New Economics Papers
on Risk Management
Issue of 2005‒07‒11
six papers chosen by

  2. Maxmin Portfolio Choice By Marco Taboga
  3. Can option smiles forecast changes in interest rates? An application to the US, the UK and the euro area By Marcello Pericoli
  4. Derivatives and systemic risk: netting, collateral, and closeout By Robert R. Bliss; George C. Kaufman
  5. Risk Perceptions and Attitudes By Miroslav Misina
  6. Migration, Risk and Liquidity Constraints in El Salvador By Timothy Halliday

  1. By: Andrea Resti (University of Milan L. Bocconi); Andrea Sironi (University of Milan L. Bocconi)
    Abstract: The Basel Committee for Banking Supervision designed a system of risk weights (the so called standardised approach) to measure the riskiness of banks’ loan portfolios. Its ability to adequately reflect risk is empirically investigated in this paper, through an analysis of the economic capital allocations implied in corporate bond spreads. This is based on a unique dataset of issuance spreads, ratings and other relevant bond variables (such as maturity, face value, time of issuance and currency of denomination) including 7,232 eurobonds issued mostly by Canadian, European, Japanese and U.S. companies during 1991-2003. Three main results emerge. First, the spread/rating relationship is strongly significant with spreads increasing when ratings worsen. Second, the estimated spreads per rating class indicate that the risk/rating relationship might be steeper than the one approved by the Basel Committee. Finally the difference between the spread/rating relation of banks and non-financial firms appears quite blurred and statistically questionable. Following this empirical evidence, we underline some adjustments in the standardised approach risk-weights that might be considered for the future versions of the Basel Accord.
    Keywords: eurobonds, credit ratings, spreads, capital regulation, banks.
    JEL: G15 G21 G28
    Date: 2005–02
  2. By: Marco Taboga (Bank of Italy, Economic Research Department)
    Abstract: We solve two robust portfolio selection problems, where a maxmin criterion is adopted to deal with parameter uncertainty. The two models, which yield closed formulae for the optimal allocation, lend themselves to be thoroughly analyzed both from a geometric and a game-theoretic point of view.
    Keywords: Portfolio choice, parameter uncertainty, robustness.
    JEL: G11
    Date: 2005–02
  3. By: Marcello Pericoli (Bank of Italy, Economic Research Department)
    Abstract: This paper evaluates the use of risk-neutral probability density functions implied in 3-month interest-rate futures options to assess market perceptions regarding future monetary policy moves options allow the information content implied in simpler derivatives to be extended by providing indicators for asymmetry and extreme values. First, a cubic spline is implemented to evaluate the densities. Second, the methodology is applied to quotes on deposits denominated in US dollars, euros and sterling from January 1999 toMay 2004 results show that markets correctly forecast the monetary easing of 2001 in the United States in the course of the second half of 2000, but not in the euro area and the United Kingdom. The evidence for the tightening cycle of 1999 is mixed: markets expected an increase in euro area policy rates at the beginning of 1999 expectations were less clear for the United States’ interest-rate increases. In the case of the United Kingdom the increase was not foreseen.
    Keywords: risk-neutral density, cubic spline, monetary policy, interest-rate futures options
    JEL: C52 E58 G13 G14 G15
    Date: 2005–02
  4. By: Robert R. Bliss; George C. Kaufman
    Abstract: In the U.S., as in most countries with well- developed securities markets, derivative securities enjoy special protections under insolvency resolution laws. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy. However, many derivatives contracts are exempt from these stays. Furthermore, derivatives enjoy netting and close-out, or termination, privileges which are not always available to most other creditors. The primary argument used to motivate passage of legislation granting these extraordinary protections is that derivatives markets are a major source of systemic risk in financial markets and that netting and close- out reduce this risk. To date, these assertions have not been subjected to rigorous economic scrutiny. This paper critically reexamines this hypothesis. These relationships are more complex than often perceived. We conclude that it is not clear whether netting, collateral, and/or close-out lead to reduced systemic risk, once the impact of these protections on the size and structure of the derivatives market has been taken into account.
    Date: 2005
  5. By: Miroslav Misina (Bank of Canada)
    Abstract: Changes in risk perception have been used in various contexts to explain shorter-term developments in financial markets, as part of a mechanism that amplifies fluctuations in financial markets, as well as in accounts of “irrational exuberance.” This approach holds that changes in risk perception affect actions undertaken in risky situations, and create a discrepancy between the risk attitude implied by those actions and the a priori description of risk attitude as summarized by the Arrow-Pratt coefficients of risk aversion. The author characterizes this discrepancy by introducing the notion of risk perception within the expected utility theory, and proposes the concept of implied risk aversion as a summary measure of risk attitudes implied by agents’ actions. Properties of implied risk aversion are related to an individual’s future outlook. Key ideas are illustrated using an asset-pricing model.
    Keywords: risk attitudes, risk perception, expectations, asset prices
    JEL: D81 D84 G12
    Date: 2005–07–08
  6. By: Timothy Halliday (Department of Economics, University of Hawaii at Manoa; John A. Burns School of Medicine, University of Hawaii at Manoa)
    Abstract: This paper utilizes panel data from El Salvador to investigate the use of trans-national migration as an ex post risk management strategy. We show that adverse agricultural conditions in El Salvador increase both migration to the US and remittances sent back to El Salvador. We show that, in the absence of any agricultural shocks, the probability that a household sent members to the US would have decreased by 24.26%, on average. We also show that the 2001 earthquakes reduced net migration to the US. A one standard deviation increase in earthquake damage reduced the average probability of northward migration by 37.11%. The evidence suggests that the effects of the earthquakes had more to do with households retaining labor at home to cope with the effects of the disaster rather than the earthquakes disrupting migration financing.
    Keywords: Migration, Insurance, Liquidity Constraints
    JEL: O1
    Date: 2005

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