New Economics Papers
on Risk Management
Issue of 2006‒07‒09
five papers chosen by

  1. An Upper Bound of the Sum of Risks: two Applications of Comonotonicity By Carry Mout
  2. Australian Government Balance Sheet Management By Wilson Au-Yeung; Jason McDonald; Amanda Sayegh
  3. Visible and hidden risk factors for banks By Til Schuermann; Kevin J. Stiroh
  4. The Relationship between Risk and Expected Return in Europe. By Ángel León; Juan Nave; Gonzalo Rubio
  5. The Performance of International Equity Portfolios By Charles P. Thomas; Francis E. Warnock; Jon Wongswan

  1. By: Carry Mout
    Abstract: This paper discusses the method of comonotonicity to estimate the sum of risks. Two applications are presented. First, we estimate a property insurer.s exposure to claims after a severe storm. Second, we apply our approach to a pension fund.s investment risk to estimate the prospective total assets and the conditional prospective funding rate. Both applications show that comonotonicity can be a useful tool to assess the upper bound for the risk exposure of financial institutions.
    Keywords: estimate, sum of risks, investment
    JEL: C13 G22 G23
    Date: 2006–06
  2. By: Wilson Au-Yeung; Jason McDonald; Amanda Sayegh
    Abstract: Since almost eliminating net debt, the Australian Government’s attention has turned to the financing of broader balance sheet liabilities, such as public sector superannuation. Australia will be developing a significant financial asset portfolio in the ‘Future Fund’ to smooth the financing of expenses through time. This raises the significant policy question of how best to manage the government balance sheet to reduce risk. This paper provides a framework for optimal balance sheet management. The major conclusions are that: – fiscal sustainability depends on both the expected path of future taxation and the risks around that path; – optimal balance sheet management requires knowledge of how risks affect the balance sheet (and therefore volatility in tax rates); and – the government’s financial investment strategy should reduce the risk to government finances from macroeconomic shocks that permanently affect the budget. Based on this framework, we find that a Future Fund portfolio that included (amongst other potential investments) domestic nominal securities and equities of selected countries would reduce overall balance sheet risk.
    JEL: H5 H6
    Date: 2006–06
  3. By: Til Schuermann; Kevin J. Stiroh
    Abstract: This paper examines the common factors that drive the returns of U.S. bank holding companies from 1997 to 2005. We compare a range of market models from a basic one-factor model to a nine-factor model that includes the standard Fama-French factors and additional factors thought to be particularly relevant for banks such as interest and credit variables. We show that the market factor clearly dominates in explaining bank returns, followed by the Fama-French factors. The bank-specific factors are not informative, particularly for the largest banks, which take advantage of protection in the form of interest rate and credit derivatives. Even in our broadest model, however, considerable residual variation remains, with the mean pairwise correlation of residuals for the largest banks near 0.25. This finding suggests that important hidden factors remain. A principal component analysis shows that this residual variance is relatively diffuse, although the largest banks do tend to load in the same direction on the first component. Relative to the returns of large firms in other sectors, bank returns are relatively well explained with standard risk factors, and both the residual correlation and degree of factor loading agreement are not particularly large. These results have clear implications both for public policymakers seeking to quantify those shared bank exposures that create systemic risk and to portfolio managers seeking to devise optimal diversification strategies.
    Keywords: Bank holding companies ; Bank profits ; Rate of return ; Bank investments
    Date: 2006
  4. By: Ángel León (University of Alicante); Juan Nave (University of Castilla La Mancha); Gonzalo Rubio (University of the Basque Country)
    Abstract: We employ MIDAS (Mixed Data Sampling) to study the risk-expected return trade-off in several European stock indices. Using MIDAS, we report that, in most indices, there is a significant and positive relationship between risk and expected return. This strongly contrasts with the result we obtain when we employ both symmetric and asymmetric GARCH models for conditional variance. We also find that asymmetric specifications of the variance process within the MIDAS framework improve the relationship between risk and expected return. Finally, we introduce bivariate MIDAS and find some evidence of significant pricing of the hedging component for the intertemporal riskreturn trade-off.
    Keywords: Risk-return trade-off, hedging component, MIDAS, conditional variance
    JEL: G12 C22
    Date: 2005–07–04
  5. By: Charles P. Thomas; Francis E. Warnock; Jon Wongswan
    Abstract: This paper evaluates the ability of U.S. investors to allocate their foreign equity portfolios across 44 countries over a 25-year period. We find that U.S. portfolios achieved a significantly higher Sharpe ratio than foreign benchmarks, especially since 1990. We test whether this strong performance owed to trading expertise or longer-term allocation expertise. The evidence is overwhelmingly against trading expertise. While U.S. investors did abstain from momentum trading and instead sold past winners, we find no evidence that these past winners subsequently underperformed. In addition, conditional performance measures, which directly test reallocating into (out of) markets that subsequently outperformed (underperformed), suggest no significant trading expertise. In contrast, we offer strong evidence of longer-term allocation expertise: If we fix portfolio weights at the end of 1989 and do not allow reallocations, we still find superior performance in the recent period.
    JEL: G11 G12 F21
    Date: 2006–07

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