nep-rmg New Economics Papers
on Risk Management
Issue of 2007‒05‒04
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. A Multivariate Commodity Analysis and Applications to Risk Management By Reik H. Boerger; Alvaro Cartea; Ruediger Kiesel; Gero Schindlmayr
  2. Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing Under Data-Restricted Environments By Miguel A. Segoviano Basurto
  3. Contagion Risk in the International Banking System and Implications for London as a Global Financial Center By Li L. Ong; Srobona Mitra; Jorge A. Chan-Lau
  4. Economic Integration and Financial Stability: A European Perspective By Gianni De Nicoló; Alexander F. Tieman
  5. Bank Risk-Taking and Competition Revisited: New Theory and New Evidence By Gianni De Nicoló; John H. Boyd; Abu M. Jalal
  6. What Drives Corporate Bond Market Betas? By Abhay Abhyankar; Angelica Gonzalez
  7. Sovereign Ceilings "Lite"? the Impact of Sovereign Ratings on Corporate Ratings in Emerging Market Economies By Kevin Cowan; Patricio Valenzuela; Eduardo Borensztein
  8. Capturing asymmetry in real exchange rate with quantile autoregression By Mauro S. Ferreira
  9. Multiple Bank Relationships and the Main Bank System: Evidence from a Matched Sample of Japanese Small Firms and Main Banks By OGAWA Kazuo; Elmer STERKEN; TOKUTSU Ichiro

  1. By: Reik H. Boerger; Alvaro Cartea (School of Economics, Mathematics & Statistics, Birkbeck); Ruediger Kiesel; Gero Schindlmayr
    Abstract: The understanding of joint asset return distributions is an important ingredient for managing risks of portfolios. While this is a well-discussed issue in fixed income and equity markets, it is a challenge for energy commodities. In this paper we are concerned with describing the joint return distribution of energy related commodities futures, namely power, oil, gas, coal and carbon. The objective of the paper is threefold. First, we conduct a careful analysis of empirical returns and show how the class of multivariate generalized hyperbolic distributions performs in this context. Second, we present how risk measures can be computed for commodity portfolios based on generalized hyperbolic assumptions. And finally, we discuss the implications of our findings for risk management analyzing the epxosure of power plants which represent typical energy portfolios. Our main findings are that risk estimates based on a normal distribution in the context of energy commodities can be statistically improved using generalized hyperbolic distributions. Those distributions are flexible enough to incorporate many characteristics of commodity returns and yield more accurate risk estimates. Our analysis of the market suggests that carbon allowances can be a helpful tool for controlling the risk exposure of a typical energy portfolio representing a power plant.
    Date: 2007–04
  2. By: Miguel A. Segoviano Basurto
    Abstract: Portfolio credit risk measurement is greatly affected by data constraints, especially when focusing on loans given to unlisted firms. Standard methodologies adopt convenient, but not necessarily properly specified parametric distributions or simply ignore the effects of macroeconomic shocks on credit risk. Aiming to improve the measurement of portfolio credit risk, we propose the joint implementation of two new methodologies, namely the conditional probability of default (CoPoD) methodology and the consistent information multivariate density optimizing (CIMDO) methodology. CoPoD incorporates the effects of macroeconomic shocks into credit risk, recovering robust estimators when only short time series of loans exist. CIMDO recovers portfolio multivariate distributions (on which portfolio credit risk measurement relies) with improved specifications, when only partial information about borrowers is available. Implementation is straightforward and can be very useful in stress testing exercises (STEs), as illustrated by the STE carried out within the Danish Financial Sector Assessment Program.
    Keywords: Portfolio credit risk measurement , stress testing , macroeconomic shock measurement , multivariate density estimation , entropy distribution , Credit risk , Economic conditions , Statistics , Economic models ,
    Date: 2007–01–03
  3. By: Li L. Ong; Srobona Mitra; Jorge A. Chan-Lau
    Abstract: In this paper, we use the extreme value theory (EVT) framework to analyze contagion risk across the international banking system. We test for the likelihood that an extreme shock affecting a major, systemic U.K. bank would also affect another large local or foreign counterpart, and vice-versa. Our results reveal several key trends among major global banks: contagion risk among banks exhibits "home bias"; individual banks are affected differently by idiosyncratic shocks to their major counterparts; and banks are affected differently by common shocks to the real economy or financial markets. In general, bank soundness appears more susceptible to common (macro and market) shocks when the global environment is turbulent; this may have important implications for London as a major financial services and capital markets hub.
    Keywords: Bank soundness , co-exceedance , contagion risk , distance-to-default , extreme value theory , LOGIT ,
    Date: 2007–04–03
  4. By: Gianni De Nicoló; Alexander F. Tieman
    Abstract: This paper assesses changes in synchronization of real activity and financial market integration in Western Europe and evaluates their implications for financial stability. We find increased synchronization of real activity since the early 1980s and increased equity markets integration since the early 1990s. We also find that measures of systemic risk at large European financial institutions have not declined during the period 1990-2004 and that bank systemic risk profiles have converged. At the same time, the sensitivity of bank and insurance systemic risk measures to common real and financial shocks has increased in most countries. Overall, these results suggest that the integration process does not necessarily entail an unambiguously positive effect on financial stability.
    Keywords: Financial stability , economic integration , Europe , Financial stability , Europe , European Union , Economic models ,
    Date: 2007–01–08
  5. By: Gianni De Nicoló; John H. Boyd; Abu M. Jalal
    Abstract: This paper studies two new models in which banks face a non-trivial asset allocation decision. The first model (CVH) predicts a negative relationship between banks' risk of failure and concentration, indicating a trade-off between competition and stability. The second model (BDN) predicts a positive relationship, suggesting no such trade-off exists. Both models can predict a negative relationship between concentration and bank loan-to-asset ratios, and a nonmonotonic relationship between bank concentration and profitability. We explore these predictions empirically using a cross-sectional sample of about 2,500 U.S. banks in 2003 and a panel data set of about 2,600 banks in 134 nonindustrialized countries for 1993-2004. In both these samples, we find that banks' probability of failure is positively and significantly related to concentration, loan-to-asset ratios are negatively and significantly related to concentration, and bank profits are positively and significantly related to concentration. Thus, the risk predictions of the CVH model are rejected, those of the BDN model are not, there is no trade-off between bank competition and stability, and bank competition fosters the willingness of banks to lend.
    Keywords: Bank competition , concentration , risk , asset allocations , Bank soundness , Competition , Profits , Asset management , Resource allocation , Risk management , Economic models ,
    Date: 2007–01–08
  6. By: Abhay Abhyankar; Angelica Gonzalez
    Abstract: We study the cross-section of expected corporate bond returns using an intertemporal CAPM with three factors; innovations in future excess bond returns, future real interest rates and future expected inflation. Our test assets are a broad range of bond market index portfolios of different default categories. We find, using the Fama MacBeth cross-sectional method, that innovations in future expected real interest ratesand future expected inflation explain the cross-section of expected corporate bond returns. Our model provides an alternative to ad hoc risk factors used, for example, in evaluating the performance of bond mutual funds.
    Keywords: bond market, fixed income mutual funds, asset pricing model, variance decomposition, recursive utility, betas, factor pricing.
    JEL: F31 F37
  7. By: Kevin Cowan; Patricio Valenzuela; Eduardo Borensztein
    Abstract: Although credit rating agencies have gradually moved away from a policy of never rating a private borrower above the sovereign (the "sovereign ceiling") it appears that sovereign ratings remain a significant determinant of the credit rating assigned to corporations. We examine this link using data for advanced and emerging economies over the past decade and conclude that the sovereign ratings have a significant and robust effect on private ratings even after controlling for country specific macroeconomic conditions and firm-level performance indicators. This suggests that public debt management affects the private sector through a channel that had not been previously recognized.
    Keywords: Credit risk , sovereign risk , credit ratings ,
    Date: 2007–04–05
  8. By: Mauro S. Ferreira (Cedeplar-UFMG)
    Abstract: Quantile autoregression is used to explore asymmetries in the adjustment process of pair wise real exchange rate between the Italian lire, French franc, Deutsch mark, and the British pound. Based on the best specification for each quantile we construct predicted conditional density functions which guided us to identify two sources of asymmetry: 1) dispersion depends on the conditioned value of the real exchange rate, i.e., “conditional” heterokedasticity; 2) the probability of increases and falls also changes according to the conditioned value, i.e., there is higher probability for the real exchange rate to appreciate (depreciate) given the currency is depreciated (appreciated).We only verified strong heterokedasticity in relations among the lire, franc, and mark, which was resolved by estimating quadratic autoregressive model for some quantiles. Relations involving the pound presented stable but higher dispersion indicating larger probability of wider oscillation.
    Keywords: exchange rate; quantile autoregression; unit root; asymmetry
    JEL: C14 C22 F31
    Date: 2007–04
  9. By: OGAWA Kazuo; Elmer STERKEN; TOKUTSU Ichiro
    Abstract: Based on a matched sample of Japanese small firms and main banks, we investigate bank-firm relationships in the early 2000s. We obtain some remarkable new findings. First, small firms have multiple bank relationships even though they have their main bank relations. Second, firms tied with financially weak main banks increase their number of bank relations to diversify liquidity risk. Third, the duration of a main bank relation has a positive effect on the number of bank relations. This is interpreted as either a reputation effect or firms' counterbalance actions against the monopoly power of main banks. To go further into this issue, we examine the effects of a main bank relation on the design of loan contracts. We find that firms with fewer bank relations tend to pledge personal guarantees to their main banks and are charged a higher interest rate. Our evidence lends support for the hypothesis of monopoly exploitation by main banks.
    Date: 2007–04

This nep-rmg issue is ©2007 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.