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on Risk Management |
| By: | Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Juan-Angel Jimenez-Martin (Department of Quantitative Economics, Complutense University of Madrid); Teodosio Perez-Amaral (Department of Quantitative Economics, Complutense University of Madrid) |
| Abstract: | The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. In this paper we define risk management in terms of choosing sensibly from a variety of risk models, discuss the selection of optimal risk models, consider combining alternative risk models, discuss the choice between a conservative and aggressive risk management strategy, and evaluate the effects of the Basel II Accord on risk management. We also examine how risk management strategies performed during the 2008-09 financial crisis, evaluate how the financial crisis affected risk management practices, forecasting VaR and daily capital charges, and discuss alternative policy recommendations, especially in light of the financial crisis. These issues are illustrated using Standard and Poor's 500 Index, with an emphasis on how risk management practices were monitored and encouraged by the Basel II Accord regulations during the financial crisis. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf643&r=rmg |
| By: | Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Juan-Angel Jimenez-Martin (Department of Quantitative Economics, Complutense University of Madrid); Teodosio Perez-Amaral (Department of Quantitative Economics, Complutense University of Madrid) |
| Abstract: | When dealing with market risk under the Basel II Accord, variation pays in the form of lower capital requirements and higher profits. Typically, GARCH type models are chosen to forecast Value-at-Risk (VaR) using a single risk model. In this paper we illustrate two useful variations to the standard mechanism for choosing forecasts, namely: (i) combining different forecast models for each period, such as a daily model that forecasts the supremum or infinum value for the VaR; (ii) alternatively, select a single model to forecast VaR, and then modify the daily forecast, depending on the recent history of violations under the Basel II Accord. We illustrate these points using the Standard and Poor's 500 Composite Index. In many cases we find significant decreases in the capital requirements, while incurring a number of violations that stays within the Basel II Accord limits. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf636&r=rmg |
| By: | Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Juan-Angel Jimenez-Martin (Department of Quantitative Economics, Complutense University of Madrid); Teodosio Perez-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 analyze the profit maximizing problem of an ADI subject to capital requirements under the Basel II Accord as ADI's have to choose an optimal VaR reporting strategy that minimizes daily capital charges. Accordingly, we suggest a dynamic communication and forecasting strategy 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: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf644&r=rmg |
| By: | Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Christian Mazza (Département de Mathématiques - Université de Fribourg); Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429) |
| Abstract: | The classical risk model is considered and a sensitivity analysis of finite-time ruin probabilities is carried out. We prove the weak convergence of a sequence of empirical finite-time ruin probabilities. So-called partly shifted risk processes are introduced, and used to derive an explicit expression of the asymptotic variance of the considered estimator. This provides a clear representation of the influence function associated with finite time ruin probabilities, giving a useful tool to quantify estimation risk according to new regulations. |
| Keywords: | Finite-time ruin probability; robustness; Solvency II; reliable ruin probability; asymptotic normality; influence function; partly shifted risk process; Estimation Risk Solvency Margin. (ERSM). |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-00168716_v1&r=rmg |
| By: | Di Cesare, Antonio |
| Abstract: | This paper analyzes the effects of CDO issuance on the risk of default of banks. Previous literature showed that the overall riskiness of a bank can increase when it sells part of the loans in its portfolio by issuing a CDO of which it retains the equity tranche. Using Monte Carlo simulations, this paper confirms previous results but also highlights that they can change substantially if one modifies the hypothesis regarding how the proceeds of securitizations are reinvested. The assessment of the effects of securitizations on bank stability is thus mainly a matter of empirical research. Using data for Italian banks I provide evidence that the securitization activity has been a relevant factor in changing the composition of the asset side of banks' balance sheets. Results also show that these changes have probably contributed to lower the average ex-ante riskiness of Italian banks. I also compare the riskiness of loans that have been securitized with that of new loans granted by the same securitizing banks using loan-by-loan data. Results show that new loans are on average riskier than loans that have been securitized, thus pointing to an increasing amount of risk to be born by banks as a consequence of the reinvestment of the proceeds of securitizations. |
| Keywords: | Bank stability; CDOs; Value-at-Risk; bank capital structure; Monte Carlo simulations |
| JEL: | G28 G21 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16831&r=rmg |
| By: | Romain Biard (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Claude Lefèvre (Département de Mathématique - Université Libre de Bruxelles); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Haikady Nagaraja (Department of Statistics - Ohio State University) |
| Abstract: | In the compound Poisson risk model, several strong hypotheses may be found too restrictive to describe accurately the evolution of the reserves of an insurance company. This is especially true for a company that faces natural disaster risks like earthquake or flooding. For such risks, claim amounts are often inter-dependent and they may also depend on the history of the natural phenomenon. The present paper is concerned with a situation of this kind where each claim amount depends on the previous interclaim arrival time, or on past interclaim arrival times in a more complex way. Our main purpose is to evaluate, for large initial reserves, the asymptotic finite-time ruin probabilities of the company when the claim sizes have a heavy-tailed distribution. The approach is based more particularly on the analysis of spacings in a conditioned Poisson process. |
| Keywords: | Risk process; finite-time ruin probabilities; asymptotic approximation for large initial reserves; path-dependent claims, heavy-tailed claim amounts; Poisson spacing; |
| Date: | 2009–08–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00409418_v1&r=rmg |
| By: | Delis, Manthos D; Staikouras, Panagiotis |
| Abstract: | This paper investigates the role of banking supervision, measured in terms of enforcement outputs (i.e., on-site audits and sanctions) in containing bank risk-taking. Our results on the direct banking supervision–risk-taking correlation show an inverted U-shaped relationship between on-site audits and bank risk, while the nexus between enforcement actions and risk appears linear and negative. With respect to the combined effect of efficient supervision and banking regulation (in the form of capital and transparency requirements) we find that effective supervision and disclosure prerequisites are important and complementary mechanisms in reducing bank fragility, by contrast to capital requirements which are proven rather futile in controlling bank risk, even when supplemented with a higher volume of on-site audits and enforcement actions. |
| Keywords: | Bank risk; Regulation; Supervision; Enforcement; Sanctions; Audits |
| JEL: | G38 G32 G21 |
| Date: | 2009–08–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16836&r=rmg |
| By: | Christopher D. Carroll; Patrick Toche |
| Abstract: | We present a tractable model of the effects of nonfinancial risk on intertemporal choice. Our purpose is to provide a simple framework that can be adopted in fields like representative-agent macroeconomics, corporate finance, or political economy, where most modelers have chosen not to incorporate serious nonfinancial risk because available methods were too complex to yield transparent insights. Our model produces an intuitive analytical formula for target assets, and we show how to analyze transition dynamics using a familiar Ramsey-style phase diagram. Despite its starkness, our model captures most of the key implications of nonfinancial risk for intertemporal choice. |
| JEL: | C61 D11 E24 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15265&r=rmg |
| By: | Martha Poon (CSI - Centre de sociologie de l'innovation - CNRS : UMR7185 - Mines ParisTech) |
| Abstract: | (Provides original sociological research on the development of consumer credit scoring in the United States and its links to subprime mortgage finance.) |
| Keywords: | Science and Technology Studies; Economic Sociology; Social Studies of Finance; subprime mortgages; consumer credit; risk |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00359712_v1&r=rmg |
| By: | Kartik B. Athreya; Xuan S. Tam; Eric R. Young |
| Abstract: | How might society ensure the allocation of credit to those who lack meaningful collateral? Two very different options that have each been pursued by a variety of societies through time and space are (i) relatively harsh penalties for default and, more recently, (ii) loan guarantee programs that allow borrowers to default subject to moderate consequences and use public funds to compensate lenders. The goal of this paper is to provide a quantitative statement about the relative desirability of these responses. Our findings are twofold. First, we show that under a wide array of circumstances, punishments harsh enough to ensure all debt is repaid improve welfare. With respect to loan guarantees, our findings suggest that such efforts are largely useless at best, and substantially harmful at worst. Generous loan guarantees virtually ensure substantially higher taxes — with transfers away from the non-defaulting poor to the defaulting middle-class — and greater deadweight loss from high equilibrium default rates. Taken as a whole, our findings suggest that current policy toward default is likely to be counterproductive, and that guarantees for consumption loans are not the answer. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:09-11&r=rmg |
| By: | Chia-Lin Chang (Department of Applied Economics, National Chung Hsing University); Biing-Wen Huang (Department of Applied Economics, National Chung Hsing University); Meng-Gu Chen (Department of Applied Economics, National Chung Hsing University); Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo) |
| Abstract: | The hog industry, where prices are determined according to an auction system, is of vital importance to the agricultural industry in Taiwan by providing significant production and employment. In particular, there were significant impacts on daily hog prices in the periods before, during and after joining the WTO, which we will refer to as periods of anticipation, adjustment and settlement. The purpose of the paper is to model the growth rates and volatility in daily hog prices in Taiwan from 23 March 1999 to 30 June 2007, which enables an analysis of the effects of joining the WTO. The paper provides a novel application of financial volatility models to agricultural finance. The empirical results have significant implications for risk management and policy considerations in the agricultural industry in Taiwan, especially when significant structural changes, such as joining the WTO, are concerned. The three sub-samples relating to the period before, during and after joining the WTO display significantly different volatility persistence, namely symmetry, asymmetry but not leverage, and leverage, respectively, whereby negative shocks increase volatility but positive shocks of a similar magnitude decrease volatility. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf642&r=rmg |
| By: | Ari Tjahjawandita (Department of Economics, Padjadjaran University); Tito Dimas Pradono (Department of Economics, Padjadjaran University); Rullan Rinaldi (Department of Economics, Padjadjaran University) |
| Abstract: | The global financial crisis triggered by the credit crisis in the USA as its epicenter, quickly spread across the globe. The crisis starts spreading around the world in the middle of 2007 and along the 2008, where stock markets in major economies fell, followed by collapses of large companies and leading financial institutions. In a world where economies are integrated, the spread of such crisis is unavoidable. In this paper, we try to estimate the spill over effect of the global financial crises across borders and regions. Using spatial econometrics method we employ distance based weight matrix to estimate the spatial dependence and spatial heterogeneity of the crises. On the sensitivity analysis, we also employ weights matrix that is corrected by the governance and the economic freedom index to shows how the virtual space of governance, economic institution and regimes affect the spread of the crises. |
| Keywords: | Global Financial Crises, Spillover Effect, Institutions, Globalization, Spatial Econometrics |
| JEL: | G1 C1 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:unp:wpaper:200906&r=rmg |
| By: | Andra C. Ghent; Marianna Kudlyak |
| Abstract: | We analyze the impact of lender recourse on mortgage defaults theoretically and empirically across U.S. states. We study the effect of state laws regarding deficiency judgments in a model where lenders can use the threat of a deficiency judgment to deter default or to shorten the default process. Empirically, we find that recourse decreases the probability of default when there is a substantial likelihood that a borrower has negative home equity. We also find that, in states that allow deficiency judgments, defaults are more likely to occur through a lender-friendly procedure, such as a deed in lieu of foreclosure. |
| Keywords: | Mortgage loans |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:09-10&r=rmg |
| By: | Chia-Lin Chang (Department of Applied Economics, National Chung Hsing University); Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Roengchai Tansuchat (Faculty of Economics, Maejo University and Faculty of Economics, Chiang Mai University) |
| Abstract: | This paper estimates univariate and multivariate conditional volatility and conditional correlation models of spot, forward and futures returns from three major benchmarks of international crude oil markets, namely Brent, WTI and Dubai, to aid in risk diversification. Conditional correlations are estimated using the CCC model of Bollerslev (1990), VARMAGARCH model of Ling and McAleer (2003), VARMA-AGARCH model of McAleer et al. (2009), and DCC model of Engle (2002). The paper also presents the ARCH and GARCH effects for returns and shows the presence of significant interdependences in the conditional volatilities across returns for each market. The estimates of volatility spillovers and asymmetric effects for negative and positive shocks on conditional variance suggest that VARMA-GARCH is superior to the VARMA-AGARCH model. In addition, the DCC model gives statistically significant estimates for the returns in each market, which shows that constant conditional correlations do not hold in practice. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf640&r=rmg |
| By: | Mario Jametti (University of Lugano); Thomas von Ungern-Sternberg (Université de Lausanne) |
| Abstract: | This paper studies the evolution of hurricane insurance in Florida over the last decades. Hurricanes (and other natural catastrophes) are typically referred to as “uninsurable” risks. The more exposed property owners find it difficult to obtain insurance cover from the private market and/or can do so only at premiums that substantially exceed their expected claims costs. The state of Florida has reacted to the incapacity of the private sector to insure hurricane risks at reasonable premium levels with the creation of Citizens Property Insurance Corporation (an insurer of last resort) and the Florida Hurricane Catastrophe Fund. Their existence has resulted in substantial premium reductions for the Florida property owners. Both institutions have the possibility of spreading the costs of a major hurricane over a (very) large number of policy holders through after the event compulsory assessments. The risk borne by each individual property owner is thus reasonably small, with substantial benefits for consumers as a group. Looking forward the challenge to the policy maker will be to fine-tune the operation (premium structure) of these two institutions so as to increase their political acceptance. To this end it will be necessary to limit the implicit subsidy of the “bad risks” through the “good risks”. |
| Keywords: | Hurricane, Catastrophe Insurance, Regulation, Market Failure, Florida |
| JEL: | G22 L51 L33 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:lug:wpaper:0905&r=rmg |
| By: | Chia-Lin Chang (Department of Applied Economics, National Chung Hsing University); Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Roengchai Tansuchat (Faculty of Economics, Maejo University and Faculty of Economics, Chiang Mai University) |
| Abstract: | The purpose of this paper is to investigate the volatility spillovers between the returns on crude oil futures and oil company stocks using alternative multivariate GARCH models, namely the CCC model of Bollerslev (1990), VARMA-GARCH model of Ling and McAleer (2003), and VARMA-AGARCH model of McAleer et al. (2008). The paper investigates WTI crude oil futures returns and the stock returns of ten oil companies, which comprise the "supermajor" group of oil companies, namely Exxon Mobil (XOM), Royal Dutch Shell (RDS), Chevron Corporation (CVX), ConocoPhillips (COP), BP (BP) and Total S.A. (TOT), and four other large oil and gas companies, namely Petrobras (PBRA), Lukoil (LKOH), Surgutneftegas (SNGS), and Eni S.p.A. (ENI). Estimates of the conditional correlations between the WTI crude oil futures returns and oil company stock returns are found to be quite low using the CCC model, while the VARMA-GARCH and VARMA-AGARCH models suggest no significant volatility spillover effects in any pairs of returns. The paper also presents evidence of the asymmetric effects of negative and positive shocks of equal magnitude on the conditional variances in all pairs of returns. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf639&r=rmg |
| By: | Franz Fuerst (School of Real Estate & Planning, University of Reading Business School); Gianluca Marcato (School of Real Estate & Planning, University of Reading) |
| Abstract: | While style analysis has been studied extensively in equity markets, applications of this valuable tool for measuring and benchmarking performance and risk in a real estate context are still relatively new. Most previous real estate studies on this topic have identified three investment categories (rather than styles): sectors, administrative regions and economic regions. However, the low explanatory power reveals the need to extend this analysis to other investment styles. We identify four main real estate investment styles and apply a multivariate model to randomly generated portfolios to test the significance of each style in explaining portfolio returns. Results show that significant alpha performance is significantly reduced when we account for the new investment styles, with small vs. big properties being the dominant one. Secondly, we find that the probability of obtaining alpha performance is dependent upon the actual exposure of funds to style factors. Finally we obtain that both alpha and systematic risk levels are linked to the actual characteristics of portfolios. Our overall results suggest that it would be beneficial for real estate fund managers to use these style factors to set benchmarks and to analyze portfolio returns. |
| Keywords: | investment styles, commercial real estate, portfolio analysis, performance measurement |
| JEL: | C20 G1 G11 G12 R33 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:rdg:repxwp:rep-wp2009-01&r=rmg |