nep-rmg New Economics Papers
on Risk Management
Issue of 2008‒02‒02
seven papers chosen by
Stan Miles
Thompson Rivers University

  1. Designing and Implementing a Basel II Compliant PIT-TTC Ratings Framework By Aguais, Scott
  2. Risk-based supervision of pension funds : a review of international experience and preliminary assessment of the first outcomes By Rocha, Roberto; Hinz, Richard; Brunner, Gregory
  3. Measuring downside risk - realised semivariance By Ole E. Barndorff-Nielsen; Silja Kinnebrock; Neil Shephard
  4. Idiosyncratic Risk in Emerging Markets By Timotheos Angelidis
  5. On Emerging Economy Sovereign Spreads and Ratings By Andrew Powell; Juan Francisco Martínez
  6. Ownership links, leverage and credit risk By Elisa Luciano; Giovanna Nicodano
  7. Macroeconomic Impact on Expected Default Frequency By Åsberg Sommar, Per; Shahnazarian, Hovick

  1. By: Aguais, Scott
    Abstract: From 'The Basel Handbook' a description of a framework for calculating both "point-in-time" (PIT) and "through-the-cycle" (TTC) PDs, to enable banks to achieve Basel II compliance at an advanced level. The framework described here reflects broadly the one implemented globally in May 2005 at Barclays Capital.
    JEL: G32
    Date: 2008–01–27
  2. By: Rocha, Roberto; Hinz, Richard; Brunner, Gregory
    Abstract: This paper provides a review of the design and experience of risk-based pension fund supervision in several countries that have been leaders in the development of these methods. The utilization of risk-based methods originates primarily in the supervision of banks. In recent years it has increasingly been extended to other types of financial intermediaries including pension funds and insurers. The trend toward risk-based supervision of pensions is closely associated with movement toward the integration of pension supervision with that of banking and other financial services into a single national authority. Although similar in concept to the techniques developed in banking, the application to pension funds has required modifications, particularly for defined contribution funds that transfer investment risk to fund members. The countries examined provide a range of experiences that illustrate both the diversity of pension systems and approaches to risk-based supervision, but also a commonality of the focus on sound risk management and effective supervisory outcomes. The paper provides a description of pension supervision in Australia, Denmark, Mexico and the Netherlands, and an initial evaluation of the results achieved in relation to the underlying objectives.
    Keywords: Debt Markets,,Insurance & Risk Mitigation,Emerging Markets,Banks & Banking Reform
    Date: 2008–01–01
  3. By: Ole E. Barndorff-Nielsen; Silja Kinnebrock; Neil Shephard
    Abstract: We propose a new measure of risk, based entirely on downwards moves measured using high frequency data. Realised semivariances are shown to have important predictive qualities for future market volatility. The theory of these new measures is spelt out, drawing on some new results from probability theory.
    Keywords: Market frictions; Quadratic variation; Realised variance; Semimartingale; Semivariance
    Date: 2008
  4. By: Timotheos Angelidis
    Abstract: It is well documented that idiosyncratic risk is the most important component of total volatility in developed markets. However, little research has been conducted on the properties of asset-specific risk in emerging markets, though they are more volatile, characterized by substantial returns, and represent at least 7.5% of the total world investable market capitalization. Using firm level data for 24 emerging markets, idiosyncratic risk explains 55% of the total volatility, and there is no evidence for an upward trend. Asset-specific risk is negatively correlated with future market returns, whereas market risk is not related. Idiosyncratic volatility and the correlation between security returns affects the number of stocks included in a portfolio, and thus, an investor must always adjust the number of holdings to achieve a given level of risk.
    Keywords: Emerging markets, Idiosyncratic risk, Portfolio management, Tracking error volatility.
    Date: 2008
  5. By: Andrew Powell (Inter-American Development Bank); Juan Francisco Martínez (Oxford University)
    Abstract: This paper analyzes alternative models for emerging sovereign ratings. Although a small number of economic fundamentals explain ratings reasonably well, variations in those economic fundamentals are themselves explained by a small number of world factors. On the other hand, global financial variables associated with risk aversion are additionally required in order to explain the significant spread compression at the end of 2006. To determine whether ratings matter for spreads, the paper compares results across different methodologies, in particular exploiting differences in opinion between rating agencies. The evidence from this and previous methodologies is that ratings do matter. Finally, the paper finds that global indicators of risk aversion have become less important for emerging market spreads and that the effect of sub-prime news is less than the effect of “average news” on emerging economy credit default swap (CDS) spreads.
    Keywords: Ratings, Spreads, Panel Data
    JEL: F37 G14 G15 C23
    Date: 2008–01
  6. By: Elisa Luciano; Giovanna Nicodano
    Abstract: This paper explores the relationship between optimal leverage and ownership links. It develops a structural model of a parent and a subsidiary, which issues debt in its own name under a guarantee by the parent. We .nd that zero leverage can be optimal for the guarantor, while leverage close to one can be optimal for the guaranteed company, as this optimally exploits the tax shield of debt while minimizing default costs. As far as credit risk is considered, their joint default probability is lower than that of stand alone units, despite their higher debt capacity. Default probability, spreads and loss given default of the subsidiary are higher than for a stand alone with similar size and volatility. We also study the situation when the subsidiary is constrained to a debt equal to the optimal stand alone level. Only in this case group credit risk depends on the ownership share.
    Keywords: : credit risk, default risk, structural models, optimal leverage, zero leverage, ownership structure, parent-subsidiary.
    JEL: G32 G33 G34
    Date: 2008
  7. By: Åsberg Sommar, Per (Financial Stability Department, Central Bank of Sweden); Shahnazarian, Hovick (Financial Stability Department, Central Bank of Sweden)
    Abstract: We use a vector error correction model to study the long-term relationship between aggregate expected default frequency and the macroeconomic development, i.e. CPI, industry production and short-term interest rate. The model is used to forecast the median expected default frequency of the corporate sector by conditioning on external forecasts of macroeconomic developments. Evaluations of the model show that it yields low forecast errors in terms of RMSE. The estimation results indicate that the interest rate has the strongest impact on expected default frequency among the included macroeconomic variables. The forecasts indicate that EDF will rise gradually over the forecast period.
    Keywords: Expected Default Frequency; Macroeconomic Impact; Business cycle; vector error correction model; Financial stability; Financial and real economy interaction
    JEL: C32 C52 C53 G21 G33
    Date: 2008–01–01

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