nep-rmg New Economics Papers
on Risk Management
Issue of 2006‒09‒16
seven papers chosen by
Stan Miles
York University

  1. The adaptive markets hypothesis: evidence from the foreign exchange market By Christopher J. Neely; Paul A. Weller; Joshua M. Ulrich
  2. A tale of tails: an empirical analysis of loss distribution models for estimating operational risk capital By Kabir Dutta; Jason Perry
  3. Portfolio management implications of volatility shifts: Evidence from simulated data By Viviana Fernandez; Brian M Lucey
  4. Does aggregate relative risk aversion change countercyclically over time? evidence from the stock market By Hui Guo; Zijun Wang; Jian Yang
  5. The Returns to Currency Speculation By Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
  6. Risk and Returns Around Bond Rating Changes: New evidence from the Spanish Stock Market By Pilar Abad-Romero; M. Dolores Robles-Fernández
  7. The Matrix Rate of Return By Anna Zambrzycka; Edward W. Piotrowski

  1. By: Christopher J. Neely; Paul A. Weller; Joshua M. Ulrich
    Abstract: We analyze the intertemporal stability of returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously published rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the mid-1990s for filter and moving average (MA) rules. Returns to less-studied rules, such as channel, ARIMA, genetic programming and Markov rules, also have declined, but have probably not completely disappeared. The volatility of returns makes it difficult to estimate mean returns precisely. The most likely time for a structural break in the MA and filter rule returns is the early 1990s. These regularities are consistent with the Adaptive Markets Hypothesis (Lo, 2004), but not with the Efficient Markets Hypothesis.
    Keywords: Foreign exchange market ; Foreign exchange
    Date: 2006
  2. By: Kabir Dutta; Jason Perry
    Abstract: Operational risk is being considered as an important risk component for financial institutions as evinced by the large sums of capital that are allocated to mitigate this risk. Therefore, risk measurement is of paramount concern for the purposes of capital allocation, hedging, and new product development for risk mitigation. We perform a comprehensive evaluation of commonly used methods and introduce new techniques to measure this risk with respect to various criteria. We find that our newly introduced techniques perform consistently better than the other models we tested.
    Keywords: Risk management
    Date: 2006
  3. By: Viviana Fernandez; Brian M Lucey
    Abstract: Based on weekly data of the Dow Jones Country Titans, the CBT-municipal bond, spot and futures prices of commodities for the period 1992-2005, we analyze the implications for portfolio management of accounting for conditional heteroskedasticity and structural breaks in long-term volatility. In doing so, we first proceed to utilize the ICSS algorithm to detect volatility shifts, and incorporate that information into PGARCH models fitted to the returns series. At the next stage, we simulate returns series and compute a wavelet-based value at risk, which takes into consideration the investor’s time horizon. We repeat the same procedure for artificial data generated from distribution functions fitted to the returns by a semi-parametric procedure, which accounts for fat tails. Our estimation results show that neglecting GARCH effects and volatility shifts may lead us to overestimate financial risk at different time horizons. In addition, we conclude that investors benefit from holding commodities as their low or even negative correlation with stock indices contribute to portfolio diversification.
    Date: 2006
  4. By: Hui Guo; Zijun Wang; Jian Yang
    Abstract: Using a semiparametric estimation technique, we show that the risk-return tradeoff and the Sharpe ratio of the stock market increases monotonically with the consumption wealth ratio (CAY) across time. While early studies have commonly interpreted such a finding as evidence of the countercyclical variation in aggregate relative risk aversion (RRA), we argue that it mainly reflects changes in investment opportunities for two reasons. First, we fail to reject the null hypothesis of constant RRA after controlling for CAY as a proxy for the hedge against changes in the investment opportunity set. Second, by contrast with habit formation models but consistent with ICAPM, we find that loadings on the conditional stock market variance scaled by CAY are negatively priced in the cross-sectional regressions. For illustration, we replicate the countercyclical stock market risk-return tradeoff using simulated data from Guo's (2004) limited stock market participation model, in which RRA is constant and CAY is a proxy for shareholders' liquidity conditions.
    Keywords: Capital assets pricing model ; Stock market
    Date: 2006
  5. By: Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
    Abstract: Currencies that are at a forward premium tend to depreciate. This `forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. The first strategy, known as the carry trade, is widely used by practitioners. This strategy involves selling currencies forward that are at a forward premium and buying currencies forward that are at a forward discount. The second strategy relies on a particular regression to forecast the payoff to selling currencies forward. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. However, these Sharpe ratios do not represent unexploited profit opportunities. In the presence of microstructure frictions, spot and forward exchange rates move against traders as they increase their positions. The resulting `price pressure' drives a wedge between average and marginal Sharpe ratios. We argue that marginal Sharpe ratios are zero even though average Sharpe ratios are positive.
    JEL: E24 F31 G15
    Date: 2006–08
  6. By: Pilar Abad-Romero (Universidade de Vigo. Dpto. de Economía Aplicada.); M. Dolores Robles-Fernández (Universidad Complutense de Madrid. Facultad de CC. Económicas y Empresariales. Dpto. Dpto. Fundamentos del Análisis Económico II (Economía cuantitativa).)
    Abstract: This study analyzes the effect of corporate bond rating changes over stock prices. We explore the effects over excess of returns and systematic risk. Rating changesby Moody's, Standard and Poor's of FitchIBCA are analyzed. On an efficient market, these changes will only have some effect if they contain some new information or if they are asociated to a redestribution of wealth between shareholders and bondholders. We use an extension of the event study dummy approach. Our results indicate that rating downgrades do not cause abnormal returns around the date of the announcement while upgrades cause significantly negative effect. This behavior reflect a redistribution of wealth behaviour. Changes of both directions cause a rebalancing effect in the total risk of the firm, with significant reductions on their systematic component.
    Date: 2005
  7. By: Anna Zambrzycka; Edward W. Piotrowski
    Abstract: In this paper we give definitions of matrix rates of return which do not depend on the choice of basis describing baskets. We give their economic interpretation. The matrix rate of return describes baskets of arbitrary type and extends portfolio analysis to the complex variable domain. This allows us for simultaneous analysis of evolution of baskets parameterized by complex variables in both continuous and discrete time models.

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