credit risk – either by securitisation or credit derivatives – started to grow rapidly. the chance to sell or buy credit risk, instead of holding loans until maturity, placed banks under increased pressure to know the present values of their assets well before maturity. this posed a challenge to risk modeling as present values depend in a complex way on market factors like interest rates or exchange rates. therefore, it is not surprising that the growth of credit trade was accompanied by rapid technological progress, for instance, by the development of new credit portfolio models. it is difficult to say which came first or – in other words – whether these new risk measurement techniques were the egg and the increased credit trade the hen or vice versa. technological progress has continued up to the present day. the interaction of market and credit risk is being taken into account by more and more sophisticated models. the increased trade of credit on the one hand offers an opportunity to further diversification of credit risk over the whole financial system and to contribute to financial stability. on the other hand, it can also be seen as a development incurring new risks, be it by an inadequate recognition of risks inside a single bank, be it by new adverse risk - taking incentives or by the imperfection of hedges, be it, finally, by new effects that no one had discovered before. these developments are a first reason for bank managers, regulators and central bankers to improve their understanding of the interaction of market and credit risk. in addition to these developments, some industry representatives were concerned that diversification effects between market risk and credit risk were being ignored by regulators, which could lead to too high minimum capital requirements. a deeper understanding of diversification effects and their relevance for risk aggregation in banks is a second reason to have a conference on the interaction of market and credit risk. at the end of 2005, the research task force project group on the interaction of market and credit risk received the mandate, first, to collect and summarise information on the state of the art of measuring the interaction of market and credit risk, and second, to set up and to conduct its own research projects in a rather broad field. as this was a vastly unexplored research area, the new working group has become one of the most research - oriented groups of the research task force. ladies and gentlemen, this conference contributes to bringing together three groups involved with the interaction of market and credit risk : bank practitioners, regulators, and researchers. the need to make them exchange their ideas and

, as i mentioned already the model does not feature a money market or a financial sector. consequently, it simply assumes away the shocks that, even in the short run, can originate in those sectors. this has two main implications : one on the demand for money side, the other on the side of liquidity and credit provision. on the demand side, the model does not substantiate money ’ s role as the principal vehicle for settling transactions and providing a “ store of value ”, for example, in face of heightened uncertainty. however, it is precisely in such conditions that we see money play an active role as a primary attractor for investors and financial intermediaries alike in search for portfolio security and liquidity. in the mainstream model, all eventualities can be hedged in advance, so there is no need to maintain a liquid portfolio even in the face of major shocks. in reality, money can act as a primary determinant of portfolio allocation and spending decisions in conditions of major and sudden shifts in risk perceptions. by monitoring money and liquidity preferences a central bank acquires a first - rate indicator of the state of confidence. the second implication works through the provision of liquidity. in the main - stream model there is no borrowing or lending activity. however, these “ missing ” activities are important, as we all realise when credit markets become dysfunctional. shocks hitting, for example, financial intermediaries ’ changing perceptions of credit and aggregate risk can drive variable wedges between the interest rate that the monetary authority can control and at which banks can borrow – in fact, the only interest rate that is defined in the model – and the interest rate at which banks lend, which is relevant for aggregate demand. observation and empirical tests tell us that the latter spectrum of market rates, applying to borrowers with different degrees of creditworthiness, is linked in various ways to liquidity. but the absence of liquidity makes the mainstream model unable to provide relevant insights into the determination of credit spreads, of term premia and, in one word, of asset prices, which are the principal link in the chain of propagation of monetary policy through the economy. the strategic assignment to expand our view beyond the real sector has been instrumental in developing two avenues of analysis that would have remained atrophic otherwise. • first, we can count today on a first - rated system of real - time monitoring of monetary facts which we can resort to instantly especially in times of emergency. the financial shocks