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on Risk Management |
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Issue of 2010‒05‒02
twelve papers chosen by |
| By: | Sheri Markose; Simone Giansante; Mateusz Gatkowski; Ali Rais Shaghaghi |
| Abstract: | Credit default swaps (CDS) which constitute up to 98% of credit derivatives have had a unique, endemic and pernicious role to play in the current financial crisis. However, there are few in depth empirical studies of the financial network interconnections among banks and between banks and nonbanks involved as CDS protection buyers and protection sellers. The ongoing problems related to technical insolvency of US commercial banks is not just confined to the so called legacy/toxic RMBS assets on balance sheets but also because of their credit risk exposures from SPVs (Special Purpose Vehicles) and the CDS markets. The dominance of a few big players in the chains of insurance and reinsurance for CDS credit risk mitigation for banks’ assets has led to the idea of “too interconnected to fail” resulting, as in the case of AIG, of having to maintain the fiction of non-failure in order to avert a credit event that can bring down the CDS pyramid and the financial system. This paper also includes a brief discussion of the complex system Agent-based Computational Economics (ACE) approach to financial network modeling for systemic risk assessment. Quantitative analysis is confined to the empirical reconstruction of the US CDS network based on the FDIC Q4 2008 data in order to conduct a series of stress tests that investigate the consequences of the fact that top 5 US banks account for 92% of the US bank activity in the $34 tn global gross notional value of CDS for Q4 2008 (see, BIS and DTCC). The May-Wigner stability condition for networks is considered for the hub like dominance of a few financial entities in the US CDS structures to understand the lack of robustness. We provide a Systemic Risk Ratio and an implementation of concentration risk in CDS settlement for major US banks in terms of the loss of aggregate core capital. We also compare our stress test results with those provided by SCAP (Supervisory Capital Assessment Program). Finally, in the context of the Basel II credit risk transfer and synthetic securitization framework, there is little evidence that the CDS market predicated on a system of offsets to minimize final settlement can provide the credit risk mitigation sought by banks for reference assets in the case of a significant credit event. The large negative externalities that arise from a lack of robustness of the CDS financial network from the demise of a big CDS seller undermines the justification in Basel II that banks be permitted to reduce capital on assets that have CDS guarantees. We recommend that the Basel II provision for capital reduction on bank assets that have CDS cover should be discontinued. |
| Keywords: | Credit Default Swaps; Financial Networks; Systemic Risk; Agent Based; Credit Default Swaps, Financial Networks, Systemic Risk, Agent Based Models, Complex Systems, Stress Testing |
| Date: | 2010–04–21 |
| URL: | http://d.repec.org/n?u=RePEc:com:wpaper:033&r=rmg |
| By: | Jorge A. Chan-Lau |
| Abstract: | The recent financial crisis has highlighted once more that interconnectedness in the financial system is a major source of systemic risk. I suggest a practical way to levy regulatory capital charges based on the degree of interconnectedness among financial institutions. Namely, the charges are based on the institution’s incremental contribution to systemic risk. The imposition of such capital charges could go a long way towards internalizing the negative externalities associated with too-connected-to-fail institutions and providing managerial incentives to strengthen an institution’s solvency position, and avoid too much homogeneity and excessive reliance on the same counterparties in the financial industry. |
| Keywords: | Bank regulations , Banking sector , Capital , Credit risk , Financial crisis , Financial institutions , Financial risk , Financial stability , Global Financial Crisis 2008-2009 , Globalization , International financial system , |
| Date: | 2010–04–09 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:10/98&r=rmg |
| By: | Enrica Detragiache; Asli Demirgüç-Kunt |
| Abstract: | This paper studies whether compliance with the Basel Core Principles for effective banking supervision (BCPs) is associated with bank soundness. Using data for over 3,000 banks in 86countries, we find that neither the overall index of BCP compliance nor its individual components are robustly associated with bank risk measured by Z-scores. We also fail to find a relationship between BCP compliance and systemic risk measured by a system-wide Zscore. |
| Keywords: | Bank reforms , Bank regulations , Bank soundness , Bank supervision , Banks , Basel Core Principles , Credit risk , Cross country analysis , Financial risk , |
| Date: | 2010–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:10/81&r=rmg |
| By: | Repullo, R.; Suarez, J. (Tilburg University, Center for Economic Research) |
| Abstract: | We assess the procyclical effects of bank capital regulation in a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that under cyclically-varying risk-based capital requirements (e.g. Basel II) banks hold larger buffers in expansions than in recessions. Yet, these buffers are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level underlying Basel II can reduce its procyclical effects on the supply of credit without compromising banks’ long-run solvency targets. |
| Keywords: | Banking regulation;Basel II;Business cycles;Capital requirements;Credit crunch;Loan defaults;Relationship banking. |
| JEL: | G21 G28 E44 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:201029s&r=rmg |
| By: | Nakamura, L.I.; Roszbach, K. (Tilburg University, Center for Economic Research) |
| Abstract: | In this paper we use credit rating data from two Swedish banks to elicit evidence on these banks’ loan monitoring ability. We do so by comparing the ability of bank ratings to predict loan defaults relative to that of public ratings from the Swedish credit bureau. We test the banks’ abilility to forecast the credit bureau’s ratings and vice versa. We show that one of the banks has a superior predictive ability relative to the credit bureau. This is evidence that bank credit ratings do contain valuable private information and suggests they may be be a reasonable basis for risk management. However, public ratings are also found to have predictive ability for future bank ratings, indicating that risk analysis should be based on both public and bank ratings. The methods we use represent a new basket of straightforward techniques that enable both financial institutions and regulators to assess the performance of credit ratings systems. |
| Keywords: | Monitoring;banks;credit bureau;private information;ratings;regulation;supervision. |
| JEL: | D82 G18 G21 G24 G32 G33 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:201037s&r=rmg |
| By: | Manmohan Singh |
| Abstract: | To mitigate systemic risk, some regulators have advocated the greater use of centralized counterparties (CCPs) to clear Over-The-Counter (OTC) derivatives trades. Regulators should be cognizant that large banks active in the OTC derivatives market do not hold collateral against all the positions in their trading book and the paper proves an estimate of this under-collateralization. Whatever collateral is held by banks is allowed to be rehypothecated (or re-used) to others. Since CCPs would require all positions to have collateral against them, off-loading a significant portion of OTC derivatives transactions to central counterparties (CCPs) would require large increases in posted collateral, possibly requiring large banks to raise more capital. These costs suggest that most large banks will be reluctant to offload their positions to CCPs, and the paper proposes an appropriate capital levy on remaining positions to encourage the transition. |
| Keywords: | Asset management , Banks , Capital , Capital markets , Credit risk , Financial institutions , Financial instruments , Financial risk , Securities regulations , |
| Date: | 2010–04–09 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:10/99&r=rmg |
| By: | T. C. Wong (Hong Kong Monetary Authority); C. H. Hui (Hong Kong Monetary Authority, Hong Kong Institute for Monetary Research); C. F. Lo (The Chinese University of Hong Kong, Hong Kong Institute for Monetary Research) |
| Abstract: | This paper studies the discriminatory power and calibration quality of the structural credit risk models under the ¡§exogenous default boundary¡¨ approach including those proposed by Longstaff and Schwartz (1995) and Collin-Dufresne and Goldstein (2001), and ¡§endogenous default boundary¡¨ approach in Leland and Toft (1996) based on 2,050 non-financial companies in 46 economies during the period 1998 to 2005. Their discriminatory power in terms of differentiating defaulting and non-defaulting companies is adequate and the differences among them are not material. In addition, the calibration quality of the three models is similar, although limited evidence is found that the Longstaff and Schwartz model marginally outperforms the others in some subsamples. Overall, no significant difference in the capability of measuring credit risk between the ¡§exogenous default boundary¡¨ and ¡§endogenous default boundary¡¨ approaches is found. |
| Keywords: | Default Probabilities, Credit Risk Models |
| JEL: | C60 G13 G28 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:342009&r=rmg |
| By: | Dobrin, Marinica (Universitatea Spiru Haret. Facultatea de Management Financiar Contabil) |
| Abstract: | Statements and financial reports are tools allowing managers as well as external analysts to make quality and / or quantitative value judgments regarding status, dynamics and prospects of a firm. By analyzing these instruments, internal and external information is processed in order to formulate relevant assessments on the situation at the company level and on the quality of its performance, at the degree of risk in a competitive environment. |
| Keywords: | Balance sheet; income statement; cash flow picture |
| JEL: | A11 |
| Date: | 2010–04–23 |
| URL: | http://d.repec.org/n?u=RePEc:ris:sphedp:2010_055&r=rmg |
| By: | Madalina Andreica (Department of Economic Cybernetics - The Bucharest Academy of Economic Studies); Mugurel Ionut Andreica (Parallel and Distributed Systems Laboratory [Bucarest] - University Politehnica of Bucarest); Marin Andreica (Faculty of Management - Bucharest Academy of Economic Studies) |
| Abstract: | In the context of the current financial crisis, when more companies are facing bankruptcy or insolvency, the paper aims to find methods to identify distressed firms by using financial ratios. The study will focus on identifying a group of Romanian listed companies, for which financial data for the year 2008 were available. For each company a set of 14 financial indicators was calculated and then used in a principal component analysis, followed by a cluster analysis, a logit model, and a CHAID classification tree. |
| Keywords: | distressed company; financial ratio; cluster; CHAID; logit model |
| Date: | 2009–06–15 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-00474278_v1&r=rmg |
| By: | Burnecki, Krzysztof; Misiorek, Adam; Weron, Rafal |
| Abstract: | This paper is intended as a guide to statistical inference for loss distributions. There are three basic approaches to deriving the loss distribution in an insurance risk model: empirical, analytical, and moment based. The empirical method is based on a sufficiently smooth and accurate estimate of the cumulative distribution function (cdf) and can be used only when large data sets are available. The analytical approach is probably the most often used in practice and certainly the most frequently adopted in the actuarial literature. It reduces to finding a suitable analytical expression which fits the observed data well and which is easy to handle. In some applications the exact shape of the loss distribution is not required. We may then use the moment based approach, which consists of estimating only the lowest characteristics (moments) of the distribution, like the mean and variance. Having a large collection of distributions to choose from, we need to narrow our selection to a single model and a unique parameter estimate. The type of the objective loss distribution can be easily selected by comparing the shapes of the empirical and theoretical mean excess functions. Goodness-of-fit can be verified by plotting the corresponding limited expected value functions. Finally, the hypothesis that the modeled random event is governed by a certain loss distribution can be statistically tested. |
| Keywords: | Loss distribution; Insurance risk model; Random variable generation; Goodness-of-fit testing; Mean excess function; Limited expected value function |
| JEL: | G22 C46 C15 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22163&r=rmg |
| By: | Knapp, S. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University); Velden, M. van de (Erasmus Research Institute of Management (ERIM), RSM Erasmus University) |
| Abstract: | This article uses correspondence analysis to visualize risk profiles and their changes over the time period 1977 to 2008. It is based on a unique dataset which combines incident data and ship particular data. The risk profiles can help stakeholders better understand the relationship of ship particulars, casualty types, incident locations, loss of life and pollution and link the results to developments of the legislative framework. The results demonstrate that the fleet improved their risk profiles over time reflecting legislative measures, port state control and vetting inspections. Older, general cargo ships flagged by black listed flags are most likely to be wrecked, stranded or grounded and remain risk prone towards flooding, foundering and capsizing. Some trading areas characterized by inter-regional trade operating outside the legislative framework remain risk prone. Most incidents do not involve loss of life or pollution. In terms of absolute figures, high risk prone areas for loss of life are the North and South China Sea, Japan and South Korea, the Mediterranean, Red and Black Sea and the Arabian Gulf. Casualty types which are more likely to lead to higher loss of life are flooding, foundering and capsizing on vessels which are flagged with black listed flags. For pollution, most oil pollution occurred in the area of the British Isles, the North Sea, the English Channel and the Bay of Biscay. High pollution quantities are more likely to be found due to collision and the vessel being wrecked, stranded and grounded than with other casualty types. |
| Keywords: | maritime safety;ship risk profiles |
| Date: | 2010–03–23 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:eureri:1765019197&r=rmg |
| By: | Leonardo Martinez; Juan Carlos Hatchondo; Horacio Sapriza |
| Abstract: | We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis questions the robustness of results in the sovereign default literature and is also relevant for the study of other credit markets. |
| Date: | 2010–04–16 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:10/100&r=rmg |