Guillaume Plantin

Fair Value Accounting and Financial Stability

Market prices give timely signals that can aid decision making. However, in the presence of distorted incentives and illiquid markets, there are other less benign effects that inject artificial volatility to prices that distorts real decisions. In a world of marking-to-market, asset price changes show up immediately on the balance sheets of financial intermediaries and elicit responses from them. Banks and other intermediaries have always responded to changes in economic environment, but marking-to-market sharpens and synchronises their responses, adding impetus to the feedback effects in financial markets. For junior assets trading in liquid markets (such as traded stocks), marking-to-market is superior to historical cost in terms of the trade offs. But for senior, long-lived and illiquid assets and liabilities (such as bank loans and insurance liabilities), the harm caused by distortions can outweigh the benefits. We review the competing effects and weigh the arguments.

Deliberate limits to arbitrage

This paper develops a model in which an arbitrageur may prefer to incur limits to arbitrage rather than seamlessly refinance his positions with other arbitrageurs in order to relax his capital constraints. Such deliberate limits to arbitrage arise because the sale of a position cannot be unbundled from the communication of the idea underlying it. The absence of property rights on arbitrage ideas implies that this creates future competition. We let arbitrage opportunities differ along the ease with which they can be identified and along the speed at which they mature. We find that such deliberate limits to arbitrage arise for arbitrage opportunities that are neither too slow nor too quick to mature. The range of maturities for which arbitrage is limited increases when arbitrage opportunities are easier to find.

Elements of Risk Theory

This chapter first reminds the reader of insurance premium calculation principles and of mathematical tools enabling portfolios to be ordered according to their risk levels—“orders” on risks. Next, it presents the most prevalent model of the process of total claim amounts generated by a portfolio, namely “the collective model”. This first chapter ends with the main results of ruin theory.

Reinsurance Market Practices

This chapter describes the institutional context of reinsurance. It first strives to clarify the legal nature of reinsurance transactions. It next describes the structure of the reinsurance market, and then the different legal and technical features of reinsurance contracts, called reinsurance “treaties” by practitioners. Indeed, the business of reinsurance, though only lightly regulated, takes place within a set of customary rules, making it thereby easier to describe and understand. In particular, traditional reinsurance treaties fall into a limited number of broad categories.