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Keynes Fund

Summary of Project Plan

Large shocks such as the COVID-19 pandemic underscore the importance of understanding how economic agents perceive risk associated with ‘rare disasters’, defined as low-probability, high-impact events with sharp implications for asset prices and economic activity. Agents’ perceptions of disaster risk have been identified as a key factor hindering economic recovery following crises (Baker et al., 2020), while long-term scarring of beliefs has been argued to weigh on growth prospects and long-term economic outcomes (Kozlowski, Veldkamp, and Venkateswaran, 2020).

This analysis builds on a prominent literature which studies the financial and economic implications of a time-varying probability of disasters, where agents may revise their beliefs depending on circumstances (Gabaix (2012), Gourio (2012). In this project, we emphasize that beliefs about disasters are multi-dimensional and that the horizon over which agents perceive disaster risk (i.e., over the near or distant future) is crucial for understanding its effect on the economy. By way of example, the recent rise in COVID-19 infections may lead agents to revise their beliefs about the probability of a second wave and a repeat lock-down in the short-run, but may also lead them to revise their beliefs about the incidence and costs of pandemics in the long-run. These are two dimensions of risk that can affect saving and risk taking behaviour quite differently. Similar considerations apply to climate change: near-future concerns of extreme weather phenomena vis-a-vis concerns over the trend rise in temperatures leading to a higher frequency of extreme events in the coming decades.

In this project we propose a methodology combining empirics and theory to address three
main questions:

  • What do asset prices — in particular, the yield curve and equity prices — tell us about the evolution of disaster risk and its distribution over the short- and long-run?

  • What are the macroeconomic implications of changes in the distribution of disaster risk and what can we say about its transmission across countries?

  • What is the scope for macroeconomic and financial stabilization policies in open economies in the face of disasters, both ex ante and ex post?

We believe the project is fully aligned with the remit of the Keynes Fund. We combine theory in finance and macroeconomics, along with empirical work on asset prices to identify agents outlook for short and long-term risks and study the implications for economic fluctuations and policy. The project brings together authors from Cambridge and the Bank of England promoting the interaction between the two institutions and enhancing the opportunities for impact. Finally, the scope and complexity of the analysis will require the involvement and training of a Cambridge post-doctoral researcher and Ph.D. students, fostering intellectual cooperation.


*The views expressed here are those of the authors, and do not necessarily reflect the views of the Bank of England.


Research Output

Foreign Vulnerabilities, Domestic Risks: The Global Drivers of GDP-at-Risk

Foreign Vulnerabilities, Domestic Risks: The Global Drivers of GDP-at-Risk, Simon Lloyd, Ed Manuel and Konstantin Panchev, IMF Economic Review (2023)


We study how foreign financial developments influence the conditional distribution of domestic GDP growth. We propose a method to account for foreign vulnerabilities using bilateral-exposure weights when assessing downside macroeconomic risks within quantile regressions. For an advanced-economy panel, we show that tighter foreign financial conditions and faster foreign credit-to-GDP growth are associated with a more severe left-tail of domestic GDP growth, even controlling for domestic indicators. Incorporating foreign variables improves estimates of domestic GDP-at-Risk, both in and out of sample. Decomposing GDP-at-Risk into domestic and foreign origins, we show that foreign shocks are a key driver of domestic macroeconomic tail risks.

Sharing Asymmetric Tail Risk Smoothing, Asset Pricing and Terms of Trade

Sharing Asymmetric Tail Risk Smoothing, Asset Pricing and Terms of Trade, Giancarlo Corsetti, Anna Lipińska and Giovanni Lombardo, Cambridge Working Papers in Economics (2021)


With the Global Financial Crisis, the COVID-19 pandemic, and the looming Climate Change, investors and policymakers around the world are bracing for a new global environment with heightened tail risk. Asymmetric exposure to this risk across countries raises the private and social value of arrangements improving insurance. We offer an analytical decomposition of the welfare effects of efficient capital market integration into a "smoothing" and a "level effect". Enhancing risk sharing affects the volatility of consumption, but also brings about equilibrium adjustment in asset and goods prices. This in turn drives relative wealth and consumption, as well as labor and capital allocation, across borders. Using model simulation, we explore quantitatively the empirical relevance of the different channels through which riskier and safer countries benefit from sharing macroeconomic risk. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation.

Granular Banking Flows and Exchange-Rate Dynamics

Granular Banking Flows and Exchange-Rate Dynamics, Balduin Bippus, Simon Lloyd and Daniel Ostry, Cambridge Working Papers in Economics, CWPE2359 (2023)


Using data on the external assets and liabilities of global banks based in the UK, the world’s largest centre for international banking, we identify exogenous cross-border banking flows by constructing novel Granular Instrumental Variables. In line with the predictions of a new granular international banking model, we show empirically that cross-border flows have a significant causal impact on exchange rates. A 1% increase in UK-based global banks’ net external US dollar-debt position appreciates the dollar by 2% against sterling. While we estimate that the supply of dollars from abroad is price-elastic, our results suggest that UK-resident global banks’ demand for dollars is price-inelastic. Furthermore, we show that the causal effect of banking flows on exchange rates is state dependent, with effects twice as large when banks’ capital ratios are one standard deviation below average. Our findings showcase the importance of banks’ risk-bearing capacity for exchangerate dynamics and, therefore, for insulating their domestic economies from global financial shocks.

Project Information

Project Code: JHUX
Project Investigators
  • Daniel Ostry
  • Dr Simon Lloyd
  • Emile Marin
  • Professor Giancarlo Corsetti
Research Round
Seventeenth Round (September 2020)

Project Investigators

Professor Giancarlo Corsetti is Pierre Werner Chair at the European University Institute. He specialises in International Macroeconomics and Finance.

Dr. Simon Lloyd is a Senior Research Economist in the International Directorate of the Bank of England. His research focuses on International Macroeconomics and Finance.

Emile Marin ia a Ph.D. candidate at the Faculty of Economics, University of Cambridge. His research focuses on International Economics, Monetary Economics and Optimal Policy.

Daniel Ostry ia a Ph.D. candidate at the Faculty of Economics, University of Cambridge. His research focuses on Macro-Finance and Disaster Risk.