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on Risk Management |
| By: | M. Hashem Pesaran; Til Schuermann; Björn-Jakob Treutler |
| Abstract: | The potential for portfolio diversification is driven broadly by two characteristics: the degree to which systematic risk factors are correlated with each other and the degree of dependence individual firms have to the different types of risk factors. Using a global vector autoregressive macroeconometric model accounting for about 80% of world output, we propose a model for exploring credit risk diversification across industry sectors and across different countries or regions. We find that full firm-level parameter heterogeneity along with credit rating information matters a great deal for capturing differences in simulated credit loss distributions. Imposing homogeneity results in overly skewed and fat-tailed loss distributions. These differences become more pronounced in the presence of systematic risk factor shocks: increased parameter heterogeneity reduces shock sensitivity. Allowing for regional parameter heterogeneity seems to better approximate the loss distributions generated by the fully heterogeneous model than allowing just for industry heterogeneity. The regional model also exhibits less shock sensitivity. |
| Keywords: | risk management, default dependence, economic interlinkages, portfolio choice |
| JEL: | C32 E17 G20 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1548&r=rmg |
| By: | Samuel Hanson; M. Hashem Pesaran; Til Schuermann |
| Abstract: | This paper considers a simple model of credit risk and derives the limit distribution of losses under different assumptions regarding the structure of systematic and idiosyncratic risks and the nature of firm heterogeneity. The theoretical results obtained indicate that if firm-specific risk exposures (including their default thresholds) are heterogeneous but come from a common parameter distribution, for sufficiently large portfolios there is no scope for further risk reduction through active credit portfolio management. However, if the firm risk exposures are draws from different parameter distributions, say for different sectors or countries, then further risk reduction is possible, even asymptotically, by changing the portfolio weights. In either case, neglecting parameter heterogeneity can lead to underestimation of expected losses. But, once expected losses are controlled for, neglecting parameter heterogeneity can lead to overestimation of risk, whether measured by unexpected loss or value-at-risk. The theoretical results are confirmed empirically using returns and credit ratings for firms in the U.S. and Japan across seven sectors. Ignoring parameter heterogeneity results in far riskier credit portfolios. |
| Keywords: | risk management, correlated defaults, heterogeneity, diversification, portfolio choice |
| JEL: | C33 G13 G21 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1531&r=rmg |
| By: | Marc Henrard (Bank for International Settlements) |
| Abstract: | This book presents a simple model (the simplest?) for the computation of the value-at-risk: the delta-normal approach. It doesn't explain the shortcomings and advantages of the method nor compares it with other models. Even on this single topic, by no way it pretends to be complete or in the forefront. |
| Keywords: | value-at-risk; delta normal approach |
| Date: | 2005–09–29 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpri:0509001&r=rmg |
| By: | Peter Galos; Kimmo Soramäki (Corresponding author: Directorate General Payment Systems and Market Infrastructures, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany) |
| Abstract: | The paper analyses the consequences of an isolated, sudden and unexpected failure of a bank in alternative interbank payment system designs. We assess the exposures and the contagion by a counterfactual analysis assuming that payments currently settled by the pan-European large-value payment system, TARGET, are settled in alternative payment systems - an unsecured end-of-day net settlement system and a secured net settlement system with limits on intraday credit, with collateral and loss-sharing. The results indicate that systemic consequences of one bank's failure on the solvency of other banks can be rather low. If risk management techniques such as legal certainty for multilateral netting, limits on exposures, collateralisation and loss sharing are introduced, the systemic consequences can be mitigated to a high degree. How, and under which circumstances the analyzed failures would render other banks illiquid to meet their payment obligations is outside the scope of the paper. |
| Keywords: | Payment systems, Systemic risk, TARGET, Contagion. |
| JEL: | E42 G21 |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050508&r=rmg |
| By: | James Vickery |
| Abstract: | Although small firms are most sensitive to interest rate and other shocks, empirical work on corporate risk management has focused instead on large public companies. This paper studies fixed-rate and adjustable-rate loans to see how small firms manage their exposure to interest rate risk. The cross-sectional findings are as follows: credit-constrained firms consistently favor fixed-rate loans, minimizing their exposure to rising interest rates; firms adjust their exposure depending on how interest rate shocks covary with industry output; and "fixed versus adjustable" outcomes are correlated with lender characteristics. In a twenty-eight-year time series, the aggregate share of fixed-rate bank loans moves with interest rates in a manner consistent with recent evidence on debt market timing. I conclude that the "fixed versus adjustable" dimension of financial contracting helps small U.S. firms ameliorate interest rate risk, and discuss the implications for risk management theories and the credit channel of monetary policy. |
| Keywords: | Interest rates ; Risk management ; Commercial loans |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:215&r=rmg |