nep-rmg New Economics Papers
on Risk Management
Issue of 2010‒03‒06
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Information Asymmetry in Pricing of Credit Derivatives By Caroline Hillairet; Ying Jiao
  2. Shaping up the company’s internal investment fund through separation portfolios By Rodolfo Apreda
  3. Accounting for risk of non linear portfolios: a novel Fourier approach By Giacomo Bormetti; Valentina Cazzola; Danilo Delpini; Giacomo Livan
  4. Risk Appetite and Endogenous Risk By Jean-Pierre Zigrand; Hyun Song Shin; Jon Danielsson
  5. Unlearned Lessons from Risk, Debt Service, Bank Credit, and Asymmetric Information By Muradali V. Ibrahimo; Carlos P. Barros;
  6. Risk heterogeneity and credit supply: evidence from the mortgage market By Bealey, Timothy; Meads, Neil; Surico, Paolo
  7. Modelling a Housing and Mortgage Crisis By Alexandros Vardoulakis; Dimitrios Tsomocos; Charles Goodhart
  8. Dynamic risk measures By Beatrice Acciaio; Irina Penner
  9. Spin Glass Model of Operational Risk By M. Bardoscia; P. Facchi; S. Pascazio; A. Trullo
  10. Defining and measuring systematic risk. By Eijffinger, S.C.W.
  11. Failing and Merging as Competing Alternatives during Times of Financial Distress: Evidence from the Colombian Financial Crisis By Jose Eduardo Gómez-González; Juan Carlos Mendoza
  12. A Productivity analysis of Eastern European banking taking into account risk decomposition and environmental variables By Karligash Kenjegalieva; Richard Simper
  13. Risk assessment for uncertain cash flows: Model ambiguity, discounting ambiguity, and the role of bubbles By Beatrice Acciaio; Hans Foellmer; Irina Penner
  14. How Does Life Settlement Affect the Primary Life Insurance Market? By Hanming Fang; Edward Kung

  1. By: Caroline Hillairet (CMAP); Ying Jiao (PMA)
    Abstract: We study the pricing of credit derivatives with asymmetric information. The managers have complete information on the value process of the firm and on the default threshold, while the investors on the market have only partial observations, especially about the default threshold. Different information structures are distinguished using the framework of enlargement of filtrations. We specify risk neutral probabilities and we evaluate default sensitive contingent claims in these cases.
    Date: 2010–02
  2. By: Rodolfo Apreda
    Abstract: This research paper sets forth that an alternative for managing the internal investment fund of any company, lies on separation portfolios. Firstly, the company’s internal investment portfolio is built up within the context of the incremental cash-flow model. Next, separation portfolios are introduced and consequential features for this paper are predicated upon them: firstly, they provide an easier framework for risk-management; secondly, their risk-return profile bring about a down-to-earth performance benchmark. Afterwards, the internal investment portfolio is mapped out like a distinctive separation portfolio. Lastly, pragmatic consequences and some corporate governance advantages of this financial engineering will follow.
    Keywords: separation portfolios, portfolio management, incremental cash-flow model, corporate governance, internal investment fund, risk metrics
    JEL: G11 G34 G32
    Date: 2010–02
  3. By: Giacomo Bormetti; Valentina Cazzola; Danilo Delpini; Giacomo Livan
    Abstract: The presence of non linear instruments is responsible for the emergence of non Gaussian features in the price changes distribution of realistic portfolios, even for Normally distributed risk factors. This is especially true for the benchmark Delta Gamma Normal model, which in general exhibits exponentially damped power law tails. We show how the knowledge of the model characteristic function leads to Fourier representations for two standard risk measures, the Value at Risk and the Expected Shortfall, and for their sensitivities with respect to the model parameters. We detail the numerical implementation of our formulae and we emphasizes the reliability and efficiency of our results in comparison with Monte Carlo simulation.
    Date: 2010–02
  4. By: Jean-Pierre Zigrand; Hyun Song Shin; Jon Danielsson
    Abstract: Risk is endogenous. Equilibrium risk is the fixed point of the mapping that takes perceived risk to actual risk. When risk-neutral traders operate under Value-at-Risk constraints, market conditions exhibit signs of fluctuating risk appetite and amplification of shocks through feedback effects. Correlations in returns emerge even when underlying fundamental shocks are independent. We derive a closedform solution of equilibrium returns, correlation and volatility by solving the fixed point problem in closed form. We apply our results to stochastic volatility and option pricing.
    Date: 2010–02
  5. By: Muradali V. Ibrahimo; Carlos P. Barros;
    Abstract: This paper presents a model of the economy that explains the economic bubbles, based on bank credit, debt service and risk. In the first period of the model, banks offer too much credit seeking to maximise their expected profits. The excessive debt created in the boom period generates, in the second-period, the expansion of the debt bubble, which induces failures in the financial market and the downturn of the overall economy. Business cycles are inherent in the free market systems. They may be caused by endogenous factors of financial markets and, given the absence of adequate, effective regulation, they may be unavoidable. Credit crunch in the financial market is therefore highly probable. In order to reduce substantially the risk of such occurrences, economic and financial policies are proposed. Key words: Asymmetric information, bank credit, risk, debt service and business cycle
    Date: 2009–10
  6. By: Bealey, Timothy; Meads, Neil; Surico, Paolo
    Abstract: This paper uses a unique data set on more than 600,000 mortgage contracts to estimate a credit supply function which allows for risk-heterogeneity. Non-linearity is modelled using quantile regressions. We propose an instrumental variable approach in which changes in the tax treatment of housing transactions are used as an instrument for loan demand. The results are suggestive of considerable risk heterogeneity with riskier borrowers penalised more for borrowing more.
    Keywords: individual mortgage data; credit supply; risk pricing; heterogeneous effects; instrumental variable.
    JEL: D10 E21 G21
    Date: 2010–02
  7. By: Alexandros Vardoulakis; Dimitrios Tsomocos; Charles Goodhart
    Abstract:  The purpose of this paper is to explore financial instability in this case due to a housing crisis and defaults on mortgages. The model incorporates heterogeneous banks and households. Mortgages are secured by collateral, which is equal to the amount of housing which agents purchase. Individual default is spread through the economy via the interbank market. Several comparative statics illustrate the directional effects of a variety of shocks in the economy.
    Date: 2010–02
  8. By: Beatrice Acciaio; Irina Penner
    Abstract: This paper gives an overview of the theory of dynamic convex risk measures for random variables in discrete time setting. We summarize robust representation results of conditional convex risk measures, and we characterize various time consistency properties of dynamic risk measures in terms of acceptance sets, penalty functions, and by supermartingale properties of risk processes and penalty functions.
    Date: 2010–02
  9. By: M. Bardoscia; P. Facchi; S. Pascazio; A. Trullo
    Abstract: We analyze operational risk in terms of a spin glass model. Several regimes are investigated, as a functions of the parameters that characterize the dynamics. The system is found to be robust against variations of these parameters. We unveil the presence of limit cycles and scrutinize the features of the asymptotic state.
    Date: 2010–02
  10. By: Eijffinger, S.C.W. (Tilburg University)
    Date: 2010
  11. By: Jose Eduardo Gómez-González; Juan Carlos Mendoza
    Abstract: This paper studies the determinants of individual bank failures and M&A processes in Colombia during the financial crisis of the late 1990s. Using bank-specific data we estimate competing risk hazards models and find that while profitability and capitalization are the most important determinants of the probability of failing, bank´s size, efficiency and capitalization are the main determinants of the probability of participating in an integration process. All else constant, an increase in capitalization reduces the probability of disappearing, whether due to the occurrence of bankruptcy, a merge or an acquisition. However, a marginal increase in capitalization reduces significantly more the probability of bankruptcy than the probability of integration. This study is the first to present a competing risks hazard model to identify covariates that excerpt significant influence on the probability of failing or merging for banks of an emerging economy.
    Date: 2010–02–21
  12. By: Karligash Kenjegalieva (Dept of Economics, Loughborough University); Richard Simper (Dept of Economics, Loughborough University)
    Abstract: This paper develops a new Luenberger productivity which is applied to a technology where the desirable and undesirable outputs are jointly produced and are possibly negative. The components of this Luenberger productivity index - the efficiency change and the components of the technological shift - are then decomposed into factors determined by the technology, adjusted for ‘risk and environment’, ‘risk management’ and ‘environmental effects’. The method is applied to Central and Eastern European banks operating during 1998–2003 utilising three alternative input/output methodologies (intermediation, production and profit/revenue). Additionally, the comparative analysis of the sensitivity of the productivity indices in the choice of the methodologies is undertaken using statistical and kernel density tests. It is found that the main driver of productivity change in Central and Eastern European banks is technological improvement, which, in the beginning of the analysed period, hinged on the banks’ ability to capitalise on advanced technology and successfully take into account risk and environmental factors. Whereas, in the later sampled periods, we show that one of the most important factors of technological improvement/decline is risk management. Finally, the tests employed confirm previous findings, such as Pasiouras (2008) in this journal, that different input/output methodologies produce statistically different productivity results. Indeed, we also find that external factors, such as a risk in the economy and banking production, and a ‘corruption perception’ affect the productivity of banks.
    Keywords: Luenberger productivity index; DEA; banking; undesirable outputs; negative data.
    JEL: C14 G2 L1
    Date: 2010–01
  13. By: Beatrice Acciaio; Hans Foellmer; Irina Penner
    Abstract: We study the risk assessment of uncertain cash flows in terms of dynamic convex risk measures for processes as introduced in Cheridito, Delbaen, and Kupper (2006). These risk measures take into account not only the amounts but also the timing of a cash flow. We discuss their robust representation in terms of suitably penalized probability measures on the optional sigma-field. This yields an explicit analysis both of model and discounting ambiguity. We focus on supermartingale criteria for different notions of time consistency. In particular we show how bubbles may appear in the dynamic penalization, and how they cause a breakdown of asymptotic safety of the risk assessment procedure.
    Date: 2010–02
  14. By: Hanming Fang; Edward Kung
    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).
    JEL: G22 L11
    Date: 2010–02

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