nep-rmg New Economics Papers
on Risk Management
Issue of 2009‒10‒31
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Capital adequacy and risk management - premises for strengthening financial system stability By Bunea-Bontaş, Cristina Aurora; Lăzărică, Marinela; Petre, Mihaela Cosmina
  2. Australian Bank and Corporate Sector Vulnerabilities--An International Perspective By Patrizia Tumbarello; Elöd Takáts
  3. Risk Management Lessons from the Global Financial Crisis for Derivative Exchanges By Jayanth R. Varma
  4. Systematic risk analysis: first steps towards a new definition of beta By Michel Fliess; Cédric Join
  5. BANKS RISK RACE: A SIGNALING EXPLANATION By Damien Besancenot; Radu Vranceanu
  6. New Zealand Bank Vulnerabilities in International Perspective By Ray Brooks; Rodrigo Cubero
  7. Mortgage loan securitization and relative loan performance By John Krainer; Elizabeth Laderman
  8. Issues on Hedge Effectiveness Testing By Bunea-Bontaş, Cristina Aurora; Petre, Mihaela Cosmina; Culiţă, Gica
  9. The Effectiveness of Central Bank Interventions During the First Phase of the Subprime Crisis By Heiko Hesse; Nathaniel Frank
  10. Mortgage default and mortgage valuation By John Krainer; Stephen F. LeRoy; Munpyung O
  11. Accounting Discretion of Banks During a Financial Crisis By Luc Laeven; Harry Huizinga
  12. International Risk Sharing During the Globalization Era By Akito Matsumoto; Robert P. Flood; Nancy P. Marion
  13. The determinants of bank capital structure. By Reint Gropp; Florian Heider
  14. Why do markets freeze? By Philip Bond; Yaron Leitner

  1. By: Bunea-Bontaş, Cristina Aurora; Lăzărică, Marinela; Petre, Mihaela Cosmina
    Abstract: In the last decades, we have witnessed the progressive integration of European financial system, as a result of the cumulative effect of markets' liberalization, innovation and globalisation, and of harmonization of the regulations and implementation of financial reforms by the EU Member States. In this context, increased risk of financial instability necessarily requires the development of standards and codes of best practices in order to improve financial system integrity and stability, and to insure the health of the global banking and financial markets. From this perspective, the Basel II Accord represents a true revolution, aiming the improvement of the consistency of capital regulations internationally and better operational risk management practices. As a member of the EU, Romania is currently through the stages of implementation of Basel II, starting 1st of January 2008. As a central bank, NBR main objectives are: to adapt national legislation; to coordinate the efforts of credit institutions to develop new strategies regarding solvency, capital adequacy and measurement system for each risk category; to impose the disclosure requirements for financial reports and to adapt the IT system.
    Keywords: Basel II Accord; capital adequacy; financial system stability; minimum capital requirements; risk management; risk-weighted assets
    JEL: G28 F33 G21
    Date: 2009–06–30
  2. By: Patrizia Tumbarello; Elöd Takáts
    Abstract: This paper focuses on how the exposure to the corporate sector may impact the health of the Australian banking system. It also compares Australian banks with their international peers. Finally, it investigates banks' exposure to credit risk using the new Basel II Pillar 3 disclosure data. The analysis shows that Australian banks have remained very sound by international standards, despite the global financial turmoil. While the international downturn points to several vulnerabilities, the risks from the corporate and household sectors appear to be manageable.
    Keywords: Australia , Banking sector , Banks , Corporate sector , Credit risk , Cross country analysis , Financial assets , Financial soundness indicators , Loans , Private sector , Risk management ,
    Date: 2009–10–14
  3. By: Jayanth R. Varma
    Abstract: During the global financial turmoil of 2007 and 2008, no major derivative clearing house in the world encountered distress while many banks were pushed to the brink and beyond. An important reason for this is that derivative exchanges have avoided using value at risk, normal distributions and linear correlations. This is an important lesson. The global financial crisis has also taught us that in risk management, robustness is more important than sophistication and that it is dangerous to use models that are over calibrated to short time series of market prices. The paper applies these lessons to the important exchange traded derivatives in India and recommends major changes to the current margining systems to improve their robustness. It also discusses directions in which global best practices in exchange risk management could be improved to take advantage of recent advances in computing power and finance theory. The paper argues that risk management should evolve towards explicit models based on coherent risk measures (like expected shortfall), fat tailed distributions and non linear dependence structures (copulas).
    Date: 2009–03–03
  4. By: Michel Fliess (LIX - Laboratoire d'informatique de l'école polytechnique - CNRS : UMR7161 - Polytechnique - X, INRIA Saclay - Ile de France - ALIEN - INRIA - Polytechnique - X - CNRS : UMR - Ecole Centrale de Lille); Cédric Join (INRIA Saclay - Ile de France - ALIEN - INRIA - Polytechnique - X - CNRS : UMR - Ecole Centrale de Lille, CRAN - Centre de recherche en automatique de Nancy - CNRS : UMR7039 - Université Henri Poincaré - Nancy I - Institut National Polytechnique de Lorraine - INPL)
    Abstract: We suggest a new model-free definition of the beta coefficient, which plays an important rôle in systematic risk management. This setting, which is based on the existence of trends for financial time series via nonstandard analysis (Fliess M., Join C.: A mathematical proof of the existence of trends in financial time series, Proc. Int. Conf. Systems Theory: Modelling, Analysis and Control, Fes, 2009, online: leads to convincing computer experiments which are easily implementable.
    Keywords: Quantitative finance; risk analysis; beta; alpha; trends; technical analysis; estimation techniques; forecasting; abrupt changes; nonstandard analysis.
    Date: 2009
  5. By: Damien Besancenot (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Radu Vranceanu (Department of Economics - ESSEC)
    Abstract: Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 …nancial turmoil. But what could have pushed banks to engage in such a risk race? The answer brought by this paper builds on the classical signaling model by Spence. If banks' returns can be observed while risk cannot, less efficient banks can hide their type by taking more risks and paying the same returns as the efficient banks. The latter can signal themselves by taking even higher risks and delivering bigger returns. The game presents several equilibria that are all characterized by excessive risk taking as compared to the perfect information case.
    Keywords: Banking sector, Risk strategy, Risk/return tradeoff, Signaling, Imperfect information.
    Date: 2009–10–14
  6. By: Ray Brooks; Rodrigo Cubero
    Abstract: The global financial crisis is creating stress on banking systems across the world through funding and asset quality shocks. This paper combines different stress scenarios, as well as cross-country analysis, to assess New Zealand bank vulnerabilities to the global crisis and the domestic recession. It finds that a sharp worsening of asset quality would be required to reduce bank capital below the regulatory minimum. On the funding side, a disruption to banks' offshore funding may put pressure on the exchange rate, but would not trigger a systemic liquidity problem.
    Keywords: Banking sector , Banks , Corporate sector , Credit risk , Cross country analysis , Financial assets , Financial crisis , Financial soundness indicators , Household credit , Housing prices , New Zealand , Private sector , Risk management ,
    Date: 2009–10–14
  7. By: John Krainer; Elizabeth Laderman
    Abstract: We compare the ex ante observable risk characteristics and the default rates of securitized mortgage loans and mortgage loans retained by the original lender. We find that privately securitized loans tend to be riskier and to default at a faster rate than loans securitized with the GSEs and lender-retained loans. However, the differences in default rates across investor types are of secondary importance for explaining mortgage defaults compared to more conventional predictors, such as original loan-to-value ratios and the path for house prices. Privately securitized home mortages have conditionally higher expected returns than retained loans, suggesting the presence of risk factors that are unobservable but nonetheless at least partially acknowledged by the market.
    Keywords: Mortgage loans
    Date: 2009
  8. By: Bunea-Bontaş, Cristina Aurora; Petre, Mihaela Cosmina; Culiţă, Gica
    Abstract: The starting point for risk management and hedging lies in understanding a corporation’s exposure to different risks. Hedging is vital for corporate risk management, involving reducing the exposure of the company to particular risks. Hedge effectiveness testing permits firms to assess if they match the timing of the gains and losses of hedged items and their hedging derivatives. In principle, a hedge is highly effective if the changes in fair value or cash flow of the hedged item and the hedging derivative offset each other to a significant extent. This article reviews the concepts of accounting and economic hedging, and presents the requirements for testing the hedge effectiveness.
    Keywords: hedge accounting; hedging effectiveness; hedging ineffectiveness; highly effective; effectiveness test
    JEL: G11 M41
    Date: 2009–10–11
  9. By: Heiko Hesse; Nathaniel Frank
    Abstract: This paper provides evidence that central bank interventions had a statistically significant impact on easing stress in unsecured interbank markets during the first phase of the subprime crisis which began in July 2007. Extraordinary liquidity provisions, such as the Term Auction Facility by the Federal Reserve, are analyzed. First a decomposition of the Libor-OIS spread indicates that credit premia increased in importance as the crisis deepened. Second, using Markov switching models, central bank operations are then graphically associated with reductions in term funding stress. Finally, bivariate VAR and GARCH models are adopted to econometrically quantified these impacts. While helpful in compressing Libor spreads, the economic magnitudes of central interventions have overall not been very large.
    Keywords: Bank credit , Banking sector , Central bank policy , Central banks , Credit risk , Economic models , Financial crisis , Liquidity management , Loans , Monetary policy , Risk management ,
    Date: 2009–09–25
  10. By: John Krainer; Stephen F. LeRoy; Munpyung O
    Abstract: We study optimal exercise by mortgage borrowers of the option to default. Also, we use an equilibrium valuation model incorporating default to show how mortgage yields and lender recovery rates on defaulted mortgages depend on initial loan-to-value ratios when borrowers default optimally. The analysis treats both the frictionless case and the case in which borrowers and/or lenders incur deadweight costs upon default. The model is calibrated using data on California mortgages. We find that the model's principal testable implication for default and mortgage pricing—that default rates and yield spreads will be higher for high loan-to-value mortgages—is borne out empirically.
    Keywords: Mortgage loans ; Mortgage loans - California ; Default (Finance)
    Date: 2009
  11. By: Luc Laeven; Harry Huizinga
    Abstract: This paper shows that banks use accounting discretion to overstate the value of distressed assets. Banks' balance sheets overvalue real estate-related assets compared to the market value of these assets, especially during the U.S. mortgage crisis. Share prices of banks with large exposure to mortgage-backed securities also react favorably to recent changes in accounting rules that relax fair-value accounting, and these banks provision less for bad loans. Furthermore, distressed banks use discretion in the classification of mortgage-backed securities to inflate their books. Our results indicate that banks' balance sheets offer a distorted view of the financial health of the banks.
    Keywords: Accounting , Asset management , Asset prices , Bank accounting , Bank regulations , Banks , Financial crisis , Housing prices , Investment , Liquidity management , Real estate prices ,
    Date: 2009–09–28
  12. By: Akito Matsumoto; Robert P. Flood; Nancy P. Marion
    Abstract: Though theory suggests financial globalization should improve international risk sharing, empirical support has been limited. We develop a simple welfare-based measure that captures how far countries are from the ideal of perfect risk sharing. We then take it to data and find international risk sharing has, indeed, improved during globalization. Improved risk sharing comes mostly from the convergence in rates of consumption growth among countries rather than from synchronization of consumption at the business cycle frequency. Our finding explains why many existing measures fail to detect improved risk sharing-they focus only on risk sharing at the business cycle frequency.
    Keywords: Business cycles , Consumption , Cross country analysis , Economic growth , Economic integration , Economic models , Globalization , International trade , Risk management , Welfare ,
    Date: 2009–09–28
  13. By: Reint Gropp (European Business School, Wiesbaden and Centre for European Economic Research (ZEW) Mannheim, Germany.); Florian Heider (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper shows that mispriced deposit insurance and capital regulation were of second order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms’ leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks’ liability structure away from deposits towards non-deposit liabilities. We find that unobserved timeinvariant bank fixed effects are ultimately the most important determinant of banks’ capital structures and that banks’ leverage converges to bank specific, time invariant targets. JEL Classification: G32, G21.
    Keywords: bank capital, capital regulation, capital structure, leverage.
    Date: 2009–09
  14. By: Philip Bond; Yaron Leitner
    Abstract: Consider the sale of mortgages by a loan originator to a buyer. As widely noted, such a transaction is subject to a severe adverse selection problem: the originator has a natural information advantage and will attempt to sell only the worst mortgages. However, a second important feature of this transaction has received much less attention: both the seller and the buyer may have existing inventories of mortgages similar to those being sold. The authors analyze how the presence of such inventories affects trade. They use their model to discuss implications for regulatory intervention in illiquid markets.
    Keywords: Mortgage loans
    Date: 2009

This nep-rmg issue is ©2009 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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