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on Risk Management |
| By: | Jan Pieter Krahnen (Goethe University Frankfurt, CFS, and CEPR); Christian Wilde (Goethe University Frankfurt) |
| Abstract: | This paper analyzes the risk properties of typical asset-backed securities (ABS), like CDOs or MBS, relying on a model with both macroeconomic and idiosyncratic components. The examined properties include expected loss, loss given default, and macro factor dependencies. Using a two-dimensional loss decomposition as a new metric, the risk properties of individual ABS tranches can directly be compared to those of corporate bonds, within and across rating classes. By applying Monte Carlo Simulation, we find that the risk properties of ABS differ significantly and systematically from those of straight bonds with the same rating. In particular, loss given default, the sensitivities to macroeconomic risk, and model risk differ greatly between instruments. Our findings have implications for understanding the credit crisis and for policy making. On an economic level, our analysis suggests a new explanation for the observed rating inflation in structured finance markets during the pre-crisis period 2004-2007. On a policy level, our findings call for a termination of the 'one-size-fits-all' approach to the rating methodology for fixed income instruments, requiring an own rating methodology for structured finance instruments. |
| Keywords: | Credit Risk, Risk Transfer, Systematic Risk |
| JEL: | G21 G28 |
| Date: | 2009–06–24 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200911&r=rmg |
| By: | Avouyi-Dovi, S.; Bardos, M.; Jardet, C.; Kendaoui, L.; Moquet , J. |
| Abstract: | The aim of this paper is to build and estimate a macroeconomic model of credit risk for the French manufacturing sector. This model is based on Wilson's CreditPortfolioView model (1997a, 1997b); it enables us to simulate loss distributions for a credit portfolio for several macroeconomic scenarios. We implement two simulation procedures based on two assumptions relative to probabilities of default (PDs): in the first procedure, firms are assumed to have identical default probabilities; in the second, individual risk is taken into account. The empirical results indicate that these simulation procedures lead to quite different loss distributions. For instance, a negative one standard deviation shock on output leads to a maximum loss of 3.07% of the financial debt of the French manufacturing sector, with a probability of 99%, under the identical default probability hypothesis versus 2.61% with individual default probabilities. |
| Keywords: | macro stress test ; credit risk model ; loss distribution. |
| JEL: | G32 C22 C53 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:238&r=rmg |
| By: | Alfred Galichon (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X) |
| Abstract: | I show that the structure of the rm is not neutral in respect to regulatory capital budgeted under rules which are based on the Value-at-Risk. |
| Keywords: | value-at-risk |
| Date: | 2009–07–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00401793_v1&r=rmg |
| By: | Giorgia Callegaro (Scuola Normale Superiore di Pisa - Scuola Normale Superiore di Pisa); Abass Sagna (PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Denis Diderot - Paris VII) |
| Abstract: | In this paper we use a hybrid Monte Carlo-Optimal quantization method to approximate the conditional survival probabilities of a firm, given a structural model for its credit defaul, under partial information. We consider the case when the firm's value is a non-observable stochastic process $(V_t)_{t \geq 0}$ and inverstors in the market have access to a process $(S_t)_{t \geq 0}$, whose value at each time t is related to $(V_s, s \leq t)$. We are interested in the computation of the conditional survival probabilities of the firm given the "investor information". As a application, we analyse the shape of the credit spread curve for zero coupon bonds in two examples. |
| Keywords: | credit risk, structural approach, survival probabilities, partial information, filtering, optimal quantization, Monte Carlo method. |
| Date: | 2009–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00400666_v1&r=rmg |
| By: | Guiso, Luigi; Sapienza, Paola; Zingales, Luigi |
| Abstract: | We use survey data to study American households’ propensity to default when the value of their mortgage exceeds the value of their house even if they can afford to pay their mortgage (strategic default). We find that 26% of the existing defaults are strategic. We also find that no household would default if the equity shortfall is less than 10% of the value of the house. Yet, 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. Besides relocation costs, the most important variables in predicting strategic default are moral and social considerations. Ceteris paribus, people who consider it immoral to default are at 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to declare their intention to do so. The willingness to default increases nonlinearly with the proportion of foreclosures in the same ZIP code. That moral attitudes toward default do not change with the percentage of foreclosures is likely to derive from a contagion effect that reduces the social stigma associated with default as defaults become more common. |
| Keywords: | foreclosure; moral constraint; mortgage; social constraint; strategic default |
| JEL: | D12 G18 G21 G33 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7352&r=rmg |
| By: | Luigi Guiso; Paola Sapienza; Luigi Zingales |
| Abstract: | We use survey data to study American households‘ propensity to default when the value of their mortgage exceeds the value of their house even if they can afford to pay their mortgage (strategic default). We find that 26% of the existing defaults are strategic. We also find that no household would default if the equity shortfall is less than 10% of the value of the house. Yet, 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. Besides relocation costs, the most important variables in predicting strategic default are moral and social considerations. Ceteris paribus, people who consider it immoral to default are 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to declare their intention to do so. The willingness to default increases nonlinearly with the proportion of foreclosures in the same ZIP code. That moral attitudes toward default do not change with the percentage of foreclosures in the area suggests that the correlation between willingness to default and percentage of foreclosures is likely to derive from a contagion effect that reduces the social stigma associated with default as defaults become more common. |
| Keywords: | Default decisions; moral rules; culture and economics |
| JEL: | D2 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/27&r=rmg |
| By: | Alfred Galichon (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X); Ivar Ekeland (Canada Research Chair in Mathematical Economics - University of British Columbia); Marc Henry (Départment de sciences économiques - Université de Montréal, CIRANO - Montréal - , CIREQ - Centre Interuniversitaire de Recherche en Economie Quantitative) |
| Abstract: | We propose a multivariate extension of a well-known characterization by S. Kusuoka of regular and coherent risk measures as maximal correlation functionals. This involves an extension of the notion of comonotonicity to random vectors through generalized quantile functions. Moreover, we propose to replace the current law invari- ance, subadditivity and comonotonicity axioms by an equivalent property we call strong coherence and that we argue has more natural economic interpretation. Finally, we refor- mulate the computation of regular and coherent risk measures as an optimal transportation problem, for which we provide an algorithm and implementation. |
| Keywords: | regular risk measures, coherent risk measures, comonotonicity, maximal correlation, optimal transportation, strongly coherent risk measures. |
| Date: | 2009–07–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00401828_v1&r=rmg |
| By: | Matthew S. Yiu (Research Department, Hong Kong Monetary Authority); Alex Ho (Research Department, Hong Kong Monetary Authority); Lu Jin (Research Department, Hong Kong Monetary Authority) |
| Abstract: | This study adopts an econometric approach to develop an early warning system of the vulnerability in the banking system and currency markets for the 11 EMEAP economies over the period from1990 to 2008. We identify a set of leading indicators of banking distress and currency pressure and investigate the causal and contemporaneous linkages between them by using separate panel probit models and a simultaneous probit equation system. Asset-price misalignments, default risk of commercial banks and the non-financial corporate sector, and growth of real credit to the private sector are found to be significant leading indicators for both banking distress and currency pressure. Economic growth, inflation and the ratio of short-term external debt to international reserves are found to be important determinants of banking distress, whereas growth of M2 relative to international reserves, total trade balance over GDP, real effective exchange rate over-valuation and trade integration with China are identified to be crucial indicators of currency pressure. Currency market pressure is shown to have strong leading and contemporaneous impacts on banking distress for the EMEAP economies but not vice versa. These findings imply that the policy measures aimed at sustaining exchange rate stability will have the additional benefit of lowering the likelihood of banking distress in the region. Lastly, China is found to play a stabilising role in the region, i.e. the greater the trade with China, the lower the chance of experiencing currency pressure. |
| Keywords: | Banking distress, Currency crises, Twin crises, Asia Pacific economies, econometric model |
| JEL: | E44 F31 F42 F47 G21 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:hkg:wpaper:0908&r=rmg |
| By: | Laurent Devineau (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429, R&D, Milliman, Paris - Milliman); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429) |
| Abstract: | Two approaches may be considered in order to determine the Solvency II economic capital: the use of a standard formula or the use of an internal model (global or partial). However, the results produced by these two methods are rarely similar, since the underlying hypothesis of marginal capital aggregation is not verified by the projection models used by companies. We demonstrate that the standard formula can be considered as a first order approximation of the result of the internal model. We therefore propose an alternative method of aggregation that enables to satisfactorily capture the diversity among the various risks that are considered, and to converge the internal models and the standard formula. |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00403662_v1&r=rmg |
| By: | Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Nicolas Privault (Department of Mathematics - City University of Hong Kong) |
| Abstract: | The goal of this paper is to obtain probabilistic representation formulas that are suitable for the numerical computation of the (possibly non-continuous) density functions of infima of reserve processes commonly used in insurance. In particular we show, using Monte Carlo simulations, that these representation formulas perform better than standard finite difference methods. Our approach differs from standard Malliavin probabilistic representation techniques which generally require more smoothness on random variables, entailing the continuity of their density functions. |
| Keywords: | Ruin probability; Malliavin calculus; insurance; integration by parts |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-00201347_v3&r=rmg |