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on Risk Management |
| By: | Jokivuolle, Esa (Bank of Finland Research); Virolainen, Kimmo (Financial Markets and Statistics Department); Vähämaa, Oskari (Bank of Finland Research) |
| Abstract: | Basel II framework requires banks to conduct stress tests on their potential future minimum capital requirements and consider ‘at least the effect of mild recession scenarios’. We propose a stress testing framework for minimum capital requirements in which banks’ corporate credit risks are modeled with macroeconomic variables. We can thus define scenarios such as a mild recession and consider the resulting credit risk developments and consequent changes in minimum capital requirements. We also emphasize the importance of stress testing future minimum capital requirements jointly with credit losses. Our illustrative results based on Finnish data underline the importance of such joint modeling. We also find that stress tests based on scenarios envisaged by regulators are not likely to imply binding capital constraints on banks. |
| Keywords: | Basel II; capital requirements; credit risk; loan losses; stress tests |
| JEL: | C15 G21 G28 G33 |
| Date: | 2008–09–02 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2008_017&r=rmg |
| By: | Vít Bubák (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; MSE, Université de Paris I. Panthéon-Sorbonne) |
| Abstract: | Using daily return data from the four major Central and Eastern European stock markets including fourteen highly liquid stocks and ATX (Vienna), PX (Prague), BUX (Budapest), and WIG20 (Warsaw) market indices, we model the value-at-risk using a set of univariate GARCH-type models. Our results show that, in both in-sample and out-of-sample value-at-risk estimations, the models based on asymmetric distribution of the error term tend to perform better or at least as well as the models based on symmetric distribution (i.e., Normal or Student) when the left tails of daily return distributions are concerned. Evaluation of the same models is less clear, however, when the right tails of the distribution of daily returns must be modelled. We suggest an asset-specific approach to selecting the correct parametric VaR model that depends not only on the risk level considered but also on the position in the underlying asset. |
| Keywords: | Value-at-Risk, Expected Shortfall, Backtesting |
| JEL: | C14 C32 C52 C53 G12 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2008_18&r=rmg |
| By: | Pena, Alejandro; Rodríguez, Analía |
| Abstract: | This paper analyses the through-the-cycle rating concept; basically, we try to specify its main characteristics, focusing on the differences with point-in-time ratings. We also discuss the effects of this methodology on the prediction power of default probabilities, on the stability of those ratings, and their impact on the capital requirements that emerge from Basel II, in terms of their potential procyclicality. On the other hand, we argue how predictable rating changes are, and the ability of the agencies to look through the cycle when assigning qualifications. Based on that, we conclude about the way that economical fundamentals must be incorporated in rating calculations. We estimate a panel data model with random effects ordered probit, using data for the period 1997-2007. |
| Keywords: | Credit Rating Methodology; Panel Data Ordered Probit; |
| JEL: | F30 C25 G20 |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10458&r=rmg |
| By: | Radovan Chalupka (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Petr Teplý (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic) |
| Abstract: | In this paper we review the actual operational data of an anonymous Central European Bank, using two approaches described in the literature: the loss distribution approach and the extreme value theory (“EVT”). Within the EVT analysis, two estimation methods were applied; the standard maximum likelihood estimation method and the probability weighted method (“PWM”). Our results proved a heavy-tailed pattern of operational risk data consistent with the results documented by other researchers in this field. Additionally, our research demonstrates that the PWM is quite consistent even when the data is limited since our results provide reasonable and consistent capital estimates. From a policy perspective, it should be noted that banks from emerging markets such as Central Europe are exposed to these operational risk events and that successful estimates of the likely distribution of these risk events can be derived from more mature markets. |
| Keywords: | operational risk, economic capital, Basel II, extreme value theory, probability weighted method |
| JEL: | G18 G21 G32 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2008_17&r=rmg |
| By: | Yannick LE PEN; Benoît SEVI |
| Abstract: | Using daily data from March 2001 to June 2005, we estimate a VAR-BEKK model and find evidence of return and volatility spillovers between the German, the Dutch and the British forward electricity markets. We apply Hafner and Herwartz [2006, Journal of International Money and Finance 25, 719-740] Volatility Impulse Response Function(VIRF) to quantify the impact of shock on expected conditional volatility. We observe that a shock has a high positive impact only if its size is large compared to the current level of volatility. The impact of shocks are usually not persistent, which may be an indication of market efficiency. Finally, we estimate the density of the VIRF at different forecast horizon. These fitted distributions are asymmetric and show that extreme events are possible even if their probability is low. These results have interesting implications for market participants whose risk management policy is based on option prices which themselves depend on the volatility level. |
| Keywords: | volatility impulse response function, GARCH, non Gaussian distributions, electricity market, forward markets |
| JEL: | C3 G1 Q43 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:mop:credwp:08.09.77&r=rmg |
| By: | Adams, Charles (National University of Singapore) |
| Abstract: | This paper looks at the development of the banking sector in emerging East Asia in the 10 years since the financial crisis of 1997/98. It suggests that the health of banking sectors in the region has improved substantially, with key changes including increased foreign ownership, movement into new business lines, greater transparency, and shifts toward household and real estate lending. In addition, supervisory and regulatory systems have been upgraded and have become more forward looking and risk based. However, it notes that major credit rating agencies continue to maintain relatively low ratings for many banks in the region, bank share prices have generally underperformed the market, and significant differences persist in the health of the region's banking systems. In addition, bank lending to private business has been weak across much of the region. Restructuring and reform are ongoing processes and will need to continue not only where further rehabilitation from the effects of the 1997/98 crisis is still required, but in other economies as well. |
| Keywords: | Financial crisis; restructuring and reform; credit rating; Basel core principles. |
| JEL: | G21 G24 G28 G32 |
| Date: | 2008–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:ris:adbrei:0016&r=rmg |
| By: | Nier, Erlend (Bank of England); Yang, Jing (Bank of England); Yorulmazer, Tanju (Bank of England); Alentorn, Amadeo (University of Essex) |
| Abstract: | Systemic risk is a key concern for central banks charged with safeguarding overall financial stability. In this paper we investigate how systemic risk is affected by the structure of the financial system. We construct banking systems that are composed of a number of banks that are connected by interbank linkages. We then vary the key parameters that define the structure of the financial system - including its level of capitalisation, the degree to which banks are connected, the size of interbank exposures and the degree of concentration of the system - and analyse the influence of these parameters on the likelihood of contagious (knock-on) defaults. First, we find that the better capitalised banks are, the more resilient is the banking system against contagious defaults and this effect is non-linear. Second, the effect of the degree of connectivity is non-monotonic, that is, initially a small increase in connectivity increases the contagion effect; but after a certain threshold value, connectivity improves the ability of a banking system to absorb shocks. Third, the size of interbank liabilities tends to increase the risk of knock-on default, even if banks hold capital against such exposures. Fourth, more concentrated banking systems are shown to be prone to larger systemic risk, all else equal. In an extension to the main analysis we study how liquidity effects interact with banking structure to produce a greater chance of systemic breakdown. We finally consider how the risk of contagion might depend on the degree of asymmetry (tiering) inherent in the structure of the banking system. A number of our results have important implications for public policy, which this paper also draws out. |
| Keywords: | Networks; financial stability; contagion; liquidity risk. |
| JEL: | C63 C90 G28 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0346&r=rmg |
| By: | Fulvio Corsi; Davide Pirino; Roberto Renò |
| Abstract: | This study reconsiders the role of jumps for volatility forecasting by showing that jumps have positive and mostly significant impact on future volatility. This result becomes apparent once volatility is correctly separated into its continuous and discontinuous component. To this purpose, we introduce the concept of threshold multipower variation (TMPV), which is based on the joint use of bipower variation and threshold estimation. With respect to alternative methods, our TMPV estimator provides less biased and robust estimates of the continuous quadratic variation and jumps. This technique also provides a new test for jump detection which has substantially more power than traditional tests. We use this separation to forecast volatility by employing an heterogeneous autoregressive (HAR) model which is suitable to parsimoniously model long memory in realized volatility time series. Empirical analysis shows that the proposed techniques improve significantly the accuracy of volatility forecasts for the S&P500 index, single stocks and US bond yields, especially in periods following the occurrence of a jump |
| Keywords: | volatility forecasting, jumps, bipower variation, threshold estimation, stock, bond |
| JEL: | G1 C1 C22 C53 |
| Date: | 2008–06 |
| URL: | http://d.repec.org/n?u=RePEc:usi:wpaper:534&r=rmg |
| By: | Petr Jakubík (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Czech National Bank; EEIP, a.s; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic) |
| Abstract: | This article presents a financial scoring model estimated on Czech corporate accounting data. Seven financial indicators capable of explaining business failure at a 1-year prediction horizon are identified. Using the model estimated in this way, an aggregate indicator of the creditworthiness of the Czech corporate sector (named as JT index) is then constructed and its evolution over time is shown. This indicator aids the estimation of the risks of this sector going forward and broadens the existing analytical set-up used by the Czech National Bank for its financial stability analyses. The results suggest that the creditworthiness of the Czech corporate sector steadily improved between 2004 and 2006, but slightly deteriorated in 2007 what could be explained through global market turbulences. |
| Keywords: | bankruptcy prediction, financial stability, logit analysis, corporate sector risk, JT index |
| JEL: | G32 G33 G21 G28 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2008_19&r=rmg |
| By: | Knüppel, Malte; Schultefrankenfeld, Guido |
| Abstract: | Macroeconomic risk assessments play an important role in the forecasts of many institutions. However, to the best of our knowledge their performance has not been investigated yet. In this work, we study the Bank of England’s risk forecasts for inflation. We find that these forecasts do not contain the intended information. Rather, they either have no information content, or even an adverse information content. Our results imply that under mean squared error loss, it is better to use the Bank of England’s mode forecasts than the Bank of England’s mean forecasts. |
| Keywords: | Forecast evaluation, risk forecasts, Bank of England inflation forecasts |
| JEL: | C12 C53 E37 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:7369&r=rmg |