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on Risk Management |
| By: | Koedijk, Kees; Kole, Erik; Verbeek, Marno |
| Abstract: | Copulas offer financial risk managers a powerful tool to model the dependence between the different elements of a portfolio and are preferable to the traditional, correlation-based approach. In this paper we show the importance of selecting an accurate copula for risk management. We extend standard goodness-of-fit tests to copulas. Contrary to existing, indirect tests, these tests can be applied to any copula of any dimension and are based on a direct comparison of a given copula with observed data. For a portfolio consisting of stocks, bonds and real estate, these tests provide clear evidence in favour of the Student’s t copula, and reject both the correlation-based Gaussian copula and the extreme value-based Gumbel copula. In comparison with the Student’s t copula, we find that the Gaussian copula underestimates the probability of joint extreme downward movements, while the Gumbel copula overestimates this risk. Similarly we establish that the Gaussian copula is too optimistic on diversification benefits, while the Gumbel copula is too pessimistic. Moreover, these differences are significant. |
| Keywords: | copulas; distributional tests; financial dependence; risk management; tail dependence |
| JEL: | C12 C14 G11 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5652&r=rmg |
| By: | Hussain, M. Ershad (University of New Orleans); Hassan, M. Kabir (University of New Orleans; Drexel University) |
| Abstract: | Existing literature has focused attention on the impact of Basle I and similar capital requirement regulations on developed countries where such regulations were found to be effective in increasing capital ratios and reducing portfolio credit risk of commercial banks. In the present study, we study the impact of such capital requirement regulations on commercial banks in 11 developing countries around the world within a cross-section framework with the widely popular simultaneous equations model of Shrieves and Dahl (1992). Surprisingly, we find that such regulations did not increase the capital ratios of banks in the developing countries. This implies that particular attention should be given to the business, environmental, legal, cultural realities of such countries while designing and implementing such policies for developing countries. However, we find evidence that such regulations did reduce portfolio risk of banks. We also find that capital ratios and portfolio risk are inversel. |
| Keywords: | Capital requirement, Commercial banks, Credit risk |
| JEL: | G21 G28 C12 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:uno:wpaper:2005-01&r=rmg |
| By: | Lorenzo Cappiello (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Peter Hördahl (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Arjan Kadareja (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Simone Manganelli (European Central Bank, DG Research, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | We assess whether the euro had an impact first on the degree of integration of European financial markets, and, second, on the euro area term structure. We propose two methodologies to measure integration - one relies on time-varying GARCH correlations, and the other one on a regression quantile-based codependence measure. We document an overall increase in co-movements in both equity and bond euro area markets, suggesting that integration has progressed since the introduction of the euro. However, while the correlations in bond markets reaches almost one for all euro area countries, co-movements in equity markets are much lower and the increase is limited to large euro area economies only. In the second part of the paper, we focus on the asset pricing implications of the euro. Specifically, we use a dynamic no-arbitrage term structure model to examine the risk ? return trade-off in the term structure of interest rates before and after the introduction of the euro. The analysis shows that while the average level of term premia seems little changed following the euro introduction, the variability of premia has been reduced as a result of smaller macro shocks during the euro period. Moreover, the macro factors that were found to be important in explaining the dynamics of premia before the introduction of the euro continue to play a key role in this respect also thereafter. |
| Keywords: | Financial markets, euro, financial integration, volatility, conditional correlation, term structure, fundamentals, risk premia. |
| JEL: | F36 G12 E43 E44 C22 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20060598&r=rmg |
| By: | Krahnen, Jan Pieter; Wilde, Christian |
| Abstract: | Large banks often sell part of their loan portfolio in the form of collateralized debt obligations (CDO) to investors. In this paper we raise the question whether credit asset securitization affects the cyclicality (or commonality) of bank equity values. The commonality of bank equity values reflects a major component of systemic risks in the banking market, caused by correlated defaults of loans in the banks' loan books. Our simulations take into account the major stylized fact of CDO\ transactions, the non-proportional nature of risk sharing that goes along with tranching. We provide a theoretical framework for the risk transfer through securitization that builds on a macro risk factor and an idiosyncratic risk factor, allowing an identification of the types of risk that the individual tranche holders bear. This allows conclusions about the risk positions of issuing banks after risk transfer. Building on the strict subordination of tranches, we first evaluate the correlation properties both within and across risk classes. We then determine the effect of securitization on the systematic risk of all tranches, and derive its effect on the issuing bank's equity beta. The simulation results show that under plausible assumptions concerning bank reinvestment behavior and capital structure choice, the issuing intermediary's systematic risk tends to rise. We discuss the implications of our findings for financial stability supervision. |
| Keywords: | risk transfer; systematic risk; systemic risk |
| JEL: | G28 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5618&r=rmg |
| By: | Nam, Jouahn (Pace University); Wang, Jun (Baruch College); Zhang, Ge (University of New Orleans) |
| Abstract: | We present a dynamic model of corporate risk management and managerial career concerns. We show that managers with high (low) career concerns are more likely to speculate (hedge) early in their careers. In the later stage of their careers when managers have less career concerns, there is no speculative motive for self interested managers. On the other hand, managers with minimal career concerns engage in neither hedging nor speculation early in their careers, but they may choose to hedge after poor early performance. |
| Keywords: | Risk management, Dynamic model, Hedging, Speculation |
| JEL: | G34 C73 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:uno:wpaper:2005-10&r=rmg |
| By: | Daal, Elton (University of New Orleans); Naka, Atsuyuki (University of New Orleans); Yu, Jung-Suk (University of New Orleans) |
| Abstract: | This paper proposes asymmetric GARCH-Jump models that synthesize autoregressive jump intensities and volatility feedback in the jump component. Our results indicate that these models provide a better fit for the dynamics of the equity returns in the US and emerging Asian markets, irrespective whether the volatility feedback is generated through a common GARCH multiplier or a separate measure of volatility in the jump intensity function. We also find that they can capture several distinguishing features of the return dynamics in emerging markets, such as, more volatility persistence, less leverage effects, fatter tails, and greater contribution and variability of the jump component. |
| Keywords: | Volatility feedback, Time-varying jump intensity, Volatility clustering, Leverage effect, Leptokurtosis |
| JEL: | C22 F31 G15 |
| Date: | 2006–01–20 |
| URL: | http://d.repec.org/n?u=RePEc:uno:wpaper:2005-03&r=rmg |