nep-rmg New Economics Papers
on Risk Management
Issue of 2010‒02‒05
twelve papers chosen by
Stan Miles
Thompson Rivers University

  1. Assessing the systemic risk of a heterogeneous portfolio of banks during the recent financial crisis By Xin Huang; Hao Zhou; Haibin Zhu
  2. Are banks too big to fail? By Chen Zhou
  3. Crucial relationship among energy commodity prices By Cristina Bencivenga; Giulia Sargenti
  4. Bank capital regulation, the lending channel and business cycles By Zhang, Longmei
  5. Interest rates and bank risk-taking By Delis, Manthos D; Kouretas, Georgios
  6. Have more strictly regulated banking systems fared better during the recent financial crisis? By Ahrend, Rudiger; Arnold, Jens; Murtin, Fabrice
  7. Empirical Asset Pricing with Nonlinear Risk Premia By Aleksandar Mijatovic; Paul Schneider
  8. Returns to private equity: idiosyncratic risk does matter! By Müller, Elisabeth
  9. Does the Interest Risk Premium Predict Housing Prices? By Gogas, Periklis; Pragidis, Ioannis
  10. On behavioral Arrow Pratt risk process with applications to risk pricing, stochastic cash flows, and risk control By Cadogan, Godfrey
  11. Functional overview of financial crises development and propagation By Popa, Catalin C.
  12. The crisis and beyond: thinking outside the box By Hillinger, Claude

  1. By: Xin Huang; Hao Zhou; Haibin Zhu
    Abstract: This paper extends the approach of measuring and stress-testing the systemic risk of a banking sector in Huang, Zhou, and Zhu (2009) to identifying various sources of financial instability and to allocating systemic risk to individual financial institutions. The systemic risk measure, defined as the insurance cost to protect against distressed losses in a banking system, is a summary indicator of market perceived risk that reflects expected default risk of individual banks, risk premia as well as correlated defaults. An application of our methodology to a portfolio of twenty-two major banks in Asia and the Pacific illustrates the dynamics of the spillover effects of the global financial crisis to the region. The increase in the perceived systemic risk, particularly after the failure of Lehman Brothers, was mainly driven by the heightened risk aversion and the squeezed liquidity. Further analysis, which is based on our proposed approach to quantifying the marginal contribution of individual banks to the systemic risk, suggests that “too-big-to-fail” is a valid concern from a macroprudential perspective of bank regulation.
    Keywords: systemic risk, Macroprudential regulation, Portfolio distress loss, Credit default swap, Dynamic conditional correlation
    Date: 2010–01
  2. By: Chen Zhou
    Abstract: Abstract We consider three measures on the systemic importance of a financial institu- tion within a interconnected financial system. Based on the measures, we study the relation between the size of a financial institution and its systemic importance. From both theo- retical model and empirical analysis, we find that in analyzing the systemic risk posed by one financial institution to the system, size should not be considered as a proxy of systemic importance. In other words, the "too big to fail" argument is not always valid, and alter- native measures on systemic importance should be considered. We provide the estimation methodology of systemic importance measures under the multivariate Extreme Value Theory (EVT) framework.
    Keywords: Too big to fail; systemic risk; systemic importance; multivariate extreme value theory.
    JEL: F3 G11 G15
    Date: 2010–01
  3. By: Cristina Bencivenga; Giulia Sargenti (Department of Economic Theory and Quantitative Methods for Political Choices,Sapienza University of Rome,)
    Abstract: This study investigates the short and long run relationship between crude oil, natural gas and electricity prices in US and in European commodity markets. The relationship between energy commodities may have several implications for the pricing of derivative products and for risk management purposes. Using daily price data over the period 2001-2009 we perform a correlation analysis to study the short run relationship, while the long run relationship is analyzed using a cointegration framework. The results show an erratic relationship in the short run while in the long run an equilibrium may be identi ed having di erent features for the European and the US markets.
    Keywords: Energy, commodities, prices.
    Date: 2010
  4. By: Zhang, Longmei
    Abstract: This paper develops a Dynamic Stochastic General Equilibrium (DSGE) model to study how the instability of the banking sector can amplify and propagate business cycles. The model builds on Bernanke, Gertler and Gilchrist (BGG) (1999), who consider credit demand friction due to agency cost, but it deviates from BGG in that financial intermediaries have to share aggregate risk with entrepreneurs, and therefore bear uncertainty in their loan portfolios. Unexpected aggregate shocks will drive loan default rate away from expected, and have an impact on both firm and bank's balance sheet via the financial contract. Low bank capital position can create strong credit supply contraction, and have a significant effect on business cycle dynamics. --
    Keywords: Bank capital regulation,banking instability,financial friction,business cycle
    JEL: E32 E44 E52
    Date: 2009
  5. By: Delis, Manthos D; Kouretas, Georgios
    Abstract: In a recent line of research the low interest-rate environment of the early to mid 2000s is viewed as an element that triggered increased risk-taking appetite of banks in search for yield. This paper uses approximately 18,000 annual observations on euro area banks over the period 2001-2008 and presents strong empirical evidence that low interest rates indeed increase bank risk-taking substantially. This result is robust across a number of different specifications that account, inter alia, for the potential endogeneity of interest rates and/or the dynamics of bank risk. Notably, among the banks of the large euro area countries this effect is less pronounced for French institutions, which held on average a relatively low level of risk assets. Finally, the distributional effects of interest rates on bank risk-taking due to individual bank characteristics reveal that the impact of interest rates on risk assets is diminished for banks with higher equity capital and is amplified for banks with higher off-balance sheet items.
    Keywords: Interest rates; bank risk-taking; panel data; euro area banks
    JEL: E43 E52 G21
    Date: 2010–01–01
  6. By: Ahrend, Rudiger; Arnold, Jens; Murtin, Fabrice
    Abstract: We assess whether during the recent financial crisis banking systems in countries with more stringent prudential banking regulation have proved more stable. We find indicators of regulatory strength to be relatively well correlated with the extent to which countries have escaped damage during the recent crisis, as measured either by the degree of equity value destruction in the banking sector or by the fiscal cost of financial sector rescue.
    Keywords: Prudential regulation; banking; stability; financial crisis; crisis cost; banking sector bail-out; banking share prices.
    JEL: G28 G21
    Date: 2009–12–20
  7. By: Aleksandar Mijatovic; Paul Schneider
    Date: 2009
  8. By: Müller, Elisabeth
    Abstract: Owners of private companies often invest a substantial share of their net worth in one company, which exposes them to idiosyncratic risk. For US companies we investigate whether owners require compensation for lack of diversification in the form of higher returns to equity. Exposure to idiosyncratic risk is measured as the share of the owner’s net worth invested in the company. Equity returns are measured as the earnings rate and as capital gains. For both returns measures we find a positive and significant influence of exposure to idiosyncratic risk. This paper improves our understanding of returns to private equity. --
    Keywords: returns to private equity,exposure to idiosyncratic risk,private companies
    JEL: G32 G11 L26
    Date: 2009
  9. By: Gogas, Periklis (Democritus University of Thrace, Department of International Economic Relations and Development); Pragidis, Ioannis (Democritus University of Thrace, Department of International Economic Relations and Development)
    Abstract: In this paper we examine the predictability power of long term risk premium over Housing prices in U.S.A. of a period of 19 years (1991-2009). For reasons that are cited clearly in the text, the interest rate risk premium is preferred over yield curve. Under a probit framework, it is tested whether recent housing pricing bust could have been predicted. We employ adaptive expectations for the formation of the agents’ short-term interest rate expectations. The ability to forecast such price changes is of great importance to investors and analysts of the housing market and for the design of financial institutions’ mortgage policy in a more prudential path.
    Keywords: Housing prices; risk premium; probit; forecasting
    JEL: D58 D74 E31 G21 G32 H20 R20
    Date: 2010–01–26
  10. By: Cadogan, Godfrey
    Abstract: We introduce a closed form behavioural stochastic Arrow-Pratt risk process, decomposed into discrete asymmetric risk seeking and risk averse components that run on different local times in ϵ-disks centered at risk free states. Additionally, we embed Arrow-Pratt (“AP”) risk measure in a simple dynamic system of discounted cash flows with constant volatility, and time varying drift. Signal extraction of Arrow-Pratt risk measure shows that it is highly nonlinear in constant volatility for cash flows. Robust identifying restrictions on the system solution confirm that even for small time periods constant volatility is not a measure of AP risk. By contrast, time-varying volatility measures aspects of embedded AP risk. Whereupon maximal AP risk measure is obtained from a convolution of input volatility and idiosyncratic shocks to the system. We provide four applications for our theory. First, we find that Engle, Ng and Rothschild (1990) Factor-ARCH model for risk premia is misspecified because the factor price of risk is time varying and unstable. Our theory predicts that a hyper-ARCH correction factor is required to remove the Factor-ARCH specification. Second, when applied to analysts beliefs about interest rates and volatility, we find that AP risk measure is a feedback control over stochastic cash flows. Whereupon increased risk aversion to negative shocks to earnings increases volatility. Third, we use an oft cited example of Benes, Shepp and Witsenhausen (1980) to characterize a controlled AP diffusion for a conservative investor who wants to minimize the AP risk process for an asset. Fourth, we recover stochastic differential utility functional from the AP risk process and show how it is functionally equivalent to Duffie and Epstein’s (1992) parametrization.
    Keywords: behavioural Arrow-Pratt risk process; asymmetric risk decomposition; asset pricing; Markov process; local martingale; local time change
    JEL: G12 C00 G31
    Date: 2009–12–31
  11. By: Popa, Catalin C.
    Abstract: The U.S. sub-prime crise developed in the last few months as a dangerous syncope for the entire international financial system, recall for the rethinking of market functionality, revealing the international institutional weakness in financial system supervision on global scale. The mortgage volatility induced by the international dereglementation and derivates contemporary burst, correlated with a relaxed supervision framework, transformed progressively the credit market into a system “bubble”, making possible the distortion of real estates values toward those levels forced by creditors. Throughout a weakness chain, many financial institutions, determined by a savage competition on this sector, left away the prudence and borrowed money from different investors, guarantying the long terms transactions, with short time derivates from speculative short-term market, supplying the bubble. In this context, the paperwork is meant to recall for reinventing the risks models, so that the crises to be anticipated earlier than its development moment.
    Keywords: globalization; financial crise; global economy; monetary system; international management
    JEL: F42 F34 F30 G3
    Date: 2009–01–19
  12. By: Hillinger, Claude
    Abstract: In this paper the author attempts an analysis of the current financial/economic crisis that is wider ranging and more fundamental than he has been able to find. For this purpose he reviews some social science literature that views the current crisis as an episode in the secular decline of the United States and more generally of the Western Democracies. The timidity of current reforms, which is striking when compared to those that followed the excesses of the Gilded Age and the Great Depression, can be understood in this framework. The author discusses alternatives to the financial bailouts and shows how the crisis could have been dealt with more efficiently and at little cost to taxpayers. Finally, he discusses fundamental reforms that would greatly reduce the volatility of financial markets and increase their efficiency. --
    Keywords: Deficit financing,financial crisis,financial instability,full reserve banking,toxic assets
    JEL: E31 E42 E58
    Date: 2010

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