nep-rmg New Economics Papers
on Risk Management
Issue of 2007‒08‒14
seven papers chosen by
Stan Miles
Thompson Rivers University

  1. Modelling and calibration errors in measures of portfolio credit risk By Nikola A. Tarashev; Haibin Zhu
  2. A Component GARCH Model with Time Varying Weights By Luc, BAUWENS; G., STORTI
  3. Determinants of the time varying risk premia By Pornpinun Chantapacdepong
  4. Regulation of Bank Capital and Behavior of Banks: Assessing the US and the EU-15 Region Banks in the 2000-2005 Period By Petr Teplý; Milan Matejašák
  5. Multilateral Adjustment and Exchange Rate Dynamics: The Case of Three Commodity Currencies By Jeannine Bailliu; Ali Dib; Takashi Kano; Lawrence Schembri
  6. Inflation risk premia in the term structure of interest rates By Peter Hoerdahl; Oreste Tristani
  7. Cycles of violence and terrorist attacks index for the State of Arizona By Gómez-Sorzano, Gustavo

  1. By: Nikola A. Tarashev; Haibin Zhu
    Abstract: This paper develops an empirical procedure for analyzing the impact of model misspecification and calibration errors on measures of portfolio credit risk. When applied to large simulated portfolios with realistic characteristics, this procedure reveals that violations of key assumptions of the well-known Asymptotic Single-Risk Factor (ASRF) model are virtually inconsequential. By contrast, flaws in the calibrated interdependence of credit risk across exposures, which are driven by plausible small-sample estimation errors or popular rule-of-thumb values of asset return correlations, can lead to significant inaccuracies in measures of portfolio credit risk. Similar inaccuracies arise under erroneous, albeit standard, assumptions regarding the tails of the distribution of asset returns.
    Keywords: Correlated defaults, value at risk, multiple common factors, granularity, estimation error, tail dependence, bank capital
    Date: 2007–06
    Abstract: We present a novel GARCH model that accounts for time varying, state dependent, persistence in the volatility dynamics. The proposed model generalizes the component GARCH model of Ding and Granger (1996). The volatility is modelled as a convex combination of unobserved GARCH components where the combination weights are time varying as a function of appropriately chosen state variables. In order to make inference on the model parameters, we develop a Gibbs sampling algorithm. Adopting a fully Bayesian approach allows to easily obtain medium and long term predictions of relevant risk measures such as value at risk and expected shortfall. Finally we discuss the results of an application to a series of daily returns on the S&P500.
    Keywords: Persistence, Volatility components, Value-at-risk, Expected short-fall
    JEL: C11 C15 C22
    Date: 2007–03–28
  3. By: Pornpinun Chantapacdepong
    Abstract: This paper generates monthly risk premia data using zero coupon government treasury bills for 43 countries over the period of 1994-2006. The measure of risk premia is based on the ARCH-in-Mean (ARCH-M) model introduced by Engle, Lilien and Robins (1987). We show that the risk premia are time varying and also vary considerably across sample countries. Countries with better financial development and higher income generally have lower risk premia of government assets. This study also examines the macroeconomic and political determinants of the risk premia by using cross-section and dynamic panel regression analyses. The results show that the risk premia are significantly affected by macroeconomic circumstances, especially economic growth and the real e¤ective exchange rate. The results are robust across the majority of countries in our study.
    Keywords: ARCH-in-Mean, term structure of interest rates, risk premium, dynamic panel regression analysis.
    JEL: E43 E44 G12 G15
  4. By: Petr Teplý (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Milan Matejašák (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: In recent years, regulators have increased their focus on the capital adequacy of banking institutions to enhance their stability, hence the stability of the whole financial system. The purpose of this paper is to assess and compare how American and European banks adjust their level of capital and portfolio risk under capital regulation, whether and how they react to constraints placed by the regulators. In order to do this, we estimate a modified version of the simultaneous equations model developed by Shrieves and Dahl. This model analyzes adjustments in capital and risk at banks when they approach the minimum regulatory capital level. The results indicate that regulatory requirements have the desired effect on bank behavior. Both American and European banks that are close to minimum requirements simultaneously increase their capital. In addition, the US banks decrease their portfolio risk taking.
    Keywords: banking regulation, Basel Capital Accord, capital adequacy, banks, simultaneous equations model
    JEL: C30 G18 G21
    Date: 2007–08
  5. By: Jeannine Bailliu; Ali Dib; Takashi Kano; Lawrence Schembri
    Abstract: In this paper, we empirically investigate whether multilateral adjustment to large U.S. external imbalances can help explain movements in the bilateral exchange rates of three commodity currencies -- the Australian, Canadian and New Zealand (ACNZ) dollars. To examine the relationship between exchange rates and multilateral adjustment, we develop a new regimeswitching model that augments a standard Markov-switching framework with a threshold variable. This enables us to model the exchange rate dynamics of our commodity currencies in the context of two regimes: one in which multilateral adjustment to large U.S. external imbalances is an important factor driving the commodity currencies and the second in which there are no significant U.S. external imbalances and hence multilateral adjustment is not a factor. We compare the performance of this model, both in and out-of-sample, to several other alternative models. In addition to developing this new model, another distinguishing feature of our paper is that we estimate all of our models using a Bayesian approach. We opt for a Bayesian approach in this context because it provides a simpler and more intuitive means of evaluating and comparing our different non-nested models. Moreover, it is relatively straightforward using a Bayesian approach to evaluate the importance of nonlinearities in the relationship between exchange rates and multilateral adjustment. Our findings suggest that during periods of large U.S. imbalances, fiscal and external, an exchange rate model for the ACNZ dollars should allow for multilateral adjustment effects. Moreover, we also find evidence to suggest that the adjustment of exchange rates to multilateral adjustment factors is best modelled as a non-linear process.
    Keywords: Exchange rates; Econometric and statistical methods
    JEL: F31 F32 C11 C22
    Date: 2007
  6. By: Peter Hoerdahl; Oreste Tristani
    Abstract: This paper estimates the size and dynamics of inflation risk premia in the euro area, based on a joint model of macroeconomic and term structure dynamics. Information from both nominal and index-linked yields is used in the empirical analysis. Our results indicate that term premia in the euro area yield curve reflect predominantly real risks, i.e. risks which affect the returns on both nominal and index-linked bonds. On average, inflation risk premia were negligible during the EMU period but occasionally subject to statistically signifcant fluctuations in 2004-2006. Movements in the raw break-even rate appear to have mostly reflected such variations in inflation risk premia, while long-term inflation expectations have remained remarkably anchored from 1999 to date.
    Keywords: Term structure of interest rates, inflation risk premia, central bank credibility
    Date: 2007–05
  7. By: Gómez-Sorzano, Gustavo
    Abstract: I apply the Beveridge-Nelson business cycle decomposition method to the time series of per capita murder in the State of Arizona (1933-2005). Separating out “permanent” from “cyclical” murder, I hypothesize that the cyclical part coincides with documented waves of organized crime, internal tensions, breakdowns in social order, crime legislation, social, and political unrest, and recently with the periodic terrorist attacks to the U.S. The estimated cyclical component of murder warns that terrorist attacks in the U.S. soil, and foreign wars fought by the country from 1941 to 2005, have affected Arizona creating estimated turning point dates clearly marked by the most tragic terrorist attacks to the nation: the shut down in power in NYC in 1965, the World Trade Center Bombing in 1993, and 9/11 2001. Other indexes already constructed include the attacks indexes for the U.S (, New York City (, and Massachusetts ( These indexes must be used as dependent variables in structural models for terrorist attacks, and in models assessing the effects of terrorism over the U.S. economy.
    Keywords: A model of cyclical terrorist murder in Colombia; 1950-2004. Forecasts 2005-2019; the econometrics of violence; terrorism; and scenarios for peace in Colombia from 1950 to 2019; scenarios for sustainable peace in Colombia by year 2019; decomposing violence: terrorist murder in the twentieth in the United States; using the Beveridge and Nelson decomposition of economic time series for pointing out the occurrence of terrorist attacks; decomposing violence: terrorist murder and attacks in New York State from 1933 to 2005; terrorist murder; cycles of violence; and terrorist attacks in New York City during the last two centuries; cycles of violence; and terrorist attacks index for the State of Massachusetts.
    JEL: D74 K14 O51 K42 N42 H56 C22
    Date: 2007–01–22

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