nep-cfn New Economics Papers
on Corporate Finance
Issue of 2014‒06‒07
four papers chosen by
Zelia Serrasqueiro
University of the Beira Interior

  1. Estimating Operational Risk Capital with Greater Accuracy, Precision, and Robustness By J. D. Opdyke
  2. Option Pricing in an Imperfect World By Gianluca Cassese
  3. Corporate governance in Islamic financial institutions By Elasrag, Hussein
  4. Having it Both Ways: A Theory of the Banking Firm with Time-Consistent and Time-Inconsistent Depositors By Carolina Laureti; Ariane Szafarz

  1. By: J. D. Opdyke
    Abstract: The largest US banks are required by regulatory mandate to estimate the operational risk capital they must hold using an Advanced Measurement Approach (AMA) as defined by the Basel II/III Accords. Most use the Loss Distribution Approach (LDA) which defines the aggregate loss distribution as the convolution of a frequency and a severity distribution representing the number and magnitude of losses, respectively. Estimated capital is a Value-at-Risk (99.9th percentile) estimate of this annual loss distribution. In practice, the severity distribution drives the capital estimate, which is essentially a very high quantile of the estimated severity distribution. Unfortunately, because the relevant severities are heavy-tailed AND the quantiles being estimated are so high, VaR is a convex function of the severity parameters, so all widely-used estimators will generate biased capital estimates due to Jensen's Inequality. This capital inflation is sometimes enormous, even hundreds of millions of dollars at the unit-of-measure (UoM) level. Herein I present an estimator of capital that essentially eliminates this upward bias. The Reduced-bias Capital Estimator (RCE) is more consistent with the regulatory intent of the LDA framework than implementations that fail to mitigate, if not eliminate this bias. RCE also notably increases the precision of the capital estimate and consistently increases its robustness to violations of the i.i.d. data presumption (which are endemic to operational risk loss event data). So with greater capital accuracy, precision, and robustness, RCE lowers capital requirements at both the UoM and enterprise levels, increases capital stability from quarter to quarter, ceteris paribus, and does both while more accurately and precisely reflecting regulatory intent. RCE is straightforward to explain, understand, and implement using any major statistical software package.
    Date: 2014–06
  2. By: Gianluca Cassese
    Abstract: In a model with no given probability measure, we consider asset pricing in the presence of frictions and other imperfections and characterize the property of coherent pricing, a notion related to (but much weaker than) the no arbitrage property. We show that prices are coherent if and only if the set of pricing measures is non empty, i.e. if pricing by expectation is possible. We then obtain a decomposition of coherent prices highlighting the role of bubbles. eventually we show that under very weak conditions the coherent pricing of options allows for a very clear representation from which it is possible, as in the original work of Breeden and Litzenberger, to extract the implied probability. Eventually we test this conclusion empirically via a new non parametric approach.
    Date: 2014–06
  3. By: Elasrag, Hussein
    Abstract: This paper is one of few papers that highlight the importance of studying corporate governance for institutions offering Islamic financial services. The book is of value in describing governance in Islamic institutions and how there are many issues under the investigation process, especially issues related to the shari‘a Supervisory board and its functionality. One of the objectives of this paper is to discuss, and create greater awareness of, some of the crucial issues related to corporate governance in Islamic financial institutions. A second, but in fact more important, objective is to provide, in the light of this discussion, certain essential guidelines to improve corporate governance in these institutions and thereby enable them to not only maintain their momentum of growth and international acceptance but also safeguard the interests of all stakeholders. The paper gives particular attention to the mechanisms for corporate governance, including the Board of Directors, Senior Management, shareholders, depositors, and regulatory and supervisory authorities. It also focuses on the effective management of risks and, in particular, on creating a supporting environment through moral uplift, social, legal and institutional checks, greater transparency, internal controls, and Shari'a as well as external audit. The paper also indicates briefly the shared institutions that are needed for effective corporate governance.
    Keywords: Corporate governance,Islamic Finance,ISLAMIC FINANCIAL INSTITUTIONS,SHARI‘A GOVERNANCE
    JEL: G0 G15 G2 G21 G34
    Date: 2014–05–26
  4. By: Carolina Laureti; Ariane Szafarz
    Abstract: Our equilibrium model determines the liquidity premium offered by a monopolistic bank to a pool of depositors made up of time-consistent and time-inconsistent agents. Time-consistent depositors demand compensation for illiquidity, whereas time-inconsistent ones are willing to forgo interest on illiquid savings accounts to discipline their future selves. We show that formal financial markets can reward time-inconsistent clients for illiquidity, even though these agents would agree to pay for it. The explanation combines two factors: the existence of reserve requirements making the bank keen to reward illiquid accounts more than liquid ones, and the presence of time-consistent agents who view illiquidity as a burden and therefore demand compensation for holding illiquid accounts.
    Keywords: Deposit; commitment; flexibility; liquidity premium; hyperbolic discounting; Bangladesh
    JEL: G21 D53 D82 D91 O12 O16
    Date: 2014–05–26

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