pricing of default correlation. default correlation measures the tendency of firms to default at the same time. suppose a bank makes a set of loans that appear to be safe when looked at individually. whether the loans are likely to default at nearly the same time can represent the difference between whether the bank remains healthy or has the potential to become insolvent. for this reason, the modeling of default correlations, and how correlations change with economic conditions, is one of the most important inputs into measures of portfolio credit risk at banks. default correlations and how they are modeled are also important to bank regulators and are heavily emphasized within the basel ii capital standards. collateralized debt obligations, or cdos, are one of a number of financial instruments whose prices are sensitive to the pattern of default correlations. as a result, the prices of these instruments provide us with a forward - looking picture of the market ’ s perception of default correlations and an indication of how the risks of changes in correlation are priced. of course, as some of the papers in the conference demonstrate, the pricing of correlation - sensitive instruments is, putting it generously, somewhat less than straightforward. for that reason, there is substantial model risk involved in making inferences from these prices. nevertheless, the prices of these instruments provide a blurry view of default correlations that i expect will improve through time as credit derivatives markets continue to grow and mature. credit derivatives, like all derivatives, are in zero net supply, and, abstracting from the very important issue of counterparty credit risk, they neither add to nor subtract from the stock of financial risk in the economy. they do, however, provide new and more - efficient ways for sharing and hedging the risks that do exist, and they facilitate the transfer of those risks to those who are most willing to evaluate and bear them. as a consequence, as the credit derivatives market continues to develop and deepen, my guess, and it is just a guess, is that cleaner measures of credit risk will, all else being equal, reduce the costs of arbitraging between markets and will improve the harmonization of risk across markets – one of the asset - pricing puzzles i highlighted. two of the other puzzles i described earlier are the credit - spread and equity - premium puzzles. at least a part of these puzzles may be due to imperfect risk sharing among active market participants. if this is indeed part of the puzzle, then financial innovations such as credit derivatives may,

basis points. the policy repo rate has been raised by a cumulative 325 basis points. as the liquidity in the system transited from surplus to deficit, the effective tightening has been of the order of 475 basis points. thus, the cumulative monetary policy action would have the desired impact on inflation. it is expected that inflation would moderate towards the later part of 2011 – 12 and come down to around 7 per cent by the end of the year. the current monetary stance remains anti - inflationary. sixth, inflation imposes real costs which are borne disproportionately by the different segments of the economy. prolonged high inflation, even if originating from the supply side, could give rise to increased inflation expectations and cause general prices to rise. as monetary policy statement 2011 – 12, may 3, 2011, reserve bank of india. bis central bankers ’ speeches inflation is inimical to growth, it becomes necessary for monetary policy to respond to contain inflation and anchor inflationary expectations. seventh, the medium - term objective of the reserve bank is to bring down inflation to 3. 0 per cent consistent with india ’ s broader integration into the global economy. in this direction, monetary policy aims to contain perceptions of inflation in the range of 4. 0 – 4. 5 per cent with a particular focus on the behaviour of the non - food manufacturing component. this objective is consistent with the estimated threshold level of inflation of 4 – 6 per cent suggesting the absence of a “ new normal ” for inflation in india. finally, at the end of my talk what advice can i give to this gathering of bright minds? i believe, innovation and enterprise coupled with the spirit of youth will rapidly propel india to its rightful place in the global economy in the coming years. so unless you dare the frontiers, we will not know what lies beyond. thank you for your kind attention. bis central bankers ’ speeches