
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) 
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 ValueatRisk (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:  2009–08 
URL:  http://d.repec.org/n?u=RePEc:tky:fseres:2009cf652&r=rmg 
By:  Marcos Souto; Benjamin M. Tabak; Francisco Vazquez 
Abstract:  This study constructs a set of credit risk indicators for 39 Brazilian banks, using the Merton framework and balance sheet information on the banks’ total assets and liabilities. Despite the simplifying assumptions, the methodology captures well several stylized facts in the recent history of Brazil. In particular, it identifies deterioration in the credit risk indicators of the banking sector, following the crisis in the early 2000s. The risk indicators were regressed against a number of macrofinancial variables at both individual and systemic level, showing that an increase in the system EDF, interest rates, and CDS spreads will lead to a deterioration of the individual expected default probability. 
Date:  2009–07 
URL:  http://d.repec.org/n?u=RePEc:bcb:wpaper:189&r=rmg 
By:  BuneaBontas, Cristina Aurora 
Abstract:  The development of the capital markets increases the key role of the financial manager both in using the new techniques for administrating the risks and in assessing hedge effectiveness. Risk means possible uncertainty regarding cash flows, influencing the fair value of assets and liabilities or the value of cash flow relating to future transactions of the entity. This article emphasizes that possible financial risk in international business, like as price risk, credit risk, risk of liquidity, can be hedged using financial instruments, especially derivatives, like as forward, futures, options and swaps. The accounting treatment for these instruments is presented in accordance to the basic principles of hedge accounting imposed by IAS 39. Additionally, there are references to the most important requirements regarding the accounting rules regarding recognition and measurement of hedged derivatives according to the Romanian regulations. 
Keywords:  hedge derivatives; fair value; hedge accounting; hedge effectiveness; risk management 
JEL:  M41 D84 F30 E40 G20 
Date:  2009–08 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:17072&r=rmg 
By:  Alan Cosme Rodrigues da Silva; Antônio Carlos Magalhães da Silva; Jaqueline Terra Moura Marins; Myrian Beatriz Eiras da Neves; Giovani Antonio Silva Brito 
Abstract:  Using data drawn from the Brazilian Central Bank Credit Information System, this paper evaluates the impact of the use of collateral on the probability of default and, consequently, on capital requirement levels in the Brazilian financial system. Literature suggests that the existence of collateral in some credit operations increases the debtor's readiness to honor its commitment and, therefore, could result in a lower probability of default. The methodology used to calculate capital requirements is based on the Basel II IRBFoundation Approach, although the probabilities of default have been estimated by historical averages following Basel II orientation, and corroborated by a logistic regression model. The test of hypothesis about difference between collateralized and uncollateralized probabilities of default for each risk class indicates that they are statistically different. This result was obtained both from historical average probability of default as from logistic regression model.Sob condições específicas, incluindo o requerimento de capital de 11% adotado no Brasil e a Perda dado Default (ou LGD da sigla em inglês) estabelecida em 45%, este artigo também procura identificar um fator de equivalência da razão entre os requerimentos de capital para risco de crédito na Abordagem Padronizada Simplificada e aqueles calculados pela Abordagem Básica do IRB. Para a amostra utilizada, os resultados indicam que operações de nãovarejo com garantia possuem uma probabilidade média de default de 2,46% e um fator de equivalência de 60%. Em contrapartida, operações não garantidas possuem uma probabilidade média de default de 6,66% e um fator de equivalência de 93%, aproximandose bastante do fator de ponderação de 100% da Abordagem Padronizada Simplificada. 
Date:  2009–06 
URL:  http://d.repec.org/n?u=RePEc:bcb:wpaper:187&r=rmg 
By:  Düllmann, Klaus; Erdelmeier, Martin 
Abstract:  In this paper we stresstest credit portfolios of 28 German banks based on a Mertontype multifactor credit risk model. The adhoc stress scenario is an economic downturn in the automobile industry that constitutes an exceptional but plausible event suggested by historical data. Rather than on a particular stress forecast, the focus of the paper is on the main drivers of the stress impact on banks' credit portfolios. Although the percentage of loans in the automobile sector is relatively low for all banks in the sample, the expected loss conditional on the stress event increases substantially by 70%80% for the total portfolio. This result confirms the need to account for hidden sectoral concentration risk because the increase in expected loss is driven mainly by correlation effects with related industry sectors. Therefore, credit risk dependencies between sectors have to be adequately captured even if the trigger event is confined to a single sector. Finally, we calculate the impact on banks' own funds ratios. The main results are robust against various robustness checks, namely those concerning the granularity of the credit portfolio, the level of intersector asset correlations, and a crosssectional variation of intrasector asset correlations. 
Keywords:  Asset correlation,portfolio credit risk,stress test,sectoral credit concentration 
JEL:  G21 G33 C13 C15 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:zbw:bubdp2:200902&r=rmg 
By:  Gaisser, Sandra; Memmel, Christoph; Schmidt, Rafael; Wehn, Carsten 
Abstract:  From a banking supervisory perspective, this paper analyses aspects of market risk of an aggregated trading portfolio comprised of the trading books of 11 German banks with a regulatory approved internal market risk model. Based on real, clean profit and loss data and ValueatRisk estimates of the 11 banks, the paper specifically models and analyzes the portfolio's dependence and diversification structure, indispensable for financial stability studies. The high sensitivity of market risk measurements with respect to dependence structure of the underlying portfolio is nowadays a wellknown fact. However, only few techniqques for highdimensional and hierarchical dependence analysis have been proposed and studied in the financial literature so far. One reason is certainly the increasing complexity of the statistical theory, which is commonly referred to as the curse of highdimensionality. The present paper develops and applies multidimensional (asymptotic) test statistics based on the copula theory with the aim of detecting significant longterm level changes in the supervisory portfolio's dependence over time. Furthremore, a statistical hyphothesis test is proposed to identify the distinct contributions of subportfolios towards the overall dependence level in ahiercharchical manner. The utilized techniques are distributionfree and, in particulaar, are invariant with respect to the maarginaal return distributions. 
Keywords:  Multivariate dependence modelling,multivariate Spearman's rho,timevarying copula,asymptotic test theory,hierarchical testing,control chart theory 
JEL:  C12 C13 C14 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:zbw:bubdp2:200907&r=rmg 
By:  Blank, Sven; Buch, Claudia M.; Neugebauer, Katja 
Abstract:  Size matters in banking. In this paper, we explore whether shocks originating at large banks affect the probability of distress of smaller banks and thus the stability of the banking system. Our analysis proceeds in two steps. In a first step, we follow Gabaix (2008a) and construct a measure of idiosyncratic shocks at large banks, the socalled Banking Granular Residual. This measure documents the importance of size effects for the German banking system. In a second step, we incorporate this measure of idiosyncratic shocks at large banks into an integrated stresstesting model for the German banking system following De Graeve et al. (2007). We find that positive shocks at large banks reduce the probability of distress of small banks. 
Keywords:  Banking sector distress,size effects,shock propagation,Granular Residual 
JEL:  E44 E52 E32 G21 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:zbw:bubdp2:200904&r=rmg 
By:  Columba, Francesco; Gambacorta, Leonardo; Mistrulli, Paolo Emilio 
Abstract:  In this paper we investigate whether or not mutual guarantee consortia (MGC), a financial institution well developed in Italy, alleviate the difficulties that Small and Medium Enterprises (SMEs) face when they ask for a bank loan. We find that the probability of a small firm affiliated to a MGC of going into default is lower than that of firms not affiliated to such a consortium. These results indicate that MGCs improve the ability of banks to screen and monitor small firms. 
Keywords:  bank credit; financial intermediaries; small and medium enterprises; bad debt. 
JEL:  O16 D82 G30 G21 
Date:  2009–04 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:17052&r=rmg 
By:  Völz, Manja; Wedow, Michael 
Abstract:  This paper examines the potential distortion of prices in the CDS market caused by toobigtofail. Overall, we find evidence for market discipline in the CDS market. However, CDS prices are distorted due to a size effect which arises when investors expect a public bailout as a result of toobigtofail. A one percentage point increase in size reduces the CDS spread of a bank by about two basis points. We further find that some banks have already reached a size that makes them toobigtoberescued. While the price distortion for these banks decreases the existence of banks that are considered to be toobigtorescue raises important new issues for banking supervisors. 
Keywords:  Market Discipline,Too Big To Fail,Too Big to Rescue CDS Spreads 
JEL:  G14 G21 G28 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:zbw:bubdp2:200906&r=rmg 
By:  Rocío Elizondo; Pablo Padilla; Mogens Bladt 
Abstract:  We give a new way to price American options, using Samuelson´s formula. We first obtain the option price corresponding to a European option at time t, weighting it by the probability that the underlying asset takes the value S at time t. This factor is given by the solution of the FokkerPlanck (Kolmogorov) equation for the transition probability density. The main advantage of this approach is that we can introduce systematically the effect of macroeconomic factors. If a macroeconomic framework is given by a dynamic system in the form of a set of ordinary differential equations we only have to solve a partial differential equation, for the transition probability density. In this context, we verify, for the sake of consistency, that this formula is consistent with the BlackScholes model. 
Keywords:  American options, FokkerPlanck, BlackScholes, Samuelson, density probability function. 
JEL:  C00 C02 G10 G13 
Date:  2009–08 
URL:  http://d.repec.org/n?u=RePEc:bdm:wpaper:200906&r=rmg 
By:  Roland Winkler; HansWerner Wohltmann 
Abstract:  This paper analyzes the impacts of news shocks on macroeconomic volatility. Whereas anticipation amplifies volatility in any purely forwardlooking model, such as the baseline New Keynesian model, the results are ambiguous when including a backwardlooking component. In addition to these theoretical findings, we use the estimated model of Smets and Wouters (2003) to provide numerical evidence that news shocks increase the volatility of key macroeconomic variables in the euro area when compared to unanticipated shocks. 
Keywords:  Anticipated Shocks, Business Cycles, Volatility 
JEL:  E32 
Date:  2009–08 
URL:  http://d.repec.org/n?u=RePEc:kie:kieliw:1542&r=rmg 
By:  Frahm, Gabriel; Memmel, Christoph 
Abstract:  Two shrinkage estimators for the global minimum variance portfolio that dominate the traditional estimator with respect to the outofsample variance of the portfolio return are derived. The presented results hold for any number of observations n >= d 2 and number of assets d >= 4. The smallsample properties of the shrinkage estimators and also their largesample properties for fixed d but n > infinity as well as n,d > infinity but n/d > q <= infinity are investigated. Further, a smallsample test for the question whether it is better to completely ignore time series information in favor of naive diversification is presented. 
Keywords:  Covariance matrix estimation,global minimum variance portfolio,JamesStein estimation,naive diversification,shrinkage estimator 
JEL:  C13 G11 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:zbw:bubdp2:200901&r=rmg 
By:  Akihiko Takahashi (Faculty of Economics, University of Tokyo); Kohta Takehara (Graduate School of Economics, University of Tokyo) 
Abstract:  This chapter presents a basic of the methodology socalled an asymptotic expansion approach, and applies this method to approximation of prices of currency options with a libor market model of interest rates and stochastic volatility models of spot exchange rates. The scheme enables us to derive closedform approximation formulas for pricing currency options even with high flexibility of the underlying model; we do not model a foreign exchange rate's variance such as in Heston [27], but its volatility that follows a general timeinhomogeneous Markovian process. Further, the correlations among all the factors such as domestic and foreign interest rates, a spot foreign exchange rate and its volatility, are allowed. At the end of this chapter some numerical examples are provided and the pricing formula is applied to the calibration of volatility surfaces in the JPY/USD option market. 
Date:  2009–08 
URL:  http://d.repec.org/n?u=RePEc:tky:fseres:2009cf654&r=rmg 
By:  Zhaojun Yang; ChristianOliver Ewald; Olaf Menkens 
Abstract:  We use Malliavin calculus and the ClarkOcone formula to derive the hedging strategy of an arithmetic Asian Call option in general terms. Furthermore we derive an expression for the density of the integral over time of a geometric Brownian motion, which allows us to express hedging strategy and price of the Asian option as an analytic, that is closed form, expression. Numerical computations which are based on this expression are provided. 
Keywords:  Asian options, option pricing, hedging, Malliavin calculus. 
JEL:  G12 G13 
Date:  2009–09 
URL:  http://d.repec.org/n?u=RePEc:san:crieff:0910&r=rmg 
By:  Claudio Henrique da Silveira Barbedo; José Valentim Machado Vicente; Octávio Manuel Bessada Lion 
Abstract:  Pricing interest rate derivatives is a challenging task that has attracted the attention of many researchers in recent decades. Portfolio and risk managers, policymakers, traders and more generally all market participants are looking for valuable information from derivative instruments. We use a standard procedure to implement the HJM model and to price IDI options. We intend to assess the importance of the principal components of pricing and interest rate hedging derivatives in Brazil, one of the major emerging markets. Our results indicate that the HJM model consistently underprices IDI options traded in the overthecounter market while it overprices those traded in the exchange studied. We also find a direct relationship between time to maturity and pricing error and a negative relation with moneyness. 
Date:  2009–06 
URL:  http://d.repec.org/n?u=RePEc:bcb:wpaper:188&r=rmg 