New Economics Papers
on Risk Management
Issue of 2009‒02‒28
twelve papers chosen by

  1. A Theory of Systemic Risk and Design of Prudential Bank Regulation By Acharya, Viral V
  2. Firm Default and Aggregate Fluctuations By Jacobson, Tor; Kindell, Rikard; Lindé, Jesper; Roszbach, Kasper F.
  3. Credit Spread Changes within Switching Regimes By Olfa Maalaoui; Georges Dionne; Pascal François
  4. Multiple-Bank Lending, Creditor Rights and Information Sharing By Bennardo, Alberto; Pagano, Marco; Piccolo, Salvatore
  5. When risk weights increase the risk: some concerns for capital regulation By Varsanyi, Zoltan
  6. Cash Holdings and Credit Risk By Acharya, Viral V; Davydenko, Sergei A.; Strebulaev, Ilya
  7. Optimal capital allocation principles By Dhaene, Jan; Tsanakas, Andreas; Emiliano, Valdez; Steven, Vanduffel
  8. Sorting out Downside Beta By Post, G.T.; Vliet, P. van; Lansdorp, S.D.
  9. Euro corporate bonds risk factors By Castagnetti, Carolina; Rossi, Eduardo
  10. Stock-Market Crashes and Depressions By Robert J. Barro; Jose Ursua
  11. Contrasting Trends in Firm Volatility: Theory and Evidence By Thesmar, David; Thoenig, Mathias
  12. Global Financial Crisis: Causes and Lessons - A Neo-Schumpeterian perspective By Horst Hanusch; Florian Wackermann

  1. By: Acharya, Viral V
    Abstract: Systemic risk is modeled as the endogenously chosen correlation of returns on assets held by banks. The limited liability of banks and the presence of a negative externality of one bank’s failure on the health of other banks give rise to a systemic risk-shifting incentive where all banks undertake correlated investments, thereby increasing economy-wide aggregate risk. Regulatory mechanisms such as bank closure policy and capital adequacy requirements that are commonly based only on a bank’s own risk fail to mitigate aggregate risk-shifting incentives, and can, in fact, accentuate systemic risk. Prudential regulation is shown to operate at a collective level, regulating each bank as a function of both its joint (correlated) risk with other banks as well as its individual (bank-specific) risk.
    Keywords: Bank regulation; Capital adequacy; Crisis; Risk-shifting; Systemic risk
    JEL: D62 E58 G21 G28 G38
    Date: 2009–02
  2. By: Jacobson, Tor; Kindell, Rikard; Lindé, Jesper; Roszbach, Kasper F.
    Abstract: This paper studies the relation between macroeconomic fluctuations and corporate defaults while conditioning on industry affiliation and an extensive set of firm-specific factors. Using a multiperiod logit approach on a panel data set for all incorporated Swedish businesses over 1990-2002, we find strong evidence for a substantial and stable impact of aggregate fluctuations. Macroeffects differ across industries in an economically intuitive way. Out-of-sample evaluations show our approach is superior to both models that exclude macro information and best fitting naive forecasting models. While firm-specific factors are useful in ranking firms' relative riskiness, macroeconomic factors capture fluctuations in the absolute risk level.
    Keywords: Business cycles; Default; Default-risk model; Logit model; Macroeconomic variables; Micro-data
    JEL: C35 C41 C52 E44 G21 G33
    Date: 2008–12
  3. By: Olfa Maalaoui; Georges Dionne; Pascal François
    Abstract: Many empirical studies on credit spread determinants consider a single-regime model over the entire sample period and find limited explanatory power. We model the credit cycle independently from macroeconomic fundamentals using a Markov regime switching model. We show that accounting for endogenous credit cycles enhances the explanatory power of credit spread determinants. The single regime model cannot be improved when conditioning on the states of the NBER economic cycle. Furthermore, the regime-based model highlights a positive relation between credit spreads and the risk-free rate in the high regime. Inverted relations are also obtained for some other determinants.
    Keywords: Credit spread, switching regimes, market risk, liquidity risk, default risk, credit cycle, NBER economic cycle
    JEL: C32 C52 C61 G12 G13
    Date: 2009
  4. By: Bennardo, Alberto; Pagano, Marco; Piccolo, Salvatore
    Abstract: When a customer can borrow from several competing banks, multiple lending raises default risk. If creditor rights are poorly protected, this contractual externality can generate novel equilibria with strategic default and rationing, in addition to equilibria with excessive lending or non-competitive rates. Information sharing among banks about clients' past indebtedness lowers interest and default rates, improves access to credit (unless the value of collateral is very uncertain) and may act as a substitute for creditor rights protection. If information sharing also allows banks to monitor their clients' subsequent indebtedness, the credit market may achieve full efficiency.
    Keywords: creditor rights; information sharing; multiple-bank lending; non-exclusivity; seniority
    JEL: D73 K21 K42 L51
    Date: 2009–02
  5. By: Varsanyi, Zoltan
    Abstract: In this chapter I argue that as a response to the introduction of capital requirements in the form of risk weights investors might potentially choose riskier portfolios than before the regulation – this is, presumably, not what the regulation intends to achieve. That is, while regulation most likely diverts investors from their optimum decision it does not guarantee that the new optimum has a lower risk. The effect of the regulation depends on several things, most importantly the correlation between individual investments, investor preferences and the relative size of risk weights.
    Keywords: portfolio selection; regulation; Basel II; risk
    JEL: G11 G18
    Date: 2009–02–23
  6. By: Acharya, Viral V; Davydenko, Sergei A.; Strebulaev, Ilya
    Abstract: Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal cash reserves are positively related to credit risk, resulting in a positive correlation between cash and spreads. In contrast, spreads are negatively related to the ``exogenous'' component of cash holdings that is independent of credit risk factors. Similarly, although firms with higher cash reserves are less likely to default over short horizons, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.
    Keywords: Credit spreads; Default; Liquidity; Precautionary savings
    JEL: G32 G33
    Date: 2009–01
  7. By: Dhaene, Jan; Tsanakas, Andreas; Emiliano, Valdez; Steven, Vanduffel
    Abstract: This paper develops a unifying framework for allocating the aggregate capital of a financial firm to its business units. The approach relies on an optimisation argument, requiring that the weighted sum of measures for the deviations of the business unit’s losses from their respective allocated capitals be minimised. This enables the association of alternative allocation rules to specific decision criteria and thus provides the risk manager with flexibility to meet specific target objectives. The underlying general framework reproduces many capital allocation methods that have appeared in the literature and allows for several possible extensions. An application to an insurance market with policyholder protection is additionally provided as an illustration.
    Keywords: Capital allocation; risk measure; comonotonicity; Euler allocation; default option; Lloyd’s of London.
    JEL: G00 G20
    Date: 2009–01–23
  8. By: Post, G.T.; Vliet, P. van; Lansdorp, S.D. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: Downside risk, when properly defined and estimated, helps to explain the cross-section of US stock returns. Sorting stocks by a proper estimate of downside market beta leads to a substantially larger cross-sectional spread in average returns than sorting on regular market beta. This result arises despite the fact that downside beta is based on fewer return observations and therefore is more difficult to estimate and predict. The explanatory power of downside risk remains after controlling for other stock characteristics, including firm-level size, value and momentum.
    Keywords: asset pricing;downside risk;semi-variance;lower partial moments
    Date: 2009–02–18
  9. By: Castagnetti, Carolina; Rossi, Eduardo
    Abstract: This paper investigates the determinants of credit spread changes in Euro-denominated bonds. Because credit spread changes can be easily viewed as an excess return on corporate bonds over treasury bonds, we adopt a factor model framework, inspired by the credit risk structural approach. We try to assess the relative importance of market and idiosyncratic factors in explaining the movements in credit spreads. We adopt a heterogeneous panel with a multifactor error model and propose a two-step estimation procedure which yields consistent estimates of unobserved factors. The analysis is carried out with a panel of monthly redemption yields on a set of corporate bonds for a time span of three years. Our results suggest that the Euro corporate market is driven by observable and unobservable factors. Where the latter are identified through a consistent estimation of individual and common observable effects. We observe that the factors predicted by the structural model are not as relevant as in the case of the US market. The empirical results also suggest that an unobserved common factor has a significant role in explaining the systematic changes in credit spreads. However, contrary to the American evidence, it cannot be identified as a market factor.
    Keywords: Euro Corporate Bonds; Cross Section Dependence; Common Correlated Effects; Yield Curve
    JEL: G10
    Date: 2008–10–16
  10. By: Robert J. Barro; Jose Ursua
    Abstract: Long-term data for 25 countries up to 2006 reveal 195 stock-market crashes (multi-year real returns of -25% or less) and 84 depressions (multi-year macroeconomic declines of 10% or more), with 58 of the cases matched by timing. The United States has two of the matched events - the Great Depression 1929-33 and the post-WWI years 1917-21, likely driven by the Great Influenza Epidemic. 45% of the matched cases are associated with war, and the two world wars are prominent. Conditional on a stock-market crash, the probability of a minor depression (macroeconomic decline of at least 10%) is 30% and of a major depression (at least 25%) is 11%. In a non-war environment, these probabilities are lower but still substantial - 20% for a minor depression and 3% for a major depression. Thus, the stock-market crashes of 2008-09 in the United States and other countries provide ample reason for concern about depression. In reverse, the probability of a stock-market crash is 69%, conditional on a depression of 10% or more, and 91% for 25% or more. Thus, the largest depressions are particularly likely to be accompanied by stock-market crashes, and this finding applies equally to non-war and war events. We allow for flexible timing between stock-market crashes and depressions for the 58 matched cases to compute the covariance between stock returns and an asset-pricing factor, which depends on the proportionate decline of consumption during a depression. If we assume a coefficient of relative risk aversion around 3.5, this covariance is large enough to account in a familiar looking asset-pricing formula for the observed average (levered) equity premium of 7% per year. This finding complements previous analyses that were based on the probability and size distribution of macroeconomic disasters but did not consider explicitly the covariance between macroeconomic declines and stock returns.
    JEL: E01 E21 E23 E44 G12
    Date: 2009–02
  11. By: Thesmar, David; Thoenig, Mathias
    Abstract: Over the past decades, the real and financial volatility of listed firms has increased, while the volatility of private firms has decreased. We first provide panel data evidence that, at the firm level, sales and employment volatility are impacted by changes in the degree of ownership concentration. We then construct a model with private and listed firms where risk taking is a choice variable at the firm-level. Due to general equilibrium feedback, we find that an increase in stock market participation or integration in international capital markets generate opposite trends in volatility for private and listed firms. This pattern cannot be replicated by alternative comparative statics exercises, such as an increase in product market competition, an increase in product market size, an increase in the fraction of listed firms, or a decrease in aggregate volatility.
    Keywords: Financial Integration; Firm-level Volatility; Listed vs non-listed Firms; Stockmarket Participation
    JEL: E44 F41 G32
    Date: 2009–01
  12. By: Horst Hanusch (University of Augsburg, Department of Economics); Florian Wackermann (University of Augsburg, Department of Economics)
    Abstract: This paper analyses the current financial crisis from a Neo-Schumpeterian perspective. We postulate four linkages that led to the crisis, and that will help us find our way out of the crisis. Therefore, we show that the current evolution is very similar to the Japanese crisis in the beginning of the 1990s. Furthermore, we address the issue why the world was faced with this crisis in such an unprepared way and look at the deficiencies in current economic theories that are responsible for the fact that we did not foresee this development. Besides, we elaborate that the crisis is not a systemic default of the capitalistic system but that it is rather a consequence of its enormous success. Finally, we propose the Neo-Schumpeterian Corridor as a theoretical framework that can help avoid such dramatic evolutions as the current crisis and look at possibilities to overcome this situation.
    Keywords: financial crisis, Neo-Schumpeterian Corridor, crisis evolution, governmental role
    JEL: B52 H11 N20 O20
    Date: 2009–02

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