New Economics Papers
on Risk Management
Issue of 2007‒06‒11
ten papers chosen by

  1. Determinants of Insurers' Performance in Risk Pooling, Risk Management, and Financial Intermediation Activities By Georges Dionne; Robert Gagné; Abdelhakim Nouira
  2. Schätzunsicherheit oder Korrelation, Welche Risikokomponente sollten Unternehmen bei der Bewertung von Kreditportfoliorisiken wann berücksichtigen? By Henry Dannenberg
  3. Estimating Probabilities of Default With Support Vector Machines By Wolfgang Härdle; Rouslan Moro; Dorothea Schäfer
  4. Betas and the Business Cycle: An Analysis Based on Real-Time Data By Pierdzioch, Christian; Kizys, Renatas
  5. Long Term Risk Assessment in a Defined Contribution Pension System By Castaneda, Pablo
  6. Diversification and the banks’ risk-return-characteristics – evidence from loan portfolios of German banks By Behr, Andreas; Kamp, Andreas; Memmel, Christoph; Pfingsten, Andreas
  7. The Death of the Overreaction Anomaly? A Multifactor Explanation of Contrarian Returns By Michael Drew; Adam Clements; Evan Reedman; Madhu Veeraraghavan
  8. Institutions and Speculative Bubbles in International Stock Markets By Pierdzioch, Christian; Kizys, Renatas
  10. Does the Option Market Produce Superior Forecasts of Noise-Corrected Volatility Measures? By Gael M. Martin; Andrew Reidy; Jill Wright

  1. By: Georges Dionne; Robert Gagné; Abdelhakim Nouira
    Abstract: Corporate finance theory predicts that firms' characteristics affect agency costs and hence their efficiency. Cummins et al. (2006) have proposed a cost function specification that measures separately insurer efficiency in handling risk pooling, risk management, and financial intermediation functions. We investigate the insurer characteristics that determine these efficiencies. Our empirical results show that mutuals outperform stock insurers in handling the three functions. Independent agents and high capitalization reduce the cost efficiency of risk pooling. Certain characteristics such as being a group of affiliated insurers, handling a higher volume of business in commercial lines, assuming more reinsurance or investing a higher proporotion of assets in bonds, do significantly increase insurers' efficiency in risk management and financial intermediation.
    Keywords: Risk pooling, risk management, financial intermediation, property-liability insurance, efficiency, agency costs
    JEL: D21 D23 G22
    Date: 2007
  2. By: Henry Dannenberg
    Abstract: The use of probability of default estimates to assess the risks of a credit portfolio should not ignore estimation uncertainty. The latter can be quantified by confidence intervals. But assumptions about dependencies of these intervals are inconsistent with assumptions of conventional credit portfolio models. Based on simulation studies this paper shows, that a model which include estimation uncertainty but ignore default correlation might estimate the real credit risk more correctly than a model that implicates default correlation but ignore estimation uncertainty. The latter is a trait of conventional credit portfolio models. In this paper quantifying of estimation uncertainty based on the idea of confidence intervals and the underlying probability distributions of these intervals.
    Keywords: Probability of Default, Estimation Uncertainty, Risk Assessment
    JEL: C15 D81 G11
    Date: 2007–05
  3. By: Wolfgang Härdle; Rouslan Moro; Dorothea Schäfer
    Abstract: This paper proposes a rating methodology that is based on a non-linear classification method, the support vector machine, and a non-parametric technique for mapping rating scores into probabilities of default. We give an introduction to underlying statistical models and represent the results of testing our approach on German Bundesbank data. In particular we discuss the selection of variables and give a comparison with more traditional approaches such as discriminant analysis and the logit regression. The results demonstrate that the SVM has clear advantages over these methods for all variables tested.
    Keywords: Bankruptcy, Company rating, Default probability, Support vector machines.
    JEL: C14 G33 C45
    Date: 2007–06
  4. By: Pierdzioch, Christian; Kizys, Renatas
    Abstract: Our results shed light on the link between the betas of portfolios formed on market capitalization and book-to-market value and the U.S. business cycle. We derived our results by estimating a state-space model that captures the idea that both the portfolio betas and the business cycle are measured with error. We measured the business cycle using real-time and revised data. Our results indicate that the sensitivity of portfolio betas to the business cycle is significant and large when the book-to-market value is high and estimates are based on real-time data. Equity market investors should use real-time data when assessing the business-cycle sensitive risks of investments into portfolios with a high book-to-market value.
    Keywords: State-space model; Portfolio betas; Real-time data; Business Cycle; United States
    JEL: E32 C32 G12 E44
    Date: 2007–05–06
  5. By: Castaneda, Pablo
    Abstract: One of the most important consequences of the Chilean pension reform undertaken in the early 1980s was to transfer a significant portion of the risk associated to the financing of pensions, from the State, to the pension fund participants of the newly established compulsory pension system. This paper is concerned with the risk embedded in the portfolio strategies of pension fund portfolio managers. We develop an analytic framework that permits to incorporate the behavior of a pension fund manager in the long-term risk assessment of its investment strategy, where the latter is conducted from the point of view of the pension fund participant, who has preferences over his/her final pension. The pension fund manager’s problem is cast as a dynamic portfolio choice problem, and its solution is used afterwards to quantify the risk exposure of the pension fund participant. Our results from a simulation exercise show that the lower is the risk aversion of the participant, the higher is his/her Wealth-at-Risk —defined as the monetary compensation that leaves the participant indifferent with respect to his/her outside option— a result that is due to the fact that the outside option increases relatively more than the benefit derived from the pension provided by the fund manager. The same logic is behind the negative relationship between stock return volatility and pension risk.
    Keywords: Dynamic convex risk measure; Pension system; Portfolio selection
    JEL: H55 D81 G18 G11
    Date: 2006–07–31
  6. By: Behr, Andreas; Kamp, Andreas; Memmel, Christoph; Pfingsten, Andreas
    Abstract: Banks face a tradeoff between diversifying and focusing their loan portfolio. In this paper we carry out an empirical study for the German market to shed light on the question whether or not the benefits of risk sharing outweigh those of specialization. We use data from the Bundesbank’s quarterly borrowers statistic to determine the degree of diversification in the banks’ loan portfolios and combine this data with the banks’ balance sheets and audit reports. The unique database comprises data from all German banks during the period from 1993 to 2003. Our main results can be summarized in three statements: i) Specialized banks have a slightly higher return than diversified banks. ii) Specialized banks have lower relative loan loss provisions and lower shares of non-performing loans, iii) However, the standard deviations of the loan loss provision ratio and the non-performing loan ratio are lower for diversified banks.
    Keywords: bank lending, loan portfolio, portfolio theory, diversification, riskreturn analysis
    JEL: C23 C43 G11 G21
    Date: 2007
  7. By: Michael Drew; Adam Clements; Evan Reedman; Madhu Veeraraghavan
    Abstract: Are the returns accruing to De Bondt and Thaler’s (1985) (DT) much celebrated overreaction anomaly pervasive? Using the CRSP data set used by for the period 1926 through 1982, and, for the first time, an additional two decades of data (1983 through 2003), we provide preliminary support for the original work of DT, reporting that the overreaction anomaly has not only persisted over the past twenty years but has increased, on a risk-unadjusted basis. However, using the three factor model of Fama and French (1993) (FF), we find no statistically significant alpha can be garnered via the overreaction anomaly, with contrarian returns driven by the factors of size and value, not the behavioral biases of investors. It is our conjecture that the anomaly is not robust under the FF framework, with ‘contrarian’ investors following such a scheme simply compensated for the inherent portfolio risk held.
    Keywords: Overreaction, anomaly, multifactor asset pricing model
    JEL: G11 G12 G14
    Date: 2007–05–31
  8. By: Pierdzioch, Christian; Kizys, Renatas
    Abstract: We combine tests for speculative bubbles in stock markets with a cross-country regression framework to analyze whether specific institutional characteristics of an economy can be identified that make speculative bubbles in stock markets more likely to occur. The list of institutional characteristics that have a significant effect on the probability that a speculative bubble arises includes the law and order tradition of a country, expropriation risk, the tax rates on dividend income and interest income, and the overall efficiency of the financial system. We also find that speculative bubbles are less likely to occur in an economy that experiences strong economic growth.
    Keywords: Speculative bubbles; cointegration; cross-country regression model; institutions
    JEL: E32 C32 G12 E44
    Date: 2007–06–06
  9. By: Vanessa E. Daniel (Department of Spatial Economics, Vrije Universiteit); Raymond J.G.M. Florax (Department of Agricultural Economics, Purdue University); Piet Rietveld (Department of Spatial Economics, Vrije Universiteit)
    Abstract: Climate change, the ‘boom and bust’ cycles of rivers, and altered water resource management practice have caused significant changes in the spatial distribution of the risk of flooding. Hedonic pricing studies, predominantly for the US, have assessed the spatial incidence of risk and the associated implicit price of flooding risk. Using these implicit price estimates and their associated standard errors, we perform a meta-analysis and find that houses located in the 100-year floodplain have a –0.3 to –0.8% lower price. The actual occurrence of a flooding event or increased stringency in disclosure rules causes ex ante prices to differ from ex post prices, but these effects are small. The marginal willingness to pay for reduced risk exposure has increased over time, and it is slightly lower for areas with a higher per capita income. We show that obfuscating amenity effects and risk exposure associated with proximity to water causes systematic bias in the implicit price of flooding risk.
    Keywords: Manufactured Housing; valuation, environmental risk, meta-analysis, hedonic pricing
    JEL: D81 Q51 Q54
    Date: 2007
  10. By: Gael M. Martin; Andrew Reidy; Jill Wright
    Abstract: This paper presents a comprehensive empirical evaluation of option-implied and returns-based forecasts of volatility, in which recent developments related to the impact on measured volatility of market microstructure noise are taken into account. The paper also assesses the robustness of the performance of the option-implied forecasts to the way in which those forecasts are extracted from the option market. Using a test for superior predictive ability, model-free implied volatility, which aggregates information across the volatility 'smile', and at-the-money implied volatility, which ignores such information, are both tested as benchmark forecasts. The forecasting assessment is conducted using intraday data for three Dow Jones Industrial Average (DJIA) stocks and the S&P500 index over the 1996-2006 period, with future volatility proxied by a range of alternative noise-corrected realized measures. The results provide compelling evidence against the model-free forecast, with its poor performance linked to both the bias and excess variability that it exhibits as a forecast of actual volatility. The positive bias, in particular, is consistent with the option market factoring in a substantial premium for volatility risk. In contrast, implied volatility constructed from liquid at-the-money options is given strong support as a forecast of volatility, at least for the DJIA stocks. Neither benchmark is supported for the S&P500 index. Importantly, the qualitative results are robust to the measure used to proxy future volatility, although there is some evidence to suggest that any option-implied forecast may perform less well in forecasting the measure that excludes jump information, namely bi-power variation.
    Keywords: Volatility Forecasts; Quadratic Variation; Intraday Volatility Measures
    JEL: C10 C53 G12
    Date: 2007–06

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