nep-rmg New Economics Papers
on Risk Management
Issue of 2009‒08‒02
eight papers chosen by
Stan Miles
Thompson Rivers University

  1. Forecasting VaR and Expected Shortfall using Dynamical Systems: A Risk Management Strategy By Cyril Caillault; Dominique Guegan
  2. A new alogrithm for the loss distribution function with applications to Operational Risk Management By Dominique Guegan; Bertrand Hassani
  3. A Risk Management Approach for Portfolio Insurance Strategies By Benjamin Hamidi; Bertrand Maillet; Jean-Luc Prigent
  4. Regulations, competition and bank risk-taking in transition countries By Agoraki, Maria-Eleni; Delis, Manthos D; Pasiouras, Fotios
  5. Predicting Stock Returns in a Cross-Section : Do Individual Firm chatacteristics Matter ? By Kateryna Shapovalova; Alexander Subbotin
  6. Risk Management Framework for Hedge Funds: Role of Funding and Redemption Options on Leverage By Dai, John; Sundaresan, Suresh
  7. Investment Regulations and Defined Contribution Pensions By Pablo Antolín; Sandra Blome; David Karim; Stéphanie Payet; Gerhard Scheuenstuhl; Juan Yermo
  8. Financial Stability in the United Kingdom: Banking on Prudence By E. Philip Davis

  1. By: Cyril Caillault (Fortis Investments - Fortis investments); Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: Using non-parametric and parametric models, we show that the bivariate distribution of an Asian portfolio is not stable along all the period under study. We suggest several dynamic models to compute two market risk measures, the Value at Risk and the Expected Shortfall: the RiskMetrics methodology, the Multivariate GARCH models, the Multivariate Markov-Switching models, the empirical histogram and the dynamic copulas. We discuss the choice of the best method with respect to the policy management of bank supervisors. The copula approach seems to be a good compromise between all these models. It permits taking financial crises into account and obtaining a low capital requirement during the most important crises.
    Keywords: Value at Risk ; Expected Shortfall ; Copulas ; Risk management ; GARCH models ; Markov switching models
    Date: 2009–04
  2. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Bertrand Hassani (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: Operational risks inside banks and insurance companies is currently an important task. The computation of a risk measure associated to these risks lies on the knowledge of the so-called Loss Distribution Function. Traditionally this distribution function is computed via the Panjer algorithm which is an iterative algorithm. In this paper, we propose an adaptation of this last algorithm in order to improve the computation of convolutions between Panjer class distributions and continuous distributions. This new approach permits to reduce drastically the variance of the estimated VAR associated to the operational risks.
    Keywords: Operational risk, Panjer algorithm, Kernel, numerical integration, convolution.
    Date: 2009–04
  3. By: Benjamin Hamidi (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, A.A.Advisors-QCG - ABN AMRO); Bertrand Maillet (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, A.A.Advisors-QCG - ABN AMRO, EIF - EIF); Jean-Luc Prigent (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)
    Abstract: Controlling and managing potential losses is one of the main objectives of the Risk Management. Following Ben Ameur and Prigent (2007) and Chen et al. (2008), and extending the first results by Hamidi et al. (2009) when adopting a risk management approach for defining insurance portfolio strategies, we analyze and illustrate a specific dynamic portfolio insurance strategy depending on the Value-at-Risk level of the covered portfolio on the French stock market. This dynamic approach is derived from the traditional and popular portfolio insurance strategy (Cf. Black and Jones, 1987 ; Black and Perold, 1992) : the so-called "Constant Proportion Portfolio Insurance" (CPPI). However, financial results produced by this strategy crucially depend upon the leverage - called the multiple - likely guaranteeing a predetermined floor value whatever the plausible market evolutions. In other words, the unconditional multiple is defined once and for all in the traditional setting. The aim of this article is to further examine an alternative to the standard CPPI method, based on the determination of a conditional multiple. In this time-varying framework, the multiple is conditionally determined in order to remain the risk exposure constant, even if it also depends upon market conditions. Furthermore, we propose to define the multiple as a function of an extended Dynamic AutoRegressive Quantile model of the Value-at-Risk (DARQ-VaR). Using a French daily stock database (CAC 40) and individual stocks in the period 1998-2008), we present the main performance and risk results of the proposed Dynamic Proportion Portfolio Insurance strategy, first on real market data and secondly on artificial bootstrapped and surrogate data. Our main conclusion strengthens the previous ones : the conditional Dynamic Strategy with Constant-risk exposure dominates most of the time the traditional Constant-asset exposure unconditional strategies.
    Keywords: CPPI, Portfolio insurance, VaR, CAViaR, quantile regression, dynamic quantile model.
    Date: 2009–05
  4. By: Agoraki, Maria-Eleni; Delis, Manthos D; Pasiouras, Fotios
    Abstract: This study investigates whether regulations have an independent effect on bank risk-taking or whether their effect is channeled through the market power possessed by banks. Given a well-established set of theoretical priors, the regulations considered are capital requirements, restrictions on bank activities and official supervisory power. We use data from the Central and Eastern European banking sectors over the period 1998-2005. The empirical results suggest that banks with market power tend to take on lower credit risk and have a lower probability of default. Capital requirements reduce risk in general, but for banks with market power this effect significantly weakens. Higher activity restrictions in combination with more market power reduce both credit risk and the risk of default, while official supervisory power has only a direct impact on bank risk.
    Keywords: Banking sector reform; regulations; competition; risk-taking; CEE banks
    JEL: G38 G32 G21
    Date: 2009–06–01
  5. By: Kateryna Shapovalova (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Alexander Subbotin (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: It is a common wisdom that individual stocks' returns are difficult to predict, though in many situations it is important to have such estimates at our disposal. In particular, they are needed to determine the cost of capital. Market equilibrium models posit that expected returns are proportional to the sensitivities to systematic risk factors. Fama and French (1993) three-factor model explains the stock returns premium as a sum of three components due to different risk factors : the traditional CAPM market beta, and the betas to the returns on two portfolios, "Small Minus Big" (the differential in the stock returns for small and big companies) and "High Minus Low" (the differential in the stock returns for the companies with high and low book-to-price ratio). The authors argue that this model is sufficient to capture the impact on returns of companies' accounting fundamentals, such as earnings-to-price, cash flow-to-price, past sales growth, long term and short-term past earnings. Using a panel of stock returns and accounting data from 1979 to 2008 for the companies listed on NYSE, we show that this is not the case, at least at individual stocks' level. According to our findings, fundamental characteristics of companies' performance are of higher importance to predict future expected returns than sensitivities to the Fama and French risk factors. We explain this finding within the rational pricing paradigm : contemporaneous accounting fundamentals may be better proxies for the future sensitivity to risk factors, than the historical covariance estimates.
    Keywords: Accounting fundamentals, equity performance, style analysis, value and growth, cost of capital.
    Date: 2009–05
  6. By: Dai, John; Sundaresan, Suresh
    Abstract: We develop a model of hedge fund returns, which reflect the contractual relationships between a hedge fund, its investors and its prime brokers. These relationships are modelled as short option positions held by the hedge fund, wherein the “funding option” reflects the short option position with prime brokers and the “redemption option” reflects the short option position with the investors. Given an alpha producing human capital, the hedge fund’s ability to deploy leverage to magnify its alpha is shown to be sharply constrained by the presence of these short options, which have a high probability of being exercised in “bad states” of the world, either due to poor performance or due to macroeconomic developments that are performance-independent. We show that the hedge funds typically have an optimal level of leverage that trades off rationally the ability to increase alpha with the risk of early exercise of short options, which may precipitate the liquidation of the fund. Optimal leverage is shown to differ across hedge funds reflecting their de-levering costs, Sharpe ratios, correlation of assets, secondary market liquidity of their assets, and the volatility of the assets. Using a minimum level of unencumbered cash level as a risk limit, we show how a hedge fund can optimally choose aggregate risk capital and then allocate its risk capital across different risk-taking units to maximize alpha in the presence of these short option positions. Implications of our analysis for hedge fund investors and policy makers are summarized. Our framework can be easily modified to study portfolio selection problem facing any fund, which has granted redemption rights to its investors (money market funds, long-only funds, etc).
    Keywords: Leverage; Unencumbered cash; funding option; redemption option; prime brokers; funding counterparties; hair cuts; margin multiplier.
    JEL: G1 G2
    Date: 2009–07
  7. By: Pablo Antolín; Sandra Blome; David Karim; Stéphanie Payet; Gerhard Scheuenstuhl; Juan Yermo
    Abstract: This paper assesses the impact of different quantitative approaches to regulate investment risk on the retirement income stemming from defined contribution (DC) pension plans. It looks at how such regulations affect the spectrum of investment policies available and, through this channel, how they affect the retirement income that an individual may expect from a DC pension plan. The analysis shows that there is a trade-off between potential retirement income and protection from bad outcomes. Reducing the downside risk on retirement income from DC pension plans requires moving into relatively conservative investment policies where the share of assets allocated to bonds may be quite large. However, this comes at the cost of renouncing potentially higher replacement rates that are attainable but at a higher risk of unfavourable retirement income outcomes. Less risk adverse regulators and supervisors would aim at lower probability requirements as regard the downside risk, which will increase the range of investment policies available and thus the share of riskier assets.<P>Réglementations en matière d’investissements et retraites à cotisations définies<BR>Ce document examine l'impact de différentes approches quantitatives en matière de réglementation du risque d'investissement sur le revenu de retraite issu de plans de retraite à cotisations définies. Il étudie dans quelle mesure ces réglementations affectent le spectre des stratégies d'investissement et, par leur intermédiaire, le revenu de retraite qu'un individu peut attendre d‘un plan de retraite à cotisations définies. Cette analyse montre qu‘il existe un compromis entre le revenu de retraite potentiel et la protection contre des évènements défavorables. La réduction du risque de baisse du revenu de retraite issu de plans de retraite à cotisations définies nécessite d‘aller vers des stratégies d‘investissement relativement conservatives, dans lesquelles la part allouée aux obligations peut être assez importante. Cependant, ceci n‘est possible qu‘à condition de renoncer à des taux de remplacement potentiellement plus élevés, qui ne peuvent être atteints qu‘à un niveau de risque plus élevé de survenue d‘évènements défavorables pour le revenu de retraite. Des régulateurs et superviseurs moins averses au risque peuvent diminuer leurs exigences en terme de probabilité du risque de baisse, ce qui augmentera la gamme des stratégies d‘investissement disponibles et ainsi la part des actifs plus risqués.
    Keywords: investment, investissement, regulation, replacement ratios, taux de remplacement, plans de retraite à cotisations définies, defined contribution plans , risk management, gestion des risques, retirement income, revenu des retraites
    JEL: D14 D91 E21 G11 G38 J14 J26
    Date: 2009–07–20
  8. By: E. Philip Davis
    Abstract: The UK financial market has been severely affected by the recent financial crisis. The crisis has exposed weaknesses in the supervisory framework as well as that for crisis management and resolution. This paper reviews the supervisory and regulatory framework and the many reforms that have already been adopted to remedy these weaknesses. It also provides recommendations for further reforms. This Working Paper relates to the 2009 Economic Survey of the United Kingdom (<P>Stabilité financière au Royaume-Uni : miser sur la prudence<BR>Le marché financier britannique a été sévèrement touché par la crise financière. Celle-ci a mis en évidence de nombreuses faiblesses des mécanismes de contrôle et des dispositifs de gestion et de résolution des crises. Le présent chapitre examine le cadre de contrôle et de réglementation, ainsi que les nombreuses réformes qui ont déjà été adoptées pour remédier à ses faiblesses. Il s’achève par des recommandations concernant de nouvelles réformes. Ce document de travail se rapporte à l'Étude économique de l'OCDE sur le Royaume-Uni 2009 (
    Keywords: financial regulation, réglementation financière, UK banking system, système bancaire du Royaume-Uni, macroprudential issues, questions macroprudentielles, financial stability, stabilité financière
    JEL: G18 G21 G29
    Date: 2009–07–22

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