New Economics Papers
on Risk Management
Issue of 2008‒03‒01
twelve papers chosen by

  1. Operational Risk--The Sting is Still in the Tail but the Poison Depends on the Dose By Andreas Jobst
  2. Consistent Quantitative Operational Risk Measurement and Regulation: Challenges of Model Specification, Data Collection, and Loss Reporting By Andreas Jobst
  4. A Risk-Based Debt Sustainability Framework: Incorporating Balance Sheets and Uncertainty By Elena Loukoianova; Cheng Hoon Lim; Samuel Malone; Dale F. Gray
  5. Multivariate Regime–Switching GARCH with an Application to International Stock Markets By Markus Haas; Stefan Mittnik
  6. Decomposing Financial Risks and Vulnerabilities in Eastern Europe By Andrea M. Maechler; Srobona Mitra; DeLisle Worrell
  7. ABS, MBS and CDO Compared: an Empirical Analysis By Vink, Dennis; Thibeault, André E.
  8. Capital Account Liberalization and Risk Management in India By Amadou N. R. Sy
  9. Sukuk vs. Eurobonds: Is There a Difference in Value-at-Risk? By Selim Cakir; Faezeh Raei
  10. Non-Market Wealth, Background Risk and Portfolio Choice By Günter Franke; Harris Schlesinger; Richard Stapleton
  11. Do Daylight-Saving Time Adjustments Really Impact Stock Returns? By Douglas Steigerwald; Marc Conte
  12. Islamic Banks and Financial Stability: An Empirical Analysis By Martin Cihák; Heiko Hesse

  1. By: Andreas Jobst
    Abstract: This paper investigates the generalized parametric measurement methods of aggregate operational risk in compliance with the regulatory capital standards for operational risk in the New Basel Capital Accord ("Basel II"). Operational risk is commonly defined as the risk of loss resulting from inadequate or failed internal processes and information systems, from misconduct by people or from unforeseen external events. Our analysis informs an integrated assessment of the quantification of operational risk exposure and the consistency of current capital rules on operational risk based on generalized parametric estimation.
    Keywords: Working Paper , Financial risk , Bank regulations , Risk management , Economic models ,
    Date: 2007–10–30
  2. By: Andreas Jobst
    Abstract: Amid increased size and complexity of the banking industry, operational risk has a greater potential to transpire in more harmful ways than many other sources of risk. This paper provides a succinct overview of the current regulatory framework of operational risk under the New Basel Capital Accord with a view to inform a critical debate about the influence of varying loss profiles and different methods of data collection, loss reporting, and model specification on the reliability of operational risk estimates and the consistency of risk-sensitive capital rules. The presented findings offer guidance on enhanced market practice and more effective prudential standards for operational risk measurement.
    Keywords: Risk management , Bank regulations , Globalization , Banking systems ,
    Date: 2007–11–05
  3. By: Mohammed Bouaddi; Jeroen V.K. Rombouts (IEA, HEC Montréal)
    Abstract: To match the stylized facts of high frequency financial time series precisely and parsimoniously, this paper presents a finite mixture of conditional exponential power distributions where each component exhibits asymmetric conditional heteroskedasticity. We provide stationarity conditions and unconditional moments to the fourth order. We apply this new class to Dow Jones index returns. We find that a two-component mixed exponential power distribution dominates mixed normal distributions with more components, and more parameters, both in-sample and out-of-sample. In contrast to mixed normal distributions, all the conditional variance processes become stationary. This happens because the mixed exponential power distribution allows for component-specific shape parameters so that it can better capture the tail behaviour. Therefore, the more general new class has attractive features over mixed normal distributions in our application: Less components are necessary and the conditional variances in the components are stationary processes. Results on NASDAQ index returns are similar.
    Keywords: Finite mixtures, exponential power distributions, conditional heteroskedasticity, asymmetry, heavy tails, value at risk.
    JEL: C11 C22 C52
    Date: 2007–12
  4. By: Elena Loukoianova; Cheng Hoon Lim; Samuel Malone; Dale F. Gray
    Abstract: This paper proposes a new framework for the analysis of public sector debt sustainability. The framework uses concepts and methods from modern practice of contingent claims to develop a quantitative risk-based model of sovereign credit risk. The motivation in developing this framework is to provide a clear and workable complement to traditional debt sustainability analysis which-although it has many useful applications-suffers from the inability to measure risk exposures, default probabilities and credit spreads. Importantly, this new framework can be adapted for policy analysis, including debt and reserve management.
    Keywords: Risk management , Public sector , Public debt , Reserve management policy ,
    Date: 2008–02–11
  5. By: Markus Haas (University of Munich, Institute of Statistics); Stefan Mittnik (Department of Statistics, University of Munich, Center for Financial Studies, Frankfurt, and Ifo Institute for Economic Research, Munich)
    Abstract: We develop a multivariate generalization of the Markov–switching GARCH model introduced by Haas, Mittnik, and Paolella (2004b) and derive its fourth–moment structure. An application to international stock markets illustrates the relevance of accounting for volatility regimes from both a statistical and economic perspective, including out–of–sample portfolio selection and computation of Value–at–Risk.
    Keywords: Conditional Volatility, Markov–Switching, Multivariate GARCH
    JEL: C32 C51 G10 G11
    Date: 2008–01
  6. By: Andrea M. Maechler; Srobona Mitra; DeLisle Worrell
    Abstract: This paper assesses how various types of financial risk such as credit risk, market risk, and liquidity risk affect banking stability in the ten countries that joined the European Union most recently, and eight neighboring countries. It also examines how the quality of supervisory standards may have mitigated the vulnerabilities arising from these risk factors. Using panel data, the study finds substantial variation in the impacts of financial risks, the macroeconomic environment, and supervisory standards on banks' risk profile across different country clusters. Credit quality is of general concern especially in circumstances where credit growth is accelerating.
    Keywords: Working Paper , Financial risk , Europe , Bank soundness , Bank supervision , Economic models ,
    Date: 2007–10–29
  7. By: Vink, Dennis; Thibeault, André E. (Nyenrode Business Universiteit)
    Abstract: The capital market in which the asset-backed securities are issued and traded is composed of three main categories: ABS, MBS and CDOs. We were able to examine a total number of 3,951 loans (worth €730.25 billion) of which 1,129 (worth €208.94 billion) have been classified as ABS. MBS issues represent 2,224 issues (worth €459.32 billion) and 598 are CDO issues (worth €61.99 billion). We have investigated how common pricing factors compare for the main classes of securities. Due to the differences in the assets related to these securities, the relevant pricing factors for these securities should differ, too. Taking these three classes as a whole, we have documented that the assets attached as collateral for the securities differ between security classes, but that there are also important univariate differences to consider. We found that most of the common pricing characteristics between ABS, MBS and CDO differ significantly. Furthermore, applying the same pricing estimation model to each security class revealed that most of the common pricing characteristics associated with these classes have a different impact on the primary market spread exhibited by the value of the coefficients. The regression analyses we performed demonstrated econometrically that ABS, MBS, and CDOs are in fact different financial instruments.
    Keywords: asset securitization, asset-backed securitisation, bank lending, default risk, risk management, spreads, leveraged financing.
    Date: 2008
  8. By: Amadou N. R. Sy
    Abstract: This paper takes a closer look at the prudential and regulatory measures needed to prepare India's financial system to manage the risks arising from fuller capital account convertibility (FCAC). The paper contributes to the debate on FCAC in two ways. First, it reviews the potential and existing financial stability challenges to FCAC in India. Second it studies how prudential regulation and supervision is addressing these challenges. The main conclusion is that regulatory and supervisory measures alone are not enough and will need to be complemented by improvements in Indian banks' risk management and further development of the domestic capital markets.
    Keywords: Working Paper , Capital account convertibility , India , Risk management ,
    Date: 2007–10–30
  9. By: Selim Cakir; Faezeh Raei
    Abstract: This paper assesses the impact of bonds issued according to Islamic principles (Sukuk), on the cost and risk structure of investment portfolios by using the Value-at-Risk (VaR) framework. The market for Sukuk has grown tremendously in recent years at about 45 percent a year. Sukuk provide sovereign governments and corporations with access to the huge and growing Islamic liquidity pool, in addition to the conventional investor base. The paper analyzes whether secondary market behavior of Eurobonds and Sukuk issued by the same issuer are significantly different to provide gains from diversification. The analysis, employing the delta-normal as well as Monte-Carlo simulation methods, implies such gains are present and in certain cases very significant.
    Keywords: Working Paper , Islamic banking , Bonds , Eurobond market , Investment ,
    Date: 2007–10–15
  10. By: Günter Franke (University of Konstanz); Harris Schlesinger; Richard Stapleton
    Abstract: We examine the effects of non-portfolio risks on optimal portfolio choice. Examples of non-portfolio risks include, among others, uncertain labor income, uncertainty about the terminal value of fixed assets such as housing and uncertainty about future tax liabilities . In particular, while some of these risks are added to portfolio value and have been amply studied, others are multiplicative in nature and have received far less attention. Moreover, the combined effects of multiple risks lead to some seemingly paradoxical choice behavior. We rationalize such behavior and we show how non-portfolio risks might lead to seemingly U-shaped relative risk aversion for a representative investor, as found empirically by Ait-Sahilia and Lo (2000) and Jackwerth (2000).
    Keywords: Portfolio choice, Derived relative risk aversion, Additive background risk, Multiplicative background risk
    JEL: G11
    Date: 2007–07–26
  11. By: Douglas Steigerwald (University of California, Santa Barbara); Marc Conte (University of California, Santa Barbara)
    Abstract: We study the possible impact of daylight-saving time adjustment on stock returns. Previous work reveals that average returns tend to decline following an adjustment. As averages are sensitive to outliers, more recent work focused on the entire distribution of returns and found little impact following adjustments. Unfortunately, the general nature of the alternative hypothesis reduces the power of the distribution test to detect an effect of adjustments on the location of the distribution. We construct robust tests that are designed to have power to detect a time-adjustment effect on the location of returns. We also develop a more novel test of exponential tilting that is designed to accommodate possible heterogeneity in the return distribution over time. When we apply these test to S&P 500 stock returns, we are unable to rigorously detect a time adjustment effect on stock returns.
    Keywords: asset price anomalies, daylight-saving time, exponential tilting, order and rank statistics, robust test,
    Date: 2007–07–01
  12. By: Martin Cihák; Heiko Hesse
    Abstract: The relative financial strength of Islamic banks is assessed empirically based on evidence covering individual Islamic and commercial banks in 18 banking systems with a substantial presence of Islamic banking. We find that (i) small Islamic banks tend to be financially stronger than small commercial banks; (ii) large commercial banks tend to be financially stronger than large Islamic banks; and (iii) small Islamic banks tend to be financially stronger than large Islamic banks, which may reflect challenges of credit risk management in large Islamic banks. We also find that the market share of Islamic banks does not have a significant impact on the financial strength of other banks.
    Keywords: Islamic banking , Financial stability ,
    Date: 2008–01–30

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