nep-rmg New Economics Papers
on Risk Management
Issue of 2009‒03‒28
eleven papers chosen by
Stan Miles
Thompson Rivers University

  1. The ten commandments for optimizing value-at-risk and daily capital charges By McAleer, M.
  2. A decision rule to minimize daily capital charges in forecasting value-at-risk By McAleer, M.; Jimenez-Marin, J-. A.; Perez-Amaral, T.
  3. Risk measures and their applications in asset management By Birbil, S.I.; Frenk, J.B.G.; Kaynar, B.; Noyan, N.
  4. Norwegian banks in a recession: Procyclical implications of Basel II By Henrik Andersen
  5. Returns to Defaulted Corporate Bonds By Thorsell, Håkan
  6. Distress in European Banks: An Analysis Based on a New Dataset By Martin Cihák; Tigran Poghosyan
  7. Financial (In)stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach By de Walque, Gregory; Pierrard, Olivier; Rouabah, Abdelaziz
  8. Effects of Macroeconomic Announcements on Stock Returns across Volatility Regimes By Henry Aray
  9. Procyclicality and Fair Value Accounting By Juan Sole; Alicia Novoa; Jodi Scarlata
  10. Gauging Risk with Higher Moments: Handrails in Measuring and Optimising Conditional Value at Risk By Raimond Maurer; Gyöngyi Bugár; Huy Thanh Vo
  11. Towards New Technical Indicators for Trading Systems and Risk Management By Michel Fliess; Cédric Join

  1. By: McAleer, M. (Erasmus Econometric Institute)
    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.
    Keywords: dail;y capital charges;excessive risk taking;market risk;risk management;value-at-risk;violations
    Date: 2008–11–25
  2. By: McAleer, M.; Jimenez-Marin, J-. A.; Perez-Amaral, T. (Erasmus Econometric Institute)
    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.
    Keywords: daily capital charges;endogenous violations;frequency of violations;optimizing strategy;risk forecasts;value-at-risk
    Date: 2008–12–01
  3. By: Birbil, S.I.; Frenk, J.B.G.; Kaynar, B.; Noyan, N. (Erasmus Econometric Institute)
    Abstract: Several approaches exist to model decision making under risk, where risk can be broadly defined as the effect of variability of random outcomes. One of the main approaches in the practice of decision making under risk uses mean-risk models; one such well-known is the classical Markowitz model, where variance is used as risk measure. Along this line, we consider a portfolio selection problem, where the asset returns have an elliptical distribution. We mainly focus on portfolio optimization models constructing portfolios with minimal risk, provided that a prescribed expected return level is attained. In particular, we model the risk by using Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR). After reviewing the main properties of VaR and CVaR, we present short proofs to some of the well-known results. Finally, we describe a computationally efficient solution algorithm and present numerical results.
    Keywords: elliptical distributions;mean-risk;value-at-risk;conditional value-at-risk;portfolio optimization
    Date: 2008–08–21
  4. By: Henrik Andersen (Norges Bank (Central Bank of Norway))
    Abstract: While the new capital adequacy framework, Basel II, aims to make the banks’ capital requirements more sensitive to the underlying risk of the assets, it may also introduce an additional source of procyclicality in the banking sector. A growing share of the literature has assessed the potential cyclicality of Basel II. However, only parts of the banks’ assets have been considered. In addition, the cyclicality of the capital positions is usually left out of the calculations. This paper applies the stress testing framework of Norges Bank to analyse the cyclicality of capital positions and the cyclicality of Basel II capital requirements for the entire bank portfolio of Norwegian banks. We find a substantial increase in the calculated Basel II capital requirements in a recession scenario for the Norwegian economy. We also find a negative co-movement between capital positions and Basel II capital requirements. Hence, our analysis demonstrates that Basel II may introduce an additional source of procyclicality.
    Keywords: Basel II, procyclicality, capital positions
    JEL: E32 G21 G28 G33
    Date: 2009–03–13
  5. By: Thorsell, Håkan (Dept. of Business Administration, Stockholm School of Economics)
    Abstract: I test for short term excess return in a sample of 279 defaulted US corporate bonds using multiple regression analysis. There are robust excess returns after controlling for market and liquidity risk. The expected recovery rate during 2001-2006 is estimated to be, on average, four percentage points lower the first month after default than the present value of the recovery rate after nine months.
    Keywords: Bond pricing; Recovery rate
    Date: 2009–03–23
  6. By: Martin Cihák; Tigran Poghosyan
    Abstract: The global financial crisis has highlighted the importance of early identification of weak banks: when problems are identified late, solutions are much more costly. Until recently, Europe has seen only a small number of outright bank failures, which made the estimation of early warning models for bank supervision very difficult. This paper presents a unique database of individual bank distress across the European Union from mid-1990s to 2008. Using this data set, we analyze the causes of banking distress in Europe. We identify a set of indicators and thresholds that can help to distinguish sound banks from those vulnerable to financial distress.
    Keywords: Banks , Europe , Bank soundness , Bank supervision , Financial stability , Databases , Forecasting models , Data analysis , Cross country analysis , Economic integration ,
    Date: 2009–01–21
  7. By: de Walque, Gregory; Pierrard, Olivier; Rouabah, Abdelaziz
    Abstract: We develop a dynamic stochastic general equilibrium model with an heterogeneous banking sector. We introduce endogenous default probabilities for both firms and banks, and allow for bank regulation and liquidity injection into the interbank market. Our aim is to understand the interactions between the banking sector and the rest of the economy, as well as the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real US data and used for simulations. We show that Basel regulation reduces the steady state but improves the resilience of the economy to shocks, and that moving from Basel I to Basel II is procyclical. We also show that liquidity injections relieve financial instability but have ambiguous effects on output fluctuations.
    Keywords: banking sector; central bank; default risk; DSGE; supervision
    JEL: E13 E20 G21 G28
    Date: 2009–03
  8. By: Henry Aray (Department of Economic Theory and Economic History, University of Granada.)
    Abstract: Based on a simple Markov regime switching model, this article presents evidence on the effects of macroeconomic announcements on individual stocks returns. The model specification allows two regimes to be distinguished: one with high volatility and the other with low volatility. Considering the level of significance at 5%, the response of stock returns to macroeconomic announcements is much stronger in the low volatility regime. However, the effects of the Fama-French factors on individual stock returns is unambiguously significant in both regimes.
    Keywords: Markov Switching Model, Macroeconomic announcements, Stock Returns.
    JEL: E44 G14
    Date: 2008–12–30
  9. By: Juan Sole; Alicia Novoa; Jodi Scarlata
    Abstract: In light of the uncertainties about valuation highlighted by the 2007-2008 market turbulence, this paper provides an empirical examination of the potential procyclicality that fair value accounting (FVA) could introduce in bank balance sheets. The paper finds that, while weaknesses in the FVA methodology may introduce unintended procyclicality, it is still the preferred framework for financial institutions. It concludes that capital buffers, forward-looking provisioning, and more refined disclosures can mitigate the procyclicality of FVA. Going forward, the valuation approaches for accounting, prudential measures, and risk management need to be reconciled and will require adjustments on the part of all parties.
    Date: 2009–03–16
  10. By: Raimond Maurer; Gyöngyi Bugár; Huy Thanh Vo
    Abstract: The aim of the paper is to study empirically the influence of higher moments of the return distribution on conditional value at risk (CVaR). To be more exact, we try to reveal the extent to which the risk given by CVaR can be estimated when relying on the mean, standard deviation, skewness and kurtosis. Furthermore, it is intended to study how this relationship can be utilised in portfolio optimisation. First, based on a database of 600 individual equities from 22 emerging world markets, factor models incorporating the first four moments of the return distribution have been constructed at different confidence levels for CVaR, and the contribution of the identified factors in explaining CVaR was determined. Following this the influence of higher moments was examined in portfolio context, i.e. asset allocation decisions were simulated by creating emerging market portfolios from the viewpoint of US investors. In our analysis we compare different approaches which take higher moments into account with the standard mean-variance framework. Throughout the work special attention is given to implied preferences to the different higher moments in optimising CVaR.
    Date: 2009–03
  11. By: Michel Fliess (LIX - Laboratoire d'informatique de l'école polytechnique - CNRS : UMR7161 - Polytechnique - X, INRIA Saclay - Ile de France - ALIEN - INRIA - Polytechnique - X - CNRS : UMR - Ecole Centrale de Lille); Cédric Join (INRIA Saclay - Ile de France - ALIEN - INRIA - Polytechnique - X - CNRS : UMR - Ecole Centrale de Lille, CRAN - Centre de recherche en automatique de Nancy - CNRS : UMR7039 - Université Henri Poincaré - Nancy I - Institut National Polytechnique de Lorraine - INPL)
    Abstract: We derive two new technical indicators for trading systems and risk management. They stem from trends in time series, the existence of which has been recently mathematically demonstrated by the same authors (A mathematical proof of the existence of trends in financial time series, Proc. Int. Conf. Systems Theory: Modelling, Analysis and Control, Fes, 2009), and from higher order quantities which replace the familiar statistical tools. Recent fast estimation techniques of algebraic flavor are utilized. The first indicator tells us if the future price will be above or below the forecasted trendline. The second one predicts abrupt changes. Several promising numerical experiments are detailed and commented.
    Keywords: Quantitative Finance, technical analysis, trading systems, risk management, trends, technical indicators, time series
    Date: 2009

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