New Economics Papers
on Risk Management
Issue of 2008‒08‒31
seven papers chosen by

  1. Macroeconomic Volatility and Stock Market Volatility, World-Wide By Francis X. Diebold; Kamil Yilmaz
  2. The Costs and Benefits of Reinsurance By J. David Cummins; Georges Dionne; Robert Gagné; Abdelhakim Nouira
  3. Support Vector Machines (SVM) as a Technique for Solvency Analysis By Laura Auria; Rouslan A. Moro
  4. Monitoring business cycles with structural changes By Chauvet, Marcelle; Potter, Simon
  5. How Much Do Banks Use Credit Derivatives to Hedge Loans? By Minton, Bernadette; Stulz, Rene; Williamson, Rohan
  6. Common Patterns in Commonality in Returns, Liquidity, and Turnover around the World By Karolyi, G. Andrew; Lee, Kuan Hui; van Dijk, Mathijs A.
  7. Foreign Currency Exposure and Hedging: Evidence from Foreign Acquisitions By Bartram, Söhnke M.; Burns, Natasha; Helwege, Jean

  1. By: Francis X. Diebold (Department of Economics, University of Pennsylvania and NBER); Kamil Yilmaz (Department of Economics, Koc University)
    Abstract: Notwithstanding its impressive contributions to empirical financial economics, there remains a significant gap in the volatility literature, namely its relative neglect of the connection between macroeconomic fundamentals and asset return volatility. We progress by analyzing a broad international cross section of stock markets covering approximately forty countries. We find a clear link between macroeconomic fundamentals and stock market volatilities, with volatile fundamentals translating into volatile stock markets.
    Keywords: Financial market, equity market, asset return, risk, variance, asset pricing
    JEL: G1 E0
    Date: 2008–08–06
  2. By: J. David Cummins; Georges Dionne (HEC Montréal); Robert Gagné (IEA, HEC Montréal); Abdelhakim Nouira
    Abstract: Purchasing reinsurance reduces insurers’ insolvency risk by stabilizing loss experience, increasing capacity, limiting liability on specific risks, and/or protecting against catastrophes. Consequently, reinsurance purchase should reduce capital costs. However, transferring risk to reinsurers is expensive. The cost of reinsurance for an insurer can be much larger than the actuarial price of the risk transferred. In this article, we analyze empirically the costs and the benefits of reinsurance for a sample of U.S. property-liability insurers. The results show that reinsurance purchase increases significantly the insurers’ costs but reduces significantly the volatility of the loss ratio. With purchasing reinsurance, insurers accept to pay higher costs of insurance production to reduce their underwriting risk.
    Keywords: reinsurance, insolvency risk, risk management, financial intermediation, cost functions, panel data.
    Date: 2008–06
  3. By: Laura Auria; Rouslan A. Moro
    Abstract: This paper introduces a statistical technique, Support Vector Machines (SVM), which is considered by the Deutsche Bundesbank as an alternative for company rating. A special attention is paid to the features of the SVM which provide a higher accuracy of company classification into solvent and insolvent. The advantages and disadvantages of the method are discussed. The comparison of the SVM with more traditional approaches such as logistic regression (Logit) and discriminant analysis (DA) is made on the Deutsche Bundesbank data of annual income statements and balance sheets of German companies. The out-of-sample accuracy tests confirm that the SVM outperforms both DA and Logit on bootstrapped samples.
    Keywords: Company rating, bankruptcy analysis, support vector machines
    JEL: C13 G33 C45
    Date: 2008
  4. By: Chauvet, Marcelle; Potter, Simon
    Abstract: This paper examines the predictive content of coincident variables for monitoring U.S. recessions in the presence of instabilities. We propose several specifications of a probit model for classifying phases of the business cycle. We find strong evidence in favor of the ones that allow for the possibility that the economy has experienced recurrent breaks. The recession probabilities of these models provide a clearer classification of the business cycle into expansion and recession periods, and superior performance in the ability to correctly call recessions and to avoid false recession signals. Overall, the sensitivity, specificity, and accuracy of these models are far superior as well as their ability to timely signal recessions. The results indicate the importance of considering recurrent breaks for monitoring business cycles.
    Keywords: Recession; Instability; Bayesian Methods; Probit model; Breaks.
    JEL: E32 C35 C11
    Date: 2007–12–31
  5. By: Minton, Bernadette (Ohio State U); Stulz, Rene; Williamson, Rohan (Georgetown U)
    Abstract: This paper examines the use of credit derivatives by US bank holding companies with assets in excess of one billion dollars from 1999 to 2005. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2005 the gross notional amount of credit derivatives held by banks exceeds the amount of loans on their books. Only 23 large banks out of 395 use credit derivatives and most of their derivatives positions are held for dealer activities rather than for hedging of loans. The net notional amount of credit derivatives used for hedging of loans in 2005 represents less than 2% of the total notional amount of credit derivatives held by banks and less than 2% of their loans. Banks hedge less risky loans more than riskier ones. The banks are more likely to be net protection buyers if they have lower capital ratios, a lower net interest rate margin, engage in asset securitization, originate foreign loans, have more commercial and industrial loans in their portfolio, and have fewer agricultural loans. We conclude that the use of credit derivatives by banks to hedge loans is limited because of adverse selection and moral hazard problems and because of the inability of banks to use hedge accounting when hedging with credit derivatives. Our evidence raises important questions about the validity of the often-held view that the use of credit derivatives makes banks sounder.
    Date: 2008–01
  6. By: Karolyi, G. Andrew (Ohio State U); Lee, Kuan Hui (Rutgers U); van Dijk, Mathijs A. (RSM Erasmus U)
    Abstract: We uncover similar cross-country and time-series patterns in co-movement or “commonality” in stock returns, liquidity, and trading activity across 40 developed and emerging countries. The extent to which the liquidity and turnover of individual stocks within a country move together is related to the same institutional characteristics as is comovement in stock returns. Commonality is greater in countries with weaker investor protection and a more opaque information environment. Monthly variation in commonality in returns, liquidity, and turnover is also driven by common determinants. Commonality increases during times of high market volatility, large market declines, and high interest rates, and is negatively related to capital market openness. Our results are consistent with theoretical models in which changes in the wealth and collateral value of traders and financial intermediaries endogenously affect liquidity, trading, and pricing.
    JEL: G12
    Date: 2007–09
  7. By: Bartram, Söhnke M.; Burns, Natasha; Helwege, Jean
    Abstract: Previous research on the impact of currency risk on stock returns has failed to find a significant role for foreign exchange rates. This paper addresses several explanations of this finding with a unique dataset of U.S. firms that acquire targets in other countries. The dataset allows estimation of the impact of exchange rates using firm-specific bilateral exchange rates and a time period over which underlying exposure is known to significantly change. We also relate the change in exposure from before to after the acquisition to various characteristics of the acquirer, such as its presence in the target country prior to the deal and its hedging activities, and characteristics of the target, such as the exposure of the target prior to the deal. The results suggest that identifying a relevant exchange rate can be an important consideration in studying the impact of exchange rate risk on stock returns, but identifying financial hedging information is not. Further, foreign targets often provide operational hedging benefits to the U.S. acquirers, as exposure estimates are significantly affected by the acquisition.
    Keywords: Exchange rates; exposure; hedging; derivatives; mergers; acquisitions
    JEL: F4 F3 G3
    Date: 2007–04–01

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