
truly democratic by insuring more people
participated in the growth of India but
participation in markets required
education so curriculum in schools
investor gaps and international speakers
today 25 years later NSC is ready yet
again now to facilitate the transition
of India's 2.5 trillion dollar economy
to a five trillion dollar economy yes
connecting India to India and further
integrating India with other world
markets because NSC is committed to help
India achieve its calling to be amongst
the world's largest economies or nation
to be admired
may india always bloom with respecting
so ladies and gentlemen that was NEC is
glorious journey right from its
establishment through its achievements
and accomplishments over the last 25
years put in a nutshell for all of you
I will now request the MD and CEO of NSC
mr. Vikram LeMay to please step on stage
for the welcome address sir
good evening ladies and gentlemen a very
warm welcome to all of you this year as
we celebrate NSE silver jubilee
this annual lecture in the memory of our
founding managing director dr. RH
party'll is a truly special one this
annual lecture features thought leaders
of the highest caliber and reputation as
a fitting tribute to the memory of dr.
Patel who was one of the tallest leaders
and institution builders of the Indian
financial services industry it was the
passing of the SEBI Act in 1990 to post
the Harshad Mehta scam which paved the
way for setting up of a modern exchange
and IDBI was charged with the
responsibility of leading a group of
institutions that would eventually set
up the National Stock Exchange the then
chairman of IDBI h3 SS not Carney
assigned the project to dr. RH party NSE
was incorporated in 1993 and commenced
trading in 1994 it was the first deem
utilized exchange that was
professionally managed and with an
institutional shareholding base the new
exchange managed to achieve the
remarkable feat of overcoming tradition
practices and strong loyalties that were
over a century old a lot of skepticism
from market participants and resistance
from entrenched businesses dr. podila
had the foresight and vision to set up a
technology led nationwide disruptive
platform that challenged the status quo
and brought in best-in-class standards
and practices NSE revolutionized markets
through a pan-indian network of
connectivity and technology that was no
mean achievement during the mid-90s
nationwide 24 by 7 connectivity was a
daunting task during those times and it
was achieved through a VSAT network NSE
had to in fact become a telecom company
as it became an exchange NSE under the
leadership of dr. party led many firsts
including a role in setting up the first
depository and The Clearing Corporation
these were critical market
infrastructure institutions to guarantee
settlement and to provide d-mat
securities to erratic to eradicate
problems of bad delivery and fraudulent
and duplicate certificates
this established trust in markets which
is absolutely key for the development of
Indian capital markets NSE o is a deep
sense of gratitude to the vision and
missionary zeal of dr. Patel the
founding team past and present employees
Sebby and the government for putting in
place critical market infrastructure
institutions that have been responsible
for the tremendous growth of our economy
and capital markets over the past
two-plus decades dr. Patil was an
institution builder and a wonderful and
humble human being with strong value
system and ability to motivate and
nurture talent and as he was indeed
fortunate to have dr. Patel as its
founding managing director and was a
deep sense of gratitude to his many
contributions NSE over a relatively
short period of time has emerged as not
only the largest exchange in India but
also amongst the top three exchanges in
the world it is also the largest
derivatives exchange in the world in
terms of the number of contracts traded
few institutions in India have built a
strong global reputation and I would
submit that and I would submit that NSE
is one of them as an institution of
national importance and as he plays a
critical role with regulators government
and market participants in the
development of markets NSE has always
focused on what is in the best interest
of the Indian economy markets and
investors and is focused on improving
the financial well-being of people we
recognize a responsibility to help in
they achieve its aspirations and take
its rightful place amongst the world's
leading economies in order to achieve
sustainable high rates of GDP growth it
is critical that we expedite market
development and capital formation while
the equity markets in India are
relatively well developed penetration is
still at very low levels relative to the
emerging market averages we need to
continue to focus on finding creative
ways for investor education and
awareness NSE has a very elaborate
investor education and awareness program
that runs across six hundred plus
districts in the country and includes
over 4,000 programs conducted through
the year and several partnerships to
deliver digital programs in order to
achieve scale
beyond the equity markets bond markets
currency and commodity markets are at a
nascent stage relative to potential and
it is critical that these markets
develop over the next two to three years
access to capital for SMEs is another
important aspect to support growth and
employment NSE is doing its bit to
provide an ecosystem for equity and debt
financing for SMEs through the NSE
emerge platform for SME IPOs and the
bill discounting exchange are xil for
providing working capital financing to
SMEs through a joint venture with SIDBI
it is important that the trust in
markets is enhanced and that we further
integrate the indian economy and markets
into the global ecosystem we need to
therefore make sure that markets
developed in a disciplined way and NSE
is focused on ensuring the highest
standards of governance amongst listed
corporates and the integrity of markets
through regulation and surveillance of
market intermediaries and trading
activity technology and risk management
in all its dimensions are critical areas
of focus and we will continue to invest
in these areas from a policy and
regulatory standpoint it is important to
demonstrate stability of policy
regulations and taxation in order to
give confidence to investors we also
need to focus on making sure that we
continue to streamline compliance
requirements to make it easier for
people to invest in Indian markets
product innovation and simplicity are
also critical to further penetrate an
intermediate intermediate retail savings
into markets and the growth of the ETF
market could be an important driver to
improve penetration we have come a long
way over the last 25 years in the
evolution of markets and the growth of
our economy the aspirations of our
country is a guiding light as India
powers itself forward to a five trillion
economy we all need to recommit
ourselves to creating the right
environment an institutional
architecture that is important to drive
growth and development over the next 25
years NSE is committed to contributing
to the development of the economy
markets and the financial well-being of
people as we reflect on the evolution
over the last 25 years and the bold
vision of dr. Patil in creating
institution
that have stood the test of time and
I've been critical for our development
we need to reimagine the future and
embrace technology and encourage
innovation to drive productivity and
growth we were very fortunate and
honored to have with us today professor
Robert Engel as a keynote speaker for
the dr. Patel memorial lecture for 2019
professor angle the Michael R Molina
professor of finance at New York
University's Stern School of Business
was awarded the 2003 Nobel Prize in
Economics
professor angle is an expert in time
series analysis with a long-standing
interest in the analysis of financial
markets his arch model and its
generalizations have become
indispensable tools not only for
researchers but also for analysts of
financial markets who use them an asset
pricing and in evaluating portfolio risk
he's currently the director of the NYU
Stern volatility Institute and is the
co-founding president of the Society for
financial econometrics a global
not-for-profit organization housed at
NYU
before joining NYU Stern in 2000
professor Engel was the chair of the
economics department at the University
of California San Diego and an associate
professor of economics at the
Massachusetts Institute of Technology
the dr. R each party memorial lecture is
an annual event and we are committed to
honoring dr. patel's legacy by inviting
world-renowned thought leaders that is
all put our hands together to welcome
professor Engel
and for we will gain valuable insights
from Professor angles lecture and
thoughts and we would like to thank all
of you for coming thank you very much
good evening it's a great pleasure to be
here and thank you so much to the NSC
and I am very honored to be the RH putty
lecturer this year the NSE has done an
amazing job as we just heard and I thank
mr. dr. LeMay for the very nice
introduction and and discussion uh I'd
like to talk about geopolitical risk
tonight and we are in a time when
geopolitical risk is on everybody's mind
and as we study and plan our investment
portfolios and look at our performance
it's very common to say well I would
have done better if it hadn't been for
geopolitical risk so can we talk more
precisely about what we mean by
geopolitical risk and this slide kind of
suggests one view of what we mean by
geopolitical risk it's it's it's a
picture of a sculpture in a garden in
Budapest which is dedicated to Soviet
era art and it really captures that idea
and is this really what we mean by
geopolitical risk well let's take a look
I'm going to talk about paper tonight
which is joint with susana martins and
discusses a way of measuring
geopolitical risk and then examining how
it impacts financial market stability so
what actually do we mean by geopolitical
risk is this about politics or is it
about economics is it about terrorism
military risks cyber risks or is it
about more conventional changes like
elections and congressional actions and
political movements is it about the
level of risk or is it about the
surprise and is it best measured in the
news or in the financial markets
themselves this leads to a lot of
different ways to measure geopolitical
risk as you answer these questions a
couple of quotes might lead the way to
what I'm going to do tonight we are
drowning in information and starving for
knowledge not too bad and then from the
work of the statisticians that have
brought us a lot of the big data and
artificial intelligence research comes
the answer the statisticians job is to
make sense of it all to extract
important patterns and trends and
understand what the data says we call
this learning from the data we are going
to try to learn from the data what
geopolitical risk really is we have a
website at the volatility and risk
Institute at NYU which produces
measures of risk all over the world
every day and when you go to our website
the first thing you'll see is a
volatility map and what this is is a map
of the world color-coded for volatility
and this is the what it looked like on I
guess Saturday which was the forecast of
what Monday was going to look like and
the idea is that in countries where
volatility is low they're color-coded as
green and when volatility is high
they're color-coded as red and then
there's gradations in between so the
surprising thing you see from looking at
this map is of course how much green
there is we often think volatility in
this in asset markets is high but in
fact it's typically these days quite low
and it has been low for quite a long
time although there are pockets of time
and pockets of places where it's higher
you see on here notably Chile in
Argentina
both have had political difficulties and
show heavy red color coding for their
financial markets but not too many other
places show that kind of high volatility
but if you look back in time of course
after the brexit vote you see that a
great deal of the world turned red in
particular something like 20 markets in
in you in Europe are all red in this
picture as well as the US Canada
Australia South Africa Japan Thailand
that lots of places are red so one of
the things we see when we look at
measures of volatility and this is again
from V lab you see that volatility is
continually going up and down and what's
plotted on here is the volatility
different asset classes some of these
are stocks some are bonds some are real
estate we have commodities and I think
even and the euro is on there and I
think even exchange rates are on this
this map so on this chart
why do volatilities move like this well
it's not too surprising really we have
an explanation for this which is
generally that factors that we consider
to be important in pricing assets and
measuring the risk around the world or
the the reason that they all those
factors carry this information and these
factors explain why assets are
correlated with each other but it turns
out that these factors of asset pricing
do not explain why volatilities are
correlated with each other if you take
out the factors so that we see only
what's called the idiosyncrasies that is
the part of returns that are not
explained by the factors they also peak
at the same time so it really is not our
the factors that we tend to study and we
build our financial morals about that
explain why volatilities move together
so what is it well I think its
geopolitical risk and that's where we're
going tonight so here's some facts about
volatilities that we'll find useful in
understanding this even though asset
returns are nearly impossible to predict
volatilities are not too hard to predict
we can build statistical models to
predict volatility that's what I got my
Nobel Prize for and it's what I showed
on that
last last slide so called arch and GARCH
models are early candidates and there
are much more recent candidates for this
now but if you can predict something
then you can talk about the surprises in
this prediction if you predict something
and what happens is different then
that's a surprise we call it an
innovation and what we are going to show
is that the volatile stew volatility are
really where geopolitical risk lies
these shocks to the volatility of one
asset class and the shocks to volatility
of another asset class of a one country
and another country are all correlated
with each other so the fact that these
volatility shocks are correlated means
that that this is a pervasive factor
that we have not previously identified
and it's a volatility factor which we're
going to examine so I'm going to call
this factor G of all so that we give it
a name and it stands for it geopolitical
volatility but it stands for it in a
very particular fashion when G of all
has a high value it means that all asset
returns are more volatile they aren't
necessarily going down they might be
going up but their volatile and so G of
all is going to be high when there is
news which affects all asset classes and
all countries around the world that's
the idea
sometimes G of all will reflect
political or military or terrorist
activities sometimes it's very impactful
economic news but altogether we're going
to think of it as geopolitical
volatility so how do we measure the
shocks to volatility well if you have a
way of predicting volatility which the
arts and GARCH models are a way of doing
this then we can talk about how good
your predictions are and so if we look
at the return on stock - what it was
predicted to be using past information
and these factors of production that's
the error in predicting what the stock
market was going to do and the
volatility is the square of that we're
going to divide it by the predicted
level of volatility to make it a
percentage error in volatility and that
is the raw material that we're going to
talk about tonight the difference
between what the stock return is and
what is predicted to be is a forecast
error and it's square is a volatility
shock so we construct our factors of
production so that there's no more
correlation across assets but this does
not imply that the squares of this asset
are not correlated and this is the
factor which we're going to use to
define GOL we can look at the
correlation across assets in this square
of this volatility shock and see whether
in fact there is something something
that we hadn't previously observed which
we are going to call the G of all so
I said I wasn't going to have any
equations tonight I I promised that I
wouldn't have any equations I know
you're heartbroken about this but well
here's one I think it's the only one
which says let's write down an equation
which tells you how this G of all shock
affects a particular asset so this is an
asset that you're holding in your
portfolio and we want to know what its
variance is when we do risk management
we're always interested in variances and
so this is a question what is the
variance of of the asset that you've got
and it's if X is the G of all we think
that this asset might have a coefficient
which is this impact so this is a factor
well in the language of factors this is
a factor loading but in language of just
common sense it's the fraction of G of
all that you're going to get so if your
if your asset is not very exposed your
little s is going to be a small number
if your asset is highly exposed to
geopolitical risk then your little s is
going to be a big number and since we
know that the variance of e is supposed
to be 1 since we this is a normalization
that we've already done then we have to
add 1 minus s to this and this is our
little simple equation for how a
political volatility affects the assets
that we own it affects all of them but
it affects some more than others
ok ok so our interpretation is that X is
like a variance and when the factor
loading is high it means that
the stocks which have this high factor
loading will have a bigger standard
deviation than stock when this X is
small and when the s is small it isn't a
big difference but when s is big there's
a big difference between times of
geopolitical volatility and times
without it so this looks like another
equation but it's really the same
equation and for people who know how
I've written volatility models in the
past we can think about the shot to our
asset return as being written as
volatility their standard deviation
times a purely random shock and this is
the equation which we use for arch
models we use for GARCH models and but
this is a different version of it which
is specifically designed for this GEVO
factor okay how does this work let's
take a look at a data set and this is a
country data set with one ETF which are
traded in the US and the picture in blue
is for the returns of the first asset
and the data set which happens to be
Austria so you can see from this that
sometimes what returns are more volatile
than others and if you're interested in
what we mean by volatility it means that
the amplitude is high and you can see
the financial crisis it is a time of
very high amplitude or high volatility
for this asset if you build a GARCH
model on this asset and you plot two
standard deviations of it you get the
red curve on the top and you can see
that's a way of measuring the volatility
at every
point in time and when I showed you the
volatility of map of the world it would
be the last point on this picture if
this was the end of our data set would
be telling you what the volatility is
predicted to be tomorrow so you can see
it goes up when volatility is high and
goes back down otherwise and so it's
it's a clever little statistical model
which does that the bottom curve is our
shocks to returns divided by the
predicted standard deviation and when we
think we have a good model for
volatility what it means is there is no
more change in amplitude that's
predictable there's no more what we call
volatility clustering in the green curve
and looking at that picture you say this
was successful and I tell my students
look at this when there's no more
volatility clustering it means that
you've done a good job estimating this
model and people all over the world
stopped modeling at that point but
tonight we're going to carry it a step
further because you can see that there
are some days in which the volatility is
bigger than usual and some days when
it's smaller than usual and what we're
going to recognize is that the days when
it's bigger than usual for Austria it's
likely to be bigger than usual for all
the other countries and that's the new
piece of information that we're going to
use to define geopolitical volatility
okay so
this is what the data looks like you
know these are the stock returns in all
these different countries when you've
estimated the the models for each of the
country you get this is the green
picture for each of these countries they
don't look exactly the same but what we
want to know is whether they're big at
the same time in different countries so
a way of doing that is to square them so
that positives and negatives tree are
treated the same and then look at the
correlation structure and if you look at
them we have something like 45 countries
so this correlation matrix has a whole
lot of entries in it and this is just a
little part of it and this is the
correlation between the first 16 of
these and the first six over here you
see the numbers aren't very big but
there is something very special about
these numbers they're all positive and
if these were random there half of them
would be negative but they're all
positive and if you look at this 45 by
45 matrix you still you will see that I
think all of them are positive still so
this is very significant evidence that
there is a geopolitical volatility
factor which is driving all these
countries at the same time so I have a
nice little econometrics way of
estimating this it involves estimating
time series models to get the to get the
factor loadings and cross section models
to get the estimate of G of all and then
doing it over and over again until it
converges probably you don't want me to
do that right okay let me just show you
the results this is in the middle here
there we go in the middle here is the
data on the G of all and it's sorted so
that the largest day is first and then
there are something like 5,000 days in
the data set so the smallest one is way
under the platform here so let's just
look at the at the top of this list the
date of the largest G of all event is
2001 September 17th so what is that date
well that date is one week after the
9/11 terrorist crashing the airplanes
into the World Trade Towers in New York
and the markets were closed for a week
and so this is the day they reopened and
this is the the biggest geo volatility
shock in our data set by this measure
the second one is 2016 June 24th that's
brexit this is the day after the brexit
election vote the third one is 2007
February 27th so this is the first early
warning of the financial crisis and it's
also a day when the Chinese stock market
had a big big drop Chinese stock market
had a big drop and UBS had some hedge
funds that were invested in mortgage
securities which got into trouble so
this actually was a harbinger for the
financial crisis and move markets
dramatically
I don't think we have a good
identification of April 21st but in 1997
October 27th there was a stock market
crash which caused the exchange in New
York to be closed early then we see we
have down here the the Trump election in
2016 11:09 that's November 9th going
down a little further we get commodity
collapse and Chinese stock they call it
Black Monday this is when the the bubble
and the Chinese stock market actually
collapsed and 2008 September 29th is the
day on which the house rejected the tarp
bill and down here 2008 October 13th is
the day they passed the tarp bill in any
case you can go down this list and may
you may be able to identify some events
that I haven't done yet but it's a
pretty reasonable list of things that
have happened over the last two decades
two to two and a half decades really and
which ones really moved all the markets
of the world that means that they are
geopolitical events on the far right
hand side is what the average of all
these markets did on that day and so you
see many of those are negative so that
when when there's the geopolitical event
typically the returns or negative
however for some of these events the
returns are positive they move the
markets a lot but it could be up or it
could be down
now corresponding to these events our
factor loadings so these are what tell
you which asks which countries are most
impacted by these geopolitical events so
you multiply the geopolitical factor by
s for each country tells you how much of
it you're you're getting and the highest
ones are France Netherlands Germany
Spain Belgium so those are all European
countries and they were impacted
together but then you also see Thailand
Malaysia Korea United States is down a
little a little bit further and you go
down this list China is in the the
second top of the second column and as
you keep going down and you find you
come to the ones at the bottom which are
less impacted by geopolitical risk and
there's Pakistan New Zealand and the
third went up is India so it's the
countries that are in the bottom of this
list may have a lot of volatility but
it's not so coordinated with the rest of
the world so they're less sensitive to
geopolitical risk and I think a lot of
that makes sense
and so the
I think it's interesting to see what
these are this is really our first
estimate of these factors but it may be
that this is leading us to a way of
taking our portfolios and tilting them a
little bit toward assets which are less
correlated with the geopolitical events
of our times so
what are what are the Kippur some other
approaches to measuring geopolitical
risk and do they give the same answer as
this well first of all let's take a look
at these numbers and look at these as a
one a monthly average and what you see
are some of these events here you see
the 911 as is the biggest on the screen
but also laymen's collapses hi
Chinese bubble Dow Jones the debt crisis
brexit Trump but interestingly when you
get all the way to the present it
doesn't look that high we tend to think
that we are in an age when geopolitical
risk is really elevated but the markets
don't seem to know about that the
markets think this is not a time that's
especially dangerous and that's the
green that we showed on the volatility
plot map it's the markets are not so
worried about these geopolitical events
as we tend to be here are two more
measures of geopolitical risk one of
which is the geopolitical estimate of
political uncertainty and that's in blue
this is by three professors Baker bloom
and Davis and what you see is it was
somewhat elevated during 2001 when the
World Trade Towers were hit it was
somewhat elevated during the financial
crisis but it's actually higher since
2016 and maybe the highest
on the entire graph is in 2000 2019
that's this year so this is a measure
which is based on newspapers reading the
newspapers and seeing how much political
uncertainty is there when you read the
newspaper and there's a lot of political
uncertainty when you when when writers
write about the geopolitical risk
they're very concerned about the events
of our times and it shows in the
newspapers and it's on the screen a
second one is by two researchers at the
New York at the the Federal Reserve Bank
in Washington and that's a little bit
more focused on stress between countries
but particularly military and terrorist
stress and you see it has an enormous
spike around 9/11 and also subsequently
the Iraq war that relatively
disastrously we did so it shows a little
bit of a rise at the end but it's
certainly not the highest it ever was
and but it is elevated here's a third
one and this is comes from Blackrock
which has a careful analysis of
geopolitical risk based on experts they
asked expert opinion what are the 10
things that you're most worried about
and let's figure out how they are going
to impact financial markets and how
likely they are to happen and how big is
the effect going to be and so as they do
that they come up with this picture of
rising and following geopolitical risk
and this also thinks that today is
particularly high in geopolitical risk I
must say
if if your broker tells you to worry
about this then you might buy some stock
or sell some and I think if this chart
didn't show anything
Blackrock wouldn't be doing it so I
think that the I think that there is a
real reason to be interested in the most
recent part because that's where the
clients are are trading so I think again
there is evidence that black rocks
experts think that geopolitical risk is
high but all together these four
measures
don't tell the same story they're not
the same measures they're measuring
different things but if you're
interested in how vulnerable the markets
are it is not a time when when the
geopolitical risk seems to be high so
what are the implications of this for
financial stability do we have a heavy
weight over over us supposed to be funny
yeah it's okay so this is a nice
sculpture park outside of New York City
and it seems like a reasonable thing to
look at when we're asking whether there
is an implication for financial
stability of this geopolitical risk so
I'm going to show you some data on this
risk which is what we call systemic risk
and what it is is a way of measuring
whether the financial sector is under
stress whether the financial sector is
under capitalized we calculate this
measure
once a week for more than a thousand
financial firms around the world we can
do it with publicly available
information it uses some of the
statistical methods from the Nobel Prize
to talk about time varying volatilities
and correlations but basically it's a
pretty simple measure what's it supposed
to measure it's supposed to measure the
number of dollars a financial firm would
need in order to continue to function
normally if there is a global stock
market decline of 40 percent over the
next six months okay so there's the
stock market goes down financial firms
stock goes down with it does it go down
so far that they need to raise capital
in order to continue to do their
business that's the question and if they
have to raise capital how much they have
to raise how does it work
it looks at the ratio of the market cap
to the accounting liabilities it looks
not just in what that ratio looks like
today it looks like what that ratio
would look like if the global stock
market fell by 40 percent okay and then
it says okay how much capital would you
need to bring it back up to a normal
level which we interpret is 8 percent
for many financial institutions that's
more or less where they operate so s
risk as a consequence is high when the
market value of assets is low that is
when they're the loans that they've
written or are low in value or the
companies that they own go down in value
and it's especially high when the firm
is highly levered and big so why is this
important well in Western economies when
the firm has highest risk it means that
it's vulnerable if there's going to be a
financial crisis it's at risk you know
no one wants to raise capital in the
middle of
downturn so the risk manager and the
regulator are going to come to these
companies and say you shouldn't have so
much leverage you should reduce your s
risk you should reduce your leverage
reduce improve strengthen your balance
sheet commonly this is done by selling
assets and using the proceeds to retire
debt so if one firm does this it's
likely to be pretty successful in its
strength in its balance sheet but if
it's one of many firms in a country that
are trying to strengthen their balance
sheet at the same time then there are no
buyers for these assets and that's
exactly when the price is going to fall
a lot unless international buyers will
buy these these assets these loans these
bonds but if the rest of the world is
also undercapitalized at this point and
they're not going to buy them either so
they're going to fall dramatically in
value as they fall in value the stock
prices will fall even further for these
financial firms they will there s risk
will get even higher and we have what we
call a fire sale spiral where the values
spiral down because everyone's trying to
sell these assets you could think about
the the mortgage-backed securities that
that banks tried to sell during the
financial crisis the values fell so far
that they decided they often that they
wouldn't sell them but they couldn't
really restructure their balance sheets
it shows how hard it is to do this when
you try to do it all at the same time so
the risk of one country depends on its
financial institutions and how high
their SRS is but it also depends on the
rest of the world
and this is one of the reasons why
cooperation in coordination of monetary
and and and financial policy across
central bank's is tremendously important
I should say that this is described in
more detail in a paper in the
Proceedings of the National Academy of
Science that I wrote with my co-author
Tian Yu Rouen who is a professor at
National University of Singapore why is
this important in China or why is it
important in India well in economies
such as China and India where many of
the financial institutions are
state-owned the pressure for an
undercapitalized institution to deliver
is reduced because there is since their
state-owned there is no possibility that
a Chinese bank is going to fail and I
don't know but I don't think there's a
strong possibility that an Indian public
li owned government owned bank is likely
to fail there will be capital
forthcoming - to bail them out they
won't have to rely on the private sector
to try to do this nevertheless if such a
bank is undercapitalized they are not
going to want to make new loans if they
make new loans and then it turns out
that they are they need to go and beg
for money to the government they are
going to feel like they're going to be
criticized as bad managers who don't
know what they're doing and perhaps lose
their job so they're on top of this
state-owned banks often have legacy
loans that are underperforming they may
be non performing or just
underperforming and there will be
pressure on them to extend re-extend
loans to to these companies and
that puts further pressure on the
balance sheet of the banks so as a
consequence if the state-owned or or
private borrowers weaken the banks tend
to weaken even in state-owned systems
and so the same kind of dynamic maybe
not true there what to do well rather
than extending new loans to legacy
borrowers we state-owned banks can
contemplate letting the loans default in
letting the loans default has not been
very common in China China tends to
think that that's leads to social unrest
and so they have stopped doing they
stopped a lot of defaults from happening
in India there is a new bankruptcy law
which will some of you know a lot about
so in any case if we think that
bankruptcy laws are like a hospital for
distressed companies then really it
might make sense to fail to roll over
existing loans and make new loans to
more profitable companies and let the
old loans default there is some
collateral that you can recover and it
may be actually that has more value as a
strategy than rolling over the old loans
so from a social point of view of course
this also makes sense because you'd like
to reduce your exposure to industries
which are growing slowly or declining
and increase your exposure to the growth
industries you don't want to you don't
want to maintain zombie banks something
sorry zombie firms as your creditors if
you're a bank
so let's take a look at the data data
comes in all different shapes and colors
and let's see what we see
so here is the picture that worries me
this is the sum of all the s risk of all
the countries in the world so this is
what we calculate every week and if you
add up all the dollars it looks like in
the financial crisis it would have taken
a little bit less than four trillion
dollars to recapitalize all the banks in
the world in this European
sovereign-debt crisis it would have
taken just a little bit more a hair more
maybe maybe four trillion to
recapitalize them all the third peak
doesn't have a name but I think it's got
something to do with China but the last
one is the one we want to talk about
where it's actually inched above the
same level of everything we've seen
since 2000 so today we have the sum of s
risk that's higher than it's ever been
by our measurement so we have to
understand a little better where it is
what the causes are is it likely to lead
us to a financial crisis here is a
picture of what you see when you look at
the Americas this is North and South
America and at least by this low point
which is January of 2018 it's clear that
the level of s risk has come down and at
the if we stopped time at exactly the
right moment we'd say in fact we've
gotten back to pre-crisis levels but
it's now rising at the end and I think
that could be interpreted as a
consequence of this trade war
if we look at Europe you see something
similar although it has not declined as
much but it's also not rising as fast if
you look at China I mean at Asia you see
a very different story we see debt
rising the under capitalization of the
financial sector is increasing in a
pretty inexorable way over this whole
sample period particularly since the
financial crisis if you look at China by
itself you see it's even steeper so this
is obviously where some of this high s
risk is coming from if you look at Hong
Kong you see the very sharp rise just at
the end but I mean that's probably due
to the protests in Hong Kong which have
I think decimated the financial markets
to some extent and you want to see the
next one or not what is the next one
going to be it's India you're right
so what do you see when you look at
India well it doesn't have this rise at
the end it's been sort of the same level
for maybe eight or nine years and it's
jiggling around but it's not really
getting worse and it's not getting
better it's just sort of level so the
question that you're asking yourselves
is is this is this a problem so we want
to get to that so if we summarize all
these pictures that I just showed you
here's China the highest second highest
Japan I didn't show you that
then we have the United States UK France
Canada Korea and so forth and then
here's India well right in the middle
you can see it there and so it's by no
means the biggest of all at all it's
really sort of in the middle and there
are of course many countries down below
this that are have no asterisk at all
this is just these are these are the the
largest if you think that this fire sale
is the concern then you should use the
same scaling some of these countries are
bigger than others and that makes a
difference to how much s risk you would
expect and how much s risk you can
tolerate a good way of scaling is the
total assets in the financial sector and
that's the way Tian Yu and I scaled them
in the National Academy paper and this
is now the same picture but scaled by
total assets and now you see first of
all China is no longer on top it's moved
down a few spaces India is still sort of
in the middle but Japan is on top and
then we have Korea and actually Jersey
and Denmark a sort of smaller countries
there they probably don't have have the
impact but they might have the risk and
if you look more closely at India I'm
sorry if if I offend anybody here anyway
the bulk of the s risk for India is the
State Bank of India how many of you bank
there okay so do you have risk well
probably not because it's it's a
state-owned enterprise we don't think it
actually has risk but it may be
contributing to the risk of India
and ultimately to the financial system
as a whole
well bankruptcy reform is kind of what
we think might be the solution for this
it's in in in China there is a new push
to have lots of new bankruptcy courts
that are using a more US style
bankruptcy program and that is probably
a good thing there are there are NASA
and bankruptcies in China there are
mostly there in the private sector but
there have been some defaults in the
public sector in the state-owned
enterprises and my feeling is that by
providing a much more extensive set of
court systems and a more liberal
bankruptcy law it's going to be possible
for China to reduce the debt load on its
banks India is doing the same thing so
in a sense there is a lot of similarity
between these two countries even though
there of course many differences the
bankruptcy reforms were passed in 2016
which actually forced lenders to send
borrowers to bankruptcy for any missed
payment so the idea that there could be
long term non-performing loans on your
balance sheet is isn't challenged by
this law it doesn't mean that you can't
extend new credit to someone so that
they can actually pay back the old one
so that still is an option that banks
must decide whether they're going to do
or not however
this has fins a blowers was struck to
this by the courts who blocked
restructuring and sr steel and putting
this whole program in limbo but I gather
in just about a week ago the Supreme
Court rejected the lower court ruling
and has now allowing the new bankruptcy
procedures to continue in a timely
fashion so I think that that the
prospects for bankruptcy reform and
removing the non-performing loans from
the Indian banks or actually look pretty
promising as well excessive red tape and
interminable judicial schedules make it
difficult for everyone to plan what to
do about non-performing loans it makes
it difficult for the banks to decide
whether to extend new credits it makes
it difficult for firms to decide how
much risk to take it makes it difficult
for the banks to decide whether to send
extend the first loans to a risky
company so transparency in this judicial
system will be extremely valuable
incompetence is going to be extremely
important so much remains to be done to
reduce the backlog but I think the
direction is quite promising you can see
here the increase in ongoing bankruptcy
cases in India and the also the increase
in closed and you know resolved
bankruptcy filings in India so this
doesn't go up to the present but I think
it probably my guess is it continues to
look like this so in closing the
question is are we prepared and I leave
you with that question so thank you
anyone has any questions please use this
opportunity I think you'll probably get
a lot more through Q&A as well so we'll
just have to get mics around professor
my question please do the markets over a
period of time trying to they become
used to certain level of geopolitical
risk and therefore the next peaking is
much higher or much lower because they
have absorbed into their working the
markets have absorbed into their work
working certain levels of geopolitical
risk it is like a child when the child
grows the ability is better so it's
somewhat similar so so you're asking
whether people learn whether or whether
bankers learn I guess I should hope so
you know after after a big downturn such
as the financial crisis or the Asian
currency crisis which had a lot of a lot
of people that I think banks became more
conservative but not everywhere some of
the you know that I wouldn't say there's
evidence of that in in China those well
of course maybe they didn't feel the
really the the brunt of the financial
crisis so maybe that would explain why
that they didn't seem to learn but it's
also that you know you get the next
generation of managers they weren't
there we have seen in the u.s. that ten
years after the financial crisis
Congress and the Trump administration
have pretty much agreed that the
regulations are now too strong we should
really deregulate the financial sector
and
you know that could be there could be
some truth to that
but it also sounds like they're
forgetting what happened so anyway I
like to think that we learned something
from this yes I agree I see one back
there okay hello hello professor you
talk about as risk and how you calculate
it when the stock market Falls by 40%
but there could be different kinds of
decline in the stock market for example
when there was a tech burst the stock
market did fail but the banking sector
was not that much stressed compared to
the 2008 crisis so I was wondering how
do you take into account the two
different kinds of stock market crashes
and another question was that there can
be different kinds of geopolitical risk
which will affect different kind of
assets differently for example a gas
power would affect India very
differently and SJ could be very high
for a gulf war compared to say a brexit
which would affect India much lesser so
you have kept the weight on the asset
constant but it could be different for
different kinds of geopolitical risk so
do you have any comment on that well on
your first question
see what Oh different kinds of crises so
in in the measure of s risk of course we
don't know whether there's a financial
crisis happened but when we built this
little statistical model that would I
didn't really show you but I talked
about our dependent variable in that was
a measure of whether this country has a
financial crisis at this moment and how
severe it is and so the tech bubble
doesn't appear in in this kind of
dependent variable so I'm only looking
at whether s risk helps predict a
financial crisis not just a downturn
okay so that's the first part of the
question the second question
right okay so the model that we've that
I've estimated and I showed you tonight
treats them the same you know whatever
volatility shock is is large we call it
a G of all shock and we have one factor
loading for this G of all shock is it
too simple a model maybe and I think
there's a scope to have two gu Vols jus
vol 1 and G of all - and then you'd have
separate factor loadings but I think you
know we want to start with something
small but we can probably ask questions
like are these things all the same and
it wouldn't be it wouldn't be hard to do
a test for that but I think what you two
have a hard time doing is deciding which
of these five thousand days you're going
to think of as G of all one and which of
the five thousand days you're going to
think of as G of all - you know we can
maybe do it with a top ten but after
that it's going to be hard to figure out
how to go professor
yes it would be good for people to also
identify themselves until tanker I'm
from the National Stock Exchange
professor what's the intuition behind
relatively low levels of gia wall and
lifetime high risk high levels of s risk
at the moment how do we see them these
two these two things together I mean why
am I putting them in the same talk yes
yes so if so the question is how much of
the increase in s risk is due to
geopolitical news I think that's really
the question that's what I'm I am
concerned about and if you think it's
the trade war then we're talking about
geopolitical news which Blackrock
observes and my measure doesn't observe
and that would be the explanation from
what's going on if we think that the
reason Chinese s risk is so high is
because of the dynamics of the Chinese
economy where they're trying to hit
growth targets where they're trying to
transform their economy from a export
oriented investment economy to more of a
consumption economy then it's a
different it's not G of all it all that
it's causing this so I think I think I
don't exactly have an answer I think
what I've done is tried to raise the
question of do we think it's really
Jiabao geopolitical news that's causing
the financial sector to be as
undercapitalized as it is but it doesn't
really feel like the financial sector is
sufficiently undercapitalized that we're
going to have a financial crisis in in
the immediate future but the trend
doesn't look very good so I have a very
similar is sanguine from our bein coal
we have a very simple question we are
thinking of acquiring a company in UK
the problem is that there are lot of
inefficient staff working there and if
we are to remove them we are given the
legal advice that it will be big
compensation to be paid due to local
Social Security No
in UK this is a geopolitical risk can
you call it as a geopolitical risk
so you're you're asking okay whether
there are issues going on in the UK
there are geopolitical risk do you think
they're moving markets all over the
world they're just moving they're moving
your business maybe but I don't think
that they're going to be shocking
increasing volatility in in the US and
then in Latin America and so forth so I
don't think that would end up showing up
one of my GU ball out out put if I
understand correctly thank you
Thank You professor my name is a pho
confirmation Center for corporate
governance and sustainability for me
personally it was a great tutorial for
geopolitical analyst though it was a bit
of a mind gem for me but I want to step
back and talk about wherever you go
internationally today you think you
listen of another risk which is climate
climate risk and I would like to know
from a Nobel laureate like you for
example companies like ExxonMobil are
being already questioned by a security
Exchange Commission that billions of
dollars which are logged into fossil
fuel all kind of a thing while the whole
business model and world is moving
towards renewable energy the climate
risk how will is going to impact the
capital markets so is climate risk a
geopolitical risk is that is that a
short version of your question no oh is
of course I've been been United States
pulls out of the right you know 2010
records it's one but overall I wanted to
know whether climate risk per se I mean
one of the things about climate changes
it's pretty gradual and it's got a long
horizon but I I do believe that when
there's news about the climate that does
move markets I think that if you're
holding a portfolio that includes a lot
of fossil fuels companies and there is
news that the climate is worse than
people thought and it might be news that
shows up as weather or wildfires or
something else but it's it's an event
then your portfolio of fossil fuel
companies may be impacted and you might
expect
and yeah you know we think I what I
think is that there's a factor which is
a climate factor that we don't identify
and it would be fossil fuel companies
that would be in it and it would be
probably you know alternative energy
companies that you'd short in this
portfolio and that portfolio is going to
go up and down as there's news about the
climate change so the question of
whether this is the geopolitical risks
or not there's a question of how many
people hold this portfolio I think and
whether it moves it very much hi this is
Badou shaker from CFA Institute you use
the same measure s risk systemic risk
for us as well as China you know all
countries and these are very different
markets the response to a shock would be
very different in a state control
financial system like China versus you
know what we can expect from the US so
is how useful is s risk as a measure
when applied to very different contexts
and how does it connect to contagion so
for instance China may have very high s
risk measure but we need not worry too
much about it because they may manage it
in a way that is very different from how
the UK will manage it well I think I
agree that China is very different from
many other countries but so was India
and so is the United States and and
there's a lot of differences so I think
that that we are trying all the time to
figure out whether this model applies to
China and I think actually that's what I
discussed tonight is whether the
the model of how a financial crisis
would occur is the same in China and
India as it is in say Western Europe or
the United States and you know we my
view is that they are they do look
different and we need to take that
difference into account which is
actually what I described now there are
other things that are different which
are interesting as well and for example
there's a big shadow banking sector in
China that is not in our data set well
if what were really in there s risk
would be higher there is also because of
the government guarantees of these banks
you could imagine that the stock market
valuation is actually higher than it
would be if there was really a
possibility that they would default
that's also would lead to a higher risk
than what we have it seems to me most of
the corrections to my measure of s risk
would make it higher in China than what
we're observing I mean maybe that's what
your point was but so I think we are
trying to be conscious of the biases
that might be in here but still be
comprehensive we want to have a measure
that we can use in 70 different
countries which have all sorts of
different standards and accounting
systems and stock markets and you know
no one else can do that
so we had to we did it in a way that's
kind of as well as we possibly can
preserves
the features of each country and yet is
sensitive to the data and so forth
that's available
this is all V Neela Canton from
Catherine so my question was about your
G oval measure and I noticed that it was
the highest measures were for the US and
then to a lesser extent China so I'm
wondering to what extent G of all is a
proxy for the size of the economy and
its integration with the rest of the
world or whether it's capturing
something more than that well we tried
to capture that with the factor loadings
by saying that you know different
countries would have different exposures
to it but I think it's also not so
surprising to find that events that
happen in the US are more likely to
impact the whole world than events that
happen in Ireland and so I don't think I
don't think that all countries have an
equal impact on on global markets so it
might be if we had a different different
dataset or or use currencies that we
didn't have in here it would be somewhat
different I think the basic features
would be the same but it would be some
differences since we love to take
another two to three questions with
respect to what you said about can you
identify yourself as such in from
Business Standard this is with respect
to what you said about financial
institutions in India in particular what
advice would you give to the
meant with regard to the
undercapitalization that you currently
see and how urgent would a
recapitalisation be or would you suggest
other measures such as a privatization
well I think I think that if if the
banking sector and in India worked to
follow the new bankruptcy guidelines it
would actually reduce there s risk it
would improve the profitability and it
would improve the growth rate of the
Indian economy so that is actually going
to have the same effect of
recapitalizing the banks because they
will be more profitable more profitable
and a higher higher stock market
valuations so I kind of think that that
that is a good strategy for dealing with
this rather but it could be that that
the that the natural thing to do would
be for the banks to actually sell some
of these loans but I don't know what the
market looks like for them I don't know
how they're structured I don't know how
easy it would be to sell the the kinds
of loans that are non performing but
there are actually lots of distressed
debt funds and so forth that take
non-performing loans and go try to
collect them and you know there that's
another strategy for trying to improve
the strength of your balance sheet and
it might be more profitable to do it
that way then through default I don't
know it depends on how the institutions
are working the last two questions and
then we'll take one here go ahead please
yes good evening sir
de su chuan J Basu from national
institute of bank management Pune I had
two questions first shouldn't there be
an end or charity between s risk and
geopolitical risk higher geopolitical
risk believe it is risk but sure it s
risk also versus geopolitical risk
that's what we saw during the eurozone
crisis that was a major factor
that's questionable one questionable to
archon GARCH models they do capture
volatility clustering during periods of
high and low volatility but my question
was can they capture capture or predict
a spike in volatility or correlation
breakdown when markets are come to
signal the onset of a crisis thank you
sir
yes I think there is every reason to
think that G of all and s risk would be
endogenous but I don't think that
changes what we would do it might change
the policy implications of it but really
there aren't a lot of policy
implications of gol because it's not
even predictable so you know I think I
think it is that's why I put them
together on the slide actually so the
second question
oh yeah predictable hello
during a benign or calm market period
can your arch and arch models predict a
sharp spike in future volatility and
correlation breakdown to signal the
onset of a crisis well I mean arts and
GARCH models never are anticipated to
predict things that that are that are
surprised if you talk about the onset of
a financial crisis and you know it's not
predictable the arts and arts models
aren't going to predict it either and so
what happens is that they predict that
volatility will be what whatever they
predicted as of the day before and then
when it turns out that this is the day
when a financial crisis starts and there
is a big return shock probably a
negative shock then that says ooh that's
a big volatility shock and the the
volatility the next day is going to be
high as a result of it and so what we're
doing in the Geo ball is were extracting
that shock and saying you know that's
what happened on the day the crisis
started what else happened on the day
the crisis started did this show up as a
big shock in in Belgium and a big shock
in New Zealand then the big shock in in
India or not and so that's exactly where
we get the power to do the G of all the
last question please
this is Roberta from NEC
I want you to understand about the
geopolitical
Indians that you have created do you
think that depends on the frequency or
frequency of data that have used because
if you see on 9/11 the Giavanna index
was the you know highest as compared to
the other period but if you see new in
the trade war time the Geo mall declines
it did not show us much of and you know
pink in the volatility so if the
geopolitical risk previous for a longer
period of time then the index value is
not showing that much of peak for that
particular time as compared to the 9/11
which which is a single day event
right okay thank you so a continuous
event isn't going to show up
particularly strongly in the G of all
measure because there isn't one day in
which this happens but during a
continuous event like the trade war you
will see elevated volatilities every day
you're likely to anyway and so when I
took averages of the G of all over a
month things that were small but
systematically above-average
volatilities did show up in in the
average G of all even though it doesn't
show up on my top 10 list okay thank you
very much everyone and once again thank
you very much professor angle for taking
those questions thank you
so please stay back for a second
professor request mr. limit to please
present a memento to felicitate
professor Robert angle sir please accept
this special slab as a token of
gratitude and appreciation thank you we
are indeed very very privileged and
fortunate to listen to you gentlemen
please take your seats while I call upon
mr. je la vie chandran director NSE to
propose the vote of thanks
a Silver Jubilee is a big moment but
equally important is the recognition of
the architects of the institution the
dr. Raj Patel Memorial Lecture seeks to
honor a man who was the founding
managing director of NSE and helped
transform the financial markets
he was an institution builder par
excellence and a simple humble person
professor Engel thank you very much for
agreeing to be the keynote speaker at
this Tata Norwich Patel memorial lecture
event we are indeed grateful that
despite a hectic travel schedule and
extensive commitments you took time to
stop by and spend so much time with us
in recent times geopolitical risks in
recent times geopolitical risks have
escalated along with political
uncertainty and Markus have felt the
full impact of this your research and
experience from both academia and
practice provided us with some excellent
insight about how to understand this and
be better prepared to handle that we are
grateful to the government say B or ba
and other regulators our trading and
clearing members investors shareholders
listed companies technology partners
business partners industry associations
members of the media our Board of
Directors and our employees past and
present for their roles in building and
strengthening this iconic institution to
all of you who are present today thank
you very much for your presence support
and encouragement in helping us host the
dr. Patel memorial lecture and making it
successful this lecture is an annual
event and we look forward to our
continued presence
inspiration and support air after year
thank you very much on that note we
conclude today's event thank you all for
being a wonderfully lovely audience
kindly proceed for dinner that has been
arranged in the adjoining foyer this is
Marcy taking your leave have a great
time ahead thank you
you
you
