being taken over remarked that “ we have seen almost no drawbacks from being junk ”. another example of low implied volatilities and risk premia affecting risk taking occurs in cross border capital flows. in this case, low implied volatilities on interest rates and exchange rates can support cross - border carry trades because the yield pick up looks attractive when you can hedge the worst risks quite cheaply [ chart 11 ]. the continued smooth financing of global imbalances through these carry - trades in turn leads to low volatility. but this can of course work in reverse. foreign exchange volatility has jumped up since the us thanksgiving day holiday. if this volatility were to persist the perceived risks in the carry trade would increase. the common characteristic of these examples is that low implied volatilities reduce the apparent riskiness of portfolios and can encourage investors to take on more risk. and if implied volatilities are not a good measure of future volatility, they will end up bearing more risk than they expected. avoiding this pitfall requires diligent risk assessment by investors and other counterparties. that is what is needed for market discipline to do its work. it requires both adequate disclosure of risk - relevant information and its effective use in investment decisions. in the case of the hedge fund sector, for example, it seems likely that greater institutional investor interest will continue to raise the bar on disclosure requirements, particularly for those generating returns using complex products where traditional measures like value - at - risk ( var ) may fail to capture fully the underlying risks. conclusions to conclude, our overall assessment remains benign. the financial sector is strongly capitalised and well placed to handle even large shocks like amaranth. the rapid pace of innovation in financial markets also promises better and wider distribution of risk which is good not just for the financial sector ’ s stability but should support more risk taking in the real economy. greater investment could deliver stronger medium and long term growth. but there remain a number of sources of vulnerability in the world economy and in financial markets which firms need to bear in mind. volatility is low, and as time passes longer memories are needed to remember when it was high. while there have certainly been improvements in macro performance in recent years, i do not know a central banker who is not surprised at the faith that markets appear to have in us to keep the great stability going. and the risks in the wider environment are as great as ever. it

of ltcm, yet markets facilitated a smooth wind down in positions. that is reassuring though some questions remain about the capacity of markets to handle such a disturbance if the macroeconomic backdrop and the balance sheets of major institutions were less rosy. the incident may also raise some questions about how effectively market forces are acting to restrain those taking outsized risk positions, something that i will return to in a moment. taken together, these developments provide a strong baseline for financial stability. but the risks that we pointed to in july are still there. in particular, we pointed to the risk that financial firms concerned about losing market share in rapidly expanding markets might pay less attention than they should to their resilience to unexpected shocks. [ chart 1 ] gives our assessment of developments since july. it shows that a number of the vulnerabilities have edged up a little as leveraged buy - out ( lbo ) activity and commercial property lending have grown and as the number of personal insolvencies has increased. on the other hand, the slowdown in the us economy and the beginning of a narrowing in its trade balance may have reduced the risks on that side, although we didn ’ t judge this material enough to change our overall assessment. we know how easy and how fruitless it can be to draw up long lists of things that could go wrong without paying attention to their likelihood. so we try to take a balanced view that recognises not just what could go wrong but also recognises changes that we think have a positive impact on financial stability. for example, i have been clear that, in the long run, the growth of derivative markets and the development of new players like hedge funds should help to price risks better and spread them more widely, and thus make the financial system more resilient. however, there is no denying that financial markets are liable to overshoot. and it is particularly important to stay alive to this risk when new records are being set for leveraged bids, returns on equity and city bonuses. over - optimism in the financial system can have costs not just for the consenting counterparties but more broadly across the economy. by talking to you individually, drawing the threads together with our own analysis and feeding back a dispassionate but informed assessment of what your actions and plans add up to, we hope we can inform your decisions and thus help to head off instability. low volatility one of the main vulnerabilities on our league table is low risk premia