Risk Management
http://lists.repec.org/mailman/listinfo/nep-rmg
Risk Management
2018-04-02
A Dynamic Model of Central Counterparty Risk
http://d.repec.org/n?u=RePEc:arx:papers:1803.02012&r=rmg
We introduce a dynamic model of the default waterfall of derivatives CCPs and propose a risk sensitive method for sizing the initial margin (IM), and the default fund (DF) and its allocation among clearing members. Using a Markovian structure model of joint credit migrations, our evaluation of DF takes into account the joint credit quality of clearing members as they evolve over time. Another important aspect of the proposed methodology is the use of the time consistent dynamic risk measures for computation of IM and DF. We carry out a comprehensive numerical study, where, in particular, we analyze the advantages of the proposed methodology and its comparison with the currently prevailing methods used in industry.
Tomasz R. Bielecki
Igor Cialenco
Shibi Feng
2018-03
Macroprudential Stress Tests: A Reduced-Form Approach to Quantifying Systemic Risk Losses
http://d.repec.org/n?u=RePEc:imf:imfwpa:18/49&r=rmg
We present a novel approach that incorporates individual entity stress testing and losses from systemic risk effects (SE losses) into macroprudential stress testing. SE losses are measured using a reduced-form model to value financial entity assets, conditional on macroeconomic stress and the distress of other entities in the system. This valuation is made possible by a multivariate density which characterizes the asset values of the financial entities making up the system. In this paper this density is estimated using CIMDO, a statistical approach, which infers densities that are consistent with entities’ probabilities of default, which in this case are estimated using market-based data. Hence, SE losses capture the effects of interconnectedness structures that are consistent with markets’ perceptions of risk. We then show how SE losses can be decomposed into the likelihood of distress and the magnitude of losses, thereby quantifying the contribution of specific entities to systemic contagion. To illustrate the approach, we quantify SE losses due to Lehman Brothers’ default.
Zineddine Alla
Raphael A Espinoza
Qiaoluan H. Li
Miguel A. Segoviano Basurto
2018-03-09
A combined statistical framework for forecasting default rates of Greek Financial Institutions' credit portfolios
http://d.repec.org/n?u=RePEc:bog:wpaper:243&r=rmg
Credit risk modeling remains an important research topic both for financial institutions and the academic community due to its significant contribution to the issue of a bank’s capital adequacy. In this paper we build macro models for the default rates of Greek bank’s loan portfolios. Modeling is performed at two levels: First we use common techniques: regime switching regression, Bayesian regression averaging and linear regression; subsequently we combine the forecasts of the three statistical techniques. This results in increasing performance accuracy and minimizing model risk. Our main goal is twofold: First we attempt to investigate the determinants and the sensitivities of default rates in the Greek banking system where Non Performing Loans (NPLs) have risen sharply due to the sovereign debt crisis which led to a decrease in GDP from 2007 to 2016 of 25%. Secondly, the suggested statistical models can serve as the basis of projecting Greek portfolio dynamics under various macro scenarios. We find that dynamic forecasting combinations exhibit higher predictive accuracy than individual methods. This may provide practitioners with significant insight and policy tools for the banking supervision division in order to enhance monitoring efficiency and support informed decision making.
Anastasios Petropoulos
Vasilis Siakoulis
Dionysios Mylonas
Aristotelis Klamargias
Forecasting Default Rates; Forecast Combination; Stress Testing
International Risk Management in BREXIT and Policy Options
http://d.repec.org/n?u=RePEc:bwu:eiiwdp:disbei242&r=rmg
BREXIT is a historical step for the UK and the EU27 which could bring a strong Pound deprecation, an increase in risk premiums for British bonds and a transitory rise of financial market volatility plus a long term reduction of economic growth in the UK. Macroprudential supervision thus is a crucial policy challenge for EU28 in the context of BREXIT and the European Systemic Risk Board thus should have a critical role in 2018 and the following years. The IMF’s FSAP as well as the ESRB thus should timely analyze the potential risk of BREXIT and consider adequate policy options to reduce or eliminate risks. As regards the ESRB this requires full cooperation of all EU28 actors in that organization. Moreover, the EU27 faces major problems in terms of prudential supervision after BREXIT since a very large part of EU27 wholesale banking markets are in the UK and thus not regulated by the EU after March 29, 2019. The EU Commission’s competence for EU trade policy as well as international investment treaties gives the EU the opportunity to offer the UK not only a – limited – Free Trade Agreement but an international investment treaty as well, including options for global cooperation. Contract continuity is a dangerous BREXIT challenge for EU-UK negotiations. The influence of US regulation on Europe will increase due to BREXIT. Several policy innovations are proposed.
Paul J.J. Welfens
Macroprudential supervision, Brexit, EU, financial risk, economic policy
2018-03
Mortgages: estimating default correlation and forecasting default risk
http://d.repec.org/n?u=RePEc:boe:boeewp:0708&r=rmg
Default correlation is a key driver of credit risk. In the Basel regulatory framework it is measured by the asset value correlation parameter. Though past studies suggest that the parameter is over-calibrated for mortgages — generally the largest asset class on banks’ balance sheets — they do not take into account bias arising from small samples or non-Gaussian risk factors. Adjusting for these biases using a non-Gaussian, non-linear state space model I find that the Basel calibration is appropriate for UK and US mortgages. This model also forecasts mortgage default rates accurately and parsimoniously. The model generates value-at-risk estimates for future mortgage default rates, which can be used to inform stress-testing and macroprudential policy.
Neumann, Tobias
Mortgages; bank regulation; credit risk; default correlation; state space model; Basel Committee; stress testing; macroprudential policy
2018-02-09
Stochastic Approximation Schemes for Economic Capital and Risk Margin Computations
http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01710394&r=rmg
We consider the problem of the numerical computation of its economic capital by an insurance or a bank, in the form of a value-at-risk or expected shortfall of its loss over a given time horizon. This loss includes the appreciation of the mark-to-model of the liabilities of the firm, which we account for by nested Monte Carlo à la Gordy and Juneja (2010) or by regression à la Broadie, Du, and Moallemi (2015). Using a stochastic approximation point of view on value-at-risk and expected shortfall, we establish the convergence of the resulting economic capital simulation schemes, under mild assumptions that only bear on the theoretical limiting problem at hand, as opposed to assumptions on the approximating problems in Gordy-Juneja (2010) and Broadie-Du-Moallemi (2015). Our economic capital estimates can then be made conditional in a Markov framework and integrated in an outer Monte Carlo simulation to yield the risk margin of the firm, corresponding to a market value margin (MVM) in insurance or to a capital valuation adjustment (KVA) in banking par- lance. This is illustrated numerically by a KVA case study implemented on GPUs.
David Barrera
Stéphane Crépey
Babacar Diallo
Gersende Fort
Emmanuel Gobet
Uladzislau Stazhynski
2018-02-15
How much does book value data tell us about systemic risk and its interactions with the macroeconomy? A Luxembourg empirical evaluation
http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp118&r=rmg
In order to effciently capture the contribution to the aggregated systemic risk of each financial institution arising from various important balance-sheet items, this study proposes a comprehensive approach of “Mark-to-Systemic-Risk" to integrate book value data of Luxembourg financial institutions into systemic risk measures. It first characterizes systemic risks and risk spillovers in equity returns for 33 Luxembourg banks, 30 European banking groups, and 232 investment funds.1 The forward-looking systemic risk measures delta CoES, Shapley – delta CoES, SRISK and conditional concentration risk are estimated by using a large-scale dynamic grouped t-copula, and their common components are determined by the generalized dynamic factor model. Several important facts are documented during 2009-2016: (1) Measured by delta CoES of equity returns, Luxembourg banks were more sensitive to the adverse events from investment funds compared to European banking groups, and investment funds were more sensitive to the adverse events from banking groups than from Luxembourg banks. (2) Ranked by Shapley - delta CoES values, money market funds had the highest marginal contribution to the total risk of Luxembourg banks while equity funds exhibited the least share of the risk, and the systemic risk contribution of bond funds, mixed funds and hedge funds became more important toward the end of 2016. (3) The macroeconomic determinants of the aggregate systemic risk of banking groups, Luxembourg banks and investment funds, and the marginal contributions from 15 countries to the aggregate systemic risk of Luxemburg banks and their parent banking groups are all different.
Xisong Jin
_nancial stability; systemic risk; macro-prudential policy; dynamic copulas; value at risk; shapley values; risk spillovers
2018-02
THE TIME-VARYING ASYMMETRY OF EXCHANGE RATE RETURNS: A STOCHASTIC VOLATILITY – STOCHASTIC SKEWNESS MODEL
http://d.repec.org/n?u=RePEc:rug:rugwps:18/944&r=rmg
While the volatility of financial returns has been extensively modelled as time-varying, skewness is usually either assumed constant or neglected by assuming symmetric model innovations. However, it has long been understood that accounting for (time-varying) asymmetry as a measure of crash risk is important for both investors and policy makers. This paper extends a standard stochastic volatility model to account for time-varying skewness. We estimate the model by extensions of traditional Bayesian Markov Chain Monte Carlo (MCMC) methods for stochastic volatility models. When applying this model to the returns of four major exchange rates, skewness is found to vary substantially over time. The results support a potential link between carry trading and crash risk. Finally, investors appear to demand compensation for a negatively skewed return distribution.
Martin Iseringhausen
Bayesian analysis, crash risk, foreign exchange, time variation
2018-03
Capital regulation and product market outcomes
http://d.repec.org/n?u=RePEc:boe:boeewp:0715&r=rmg
This paper examines the impact of the introduction of a risk-based capital regulation regime in 2002 on product market outcomes for the insurance industry in the United Kingdom. Using proprietary data on stress-test submissions from the Bank of England, we develop a measure of firm-level shocks to regulatory constraints that is plausibly exogenous to shifts in insurance demand. We find that constrained firms reduced underwriting relative to unconstrained firms, particularly for traditional insurance products which became more capital intensive in the new regulatory regime. The reduction in underwriting was not as pronounced for linked products, products that are mainly investment vehicles like mutual funds, implying a shift in the equilibrium product mix from traditional to linked. We also show that a higher proportion of constrained firms restructured their balance sheets by transferring assets and liabilities and went through reorganizations ie a change in legal owner of the firm.
Sen, Ishita
Humphry, David
Risk-based capital regulation; stress testing; life insurance; trends in asset management
2018-03-02
Ownership Structure and Bank Risk: The Effects of Crisis, Market Discipline and Regulatory Pressure
http://d.repec.org/n?u=RePEc:nfi:nfiwps:2018-wp-03&r=rmg
Using a large panel of US BHC over the 2001:Q1-2015:Q4, we investigate the risk-taking behaviors of banks within a comparison perspective – between public and private banks - where there exists substantial differences of asymmetry information and agency problems. We document evidence of greater stability of public banks versus their private peers. However, public banks become riskier than private banks during the last crisis. These findings suggest a mixed evidence of risk-taking mitigating role of listing status. Regulatory pressure is effective in limiting risk taking by undercapitalized public banks before, but not during the crisis, casting doubt the effectiveness of regulators during the turmoil times. Public banks with high franchise value expose to risk less than others during the crisis. Debtholders discipline is ineffective in curbing the risk-taking behavior of banks. Our study is of interest for regulators, policymakers who are in search of improving bank risk-taking behavior.
Viet-Dung Tran
M. Kabir Hassan
Reza Houston
bank listing status; risk taking; crisis; market discipline; regulatory pressure
2018-03
Calibration of Local Volatility Model with Stochastic Interest Rates by Efficient Numerical PDE Method
http://d.repec.org/n?u=RePEc:arx:papers:1803.03941&r=rmg
Long maturity options or a wide class of hybrid products are evaluated using a local volatility type modelling for the asset price S(t) with a stochastic interest rate r(t). The calibration of the local volatility function is usually time-consuming because of the multi-dimensional nature of the problem. In this paper, we develop a calibration technique based on a partial differential equation (PDE) approach which allows an efficient implementation. The essential idea is based on solving the derived forward equation satisfied by P(t; S; r)Z(t; S; r), where P(t; S; r) represents the risk neutral probability density of (S(t); r(t)) and Z(t; S; r) the projection of the stochastic discounting factor in the state variables (S(t); r(t)). The solution provides effective and sufficient information for the calibration and pricing. The PDE solver is constructed by using ADI (Alternative Direction Implicit) method based on an extension of the Peaceman-Rachford scheme. Furthermore, an efficient algorithm to compute all the corrective terms in the local volatility function due to the stochastic interest rates is proposed by using the PDE solutions and grid points. Different numerical experiments are examined and compared to demonstrate the results of our theoretical analysis.
Julien Hok
Shih-Hau Tan
2018-03
Implementing Macroprudential Policy in NiGEM
http://d.repec.org/n?u=RePEc:nsr:niesrd:490&r=rmg
In this paper we incorporate a macroprudential policy model within a semi-structural global macroeconomic model, NiGEM. The existing NiGEM model is expanded for the UK, Germany and Italy to include two macroprudential tools: loan-to-value ratios on mortgage lending and variable bank capital adequacy targets. The former has an effect on the economy via its impact on the housing market while the latter acts on the lending spreads of corporate and households. A systemic risk index that tracks the likelihood of the occurrence of a banking crisis is modelled to establish thresholds at which macroprudential policies should be activated by the authorities. We then show counterfactual scenarios, including a historic dynamic simulation of the subprime crisis and the endogenous response of policy thereto, based on the macroprudential block as well as performing a cost-benefit analysis of macroprudential policies. Conclusions are drawn relating to use of this tool for prediction and policy analysis, as well as some of the limitations and potential further research.
Oriol Carreras
E Philip Davis
Ian Hurst
Iana Liadze
Rebecca Piggott
James Warren
macroprudential policy, house prices, credit, systemic risk, macroeconomic modelling
2018-03
Analyzing Credit Risk Transmission to the Non-Financial Sector in Europe: A Network Approach
http://d.repec.org/n?u=RePEc:cqe:wpaper:7218&r=rmg
A high-dimensional network of European CDS spreads is modeled to assess the transmission of credit risk to the non-financial corporate sector in Europe. We build on a network connectedness approach that uses variance decompositions in vector autoregressions (VARs) to characterize the dependence structure in the panel of CDS spreads. Our main findings suggest a sectoral clustering in the CDS network, where financial institutions are located in the center of the network and non-financial as well as sovereign CDS are grouped around the financial center. The network has a geographical component re flected in differences in the magnitude and direction of real-sector risk transmission across European countries. We identify an increase in the transmission of financial and sovereign credit risk to the non-financial sector during the global financial crisis and the European debt crisis. By contrast, we find that the transmission of risk within the non-financial sector remains largely unaffected by crisis events.
Christian Gross
Pierre L. Siklos
networks, financial-real linkages connectedness, systemic risk, credit risk, contagion
2018-03
Down payment and mortgage rates: evidence from equity loans
http://d.repec.org/n?u=RePEc:boe:boeewp:0713&r=rmg
We present new evidence that lenders use down payment size to price unobservable borrower risk. We exploit the contractual features of a UK scheme that helps home buyers top up their down payments with equity loans. We find that a 20 percentage point smaller down payment is associated with a 22 basis point higher interest rate at origination, and a higher ex-post default rate. Lenders see down payment as a signal for unobservable risk, but the relative importance of this signal is limited, as it accounts for only 10% of the difference in mortgage rates between loans with 75% and 95% loan to value ratio.
Benetton, Matteo
Bracke, Philippe
Garbarino, Nicola
Mortgage design; asymmetric information; leverage; housing policy
2018-02-23
Are the Risk Weights of Banks in the Czech Republic Procyclical? Evidence from Wavelet Analysis
http://d.repec.org/n?u=RePEc:cnb:wpaper:2017/15&r=rmg
We analyze the cyclicality of risk weights of banks in the Czech Republic from 2008 to 2016. We differentiate between risk weights under the internal ratings-based and those under the standardized approach, consider both the business cycle and the financial cycle, and employ wavelet coherence as a means of dynamic correlation analysis. Our results indicate that the risk weights of exposures under the internal ratings-based approach, including risk weights related to exposures secured by real estate collateral, are procyclical with respect to the financial cycle. We also show that the effect of changing asset quality on risk weights is present for the internal ratings-based approach, in line with our expectations based on regulatory standards. Our results can be employed for the purposes of decision-making on the activation of supervisory and macroprudential instruments, including the countercyclical capital buffer.
Vaclav Broz
Lukas Pfeifer
Dominika Kolcunova
Financial cycle, financial stability, internal ratings-based approach, risk weight
2017-12
A General Equilibrium Appraisal of Capital Shortfall
http://d.repec.org/n?u=RePEc:bfr:banfra:668&r=rmg
We quantify the capital shortfall that results from a global financial crisis by using a macrofinance dynamic stochastic general equilibrium model that captures the interactions between the financial and real sectors of the economy. We show that a crisis similar to that observed in 2008 generates a capital shortfall (or stressed expected loss, SEL) equal to 2.8% of euro-area GDP, which corresponds to approximately 250 billion euros. We also find that using a cycle-dependent capital ratio that combines concern for both credit growth and SEL has a positive effect on output growth while mitigating the excessive risk taking of the banking system. Finally, our estimates confirm that most of the variability of the macroeconomic and financial variables at business cycle frequencies is due to investment and risk shocks.
E. Jondeau
J-G. Sahuc
capital shortfall, systemic risk, leverage, financial system, euro area, DSGE model.
2018
A tiger by the tail: estimating the UK mortgage market vulnerabilities from loan-level data
http://d.repec.org/n?u=RePEc:boe:boeewp:0703&r=rmg
Following the global financial crisis, macroprudential regulators in a number of countries took actions to mitigate risks arising from stressed mortgage markets to financial and economic stability. Having disaggregated information on the stock of mortgages allows policymakers to analyse particular cohorts of the market that may be more vulnerable to stress, and model how these cohorts may evolve in the future and might affect the outlook for financial and economic stability. To this end, we produce the first ever estimate of the current stock of all regulated UK mortgages at the level of individual loans using data from the flow of new mortgages. We use loan-level information of 14 million UK mortgages at the point each loan was originated or re-mortgaged. Using a series of algorithms from Computer Science, we identify individual loans in the flow of lending that are likely to be still in the stock at different points in time. Then we estimate how key characteristics of mortgages (including borrower incomes, house prices and outstanding loan amounts) are likely to have evolved over time since origination. We validate our overall model by comparing key variables to information available from other sources that provide partial characteristics of the stock, including household surveys and regulatory returns. Our stock estimate suggests that there may have been more vulnerable borrowers in recent years than household surveys suggest. Finally, we illustrate the type of cohort analysis that can be done using the loan-level estimate.
Chakraborty, Chiranjit
Gimpelewicz, Mariana
Uluc, Arzu
Mortgage market; housing market; matching; loan-level data; stock model
2017-12-21
Long-term interest rates and bank loan supply: Evidence from firm-bank loan-level data
http://d.repec.org/n?u=RePEc:tcr:wpaper:e119&r=rmg
Based on a mean-variance model of bank portfolio selection subject to the value-at-risk constraint, we make predictions on transmission channels through which lower long-term interest rates increase bank loan supply: the portfolio balance channel, the bank balance sheet channel, and the risk-taking channel. Using a firm-bank loan-level panel dataset for Japan, we find evidence of the presence of these channels. First, an unanticipated reduction in long-term rates increased bank loan supply. Second, banks that enjoyed larger capital gains on their bond holdings increased loan supply. Further, this effect was stronger for loans to smaller, more leveraged, and less creditworthy firms.
Arito Ono, Kosuke Aoki
hinichi Nishioka
Kohei Shintani
Yosuke Yasui
2018-02
Rethinking financial stability
http://d.repec.org/n?u=RePEc:boe:boeewp:0712&r=rmg
The global financial crisis has been the prompt for a complete rethink of financial stability and policies for achieving it. Over the course of the better part of a decade, a deep and wide-ranging international regulatory reform effort has been under way, as great as any since the Great Depression. We provide an overview of the state of progress of these reforms, and assess whether they have achieved their objectives and where gaps remain. We find that additional insights gained since the start of the reforms paint an ambiguous picture on whether the current level of bank capital should be higher or lower. Additionally, we present new evidence that a combination of different regulatory metrics can achieve better outcomes in terms of financial stability than reliance on individual constraints in isolation. We discuss in depth several recurring themes of the regulatory framework, such as the appropriate degree of discretion versus rules, the setting of macroprudential objectives, and the choice of policy instruments. We conclude with suggestions for future research and policy, including on models of financial stability, market-based finance, the political economy of financial regulation, and the contribution of the financial system to the economy and to society.
Aikman, David
Haldane, Andrew
Hinterschweiger, Marc
Kapadia, Sujit
Financial stability; macroprudential policy; Basel III; capital requirements; liquidity requirements
2018-02-23
Countercyclical Prudential Tools in an Estimated DSGE Model
http://d.repec.org/n?u=RePEc:ude:wpaper:0917&r=rmg
We develop a DSGE model for a small, open economy with a banking sector and endogenous default. The model is used to perform a realistic assessment of two macroprudential tools: countercyclical capital buffers (CCB) and dynamic provisions (DP). The model is estimated with data for Uruguay, where dynamic provisioning is in place since early 2000s. In general, while both tools force banks to build buffers, we find that DP seems to outperform the CCB in terms of smoothing the cycle. We also find that the source of the shock affecting the financial system matters to discuss the relative performance of both tools. In particular, given a positive external shock the ratio of credit to GDP decreases, which discourages its use as an indicator variable to activate countercyclical regulation.
Serafín Frache
Javier García-Cicco
Jorge Ponce
banking regulation, minimum capital requirement, countercyclical capital buffer, reserve requirement, (countercyclical or dynamic) loan loss provision, endogenous default, Basel III, DSGE, Uruguay
2017-08