nep-rmg New Economics Papers
on Risk Management
Issue of 2008‒04‒21
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. Modeling International Financial Returns with a Multivariate Regime Switching Copula By Chollete, Lorán; Heinen, Andréas; Valdesogo, Alfonso
  2. Delving into country risk By Silvia Iranzo
  3. Non-stationarity and meta-distribution By Dominique Guegan
  4. The Propagation of Financial Extremes: An Application to Subprime Market Spillovers By Chollete, Lorán
  5. Level dependent annuities: Defaults of multiple degrees By Mjøs, Aksel; Persson, Svein-Arne
  6. The dynamics of ex-ante risk premia in the foreign exchange market: Evidence from the yen/usd exchange rate Using survey data By Georges Prat; Remzi Uctum
  7. A challenge to triumphant optimists? A new index for the Paris stock exchange (1854-2007) By David Le Bris; Pierre-Cyrille Hautcoeur
  8. Asymmetric News Effects on Volatility: Good vs. Bad News in Good vs. Bad Times By Laakkonen, Helinä; Lanne, Markku
  9. The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis By Atif Mian; Amir Sufi

  1. By: Chollete, Lorán (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration); Heinen, Andréas (Dept. of Statistics and Econometrics, Universidad Carlos III de Madrid); Valdesogo, Alfonso (Center for Operations Research and Econometrics (CORE), Université Catholique de Louvain)
    Abstract: In order to capture observed asymmetric dependence in international financial returns, we construct a multivariate regime-switching model of copulas. We model dependence with one Gaussian and one canonical vine copula regime. Canonical vines are constructed from bivariate conditional copulas and provide a very flexible way of characterizing dependence in multivariate settings. We apply the model to returns from the G5 and Latin American regions, and document two main findings. First, we discover that models with canonical vines generally dominate alternative dependence structures. Second, the choice of copula is important for risk management, because it modifies the Value at Risk (VaR) of international portfolio returns.
    Keywords: Asymmetric dependence; Canonical vine copula; International returns; Regime-Switching; Risk Management; Value-at-Risk
    JEL: C32 C35 G10
    Date: 2008–03–12
  2. By: Silvia Iranzo (Banco de España)
    Abstract: Since the Latin American debt crisis of the early 80s, country risk analysis has accounted for a significant part of the work of research and risk management departments of banks, insurance companies, rating agencies, financial market regulators, and multinational companies. Country risk is a very broad concept, that includes sovereign risk, transfer risk, and other risks related with international financial activities. Country risk analysis requires delving into multiple fields, such as economics, finance, politics and history. This paper addresses the concept of country risk, the agents involved, the methods for assessing country risk, the payments crises, risk prevention, the assessment of country risk in the present world and the Spanish country risk regulation.
    Keywords: country risk, financial crises, default, solvency, reserves
    JEL: E44 E66 G12 G32 F32 F33
    Date: 2008–04
  3. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I)
    Abstract: In this paper we deal with the problem of non-stationarity encountered in a lot of data sets, mainly in financial and economics domains, coming from the presence of multiple seasonnalities, jumps, volatility, distorsion, aggregation, etc. Existence of non-stationarity involves spurious behaviors in estimated statistics as soon as we work with finite samples. We illustrate this fact using Markov switching processes, Stopbreak models and SETAR processes. Thus, working with a theoretical framework based on the existence of an invariant measure for a whole sample is not satisfactory. Empirically alternative strategies have been developed introducing dynamics inside modelling mainly through the parameter with the use of rolling windows. A specific framework has not yet been proposed to study such non-invariant data sets. The question is difficult. Here, we address a discussion on this topic proposing the concept of meta-distribution which can be used to improve risk management strategies or forecasts.
    Keywords: Non-stationarity, switching processes, SETAR processes, jumps, forecast, risk management, copula, probability distribution function.
    Date: 2008–03
  4. By: Chollete, Lorán (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: What drives extreme and rare economic events? Motivated by recent theory, and events in US subprime markets, we begin to open the black box of extremes. Specifically, we build a taxonomy of extremes, then extend standard economic analysis of extreme risk. First, we model the potentially relevant dimensions of dynamics and endogeneity. In characterizing individuals' endogenous propagation of extremes, we relate the latter to public goods. Second, using over a century of daily stock price data, we construct empirical probabilities of extremes. We document that extremes are relatively frequent and persistent. We find evidence that extremes are endogenous, raising the possibility that control of extremes is a public good.
    Keywords: Extreme event; Subprime Market; Dynamics; Endogeneity; Public Good
    JEL: C10 E44 E51 H23 H41
    Date: 2008–01–31
  5. By: Mjøs, Aksel (SNF - Institute for Research in Economics and Business Administration); Persson, Svein-Arne (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: Motivated by the risk of stopped debt coupon payments from a leveraged company in financial distress, we value a level dependent annuity contract where the annuity rate depends on the value of an underlying asset-process. The range of possible values of the asset is divided into a finite number of regions. The annuity rate is constant within each region, but may differ between the regions. We consider both in finite and finite annuities, with or without bankruptcy risk, i.e., bankruptcy occurs if the asset value process hits an absorbing boundary. Such annuities are common in models of debt with credit risk in financial economics. Suspension of debt service under the US Chapter 11 provisions is one well-known real-world example. We present closed-form formulas for the market value of such multi-level annuities contracts when the market value of the underlying asset is assumed to follow a geometric Brownian motion.
    Keywords: Multi-level annuity; credit risk; financial distress
    JEL: G13 G32 G33
    Date: 2008–03–12
  6. By: Georges Prat; Remzi Uctum
    Abstract: Using financial experts’ Yen/USD exchange rate expectations provided by Consensus Forecasts surveys (London), this paper aims to model the 3 and 12-month ahead ex-ante risk premia measured as the difference between the expected and forward exchange rates. According to a two-country portfolio asset pricing model, the risk premium is modeled as the product of three factors: a constant risk aversion coefficient, the expected variance of the rate of change in the real exchange rate, and the spread between domestic agent’s market position in foreign assets and foreign agent’s market position in domestic assets (net market position). When the returns are partially predictable, the expected variance is horizondependent and this is a sufficient condition for agents not to require at any time a unique risk premium for all maturities but a set of premia scaled by the time horizon of the investment. For each horizon the expected variance is assumed to depend on the historical values of the variance and on the unobservable maturity-dependent net market positions which have been estimated through a state space model using the Kalman filter methodology. We find that the model explains satisfactorily both the common and the non-random specific time-patterns of the 3- and 12-month ex-ante premia.
    Keywords: risk premium, foreign exchange market, international asset pricing model
    JEL: D84 E44 G14
    Date: 2008
  7. By: David Le Bris; Pierre-Cyrille Hautcoeur
    Abstract: Most empirical knowledge on the long term performance of financial investments is derived from the behaviour of the most successful markets. Recent research has tried to broaden the sample of markets studied towards European ones, many of which were among the worlds most developed up to World War One and again weight substantially in today's global portfolio. The synthesis by Dimson, Marsh and Staunton (2001) proposes data on the 20th century for 16 countries, and ends up with an optimistic tone, although a less enthusiastic one than most of the American literature. They argue that even in the worst case - Belgium - the stock market long term performance remained positive (2.5% yearly real return on the 20th century), and superior to that of other investments. The results of this paper suggest that most of the continental European results may be wrong, since they may significantly overestimate the performance of investments in stocks during the 20th century. We concentrate on the French case, but we argue that similar calculations on other European countries may well give similar results. This paper describes and analyzes a new homogeneous stock index for the French stock market from 1854 to 1998, and compares it to those of some other countries. The paper first describes the index's methodology (a weighted, yearly adjusted index comparable to Euronext's CAC40). It then provides some major results. First, investment in French stocks provided a positive real return during the 19th century, but a negative one - because of inflation - in the 20th . After 1914, hoarding gold or investing in real estate provided better returns than stocks. The equity premium was low and consistent with standard models of risk aversion. These results contrast no only with those observed on the US market, but also with older studies of the French market, which were based on un-weighted large indices suffering survivor bias. They are more consistent with the history of the French financial markets and economic policy regimes in the 19th and 20th centuries.
    Date: 2008
  8. By: Laakkonen, Helinä; Lanne, Markku
    Abstract: We study the impact of positive and negative macroeconomic US and European news announcements in different phases of the business cycle on the highfrequency volatility of the EUR/USD exchange rate. The results suggest that in general bad news increases volatility more than good news. The news effects also depend on the state of the economy: bad news increases volatility more in good times than in bad times, while there is no difference between the volatility effects of good news in bad and good times.
    Keywords: Volatility; News; Nonlinearity; Smooth Transition Models
    JEL: C32 G15 F31
    Date: 2008
  9. By: Atif Mian; Amir Sufi
    Abstract: We demonstrate that a rapid expansion in the supply of mortgages driven by disintermediation explains a large fraction of recent U.S. house price appreciation and subsequent mortgage defaults. We identify the effect of shifts in the supply of mortgage credit by exploiting within-county variation across zip codes that differed in latent demand for mortgages in the mid 1990s. From 2001 to 2005, high latent demand zip codes experienced large relative decreases in denial rates, increases in mortgages originated, and increases in house price appreciation, despite the fact that these zip codes experienced significantly negative relative income and employment growth over this time period. These patterns for high latent demand zip codes were driven by a sharp relative increase in the fraction of loans sold by originators shortly after origination, a process which we refer to as "disintermediation." The increase in disintermediation-driven mortgage supply to high latent demand zip codes from 2001 to 2005 led to subsequent large increases in mortgage defaults from 2005 to 2007. Our results suggest that moral hazard on behalf of originators selling mortgages is a main culprit for the U.S. mortgage default crisis.
    JEL: E44 E51 G21 L85 O51 R21
    Date: 2008–04

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