New Economics Papers
on Risk Management
Issue of 2006‒06‒10
seven papers chosen by

  1. Long-Horizon Mean Reversion for the Brussels Stock Exchange: Evidence for the 19th Century By J. ANNAERT; W. VAN HYFTE
  2. Bankruptcy, Counterparty Risk, and Contagion By Holger Kraft; Mogens Steffensen
  3. Contagion Across and Integration of Central and Eastern European Stock Markets: Evidence from Intraday Data By Balazs Egert; Evzen Kocenda;
  4. Deteriorating Cost Efficiency in Commercial Banks Signals an Increasing Risk of Failure By Anca Podpiera; Jiri Podpiera
  5. Assessing the Impact of Market Microstructure Noise and Random Jumps on the Relative Forecasting Performance of Option-Implied and Returns-Based Volatility By Gael M. Martin; Andrew Reidy; Jill Wright
  6. Don’t Fall from the Saddle: the Importance of Higher Moments of Credit Loss Distributions By J. ANNAERT; Crispiniano Garcia Joao Batista; J. LAMOOT; G. LANINE
  7. Failure process and causes of company bankruptcy: a typology By H. OOGHE; S. DE PRIJCKER

    Abstract: In this paper, we introduce a completely new and unique historical dataset of Belgian stock returns during the nineteenth and the beginning of the twentieth century. This high-quality database comprises stock price and company related information on more than 1500 companies. Given the extensive use of CRSP return data and the data mining risks involved it provides an interesting out-of-sample dataset with which to test the robustness of ‘prevailing’ asset pricing anomalies. We re-examine mean reversals in long-horizon returns using the framework of Hodrick (1992) and Jegadeesh (1991). Our simulation experiments demonstrate that it has considerably better small sample properties than the traditional regression framework of Fama and French (1988a). In the short run, returns exhibit strong persistence, which is partially induced by infrequent trading. Contrary to Fama and French (1988a) and Poterba and Summers (1988), our results suggest that, in the long run, there is little to no evidence of stock prices containing autoregressive stationary components but instead resemble a random walk. Capital appreciation returns exhibit stronger time-varying behavior than total returns. Belgian stock returns demonstrate significant seasonality in January notwithstanding the absence of taxes. In addition, in contrast to other months, January months do show some evidence of mean reversion.
    Keywords: Brussels Stock Exchange, Financial Market History, Market Efficiency, Univariate Stock Return Predictability
    JEL: G10 G14 N23
    Date: 2006–03
  2. By: Holger Kraft (Fachbereich Mathematik, Universität Kaiserslautern); Mogens Steffensen (Department of Applied Mathematics and Statistics, University of Copenhagen)
    Abstract: This paper provides a unifying framework for the modeling of various types of credit risks such as contagion effects. We argue that Markov chains can efficiently be used to tackle these problems. However, our approach is not limited to pricing problems with contagion. Other applications include the modeling of a more sophisticated default process of a firm. On the theoretical side, we derive pricing formulas for three building blocks that are generalizations of contingent claims studied in Lando (1998). These claims can be thought of as atoms forming the basis for all credit risky payments. Furthermore, we demonstrate that, in general, all contingent claims exposed to credit risk satisfy a system of partial differential equations. This is the key result to calculate prices of credit risky claims explicitly and efficiently.
    Keywords: default risk; financial distress; default correlation; contagion; Markov chains
    JEL: G13
    Date: 2006–05
  3. By: Balazs Egert; Evzen Kocenda;
    Abstract: We analyze interrelations between three stock markets in Central and Eastern Europe and, in addition, interconnections which may exist between Western European (DAX, CAC, UKX) and Central and Eastern European stock markets (BUX, PX-50, WIG20). The novelty of our paper rests mainly on the use of the five-minute tick intraday price data from the mid-2003 to the early 2005 for stock indices and on the wide range of econometric techniques employed. We find no robust cointegration relationship for any of the stock index pairs or for any of the extended specifications. There are signs of short-term spillover effects both in terms of stock returns and stock price volatility. Granger causality tests show the presence of bidirectional causality for returns as well as volatility series. The results based on a VAR framework indicate a more limited number of short-term relationships between the stock markets. In general, it appears that spillover effects are stronger from volatility to volatility than contagion effects from return to return series.
    Keywords: contagion and spillover effects, market integration, European emerging markets, intra-day data
    JEL: C22 F36 G15 O16 P59
    Date: 2005–11–01
  4. By: Anca Podpiera; Jiri Podpiera
    Abstract: While it is generally consented that management quality is often the key determinant of banks' success in a risky world, somewhat paradoxically early warning systems are mainly built on financial ratios driving management quality assessment to the periphery. In this paper we show, using estimated cost efficiency scores for the Czech banking sector, that cost inefficient management was a predictor of bank failures during the years of banking sector consolidation, and thus suggest the inclusion of cost efficiency in early warning systems.
    Keywords: Bank failure, cost efficiency, stochastic frontier, hazard model.
    JEL: J21 J28 E58
    Date: 2005–12
  5. By: Gael M. Martin; Andrew Reidy; Jill Wright
    Abstract: This paper presents a comprehensive empirical evaluation of option-implied and returns-based forecasts of volatility, in which new developments related to the impact on measured volatility of market microstructure noise and random jumps are explicitly taken into account. The option-based component of the analysis also accommodates the concept of model-free implied volatility, such that the forecasting performance of the options market is separated from the issue of misspecification of the option pricing model. The forecasting assessment is conducted using an extensive set of observations on equity and option trades for News Corporation for the 1992 to 2001 period, yielding certain clear results. According to several different criteria, the model-free implied volatility is the best performing forecast, overall, of future volatility, with this result being robust to the way in which alternative measures of future volatility accommodate microstructure noise and jumps. Of the volatility measures considered, the one which is, in turn, best forecast by the option-implied volatility is that measure which adjusts for microstructure noise, but which retains some information about random jumps.
    Keywords: Volatility Forecasts; Quadratic Variation; Intraday Volatility Measures; Model-free Implied Volatility.
    JEL: C10 C53 G12
    Date: 2006
  6. By: J. ANNAERT; Crispiniano Garcia Joao Batista; J. LAMOOT; G. LANINE
    Abstract: The original Panjer recursion of the CreditRisk+ model is said to be unstable and therefore to yield inaccurate results of the tail distribution of credit portfolios. A much-hailed solution for the flaws of the Panjer recursion is the saddlepoint approximation method. In this paper we show that the saddlepoint approximation is an accurate and robust tool only for relatively homogenous credit portfolios with low skewness and kurtosis of the loss distribution. However, often credit portfolios are heterogeneous with large skewness and kurtosis. We show that for such portfolios the commonly applied saddlepoint approximations (the Lugannani-Rice and the Barndorff-Nielsen formulas) are not reliable. Moreover, when applied to such credit portfolios, the Lugannani-Rice formula is fragile. We explain it by the dependence of the high-order standardized cumulants and the relative error on the saddlepoints. The more the cumulants and the relative error vary, the less accurate the saddlepoint approximation is. Hence, the saddlepoint approximation is not a universal substitute to the Panjer recursion algorithm.
    Date: 2006–02
    Abstract: This paper describes a typology of failure processes within companies. Based on case studies and considering companies’ ages and management characteristics, we discovered four types of failure processes. The first failure process describes the deterioration of unsuccessful start-up companies leaded by a management with a serious deficiency in managerial and industry- related experience. The second process reveals the collapse after a failing growth of ambitious early- stage companies. Those companies have, after a failed investment, insufficient financial means to adjust their way of doing business to the changes in the environment in order to prevent bankruptcy. Third, we describe the failure process of dazzled established companies, leaded by an overconfident management without a realistic view on the company’s financial situation. Lastly, the bankruptcy of apathetic companies, describes the gradual deterioration of an apathetic established company where management had lost touch with the changing environment. This typology gives new insight into the evolution of financial performance ratios during the years preceding bankruptcy. Furthermore, we found that there is a great difference in the presence and importance of specific causes of bankruptcy between the distinctive failure processes. Errors made by management, errors in corporate policy and changes in the gradual and immediate environments differ considerably between each of the four failure processes.
    Date: 2006–05

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.