nep-rmg New Economics Papers
on Risk Management
Issue of 2010‒11‒13
seven papers chosen by
Stan Miles
Thompson Rivers University

  1. Systemic Weather Risk and Crop Insurance: The Case of China By Wei Xu; Ostap Okhrin; Martin Odening; Ji Cao
  2. Hedging Pure Endowments with Mortality Derivatives By Ting Wang; Virginia R. Young
  3. Mean-Variance & Mean-VaR Portfolio Selection: A Simulation Based Comparison in the Czech Crisis Environment By Radovan Parrák; Jakub Seidler
  4. Size, value and liquidity: Do they really matter on an emerging stock market? By Lischewski, Judith; Voronkova, Svitlana
  5. Completeness, interconnectedness and distribution of interbank exposures: A parameterized analysis of the stability of financial networks By Sachs, Angelika
  6. Financial correlations at ultra-high frequency: theoretical models and empirical estimation By Iacopo Mastromatteo; Matteo Marsili; Patrick Zoi
  7. Modelling asset correlations during the recent FInancial crisis: A semiparametric approach By Nektarios Aslanidis; Isabel Casas

  1. By: Wei Xu; Ostap Okhrin; Martin Odening; Ji Cao
    Abstract: The supply of affordable crop insurance is hampered by the existence of systemic weather risk which results in large risk premiums. In this article, we assess the systemic nature of weather risk for 17 agricultural production regions in China and explore the possibility of spatial diversification of this risk. We simulate the buffer load of hypothetical temperature-based insurance and investigate the relation between the size of the buffer load and the size of the trading area of the insurance. The analysis makes use of a hierarchical Archimedean copula approach (HAC) which allows flexible modeling of the joint loss distribution and reveals the dependence structure of losses in different insured regions. Our results show a significant decrease of the required risk loading when the insured area expands. Nevertheless, a considerable part of undiversifiable risk remains with the insurer. We find that the spatial diversification effect depends on the type of the weather index and the strike level of the insurance. Our findings are relevant for insurers and insurance regulators as they shed light on the viability of private crop insurance in China.
    Keywords: crop insurance, systemic weather risk, hierarchical Archimedean copulas
    JEL: C14 Q19
    Date: 2010–10
  2. By: Ting Wang; Virginia R. Young
    Abstract: In recent years, a market for mortality derivatives began developing as a way to handle systematic mortality risk, which is inherent in life insurance and annuity contracts. Systematic mortality risk is due to the uncertain development of future mortality intensities, or {\it hazard rates}. In this paper, we develop a theory for pricing pure endowments when hedging with a mortality forward is allowed. The hazard rate associated with the pure endowment and the reference hazard rate for the mortality forward are correlated and are modeled by diffusion processes. We price the pure endowment by assuming that the issuing company hedges its contract with the mortality forward and requires compensation for the unhedgeable part of the mortality risk in the form of a pre-specified instantaneous Sharpe ratio. The major result of this paper is that the value per contract solves a linear partial differential equation as the number of contracts approaches infinity. One can represent the limiting price as an expectation under an equivalent martingale measure. Another important result is that hedging with the mortality forward may raise or lower the price of this pure endowment comparing to its price without hedging, as determined in Bayraktar et al. [2009]. The market price of the reference mortality risk and the correlation between the two portfolios jointly determine the cost of hedging. We demonstrate our results using numerical examples.
    Date: 2010–11
  3. By: Radovan Parrák (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Jakub Seidler (Czech National Bank; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper focuses on two methods for optimum portfolio selection. We compare Mean-Variance method with Mean-VaR method by the means of investment simulation, based on Czech financial market data from turbulent market periods of the year 2007 and the year 2008. We compare both strategies, basing on measurements of relative and absolute profitability of both strategies in crisis periods. The results indicate that both strategies were relatively profitable in both simulation periods. As a consequence of our results, it seems that it is worth to adhering investment decisions to outputs of optimisation algorithms of both methods. Moreover, we consider Mean-VaR strategy to be safer in turbulent times.
    Keywords: portfolio optimization, investment strategy, Mean-Variance, Mean-Var
    JEL: C52 G11
    Date: 2010–11
  4. By: Lischewski, Judith; Voronkova, Svitlana
    Abstract: The paper extends the evidence on the factors relevant for pricing stocks in emerging markets. While previous literature focused on Latin American and Asian developing markets, Central and Eastern European markets remain under-researched. By focusing on the Polish stock market, we aim to fill in a gap in the asset pricing literature and draw attention to these previously overlooked markets. In addition to analyzing the importance of the most prominent risk-factors such as market, size and book-to-market value, we investigate whether liquidity plays a role in pricing Polish stocks. To test this conjecture we use the largest array of liquidity measures that has been used in the literature to date. We take advantage of a hand-collected dataset covering the longest period studied so far in case of the this market. Our results support existing evidence for developed markets with regard to the market, size, and book-to-market factor. However, in contrast to studies on other emerging markets, we do not find convincing evidence in favour of the liquidity risk premium on the Polish stock market. This result is robust across various liquidity measures and time periods. Analyzing specific characteristics of the Polish market, we consider possible explanations behind this finding. --
    JEL: G10 G12
    Date: 2010
  5. By: Sachs, Angelika
    Abstract: This paper assesses the impact of a certain structure of interbank exposures on the stability of a stylized financial system. Given a certain balance sheet structure of financial institutions, a large number of valid matrices of interbank exposures is created by a random generator. Assuming a certain loss given default, domino effects are simulated. The main results are, first, that financial stability depends not only on the completeness and interconnectedness of the network but also on the distribution of interbank exposures within the system (measured by entropy). Second, looking at random graphs, the sign of the correlation between the degree of equality of the distribution of claims and financial stability depends on the connectivity of the financial system as well as on additional parameters that affect the vulnerability of the system to interbank contagion. Third, the more concentrated assets are within a money center model, the less stable it is. Fourth, a money center model with asset concentration among core banks is less stable than a random graph with banks of homogeneous size. Results obtained in this paper extend existing theoretical literature that exclusively focuses on completeness and interconnectedness of the network as well as empirical literature that exclusively focuses on one particular financial network. --
    Keywords: domino effects,interbank lending,financial stability,contagion
    JEL: C63 G21 G28
    Date: 2010
  6. By: Iacopo Mastromatteo; Matteo Marsili; Patrick Zoi
    Abstract: A detailed analysis of correlation between stock returns at high frequency is compared with simple models of random walks. We focus in particular on the dependence of correlations on time scales - the so-called Epps effect. This provides a characterization of stochastic models of stock price returns which is appropriate at very high frequency.
    Date: 2010–11
  7. By: Nektarios Aslanidis; Isabel Casas (School of Economics and Management and CREATES, Aarhus University)
    Abstract: 8000 Aarhus C, Denmark
    Keywords: Semiparametric Conditional Correlation Model, Nonparametric Correlations, DCC, Local Linear Estimator, Portfolio Evaluation.
    JEL: C14 G10
    Date: 2010–10–21

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