nep-rmg New Economics Papers
on Risk Management
Issue of 2009‒03‒22
seven papers chosen by
Stan Miles
Thompson Rivers University

  1. The Ten Commandments for Optimizing Value-at-Risk and Daily Capital Charges By Michael McAleer
  2. A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk By Juan Angel Jiménez Martín; Michael McAleer; Teodosio Pérez-Amaral
  3. Corporate Hedging and Shareholder Value By Aretz, Kevin; Bartram, Söhnke M.
  4. Bank Capital Requirements and Capital Structure By John P. Harding; Xiaozhong Liang; Stephen L. Ross
  5. Maturity, indebtedness, and default risk By Satyajit Chatterjee; Burcu Eyigungor
  6. Un método de Cálculo y Temporización de Previsiones Cíclicas para el Sistema Financiero Boliviano By Gonzales-Martínez, Rolando; Hurtado, Enrique; Valdivia, Pedro
  7. Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns By Turan G. Bali; Nusret Cakici; Robert F. Whitelaw

  1. By: Michael McAleer (Department of Quantitative Economics,Complutense University of Madrid and Econometric Institute Erasmus University Rotterdam)
    Abstract: Credit risk is the most important type of risk in terms of monetary value. Another key risk measure is market risk, which is concerned with stocks and bonds, and related financial derivatives, as well as exchange rates and interest rates. This paper is concerned with market risk management and monitoring under the Basel II Accord, and presents Ten Commandments for optimizing Value-at-Risk (VaR) and daily capital charges, based on choosing wisely from: (1) conditional, stochastic and realized volatility; (2) symmetry, asymmetry and leverage; (3) dynamic correlations and dynamic covariances; (4) single index and portfolio models; (5) parametric, semiparametric and nonparametric models; (6) estimation, simulation and calibration of parameters; (7) assumptions, regularity conditions and statistical properties; (8) accuracy in calculating moments and forecasts; (9) optimizing threshold violations and economic benefits; and (10) optimizing private and public benefits of risk management. For practical purposes, it is found that the Basel II Accord would seem to encourage excessive risk taking at the expense of providing accurate measures and forecasts of risk and VaR.
    Date: 2009
  2. By: Juan Angel Jiménez Martín (Universidad Complutense de Madrid. Facultad de CC. Económicas y Empresariales. Dpto. de Fundamentos de Análisis Económico II.); Michael McAleer (Department of Quantitative Economics Complutense University of Madrid and Econometric Institute Erasmus University Rotterdam); Teodosio Pérez-Amaral (Department of Quantitative Economics Complutense University of Madrid)
    Abstract: Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) have to communicate their daily risk estimates to the monetary authorities at the beginning of the trading day, using a variety of Value-at-Risk (VaR) models to measure risk. Sometimes the risk estimates communicated using these models are too high, thereby leading to large capital requirements and high capital costs. At other times, the risk estimates are too low, leading to excessive violations, so that realised losses are above the estimated risk. In this paper we propose a learning strategy that complements existing methods for calculating VaR and lowers daily capital requirements, while restricting the number of endogenous violations within the Basel II Accord penalty limits. We suggest a decision rule that responds to violations in a discrete and instantaneous manner, while adapting more slowly in periods of no violations. We apply the proposed strategy to Standard & Poor’s 500 Index and show there can be substantial savings in daily capital charges, while restricting the number of violations to within the Basel II penalty limits.
    Date: 2009
  3. By: Aretz, Kevin; Bartram, Söhnke M.
    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
  4. By: John P. Harding (University of Connecticut); Xiaozhong Liang (State Street Corporation); Stephen L. Ross (University of Connecticut)
    Abstract: This paper studies the impact of capital requirements, deposit insurance and tax benefits on a bank's capital structure. We find that properly regulated banks voluntarily choose to maintain capital in excess of the minimum required. Central to this decision is both tax advantaged debt (a source of firm franchise value) and the ability of regulators to place banks in receivership stripping equity holders of firm value. These features of our model help explain both the capital structure of the large mortgage Government Sponsored Enterprises and the recent increase in risk taking through leverage by financial institutions.
    Keywords: Banks, Capital Structure, Capital Regulation, Financial Intermediation, Leverage, GSE, Investment Banks
    JEL: G21 G28 G32 G38
    Date: 2009–02
  5. By: Satyajit Chatterjee; 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-to-output 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: Default (Finance) ; Debts, Public ; Bonds
    Date: 2009
  6. By: Gonzales-Martínez, Rolando; Hurtado, Enrique; Valdivia, Pedro
    Abstract: The constitution of cyclical provisions is related to the effects of latent credit risk in the financial institutions, a risk that materializes during an economic downturn. This study proposes a method both to calculate the amount of cyclical provisions and to estimate the timing of this type of provisions. The calculation is based on the optimization of a partitioned matrix that contains the optimal combinations of percentages of cyclical provisions for each category of risk and for every type of credit. The timing depends upon an indicator that reflects the quality of the credit portfolio in the financial institutions across time.
    Keywords: regulación financiera; previsiones cíclicas; ciclos económicos; riesgo de crédito
    JEL: C10 E32 G18 G21
    Date: 2008–09
  7. By: Turan G. Bali; Nusret Cakici; Robert F. Whitelaw
    Abstract: Motivated by existing evidence of a preference among investors for assets with lottery-like payoffs and that many investors are poorly diversified, we investigate the significance of extreme positive returns in the cross-sectional pricing of stocks. Portfolio-level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between the maximum daily return over the past one month (MAX) and expected stock returns. Average raw and risk-adjusted return differences between stocks in the lowest and highest MAX deciles exceed 1% per month. These results are robust to controls for size, book-to-market, momentum, short-term reversals, liquidity, and skewness. Of particular interest, including MAX reverses the puzzling negative relation between returns and idiosyncratic volatility recently documented in Ang et al. (2006, 2008).
    JEL: G12
    Date: 2009–03

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