nep-rmg New Economics Papers
on Risk Management
Issue of 2009‒12‒05
six papers chosen by
Stan Miles
Thompson Rivers University

  1. Financial (in)stability, supervision and liquidity injections: a dynamic general equilibrium approach By Gregory de Walque; Olivier Pierrard; Abdelaziz Rouabah
  2. Worst-Case Value-at-Risk of Non-Linear Portfolios By Steve Zymler; Daniel Kuhn; Berc Rustem
  3. Assessing the Relationship between Probability of Default and Loss Given Default in an Agricultural Loan Portfolio By Sakaimbo, Nicholas K.; Pederson, Glenn D.
  4. Liquidity Scenario Analysis in the Luxembourg Banking Sector By ?tefan Rychtárik
  5. Assessing the influence of spot price predictability on electricity futures hedging By Torro, Hipolit
  6. On Loss Functions and Ranking Forecasting Performances of Multivariate Volatility Models By Sébastien Laurent; Jeroen Rombouts; Francesco Violente

  1. By: Gregory de Walque; Olivier Pierrard; Abdelaziz Rouabah
    Abstract: This paper develops a dynamic stochastic general equilibrium model with interactions between a heterogeneous banking sector and other private agents. We introduce endogenous default probabilities for both firms and banks, and allow for bank regulation and liquidity injection into the interbank market. Our aim is to understand the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real data and used for simulations. We show that liquidity injections reduce financial instability but have ambiguous effects on output fluctuations. The model also confirms the partial equilibrium literature results on the procyclicality of Basel II.
    Keywords: DSGE, Banking sector, Default risk, Supervision, Money
    JEL: E13 E20 G21 G28
    Date: 2008–10
  2. By: Steve Zymler; Daniel Kuhn; Berc Rustem
    Abstract: Portfolio optimization problems involving Value-at-Risk (VaR) are often computationally intractable and require complete information about the return distribution of the portfolio constituents, which is rarely available in practice. These difficulties are further compounded when the portfolio contains derivatives. We develop two tractable conservative approximations for the VaR of a derivative portfolio by evaluating the worst-case VaR over all return distributions of the derivative underliers with given first- and second-order moments. The derivative returns are modelled as convex piecewise linear or - by using a delta-gamma approximation - as (possibly non-convex) quadratic functions of the returns of the derivative underliers. These models lead to new Worst-Case Polyhedral VaR (WCPVaR) and Worst-Case Quadratic VaR (WCQVaR) approximations, respectively. WCPVaR is a suitable VaR approximation for portfolios containing long positions in European options expiring at the end of the investment horizon, whereas WCQVaR is suitable for portfolios containing long and/or short positions in European and/or exotic options expiring beyond the investment horizon. We prove that WCPVaR and WCQVaR optimization can be formulated as tractable second-order cone and semidefinite programs, respectively, and reveal interesting connections to robust portfolio optimization. Numerical experiments demonstrate the benefits of incorporating non-linear relationships between the asset returns into a worst-case VaR model.
    Keywords: Value-at-Risk, Derivatives, Robust Optimization, Second-Order Cone Programming, Semidefinite Programming
    Date: 2009–08–18
  3. By: Sakaimbo, Nicholas K.; Pederson, Glenn D.
    Keywords: Agricultural Finance,
    Date: 2009–11
  4. By: ?tefan Rychtárik
    Abstract: This paper aims to develop the basis for an approach to measure the liquidity risk sensitivity of banks in Luxembourg and to test it on real banking sector data. For this purpose we have developed four different scenarios: run on a bank, use of committed loans by counterparties, netting of the position with the parent financial group and changes in conditions of refinancing operations with the Eurosystem. The impact of all four simulations is measured by relative changes of liquidity ratios that have been introduced for this purpose. In a second step, this methodology is tested on a sample of 32 banks active in the Luxembourg banking sector aiming at identifying the most severe scenario or a combination of scenarios and the most vulnerable banks of the sample.
    Keywords: Liquidity risk, Scenario analysis, Banking sector, Stress testing
    JEL: G21
    Date: 2009–09
  5. By: Torro, Hipolit
    Abstract: A common feature of energy prices is that spot price changes are partially predictable due to weather and demand seasonalities. This paper follows the Ederington and Salas (2008) framework and considers the expected change in spot prices when minimum variance hedge ratios are computed. The poor effectiveness of hedging strategies obtained in previous studies on electricity was because the standard hedging approach underestimates the effectiveness of hedging. In the empirical study made in this paper, weekly spot price risk is hedged with weekly futures in the Nord Pool electricity market. In this case, the optimal selection of the futures contract may produce risk reductions whose values vary between 60% and 80% – depending on the hedging duration (one to three weeks) and the analysed sub-period (in-sample and out-of-sample sub-periods).
    Keywords: electricity markets; futures; hedging ratio;electricity price risk
    JEL: G11 L94 G13
    Date: 2009–03–31
  6. By: Sébastien Laurent; Jeroen Rombouts; Francesco Violente
    Abstract: A large number of parameterizations have been proposed to model conditional variance dynamics in a multivariate framework. However, little is known about the ranking of multivariate volatility models in terms of their forecasting ability. The ranking of multivariate volatility models is inherently problematic because it requires the use of a proxy for the unobservable volatility matrix and this substitution may severely affect the ranking. We address this issue by investigating the properties of the ranking with respect to alternative statistical loss functions used to evaluate model performances. We provide conditions on the functional form of the loss function that ensure the proxy-based ranking to be consistent for the true one - i.e., the ranking that would be obtained if the true variance matrix was observable. We identify a large set of loss functions that yield a consistent ranking. In a simulation study, we sample data from a continuous time multivariate diffusion process and compare the ordering delivered by both consistent and inconsistent loss functions. We further discuss the sensitivity of the ranking to the quality of the proxy and the degree of similarity between models. An application to three foreign exchange rates, where we compare the forecasting performance of 16 multivariate GARCH specifications, is provided. <P>Un grand nombre de méthodes de paramétrage ont été proposées dans le but de modéliser la dynamique de la variance conditionnelle dans un cadre multivarié. Toutefois, on connaît peu de choses sur le classement des modèles de volatilité multivariés, du point de vue de leur capacité à permettre de faire des prédictions. Le classement des modèles de volatilité multivariés est forcément problématique du fait qu’il requiert l’utilisation d’une valeur substitutive pour la matrice de la volatilité non observable et cette substitution peut influencer sérieusement le classement. Nous abordons ce problème en examinant les propriétés du classement en relation avec les fonctions de perte statistiques alternatives utilisées pour évaluer la performance des modèles. Nous présentons des conditions liées à la forme fonctionnelle de la fonction de perte qui garantissent que le classement fondé sur une valeur de substitution est constant par rapport au classement réel, c’est-à-dire à celui qui serait obtenu si la matrice de variance réelle était observable. Nous établissons un vaste ensemble de fonctions de perte qui produisent un classement constant. Dans le cadre d’une étude par simulation, nous fournissons un échantillon de données à partir d’un processus de diffusion multivarié en temps continu et comparons l’ordre généré par les fonctions de perte constantes et inconstantes. Nous approfondissons la question de la sensibilité du classement à la qualité de la substitution et le degré de ressemblance entre les modèles. Une application à trois taux de change est proposée et, dans ce contexte, nous comparons l’efficacité de prédiction de 16 paramètres du modèle GARCH multivarié (approche d’hétéroscédasticité conditionnelle autorégressive généralisée).
    Keywords: Volatility, multivariate GARCH, matrix norm, loss function, model confidence set, Volatilité, modèle GARCH multivarié, norme matricielle, fonction de perte, ensemble de modèles de confiance.
    Date: 2009–11–01

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