UST and UK gilts are based on total return indices from Global Financial Database  Chart 1: Average pairwise correlation between historical returns of FTSE 100 constituents  1.0 0.8 0.6 0.4 0.2 0.0 Jan-84  Jun-89  Dec-94  Jun-00  Nov-05  Source: Bank of England  BIS Review 2/2007  9  Chart 2: DDM Sensitivity of S&P 500 to a 1pp increase in the risk-free real interest rate Per cent change in S&P500  (Fixed, exogeneous real dividend growth rate of  -20.0 -25.0 -30.0  Average  -35.0 -40.0 -45.0 -50.0 991  1994  1997  2000  2003  2006  Chart 3: Equity index 3-month option-implied volatility  Per cent 80.0  60.0  S&P 500  FTSE 100 40.0  20.0  0.0 1983  1986  1989  1992  1995  1998  2001  2004  Source: Bank of England  Table 2: Probability masses in financial asset option-implied and historical distributions Asset USD per GBP JPY per USD USD per EUR SP500 10-y UST  Tail upper $ negative) lower $ negative) upper $ negative) lower lower (10y yield negative)  Option-implied tail  Historical tail  Historical period  15 15 15 15 15  16 16 14 11 10  1971-2006 1971-2006 1971-2006 1931-2006 1960-2006  Source: Bank of England  10  BIS Review 2/2007  Chart 4: S&P 500 returns: probability in lower implied pdf tail more than one standard deviation from the mean (3-month horizon) Per cent  18.0 17.5 17.0 16.5 16.0 15.5 15.0 1985  1990  1995  2000  2005 Source: Bank of England  Chart 5: JPYUSD: probability in lower implied pdf tail more than one standard deviation from the mean (3-month horizon) Per cent  (downside risk for dollar)  16.0 15.5 15.0 14.5 14.0 13.5 13.0  2001  2002  2003  2004  2005  2006 Source: Bank of England  Chart 6: Broad money across industrialized countries  % change oya 16.0  UK  14.0 12.0  US  10.0 8.0  Euro-area  6.0  Japan  4.0 2.0 0.0  1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006  BIS Review 2/2007  11  Chart 7: Pension fund and insurance company money holdings as a share of total financial assets  Percentages of ICPF assets 8.0 St erling deposit s  7.0  M4  6.0 5.0 4.0 3.0 2.0 1.0 0.0 1987  1990  1993  1996  1999  2002  2005  Chart 8: OFC’s M4 growth by sub-sector  Percentage points  OFAs  40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0  OFIs Securit ies dealers and ot hers Inst it ut ional invest ors OFCs M4 growt h  1999  12  2000  2001  2002  2003  2004  2005  2006  BIS Review 2/2007  Chart 9: World broad money (M2) growth (individual country M2 (or nearest equivalent) weighted by market exchange rates Per cent 16 14 12 10 8 6 4 2 0 1996  1997  1998  1999  2000  2001  2002  2003  2004  2005  -2  Chart 10: LCFI's debt held for trading versus representative indices  Index 31/12/2000 = 100 300 US LCFIs' Debt Holdings European LCFIs' Debt Holdings Global Broad Market Corporat e Index Mort gage-Backed Securit ies Index Asset -Backed Securit ies Index  250 200 150 100 50  2000  2001  2002  2003  2004  2005  2006  Source: SEC Filings, Published Accounts and Merrill Lynch.

For bonds and equities, a little bit more of the probability mass implied by options11 is currently in the lower tail (beyond one standard deviation) than is the case over fairly long-runs of historical outturns12 (Table 2). But for equities, bonds, and dollar exchange rates, the lower probability mass is pretty well in line with the average ‘tail’ implied by options markets in the past (Charts 4 - 5). That does not suggest much sensitivity to the various risks preoccupying the official sector. 9  This is a different point from that, advocated for example by Chairman Bernanke, explaining a fall in long-maturity risk-free rates in terms of an ex ante imbalance of global savings and investment. The two explanations are not mutually exclusive, as the observed fall in yields on indexed government bonds could reflect a combination of a fall in the risk-free rate and falls in term premia. 10  For example see Bank of England Financial Stability Report, Overview, July 2006, pp 5-13 and Bank of England Inflation Report, November 2006, Chapter 5. 11  Using three-month expiry options. 12  Since the 1930s for equities; 1960s for bonds; and 1970s for exchange rates. 4  BIS Review 2/2007  Market contacts offer various explanations for this – some of them, I should make clear, sceptically. One – and here bear in mind my earlier remarks – is that not much really nasty will happen given the collective wisdom of the world’s monetary authorities.