New Economics Papers
on Risk Management
Issue of 2005‒07‒03
five papers chosen by

  1. The Risks of Financial Institutions By Mark Carey; Rene M. Stulz
  2. Variation, jumps, market frictions and high frequency data in financial econometrics By Ole E. Barndorff-Nielsen; Neil Shephard
  3. Liquidity risk and contagion By Rodrigo Cifuentes; Gianluigi Ferrucci; Hyun Song Shin
  4. Firm-Level Evidence on International Stock Market Comovement By Robin Brooks,; Marc Del Negro
  5. How to Invest Optimally in Corporate Bonds: A Reduced-Form Approach By Holger Kraft; Mogens Steffensen

  1. By: Mark Carey; Rene M. Stulz
    Abstract: Over the last twenty years, the consensus view of systemic risk in the financial system that emerged in response to the banking crises of the 1930s and before has lost much of its relevance. This view held that the main systemic problem is runs on solvent banks leading to bank panics. But financial crises of the last two decades have not fit the mold. A new consensus has yet to emerge, but financial institutions and regulators have considerably broadened their assessment of the risks facing financial institutions. The dramatic rise of modern risk management has changed how the risks of financial institutions are measured and how these institutions are managed. However, modern risk management is not without weaknesses that will have to be addressed.
    JEL: G2 G21 G22 G28 G10 D81
    Date: 2005–06
  2. By: Ole E. Barndorff-Nielsen; Neil Shephard
    Abstract: We will review the econometrics of non-parametric estimation of the components of the variation of asset prices. This very active literature has been stimulated by the recent advent of complete records of transaction prices, quote data and order books. In our view the interaction of the new data sources with new econometric methodology is leading to a paradigm shift in one of the most important areas in econometrics: volatility measurement, modelling and forecasting. We will describe this new paradigm which draws together econometrics with arbitrage free financial economics theory. Perhaps the two most influential papers in this area have been Andersen, Bollerslev, Diebold and Labys(2001) and Barndorff-Nielsen and Shephard(2002), but many other papers have made important contributions. This work is likely to have deep impacts on the econometrics of asset allocation and risk management. One of our observations will be that inferences based on these methods, computed from observed market prices and so under the physical measure, are also valid as inferences under all equivalent measures. This puts this subject also at the heart of the econometrics of derivative pricing. One of the most challenging problems in this context is dealing with various forms of market frictions, which obscure the efficient price from the econometrician. Here we will characterise four types of statistical models of frictions and discuss how econometricians have been attempting to overcome them.
    Date: 2005
  3. By: Rodrigo Cifuentes; Gianluigi Ferrucci; Hyun Song Shin
    Abstract: This paper explores liquidity risk in a system of interconnected financial institutions when these institutions are subject to regulatory solvency constraints and mark their assets to market. When the market's demand for illiquid assets is less than perfectly elastic, sales by distressed institutions depress the market prices of such assets. Marking to market of the asset book can induce a further round of endogenously generated sales of assets, depressing prices further and inducing further sales. Contagious failures can result from small shocks. We investigate the theoretical basis for contagious failures and quantify them through simulation exercises. Liquidity requirements on institutions can be as effective as capital requirements in forestalling contagious failures.
  4. By: Robin Brooks,; Marc Del Negro
    Abstract: We explore the link between international stock market comovement and the degree to which firms operate globally. Using stock returns and balance sheet data for companies in 20 countries, we estimate a factor model that decomposes stock returns into global, country-specific and industry-specific shocks. We find a large and highly significant link: on average, a firm raising its international sales by 10 percent raises the exposure of its stock return to global shocks by 2 percent and reduces its exposure to countryspecific shocks by 1.5 percent. This link has grown stronger since the mid-1980s.
    Keywords: Diversification; risk; international financial markets; industrial structure
    JEL: G11 G15
    Date: 2005–05
  5. By: Holger Kraft (Department of Mathematics, University of Kaiserslautern); Mogens Steffensen (Fraunhofer ITWM, Institute for Industrial Mathematics, Department of Finance, Kaiserslautern)
    Abstract: In this paper, we analyze the impact of default risk on the portfolio decision of an investor wishing to invest in corporate bonds. Default risk is modeled via a reduced form approach and we allow for random recovery as well as joint default events. Depending on the structure of the model, we are able to derive almost explicit results for the optimal portfolio strategies. It is demonstrated how these strategies change if common default factors can trigger defaults of more than one bond or different recovery assumptions are imposed. In particular, we analyze the effect of beta distributed loss rates.
    Keywords: portfolio optimization; stochastic interest rates; default risk; recovery risk; beta distribution
    JEL: G11 G33
    Date: 2005–05

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