New Economics Papers
on Risk Management
Issue of 2010‒02‒27
eleven papers chosen by

  1. Pension Funds’ Risk-Management Framework: Regulation and Supervisory Oversight By Fiona Stewart
  2. Corporate Risk Management and Dividend Signaling Theory By Georges Dionne; Karima Ouederni
  3. Loss distributions conditional on defaults By Dirk Tasche
  4. Default Risk Modeling Beyond the First-Passage Approximation. I. Extended Black-Cox Model By Yuri Katz; Nikolai Shokhirev
  5. Modelling Co-movements and Tail Dependency in the International Stock Market via Copulae By Katja Ignatieva; Eckhard Platen
  6. Constant proportion debt obligations: a post-mortem analysis of rating models By Michael B. Gordy; Søren Willemann
  7. Illiquidity, insolvency, and banking regulation By Cao, Jin
  8. Optimal consumption and investment with bounded downside risk for power utility functions By Claudia Kluppelberg; Serguei Pergamenchtchikov
  9. Regulation Simulation By Philip Maymin
  10. The Hazards of Propping Up: Bubbles and Chaos By Philip Maymin
  11. How Does Life Settlement Affect the Primary Life Insurance Market? By Hanming Fang; Edward Kung

  1. By: Fiona Stewart
    Abstract: Drawing on the experience of the pensions and other financial sectors, this paper examines what sort of risk-management framework pension funds should have in place. Such frameworks are broken down into four main categories: management oversight and culture; strategy and risk assessment; control systems; and information and reporting. Ways in which supervisory authorities can check that such systems are operating are also considered, with a check list provided to assist pension supervisory authorities with their oversight of this important area.<P>Cadre pour la gestion des risques des fonds de pension : réglementation et surveillance<BR>A partir de l’expérience du secteur des retraites et des autres activités financières, ce document examine le type de cadre de gestion des risques dont devraient être dotés les fonds de pension. Un tel cadre devrait reposer sur quatre grands piliers : surveillance de la gestion et culture de gestion ; stratégie et évaluation des risques ; systèmes de contrôle ; information et reporting. Ce document traite également des modalités de surveillance de ces systèmes par les instances de supervision et il contient une liste de référence à l’intention des autorités compétentes à l’égard des organismes de retraite.
    Keywords: pensions, risk-management, risk assessment, internal controls, retraites, gestion des risques, évaluation des risques, contrôles internes
    JEL: G23 G32
    Date: 2010–02
  2. By: Georges Dionne; Karima Ouederni
    Abstract: This paper investigates the effect of corporate risk management on dividend policy. We extend the signaling framework of Bhattacharya (1979) by including the possibility of hedging the future cash flow. We find that the higher the hedging level, the lower the incremental dividend. This result is in line with the purpoted positive relation between information asymmetry and dividend policy (e.g., Miller and Rock, 1985) and the assertion that risk management alleviates the information asymmetry problem (e.g., DaDalt et al., 2002). Our theoretical model has testable implications.
    Keywords: Signaling theory, Dividend policy, Risk management policy, Corporate hedging, Information asymmetry
    JEL: G35 G32 D82
    Date: 2010
  3. By: Dirk Tasche
    Abstract: The impact of default events on the loss distribution of a credit portfolio can be assessed by determining the loss distribution conditional on these events. While it is conceptually easy to estimate loss distributions conditional on default events by means of Monte Carlo simulation, it becomes impractical for two or more simultaneous defaults as the conditioning event is extremely rare. We provide an analytical approach to the calculation of the conditional loss distribution for the CreditRisk+ portfolio model with independent random loss given default distributions. The analytical solution for this case can be used to study the properties of the conditional loss distributions and to discuss how they relate to the identification of risk concentrations.
    Date: 2010–02
  4. By: Yuri Katz; Nikolai Shokhirev
    Abstract: We develop a generalization of the Black-Cox structural model of default risk. The extended model captures uncertainty related to firms ability to avoid default even if companys liabilities momentarily exceeding its assets. Diffusion in a linear potential with the radiation boundary condition is used to mimic a companys default process. The exact solution of the corresponding Fokker-Planck equation allows for derivation of analytical expressions for the cumulative probability of default and the relevant hazard rate. The obtained closed formulas fit well the historical data on global corporate defaults and demonstrate the split behavior of credit spreads for bonds in different categories of speculative-grade ratings with varying time to maturity.
    Date: 2010–02
  5. By: Katja Ignatieva (House of Finance, Goethe University); Eckhard Platen (School of Finance and Economics, University of Technology, Sydney)
    Keywords: international equity market indices; Student-t distribution; symmetric generalized hyperbolic distribution; time-varying copula; Value-at-Risk; world stock index
    JEL: C13 C15 C16 C32 C52
    Date: 2009–12–01
  6. By: Michael B. Gordy; Søren Willemann
    Abstract: In its complexity and its vulnerability to market volatility, the CPDO might be viewed as the poster child for the excesses of financial engineering in the credit market. This paper examines the CPDO as a case study in model risk in the rating of complex structured products. We demonstrate that the models used by S&P and Moody's would have assigned very low probability to the spread levels realized in the investment grade corporate credit default swap market in late 2007, even though these spread levels were comparable to those of 2002. The spread levels realized in the first quarter of 2008 would have been assigned negligibly small probabilities. Had the models put non-negligible likelihood on attaining these high spread levels, the CPDO notes could never have achieved investment grade status. We conclude with larger lessons for the rating of complex products and for modeling credit risk in general.
    Date: 2010
  7. By: Cao, Jin
    Abstract: This paper provides a compact framework for banking regulation analysis in the presence of uncertainty between systemic liquidity and solvency shocks. Extending the work by Cao & Illing (2009a, b), it is shown that systemic liquidity shortage arises endogenously as part of the inferior mixed strategy equilibrium. The paper compares dierent traditional regulatory policies which intend to fix the ineciencies, and argues that the co-existence of illiquidity and insolvency problems adds extra cost for banking regulation and makes some schemes that are optimal under pure illiquidity risks (such as liquidity regulation with lender of last resort policy) fail. The regulatory cost can be minimized by combining the advantages of several instruments.
    Keywords: liquidity risk; insolvency risk; liquidity regulation; equity requirement
    JEL: E5 G21 G28
    Date: 2010–02
  8. By: Claudia Kluppelberg (LMRS); Serguei Pergamenchtchikov (LMRS)
    Abstract: We investigate optimal consumption and investment problems for a Black-Scholes market under uniform restrictions on Value-at-Risk and Expected Shortfall. We formulate various utility maximization problems, which can be solved explicitly. We compare the optimal solutions in form of optimal value, optimal control and optimal wealth to analogous problems under additional uniform risk bounds. Our proofs are partly based on solutions to Hamilton-Jacobi-Bellman equations, and we prove a corresponding verification theorem. This work was supported by the European Science Foundation through the AMaMeF programme.
    Date: 2010–02
  9. By: Philip Maymin
    Abstract: A deterministic trading strategy by a representative investor on a single market asset, which generates complex and realistic returns with its first four moments similar to the empirical values of European stock indices, is used to simulate the effects of financial regulation that either pricks bubbles, props up crashes, or both. The results suggest that regulation makes the market process appear more Gaussian and less complex, with the difference more pronounced for more frequent intervention, though particular periods can be worse than the non-regulated version, and that pricking bubbles and propping up crashes are not symmetrical.
    Date: 2010–02
  10. By: Philip Maymin
    Abstract: In the current environment of financial distress, many governments are likely to soon become major holders of financial assets, but the policy debate focuses only on the likelihood and extent of short-term market stabilization. This paper shows that government intervention and propping up are likely to lead to long-term bubbles and even wildly chaotic behavior. The discontinuities occur when the committed capital reaches a critical amount that depends on just two parameters: the market impact of trading and the target exposure percentage.
    Date: 2010–02
  11. By: Hanming Fang (Department of Economics, University of Pennsylvania); Edward Kung (Department of Economics, Duke University)
    Abstract: We study the effect of the life settlement market on the structure of long term contracts offered by the primary market for life insurance, as well as the effect on consumer welfare, using a dynamic model of life insurance with one sided commitment and bequest-driven lapsation. We show that the presence of life settlement affects the extent as well as the form of dynamic reclassification risk insurance in the equilibrium of the primary insurance market, and that the settlement market generally leads to lower consumer welfare. We also examine the primary insurers’ response to the settlement market when they can offer enriched contracts by specifying optimally chosen cash surrender values (CSVs).
    Keywords: Life insurance, dynamic insurance, secondary market
    JEL: G22 L11
    Date: 2010–02–09

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