nep-rmg New Economics Papers
on Risk Management
Issue of 2010‒12‒11
eleven papers chosen by
Stan Miles
Thompson Rivers University

  1. Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH By Chia-Lin Chang; Michael McAleer; Roengchai Tansuchat
  2. Explicit ruin formulas for models with dependence among risks By Hansjoerg Albrecher; Corina Constantinescu; Stéphane Loisel
  3. The Impossible Trio in CDO Modeling By Emmanuel Schertzer; Yadong Li; Umer Khan
  4. Public credit registries as a tool for bank regulation and supervision By Girault, Matias Gutierrez; Hwang, Jane
  5. Set-valued risk measures for conical market models By Andreas H. Hamel; Frank Heyde; Birgit Rudloff
  6. Capital Regulation after the Crisis: Business as Usual? By Hellwig, Martin
  7. The economic default time and the Arcsine law By Xin Guo; Robert A Jarrow; Adrien de Larrard
  8. Risk-return tradeoff and the behaviour of volatility on the South African stock market: Evidence from both aggregate and disaggregate data By N.Z Mandimika; Z. Chinzara
  9. Robust Estimation of Operational Risk By Nataliya Horbenko; Peter Ruckdeschel; Taehan Bae
  10. Regulatory Medicine Against Financial Market Instability: What Helps And What Hurts? By Stefan Kerbl
  11. On monetary policy and stock market anomalies By Alexandros Kontonikas; Alexandros Kostakis

  1. By: Chia-Lin Chang (Department of Applied Economics, Department of Finance, National Chung Hsing University); Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, and Institute of Economic Research, Kyoto University); Roengchai Tansuchat (Faculty of Economics, Maejo University)
    Abstract: The paper examines the performance of four multivariate volatility models, namely CCC, VARMA-GARCH, DCC, BEKK and diagonal BEKK, for the crude oil spot and futures returns of two major benchmark international crude oil markets, Brent and WTI, to calculate optimal portfolio weights and optimal hedge ratios, and to suggest a crude oil hedge strategy. The empirical results show that the optimal portfolio weights of all multivariate volatility models for Brent suggest holding futures in larger proportions than spot. For WTI, however, DCC, BEKK and diagonal BEKK suggest holding crude oil futures to spot, but CCC and VARMA-GARCH suggest holding crude oil spot to futures. In addition, the calculated optimal hedge ratios (OHRs) from each multivariate conditional volatility model give the time-varying hedge ratios, and recommend to short in crude oil futures with a high proportion of one dollar long in crude oil spot. Finally, the hedging effectiveness indicates that diagonal BEKK (BEKK) is the best (worst) model for OHR calculation in terms of reducing the variance of the portfolio.
    Keywords: Multivariate GARCH, conditional correlations, crude oil prices, optimal hedge ratio, optimal portfolio weights, hedging strategies.
    JEL: C22 C32 G11 G32
    Date: 2010–11
  2. By: Hansjoerg Albrecher (UNIL - Université de Lausanne - Université de Lausanne); Corina Constantinescu (UNIL - Université de Lausanne - Université de Lausanne, SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Stéphane Loisel (UNIL - Université de Lausanne - Université de Lausanne, SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: We show that a simple mixing idea allows to establish a number of explicit formulas for ruin probabilities and related quantities in collective risk models with dependence among claim sizes and among claim inter-occurrence times. Examples include compound Poisson risk models with completely monotone marginal claim size distributions that are dependent according to Archimedean survival copulas as well as renewal risk models with dependent inter-occurrence times.
    Date: 2010–11–24
  3. By: Emmanuel Schertzer; Yadong Li; Umer Khan
    Abstract: We show that stochastic recovery always leads to counter-intuitive behaviors in the risk measures of a CDO tranche - namely, continuity on default and positive credit spread risk cannot be ensured simultaneously. We then propose a simple recovery variance regularization method to control the magnitude of negative credit spread risk while preserving the continuity on default.
    Date: 2010–12
  4. By: Girault, Matias Gutierrez; Hwang, Jane
    Abstract: This paper is about the importance of the information in Public Credit Registries (PCRs) for supporting and improving banking sector regulation and supervision, particularly in the light of the new approach embodied in Basel III. Against the backdrop of the financial crisis and the existence of information data gaps, the importance of complete, accurate and timely credit information in the financial system is evident. Both in normal times and during crises, authorities need a device that allows them to look at the universe of credits in a detailed and readily way. And more importantly, they need to develop tools that exploit as much as possible the information therein contained. PCR databases contain individual credit information on borrowers and their credits which makes it possible to implement advanced techniques that measure banks'credit risk exposure. It allows optimizing the prudential regulation ensuring that provisioning and capital requirements are properly calibrated to cover expected and unexpected losses respectively. It also permits validating banks'internal rating systems, performing stress tests and informing macroprudential surveillance. In this respect, it is envisioned that the existence of a PCR will be a key factor to enhance the supervision and regulation of the financial system. Furthermore, the extent, accuracy and availability of the information collected by the authorities will determine the usefulness of the PCR as part of their toolkit to monitor the potential vulnerabilities not only on a microprudential level, but also on a macroprudential one.
    Keywords: Banks&Banking Reform,Access to Finance,Financial Intermediation,Debt Markets,Bankruptcy and Resolution of Financial Distress
    Date: 2010–12–01
  5. By: Andreas H. Hamel; Frank Heyde; Birgit Rudloff
    Abstract: Set-valued risk measures on $L^p_d$ with $0 \leq p \leq \infty$ for conical market models are defined, primal and dual representation results are given. The collection of initial endowments which allow to super-hedge a multivariate claim are shown to form the values of a set-valued sublinear (coherent) risk measure. Scalar risk measures with multiple eligible assets also turn out to be a special case within the set-valued framework.
    Date: 2010–11
  6. By: Hellwig, Martin
    Abstract: The paper discusses the reform of capital regulation of banks in the wake of the financial crisis of 2007/2009. Whereas the Basel Committee on Banking Supervision seems to go for marginal changes here and there, the paper calls for a thorough overhaul, moving away from risk calibration and raising capital requirements very substantially. The argument is based on the observation that the current system of risk- calibrated capital requirements, in particular under the modelbased approach, played a key role in allowing banks to be undercapitalized prior to the crisis, with strong systemic effects for deleveraging multipliers and for the functioning of interbank markets. The argument is also based on the observation that the current system has no theoretical foundation, its objectives are ill-specified, and its effects have not been thought through, either for the individual bank or for the system as a whole. Objections to substantial increases in capital requirements rest on arguments that run counter to economic logic or are themselves evidence of moral hazard and a need for regulation.
    Date: 2010–07
  7. By: Xin Guo; Robert A Jarrow; Adrien de Larrard
    Abstract: This paper develops a structural credit risk model to characterize the difference between the economic and recorded default times for a firm. Recorded default occurs when default is recorded in the legal system. The economic default time is the last time when the firm is able to pay off its debt prior to the legal default time. It has been empirically documented that these two times are distinct (see Guo, Jarrow, and Lin (2008)). In our model, the probability distribution for the time span between economic and recorded defaults follows a mixture of Arcsine Laws, which is consistent with the results contained in Guo, Jarrow, and Lin. In addition, we show that the classical structural model is a limiting case of our model as the time period between debt repayment dates goes to zero. As a corollary, we show how the firm value process's parameters can be estimated using the tail index and correlation structure of the firm's return.
    Date: 2010–12
  8. By: N.Z Mandimika; Z. Chinzara
    Abstract: The study analyses the nature and behaviour of volatility, the risk-return relationship and the long-term trend of volatility on the South African equity markets, using aggregate-level, industrial-level and sectoral-level daily data for the period 1995-2009. By employing dummy variables for the Asian and the sub-prime financial crises and the 11 September political shock, the study further examines whether the long-term trend of volatility structurally breaks during financial crises and major political shocks. Three time-varying GARCH models were employed: one of them symmetric, and the other two asymmetric. Each of these models was estimated based on three error distributional assumptions. The findings of the study are as follows: Firstly, volatility is largely persistent and asymmetric. Secondly, risk at both the aggregate and disaggregate level is generally not a priced factor on the South African stock market. Thirdly, the TARCH-M model under the Generalised Error Distribution is the most appropriate model for conditional volatility of the South African stock market. Fourthly, volatility generally increases over time and its trend structurally breaks during financial crises and major global shocks. The policy and investment implications of the findings are outlined.
    Keywords: Risk-return tradeoff, stock market volatility, asymmetric GARCH models
    JEL: G10 G11 G12 C52
    Date: 2010
  9. By: Nataliya Horbenko; Peter Ruckdeschel; Taehan Bae
    Abstract: According to the Loss Distribution Approach, the operational risk of a bank is determined as 99.9% quantile of the respective loss distribution, covering unexpected severe events. The 99.9% quantile is a tail event. Supported by the Pickands-Balkema-de Haan Theorem, tail events exceeding some high threshold are usually modeled by a Generalized Pareto Distribution (GPD). However, because of the heavy-tailedness of this distribution, estimation of its tail quantiles is not a trivial task, which becomes even more difficult when there are outliers in the data, or data is pooled among several sources. In such situations where the origin and representativeness of the available data is not clear, robust methods provide a remedy which can provide reliable estimates when classical methods already fail. We illustrate this, applying such robust methods for parameter estimation of a GPD - including some recently developed methods - to data from Algorithmics Inc. To better understand these results, we provide some useful diagnostic plots adjusted for this context: influence plot, outlyingness plot, and QQ plot with robust confidence bands.
    Date: 2010–12
  10. By: Stefan Kerbl
    Abstract: Do we know if a short selling ban or a Tobin Tax result in more stable asset prices? Or do they in fact make things worse? Just like medicine regulatory measures in financial markets aim at improving an already complex system. And just like medicine these interventions can cause side effects which are even harder to assess when taking the interplay with other measures into account. In this paper an agent based stock market model is built that tries to find answers to the questions above. In a stepwise procedure regulatory measures are introduced and their implications on market liquidity and stability examined. Particularly, the effects of (i) a ban of short selling (ii) a mandatory risk limit, i.e. a Value-at-Risk limit, (iii) an introduction of a Tobin Tax, i.e. transaction tax on trading, and (iv) any arbitrary combination of the measures are observed and discussed. The model is set up to incorporate non-linear feedback effects of leverage and liquidity constraints leading to fire sales and escape dynamics. In its unregulated version the model outcome is capable of reproducing stylised facts of asset returns like fat tails and clustered volatility. Introducing regulatory measures shows that only a mandatory risk limit is beneficial from every perspective, while a short selling ban - though reducing volatility - increases tail risk. The contrary holds true for a Tobin Tax: it reduces the occurrence of crashes but increases volatility. Furthermore, the interplay of measures is not negligible: measures block each other and a well chosen combination can mitigate unforeseen side effects. Concerning the Tobin Tax the findings indicate that an overdose can do severe harm.
    Date: 2010–11
  11. By: Alexandros Kontonikas; Alexandros Kostakis
    Abstract: This study utilizes a macro-based VAR framework to investigate whether stock portfolios formed on the basis of their value, size and past performance characteristics are affected in a differential manner by unexpected US monetary policy actions during the period 1967-2007. Full sample results show that value, small capitalization and past loser stocks are more exposed to monetary policy shocks in comparison to growth, big capitalization and past winner stocks. Subsample analysis, motivated by variation in the realized premia and parameter instability, reveals that monetary policy shocks’ impact on these portfolios is significant and pronounced only during the pre-1983 period.
    Keywords: Monetary policy, Federal funds rate, Market anomalies, Credit channel, Risk premia
    JEL: E44 E58 G12
    Date: 2010–11

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