nep-rmg New Economics Papers
on Risk Management
Issue of 2006‒09‒30
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. Risks of investing in the Russian stock market: Lessons of the first decade By Alexei Goriaev; Alexei Zabotkin
  2. Influence of News in Moscow and New York on Returns and Risks on Baltic State Stock Indices By Brännäs, Kurt; Soultanaeva, Albina
  3. Analysis and Insights from a Dynamical Model of Nuclear Plant Safety Risk By Stephen M. Hess; Alfonso M. Albano; John P. Gaertner
  4. Intraday Margining of Central Counterparties: EU Practice and a Theoretical Evaluation of Benefits and Costs By Froukelien Wendt
  5. Measuring investors' risk appetite By Prasanna Gai; Nicholas Vause
  6. Stress tests of UK banks using a VAR approach By Glenn Hoggarth; Steffen Sorensen; Lea Zicchino
  7. The influence of the business cycle on bankruptcy probability By Suzan Hol
  8. Direction-of-Change Forecasts for Asian Equity Markets Based on Conditional Variance, Skewness and Kurtosis Dynamics: Evidence from Hong Kong and Singapore By Peter F. Christoffersen; Francis X. Diebold; Roberto S. Mariano; Anthony S. Tay; Yiu Kuen Tse
  9. Defined benefit company pensions and corporate valuations: simulation and empirical evidence from the United Kingdom By Kamakshya Trivedi; Garry Young

  1. By: Alexei Goriaev (CEFIR/New Economic School); Alexei Zabotkin
    Abstract: The modern history of the Russian stock market has mirrored ups and downs of the country’s transition as well as swings in investor perceptions. In this paper, we describe the evolution of the Russian stock market over its first decade, with particular attention to the risk factors driving stock returns. First, we analyze the development of the institutional infrastructure and dynamics of the market’s size and liquidity measured by the number of listed and traded stocks, depositary receipts and IPOs as well as trading volume in the local stock exchanges and abroad. Then, we examine major political and economic events, which influenced the investor perceptions of the country risk and were reflected in stock prices. Finally, we carry out quantitative analysis of risk factors explaining considerable time and cross-sectional variation in Russian stock returns. We document a significant role of corporate governance, political risk, and macroeconomic risk factors, such as global equity markets performance, oil prices, and exchange rates, whose relative importance varied a lot over time.
    Keywords: financial institutions, risk factors, Russian stock market
    Date: 2006–08
  2. By: Brännäs, Kurt (Department of Economics, Umeå University); Soultanaeva, Albina (Department of Economics, Umeå University)
    Abstract: The impact of news of the Moscow and New York stock market exchanges on the <p> returns and volatilities of the Baltic state stock market indices is studied using daily <p> return data for the period of 2000-2005. A nonlinear time series model that accounts <p> for asymmetries in the conditional mean and variance functions is used for the em- <p> pirical work. News from New York have stronger effect on returns in Tallinn, than <p> news from Moscow. High risk shocks in New York have a strong impact on volatility <p> in Tallinn, whereas volatility of Vilnius is more influenced by high risk shocks from <p> Moscow. Riga seems to be autonomous to news arriving from abroad.
    Keywords: Estonia; Latvia; Lithuania; Time series; Estimation; Finance
    JEL: C22 C52 G10 G15
    Date: 2006–09–18
  3. By: Stephen M. Hess (Sensortex, Inc.); Alfonso M. Albano (School of Economics and Social Sciences, Singapore Management University); John P. Gaertner (Electric Power Research Institute)
    Abstract: In this paper, we expand upon previously reported results of a dynamical systems model for the impact of plant processes and programmatic performance on nuclear plant safety risk. We utilize both analytical techniques and numerical simulations typical of the analysis of nonlinear dynamical systems to obtain insights important for effective risk management. This includes use of bifurcation diagrams to show that period doubling bifurcations and regions of chaotic dynamics can occur. We also investigate the impact of risk mitigating functions (equipment reliability and loss prevention) on plant safety risk and demonstrate that these functions are capable of improving risk to levels that are better than those that are represented in a traditional risk assessment. Next, we analyze the system response to the presence of external noise and obtain some conclusions with respect to the allocation of resources to ensure that safety is maintained at optimal levels. In particular, we demonstrate that the model supports the importance of management and regulator attention to plants that have demonstrated poor performance by providing an external stimulus to obtain desired improvements. Equally important, the model suggests that excessive intervention, by either plant management or regulatory authorities, can have a deleterious impact on safety for plants that are operating with very effective programs and processes. Finally, we propose a modification to the model that accounts for the impact of plant risk culture on process performance and plant safety risk. We then use numerical simulations to demonstrate the important safety benefits of a strong risk culture.
    Keywords: Nonlinear Dynamical Systems, Process Model, Risk Management
    Date: 2005–09
  4. By: Froukelien Wendt
    Abstract: Intraday margin is a generally accepted risk management tool of central counterparties to cover increased risk exposure during the day. Central counterparties may call for intraday margin on a routine basis, but also in case of extreme price volatility or large changes in positions of clearing members. An increase in the use of a routine intraday margin call can be seen at central counterparties in the EU. Three central counterparties have recently introduced a routine intraday margin call and two central counterparties intend to do so. This article explores the concept of intraday margin and its role within the risk management framework of the central counterparty. In addition, an overview is given of the benefits, cost and side effects of intraday margining to the central counterparty, its clearing members and the capital market in general. Finally, the article examines the practice of intraday margining of central counterparties in the EU and the differences in intraday margining policies.
    Keywords: Clearinghouse; Central counterparty; Replacement cost risk; Intraday margin.
    JEL: G29 G30
    Date: 2006–08
  5. By: Prasanna Gai; Nicholas Vause
    Abstract: This paper proposes a new method for measuring investor 'risk appetite'. Like other indicators in the literature, it is based on a comparison of risk-neutral probabilities of future returns with the corresponding subjective probabilities. The precise nature of the comparison is novel, however, and involves comparing probabilities across the full range of potential returns. Unlike other indicators, our measure of market sentiment distinguishes risk appetite from risk aversion, and is reported in levels rather than changes. Implementation of the approach yields results that respond to crises and other major economic events in a plausible manner.
  6. By: Glenn Hoggarth; Steffen Sorensen; Lea Zicchino
    Abstract: This paper adopts a new approach to stress testing the UK banking system. We attempt to account for the dynamics between banks' write-offs and key macroeconomic variables, through conditioning our stress test on the historical correlation between the variables and allowing for feedback effects from credit risk to the macroeconomy. In contrast to most existing empirical stress testing work, this paper uses a direct measure of banks' fragility - the write-off to loan ratio. We find that both UK banks' total and corporate write-offs are significantly related to deviations of output from potential. Following an adverse output shock, total and corporate write-off ratios increase. Mortgage arrears, on the other hand, appear to be mainly dependent on household income gearing. The results suggest that, even if the most extreme economic stress conditions witnessed over the past two decades were repeated, the UK banking sector should remain robust.
  7. By: Suzan Hol (Statistics Norway)
    Abstract: I combine two fields of research on default prediction by empirically testing a bankruptcy prediction function where unlisted firms are evaluated on the basis of both their financial statement analysis and the macroeconomic environment. This combination is found to improve the default prediction compared to financial statements alone. The GDP-gap, a production index and the money supply M1 in combination with some financial health indicators for individual firms are found to be significant predictors on default for Norwegian firms during both a recovery and expansion in the 1990’s.
    Keywords: bankruptcy prediction; macroeconomic environment; financial ratios; logit model
    JEL: G32 G33
    Date: 2006–08
  8. By: Peter F. Christoffersen (McGill University and CIRANO); Francis X. Diebold (University of Pennsylvania and NBER); Roberto S. Mariano (School of Economics and Social Sciences, Singapore Management University); Anthony S. Tay (School of Economics and Social Sciences, Singapore Management University); Yiu Kuen Tse (School of Economics and Social Sciences, Singapore Management University)
    Abstract: Recent theoretical work has revealed a direct connection between asset return volatility forecastability and asset return sign forecastability. This suggests that the pervasive volatility forecastability in equity returns could, via induced sign forecastability, be used to produce direction-ofchange forecasts useful for market timing. We attempt to do so in the context of two key Asian equity markets, with some success, as assessed by formal probability forecast scoring rules such as the Brier score. An important ingredient is our conditioning not only on conditional variance information, but also conditional skewness and kurtosis information, when forming direction-of-change forecasts.
    Keywords: Volatility, variance, skewness, kurtosis, market timing, asset management, asset allocation, portfolio management.
    JEL: G10 G12
    Date: 2004–07
  9. By: Kamakshya Trivedi; Garry Young
    Abstract: This paper examines the role of defined benefit company pensions in amplifying the effect of common shocks to companies' stock market valuations. It identifies and evaluates the significance of two channels of amplification: cross-holdings of equities in pension schemes, and leverage induced by pension liabilities. Econometric analysis of weekly stock market data for a sample of FTSE 350 UK companies confirm that these effects are statistically significant and robust to outlying observations.

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