nep-rmg New Economics Papers
on Risk Management
Issue of 2008‒03‒08
eight papers chosen by
Stan Miles
Thompson Rivers University

  1. The Role of Realized Volatility in the Athens Stock Exchange By Dimitrios Thomakos; Michail Koubouros
  2. Risk-based supervision of pension funds in Australia By Thompson, Graeme
  3. The Credit Default Swap Market’s Determinants By Caitlin Ann Greatrex
  4. Risk-based supervision of pension institutions in Denmark By Andersen, Erik Brink; van Dam, Rein
  5. Forecasting Stock Market Volatilities Using MIDAS Regressions: An Application to the Emerging Markets By Alper, C. Emre; Fendoglu, Salih; Saltoglu, Burak
  6. Hedging for the Long Run By Eckhard Platen; Hardy Hulley
  7. Momentum in Australian Stock Returns: An Update By A. S. Hurn; V.Pavlov
  8. Evaluating Volatility and Correlation Forecasts By Andrew J. Patton; Kevin Sheppard

  1. By: Dimitrios Thomakos; Michail Koubouros
    Abstract: Using a newly developed dataset of daily, value-weighted market returns we construct and analyze the monthly realized volatility of the Athens Stock Exchange (A.S.E.) from 1985 to 2003. Our analysis focuses on the distributional and time series properties of the realized volatility series and on assessing the connection between realized volatility and returns through an multi-factor asset pricing model. In particular, we finnd strong evidence on the existence of a volatility feedback e¤ect and the leverage e¤ect, and on the existence of asymmetries between lagged returns and volatility. Furthermore, we examine the cross-sectional distribution of unconditional loadings on the realized risk factor(s) for different sets of characteristics-sorted common stock portfolios. We find that realized risk is a significantly priced factor in A.S.E. and its high explanatory power for the cross-section of portfolio average returns is independent of any return variation related to the market (CAPM) or size and book-to-market (Fama-French) factors. We discuss our findings in the context of the recent literature on realized volatility and feedback effects, as well as the literature on the pricing power of realized risk.
    Keywords: realized volatility, leverage e¤ect, volatility feedback e¤ect, asset pricing, A.S.E.
    Date: 2008
  2. By: Thompson, Graeme
    Abstract: This paper examines the development of risk-based supervision of pension funds in Australia. The large number of pension funds has meant that since the inception of pension fund supervision in the early 1990 ' s the regulator has sought to identify high risk funds and foc us its attention on these funds. However, the regulator developed a more sophisticated risk-rating model, known as PAIRS/SOARS, in 1992 in order to apply a more disciplined and consistent ratings methodology. Four reasons are given for the move towards more sophisticated risk-based supervision: 1) creation of an integrated supervisor which allowed the use of techniques used in banking and insurance to be adopted for pension fund; 2) the need to better use available supervisory resources; 3) several pension fund failures; and 4) concerns about industry weaknesses. Supervisory techniques used particularly in the banking industry, such as universal licensing, ' fit and proper ' assessment, and risk management requirements were adopted for the pension sector between 2004 and 2006. The paper provides an outline of the PAIRS/SOARS risk-rating model which was also adopted. It observes that the approach provides an analytical discipline to risk assessment, strengthens the link between risk assessment and supervisory response, and allows better targeting of supervisory resources.
    Keywords: Debt Markets,,Non Bank Financial Institutions,Labor Policies,Emerging Markets
    Date: 2008–02–01
  3. By: Caitlin Ann Greatrex (Fordham University, Department of Economics)
    Abstract: This paper explores the ability of variables suggested by structural models to explain variation in CDS spread changes. Using monthly changes in CDS spreads for 333 firms from January, 2001 – March, 2006, I find that these variables are able to explain thirty percent of the variation in CDS spread changes. A rating-based CDS index that accounts for both credit risk and overall market conditions is the single best predictor of CDS spread changes. Leverage and volatility, however, are also key determinants, as these two variables can explain almost half of the explained variation in monthly CDS spread changes.
    Keywords: Credit default swap, credit risk, leverage, stock returns, equity volatility.
    JEL: G12
    Date: 2008
  4. By: Andersen, Erik Brink; van Dam, Rein
    Abstract: This paper examines the move towards risk-based supervision of pension institutions in Denmark. Although Denmark has not adopted a comprehensive model to assess risk it has developed a number of building blocks which it uses for risk-based assessment. The motivations for improving risk assessment include a desire to identify emerging problems, and concerns about the solvency of pension institutions. In Denmark there is extensive use of guaranteed minimum returns in both the accumulation and payout phases which create substantial obligations on pension institutions, and focus attention on the integrity and solvency of the institutions which provide them. In conjunction with freeing up investment restrictions and moving towards market valuation of assets, the supervisor has introduced a ' traffic light ' stress test model which calculates the effect of several market scenarios - the red test which is the more plausible and the yellow test which is possible but less likely. In addition to the use of the traffic light system, there has been a growing emphasis on the adequacy of internal risk control systems and greater reliance on market discipline. Pension institutions have sought to reduce their exposure to market volatility by better matching of assets and liabilities. There is a much better understanding of the risks inherent in the pension institutions ' portfolios, and there has been a substantial increase in the use of hedging instruments.
    Keywords: Debt Markets,,Emerging Markets,Insurance & Risk Mitigation,Banks & Banking Reform
    Date: 2008–02–01
  5. By: Alper, C. Emre; Fendoglu, Salih; Saltoglu, Burak
    Abstract: We explore the relative weekly stock market volatility forecasting performance of the linear univariate MIDAS regression model based on squared daily returns vis-a-vis the benchmark model of GARCH(1,1) for a set of four developed and ten emerging market economies. We first estimate the two models for the 2002-2007 period and compare their in-sample properties. Next we estimate the two models using the data on 2002-2005 period and then compare their out-of-sample forecasting performance for the 2006-2007 period, based on the corresponding mean squared prediction errors following the testing procedure suggested by West (2006). Our findings show that the MIDAS squared daily return regression model outperforms the GARCH model significantly in four of the emerging markets. Moreover, the GARCH model fails to outperform the MIDAS regression model in any of the emerging markets significantly. The results are slightly less conclusive for the developed economies. These results may imply superior performance of MIDAS in relatively more volatile environments.
    Keywords: Mixed Data Sampling regression model; Conditional volatility forecasting; Emerging Markets.
    JEL: C53 C52 C22 G10
    Date: 2008–03
  6. By: Eckhard Platen (School of Finance and Economics, University of Technology, Sydney); Hardy Hulley (School of Finance and Economics, University of Technology, Sydney)
    Abstract: In the years following the publication of Black and Scholes [7], numerous alternative models have been proposed for pricing and hedging equity derivatives. Prominent examples include stochastic volatility models, jump di®usion models, and models based on Levy processes. These all have their own shortcomings, and evidence suggests that none is up to the task of satisfactorily pricing and hedging extremely long-dated claims. Since they all fall within the ambit of risk-neutral pricing, it is thus natural to speculate that their defciencies are (at least in part) attributable to the modelling constraints imposed by the risk-neutral approach itself. To investigate this idea, we present a simple two-parameter model for a diversifed equity accumulation index. Although our model does not admit an equivalent risk-neutral probability measure, it nevertheless fulfils a minimal no-arbitrage condition for an economically viable financial market. Furthermore, we demonstrate that contingent claims can be priced and hedged, without the need for an equivalent change of probability measure. Convenient formulae for the prices and hedge ratios of a number of standard European claims are derived, and a series of hedge experiments for extremely long-dated claims on the S&P 500 total return index are conducted. Our model serves also as a convenient medium for illustrating and clarifying several points on asset price bubbles and the economics of arbitrage.
    Keywords: long-dated claims; risk-neutral pricing; real-world pricing; arbitrage; minimal market model; squared Bessel processes; hedge simulations; asset price bubbles
    JEL: G10 G12 G13
    Date: 2008–02–01
  7. By: A. S. Hurn; V.Pavlov
    Abstract: It has been documented that a momentum investment strategy based on buying past well performing stocks while selling past losing stocks, is a profitable one in the Australian context particularly in the 1990s. The aim of this short paper is to investigate whether or not this feature of Australian stock returns is still evident. The paper confirms the presence of a medium-term momentum effect, but also provides some interesting new evidence on the importance of the size effect on momentum.
    Keywords: Stock returns, Momentum portfolios, Size effect
    JEL: G11 G12
    Date: 2008–02–26
  8. By: Andrew J. Patton; Kevin Sheppard
    Date: 2008

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