nep-rmg New Economics Papers
on Risk Management
Issue of 2011‒01‒30
fifteen papers chosen by
Stan Miles
Thompson Rivers University

  1. International Evidence on GFC-robust Forecasts for Risk Management under the Basel Accord By Michael McAleer; Juan-Ángel Jiménez-Martín; Teodosio Pérez-Amaral
  2. Counterparty Risk Subject To ATE By Zhou, Richard
  3. Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting By Damiano Brigo; Agostino Capponi; Andrea Pallavicini; Vasileios Papatheodorou
  4. Unilateral CVA for CDS in Contagion model: With volatilities and correlation of spread and interest By Bao, Qunfang; Chen, Si; Liu, Guimei; Li, Shenghong
  5. Modeling Bankruptcy Prediction for Non-Financial Firms: The Case of Pakistan By Abbas , Qaiser; Rashid , Abdul
  6. Une analyse temps-fréquences des cycles financiers. By Christophe Boucher; Bertrand Maillet
  7. An Active Margin System and its Application in Chinese Margin Lending Market By Guanghui Huang; Jianping Wan; Cheng Chen
  8. A tale of three countries, dispersed ownership and greater risk taking levels by management: risk monitoring tools in bank regulation and supervision – developments since the collapse of Barings Plc (re – visited) By Ojo, Marianne
  9. L’asset allocation dei fondi hedge durante la crisi finanziaria: un’analisi empirica By Piluso, Fabio; Amerise, Ilaria Lucrezia
  10. A note on the computation of Waring formula By Areski Cousin; Diana Dorobantu; Didier Rullière
  11. Estimating Inflation-at-Risk (IaR) using Extreme Value Theory (EVT) By Santos, Edward P.; Mapa, Dennis S.; Glindro, Eloisa T.
  12. A Modern View on Merton's Jump-Diffusion Model By Gerald Cheang; Carl Chiarella
  13. Forecasting Covariance Matrices: A Mixed Frequency Approach By Roxana Halbleib; Valerie Voev
  14. "Generalized Extreme Value Distribution with Time-Dependence Using the AR and MA Models in State Space Form" By Jouchi Nakajima; Tsuyoshi Kunihama; Yasuhiro Omori; Sylvia Fruhwirth-Schnatter
  15. Managing financial risks due to natural catastrophes By Robert Kast

  1. By: Michael McAleer (Econometrisch Instituut (Econometric Institute), Faculteit der Economische Wetenschappen (Erasmus School of Economics) Erasmus Universiteit, Tinbergen Instituut (Tinbergen Institute).); Juan-Ángel Jiménez-Martín (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid); Teodosio Pérez-Amaral (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid)
    Abstract: A risk management strategy that is designed to be robust to the Global Financial Crisis (GFC), in the sense of selecting a Value-at-Risk (VaR) forecast that combines the forecasts of different VaR models, was proposed in McAleer et al. (2010c). The robust forecast is based on the median of the point VaR forecasts of a set of conditional volatility models. Such a risk management strategy is robust to the GFC in the sense that, while maintaining the same risk management strategy before, during and after a financial crisis, it will lead to comparatively low daily capital charges and violation penalties for the entire period. This paper presents evidence to support the claim that the median point forecast of VaR is generally GFC-robust. We investigate the performance of a variety of single and combined VaR forecasts in terms of daily capital requirements and violation penalties under the Basel II Accord, as well as other criteria. In the empirical analysis, we choose several major indexes, namely French CAC, German DAX, US Dow Jones, UK FTSE100, Hong Kong Hang Seng, Spanish Ibex35, Japanese Nikkei, Swiss SMI and US S&P500. The GARCH, EGARCH, GJR and Riskmetrics models, as well as several other strategies, are used in the comparison. Backtesting is performed on each of these indexes using the Basel II Accord regulations for 2008-10 to examine the performance of the Median strategy in terms of the number of violations and daily capital charges, among other criteria. The Median is shown to be a profitable and safe strategy for risk management, both in calm and turbulent periods, as it provides a reasonable number of violations and daily capital charges. The Median also performs well when both total losses and the asymmetric linear tick loss function are considered
    Keywords: Median strategy, Value-at-Risk (VaR), daily capital charges, robust forecasts, violation penalties, optimizing strategy, aggressive risk management, conservative risk management, Basel II Accord, global financial crisis (GFC).
    JEL: G32 G11 C53 C22
    Date: 2011
  2. By: Zhou, Richard
    Abstract: Rating trigger ATE (Additional Termination Event) is a counterparty risk mitigant that allows banks to terminate and close out bilateral derivative contracts if the credit rating of the counterparty falls below the trigger level. Since credit default is often preceded by rating downgrades, ATE clause effectively reduces the counterparty credit risk by early termination of exposure. However, there is still the risk that counterparty may default without going through severe downgrade. This article presents a practical model for valuating CVA in the presence of ATE.
    Keywords: Counterparty Risk, Credit Valuation Adjustment, Rating Transition, Rating Trigger, Additional Termination Event
    JEL: C00
    Date: 2010–12
  3. By: Damiano Brigo; Agostino Capponi; Andrea Pallavicini; Vasileios Papatheodorou
    Abstract: This paper generalizes the framework for arbitrage-free valuation of bilateral counterparty risk to the case where collateral is included, with possible re-hypotecation. We analyze how the payout of claims is modified when collateral margining is included in agreement with current ISDA documentation. We then specialize our analysis to interest-rate swaps as underlying portfolio, and allow for mutual dependences between the default times of the investor and the counterparty and the underlying portfolio risk factors. We use arbitrage-free stochastic dynamical models, including also the effect of interest rate and credit spread volatilities. The impact of re-hypotecation, of collateral margining frequency and of dependencies on the bilateral counterparty risk adjustment is illustrated with a numerical example.
    Date: 2011–01
  4. By: Bao, Qunfang; Chen, Si; Liu, Guimei; Li, Shenghong
    Abstract: The price of financial derivative with unilateral counterparty credit risk can be expressed as the price of an otherwise risk-free derivative minus a credit value adjustment(CVA) component that can be seen as shorting a call option, which is exercised upon default of counterparty, on MtM of the derivative. Therefore, modeling volatility of MtM and default time of counterparty is key to quantification of counterparty risk. This paper models default times of counterparty and reference with a particular contagion model with stochastic intensities that is proposed by Bao et al. 2010. Stochastic interest rate is incorporated as well to account for positive correlation between spread and interest. Survival measure approach is adopted to calculate MtM of risk-free CDS and conditional survival probability of counterparty in defaultable environment. Semi-analytical solution for CVA is attained. Affine specification of intensities and interest rate concludes analytical expression for pre-default value of MtM. Numerical experiments at the last of this paper analyze the impact of contagion, volatility and correlation on CVA.
    Keywords: Credit Value Adjustment; Contagion Model; Stochastic Intensities and Interest; Survival Measure; Affine Specification
    JEL: G12 C63 C15 G13
    Date: 2010–10–28
  5. By: Abbas , Qaiser; Rashid , Abdul
    Abstract: This paper aims to identify the financial ratios that are most significant in bankruptcy prediction for the non-financial sector of Pakistan based on a sample of companies which became bankrupt over the 1996-2006 period. Twenty four financial ratios covering four important financial attributes namely profitability, liquidity, leverage, and turnover ratios) were examined for a five-year period prior bankruptcy. The discriminant analysis produced a parsimonious model of three variables viz. sales to total assets, EBIT to current liabilities, and cash flow ratio. Our estimates provide evidence that the firms having Z value below zero fall into the “bankrupt” whereas the firms with Z value above zero fall into the “non-bankrupt” category. The model achieved 76.9% prediction accuracy when it is applied to forecast bankruptcies on the underlying sample.
    Keywords: Bankruptcy; Z-Score; Non-Financial Firms; Financial Ratios; Pakistan
    JEL: G33
    Date: 2011–01–01
  6. By: Christophe Boucher (ABN AMRO - Variances et Centre d'Economie de la Sorbonne); Bertrand Maillet (ABN AMRO - Variances, IEF et Centre d'Economie de la Sorbonne)
    Abstract: This paper studies the role of fluctuations in the aggregate price-earning ratio at different time-scales, for predicting stock returns and exploring the channels through which returns are forecasted. Using U.S. quartely data, we find that cycles in the price-earning ratio are strong and better predictors of future returns than the aggregate price-earning ratio and several other popular forecasting variables. The proposed method, based on a wavelet multi-scaling analysis, explicitly accounts for the variations at different time scales in the expected cash-flow growth and expected returns.
    Keywords: Risk financial cycles, forecasting, wavelets.
    JEL: C22 G12
    Date: 2011–01
  7. By: Guanghui Huang; Jianping Wan; Cheng Chen
    Abstract: In order to protect brokers from customer defaults in a volatile market, an active margin system is proposed for the transactions of margin lending in China. The probability of negative return under the condition that collaterals are liquidated in a falling market is used to measure the risk associated with margin loans, and a recursive algorithm is proposed to calculate this probability under a Markov chain model. The optimal maintenance margin ratio can be given under the constraint of the proposed risk measurement for a specified amount of initial margin. An example of such a margin system is constructed and applied to $26,800$ margin loans of 134 stocks traded on the Shanghai Stock Exchange. The empirical results indicate that the proposed method is an operational method for brokers to set margin system with a clearly specified target of risk control.
    Date: 2011–01
  8. By: Ojo, Marianne
    Abstract: This paper is aimed at explaining why higher concentrations of the ownership of large firms do not necessarily and automatically facilitate lower risk taking levels – where there is scope for the abuse of powers. As well as illustrating why effective corporate governance systems are essential in facilitating high levels of monitoring, accountability and disclosure, the paper also highlights why a consideration of the costs of ownership concentration and its benefits, is required in determining whether corporate governance systems will be effective or not.
    Keywords: corporate governance; ownership structures; banks; risk; regulation; monitoring; disclosure; accountability; liquidity; internal controls
    JEL: K2 G2 G3 D8
    Date: 2011–01–14
  9. By: Piluso, Fabio; Amerise, Ilaria Lucrezia
    Abstract: The hedge funds industry was partly blamed for the global financial crisis that started in 2007, especially in Europe. If one analyses the performance of hedge funds during this period, it becomes clear that the hedge fund industry did not necessarily fare well. Some funds gained, but many others incurred heavy losses. To address the issue performance of hedge funds during the financial crisis period (2007-2008) we undertook a study to settle the question of hedge fund performance using cluster analysis. Selecting the London hedge market (as it controls 77% of the European hedge funds) we have attempted to map out the various strategies used by the different managers as well as study the patterns of risk-return during periods of financial panic which increases the volatility of the markets. We believe that the strong instability of the markets should encourage the funds to invest in good shelter and exploit the high volatility of the quoted titles (long/short strategy). Our analysis clearly shows that the cluster analysis has helped us to identify hedge fund manager’s allocation strategies that are the best persistent performers during the financial crisis period in the London hedge fund market. And the overall best performer appears to be CTA/managed futures, long/short equities, and macro.
    Keywords: hedge fund; investment strategy; cluster analysis; financial crisis
    JEL: C10 G11 G23
    Date: 2011–01–10
  10. By: Areski Cousin (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Diana Dorobantu (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: We present in this paper the Waring formula, which is used in several fields, like life-insurance or credit risk. We show that some problems can occur when using this formula, and propose alternative recursions in order to improve the complexity of the calculations, and to cope with the numerical instability of the formula.
    Date: 2011–01–19
  11. By: Santos, Edward P.; Mapa, Dennis S.; Glindro, Eloisa T.
    Abstract: The Bangko Sentral ng Pilipinas (BSP) has the primary responsibility of maintaining stable prices conducive to a balanced and sustainable economic growth. The year 2008 posed a challenge to the BSP’s monetary policy making as inflation hit an official 17-year high of 12.5 percent in August after 10 months of continuous acceleration. The alarming double-digit inflation rate was attributed to rising fuel and food prices, particularly the price of rice. A high inflation rate has impact on poverty since inflation affects the poor more than the rich. From a macroeconomic perspective, high level of inflation is not conducive to economic growth. This paper proposes a method of estimating Inflation-at-Risk (IaR) similar to the Value-at-Risk (VaR) used to estimate risk in the financial market. The IaR represents the maximum inflation over a target horizon for a given low pre-specified probability. It can serve as an early warning system that can be used by the BSP to identify whether the level of inflation is extreme enough to be considered an imminent threat to its inflation objective. The extreme value theory (EVT), which deals with the frequency and magnitude of very low probability events, is used as the basis for building a model in estimating the IaR. The estimates of the IaR using the peaks-over-threshold (POT) model suggest that the while the inflation rate experienced in 2008 can not be considered as an extreme value, it was very near the estimated 90 percent IaR.
    Keywords: Inflation-at-Risk (IaR); Extreme Value Theory (EVT); Peaks-over-Threshold (POT)
    JEL: E31 C52 C01
    Date: 2011–01
  12. By: Gerald Cheang (Centre for Industrial and Applied Mathematics, School of Mathematics and Statistics, University of South Australia); Carl Chiarella (School of Finance and Economics, University of Technology, Sydney)
    Abstract: Merton has provided a formula for the price of a European call option on a single stock where the stock price process contains a continuous Poisson jump component, in addition to a continuous log-normally distributed component. In Merton's analysis, the jump-risk is not priced. Thus the distribution of the jump-arrivals and the jump-sizes do not change under the change of measure. We go onto introduce a Radon-Nikodym derivative process that induces the change of measure from the market measure to an equivalent martingale measure. The choice of parameters in the Radon-Nikodym derivative allows us to price the option under different financial-economic scenarios. We introduce a hedging argument that eliminates the jump-risk in some sort of averaged sense, and derive an integro-partial differential equation of the option price that is related to the one obtained by Merton.
    Keywords: financial derivatives; compound Poisson processes; equivalent martingale measure; hedging portfolio
    Date: 2011–01–01
  13. By: Roxana Halbleib; Valerie Voev
    Abstract: This paper proposes a new method for forecasting covariance matrices of financial returns. the model mixes volatility forecasts from a dynamic model of daily realized volatilities estimated with high-frequency data with correlation forecasts based on daily data. This new approach allows for flexible dependence patterns for volatilities and correlations, and can be applied to covariance matrices of large dimensions. The seperate modeling of volatility and correlation forecasts considerably reduces the estimation and measurement error implied by the joint estimation and modeling of covariance matrix dynamics. Our empirical results show that the new mixing approach provides superior forecasts compared to multivariate volatility specifications using single sources of information.
    Date: 2011–01
  14. By: Jouchi Nakajima (Department of Statistical Science, Duke University); Tsuyoshi Kunihama (Department of Statistical Science, Duke University); Yasuhiro Omori (Faculty of Economics, University of Tokyo); Sylvia Fruhwirth-Schnatter (Department of Applied Statistics, Johannes Kepler University Linz)
    Abstract: A new state space approach is proposed to model the time-dependence in an extreme value process. The generalized extreme value distribution is extended to incorporate the time-dependence using a state space representation where the state variables either fol- low an autoregressive (AR) process or a moving average (MA) process with innovations arising from a Gumbel distribution. Using a Bayesian approach, an efficient algorithm is proposed to implement Markov chain Monte Carlo method where we exploit an accu- rate approximation of the Gumbel distribution by a ten-component mixture of normal distributions. The methodology is illustrated using extreme returns of daily stock data. The model is tted to a monthly series of minimum returns and the empirical results support strong evidence of time-dependence among the observed minimum returns.
    Date: 2011–01
  15. By: Robert Kast
    Abstract: this paper was prepared for the First Journées d’Economie et Econométrie de l’Asssurance, in Rennes, October 22nd and 23rd, 2009. It’s a melting pot of several papers that I have written with my co-authors, plus a very short summary of Graciella Chichilnisky enlightening results. But, before proposing partial answers to the problem of modelling catastrophes in such a way as to be able to propose how to manage them, I try and grasp what we mean by catastrophe and what are the main problems, in the introduction.
    Date: 2010

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