New Economics Papers
on Risk Management
Issue of 2009‒03‒14
fourteen papers chosen by

  1. From credit crunch to credit boom: transitional challenges in Bulgarian banking, 1999-2006 By Erdinç, Didar
  2. Are Banks Different? Evidence from the CDS Market. By Burkhard Raunig; Martin Scheicher
  3. Extreme Value Theory and the Financial Crisis of 2008 By James P. Gander
  4. Momentum in stock market returns, risk premia on foreign currencies and international financial integration By Thomas Nitschka
  5. How to find plausible, severe, and useful stress scenarios By Thomas Breuer; Martin Jandacka; Klaus Rheinberger; Martin Summer
  6. Marking to Market for Financial Institutions: A Common Sense Resolution By Franklin Allen; Elena Carletti; Finn Poschmann
  7. Transformation kernel density estimation of actuarial loss functions By Catalina Bolance (Universitat de Barcelona); Montserrat Guillen (Universitat de Barcelona); Jens Perch Nielsen (City University London)
  8. Corporate Hedging and Shareholder Value By Bartram, Söhnke M.; Aretz, Kevin
  9. What is the “value” of value-at-risk in a simulated portfolio decision-making game? By Steinbacher, Matjaz
  10. Market Structure, Capital Regulation and Bank Risk Taking By Patrick Behr; Reinhard H. Schmidt; Ru Xie
  11. Forecasting the fragility of the banking and insurance sector By Kerstin Bernoth; Andreas Pick
  12. Are Stocks Really Less Volatile in the Long Run? By Pástor, Luboš; Stambaugh, Robert F
  13. Regulations and productivity growth in banking By Delis, Manthos D; Molyneux, Philip; Pasiouras, Fotios
  14. Structure and Temporal Change of Credit Network between Banks and Large Firms in Japan By Fujiwara, Yoshi; Aoyama, Hideaki; Ikeda, Yuichi; Iyetomi, Hiroshi; Souma, Wataru

  1. By: Erdinç, Didar
    Abstract: New econometric evidence is provided to identify the determinants of the rapid credit growth in Bulgaria and evaluate whether the credit boom has increased bank fragility, based on a panel data analysis of 30 Bulgarian banks over the 1999-2006 period. Employing Fixed effects and GMM estimation techniques to explore the link between credit and capital base in a partial adjustment framework, the study provides evidence for the growing risks of credit expansion and assesses the potential for banking distress in Bulgaria. The paper argues that after a period of severe credit crunch during 1997-1999, foreign-owned Bulgarian banks have financed a credit boom, especially since 2003 but this indicated growing risk in lending and increasing vulnerability to a systemic banking crisis as banks reduced their capital base and registered an increase in non-performing loans. Aggressive lending by less-capitalized banks without appropriate loan loss provisioning has also been verified empirically in a number of panel specifications. While well-capitalized banks have tended to expand credit in proportion to their capital base, banks with weak capital base engaged in excessive risk taking, and expanded credit despite growing ratio of non-performing loans. Hence, the credit boom has come at the expense of increased banking fragility in Bulgaria, raising the probability of bank failure in the event of a downturn in global financial flows which became a disturbing reality in 2008.
    Keywords: Bulgarian banking; GMM estimation; credit boom; credit crunch
    JEL: G15 G32 G21
    Date: 2009–04
  2. By: Burkhard Raunig (Oesterreichische Nationalbank, Economic Studies Division, P.O. Box 61, A-1010 Vienna,); Martin Scheicher (European Central Bank, Kaiserstrasse 29, D – 60311, Frankfurt am Main, Germany,)
    Abstract: This paper uses regression analysis to compare the market pricing of the default risk of banks to that of other firms. We study how CDS traders discriminate between banks and other type of firms and how their judgement changes over time, in particular, since the start of the recent financial turmoil. We use monthly data on the Credit Default Swaps (CDS) of 41 major banks and 162 non-banks. By means of panel analysis, we decompose the CDS premia into the expected loss and the risk premium. Our primary result is that market participants indeed viewed banks differently and that they drastically changed their mind during the recent turmoil that started in August 2007.
    Keywords: Credit default swap, market discipline, default risk, risk premium
    JEL: E43 G12 G13
    Date: 2009–02–16
  3. By: James P. Gander
    Abstract: The paper offers an alternative approach to analyzing stock market time series data. The purpose is to develop descriptive, more intuitive, and closer to reality analogs of the behavior of US stock market prices, as indexed by the S&P500 stock price index covering the period October 2003 to October 2008. One analog developed is the “escalator principle” and the blind man. The approach is to treat prices as a random and independent variable and use extreme value theory to judge probabilistically whether prices and their attributes are from an initial universe or whether there has been a regime change. The attributes include the level, first difference, second difference and third difference of the ordered price series. Various graphing tools are used, such as, probability paper and different specifications of exponential functions representing cumulative probability distributions. The argument is that traditional time-series analysis implies a given universe, usually normal with either a constant or time-dependent variance (or measureable risk) and consequently does not handle well uncertainty (non-measureable risk) due to regime changes. The analogs show the investor how to determine when a regime change has likely occurred.
    Keywords: S&P500, Probability, Regime, Uncertainty
    JEL: C19 C22 C49 G10
    Date: 2009–03
  4. By: Thomas Nitschka
    Abstract: Momentum in developed countries' stock market index returns can be exploited to form portfolios of excess returns on foreign currencies as relatively high past foreign stock market returns signal a foreign currency appreciation. Two risk factors extracted from the stock index momentum based currency portfolio returns explain more than 80 percent of their cross-sectional variation. In contrast to currency risk factors constructed from forward discount sorted currency portfolios, these risk factors are not related to business cycle or liquidity risk. But high currency risk premia are associated with relatively deep financial integration and a high level of risk sharing.
    Keywords: Currency returns, financial integration, momentum, risk premia, UIP
    JEL: F31 F37 G15
    Date: 2009–03
  5. By: Thomas Breuer (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.); Martin Jandacka (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.); Klaus Rheinberger (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.); Martin Summer (Oesterreichische Nationalbank, Economic Studies Division, P.O. Box 61, A-1010 Vienna, Austria.)
    Abstract: We give a precise operational definition to three requirements the Basel Committee on Banking Supervision specifies for stress tests: Plausibility and severity of stress scenarios as well as suggestiveness of risk reducing actions. The basic idea of our approach is to define a suitable region of plausibility in terms of the risk factor distribution and search systematically for the worst portfolio loss over this region. One key innovation compared to the existing literature is the solution of two open problems. We suggest a measure of plausibility that is not prone to the problem of dimensional dependence of maximum loss and we derive a way to consistently deal with situations where some but not all risk factors are stressed. Among the various approaches used for partial scenarios, plausibility is maximised by setting the non stressed risk factors to their conditional expected value given the value of the stressed risk factors.
    Keywords: Stress testing, maximum loss, risk management, banking regulation.
    JEL: G28 G32 G20 C15
    Date: 2009–02–05
  6. By: Franklin Allen (University of Pennsylvania); Elena Carletti (European University Institute); Finn Poschmann (C.D. Howe Institute)
    Abstract: Debate has intensified in recent years on the advantages and disadvantages of moving towards a full mark-to-market accounting system for banks and insurance companies. The debate has been heated by moves by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board to harmonize accounting standards across countries. Proponents contend that mark-to-market accounting has the advantage of reflecting the relevant value of financial institution balance sheets, allowing regulators, investors and other users of accounting information to better assess their risk profile. Opponents counter that mark-to-market accounting leads to excessive and artificial volatility, especially when regulatory standards such as bank capital ratios are tied to reported accounting numbers.
    Keywords: mark-to-market accounting, accounting standards, financial markets
    JEL: E44 O16
    Date: 2009–02
  7. By: Catalina Bolance (Universitat de Barcelona); Montserrat Guillen (Universitat de Barcelona); Jens Perch Nielsen (City University London) (Universitat de Barcelona)
    Abstract: A transformation kernel density estimator that is suitable for heavy-tailed distributions is discussed. Using a truncated Beta transformation, the choice of the bandwidth parameter becomes straightforward. An application to insurance data and the calculation of the value-at-risk are presented.
    Keywords: non-parametric methods, heavy-tailed distributions, value at risk
    JEL: G22 C14
    Date: 2009
  8. By: Bartram, Söhnke M.; Aretz, Kevin
    Abstract: According to financial theory, corporate hedging can increase shareholder value in the presence of capital market imperfections such as direct and indirect costs of financial distress, costly external financing, and taxes. This paper presents a comprehensive review of the extensive existing empirical literature that has tested these theories, documenting overall mixed empirical support for rationales of hedging with derivatives at the firm level. While various empirical challenges and limitations advise some caution with regard to the interpretation of the existing evidence, the results are, however, consistent with derivatives use being just one part of a broader financial strategy that considers the type and level of financial risks, the availability of risk-management tools, and the operating environment of the firm. In particular, recent evidence suggests that derivatives use is related to debt levels and maturity, dividend policy, holdings of liquid assets, and the degree of operating hedging. Moreover, corporations do not just use financial derivatives, but rely heavily on pass-through, operational hedging, and foreign currency debt to manage financial risk.
    Keywords: Corporate finance; risk management; exposure; foreign exchange rates; derivatives
    JEL: F4 F3 G3
    Date: 2009–02–01
  9. By: Steinbacher, Matjaz
    Abstract: In the paper, I simulate the social network games of a portfolio selection where agents consider VaR when managing their portfolios. Such agents behave quite differently from the agents considering only the expected returns of the alternatives that are available to them in time. The level of omniscience of agents and the presence of liquidity agents are demonstrated to be significant factors for the portfolio management.
    Keywords: social networks; portfolio decision-making; stochastic finance; Value-at-Risk
    JEL: G11 G32 Z13 C73
    Date: 2009
  10. By: Patrick Behr; Reinhard H. Schmidt; Ru Xie
    Abstract: This paper discusses the effect of capital regulation on the risk taking behaviour of commercial banks. We first theoretically show that capital regulation works differently in different market structures of banking sectors. In lowly concentrated markets, capital regulation is effective in mitigating risk taking behavior because banks' franchise values are low and banks have incentives to pursue risky strategies in order to increase their franchise values. If franchise values are high, on the other hand, the effect of capital regulation on bank risk taking is ambiguous as banks lack those incentives. We then test the model predictions on a cross-country sample including 421 commercial banks from 61 countries. We find that capital regulation is effective in mitigating risk taking only in markets with a low degree of concentration. The results remain robust after accounting for financial sector development, legal system efficiency, and for other country and bank-specific characteristics.
    Keywords: Banks, market structure, risk shifting, franchise value, capital regulation
    JEL: G21 G28
    Date: 2008–06
  11. By: Kerstin Bernoth; Andreas Pick
    Abstract: This paper considers the issue of forecasting financial fragility of banks and insurances using a panel data set of performance indicators, namely distance-to-default, taking unobserved common factors into account. We show that common factors are important in the performance of banks and insurances, analyze the influences of a number of observable factors on banking and insurance performance, and evaluate the forecasts from our model. We find that taking unobserved common factors into account reduces the root mean square forecasts error of  firm specific forecasts by up to 11% and of system forecasts by up to 29% relative to a model based only on observed variables. Estimates of the factor loadings suggest that the correlation of financial institutions has been relatively stable over the forecast period.
    Keywords: Financial stability; financial linkages; banking; insurances; unobserved common factors; forecasting
    JEL: C53 G21 G22
    Date: 2009–02
  12. By: Pástor, Luboš; Stambaugh, Robert F
    Abstract: Conventional wisdom views stocks as less volatile over long horizons than over short horizons due to mean reversion induced by return predictability. In contrast, we find stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. We decompose return variance into five components, which include mean reversion and various uncertainties faced by the investor. Although mean reversion makes a strong negative contribution to long-horizon variance, it is more than offset by the other components. Using a predictive system, we estimate annualized 30-year variance to be nearly 1.5 times the 1-year variance.
    Keywords: long-run; risk; stock; variance
    JEL: G11 G23
    Date: 2009–03
  13. By: Delis, Manthos D; Molyneux, Philip; Pasiouras, Fotios
    Abstract: This paper examines the relationship between the regulatory and supervision framework and the productivity of banks in 22 countries over the period 1999-2006. We follow a semi-parametric two-step approach that combines Malmquist index estimates with bootstrap regressions. The results indicate that regulations and incentives that promote private monitoring have a positive impact on productivity. Restrictions on banks’ activities relating to their involvement in securities, insurance, real estate and ownership of non-financial firms also have a positive impact. However, regulations relating to the first and second pillars of Basel II, namely capital requirements and official supervisory power do not appear to have a statistically significant impact on productivity.
    Keywords: Banks; Basel II; Productivity; Regulations
    JEL: C14 G21
    Date: 2009–02–07
  14. By: Fujiwara, Yoshi; Aoyama, Hideaki; Ikeda, Yuichi; Iyetomi, Hiroshi; Souma, Wataru
    Abstract: Credit relationships between commercial banks and quoted firms are studied for the structure and its temporal change from the year 1980 to 2005. At each year, the credit network is regarded as a weighted bipartite graph where edges correspond to the relationships and weights refer to the amounts of loans. Reduction in the supply of credit affects firms as debtor, and failure of a firm influences banks as creditor. To quantify the dependency and influence between banks and firms, we propose to define a set of scores of banks and firms, which can be calculated by solving an eigenvalue problem determined the weight of the credit network. We found that a few largest eigenvalues and corresponding eigenvectors are significant by using a null hypothesis of random bipartite graphs, and that the scores can quantitatively describe the stability or fragility of the credit network during the 25 years.
    Keywords: Banks-firms credit, credit topology, Bipartite network
    JEL: E51 E52 G21
    Date: 2009

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