nep-rmg New Economics Papers
on Risk Management
Issue of 2009‒10‒24
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. Extension of Spot Recovery Model for Gaussian Copula By Li, Hui
  2. Off-Balance-Sheet Activities and the Shadow Banking System: An Application of the Hausman Test with Higher Moments Instruments By Christian Calmès; Raymond Théoret
  3. Bank incentives and optimal CDOs By Pagès, H.
  4. High Watermarks of Market Risks. By Bertrand Maillet; Jean-Philippe Médecin; Thierry Michel
  5. Cyclical effects of bank capital requirements with imperfect credit markets By Agenor, Pierre-Richard; Pereira da Silva, Luiz A.
  6. A sequential modelling of the VaR By Alain Monfort.
  7. Financial Liberalisation and Stock Market Volatility: The Case of Indonesia By Gregory James; Michail Karoglou
  8. Iceland: The Financial and Economic Crisis By David Carey
  9. A tale of two debt crises: a stochastic optimal control analysis By Stein, Jerome L.

  1. By: Li, Hui
    Abstract: Heightened systematic risk in the credit crisis has created challenges to CDO pricing and risk management. One important focus has been on the modeling of stochastic recovery. Different approaches within the Gaussian Copula framework have been proposed, but a consistent model was lacking until the recent paper of Bennani and Maetz [6] which shifted the modeling from period recovery to spot recovery. In this paper, we generalize their model to an arbitrary spot recovery distribution setup and extend the deterministic dependency on systematic factor to a random one. Besides, an extra parameter is introduced to control the correlation between default and recovery rate and the correlation between the recovery rates.
    Keywords: CDO; Gaussian Copula; Stochastic Recovery; Spot Recovery Model
    JEL: G32 G13
    Date: 2009–10–17
  2. By: Christian Calmès (Département des sciences administratives, Université du Québec (Outaouais), et Chaire d'information financière et organisationnelle, ESG-UQAM); Raymond Théoret (Département de stratégie des affaires, Université du Québec (Montréal), et Chaire d'information financière et organisationnelle, ESG-UQAM)
    Abstract: The noninterest income banks generate from their off-balance-sheet activities contributes greatly to the volatility of their operating revenues. Using Canadian data, we apply a modified Hausman procedure based on higher moments instruments and revisit this phenomenon to establish that the share of noninterest income (snonin) is actually endogenous to banks returns. In 1997, after the adoption of the Value at Risk (VaR) as a measure of banks risk, the snonin sign turns positive in the returns equations, indicating the emergence of diversification gains from banks non-traditional activities. ARCH-M estimations corroborate the idea that banks have gradually adapted to their new business lines, with an adjustment process begun even before 1997. However, the banks risk premium associated to OBS activities has continuously increased since that date.
    Keywords: Bank Risk Measures; Diversification; Noninterest income; Hausman test; Endogeneity; ARCH-M.
    JEL: G20 G21 C32
    Date: 2009–10–01
  3. By: Pagès, H.
    Abstract: The paper examines a delegated monitoring problem between investors and a bank holding a portfolio of correlated loans displaying “contagion.” Moral hazard prevents the bank from monitoring continuously unless it is compensated with the right incentive-compatible contract. The asset pool is liquidated when losses exceed a state-contingent cut-off rule. The bank bears a relatively high share of the risk initially, as it should have high-powered incentives to monitor, but its long term financial stake tapers off as losses unfold. Liquidity regulation based on securitization can replicate the optimal contract. The sponsor provides an internal credit enhancement out of the proceeds of the sale and extends protection in the form of weighted tranches of collateralized debt obligations. In compensation the trust pays servicing and rent-preserving fees if a long enough period elapses with no losses occurring. Rather than being detrimental, well-designed securitization seems an effective means of implementing the second best.
    Keywords: Credit risk transfer, Default Risk, Contagion.
    JEL: G21 G28 G32
    Date: 2009
  4. By: Bertrand Maillet (Centre d'Economie de la Sorbonne, EIF, A.A.Advisors-QCG (ABN AMRO)and Variances); Jean-Philippe Médecin (Centre d'Economie de la Sorbonne and Variances); Thierry Michel (LODH)
    Abstract: We present several estimates of measures of risk amongst the most well-known, using both high and low frequency data. The aim of the article is to show which lower frequency measures can be an acceptable substitute to the high precision measures, when transaction data is unavailable for a long history. We also study the distribution of the volatility, focusing more precisely on the slopee of the tail of the various risk measure distributions, in order to define the high watermarks of market risks. Based on estimates of the tail index of a Generalized Extreme Value density backed-out from the high frequency CAC 40 series in the period 1997-2006, using both Maximum Likelihood and L-moment Methods, we, finally find no evidence for the need of a specification with heavier tails than in the case of the traditional log-normal hypothesis.
    Keywords: Financial crisis, volatility estimator distributions, range-based volatility, extreme value, high frequency data.
    JEL: G10 G14
    Date: 2009–08
  5. By: Agenor, Pierre-Richard; Pereira da Silva, Luiz A.
    Abstract: This paper analyzes the cyclical effects of bank capital requirements in a simple model with credit market imperfections. Lending rates are set as a premium over the cost of borrowing from the central bank, with the premium itself depending on firms’ effective collateral. Basel I- and Basel II-type regulatory regimes are defined and a capital channel is introduced through a signaling effect of capital buffers on the cost of bank deposits. The macroeconomic effects of various shocks (a drop in output, an increase in the refinance rate, and a rise in the capital adequacy ratio) are analyzed, under both binding and nonbinding capital requirements. Factors affecting the procyclicality of each regime (defined in terms of the behavior of the risk premium) are also identified and policy implications are discussed.
    Keywords: Banks&Banking Reform,Access to Finance,Economic Theory&Research,Currencies and Exchange Rates,Debt Markets
    Date: 2009–09–01
  6. By: Alain Monfort.
    Abstract: We consider the VaR associated with the global loss generated by a set risk sources. We propose a sequence of simple models incorporating progressively the notions of contagion due to instantaneous correlations, of serial correlation, of evolution of the instantaneous correlations, of volatility clustering, of conditional heteroskedasticity and of persistency of shocks. The tools used are the standard and extended Kalman filters.
    Keywords: VaR, factor models, correlation, volatility clustering, Kalman filter.
    JEL: C10 G11
    Date: 2009
  7. By: Gregory James (Dept of Economics, Loughborough University); Michail Karoglou (Business School, Newcastle University)
    Abstract: This paper examines the relationship between financial liberalisation and stock market volatility in Indonesia. By looking at the time series properties of the Jakarta Composite Index (JCI) we identify breaks in stock market volatility which coincide with the timing of major policy events. Our main findings are (i) a significant decrease in volatility after the "official" opening of the stock market to foreign participation; (ii) a significant increase in volatility in the year before market opening following reforms that eased entry requirements and the issuance of brokerage licenses; and (iii) a significant increase in volatility at the time of the Asian crisis followed by a significant decrease in the second and sixth years after the crisis.
    Keywords: financial liberalisation; stock market volatility; Indonesia; Asian crisis.
    JEL: G14 G15
    Date: 2009–09
  8. By: David Carey
    Abstract: The global financial and economic crisis has struck Iceland with extreme force. Iceland’s three main banks, accounting for almost all of the banking system, failed in October 2008. They were unable to resist the deterioration in global financial markets following the failure of Lehman Brothers. The banks had pursued risky expansion strategies – notably borrowing in foreign capital markets to finance the aggressive international expansion of Icelandic investment companies – that made them vulnerable to the deterioration in global financial markets. They had also grown to be too big for the government to rescue. When access to foreign capital eventually closed, the banks failed. Non-financial firms and households were also vulnerable to the deterioration in global financial conditions, having taken on a lot of debt in recent years based on inflated collateral values. In some cases, the debt was foreign-currency denominated, without matching foreign-currency assets or revenues. In the wake of the banking crisis, the government obtained an IMF Stand-By Arrangement to provide favourable access to foreign capital markets and creditability for the recovery programme. Even so, the recession is likely to be deeper in Iceland than in most other OECD countries owing to the seriousness of the banking crisis and the weakness of private sector balance sheets. Reforms are needed to strengthen prudential regulation and supervision. This Working Paper relates to the 2009 Economic Survey of Iceland.<P>Islande : La crise économique et financière<BR>La crise économique et financière mondiale a frappé l’Islande avec une violence extrême. Les trois principales banques du pays, qui représentaient pratiquement l’ensemble du système bancaire, ont fait faillite en octobre 2008. Elles n’ont pas réussi à résister à la détérioration des marchés de capitaux mondiaux dans le sillage de la faillite de Lehman Brothers. Les banques avaient suivi des stratégies de développement risquées – empruntant notamment sur des marchés financiers étrangers pour soutenir une expansion internationale dynamique des sociétés d’investissement islandaises – ce qui les a rendues vulnérables à la détérioration des marchés de capitaux mondiaux. Elles avaient également atteint une taille trop importante pour que le gouvernement puisse venir à leur rescousse. Lorsque l’accès aux capitaux étrangers a été finalement fermé, les banques ont fait faillite. Les entreprises non financières et les ménages – qui s’étaient massivement endettés ces dernières années profitant de la forte valorisation de leurs garanties – étaient aussi vulnérables à la détérioration de la situation financière mondiale. Dans certains cas, la dette était libellée en devises sans que les emprunteurs n’aient d’actifs ou de revenus dans ces devises susceptibles de compenser le risque de change. À la suite de la crise du système bancaire, les pouvoirs publics ont conclu un accord de confirmation avec le FMI pour assurer des conditions d’accès favorables aux marchés de capitaux étrangers et soutenir la crédibilité du programme de redressement économique. Malgré cela, il est probable que la récession sera plus profonde en Islande que dans la plupart des autres pays de l’OCDE en raison de la gravité de la crise bancaire et de la faiblesse des bilans des entreprises et des patrimoines des ménages dans le secteur privé. Des réformes sont nécessaires pour renforcer la réglementation et la surveillance prudentielle.
    Keywords: currency crisis, Islande, Iceland, financial crisis, crise financière, deleveraging, réduction de l’effet de levier, banking crisis, crise bancaire, IMF stand-by arrangement, accord de confirmation avec le FMI, envolée du cours des actions induite par le crédit, position d’investissements internationaux, crise monétaire, sociétés d’investissement, surveillance et réglementation prudentielle, micro-prudential supervision, surveillance micro-prudentielle, macro-prudential supervision, surveillance macro-prudentielle, credit-induced asset price boom, foreign exchange exposure, investment companies, international investment position, prudential supervision and regulation
    JEL: E44 G21 G24 G28 R21
    Date: 2009–10–09
  9. By: Stein, Jerome L.
    Abstract: Banks should evaluate whether a borrower is likely to default. The author applies several techniques in the extensive mathematical literature of stochastic optimal control/dynamic programming to derive an optimal debt in an environment where there are risks on both the asset and liabilities sides. The vulnerability of the borrowing firm to shocks from either the return to capital, the interest rate or capital gain, increases in proportion to the difference between the Actual and Optimal debt ratio, called the excess debt. As the debt ratio exceeds the optimum, default becomes ever more likely. This paper is A Tale of Two Crises because the analysis is applied to the agricultural debt crisis of the 1980s and to the sub-prime mortgage crisis of 2007. A measure of excess debt is derived, and the author shows that it is an early warning signal of a crisis.
    Keywords: Optimization,banking,stochastic optimal control,agriculture debt crisis,subprime mortgage crisis
    JEL: C61 D81 D91 D92
    Date: 2009

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