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on Risk Management |
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Issue of 2006‒08‒19
three papers chosen by |
| By: | Hayden, Evelyn; Porath, Daniel; von Westernhagen, Natalja |
| Abstract: | Should banks be diversified or focused? Does diversification indeed lead to enhanced performance and, therefore, greater safety for banks, as traditional portfolio and banking theory would suggest? This paper investigates the link between banks’ profitability (ROA) and their portfolio diversification across different industries, broader economic sectors and geographical regions measured by the Herfindahl Index. To explore this issue, we use a unique data set of the individual bank loan portfolios of 983 German banks for the period from 1996 to 2002. The overall evidence we provide shows that there are no large performance benefits associated with diversification since each type of diversification tends to reduce the banks’ returns. Moreover, we find that the impact of diversification depends strongly on the risk level. However, it is only for moderate risk levels and in the case of industrial diversification that diversification significantly improves the banks’ returns. |
| Keywords: | focus, diversification, monitoring, bank returns, bank risk |
| JEL: | G21 G28 G32 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp2:4536&r=rmg |
| By: | Georges Dionne; Sadok Laajimi; Sofiane Mejri; Madalina Petrescu |
| Abstract: | Two models of default risk are prominent in the financial literature: Merton's structural model and Altman's non-structural model. Merton's structural model has the benefit of being responsive, since the probabilities of default can continually be updated with the evolution of firms' asset values. Its main flaw lies in the fact that it may over- or underestimate the probabilities of default, since asset values are unobservable and must be extrapolated from the share prices. Altman's nonstructural model, on the other hand, is more precise, since it uses firms' accounting data-but it is less flexible. In this paper, the authors investigate the hybrid contingent claims approach with publicly traded Canadian companies listed on the Toronto Stock Exchange. The authors' goal is to assess how their ability to predict companies' probability of default is improved by combining the companies' continuous market valuation (structural model) with the value given in their financial statements (non-structural model). The authors' results indicate that the predicted structural probabilities of default (PDs from the structural model) contribute significantly to explaining default probabilities when PDs are included alongside the retained accounting variables in the hybrid model. The authors also show that quarterly updates to the PDs add a large amount of dynamic information to explain the probabilities of default over the course of a year. This flexibility would not be possible with a non-structural model. The authors conduct a preliminary analysis of correlations between structural probabilities of default for the firms in their database. Their results indicate that there are substantial correlations in the studied data. |
| Keywords: | Debt management; Credit and credit aggregates; Financial markets; Recent economic and financial developments; Econometric and statistical methods |
| JEL: | G21 G24 G28 G33 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:06-28&r=rmg |
| By: | Ulrich Bindseil (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Francesco Papadia (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany) |
| Abstract: | This paper reviews the role and effects of the collateral framework which central banks, and in particular the Eurosystem, use in conducting temporary monetary policy operations. First, the paper explains the design of such a framework from the perspective of risk mitigation, which is the purpose of collateralisation. The paper argues that, by means of appropriate risk mitigation measures, the residual risk on any potentially eligible asset can be equalised and brought down to the level consistent with the risk tolerance of the central bank. Once this result has been achieved, eligibility decisions should be based on an economic cost-benefit analysis. Second, the paper looks at the effects of the collateral framework on financial markets, and in particular on spreads between eligible and ineligible assets. |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbops:20060049&r=rmg |