2012.04.18 - IMF_April_2012_text
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2012.04.18 - IMF_April_2012_text


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risky assets, an 
active and sizable market, and low market correla-
tion, among others.7 Importantly, different investors 
place a different emphasis on each of these criteria. 
For example, investors with long-term liabilities\u2014
such as pension funds and insurance companies\u2014
place limited emphasis on market liquidity and thus 
consider less liquid, longer maturity assets as safe. 
If their potential payoffs are linked to inflation and 
no inflation indexed securities are available, pension 
funds emphasize the real capital preservation aspect 
of safe assets. Global reserve managers consider all 
of these aspects, in view of the high share of credit 
instruments denominated in foreign currencies 
and their need to maintain ready liquidity. Finally, 
demand for some noncredit instruments, such as 
gold, is largely driven by perceptions of its store of 
value, with less regard to its market risk. 
Changes in Safe Asset Perceptions
The global financial crisis was preceded by consid-
erable overrating, and hence mispricing, of safety. In 
retrospect, high credit ratings were applied too often, 
both for private and sovereign issuers, and they did 
not sufficiently differentiate across assets with differ-
ent underlying qualities. 
6See also Gaillard (2011).
7For a more detailed discussion of the safety criteria for assets 
underlying liquidity risk management, see BCBS (2010a), pp. 
5\u20136.
0
1
2
3
4
5
6
7
8
Mar-
07
Sep-
07
Mar-
08
Mar-
09
Sep-
08
Sep-
09
Mar-
10
Sep-
10
Mar-
11
Sep-
11
United States Canada Japan
United Kingdom Germany
France Spain Italy
Portugal Greece
Netherlands Austria Belgium
Source: Bloomberg L.P.
Note: Yields greater than 8 percent are deliberately excluded to clarify developments in 
the low-yield range.
Figure 3.1. Ten-Year Government Bond Yields in Selected 
Advanced Economies
(In percent)
C H A P T E R 3 S A f e A S S e tS: f i n A n c i A l S yS t e m co r n e r S to n e?
 International Monetary Fund | April 2012 5
Ta
bl
e 3
.1
. H
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 1
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 s
ee
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ha
tia
 (2
00
2)
.
G LO B A L F I N A N C I A L S TA B I L I T Y R E P O RT
6 International Monetary Fund | April 2012
 \u2022 AAA-rated securitizations were found to embed 
much higher default risks than warranted by their 
high ratings. For example, as of August 2009, 
63 percent of AAA-rated straight private-label 
residential mortgage-backed securities issued from 
2005 to 2007 had been downgraded, and 
52 percent were downgraded to BB or lower.8
 \u2022 Five-year probabilities of default associated with 
AAA-rated sovereign debt were about 0.1 percent in 
2007, suggesting virtually no credit risk, but markets\u2019 
implied default rates had risen to more than 1 percent 
by 2011 (Table 3.2). The large difference between the 
implied default probabilities within each rating bucket 
across the two periods suggests that the default prob-
abilities do not increase consistently with the decline 
in ratings, reaffirming ratings should not be relied 
upon as the sole quantitative measure of safety.9 
8See IMF (2009a) for a detailed discussion of securitization and 
credit ratings flaws.
9The implied volatility of default falls from 6.050 to 4.240 
between the BBB and BB rating groups and rises again for the B 
groupings, showing the large volatility across ratings.
 \u2022 Haircuts on the highest rated securitized instru-
ments in the U.S. private bilateral repo market 
increased sharply from near-zero precrisis levels to 
more than 30 percent for certain instruments (see 
Gorton, 2009).
 \u2022 In the euro area, the years following the creation 
of the monetary union were characterized by 
almost perfect convergence of government bond 
yields. As evidenced by greater risk differentiation 
since 2010, this development was arguably not 
justified on the basis of fiscal fundamentals of dif-
ferent euro area member states.
Empirical analyses confirm the mispricing of 
risk prior to the crisis. Returns show a high degree 
of homogeneity across assets of different quality 
within each asset class (Figure 3.2). Asset classes were 
grouped closely into asset pools with limited dif-
ferentiation in terms of safety. These pools included: 
(1) U.S. debt (sovereign, agency, and corporate); 
(2) Japanese debt (sovereign and corporate); (3) 
European debt (sovereign and corporate), including 
EU covered bonds and highly collateralized bonds 
issued by German banks (Pfandbriefe); (4) emerg-
ing market sovereign debt; and (5) a more dispersed 
set including equity market indices, commodities, 
and currencies. The very tight clustering of euro 
area sovereign debt shown in Figure 3.2 confirms 
that, indeed, prior to the crisis, there was little 
price differentiation across assets of varied quality.10 
Moreover, sovereign debt instruments of advanced 
economies were found to have highly homogeneous 
exposures to aggregate risk factors.11 This suggests 
that market prices did not embed information suffi-
cient to differentiate the underlying risks of coun-
tries with weaker fundamentals.12 
After the crisis, the differentiation in the 
perceived safety of various asset classes increased 
10See Annex 3.1 for details. 
11These factors include (1) the excess return on the global 
market portfolio as a measure of perceived market risk of an asset 
or a portfolio, (2) the VIX as a measure of market uncertainty, 
(3) the term spread as a measure of rollover or reinvestment risk, 
(4) a measure of market