nep-rmg New Economics Papers
on Risk Management
Issue of 2007‒02‒10
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. A Data-Driven Optimization Heuristic for Downside Risk Minimization By Manfred Gilli; Evis Këllezi; Hilda Hysi
  2. Liquidity and Risk Management By Nicolae B. Garleanu; Lasse H. Pedersen
  3. Asset allocation by penalized least squares. By Simone Manganelli
  4. Volatility Spillover Between the Stock Market and the Foreign Exchange Market in Pakistan By Qayyum, Abdul; Kemal, A. R.
  5. Quantile Sieve Estimates For Time Series By Jürgen Franke; Jean-Pierre Stockis; Joseph Tadjuidje
  6. Predicting recessions with leading indicators: An application on the Icelandic economy By Bruno Eklund
  7. Rating philosophies: some clarifications By Varsanyi, Zoltan
  8. The transmission of emerging market shocks to global equity markets. By Marcel Fratzscher; Christian Thimann; Lucia Cuadro Sáez
  9. On the Group Level Swiss Solvency Test By Damir Filipovic; Michael Kupper

  1. By: Manfred Gilli (University of Geneva); Evis Këllezi (Mirabaud & cie); Hilda Hysi (University of Geneva - Department of Econometrics)
    Abstract: In practical portfolio choice models risk is often defined as VaR, expected short-fall, maximum loss, Omega function, etc. and is computed from simulated future scenarios of the portfolio value. It is well known that the minimization of these functions can not, in general, be performed with standard methods. We present a multi-purpose data-driven optimization heuristic capable to deal efficiently with a variety of risk functions and practical constraints on the positions in the portfolio. The efficiency and robustness of the heuristic is illustrated by solving a collection of real world portfolio optimization problems using different risk functions such as VaR, expected shortfall, maximum loss and Omega function with the same algorithm.
    Keywords: Portfolio optimization, Heuristic optimization, Threshold accepting, Downside risk
    JEL: C61 C63 G11 G32
  2. By: Nicolae B. Garleanu; Lasse H. Pedersen
    Abstract: This paper provides a model of the interaction between risk-management practices and market liquidity. On one hand, tighter risk management reduces the maximum position an institution can take, thus the amount of liquidity it can offer to the market. On the other hand, risk managers can take into account that lower liquidity amplifies the effective risk of a position by lengthening the time it takes to sell it. The main result of the paper is that a feedback effect can arise: tighter risk management reduces liquidity, which in turn leads to tighter risk management, etc. This can help explain sudden drops in liquidity and, since liquidity is priced, in prices in connection with increased volatility or decreased risk-bearing capacity.
    JEL: G10
    Date: 2007–02
  3. By: Simone Manganelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper shows how the problem of mean-downside risk portfolio allocation can be cast in terms of penalized least squares (PLS). The penalty is given by a power function of the returns below a certain threshold. We derive the asymptotic properties of the PLS estimator, allowing for possible nonlinearities and misspecification of the model. We illustrate the usefulness of this new class of estimators with two empirical applications. First, we estimate an autoregressive model, in the spirit of the GARCH literature. Second, we suggest a simple strategy to derive the optimal portfolio weights associated to a mean-downside risk model. JEL Classification: C14, C22, G11.
    Keywords: Portfolio otpimization, mean-risk utility model, stochastic dominance, asymmetric least squares, expectile.
    Date: 2007–02
  4. By: Qayyum, Abdul; Kemal, A. R.
    Abstract: Our paper examines the volatility spillover between the stock market and the foreign exchange market in Pakistan. For long run relationship we use Engle Granger two step procedure and the volatility spillover is modelled through bivariate EGARCH method. The estimated results from cointegration analysis show that there is no long run relationship between the two markets. The results from the volatility modelling show that the behaviour of both the stock exchange and the foreign exchange markets are interlinked. The returns of one market are affected by the volatility of other market. Particularly the returns of the stock market are sensitive to the returns as well as the volatility of foreign exchange market. On the other hand returns in the foreign exchange market are mean reverting and they are affected by the volatility of stock market returns. There is strong relationship between the volatility of foreign exchange market and the volatility of returns in stock market.
    Keywords: Stock Market; Forex Market; EGARCH; Volatility Spillover; Stock market return; Foreign Exchange return; Pakistan
    JEL: G1
    Date: 2006
  5. By: Jürgen Franke; Jean-Pierre Stockis; Joseph Tadjuidje
    Abstract: We consider the problem of estimating the conditional quantile of a time series at time t given observations of the same and perhaps other time series available at time t - 1. We discuss sieve estimates which are a nonparametric versions of the Koenker-Bassett regression quantiles and do not require the specification of the innovation law. We prove consistency of those estimates and illustrate their good performance for light- and heavy-tailed distributions of the innovations with a small simulation study. As an economic application, we use the estimates for calculating the value at risk of some stock price series.
    Keywords: Conditional Quantile, Time Series, Sieve Estimate, Neural Network, Qualitative Threshold Model, Uniform Consistency, Value at Risk
    JEL: C14 C45
    Date: 2007–02
  6. By: Bruno Eklund
    Abstract: This paper focuses on the Stock and Watson methodology to fore- cast the future state of the business cycle in the Icelandic economy. By selecting variables available on a monthly basis that mimic the cyclical behaviour of the quarterly GDP, coincident and leading vari- ables are identi?ed. A factor model is then speci?ed based on the assumption that a single common unobservable element drives the cyclical evolution of many of the Icelandic macroeconomic variables. The model is cast into a state space form providing a simple frame- work both for estimation and for predicting the future recession and expansion patterns. Based on the bootstrap resampling technique, a simple approach to estimate recession and expansion probabilities is developed. This method is completely nonparametric compared to the semi-parametric approach used by Stock and Watson.
    Date: 2007–01
  7. By: Varsanyi, Zoltan
    Abstract: In this paper I try to give answers to some of the questions and problems that arise in relation to point in time (PIT) and through the cycle (TTC) rating philosophies. One of the most confusing of these is the definition of the two approaches that, as I argue, should be based on the scope of information behind the systems. Through a simple model I demonstrate that the results of quantitative analyses can be very sensitive to the definitions and, additionally, the stress concept applied. I analyze the role played by the rating philosophies in capital requirements calculations and stress tests, and touch on their implications on the pro-cyclicality of credit risk capital regulation.
    Keywords: rating model; rating philosophy; stress test; pro-cyclicality
    JEL: G28 C1
    Date: 2007–01
  8. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Christian Thimann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Lucia Cuadro Sáez (Banco de España, Alcalá 48, 28014 Madrid, Spain.)
    Abstract: The paper analyses whether, and to what extent, emerging market economies (EMEs) have systemic importance for global financial markets, above and beyond their influence during crises episodes. Using a novel database of exogenous economic and political shocks for 14 systematically relevant EMEs, we find that EME shocks not only have a statistically but also economically significant impact on global equity markets. The economic significance of EME shocks is in particular underlined by their remarkably persistent effects over time. Importantly, EMEs are found to influence global equity markets about just as much in “good” times as in “bad” times, i.e. during crises or periods of financial turbulence. Finally, we detect a large degree of heterogeneity in the transmission of EME shocks to individual countries’ equity markets, stressing the different degrees of financial exposure, which is relatively higher for European equity markets. JEL Classification: F36; F30; G15.
    Keywords: Keywords: global financial markets; equity markets; transmission; financial integration; shocks; news; emerging market economies; mature economics; euro area; United States.
    Date: 2007–02
  9. By: Damir Filipovic (Department of Mathematics, University of Munich); Michael Kupper
    Abstract: In this paper we elaborate on Swiss Solvency Test (SST) consistent group diversification effects via optimizing the web of capital and risk transfer (CRT) instruments between the legal entities. A group level SST principle states that subsidiaries can be sold by the parent company at their economic value minus some minimum capital requirement. In a numerical example we examine the dependence of the optimal CRT on this minimum capital requirement. Our findings raise the question of how to actually implement this group level SST principle and how to define the respective level of minimum capital requirements, in particular.
    Keywords: convex optimization; group diversification; minimum capital requirement; Swiss solvency test
    Date: 2007–01–01

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