New Economics Papers
on Risk Management
Issue of 2010‒05‒22
nineteen papers chosen by

  1. VaR Limits for Pension Funds: An Evaluation By Berstein, Solange; Chumacero, Rómulo
  2. Cyclicality and Term Structure of Value-at-Risk in Europe By Bec, Frédérique; Gollier, Christian
  3. "Collateral Posting and Choice of Collateral Currency - Implications for Derivative Pricing and Risk Management-" By Masaaki Fujii; Yasufumi Shimada; Akihiko Takahashi
  4. Volatility and the Hedging Effectiveness of China Fuel Oil Futures By Wei Chen; J L Ford
  5. Non-Gaussian Component Analysis: New Ideas, New Proofs, New Applications By Vladimir Panov
  6. Extreme Volatilities, Financial Crises and L-moment Estimations of Tail-indexes By Bertrand B. Maillet; Jean-Philippe R. Médecin
  7. Stress Testing Credit Risk: The Great Depression Scenario By Simone Varotto
  8. Value-At-Risk Optimal Policies for Revenue Management Problems By Matthias Koenig; Joern Meissner
  9. A framework for assessing systemic risk By Dijkman, Miquel
  10. Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures By Wall, Larry D.
  11. Intertemporal Risk-Return Trade-off in Foreign Exchange Rates By Charlotte Christiansen
  12. Managing Investment Risk in Defined Benefit Pension Funds By Dorothee Franzen
  13. Designing the payout Phase of pension systems : policy issues, constraints and options By Rocha, Roberto; Vittas, Dimitri
  14. Risk Analysis in Selected European and International Food Chains By Ameseder, Christoph; Haas, Rainer; Fritz, Melanie; Schiefer, Gerhard
  15. The Relationship between Risk, Capital and Efficiency: Evidence from Japanese Cooperative Banks By Tara Deelchand; Carol Padgett
  16. Illiquidity and All Its Friends By Tirole, Jean
  17. Brazilian Strategy for Managing the Risk of Foreign Exchange Rate Exposure During a Crisis By Antonio Francisco A. Silva Jr.
  18. The payout phase of pension systems : a comparison of five countries By Rocha, Roberto; Vittas, Dimitri; Rudolph, Heinz P.
  19. What Is the Impact of the Global Financial Crisis on the Banking System in East Asia? By Pomerleano, Michael

  1. By: Berstein, Solange; Chumacero, Rómulo
    Abstract: This paper evaluates the effects of imposing Value-at-Risk (VaR) limits and quantitative restrictions on portfolio choices in the context of a risk-based supervision framework for defined contribution pension funds. It shows the conditions under which VaR constraints are equivalent to constraints on volatility. The paper also presents some further considerations that regulators should take into account when adopting a risk-based supervision framework when contributions are mandatory and a significant part of the pension depends on the performance of past investments.
    Keywords: Portfolio Choice; VaR
    JEL: G11 G38
    Date: 2010–04–10
  2. By: Bec, Frédérique; Gollier, Christian
    Abstract: This paper explores empirically the link between stocks returns Value-at-Risk (VaR) and the state of financial markets cycle. The econometric analysis is based on a simple vector autoregression setup. Using quarterly data from 1970Q4 to 2008Q4 for France, Germany and the United-Kingdom, it turns out that the k-year VaR of equities is actually dependent on the cycle phase: the expected losses as measured by the VaR are smaller in recession times than expansion periods, whatever the country and the horizon. These results strongly suggest that the European rules regarding the solvency capital requirements for insurance companies should adapt to the state of the financial market’s cycle.
    Date: 2009–05
  3. By: Masaaki Fujii (Graduate School of Economics, University of Tokyo); Yasufumi Shimada (Capital Markets Division, Shinsei Bank, Limited); Akihiko Takahashi (Faculty of Economics, University of Tokyo)
    Abstract: In recent years, we have observed the dramatic increase of the use of collateral as an important credit risk mitigation tool. It has become even rare to make a contract without collateral agreement among the major financial institutions. In addition to the significant reduction of the counterparty exposure, collateralization has important implications for the pricing of derivatives through the change of effective funding cost. This paper has demonstrated the impact of collateralization on the derivative pricing by constructing the term structure of swap rates based on the actual market data. It has also shown the importance of the "choice" of collateral currency. Especially, when the contract allows multiple currencies as eligible collateral and free replacement among them, the paper has found that the embedded "cheapest-to-deliver" option can be quite valuable and significantly change the fair value of a trade. The implications of these findings for market risk management have been also discussed.
    Date: 2010–05
  4. By: Wei Chen; J L Ford
    Abstract: This paper is an original study of the volatility in China’s oil fuel spot and futures markets, and in the spot market of Singapore one of China’s main source of imports. GARCH(1,1), TGARCH(1,1) and a constant variance model are estimated using 500 daily observations from 25 August 2005. The optimum hedge ratios derived from the competing models are evaluated in terms of the variance and semi-variance (downside) risk that they promise compared with a no-hedge portfolio: and also in terms of their expected utility. This is also accomplished for hedging in the Singapore market. Out-of-sample observations (54) are used to up-date, day-by-day, the variance-covariance matrices from the estimation period. The findings are used to compare the competing models, and the two hedging strategies, over that extended period. They showed the stability of the original estimates and of the ranking of the models under any given criterion. Hedging in China’s market is more effective in terms of reducing downside risk and maximising expected utility than is hedging in Singapore’s market. The latter dominates in terms of variance reduction.
    Keywords: China's fuel oil spot and futures returns, Singapore's spot market, volatility, bivariate GARCH and TGARCH, hedged portfolio returns, variance reduction, downside risk, expected utility
    JEL: G10 C53
    Date: 2010–04
  5. By: Vladimir Panov
    Abstract: In this article, we present new ideas concerning Non-Gaussian Component Analysis (NGCA). We use the structural assumption that a high-dimensional random vector X can be represented as a sum of two components - a lowdimensional signal S and a noise component N. We show that this assumption enables us for a special representation for the density function of X. Similar facts are proven in original papers about NGCA ([1], [5], [13]), but our representation differs from the previous versions. The new form helps us to provide a strong theoretical support for the algorithm; moreover, it gives some ideas about new approaches in multidimensional statistical analysis. In this paper, we establish important results for the NGCA procedure using the new representation, and show benefits of our method.
    Keywords: dimension reduction, non-Gaussian components, EDR subspace, classification problem, Value at Risk
    JEL: C13 C14
    Date: 2010–05
  6. By: Bertrand B. Maillet (ABN AMRO Advisors, Variances and University of Paris-1 (CES/CNRS and EIF)); Jean-Philippe R. Médecin (Paris School of Economics, University of Paris-1 and Variances)
    Abstract: Following Bali and Weinbaum (2005) and Maillet et al. (2010), we present several estimates of volatilities computed with high- and low frequency data and complement their results using additional measures of risk and several alternative methods for Tail-index estimation. The aim here is to confirm previous results regarding the slope of the tail of various risk measure distributions, in order to define the high watermarks of market risks. We also produce synthetic general results concerning the method of estimation of the Tail-indexes related to expressions of the L-moments. Based on estimates of Tail-indexes, retrieved from the high frequency 30’ sampled CAC40 French stock Index series from the period 1997-2009, using Non-parametric Generalized Hill, Maximum Likelihood and various kinds of L-moment Methods for the estimation of both a Generalized Extreme Value density and a Generalized Pareto Distribution, we confirm that a heavy-tail density specification of the Log-volatility is not necessary.
    Keywords: Financial Crisis, Realized Volatility, Range-based Volatility, Extreme Value Distributions, Tail-index, L-moments, High Frequency Data.
    JEL: G10 G14
  7. By: Simone Varotto (ICMA Centre, University of Reading)
    Abstract: By using Moody's historical corporate default histories we explore the implications of scenarios based on the Great Depression for banks' economic capital and for existing and proposed regulatory capital requirements. By assuming different degrees of portfolio illiquidity, we then investigate the relationship between liquidity and credit risk and employ our findings to estimate the Incremental Risk Charge (IRC), the new credit risk capital add-on introduced by the Basel Committee for the trading book. Finally, we compare our IRC estimates with stressed market risk measures derived from a sample of corporate bond indices encompassing the recent financial crisis. This allows us to determine the extent to which trading book capital would change in stress conditions under newly proposed rules. We find that, typically, banking book regulation leads to minimum capital levels that would enable banks to withstand Great Depression-like events, except when their portfolios have long average maturity. We also show that although the IRC in the trading book may be considerable, the capital needed to absorb market risk related losses in stressed scenarios can be more than twenty times larger.
    Keywords: Credit Risk, Financial Crisis, Economic Capital, Basel II, Liquidity Risk
    JEL: G11 G21 G22 G28 G32
    Date: 2010–03
  8. By: Matthias Koenig (Department of Management Science, Lancaster University Management School); Joern Meissner (Department of Management Science, Lancaster University Management School)
    Abstract: Consider a single-leg dynamic revenue management problem with fare classes controlled by capacity in a risk-averse setting. The revenue management strategy aims at limiting the down-side risk, and in particular, value-at-risk. A value-at-risk optimised policy offers an advantage when considering applications which do not allow for a large number of reiterations. They allow for specifying a confidence level regarding undesired scenarios. We state the underlying problem as a Markov decision process and provide a computational method for computing policies, which optimise the value-at-risk for a given confidence level. This is achieved by computing dynamic programming solutions for a set of target revenue values and combining the solutions in order to attain the requested multi-stage risk-averse policy. Numerical examples and comparison with other risk-sensitive approaches are discussed.
    Keywords: operations research, risk management, capacity control, revenue management, risk, value-at-risk
    JEL: C61
    Date: 2010–05
  9. By: Dijkman, Miquel
    Abstract: When faced with financial crises, authorities worldwide tend to respond aggressively with public support measures. Given the adverse impact on moral hazard and market discipline, support measures involving public money are ideally limited to crisis situations involving systemic risk: a disturbance in the financial system that is serious enough to affect the real economy. This note sets out the main characteristics of a systemic risk assessment framework: a simple analytical framework that can be used by authorities with financial crisis management responsibilities in times of financial crisis to assess the extent to which that particular crisis situation poses systemic risk.
    Keywords: Debt Markets,Banks&Banking Reform,Emerging Markets,Financial Intermediation,Bankruptcy and Resolution of Financial Distress
    Date: 2010–04–01
  10. By: Wall, Larry D. (Asian Development Bank Institute)
    Abstract: The recent global financial crisis reflects numerous breakdowns in the prudential discipline of financial firms. This paper discusses ways to strengthen micro- and macroprudential supervision and restore credible market discipline. The discussion notes that microprudential supervisors are typically assigned a variety of goals that sometimes have conflicting policy implications. In such a setting, the structure of the regulatory agencies and the priority given to prudential goals are critical to achieving those goals. <p>The analysis of macroprudential supervision emphasizes that this supervisor must be both bold and modest: bold in seeking to understand the sources and distributions of systemically important risks, and modest about what a supervisor can do without imposing overly restrictive regulations. <p>Finally, the paper argues that the primary responsibility for risk management must rest with firms, not with government supervisors. Unfortunately, systemic risk concerns have led governments to shield the private sector from the full losses that dull their incentive to discipline risk taking. This section of the paper suggests that deposit insurance reform, special resolutions for systemically important firms, and requiring firms to plan for their own resolution and contingent capital may all have a role to play in restoring effective market discipline.
    Keywords: prudential discipline financial firms; prudential supervision financial firms; prudential regulatory agencies
    JEL: E44 G28 K23
    Date: 2009–12–10
  11. By: Charlotte Christiansen (CREATES, School of Economics and Management, Aarhus University)
    Abstract: We investigate the intertemporal risk-return trade-off of foreign ex- change (FX) rates for ten currencies quoted against the USD. For each currency, we use three risk measures simultaneously that pertain to that currency; its re- alized volatility, its realized skewness, and its value-at-risk. We apply monthly FX excess returns and monthly FX risk measures calculated from daily ob- servations. We find that there is a positive and signi?cant contemporaneous risk-return trade-off for most currencies. There is no evidence of noncontem- poraneous risk-return trade-off. The risk-return trade-off changes during the recent financial crisis in that it becomes nonexistent for several currencies and negative for others.
    Keywords: Foreign exchange rates, Risk-return trade-off, Realized volatility, Realized skewness, Value-at-risk, Financial crisis
    JEL: F31 G15
    Date: 2010–05–05
  12. By: Dorothee Franzen
    Abstract: This paper inquires into the forces that drive the practice of risk management at defined benefit (DB) pension funds in Germany, Netherlands, United Kingdom and the United States in the aftermath of the perfect pension storm. First, pension funds‘ risk management is grounded in the context of the development of modern risk management in the financial industry more general. Second, focusing solely on single-employer sponsored DB pension funds this research critically examines the impact of recent changes in the regulatory and accounting environment for pension funds and their sponsors thereby explicitly taking into account the specific governance context in which pension funds are situated. The aim of this research is, first, to provide a better understanding of the investment risk management of DB pension funds thereby contributing to the theory of financial decision-making. Second, by conducting this analysis on a cross-country basis, this research aims at contributing to the comparative analysis of pension funds. This paper argues that the risk-taking capacity is a central element of DB pension funds. The empirical results suggest that in general risk management has become much more sophisticated but that it is often driven more by regulatory and accounting issues than by the pension fund‘s specific risk profile. Furthermore, changes to the regulatory and accounting standards increasingly impede the risk-taking capacity of DB pension funds. This research draws on in-depth interviews with market participants within the pension fund industry and their advisers.<P>Les dispositifs de retraite à prestations définies et la gestion du risque d’investissement<BR>Le présent document analyse les ressorts de la gestion des risques telle qu’elle est pratiquée par les dispositifs de retraite à prestations définies en Allemagne, aux États-Unis, aux Pays-Bas et au Royaume-Uni au lendemain de la violente tempête qui a ébranlé le secteur des retraites. Premièrement, cette gestion des risques s’ancre dans le contexte plus général de l’élaboration d’une gestion des risques moderne par le milieu de la finance. Deuxièmement, en s’attachant exclusivement aux dispositifs à prestations définies mono-employeurs, ce document examine d’un point de vue critique les répercussions des évolutions récentes du cadre réglementaire et comptable applicable aux régimes de retraite et à leurs promoteurs, prenant ainsi explicitement en compte les mécanismes de gouvernance spécifiques de ces régimes. L’objectif de cette étude est, dans un premier temps, de mieux appréhender la gestion du risque d’investissement par les dispositifs de retraite à prestations définies, et d’étayer ainsi la théorie de la décision financière. En s’intéressant à plusieurs pays, les auteurs de ce document entendent dans un deuxième temps contribuer à l’analyse comparative des régimes de retraite. Ils font ainsi valoir que la capacité de prendre des risques est fondamentale pour les dispositifs à prestations définies. Les résultats empiriques donnent à penser que de manière générale, la gestion des risques a sensiblement gagné en complexité, mais qu’elle dépend souvent davantage de problématiques réglementaires et comptables que du profil de risque propre aux dispositifs de retraite à prestations définies. De plus, les modifications des normes réglementaires et comptables pèsent de plus en plus sur l’aptitude de ces régimes à prendre des risques. Ce document s’appuie sur des entretiens approfondis menés avec des participants au marché des retraites et leurs conseillers.
    Keywords: governance, investment, regulation, pension fund, defined benefit, réglementation, gestion des risques, prestation définie, gouvernance, dispositifs de retraite
    JEL: G23 J32
    Date: 2010–03
  13. By: Rocha, Roberto; Vittas, Dimitri
    Abstract: This paper examines the policy issues, constraints and options facing policymakers in promoting the development of sound markets for retirement products. It discusses the various risks faced by pensioners and the risk characteristics of alternative retirement products and also reviews the risks faced by providers of retirement products and the management and regulatory challenges of dealing with these risks. The paper focuses on policies that could be adopted by developing and transitioning countries where financial and insurance markets are not well developed. It argues for promoting an adequate level of annuitization but avoiding excessive annuitization. It also argues for favoring combinations of payout options, covering different products at a particular point in time as well as different payout options over time. The paper also discusses the choice between centralized and decentralized markets and highlights the basic elements of an effective regulation of risk management.
    Keywords: Debt Markets,Pensions&Retirement Systems,Insurance&Risk Mitigation,Non Bank Financial Institutions,Emerging Markets
    Date: 2010–05–01
  14. By: Ameseder, Christoph; Haas, Rainer; Fritz, Melanie; Schiefer, Gerhard
    Abstract: The purpose of this study is to assess and evaluate the most important risks in selected European and international food chains from the perspective of the buying company. The primary objective is to identify the ânon-acceptableâ risks in terms of damage potential and likelihood of occurrence of value chains in the sectors grain, meat, fruit and vegetable, and olive oil. Data was collected by each partner of the European research project âe-trustâ (FP6-CT-2006-043056) by conducting 81 qualitative expert interviews with business leaders in Europe (Austria, Germany, Greece, Italy, Slovenia, Spain) as well as in Brazil, Turkey, and the USA. The study focuses on a wider supply chain or network perspective for the risk assessment. Methodically the assessed risks were classified and then evaluated using a risk map matrix. Results point out nonacceptable risks and show the differences concerning the risk evaluation in the different value chains. Results provide interesting supply chain management approaches in these sectors.
    Keywords: risk, risk analysis, supply chain, food, risk map, risk classification, Agribusiness, Agricultural and Food Policy, Farm Management, Food Security and Poverty, Industrial Organization, Institutional and Behavioral Economics, Risk and Uncertainty,
    Date: 2009–10
  15. By: Tara Deelchand (ICMA Centre, University of Reading); Carol Padgett (ICMA Centre, University of Reading)
    Abstract: The risk-capital positions of Japanese banks have been under tension throughout the 1990s. However, existing theory on the determinants of bank risk-taking still remains limited and the evidence is conflicting. Most studies concentrate on US and European banks, while empirical evidence has remained scarce for Asian banks. Added to that, to our knowledge, there are almost no papers on this subject for cooperative banks in Japan. Thus, the main contribution of this study is to shed some light on the determinants of bank risk-taking and analyse its relationship with capital and efficiency in Japanese cooperative banking (namely shinkin and credit cooperatives banks). This paper focuses on Japanese cooperative banks as they constitute an important segment of the Japanese banking sector. We employ a simultaneous equation model in which the relationships between, risk, capital and cost inefficiency are modelled. Two stage least squares with fixed effects estimation procedure are applied to a panel data set of 263 Japanese cooperative banks over the period 2003 through 2006. The results confirm the belief that risk, capital and inefficiency are simultaneously determined. The empirical model shows a negative relationship between risk and the level of capital for Japanese cooperative banks. Inefficient Japanese cooperative banks appear to operate with larger capital and take on more risk. These arguments may reflect the moral hazard problem that exists in the banking system through exploitation of the benefits of deposit insurance. We also assess the size effects and find that larger cooperative banks holding less capital take on more risk and are less efficient.
    Keywords: Risk; Capital; Efficiency; Japanese cooperative banks
    JEL: C23 D24 E44 E5 E52 G21 N25
    Date: 2009–11
  16. By: Tirole, Jean (University of Toulouse Capitole)
    Abstract: The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macroprudential policies.
    JEL: E44 E52 G28
    Date: 2009–09–12
  17. By: Antonio Francisco A. Silva Jr.
    Abstract: Even in a floating foreign exchange rate regime, monetary authorities sometimes intervene in the currency market due to liquidity demand and foreign exchange crises. Typically, central banks intervene using foreign currency trades and/or by changing domestic interest rates. We discuss this framework in the context of an optimal impulse stochastic control model. The control and performance equations include interventions with swap operations in the domestic market, since the Central Bank of Brazil also uses these operations. We evaluate risk management strategies for central bank interventions in case of crisis based on the model. We conclude that the Brazilian risk management strategy of increasing holdings of international reserves and decreasing short foreign exchange rate exposure in domestic public debt after 2004 gave the country more flexibility to manage foreign exchange rate risk in 2008 and to avoid higher interest rates to attract international capital as was necessary in previous crises.
    Date: 2010–04
  18. By: Rocha, Roberto; Vittas, Dimitri; Rudolph, Heinz P.
    Abstract: This paper provides a comparative summary of the payout phase of pension systems in five countries -- Australia, Chile, Denmark, Sweden, and Switzerland. All five countries have large pension systems with mandatory or quasi-mandatory retirement savings schemes. But they exhibit important differences in the structure and role of different pillars, regulation of payout options, level of annuitization, market structure, capital regulations, risk management, and use of risk sharing arrangements. The paper summarizes the experience of these countries and highlights the lessons they offer to other countries.
    Keywords: Pensions&Retirement Systems,Debt Markets,Emerging Markets,Insurance&Risk Mitigation,Investment and Investment Climate
    Date: 2010–04–01
  19. By: Pomerleano, Michael (Asian Development Bank Institute)
    Abstract: The paper analyzes the risks in the banking systems in East Asia using the standard supervisory framework, which assesses capital adequacy, asset quality, management, earnings, and liquidity (CAMEL), and finds that banking systems in the region are sound, but that the short-term outlook is negative. Second, it reviews the measures introduced in Asian countries to support their banking systems. The main bank support measures—direct capital support, removal and guarantees of bad assets, direct liquidity support, and guarantees for banks' existing or newly issued obligations—might be necessary to ensure stability, but they need to be handled carefully to prevent long-term distortions. It remains to be seen whether Asian policymakers will manage skillfully the lifting of bank support measures. Third, the paper conducts stress tests of the banking systems. The stress tests indicate that the largest banking systems in East Asia have a total of almost US$1.2 trillion in Tier 1 capital and a possible shortfall of US$758 billion. Fourth, it assesses the implications for liquidity of the increase in international banking flows and finds that the banking system in the Republic of Korea appears vulnerable to a reversal of capital flows. Fifth, the paper explores the implications of the crisis for credit formation, assessing whether nonbank financial institutions in the region have the capacity to provide sufficient liquidity. The author concludes that they do not. The paper ends with a brief assessment of the impact of the crisis on the corporate sector, concluding that the effects of the crisis are likely to be significant but manageable.
    Keywords: east asian bank capital; global financial crisis; government bank support policies
    JEL: F37 G15 G20
    Date: 2009–08–19

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.