Monday, April 20, 2009

The role of valuation and leverage in procyclicality

Published on the website of the Bank for International Settlements (BIS):

Executive Summary: Market practices related to market-sensitive valuation techniques appear to have contributed to an increase in the procyclicality of leverage in the financial system. This report sets out a menu of policy options that could be considered to mitigate these procyclical mechanisms. These include quantitative limits on leverage, steps to support better measurement and pricing of risk through the cycle (in particular funding liquidity risk), and measures to mitigate procyclical effects that mark-to-market valuation may have on incentives and decision-making.

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