New Economics Papers
on Risk Management
Issue of 2008‒12‒07
six papers chosen by

  1. The Age of Turbulence - Credit Derivatives Style By Bystöm, Hans
  2. Establishment and analysis of the credit risk profile in a Romanian retail bank By Popescu, Ramona Florina; Clipici, Emilia
  3. Specification analysis of structural credit risk models By Jing-zhi Huang; Hao Zhou
  4. Measuring idiosyncratic risks in leveraged buyout transactions By Gottschalg, Oliver; Groh, Alexander Peter; Baule, Rainer
  5. The Next (but not new) Frontier for Sovereign Default By Reinhart, Carmen
  6. More myths about the financial crisis of 2008 By Tatom, John

  1. By: Bystöm, Hans (Department of Economics, Lund University)
    Abstract: Abstract. This paper focuses on the many extreme credit default swap spread movements observed during the credit crisis 2007-08 and on how the tails of the spread change distribution significantly differ from those of the normal distribution. As a result, Value at Risk (VaR) estimates based on extreme value theory are found to be more accurate than those based on normal or historical distributions, particularly at more conservative VaR levels. However, not even extreme value theory methods are able to satisfactorily capture the extreme behavior of the credit derivatives market at the peak of the credit crisis. We find the extreme turbulence in the credit derivatives market in July 2007 to be comparable only to that of the US equity market in October 1987.
    Keywords: credit default swap index; extreme value theory; financial crisis
    JEL: C20 G33
    Date: 2008–11–25
  2. By: Popescu, Ramona Florina; Clipici, Emilia
    Abstract: In order to protect its stakeholders and clients interests, a bank assumes a cautious credit risk profile, correlated to the objectives established in its business strategy. This article presents the credit risk profile and the analysis of the factors involved in the estimation of the probability and the impact of the credit risk upon the loan portfolio in a Romanian retail bank. In the final part, the authors show how the analysis results affect the bank’s credit policy.
    Keywords: credit risk profile;loan portfolio;credit policy
    JEL: G32 G21
    Date: 2008–11–24
  3. By: Jing-zhi Huang; Hao Zhou
    Abstract: In this paper we conduct a specification analysis of structural credit risk models, using term structure of credit default swap (CDS) spreads and equity volatility from high-frequency return data. Our study provides consistent econometric estimation of the pricing model parameters and specification tests based on the joint behavior of time-series asset dynamics and cross-sectional pricing errors. Our empirical tests reject strongly the standard Merton (1974) model, the Black and Cox (1976) barrier model, and the Longstaff and Schwartz (1995) model with stochastic interest rates. The double exponential jump-diffusion barrier model (Huang and Huang, 2003) improves significantly over the three models. The best model is the stationary leverage model of Collin-Dufresne and Goldstein (2001), which we cannot reject in more than half of our sample firms. However, our empirical results document the inability of the existing structural models to capture the dynamic behavior of CDS spreads and equity volatility, especially for investment grade names. This points to a potential role of time-varying asset volatility, a feature that is missing in the standard structural models.
    Date: 2008
  4. By: Gottschalg, Oliver; Groh, Alexander Peter; Baule, Rainer
    Abstract: The authors use a contingent claims analysis model to calculate the idiosyncratic risks in Leveraged Buyout transactions.
    Keywords: Idiosyncratic Risk; LBO; Private Equity; Benchmarking; CCA
    JEL: G13 G24 G32
    Date: 2008–11–27
  5. By: Reinhart, Carmen
    Abstract: There is a view today that “this time it’s different” for emerging markets. Governments are reducing their dependence on external debt and relying more on domestic debt financing for the first time! Furthermore, emerging market governments are increasingly issuing long-term domestic debt. Indeed, often this change in government debt management patterns is taken as evidence of graduation from “serial default.” In this new world, debt crises in emerging markets will be a thing of the past, and the IMF is plainly out of business.
    Keywords: domestic debt; sovereign default
    JEL: E0
    Date: 2008–04
  6. By: Tatom, John
    Abstract: There are numerous myths that surround the financial crisis that began in August 2007. Some of these myths are about the role of bank credit in the crisis, while others concern the weakness of the U.S. banking system and supposed excess leverage—the ratio of assets to equity in banks-- in contributing to the crisis. This paper provides evidence that net new commercial and industrial loans at banks did not slow before the financial crisis began in August 2007, nor was there any slowing in the early months. A subsequent slowing did reach its lowest pace in June-August 2008, but even at its worst, it was not particularly severe. The paper also looks at the safety and soundness of banks as indicated by their equity-assets ratio. The concern is that bank assets are troubled and excessively leveraged, with very low equity-asset ratios so that banks could have to “deleverage” or reduce lending as their equity declines. The shrinkage of bank equity and assets due to deleveraging could deepen the recession. But banks have not suffered significant declines in their equity ratios and they have been holding near record equity ratios. Moreover bank assets are growing rapidly, with equity nearly keeping pace. Ironically the Treasury’s Troubled Asset Relief Program will add $270 beginning in the fourth quarter. The TARP’s injections of bank capital have dried up private sector injections that had appeared on the horizon from sovereign wealth funds and private equity. Equity ratios of banks could become strained in future as total loans and assets continue to expand. The financial crisis has not undermined the safety and soundness of the commercial banking system. It is not likely to do so because most of the expected losses from the foreclosure crisis have already been taken into provisions. Nonetheless, many banks heavily exposed to mortgage losses have failed and more will fail.
    Keywords: foreclosure crisis; deleverage; bank credit;
    JEL: G28 G21
    Date: 2008–11–25

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