nep-rmg New Economics Papers
on Risk Management
Issue of 2007‒10‒13
six papers chosen by
Stan Miles
Thompson Rivers University

  1. Portfolio effects and efficiency of lending under Basel II By Jokivuolle , Esa; Vesala, Timo
  2. Real-Time Measurement of Business Conditions By S. Boragan Aruoba; Francis X. Diebold; Chiara Scotti
  3. Extreme Value Analysis of Daily Canadian Crude Oil Prices By Feng Ren; David E. Giles
  4. The Accrual Anomaly: Risk or Mispricing? By Hou, Kewei; Hirshleifer, David; Teoh, Siew Hong
  5. Accruals and Aggregate Stock Market Returns By Hirshleifer, David; Hou, Kewei; Teoh, Siew Hong

  1. By: Jokivuolle , Esa (Bank of Finland Research); Vesala, Timo (Tapiola Group)
    Abstract: Although beneficial allocational effects have been a central motivation for the Basel II capital adequacy reform, the interaction of these effects with Basel II’s procyclical impact has been less discussed. In this paper, we investigate the effect of Basel II on the efficiency of bank lending. We consider competitive credit markets where entrepreneurs may apply for loans for investments of different risk profiles. In this setting, excessive risk taking typically arises because low risk borrowers cross-subsidize high risk borrowers through the price system that is based on average success rates. We find that while flat-rate capital requirements (such as Basel I) amplify overinvestment in risky projects, risk-based capital requirements alleviate the cross-subsidization effect, improving allocational efficiency. This also suggests that Basel II does not necessarily lead to exacerbation of macroeconomic cycles because the reduction in the proportion of high-risk investments softens the cyclicality of bank lending over the business cycle.
    Keywords: Basel II; bank regulation; capital requirements; credit risk; procyclicality
    JEL: D41 D82 G14 G21 G28
    Date: 2007–10–03
  2. By: S. Boragan Aruoba (Department of Economics, University of Maryland); Francis X. Diebold (Department of Economics, University of Pennsylvania); Chiara Scotti (Division of International Finance, Federal Reserve Board)
    Abstract: We construct a framework for measuring economic activity in real time (e.g., minute-by-minute), using a variety of stock and flow data observed at mixed frequencies. Specifically, we propose a dynamic factor model that permits exact filtering, and we explore the efficacy of our methods both in a simulation study and in a detailed empirical example.
    Keywords: Business cycle, Expansion, Recession, State space model, Macroeconomic forecasting, Dynamic factor model
    JEL: E32 E37 C01 C22
    Date: 2007–07–24
  3. By: Feng Ren (Department of Economics, University of Victoria); David E. Giles (Department of Economics, University of Victoria)
    Abstract: Crude oil markets are highly volatile and risky. Extreme value theory (EVT), an approach to modelling and measuring risks under rare events, has seen a more prominent role in risk management in recent years. This paper presents an application of EVT to the daily returns of crude oil prices in the Canadian spot market between 1998 and 2006. We focus on the peak over threshold method by analyzing the generalized Pareto-distributed exceedances over some high threshold. This method provides an effective means for estimating tail risk measures such as Value-at-Risk and Expected Shortfall. The estimates of risk measures computed under different high quantile levels exhibit strong stability across a range of the selected thresholds. At the 99th quantile, the estimates of VaR are approximately 6.3% and 6.8% for daily positive and negative returns, respectively.
    Keywords: Crude oil, daily returns, market volatility, extreme value analysis
    JEL: C46 G32 Q40
    Date: 2007–10–09
  4. By: Hou, Kewei; Hirshleifer, David; Teoh, Siew Hong
    Abstract: We document considerable return comovement associated with accruals after controlling for other common factors. An accrual-based factor-mimicking portfolio has a Sharpe ratio of 0.16, higher than that of the market factor or the SMB and HML factors of Fama and French (1993). In time series regressions, a model that includes the Fama-French factors and the additional accrual factor captures the accrual anomaly in average returns. However, further time series and cross-sectional tests indicate that it is the accrual characteristic rather than the accrual factor loading that predicts returns. These findings favor a behavioral explanation for the accrual anomaly.
    Keywords: Capital markets; accruals; market efficiency; behavioral finance; limited attention
    JEL: M41 G12 G14 G11
    Date: 2007–04–01
  5. By: Hirshleifer, David; Hou, Kewei; Teoh, Siew Hong
    Abstract: Past research has shown that the level of operating accruals is a negative cross-sectional predictor of stock returns. This paper examines whether the accrual anomaly extends to the aggregate stock market. In contrast with cross-sectional findings, there is no indication that aggregate operating accruals is a negative time series predictor of stock market returns; the relation is strongly positive for the market portfolio and also for several sector and industry portfolios. In addition, innovations in accruals are negatively contemporaneously associated with market returns, suggesting that changes in accruals contain information about changes in discount rates, or that firms manage earnings in response to market-wide undervaluation.
    Keywords: accruals; return predictability; stock market returns; market efficiency; asset pricing; anomalies; accounting; earnings fixation
    JEL: M41 G12 G14
    Date: 2007–09–23
  6. By: Albanese, Claudio; Vidler, Alicia
    Abstract: We present a new structural model for single name equity and credit derivatives which we also correlate across reference names to produce a model for bespoke synthetic CDOs. The model captures volatility and outlook risk along with correlation risk for small and for large moves separately. We show that the model calibrates well to both equity structured products and credit derivatives. As examples, we discuss a number of single name derivatives on IBM spanning the credit-equity spectrum and ranging from volatility swaps, to cliquets, CDS options and CDSs on leveraged loans with pre-payment risk. We also use the model to price tranches on the investment grade DJ.CDX.IG index along with tranches on the high yield index DJ.CDX.HY. We show that the model gives consistent and high precision pricing across all these derivative asset classes. We show that this can be achieved consistently, with the very same parameter choices across these diverse derivative assets and making use of only minor explicit time dependencies.
    Keywords: Credit derivatives; equity derivatives; long dated derivatives; CDOs; structural model
    JEL: G13
    Date: 2007–01–26

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.