nep-rmg New Economics Papers
on Risk Management
Issue of 2007‒07‒13
eight papers chosen by
Stan Miles
Thompson Rivers University

  1. Predictive Performance of Conditional Extreme Value Theory and Conventional Methods in Value at Risk Estimation By Ghorbel, Ahmed; Trabelsi, Abdelwahed
  2. Modelling dynamic portfolio risk using risk drivers of elliptical processes By Schmidt, Rafael; Schmieder, Christian
  3. Robustness of the Risk-Return Relationship in the U.S. Stock Market By Lanne, Markku; Luoto, Jani
  4. Exchange Rate Exposure of Sectoral Returns and Volatilities: Evidence from Japanese Industrial Sectors By Prabhath Jayasinghe; Albert K. Tsui
  5. The Effects of the Bank-Internal Ratings on the Loan Maturity By Nataliya Fedorenko; Dorothea Schäfer; Oleksandr Talavera
  6. Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans By Joshua Rauh
  7. Institutional Trade Persistence and Long-Term Equity Returns By Dasgupta, Amil; Prat, Andrea; Verardo, Michela
  8. Une Evaluation des Procédures de Backtesting By Christophe Hurlin; Sessi Tokpavi

  1. By: Ghorbel, Ahmed; Trabelsi, Abdelwahed
    Abstract: This paper conducts a comparative evaluation of the predictive performance of various Value at Risk (VaR) models such as GARCH-normal, GARCH-t, EGARCH, TGARCH models, variance-covariance method, historical simulation and filtred Historical Simulation, EVT and conditional EVT methods. Special emphasis is paid on two methodologies related to the Extreme Value Theory (EVT): The Peaks over Threshold (POT) and the Block Maxima (BM). Both estimation techniques are based on limits results for the excess distribution over high thresholds and block maxima, respectively. We apply both unconditional and conditional EVT models to management of extreme market risks in stock markets. They are applied on daily returns of the Tunisian stock exchange (BVMT) and CAC 40 indexes with the intension to compare the performance of various estimation methods on markets with different capitalization and trading practices. The sample extends over the period July 29, 1994 to December 30, 2005. We use a rolling windows of approximately four years (n= 1000 days). The sub-period from July, 1998 for BVMT (from August 4, 1998 for CAC 40) has been reserved for backtesting purposes. The results we report demonstrate that conditional POT-EVT method produces the most accurate forecasts of extreme losses both for standard and more extreme VaR quantiles. The conditional block maxima EVT method is less accurate.
    Keywords: Financial Risk management; Value-at-Risk; Extreme Value Theory; Conditional EVT; Backtesting
    JEL: G0 C22 G15
    Date: 2007–03–31
  2. By: Schmidt, Rafael; Schmieder, Christian
    Abstract: The situation of a limited availability of historical data is frequently encountered in portfolio risk estimation, especially in credit risk estimation. This makes it, for example, difficult to find temporal structures with statistical significance in the data on the single asset level. By contrast, there is often a broader availability of cross-sectional data, i.e., a large number of assets in the portfolio. This paper proposes a stochastic dynamic model which takes this situation into account. The modelling framework is based on multivariate elliptical processes which model portfolio risk via sub-portfolio specific volatility indices called portfolio risk drivers. The dynamics of the risk drivers are modelled by multiplicative error models (MEM) - as introduced by Engle (2002) - or by traditional ARMA models. The model is calibrated to Moody’s KMV Credit Monitor asset returns (also known as firm-value returns) given on a monthly basis for 756 listed European companies at 115 time points from 1996 to 2005. This database is used by financial institutions to assess the credit quality of firms. The proposed risk drivers capture the volatility structure of asset returns in different industry sectors. A characteristic temporal structure of the risk drivers, cyclical as well as a seasonal, is found across all industry sectors. In addition, each risk driver exhibits idiosyncratic developments. We also identify correlations between the risk drivers and selected macroeconomic variables. These findings may improve the estimation of risk measures such as the (portfolio) Value at Risk. The proposed methods are general and can be applied to any series of multivariate asset or equity returns in finance and insurance.
    Keywords: Portfolio risk modelling, Elliptical processes, Credit risk, multiplicative error model, volatility clustering
    JEL: C13 C16 C51
    Date: 2007
  3. By: Lanne, Markku; Luoto, Jani
    Abstract: In this paper, we study the risk-return relationship in monthly U.S. stock returns (1928:1— 2004:12) using GARCH-in-Mean models. In particular, we consider the robustness of the relationship with respect to the omission of the intercept term in the equation for the expected excess return recently recommended by Lanne and Saikkonen (2006). The existence of the relationship is quite robust, but its estimated strength is dependent on the prior belief concerning the intercept. This is the case in particular in the first half of the sample period, where also the coefficient of the relative risk aversion is found to be smaller and the equity premium greater than in the latter half.
    Keywords: ICAPM model; relative risk aversion; GARCH-in-Mean model; Bayesian analysis
    JEL: G12 C22 C11
    Date: 2007
  4. By: Prabhath Jayasinghe (Department of Economics, National University of Singapore); Albert K. Tsui (Department of Economics, National University of Singapore)
    Abstract: Most studies of exchange rate exposure of stock returns do not address three relevant aspects simultaneously. They are, namely: sensitivity of stock returns to exchange rate changes; sensitivity of volatility of stock returns to volatility of changes in foreign exchange market; and the correlation between volatilities of stock returns and exchange rate changes. In this paper, we employ a bivariate GJR-GARCH model to examine all such aspects of exchange rate exposure of sectoral indexes in Japanese industries. Based on a sample data of fourteen sectors, we find significant evidence of exposed returns and its asymmetric conditional volatility of exchange rate exposure. In addition, returns in many sectors are correlated with those of exchange rate changes. We also find support for the “averaged-out exposure and asymmetries” argument. Our findings have direct implications for practitioners in formulating investment decisions and currency hedging strategies.
    Keywords: exchange rate exposure; asymmetric volatility spillovers; GARCH-type models; conditional correlation
    JEL: C22 F31 G12 G15
    Date: 2007–06
  5. By: Nataliya Fedorenko; Dorothea Schäfer; Oleksandr Talavera
    Abstract: The paper focuses on the effects of three different internal bank ratings - Risk-, Property- and Creditworthiness-Rating - on the loan maturity. We use a sample of about 5,000 loans given to sole proprietors and corporate borrowers by two German banks from January 2003 till July 2005. The estimation results for corporate borrowers are consistent with Diamond's (1991) predictions of non-monotonic relationship between ratings and maturity. The best rated and the worst rated loans tend to have shorter maturities than loans with an intermediate rating. However, our results for sole proprietors conflict with the predictions of Diamond and with the majority of the empirical literature. We find a negative association between ratings and maturity of the loans given to sole proprietors.
    Keywords: loan maturity, internal bank ratings, risk of default, creditworthiness
    JEL: C25 D82 G20
    Date: 2007
  6. By: Joshua Rauh
    Abstract: The asset allocation of defined benefit pension plans is a setting where both risk shifting and risk management incentives are likely be present. Empirically, firms with poorly funded pension plans and weak credit ratings allocate a greater share of pension fund assets to safer securities such as government debt and cash, whereas firms with well-funded pension plans and strong credit ratings invest more heavily in equity. These relations hold both in the cross-section and within firms and plans over time. The incentive to limit costly financial distress plays a considerably larger role than risk shifting in explaining variation in pension fund investment policy among U.S. firms.
    JEL: G23 G31 G32 H32
    Date: 2007–07
  7. By: Dasgupta, Amil; Prat, Andrea; Verardo, Michela
    Abstract: How does the trading behaviour of institutional money managers affect stock prices? In this paper we document a robust relationship between the net trade patterns of institutional money managers and long term equity returns. Examining quarterly data on US institutional holdings from 1983 to 2004, we find evidence that stocks that have been persistently bought (sold) by institutions in the past 3 to 5 quarters underperform (overperform) the rest of the market in the next 12 to 30 months. Our results are of a similar magnitude to, but distinct from, other known asset pricing anomalies. Furthermore, we find that institutional investors show an aggregate tendency to trade in the direction of past institutional trades, buying stocks that have been persistently bought and selling stocks that have been persistently sold. We present a simple model of career-concerned trading by delegated portfolio managers that generates results consistent with our empirical findings.
    Keywords: career concerns; institutional investors; return predictability; trading behaviour
    JEL: G1 G14 G23
    Date: 2007–07
  8. By: Christophe Hurlin (LEO - Laboratoire d'économie d'Orleans - [CNRS : UMR6221] - [Université d'Orléans]); Sessi Tokpavi (LEO - Laboratoire d'économie d'Orleans - [CNRS : UMR6221] - [Université d'Orléans])
    Abstract: Dans cet article, nous proposons une démarche originale visant à évaluer la capacité des tests usuels de backtesting à discriminer différentes prévisions de Value at Risk (VaR) ne fournissant pas la même évaluation ex-ante du risque. Nos résultats montrent que, pour un même actif, ces tests conduisent très souvent à ne pas rejeter la validité, au sens de la couverture conditionnelle, de la plupart des six prévisions de VaR étudiées, même si ces dernières sont sensiblement différentes. Autrement dit, toute prévision de VaR a de fortes chances d'être validée par ce type de procédure.
    Keywords: Value-at-Risk; Backtesting
    Date: 2007–07–04

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