nep-rmg New Economics Papers
on Risk Management
Issue of 2007‒09‒09
eight papers chosen by
Stan Miles
Thompson Rivers University

  1. Risk in Transport investments By André de Palma; Nathalie Picard; Laetitia Andrieu
  3. Performance evaluation of portfolio insurance strategies using stochastic dominance criteria By J. ANNAERT; S. VAN OSSELAER; B. VERSTRAETE
  4. Monte-Carlo Estimations of the Downside Risk of Derivative Portfolios By Patarick Leoni;
  5. A Framework for Stress Testing Bank's Credit Risk By Jim Wong; Ka-fai Choi; Tom Fong
  6. Measuring Market Sentiment in Hong Kong's Stock Market By Ip-wing Yu; Chi-sang Tam
  7. Can investors profit from banks’ stock recommendations? Evidence for the German DAX index By Pierdzioch, Christian; Kempa, Bernd; Hendricks, Torben
  8. Time-varying contributions by the corporate bond and CDS markets to credit risk price discovery By Dötz, Niko

  1. By: André de Palma (THEMA,University of Cergy-Pontoise,and ENPC); Nathalie Picard (THEMA,University of Cergy-Pontoise,and INED); Laetitia Andrieu (ENPC)
    Abstract: We discuss how the standard Cost-Benefit Analysis should be modified in order to take risk (and uncertainty) into account. We propose different approaches used in finance (Value at Risk, Conditional Value at Risk, Downside Risk Measures, and Efficiency Ratio) as useful tools to model the impact of risk in project evaluation. After introducing the concepts, we show how they could be used in CBA and provide some simple examples to illustrate how such concepts can be applied to evaluate the desirability of a new project infrastructure.
    Keywords: Cost-Benefit Analysis, Risk, transportation, large project, Value at Risk, Conditional Value at Risk.
    Date: 2007
  2. By: Carlo Domenico Mottura; Andrea Gheno
    Date: 2007–07
    Abstract: The continuing creation of portfolio insurance applications as well as the mixed research evidence suggests that so far no consensus has been reached about the effectiveness of portfolio insurance. Therefore, this paper provides a performance evaluation of the stop-loss, synthetic put and constant proportion portfolio insurance techniques based on a block-bootstrap simulation. Apart from more traditional performance measures, we consider the Value-at-risk and Expected Shortfall of the strategies, which are more appropriate in an insurance context. An additional performance evaluation is given by means of the stochastic dominance framework where we account for sampling error. A sensitivity analysis is performed in order to examine the impact on performance of a change in a specific decision variable (ceteris paribus). The results indicate that a buy-and-hold strategy does not dominate the portfolio insurance strategies at any stochastic dominance order. Moreover, both for the stop-loss and synthetic put strategy a 100% floor value outperforms lower floor values. For the CPPI strategy we find that a higher CPPI multiple enhances the upward potential of the CPPI strategies, but harms the protection level in return. As regards the optimal rebalancing frequency, daily rebalancing should be preferred for the synthetic put and CPPI strategy, despite the higher transaction costs.
    Keywords: Portfolio insurance; Performance evaluation; Stochastic dominance; Block-bootstrap simulation
    JEL: G11
    Date: 2007–06
  4. By: Patarick Leoni (Economics Department, National University of Ireland, Maynooth);
    Abstract: We simulate the performances of a standard derivatives portfolio to evaluate the relevance of benchmarking in terms of downside risk reduction. The simulation shows that benchmarking always leads to significantly more severe losses in average than those generated by letting the portfolio reach the end of a given horizon. Moreover, switching from a 0-correlation across underlyings to a very mild form of correlation significantly increases the probability of reaching the downside benchmark before maturity, whereas adding more correlation does not significantly increase this figure.
    Keywords: : Derivatives; Portfolio management; Benchmarking; Downside risk; Monte-Carlo simulations.
    Date: 2007
  5. By: Jim Wong (Research Department, Hong Kong Monetary Authority); Ka-fai Choi (Research Department, Hong Kong Monetary Authority); Tom Fong (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper develops a framework for stress testing the credit exposures of Hong Kong's retail banks to macroeconomic shocks. It involves the construction of macroeconomic credit risk models, each consisting of a multiple regression model explaining the default rate of banks, and a set of autoregressive models explaining the macroeconomic environment estimated by the method of seemingly unrelated regression. Specifically, two macroeconomic credit risk models are built. One model is specified for the overall loan portfolios of banks and, to illustrate how the same framework can be applied for stress testing loans to different economic sectors, the other model is specified for the banks' mortgage exposures only. The empirical results suggest a significant relationship between the default rates of bank loans and key macroeconomic factors including Hong Kong¡¦s real GDP, real interest rates, real property prices and Mainland China's real GDP. Macro stress testing is then performed to assess the vulnerability and risk exposures of banks' overall loan portfolios and mortgage exposures. By using the framework, a Monte Carlo method is applied to estimate the distribution of possible credit losses conditional on an artificially introduced shock. Different shocks are individually introduced into the framework for the stress tests. The magnitudes of the shocks are specified according to those occurred during the Asian financial crisis. The result shows that even for the Value-at-Risk (VaR) at the confidence level of 90%, banks would continue to make a profit in most stressed scenarios, suggesting that the current credit risk of the banking sector is moderate. However, under the extreme case for the VaR at the confidence level of 99%, banks' credit loss would range from a maximum of 3.22% to a maximum of 5.56% of the portfolios, and if a confidence level of 99.9% is taken, it could range from a maximum of 6.08% to a maximum of 8.95%. These estimated maximum losses are very similar to what the market experienced one year after the Asian financial crisis shock. However, the probability of such losses and beyond is very low.
    Date: 2006–10
  6. By: Ip-wing Yu (Research Department, Hong Kong Monetary Authority); Chi-sang Tam (Research Department, Hong Kong Monetary Authority)
    Abstract: Market sentiment is increasingly seen as a key factor driving the movement of asset prices. This paper develops two indicators to measure investors' attitude towards risk in the Hong Kong stock market: a) a risk appetite index and b) an investment sentiment index. We find that although the risk appetite index based on the work of Gai and Vause (2006) is able to capture episodes of extreme optimism and pessimism between 1996 and 2006, it is volatile and in some cases gives spurious signals. Our results also show that the investment sentiment indicator, a sentiment measure derived by combining the current realised return and the expected short-term return of the stock market, has adequate power to predict the subsequent return of the stock market over a period of 6 to 12 months.
    Keywords: risk appetite, risk aversion, market sentiment, Hong Kong stock market
    JEL: G10 G12 G13
    Date: 2007–04
  7. By: Pierdzioch, Christian; Kempa, Bernd; Hendricks, Torben
    Abstract: We find that banks’ buy and sell recommendations only have a minor effect on the out-of-sample predictability of daily stock returns and the market-timing ability of an investor trading in real time in the German DAX30 stock index. Banks’ stock recommendations may improve the performance of simple trading rules in real time. These improvements, however, are in general small and sensitive to the model-selection criterion being used by an investor to set up a forecasting model for stock returns.
    Keywords: Forecasting stock returns; trading rules; buy and sell recommendations by banks
    JEL: G11 E44 C53
    Date: 2007–01–09
  8. By: Dötz, Niko
    Abstract: This paper looks at the dynamic price relationship between spreads in the corporate bond market and credit default swaps (CDS). It picks up where Blanco et al (2005) leave off but is focused on European credit markets. The study is based on companies listed in the iTraxx CDS index and thus on new data on a more liquid CDS market. Unlike previous studies, which look at price formation in a time-invariant context, the contributions of both markets to price discovery are analysed in a timevariant context. We devote particular attention to the question of whether such information input is stable in times of crisis and find that, although the CDS market slightly dominates the price discovery process, its contribution fell visibly during the turbulence on the credit markets in early 2005 in favour of that of the bond market.
    Keywords: price discovery, credit risk, corporate bonds, credit derivatives, Kalman filter
    JEL: C32 G10 G14
    Date: 2007

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