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on Risk Management |
| By: | Lillie Lam (Research Department, Hong Kong Monetary Authority); Laurence Fung (Research Department, Hong Kong Monetary Authority); Ip-wing Yu (Research Department, Hong Kong Monetary Authority) |
| Abstract: | In portfolio and risk management, estimating and forecasting the volatilities and correlations of asset returns plays an important role. Recently, interest in the estimation of the covariance matrix of large dimensional portfolios has increased. Using a portfolio of 63 assets covering stocks, bonds and currencies, this paper aims to examine and compare the predictive power of different popular methods adopted by i) market practitioners (such as the sample covariance, the 250-day moving average, and the exponentially weighted moving average); ii) some sophisticated estimators recently developed in the academic literature (such as the orthogonal GARCH model and the Dynamic Conditional Correlation model); and iii) their combinations. Based on five different criteria, we show that a combined forecast of the 250-day moving average, the exponentially weighted moving average and the orthogonal GARCH model consistently outperforms the other methods in predicting the covariance matrix for both one-quarter and one-year ahead horizons. |
| Keywords: | Volatility forecasting; Risk management; Portfolio management; Model evaluation |
| JEL: | G32 C52 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:hkg:wpaper:0901&r=rmg |
| By: | Henry Dannenberg |
| Abstract: | For credit risk assessment, probability of default and correlation have to be estimated simultaneously. However, these estimates are uncertain. To assess this uncertainty the literature has discussed the use of asymptotic confidence regions. This kind of region though needs a long credit history for exact assessment. An alternative method to generate a confidence region for a short credit history is bootstrapping. Hence, it could be more appropriate to assess estimation uncertainty with bootstrapping than with asymptotic methods if only a short credit history is available. Based on a simulation study, it is analyzed how many periods should be available for assessing credit risk – taking account of estimation uncertainty – if bootstrapping and a Wald confidence region shall achieve similar results. This article shows that more than 100 cycles have to be available for similar results. |
| Keywords: | confidence region, credit portfolio risk, estimation uncertainty, bootstrapping |
| JEL: | C15 D81 G11 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:iwh:dispap:3-09&r=rmg |
| By: | Paulson, Nicholas; Babcock, Bruce A.; Hart, Chad E.; Hayes, Dermot J. |
| Date: | 2008–05–15 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genres:12938&r=rmg |
| By: | Palmroos, Peter (Bank of Finland Research) |
| Abstract: | This paper demonstrates how the observed correlation between probability of default and loss given default depends on the fact that defaults in which collateral provides 100% recovery are not observed. Creditors see only the defaults of mortgagors who suffer from a fall in collateral value to less than the remaining loan principal. Consequently, the default data available to creditors amounts to a mere truncated sample from the underlying population of defaults. Correlation estimates based on such truncated samples are biased and differ substantially from estimates derived from representative non-truncated samples. Moreover, the observed correlation between default probability and loss given default is sensitive to the truncation point, which may explain the differences in correlation estimates found in the literature. This may also explain why correlation estimates seem to be specific to cycle phase. |
| Keywords: | credit risks; mortgage loans; truncated distributions; sample selection; log-normal distribution |
| JEL: | C46 E32 G21 G28 |
| Date: | 2009–01–21 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2009_003&r=rmg |
| By: | Reinhart, Carmen |
| Abstract: | Global financial markets are showing strains on a scale and scope not witnessed in the past three-quarters of a century. What started with elevated losses on U.S.-subprime mortgages has spread beyond the borders of the United States and the confines of the mortgage market. Many risk spreads have ballooned, liquidity in some market segments has dried up, and large complex financial institutions have admitted significant losses. Bank runs are no longer the subject exclusively of history.These events have challenged policymakers, and the responses have varied across region. The European Central Bank has injected reserves in unprecedented volumes. The Bank of England participated in the bail-out and, ultimately, the nationalization of a depository, Northern Rock. The U.S. Federal Reserve has introduced a variety of new facilities and extended its support beyond the depository sector. These events have also challenged economists to explain why the crisis developed, how it is unfolding, and what can be done. This volume compiles contributions by leading economists in VoxEU over the past year that attempt to answer these questions. We have grouped these contributions into three sections corresponding to those three critical questions. |
| Keywords: | financial crisis subprime mortgages monetary policy |
| JEL: | E0 F3 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13288&r=rmg |
| By: | Toivanen, Mervi (Bank of Finland Research) |
| Abstract: | Using the maximum entropy method, this paper estimates the danger of contagion in the Finnish interbank market in 2005–2007 as well as the existence of contagion during a Finnish banking crisis. The contagion analysis of the early 1990s is able to predict the most troublesome and defaulting banks in the banking sector. The simulation results for 2005–2007 suggest that five of ten deposit banks are possible starting points for contagious effects. The magnitude of contagion is conditional on the first failing bank. In addition to large commercial banks, middle-sized banks also cause damaging domino effects. Over the last few years, the negative effects of contagion on the Finnish banking sector have been, on average, more limited than those of the early 1990s. The contagion is currently a low probability event in the Finnish interbank market. |
| Keywords: | contagion; interbank markets; Finland; maximum entropy |
| JEL: | G21 |
| Date: | 2009–01–28 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2009_006&r=rmg |
| By: | Satyajit Chatterjee (Federal Reserve Bank of Philadelphia); Burcu Eyigungor |
| Abstract: | We present a novel and tractable model of long-term sovereign debt. We make two sets of contributions. First, on the substantive side, using Argentina as a test case we show that unlike one-period debt models, our model of long-term sovereign debt is capable of accounting for the average spread, the average default frequency, and the average debt-tooutput ratio of Argentina over the 1991-2001 period without any deterioration in the model’s ability to account for Argentina’s cyclical facts. Using our calibrated model we determine what Argentina’s debt, default frequency and welfare would have been if Argentina had issued only short-term debt. Second, on the methodological side, we advance the theory of sovereign debt begun in Eaton and Gersovitz (1981) by establishing the existence of an equilibrium pricing function for long-term sovereign debt and by providing a fairly complete set of characterization results regarding equilibrium default and borrowing behavior. In addition, we identify and solve a computational problem associated with pricing long-term unsecured debt that stems from nonconvexities introduced by the possibility of default. |
| Keywords: | Unsecured Debt, Sovereign Debt, Long Duration Bonds, Debt Dilution, Random Maturity Bonds, Default Risk |
| JEL: | F34 F41 G12 G33 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:koc:wpaper:0901&r=rmg |