New Economics Papers
on Risk Management
Issue of 2008‒12‒01
eight papers chosen by

  1. Models for Moody’s bank ratings By Peresetsky , Anatoly; Karminsky, Alexander
  2. A value at risk analysis of credit default swaps. By Burkhard Raunig; Martin Scheicher
  3. An MCDA-based Approach for Creditworthiness Assessment By Marco Corazza; Stefania Funari; Federico Siviero
  4. Credit contagion in a network of firms with spatial interaction By Diana Barro; Antonella Basso
  5. Regime switching models of hedge fund returns By Szabolcs Blazsek; Anna Downarowitz
  6. The Use of Blanket Guarantees in Banking Crises By Luc Laeven; Fabian Valencia
  7. Banks' Precautionary Capital and Credit Crunches By Fabian Valencia
  8. Securitizing peanut production risk with catastrophe (CAT) bonds By Epperson, James E.

  1. By: Peresetsky , Anatoly (BOFIT); Karminsky, Alexander (BOFIT)
    Abstract: The paper presents an econometric study of the two bank ratings assigned by Moody's Investors Service. According to Moody’s methodology, foreign-currency long-term deposit ratings are assigned on the basis of Bank Financial Strength Ratings (BFSR), taking into account “external bank support factors” (joint-default analysis, JDA). Models for the (unobserved) external support are presented, and we find that models based solely on public information can reasonably well approximate the ratings. It appears that the observed rating degradation can be explained by growth of the banking system as a whole. Moody’s has a special approach for banks in developing countries and Russia in particular. The models help reveal the factors that are important for external bank support.
    Keywords: banks; ratings; rating model; risk evaluation; early warning system
    JEL: G21 G32
    Date: 2008–11–21
  2. By: Burkhard Raunig (Oesterreichische Nationalbank, Otto-Wagner-Platz 3, A–1011 Vienna, Austria.); Martin Scheicher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We investigate the risk of holding credit default swaps (CDS) in the trading book and compare the Value at Risk (VaR) of a CDS position to the VaR for investing in the respective firm’s equity using a sample of CDS – stock price pairs for 86 actively traded firms over the period from March 2003 to October 2006. We find that the VaR for a stock is usually far larger than the VaR for a position in the same firm’s CDS. However, the ratio between CDS and equity VaR is markedly smaller for firms with high credit risk. The ratio also declines for longer holding periods. We also observe a positive correlation between CDS and equity VaR. Panel regressions suggest that our findings are consistent with qualitative predictions of the Merton (1974) model. JEL Classification: E43, G12, G13.
    Keywords: Credit Default Swap, Value at Risk, Structural Credit Risk Models.
    Date: 2008–11
  3. By: Marco Corazza (Department of Applied Mathematics, University of Venice); Stefania Funari (Department of Applied Mathematics, University of Venice); Federico Siviero (Cohen & Company, Subsidiary of London)
    Abstract: In this paper we propose a deterministic methodology for creditworthiness evaluation based on the Multi-Criteria Decision Analysis (MCDA) method known as MUlticriteria RAnking MEthod (MURAME). This approach allows to rank the firms according to their credit risk characteristics and to sort them into a prefixed number of homogeneous creditworthiness groups. Moreover, the methodology allows to estimate ex-post proxies of the probabilities of default and of the probabilities of transition. Then, we apply the proposed approach to check its capability to evaluate the creditworthiness in real cases; in particular, we consider the case of an important north eastern Italian bank.
    Keywords: Multi-Criteria Decision Analysis (or MCDA), MUlti-criteria RAnking MEthod (or MURAME), credit risk assessment
    JEL: C02 G20 G32
    Date: 2008–11
  4. By: Diana Barro (Department of Applied Mathematics and SSAV, University of Venice); Antonella Basso (Department of Applied Mathematics and SSAV, University of Venice)
    Abstract: In this contribution we carried out a wide simulation analysis in order to study the contagion mechanism induced in a portfolio of bank loans by the presence of business relationships among the positions. To this aim we jointly apply a structural model based on a factor approach extended in order to include the presence of microeconomic relationships that takes into account the counterparty risk, and a network model to describe the business connections among interdependent firms. The network of firms is generated resorting to an entropy spatial interaction model.
    Keywords: credit risk, bank loan portfolios, contagion models, entropy spatial models
    JEL: D61 C63
    Date: 2008–11
  5. By: Szabolcs Blazsek (Department of Business, Universidad de Navarra); Anna Downarowitz (Instituto de Empresa)
    Abstract: We estimate and compare the forecasting performance of several dynamic models of returns of different hedge fund strategies. The conditional mean of return is an ARMA process while its conditional volatility is modeled according to the GARCH specification. In order to take into account the high level of risk of these strategies, we also consider a Markov switching structure of the parameters in both equations to cap ture jumps. Finally, the one-step-ahead out-of-sample forecast performance of different models is compared.
    Keywords: Markov switching ARMA-GARCH, forecasting performance
    JEL: C13 C15 G32
    Date: 2008–11–26
  6. By: Luc Laeven; Fabian Valencia
    Abstract: In episodes of significant banking distress or perceived systemic risk to the financial system, policymakers have often opted for issuing blanket guarantees on bank liabilities to stop or avoid widespread bank runs. In theory, blanket guarantees can prevent bank runs if they are credible. However, guarantee could add substantial fiscal costs to bank restructuring programs and may increase moral hazard going forward. Using a sample of 42 episodes of banking crises, this paper finds that blanket guarantees are successful in reducing liquidity pressures on banks arising from deposit withdrawals. However, banks' foreign liabilities appear virtually irresponsive to blanket guarantees. Furthermore, guarantees tend to be fiscally costly, though this positive association arises in large part because guarantees tend to be employed in conjunction with extensive liquidity support and when crises are severe.
    Keywords: Banking crisis , Loan guarantees , Risk management , Liquidity , Bank credit , Financial systems , Moral hazard ,
    Date: 2008–10–28
  7. By: Fabian Valencia
    Abstract: Periods of banking distress are often followed by sizable and long-lasting contractions in bank credit. They may be explained by a declined demand by financially impaired borrowers (the conventional financial accelerator) or by lower supply by capital-constrained banks, a "credit crunch". This paper develops a bank model to study credit crunches and their real effects. In this model, banks maintain a precautionary level of capital that serves as a smoothing mechanism to avert disruptions in the supply of credit when hit by small shocks. However, for larger shocks, highly persistent credit crunches may arise even when the impulse is a one time, non-serially correlated event. From a policy perspective, the model justifies the use of public funds to recapitalize banks following a significant deterioration in their capital position.
    Keywords: Banking crisis , Bank credit , External shocks , Liquidity management , Financial risk , Economic models ,
    Date: 2008–10–28
  8. By: Epperson, James E.
    Abstract: A catastrophe (CAT) bond is designed for peanut production as a means of transferring natural disaster risks from insurance purveyors to the global capital market. The CAT bond so designed is priced using state-level historical yields for peanut production in the southern part of the United States in the State of Georgia. The index triggering the CAT bond contract was based on percent deviation from state average yield. The principal finding of the study is that it appears feasible for crop insurance purveyors to issue insurance-linked securities. CAT bonds can reduce the variance of the loss ratio when issued optimally with regard to the number of bonds and contract specifications. CAT bonds could therefore be used in hedging catastrophic risk effectively in peanut production given that crop insurance purveyors normally seek to minimize the variance of the loss ratio. CAT bonds were found to be feasible as hedging instruments even in the range of normal losses commonly covered by crop insurance and reinsurance.
    Keywords: Insurance, Reinsurance, Pricing, Hedging, Agricultural Finance, Crop Production/Industries, Risk and Uncertainty,
    Date: 2008–10–31

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