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on Risk Management |
| By: | Michael G. Papaioannou |
| Abstract: | This paper presents some conventional and new measures of market, credit, and liquidity risks for government bonds. These measures are analyzed from the perspective of a sovereign's debt manager. In particular, it examines duration, convexity, M-square, skewness, kurtosis, and VaR statistics as measures of interest rate exposure; a VaR statistic as the prominent measure of exchange rate exposure; the balance sheet approach (or contingent claims approach), and its consequent probability of default as the most promising measure of credit risk exposure; and an elasticity approach and a VaR statistic to measure liquidity risk. Along with the formulas for the various statistics proposed, we provide simple examples of their application to some common risk valuation cases. Finally, we present an integrated approach for the simultaneous estimation of a portfolio's interest rate and exchange rate risk using the VaR methodology. The integrated approach is then extended to also include N risk factors. This approach allows us to measure the total risk of a portfolio, provided that the volatilities and correlations among the risk factors can be estimated. |
| Keywords: | Risk measurement , market risk , credit risk , liquidity risk , Debt , Credit risk , Debt management , |
| Date: | 2006–09–05 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:06/195&r=rmg |
| By: | Enzo Giacomini; Wolfgang Härdle; Ekaterina Ignatieva; Vladimir Spokoiny |
| Abstract: | Measuring dependence in a multivariate time series is tantamount to modelling its dynamic structure in space and time. In the context of a multivariate normally distributed time series, the evolution of the covariance (or correlation) matrix over time describes this dynamic. A wide variety of applications, though, requires a modelling framework different from the multivariate normal. In risk management the non-normal behaviour of most financial time series calls for nonlinear (i.e. non-gaussian) dependency. The correct modelling of non-gaussian dependencies is therefore a key issue in the analysis of multivariate time series. In this paper we use copulae functions with adaptively estimated time varying parameters for modelling the distribution of returns, free from the usual normality assumptions. Further, we apply copulae to estimation of Value-at-Risk (VaR) of a portfolio and show its better performance over the RiskMetrics approach, a widely used methodology for VaR estimation. |
| Keywords: | Value-at-Risk, time varying copula, adaptive estimation, nonparametric estimation. |
| JEL: | C14 |
| Date: | 2006–11 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2006-075&r=rmg |
| By: | Ying Chen; Wolfgang Härdle; Vladimir Spokoiny |
| Abstract: | Over recent years, study on risk management has been prompted by the Basel committee for regular banking supervisory. There are however limitations of some widely-used risk management methods that either calculate risk measures under the Gaussian distributional assumption or involve numerical difficulty. The primary aim of this paper is to present a realistic and fast method, GHICA, which overcomes the limitations in multivariate risk analysis. The idea is to first retrieve independent components (ICs) out of the observed high-dimensional time series and then individually and adaptively fit the resulting ICs in the generalized hyperbolic (GH) distributional framework. For the volatility estimation of each IC, the local exponential smoothing technique is used to achieve the best possible accuracy of estimation. Finally, the fast Fourier transformation technique is used to approximate the density of the portfolio returns. The proposed GHICA method is applicable to covariance estimation as well. It is compared with the dynamic conditional correlation (DCC) method based on the simulated data with d = 50 GH distributed components. We further implement the GHICA method to calculate risk measures given 20-dimensional German DAX portfolios and a dynamic exchange rate portfolio. Several alternative methods are considered as well to compare the accuracy of calculation with the GHICA one. |
| Keywords: | Multivariate Risk Management, Independent Component Analysis, Generalized Hyperbolic Distribution, Local Exponential Estimation, Value at Risk, Expected Shortfall. |
| JEL: | C14 C16 C32 C61 G20 |
| Date: | 2006–11 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2006-078&r=rmg |
| By: | Shiyi Chen; Wolfgang Härdle; Rouslan Moro |
| Abstract: | Predicting default probabilities is important for firms and banks to operate successfully and to estimate their specific risks. There are many reasons to use nonlinear techniques for predicting bankruptcy from financial ratios. Here we propose the so called Support Vector Machine (SVM) to estimate default probabilities of German firms. Our analysis is based on the Creditreform database. The results reveal that the most important eight predictors related to bankruptcy for these German firms belong to the ratios of activity, profitability, liquidity, leverage and the percentage of incremental inventories. Based on the performance measures, the SVM tool can predict a firms default risk and identify the insolvent firm more accurately than the benchmark logit model. The sensitivity investigation and a corresponding visualization tool reveal that the classifying ability of SVM appears to be superior over a wide range of the SVM parameters. Based on the nonparametric Nadaraya-Watson estimator, the expected returns predicted by the SVM for regression have a significant positive linear relationship with the risk scores obtained for classification. This evidence is stronger than empirical results for the CAPM based on a linear regression and confirms that higher risks need to be compensated by higher potential returns. |
| Keywords: | Support Vector Machine, Bankruptcy, Default Probabilities Prediction, Expected Profitability, CAPM. |
| JEL: | C14 G33 C45 G32 |
| Date: | 2006–11 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2006-077&r=rmg |
| By: | Elsinger, Helmut; Lehar, Alfred; Summer, Martin |
| Abstract: | We propose a new method for the analysis of systemic stability of a banking system relying mostly on market data. We model both asset correlations and interlinkages from interbank borrowing so that our analysis gauges two major sources of systemic risk: correlated exposures and mutual credit relations that may cause domino effects of insolvencies. We apply our method to a data set of the ten major UK banks and analyze insolvency risk over a one-year horizon. We also suggest a stress-testing procedure by analyzing the conditional asset return distribution that results from the hypothetical failure of individual institutions in this system. Rather than looking at individual bank defaults ceteris paribus, we take the change in the asset return distribution and the resulting change in the risk of all other banks into account. This takes previous stress tests of interlinkages a substantial step further. |
| Keywords: | Systemic Risk; Financial Stability; Stress Testing; Interbank Market |
| JEL: | G00 G0 |
| Date: | 2005–09–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:817&r=rmg |
| By: | Joan Jasiak (Department of Economics, York University); C. Gourieroux (CREST, CEPREMAP, University of Toronto) |
| Abstract: | This paper introduces new dynamic quantile models called the Dynamic Additive Quantile (DAQ) model and Quantile Factor Model (QFM) for univariate time series and panel data, respectively. The Dynamic Additive Quantile (DAQ) model is suitable for applications to financial data such as univariate returns, and can be used for computation and updating of the Value-at-Risk. The Quantile Factor Mode (QFM) is a multivariate model that can represent the dynamics of cross-sectional distributions of returns, individual incomes, and corporate ratings. The estimation method proposed in the paper relies on an optimization criterion based on the inverse KLIC measure. Goodness of fit tests and diagnostic tools for fit assessment are also provided. For illustration, the models are estimated on stock return data form the Toronto Stock Exchange (TSX). |
| Keywords: | Value-at-Risk, Factor Model, Information Criterion, Income Inequality, Panel Data, Loss-Given-Default |
| JEL: | C10 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:yca:wpaper:2006_4&r=rmg |
| By: | Gai, Prasanna; Vause, Nicholas |
| Abstract: | This paper proposes a method for measuring investor risk appetite based on the variation in the ratio of risk-neutral to subjective probabilities used by investors in evaluating possible future returns to an asset. Unlike other indicators advanced in the literature, 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. |
| Keywords: | Risk appetite; market sentiment; risk-neutral pricing; risk aversion |
| JEL: | G00 G0 |
| Date: | 2005–12–07 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:818&r=rmg |
| By: | Kim, Joocheol; Kim, KiHyung |
| Abstract: | The proposals of the Basel Committee on Banking Supervision for the revision of minimum requirements for bank's risk capital leave the quanti¯cation of loss-given-default (LGD) parameter used for capital calculation unspeci¯ed. This paper proposes a new methodology for incorporating LGD parameter explicitly into the Basel risk weight function. Numerical examples based on the new methodology are compared to the current proposals of the Basel committee on Banking Supervision. |
| Keywords: | LGD; Single Risk Factor; Basel |
| JEL: | G21 |
| Date: | 2006–11–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:860&r=rmg |
| By: | J. David Cummins; Georges Dionne (IEA, HEC Montréal); Robert Gagné (IEA, HEC Montréal); Abdelhakim Nouira |
| Abstract: | Risk management is now present in many economic sectors. This paper investigates the role of risk management in creating value for financial institutions by analyzing U.S. property-liability insurers. Property-liability insurers are financial intermediaries whose primary role in the economy is risk pooling and risk bearing. The risk pooling and risk bearing functions performed by insurers are the primary determinants of the need for risk management. The main goal of this paper is to test how risk management and financial intermediation activities create value for insurers by enhancing economic efficiency. Insurer cost efficiency is measured relative to an econometric cost frontier. Since the prices of risk management and financial intermediation services are not observable, we consider these two activities as intermediate outputs and estimate their shadow prices. The shadow prices isolate the contributions of risk management and financial intermediation to insurer cost efficiency. The econometric results show that both activities significantly increase the efficiency of the property-liability insurance industry. |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:iea:carech:0606&r=rmg |
| By: | Josep Vallverdu Calafell; Antonio Somoza Lopez; Soledad Moya Gutierrez (Universitat de Barcelona) |
| Abstract: | This article has an immediate predecessor, upon which it is based and with which readers must necessarily be familiar: Towards a Theory of the Credit-Risk Balance Sheet (Vallverdu, Somoza and Moya, 2006). The Balance Sheet is conceptualised on the basis of the duality of a credit-based transaction; it deals with its theoretical foundations, providing evidence of a causal credit-risk duality, that is, a true causal relationship; its characteristics, properties and its static and dynamic characteristics are analyzed. This article, which provides a logical continuation to the previous one, studies the evolution of the structure of the Credit-Risk Balance Sheet as a consequence of a businesss dynamics in the credit area. Given the Credit-Risk Balance Sheet of a company at any given time, it attempts to estimate, by means of sequential analysis, its structural evolution, showing its usefulness in the management and control of credit and risk. To do this, it bases itself, with the necessary adaptations, on the by-now classic works of Palomba and Cutolo. The establishment of the corresponding transformation matrices allows one to move from an initial balance sheet structure to a final, future one, to understand its credit-risk situation trends, as well as to make possible its monitoring and control, basic elements in providing support for risk management. |
| Keywords: | credit-risk balance sheet, bad debts, risk, insolvency, commercial credit, transformation matrix, probabilities matrix, credit information, business risk, credit risk, credit management |
| JEL: | M10 M41 M20 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:bar:bedcje:2006165&r=rmg |
| By: | Amadou N. R. Sy; Jorge A. Chan-Lau |
| Abstract: | In contrast to corporate defaults, regulators typically take a number of statutory actions to avoid the large fiscal costs associated with bank defaults. The distance-to-default, a widely used market-based measure of corporate default risk, ignores such regulatory actions. To overcome this limitation, this paper introduces the concept of distance-to-capital that accounts for pre-default regulatory actions such as those in a prompt-corrective-actions framework. We show that both risk measures can be analyzed using the same theoretical framework but differ depending on the level of capital adequacy thresholds and asset volatility. We also use the framework to illustrate pre-default regulatory actions in Japan in 2001-03. |
| Keywords: | Banks , insolvency , closure , prompt corrective action , distance-to-default , distance-to-capital , Banks , Financial stability , |
| Date: | 2006–10–06 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:06/215&r=rmg |
| By: | Karen K. Lewis |
| Abstract: | Over the past two decades international markets have become more open, leading to a common perception that global capital markets have become more integrated. In this paper, I ask what this integration and its resulting higher correlation would imply about the diversification potential across countries. For this purpose, I examine two basic groups of international returns: (1) foreign market indices and (2) foreign stocks that are listed and traded in the US. I examine the first group since this is the standard approach in the international diversification literature, while I study the second group since some have argued that US-listed foreign stocks are the more natural diversification vehicle (Errunza et al (1999)). In order to consider the possibility of shifts in the covariance of returns over time, I extend the break-date estimation approach of Bai and Perron (1998) to test for and estimate possible break dates across returns along with their confidence intervals. I find that the covariances among country stock markets have indeed shifted over time for a majority of the countries. But in contrast to the common perception that markets have become significantly more integrated over time, the covariance between foreign markets and the US market have increased only slightly from the beginning to the end of the last twenty years. At the same time, the foreign stocks in the US markets have become significantly more correlated with the US market. To consider the economic significance of these parameter changes, I use the estimates to examine the implications for a simple portfolio decision model in which a US investor could choose between US and foreign portfolios. When restricted to holding foreign assets in the form of market indices, I find that the optimal allocation in foreign market indices actually increases over time. However, the optimal allocation into foreign stocks decreases when the investor is allowed to hold foreign stocks that are traded in the US. Also, the minimum variance attainable by the foreign portfolios has increased over time. These results suggest that the benefits to diversification have declined both for stocks inside and outside the US. |
| JEL: | F3 F4 G11 G15 |
| Date: | 2006–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12697&r=rmg |
| By: | Martin Petri; Tahsin Saadi-Sedik |
| Abstract: | We analyze the performance of the Amman Stock Exchange (ASE) and its integration with other markets. Using cointegration techniques, we find that the ASE and other Arab stock markets are cointegrated, which implies little long-run risk diversification. However, there is no cointegrating relationship between the ASE and other emerging or developed stock markets. Two of the main regional stock markets-Kuwait and Saudi Arabia-Grangercause the Jordanian stock market. The paper finds that there may have been some overvaluation at end-2005, but that the market correction in early 2006 and strong recent earnings growth have reduced overvaluation concerns. |
| Keywords: | Jordan , stock market integration , cointegration , common trends , Stock markets , Jordan , Investment , |
| Date: | 2006–08–14 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:06/187&r=rmg |
| By: | Josep Vallverdu Calafell; Antonio Somoza Lopez; Soledad Moya Gutierrez (Universitat de Barcelona) |
| Abstract: | This article designs what it calls a Credit-Risk Balance Sheet (the risk being that of default by customers), a tool which, in principle, can contribute to revealing, controlling and managing the bad debt risk arising from a companys commercial credit, whose amount can represent a significant proportion of both its current and total assets. To construct it, we start from the duality observed in any credit transaction of this nature, whose basic identity can be summed up as Credit = Risk. Credit is granted by a company to its customer, and can be ranked by quality (we suggest the credit scoring system) and risk can either be assumed (interiorised) by the company itself or transferred to third parties (exteriorised). What provides the approach that leads to us being able to talk with confidence of a real Credit-Risk Balance Sheet with its methodological robustness is that the dual vision of the credit transaction is not, as we demonstrate, merely a classificatory duality (a double risk-credit classification of reality) but rather a true causal relationship, that is, a risk-credit causal duality. Once said Credit-Risk Balance Sheet (which bears a certain structural similarity with the classic net asset balance sheet) has been built, and its methodological coherence demonstrated, its properties static and dynamic are studied. Analysis of the temporal evolution of the Credit-Risk Balance Sheet and of its applications will be the object of subsequent works. |
| Keywords: | bad debts, business risk, commercial credit, credit, credit information, credit management, credit risk, credit-risk balance sheet, insolvency, risk |
| JEL: | M10 M20 M41 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:bar:bedcje:2006148&r=rmg |