nep-rmg New Economics Papers
on Risk Management
Issue of 2010‒04‒24
ten papers chosen by
Stan Miles
Thompson Rivers University

  1. Developing the model of the credit risk assessment of the commercial bank credit loans portfolio By Pustovalova, Tatiana A.
  2. How Risky Is the Value at Risk? By Roxana Chiriac; Winfried Pohlmeier
  3. A Top-down Model for Cash CLO By Yadong Li; Ziyu Zheng
  4. Fast Correlation Greeks by Adjoint Algorithmic Differentiation By Luca Capriotti; Mike Giles
  5. Any Regulation of Risk Increases Risk By Philip Z. Maymin; Zakhar G. Maymin
  6. Risk monitoring tools in bank regulation and supervision – developments since the collapse of Barings Plc. By Ojo, Marianne
  7. Spectral Risk Measures: Properties and Limitations By Kevin Dowd; John Cotter; Ghulam Sorwar
  8. The World Bank’s approach to increasing the vulnerability of small coffee producers. By Sasha C. Breger Bush
  9. Results on numerics for FBSDE with drivers of quadratic growth By Peter Imkeller; Gon\c{c}alo dos Reis; Jianing Zhang
  10. Limit Theorem for a Modified Leland Hedging Strategy under Constant Transaction Costs rate By Sebastien Darses; Emmanuel Denis

  1. By: Pustovalova, Tatiana A.
    Abstract: Over the past decade, commercial banks have devoted many resources to developing internal models to better quantify their financial risks and assign economic capital. These efforts have been recognized and encouraged by bank regulators. Recently, banks have extended these efforts into the field of credit risk modeling. The Basel Committee on Banking Supervision proposes a capital adequacy framework that allows banks to calculate capital requirement for their banking books using internal assessments of key risk drivers. Hence the need for systems to assess credit risk. In this work, we describe the case of successful application of VAR methodology for credit risk estimation. Executive summary is available at pp. 32.
    Keywords: banking, credit risk, default, Basel 2, value of risk,
    Date: 2010
  2. By: Roxana Chiriac (University of Konstanz, CoFE); Winfried Pohlmeier (University of Konstanz, CoFE, ZEW, RCEA)
    Abstract: The recent financial crisis has raised numerous questions about the accuracy of value-at-risk (VaR) as a tool to quantify extreme losses. In this paper we present empirical evidence from assessing the out-of-sample performance and robustness of VaR before and during the recent financial crisis with respect to the choice of sampling window, return distributional assumptions and stochastic properties of the underlying financial assets. Moreover we develop a new data driven approach that is based on the principle of optimal combination and that provides robust and precise VaR forecasts for periods when they are needed most, such as the recent financial crisis.
    Keywords: Value at Risk, model risk, optimal forecast combination
    JEL: C21 C5 G28 G32
    Date: 2010–01
  3. By: Yadong Li; Ziyu Zheng
    Abstract: We propose a top-down model for cash CLO. This model can consistently price cash CLO tranches both within the same deal and across different deals. Meaningful risk measures for cash CLO tranches can also be defined and computed. This method is self-consistent, easy to implement and computationally efficient. It has the potential to bring the much needed pricing transparency to the cash CLO markets; and it could also greatly improve the risk management of cash instruments.
    Date: 2010–04
  4. By: Luca Capriotti; Mike Giles
    Abstract: We show how Adjoint Algorithmic Differentiation (AAD) allows an extremely efficient calculation of correlation Risk of option prices computed with Monte Carlo simulations. A key point in the construction is the use of binning to simultaneously achieve computational efficiency and accurate confidence intervals. We illustrate the method for a copula-based Monte Carlo computation of claims written on a basket of underlying assets, and we test it numerically for Portfolio Default Options. For any number of underlying assets or names in a portfolio, the sensitivities of the option price with respect to all the pairwise correlations is obtained at a computational cost which is at most 4 times the cost of calculating the option value itself. For typical applications, this results in computational savings of several order of magnitudes with respect to standard methods.
    Date: 2010–04
  5. By: Philip Z. Maymin; Zakhar G. Maymin
    Abstract: We show that any objective risk measurement algorithm mandated by central banks for regulated financial entities will result in more risk being taken on by those financial entities than would otherwise be the case. Furthermore, the risks taken on by the regulated financial entities are far more systemically concentrated than they would have been otherwise, making the entire financial system more fragile. This result leaves three directions for the future of financial regulation: continue regulating by enforcing risk measurement algorithms at the cost of occasional severe crises, regulate more severely and subjectively by fully nationalizing all financial entities, or abolish all central banking regulations including deposit insurance to let risk be determined by the entities themselves and, ultimately, by their depositors through voluntary market transactions rather than by the taxpayers through enforced government participation.
    Date: 2010–04
  6. By: Ojo, Marianne
    Abstract: This paper consolidates the work of its predecessor, “International Framework for Liquidity Risk Measurement, Standards and Monitoring: Corporate Governance and Internal Controls”, by considering monitoring tools which are considered to be essential if risks,(and in particular liquidity risks which are attributed to a bank), are to be managed and measured effectively by its management. It also considers developments which have triggered the need for particular monitoring tools – not only in relation to liquidity risks, but also to the rise of conglomerates and consolidated undertakings. It highlights weaknesses in financial supervision – weaknesses which were revealed following the collapses of Barings and Lehman Brothers. As well as attempting to draw comparisons between the recommendations which were made by the Board of Banking Supervision (BoBS) following Barings’ collapse, and the application issues raised by the Basel Committee in its 2009 Consultative Document, International Framework for Liquidity Risk Measurement, Standards and Monitoring, it highlights the links and relevance between both recommendations. In drawing attention to the significance of corporate governance, audit committees, and supervisory boards, the importance of effective communication between management at all levels, to ensure transmission and communication of timely, accurate and complete information, is also highlighted. Through a comparative analysis of two contrasting corporate governance systems, namely, Germany and the UK, it analyses and evaluates how the design of corporate governance systems could influence transparency, disclosure, as well as higher levels of monitoring and accountability. Whilst highlighting the need for, and the growing importance of formal risk assessment models, the paper also emphasises the dangers inherent in formalism – as illustrated by a rules based approach to regulation. It will however, demonstrate that detailed rules could still operate within a system of principles based regulation – whilst enabling a consideration of the substance of the transactions which are involved. In addressing the issues raised by principles based regulation, the extent to which such issues can be resolved, to a large extent, depends on adequate compliance with Basel Core Principle 17 (for effective banking supervision) – and particularly on the implementation, design and compliance with “clear arrangements for delegating authority and responsibility.”
    Keywords: liquidity; principles based regulation; risks; corporate governance; audit; creative compliance
    JEL: K2 G3 M42 G21
    Date: 2010–04–20
  7. By: Kevin Dowd (Centre for Risk and Insurance Studies, Nottingham University Business School); John Cotter (Centre for Financial Markets, School of Business, University College Dublin); Ghulam Sorwar (Nottingham University Business School)
    Abstract: Spectral risk measures (SRMs) are risk measures that take account of user risk-aversion, but to date there has been little guidance on the choice of utility function underlying them. This paper addresses this issue by examining alternative approaches based on exponential and power utility functions. A number of problems are identified with both types of spectral risk measure. The general lesson is that users of spectral risk measures must be careful to select utility functions that fit the features of the particular problems they are dealing with, and should be especially careful when using power SRMs.
    Keywords: coherent risk measures, spectral risk measures, exponential utility, power utility
    JEL: G15
    Date: 2010–04–13
  8. By: Sasha C. Breger Bush
    Abstract: This paper critically engages the World Bank’s recent experiments in providing marketbased price risk management for coffee farmers. Using the case of Mexico and the recent 1998–2002 coffee crisis, I argue that such advocacy of farm-level use of derivatives markets entails large direct and indirect costs for coffee farmer wellbeing. This is especially so for smallholders. Not only might hedging with derivatives further destabilise and reduce producer incomes, but the opportunity cost of the Bank’s advocacy, in terms of foregone risk management alternatives, is also problematic. I conclude with a discussion of several risk management alternatives that may better support small coffee producers facing volatile commodity prices.
    Date: 2010
  9. By: Peter Imkeller; Gon\c{c}alo dos Reis; Jianing Zhang
    Abstract: We consider the problem of numerical approximation for forward-backward stochastic differential equations with drivers of quadratic growth (qgFBSDE). To illustrate the significance of qgFBSDE, we discuss a problem of cross hedging of an insurance related financial derivative using correlated assets. For the convergence of numerical approximation schemes for such systems of stochastic equations, path regularity of the solution processes is instrumental. We present a method based on the truncation of the driver, and explicitly exhibit error estimates as functions of the truncation height. We discuss a reduction method to FBSDE with globally Lipschitz continuous drivers, by using the Cole-Hopf exponential transformation. We finally illustrate our numerical approximation methods by giving simulations for prices and optimal hedges of simple insurance derivatives.
    Date: 2010–04
  10. By: Sebastien Darses (LATP - Laboratoire d'Analyse, Topologie, Probabilités - CNRS : UMR6632 - Université de Provence - Aix-Marseille I - Université Paul Cézanne - Aix-Marseille III); Emmanuel Denis (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX)
    Abstract: We study the Leland model for hedging portfolios in the presence of a constant proportional transaction costs coefficient. The modified Leland's strategy recently defined by the second author, contrarily to the classical one, ensures the asymptotic replication of a large class of payoff. In this setting, we prove a limit theorem for the deviation between the real portfolio and the payoff. As Pergamenshchikov did in the framework of the usual Leland's strategy, we identify the rate of convergence and the associated limit distribution. This rate turns out to be improved using the modified strategy and non periodic revision dates.
    Keywords: Asymptotic hedging ; Leland-Lott strategy ; Transaction costs ; Martingale limit theorem.
    Date: 2010–02–22

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