New Economics Papers
on Risk Management
Issue of 2010‒03‒28
sixteen papers chosen by

  1. Measuring market risk using extreme value theory By Mapa, Dennis S.; Suaiso, Oliver Q.
  2. Recovery Determinants of Distressed Banks: Regulators, Market Discipline, or the Environment? By Tigran Poghosyan; Michael Koetter; Thomas Kick
  3. The Use of GARCH Models in VaR Estimation By Timotheos Angelidis; Alexandros Benos; Stavros Degiannakis
  4. Ratingmodell zur Quantifizierung des Ausfallrisikos von LBO-Finanzierungen By Lang, Michael; Cremers, Heinz; Hentze, Rainald
  5. Risk and the Corporate Structure of Banks By Giovanni Dell’Ariccia; Robert Marquez
  6. Extremal Events in a Bank Operational Losses By Hela Dahen; Georges Dionne; Daniel Zajdenweber
  7. Credit risk model for the Estonian banking sector By Rasmus Kattai
  8. Do Currency Fundamentals Matter for Currency Speculators? By Masahiro Nozaki
  9. Securitized Products, Financial Regulation, and Systemic Risk By Mariko Fujii
  10. Strengthening the resilience of the banking sector: Proposals to strengthen global capital and liquidity regulations By Ojo, Marianne
  11. Asymmetric CAPM dependence for large dimensions: the Canonical Vine Autoregressive Model By HEINEN, AndrŽas; VALDESOGO, Alfonso
  12. Lessons and Policy Implications from the Global Financial Crisis By Luc Laeven; Deniz Igan; Stijn Claessens; Giovanni Dell'Ariccia
  13. Earthquake Risk and Earthquake Catastrophe Insurance for the People's Republic of China By Wang, Zifa; Lin, Tun; Walker, George
  14. Stock Market Anomalies: A Calender Effect in BSE-Sensex By Chandra, Abhijeet
  15. Of floods and droughts : the economic and financial crisis of 2008 By Islam, Roumeen; Nallari, Raj
  16. The Financial Crisis and the Regulation of Credit Rating Agencies: A European Banking Perspective By Siegfried Utzig

  1. By: Mapa, Dennis S.; Suaiso, Oliver Q.
    Abstract: The adoption of Basel II standards by the Bangko Sentral ng Pilipinas initiates financial institutions to develop value-at-risk (VaR) models to measure market risk. In this paper, two VaR models are considered using the peaks-over-threshold (POT) approach of the extreme value theory: (1) static EVT model which is the straightforward application of POT to the bond benchmark rates; and (2) dynamic EVT model which applies POT to the residuals of the fitted AR-GARCH model. The results are compared with traditional VaR methods such as RiskMetrics and AR-GARCH-type models. The relative size, accuracy and efficiency of the models are assessed using mean relative bias, backtesting, likelihood ratio tests, loss function, mean relative scaled bias and computation of market risk charge. Findings show that the dynamic EVT model can capture market risk conservatively, accurately and efficiently. It is also practical to use because it has the potential to lower a bank’s capital requirements. Comparing the two EVT models, the dynamic model is better than static as the former can address some issues in risk measurement and effectively capture market risks.
    Keywords: extreme value theory; peaks-over-threshold; value-at-risk; market risk; risk management
    JEL: G12 C22 C01
    Date: 2009–12
  2. By: Tigran Poghosyan; Michael Koetter; Thomas Kick
    Abstract: Based on detailed regulatory intervention data among German banks during 1994-2008, we test if supervisory measures affect the likelihood and the timing of bank recovery. Severe regulatory measures increase both the likelihood of recovery and its duration while weak measures are insignificant. With the benefit of hindsight, we exclude banks that eventually exit the market due to restructuring mergers. Our results remain intact, thus providing no evidence of "bad" bank selection for intervention purposes on the side of regulators. More transparent publication requirements of public incorporation that indicate more exposure to market discipline are barely or not at all significant. Increasing earnings and cleaning credit portfolios are consistently of importance to increase recovery likelihood, whereas earnings growth accelerates the timing of recovery. Macroeconomic conditions also matter for bank recovery. Hence, concerted micro- and macro-prudential policies are key to facilitate distressed bank recovery.
    Keywords: Bank regulations , Bank resolution , Bank soundness , Bank supervision , Banking crisis , Banks , Capital , Credit risk , Economic models , Germany , Risk management ,
    Date: 2010–02–02
  3. By: Timotheos Angelidis; Alexandros Benos; Stavros Degiannakis
    Abstract: We evaluate the performance of an extensive family of ARCH models in modelling daily Value-at-Risk (VaR) of perfectly diversified portfolios in five stock indices, using a number of distributional assumptions and sample sizes. We find, first, that leptokurtic distributions are able to produce better one-step-ahead VaR forecasts; second, the choice of sample size is important for the accuracy of the forecast, whereas the specification of the conditional mean is indifferent. Finally, the ARCH structure producing the most accurate forecasts is different for every portfolio and specific to each equity index.
    Keywords: Value at Risk, GARCH estimation, Backtesting, Volatility forecasting, Quantile Loss Function.
    Date: 2010
  4. By: Lang, Michael; Cremers, Heinz; Hentze, Rainald
    Abstract: Credit risk measurement and management become more important in all financial institutions in the light of the current financial crisis and the global recession. This particularly applies to most of the complex structured financing forms whose risk cannot be quantified with com-mon rating methods. This paper explains the risk associated with leveraged buyout (LBO) transactions and demon-strates the implementation of a new rating method based on a logistic regression (logit func-tion), a rating system commonly used by banks. The system estimates probabilities of default for various time horizons between three months and two years. Input variables contain information about the transaction (based on financial covenants) as well as macroeconomic parameters. The most important factor is a firm’s cyclicality. Leve-rage and capital structure are statistically significant and are also utilized in this ratings sys-tem, however they are far less important compared to cyclicality when this method is em-ployed. The validation results demonstrate a very good calibration and discriminatory power between defaulting and non-defaulting LBO transactions. --
    Keywords: Logistic Regression,Logit,Credit Risk,Credit Risk Modeling,Rating,Probabili-ty of Default,PD,Basel II,Rating Validation,Rseudo-R-Square,Alpha Error,Beta Error,Minimum Classification Error,Cumulative Accuracy Profile Curve,CAP,Receiver Operating Characteristic,ROC,Area Under the Curve,AUC,Brier Score,Bootstrapping,Leveraged Buyout,LBO,Buyout,Leveraged Finance,Private Equity
    JEL: C01 C02 C12 C22 C52 G11 G21 G24 G32 G33
    Date: 2010
  5. By: Giovanni Dell’Ariccia; Robert Marquez
    Abstract: We identify different sources of risk as important determinants of banks' corporate structures when expanding into new markets. Subsidiary-based corporate structures benefit from greater protection against economic risk because of affiliate-level limited liability, but are more exposed to the risk of capital expropriation than are branches. Thus, branch-based structures are preferred to subsidiary-based structures when expropriation risk is high relative to economic risk, and vice versa. Greater cross-country risk correlation and more accurate pricing of risk by investors reduce the differences between the two structures. Furthermore, the corporate structure affects bank risk taking and affiliate size.
    Keywords: Capital , Corporate governance , Credit risk , Economic models , Financial risk , Foreign direct investment , International banking , International banks , Political economy ,
    Date: 2010–02–19
  6. By: Hela Dahen; Georges Dionne; Daniel Zajdenweber
    Abstract: Operational losses are true dangers for banks since their maximal values to signal default are difficult to predict. This risky situation is unlike default risk whose maximum values are limited by the amount of credit granted. For example, our data from a very large US bank show that this bank could suffer, on average, more than four major losses a year. This bank had seven losses exceeding hundreds of millions of dollars over its 52 documented losses of more than $1 million during the 1994-2004 period. The tail of the loss distribution (a Pareto distribution without expectation whose characteristic exponent is 0.95 ? ? ? 1) shows that this bank can fear extreme operational losses ranging from $1 billion to $11 billion, at probabilities situated respectively between 1% and 0.1%. The corresponding annual insurance premiums are evaluated to range between $350 M and close to $1 billion.
    Keywords: Bank operational loss, value at risk, Pareto distribution, insurance premium, extremal event
    JEL: G21 G28
    Date: 2010
  7. By: Rasmus Kattai
    Abstract: This paper gives an overview of the credit risk model that has been developed for the Estonian banking system. The non-performing loans and loan loss provisions of the four largest banks and the rest of the banking sector have been modelled conditional on the underlying economic conditions: economic growth, unemployment, interest rates, in- flation, indebtedness and credit growth. The model highlights the importance of economic growth as the most influential factor behind the soundness of the banking sector in the latest downturn. The expected fall in output volatility will probably decrease the relative importance of output growth and increase the role of interest rates in the future.
    Keywords: credit risk, stress testing, financial soundness indicators, Estonian banking sector
    JEL: E32 E37 G21
    Date: 2010–02–04
  8. By: Masahiro Nozaki
    Abstract: The answer seems affirmative. We compare currency carry trades with an investment strategy based on currency fundamentals: taking a long (short) position in undervalued (overvalued) currencies. Carry trades have high risk-adjusted returns, but are subject to "crash risk." In contrast, the fundamental strategy has lower risk-adjusted returns, but is less prone to crash risk, because the realization of crash risk coincides with corrections towards fundamentals. In particular, the fundamental strategy outperformed carry trades during the recent global financial crisis. Building on these results, we present early warning indicators for potential turbulence in the currency market.
    Keywords: Asset management , Currencies , Economic models , Exchange rate assessments , Investment , Real effective exchange rates , Terms of trade ,
    Date: 2010–02–19
  9. By: Mariko Fujii (Asian Development Bank Institute)
    Abstract: It is widely believed that the practice of securitization is one of the causes that led to the 2007–08 financial crisis. In this paper, I show that securitized products such as collateralized debt obligations (CDO) are particularly vulnerable to systematic risk and tend to show higher tail risk. These characteristics, in turn, are closely associated with joint failures and systemic risk. In order to achieve greater stability of the financial system, it is important to prevent the recurrence of the collapse of specific markets as this may lead to the collapse of other components of the financial system. From this perspective, the financial regulations that should be applied to these problematic financial products and their relation to possible systemic risks are discussed.
    Keywords: secirotozation, CDO, financial crisis, financial regulations, systemic risk
    JEL: G11 G28
    Date: 2010
  10. By: Ojo, Marianne
    Abstract: As well as addressing the Basel Committee's proposals to strengthen global capital and liquidity regulations, this paper also considers several reasons why information disclosure should be encouraged. These include the fact that imperfect information is considered to be a cause of market failure which “reduces the maximisation potential of regulatory competition”, and also because disclosure requirements would contribute to the reduction of risks which could be generated when granting reduced capital level rewards to banks who may have poor management systems. Furthermore it draws attention to the need for greater measures aimed at consolidating regulation within (and also extending regulation to) the securities markets – given the fact that „the globalisation of financial markets has made it possible for investors and capital seeking companies to switch to lightly regulated or completely unregulated markets.“
    Keywords: capital; liquidity; regulations; bank; Basel II; risks; disclosure
    JEL: K2 G2 D8
    Date: 2010–03
  11. By: HEINEN, AndrŽas (Departamento de Estadistica, Universidad Carlos III de Madrid, Spain); VALDESOGO, Alfonso (CREA, University of Luxembourg, Luxembourg)
    Abstract: We propose a new dynamic model for volatility and dependence in high dimensions, that allows for departures from the normal distribution, both in the marginals and in the dependence. The dependence is modeled with a dynamic canonical vine copula, which can be decomposed into a cascade of bivariate conditional copulas. Due to this decomposition, the model does not suffer from the curse of dimensionality. The canonical vine autoregressive (CAVA) captures asymmetries in the dependence structure. The model is applied to 95 S&P500 stocks. For the marginal distributions, we use non-Gaussian GARCH models, that are designed to capture skewness and kurtosis. By conditioning on the market index and on sector indexes, the dependence structure is much simplified and the model can be considered as a non-linear version of the CAPM or of a market model with sector effects. The model is shown to deliver good forecasts of Value-at-Risk.
    Keywords: asymmetric dependence, high dimension, multivariate copula, multivariate GARCH, Value-at-Risk
    JEL: C32 C53 G10
    Date: 2009–11–01
  12. By: Luc Laeven; Deniz Igan; Stijn Claessens; Giovanni Dell'Ariccia
    Abstract: The ongoing global financial crisis is rooted in a combination of factors common to previous financial crises and some new factors. The crisis has brought to light a number of deficiencies in financial regulation and architecture, particularly in the treatment of systemically important financial institutions, the assessments of systemic risks and vulnerabilities, and the resolution of financial institutions. The global nature of the financial crisis has made clear that financially integrated markets, while offering many benefits, can also pose significant risks, with large real economic consequences. Deep reforms are therefore needed to the international financial architecture to safeguard the stability of an increasingly financially integrated world.
    Keywords: Asset prices , Bank regulations , Bank supervision , Central bank role , Financial crisis , Financial sector , Fiscal policy , Fiscal reforms , Global Financial Crisis 2008-2009 , International financial system , Intervention , Liquidity management , Price increases , Stabilization measures ,
    Date: 2010–02–22
  13. By: Wang, Zifa; Lin, Tun; Walker, George
    Abstract: The year 2008 witnessed the renewed interests in earthquake risk management and insurance in the People's Republic of China (PRC), after the Wenchuan earthquake hit the country in May. Located along the southeastern edge of the Euro-Asian Plate, the PRC has a relatively high seismicity, which is manifested by the frequent occurrence of large and disastrous earthquakes. Buildings and infrastructure in the earthquake-prone regions of the PRC have relatively low earthquake resistance levels. Hence, disastrous earthquakes result not only in large numbers of injuries and fatalities but also in huge economic losses from property damages. While the PRC began testing earthquake insurance programs in the late 1980s, the overall penetration rate remains very low. The low penetration rate not only creates disruptions for the government after a major earthquake but also, in some cases, delays the reconstruction efforts. Moreover, as a result of the low penetration of earthquake insurance in the PRC, the government serves as the predominant bearer of financial risk from earthquake catastrophes. This paper discusses historical earthquakes and earthquake risk in the PRC and the recent developments of PRC's earthquake risk reduction efforts. The general principles of earthquake programs are explained and the critical issues of formulating earthquake programs in the PRC are discussed, including lessons from earthquake insurance in other countries and other catastrophe insurance in the PRC, data issues, loss risk modeling issues, financial risk modeling issues, legislative issues, and public awareness issues. The paper concludes with several policy directions that the Asian Development Bank can take to help the PRC in its design and implementation of earthquake insurance.
    Keywords: earthquake insurance; China; earthquake risk; Wenchuan earthquake; catastrophe insurance
    JEL: G2 Q5 G22 Q54
    Date: 2009–06
  14. By: Chandra, Abhijeet
    Abstract: Whether inexplicable patterns of abnormal stock market returns are detected in empirical studies of the stock market, a return anomaly is said to be found. There are other similar anomalies existing in the stock market. Economically meaningful stock market anomalies not only are statistically significant but also offer meaningful risk adjusted economic rewards to investors. Statistically significant stock market anomalies have yet-unknown economic and/or psychological explanations. A joint test problem exists because anomalies evidence that is inconsistent with a perfectly efficient market could be an indication of either market inefficiency or a simple failure of Capital Asset Pricing Model (CAPM) accuracy. Some of the most-discussed about market anomalies are return anomaly, market capitalization effect, value effect, calendar effect, and announcement effect. Though various studies have been conducted to find out the presence of these anomalies across the stock markets worldwide, very few studies with reference to Indian stock market are available in the financial literature. This study aims to find the evidence of one of the anomalies, calendar effect in BSE Sensex, India’s leading stock exchange.
    Keywords: Anomalies; Calender Effecr; Indian Stock Market; SENSEX
    JEL: G2 O16
    Date: 2009–06–15
  15. By: Islam, Roumeen; Nallari, Raj
    Abstract: This paper provides an overview of the period prior to the recent global crisis, and the policies that were adopted around the world in response to the crisis. It highlights a number of key issues regarding economic and financial policies that governments have faced both globally and nationally. These are related to the management of boom and bust episodes that deserve more attention in policy circles in the future.
    Keywords: Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Theory&Research,Access to Finance
    Date: 2010–03–01
  16. By: Siegfried Utzig (Asian Development Bank Institute)
    Abstract: Credit rating agencies (CRAs) bear some responsibility for the financial crisis that started in 2007 and remains ongoing. This is acknowledged by policymakers, market participants, and by the agencies themselves. It soon became clear that, given the depth of the crisis, CRAs would not be able to satisfy policymakers by eliminating flaws in their rating methods and improving corporate governance. Although the CRAs were more or less unregulated before the outbreak of the financial crisis, after the crisis started, politicians became increasingly vocal in demanding regulation. Initially, these demands were confined to a more binding form of self-regulation. But as the crisis progressed, the calls for state regulation grew ever louder. It became apparent after the November 2008 G-20 summit in Washington that state regulation could no longer be avoided. In Europe, the course had been set in this direction even before then. Since European policymakers saw the crisis as evidence that the Anglo-Saxon approach to the financial markets had failed, they believed they were now strongly placed to have a decisive influence on shaping a new international financial order. It is remarkable to note the shift in European policy from a self-regulatory approach, which was comparatively liberal in international terms, to quite rigorous state regulation of CRAs. Both the European Commission and the European Parliament drew up far-reaching plans. Although European policymakers knew that only globally consistent regulation would be appropriate for a new world financial order, their initial draft legislation was geared more toward stand-alone European regulation. While the final version of the European Union Regulation on Credit Rating Agencies focuses firmly on the European arena, the key point for all market participants is that this is unlikely to have an adverse effect on the global ratings market. It must nevertheless be recognized that the scope of the selected regulatory approach is extremely narrow. Certainly, it has the potential to improve the corporate governance of CRAs and prevent conflicts of interests. But it can do nothing to address the repeated calls for greater competition or for CRAs to be made liable for their ratings.
    Keywords: credit rating agencies, financial crisis, financial regulation, European Regulation
    JEL: G18 G21 G24
    Date: 2010

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