nep-rmg New Economics Papers
on Risk Management
Issue of 2005‒12‒09
nine papers chosen by
Stan Miles
York University

  1. Comparing Downside Risk Measures for Heavy Tailed Distributions By Casper G. de Vries; Bjørn N. Jorgensen; Sarma Mandira; Jon Danielsson
  2. Model Averaging and Value-at-Risk Based Evaluation of Large Multi-Asset Volatility Models for Risk Management By Pesaran, M Hashem; Zaffaroni, Paolo
  3. The International CAPM and a wavelet-based decomposition of Value at Risk By Viviana Fernández
  4. Valuing defaultable bonds: an excursion time approach By Martina Nardon
  5. Risk Management of Daily Tourist Tax Revenues for the Maldives By Michael McAleer; Riaz Shareef; Bernardo da Veiga
  6. Downside Risk By Andrew Ang; Joseph Chen; Yuhang Xing
  7. On characterization of a class of convex operators for pricing insurance risks By Marta Cardin; Graziella Pacelli
  8. Subadditivity Re–Examined: the Case for Value-at-Risk By Casper G. de Vries; Gennady Samorodnitsky; Bjørn N. Jorgensen; Sarma Mandira; Jon Danielsson
  9. Quadratic Portfolio Credit Risk models with Shot-noise Effects By Gaspar, Raquel M.; Schmidt, Thorsten

  1. By: Casper G. de Vries; Bjørn N. Jorgensen; Sarma Mandira; Jon Danielsson
    Abstract: Using regular variation to heavy tailed distributions, we show that prominent downside risk measures produce similar and consistent ranking of heavy tailed risk. Expected shortfall, though, may not always distinguish between the di.ering risk levels of assets.
    Date: 2005–11
  2. By: Pesaran, M Hashem; Zaffaroni, Paolo
    Abstract: This paper considers the problem of model uncertainty in the case of multi-asset volatility models and discusses the use of model averaging techniques as a way of dealing with the risk of inadvertently using false models in portfolio management. Evaluation of volatility models is then considered and a simple Value-at-Risk (VaR) diagnostic test is proposed for individual as well as ‘average’ models. The asymptotic as well as the exact finite-sample distribution of the test statistic, dealing with the possibility of parameter uncertainty, are established. The model averaging idea and the VaR diagnostic tests are illustrated by an application to portfolios of daily returns based on 22 of Standard & Poor’s 500 industry group indices over the period 1995-2003. We find strong evidence in support of ‘thick’ modelling proposed in the forecasting literature by Granger and Jeon (2004).
    Keywords: decision-based evaluations; model averaging; value-at-risk
    JEL: C32 C52 C53 G11
    Date: 2005–10
  3. By: Viviana Fernández
    Abstract: In this article, we formulate a time-scale decomposition of an international version of the CAPM that accounts for both market and exchange-rate risk. In addition, we derive an analytical formula for time-scale value at risk and marginal value at risk (VaR) of a portfolio. We apply our methodology to stock indices of seven emerging economies belonging to Latin America and Asia, the sample period 1990-2004. Our main conclusions are the following. First, the estimation results hinge upon the choice of the world market portfolio. In particular, the stock markets of the sampled countries appear to be more integrated with other emerging countries than with developed ones. Second, value at risk depends on the investor’s time horizon. In the short run, potential losses are greater than in the long run. Third, additional exposure to some specific stock indices will increase value at risk to a greater extent, depending on the investment horizon. Our results go in line with recent research in asset pricing that stresses the importance of heterogeneous investors.
    Date: 2005
  4. By: Martina Nardon (Università Ca' Foscari di Venezia, Dipartimento di Matematica Applicata)
    Abstract: Recently there has been some interest in the credit risk literature in models which involve stopping times related to excursions. The classical Black-Scholes-Merton-Cox approach postulates that default may occur, either at or before maturity, when the firm's value process falls below a critical threshold. In the excursion approach the duration of default, the time period from the financial distress announcement through its resolution, is explicitly modeled. In this contribution, we provide a review of the literature on excursion time models of credit risk. Moreover, we examine the effects on credit spreads structure of different specifications of the event that triggers default.
    Keywords: Credit risk, structural models, excursion approach, default threshold, default probability.
    JEL: C15 C63 G12 G13
    Date: 2005–11–28
  5. By: Michael McAleer (University of Western Australia); Riaz Shareef (University of Western Australia); Bernardo da Veiga (University of Western Australia)
    Abstract: International tourism is the principal economic activity for Small Island Tourism Economies (SITEs). There is a strongly predictable component of international tourism, specifically the government revenue received from taxes on international tourists, but it is difficult to predict the number of international tourist arrivals which, in turn, determines the magnitude of tax revenue receipts. A framework is presented for risk management of daily tourist tax revenues for the Maldives, which is a unique SITE because it relies entirely on tourism for its economic and social development. As these receipts from international tourism are significant financial assets to the economies of SITEs, the time-varying volatility of international tourist arrivals and their growth rate is analogous to the volatility (or dynamic risk) in financial returns. In this paper, the volatility in the levels and growth rates of daily international tourist arrivals is investigated.
    Keywords: Small Island Tourism Economies (SITEs), International tourist arrivals, Tourism tax, Volatility, Risk, Value-at-Risk (VaR), Sustainable Tourism-@-Risk (ST@R)
    JEL: G18 C32 L83 D81
    Date: 2005–10
  6. By: Andrew Ang; Joseph Chen; Yuhang Xing
    Abstract: Economists have long recognized that investors care differently about downside losses versus upside gains. Agents who place greater weight on downside risk demand additional compensation for holding stocks with high sensitivities to downside market movements. We show that the cross-section of stock returns reflects a premium for downside risk. Specifically, stocks that covary strongly with the market when the market declines have high average returns. We estimate that the downside risk premium is approximately 6% per annum. The reward for bearing downside risk is not simply compensation for regular market beta, nor is it explained by coskewness or liquidity risk, or size, book-to-market, and momentum characteristics.
    JEL: C12 C15 C32 G12
    Date: 2005–12
  7. By: Marta Cardin (Department of Applied Mathematics-University Ca'Foscari-Venice); Graziella Pacelli (Department of Social sciences- University of Ancona)
    Abstract: The properties of risk measures or insurance premium principles have been extensively studied in actuarial literature. We propose an axiomatic description of a particular class of coherent risk measures defined in Artzner, Delbaen, Eber, and Heath (1999). The considered risk measures are obtained by expansion of TVar measures, consequently they look like very interesting in insurance pricing where TVar measures is frequently used to value tail risks.
    Keywords: Risk measures, premium principles,Choquet measures distortion function,TVar .
    JEL: C7 D8
    Date: 2005–11–29
  8. By: Casper G. de Vries; Gennady Samorodnitsky; Bjørn N. Jorgensen; Sarma Mandira; Jon Danielsson
    Abstract: This paper explores the potential for violations of VaR subadditivity both theoretically and by simulations, and finds that for most practical applications VaR is subadditive. Hence, there is no reason to choose a more complicated risk measure than VaR, solely for reasons of coherence.
    Date: 2005–11
  9. By: Gaspar, Raquel M. (Dept. of Finance, Stockholm School of Economics); Schmidt, Thorsten (Department of Mathematics, University of Leipzig)
    Abstract: We propose a reduced form model for default that allows us to derive closed-form solutions to all the key ingredients in credit risk modeling: risk-free bond prices, defaultable bond prices (with and without stochastic recovery) and probabilities of survival. We show that all these quantities can be represented in general exponential quadratic forms, despite the fact that the intensity is allowed to jump producing shot-noise effects. In addition, we show how to price defaultable digital puts, CDSs and options on defaultable bonds. Further on, we study a model for portfolio credit risk where we consider both firm specific and systematic risks. The model generalizes the attempt from Duffie and Garleanu (2001). We find that the model produces realistic default correlation and clustering of defaults. Then, we show how to price first-to-default swaps, CDOs, and draw the link to currently proposed credit indices.
    Keywords: Credit risk; reduced-form models; CDS; CDO; quadratic term structures; shot-noise
    JEL: G12 G13 G33
    Date: 2005–12–02

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