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on Risk Management |
| By: | Bandyopadhyay, Arindam |
| Abstract: | This paper aims at working out a more risk sensitive measure of concentration risk and captures its impact in terms of capital number that will help the bank’s top management to manage it efficiently as well as meet the regulatory compliance. We have designed a more risk sensitive measures like expected loss based Hirschman-Herfindahl Index (HHI), loss correlation approach (single as well as multi factor), credit value at risk (C-VaR) based on bank’s internal loss data history that would measure credit concentration and suggest the amount of capital required to cover concentration risk. Using detailed borrower wide, facility wide, industry and regional loan portfolio data of a mid sized public sector bank in India, our paper attempts to provide a detail insight into measurement of concentration risk in credit portfolio and understand its impact in terms of economic capital for the bank as a whole. Regulators and other stakeholders worldwide are asking for more accurate and precise measure of concentration risk in terms of capital numbers. The detailed analysis and methods used in this paper is an attempt to find out a solution in this direction. |
| Keywords: | Portfolio Credit Concentration Risk; Bank Capital |
| JEL: | G32 G21 |
| Date: | 2011–01–31 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:28672&r=rmg |
| By: | Das, Shubhabrata (IIM (Indian Institute of Management) Bangalore, India); Kratz, Marie (ESSEC Business School) |
| Abstract: | One possible way of risk management for an insurance company is to develop an early and appropriate alarm system before the possible ruin. The ruin is defined through the status of the aggregate risk process, which in turn is determined by premium accumulation as well as claim settlement out-go for the insurance company. The main purpose of this work is to design an effective alarm system, i.e. to define alarm times and to recommend augmentation of capital of suitable magnitude at those points to prevent or reduce the chance of ruin. In the three different methods outlined in this work, the alarms are signaled on the basis of the past history of the risk process and/or properties of claim distribution. Depending on the method adopted, the alarm time can be a random one or a xed parameter of the claim distribution (and premium function). The focus of this work is on devising a sequence of alarms, which are indeed fixed parameters based on characteristics of the risk process. To draw a fair measure of effectiveness of alarm system(s), comparison is drawn between a process equipped with an alarm system, with capital being added at the sound of every alarm, and the corresponding process without any alarm system but an equivalently higher initial capital. Detailed analytical results are obtained for general processes and this is backed up simulated performances when the loss severity has exponential, or Pareto or discrete logarithmic distribution. The formulation is eventually intended to be applied and extended for devising alarm system for reinsurance contracts. |
| Keywords: | alarm system; capital accumulation function; efficiency; quantitative risk management; risk process; ruin probability |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:essewp:dr-10008&r=rmg |
| By: | John Thanassoulis |
| Abstract: | This paper studies banker remuneration in a competitive market for banker talent. I model, and then calibrate, the default risk of the banks generated by investments and remuneration pressures. Competing banks prefer to pay their banking staff in bonuses and not in wages as risk sharing on the remuneration bill is valuable. But competition for bankers generates a negative externality driving up rival banks’ default risk. Optimal financial regulation involves an appropriately structured limit on the proportion of the balance sheet used for bonuses. However stringent bonus caps are value destroying, default risk enhancing and cannot be optimal for regulators who control only a small number of banks. The paper allows an assessment of the intellectual arguments behind widespread calls to regulate the pay of bankers. The paper uses US data to calibrate the analysis and demonstrate the significant contribution of remuneration to default risk. |
| Keywords: | Bonuses, default risk, competition for bankers, financial regulation |
| JEL: | G21 G34 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:532&r=rmg |
| By: | Yavin, Tzahi; Zhang, Hu; Wang, Eugene; Clayton, Michael |
| Abstract: | As part of Basel II's incremental risk charge (IRC) methodology, this paper summarizes our extensive investigations of constructing transition probability matrices (TPMs) for unsecuritized credit products in the trading book. The objective is to create monthly or quarterly TPMs with predefined sectors and ratings that are consistent with the bank's Basel PDs. Constructing a TPM is not a unique process. We highlight various aspects of three types of uncertainties embedded in different construction methods: 1) the available historical data and the bank's rating philosophy; 2) the merger of one-year Basel PD and the chosen Moody's TPMs; and 3) deriving a monthly or quarterly TPM when the generator matrix does not exist. Given the fact that TPMs and specifically their PDs are the most important parameters in IRC, it is our view that banks may need to make discretionary choices regarding their methodology, with uncertainties well understood and managed. |
| Keywords: | Basel II; trading book; incremental risk charge; default probability; default correlation; transition probability matrix; generator matrix; credit portfolio |
| JEL: | C02 G28 G21 |
| Date: | 2011–01–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:28740&r=rmg |
| By: | T. R. Hurd; Zhuowei Zhou |
| Abstract: | We consider structural credit modeling in the important special case where the log-leverage ratio of the firm is a time-changed Brownian motion (TCBM) with the time-change taken to be an independent increasing process. Following the approach of Black and Cox, one defines the time of default to be the first passage time for the log-leverage ratio to cross the level zero. Rather than adopt the classical notion of first passage, with its associated numerical challenges, we accept an alternative notion applicable for TCBMs called "first passage of the second kind". We demonstrate how statistical inference can be efficiently implemented in this new class of models. This allows us to compare the performance of two versions of TCBMs, the variance gamma (VG) model and the exponential jump model (EXP), to the Black-Cox model. When applied to a 4.5 year long data set of weekly credit default swap (CDS) quotes for Ford Motor Co, the conclusion is that the two TCBM models, with essentially one extra parameter, can significantly outperform the classic Black-Cox model. |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1102.2412&r=rmg |
| By: | Isabel Figuerola-Ferretti; Ioannis Paraskevopoulos |
| Abstract: | This study uses a comprehensive data set of VIX and CDS markets to propose pairs trading strategies that represent the dynamic relation between market risk and credit risk in an equilibrium framework with a common non stationary factor. This involves the analysis of price discovery between VIX and the 47 most traded iTraxx companies. We find cointegration between market risk and credit risk and predominant price leadership in the VIX market. CDS spreads can thus be replicated through positions in the VIX derivatives markets. We demonstrate how one can capitalize on the price discovery between market and credit risk by building a pairs arbitrage strategy whose profits are driven by the common price discovery factor. The respective portfolios are tested against statistical arbitrage. |
| Keywords: | Pairs strategies, Credit risk, Market risk, Price discovery |
| JEL: | C13 C51 G12 G13 G14 |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wbrepe:wb110201&r=rmg |
| By: | Olga Melyukhina |
| Abstract: | This report analyzes the agricultural risk management system in New Zealand, applying a holistic approach that considers the interactions between all sources of risk, farmers’ strategies and policies. The policy analysis is structured around three layers of risk that require a differentiated policy response: normal (frequent) risks that should be retained by the farmer, marketable intermediate risks that can be transferred through market tools, and catastrophic risk that requires government assistance. The risk management policy in New Zealand is focused on prevention of pest and disease incursions. Assistance related to natural catastrophes is delivered within the Adverse Events Framework programme. The government contributes to knowledge and information systems to support private risk management efforts. |
| Keywords: | agricultural policy, bio-security, risk perceptions, levy organisations, co-operatives, risk management, Adverse Events Framework, industry good organisations |
| JEL: | Q18 |
| Date: | 2011–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:oec:agraaa:42-en&r=rmg |
| By: | Shingo Kimura; Jesús Antón |
| Abstract: | This report analyzes the agricultural risk management system in Australia, applying a holistic approach that considers the interactions between all sources of risk, farmers. strategies and policies. The policy analysis is structured around three layers of risk that require a differentiated policy response: normal (frequent) risks that should be retained by the farmer, marketable intermediate risks that can be transferred through market tools, and catastrophic risk that requires government assistance. The main focus of risk management policy in Australia is drought risk and this paper assesses the objective and instruments of the country.s national drought policy framework. |
| Keywords: | climate change, risk-management, agricultural policy, catastrophic risk, drought policy, bio-security, cost sharing, index insurance |
| JEL: | Q18 |
| Date: | 2011–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:oec:agraaa:39-en&r=rmg |
| By: | Jesús Antón; Shingo Kimura |
| Abstract: | This report analyses the agricultural risk management system in Spain, applying a holistic approach that considers the interactions between all sources of risk, farmers. strategies and policies. The policy analysis is structured around three layers of risk that require a differentiated policy response: normal (frequent) risks that should be retained by the farmer, marketable intermediate risks that can be transferred through market tools, and catastrophic risk that requires government assistance. The Spanish risk management system is dominated by public insurance. Two main policy issues are discussed in this paper. First, the contribution of the insurance system to market efficiency; this comes from the information sharing arrangement in the public private partnership, rather than from the premium subsidies. Second, the insurance system as a device for catastrophic assistance. |
| Keywords: | public-private partnerships, risk-management, agricultural policy, catastrophic risk insurance, information sharing |
| JEL: | Q18 |
| Date: | 2011–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:oec:agraaa:43-en&r=rmg |
| By: | Olga Melyukhina |
| Abstract: | This report analyzes the agricultural risk management system in the Netherlands, applying a holistic approach that considers the interactions between all sources of risk, farmers’ strategies and policies. The policy analysis is structured around three layers of risk that require a differentiated policy response: normal (frequent) risks that should be retained by the farmer, marketable intermediate risks that can be transferred through market tools, and catastrophic risk that requires government assistance. The main risk-related policies in the Netherlands are implemented as part of the EU policy framework. Specifically, national policies focus on the management of catastrophic risks by promoting public-private partnerships, such as Livestock Veterinary Fund, to manage the costs of livestock epidemics. The mutual insurance companies specialised in the coverage of specific types of risks are also promoted, with some of them receiving start-up capital and re-insurance support. The recently launched subsidised multi-peril yield insurance exploits the new opportunities created by the EU framework. |
| Keywords: | risk-management, agricultural policy, risk perceptions, pest and disease risk, Livestock Veterinary Fund, muti-peril insurance |
| JEL: | Q18 |
| Date: | 2011–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:oec:agraaa:41-en&r=rmg |
| By: | Ojo, Marianne |
| Abstract: | The meeting of the Governors and Heads of Supervision on the 12 September 2010, their decisions in relation to the new capital framework known as Basel III, as well as the endorsement of the agreements reached on the 26 July 2010, once again, reflect the typical situation where great expectations with rather unequivocal, and in a sense, disappointing results are delivered. The outcome of various consultations by the Basel Committee on Banking Supervision, consultations which culminated in the present Basel III framework, also reflect the focus on measures aimed at addressing problems attributed to Basel II, that is, measures aimed at mitigating pro cyclicality. This is rather astonishing given one critical lesson which has been drawn from the recent Financial Crisis: namely, that capital measures on their own, were and are insufficient in addressing and averting the Financial Crisis. Furthermore, banks which have been complying with capital adequacy requirements could still face severe liquidity problems. As well as an increase of the minimum common equity requirement from 2% to 4.5%, the recent agreement and decisions of the Governors and Heads of Supervision also include the stipulation that banks hold a capital conservation buffer of 2.5% - hence consolidating the stronger definition of capital (as agreed in the previous meeting held by the Governors and Heads of Supervision earlier in July 2010). |
| Keywords: | pro cyclicality; liquidity; capital; Basel III; countercyclical; forward looking provisioning; financial regulation; financial crises |
| JEL: | K2 D8 E3 |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:28550&r=rmg |
| By: | Jesús Antón; Shingo Kimura; Roger Martini |
| Abstract: | This report analyses the agricultural risk management system in Canada, applying a holistic approach that considers the interactions between all sources of risk, farmers‘ strategies and policies. The policy analysis is structured around three layers of risk that require a differentiated policy response: normal (frequent) risks that should be retained by the farmer, marketable intermediate risks that can be transferred through market tools, and catastrophic risk that requires government assistance. The main policy issue in this report is the definition of the boundaries of these different layers. In Canada the system is overcrowded with policies and unable to signal risk layers in which farmers should take their own responsibility of management. Policies include AgriInvest, AgriInsurance, AgriStability, AgriRecovery and ad hoc measures. The analysis of AgriStability provides insights about the economics of agricultural income stabilization policies. |
| Keywords: | insurance, risk-management, agricultural policy, catastrophic risk income stabilization, policy targeting, montecarlo simulations |
| JEL: | Q18 |
| Date: | 2011–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:oec:agraaa:40-en&r=rmg |
| By: | Cohen-Cole, Ethan (University of Maryland); Patacchini, Eleonora (University of Roma La Sapienza); Zenou, Yves (Dept. of Economics, Stockholm University) |
| Abstract: | We propose a novel mechanism to facilitate understanding of systemic risk in financial markets. The literature on systemic risk has focused on two mechanisms, common shocks and domino-like sequential default. Our approach is a formal model that provides an intellectual combination of the two by looking at how shocks propagate through a network of interconnected banks. Transmission in our model is not based on default. Instead, we provide a simple microfoundation of banks’ profitability based on classic competition incentives. As competitors lending quantities change, both for closely connected ones and the whole market, banks adjust their own lending decisions as a result, generating a ‘transmission’ of shocks through the system. We provide a unique equilibrium characterization of a static model, and embed this model into a full dynamic model of network formation with n agents. Because we have an explicit characterization of equilibrium behavior, we have a tractable way to bring the model to the data. Indeed, our measures of systemic risk capture the propagation of shocks in a wide variety of contexts; that is, it can explain the pattern of behavior both in good times as well as in crisis. |
| Keywords: | Financial networks; interbank lending; interconnections; network centrality; spatial autoregressive models |
| JEL: | C21 G10 |
| Date: | 2011–02–11 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2011_0006&r=rmg |
| By: | Leonidas Sandoval Junior; Italo De Paula Franca |
| Abstract: | Using the eigenvalues and eigenvectors of correlations matrices of some of the main financial market indices in the world, we show that high volatility of markets is directly linked with strong correlations between them. This means that markets tend to behave as one during great crashes. In order to do so, we investigate several financial market crises that occurred in the years 1987 (Black Monday), 1989 (Russian crisis), 2001 (Burst of the dot-com bubble and September 11), and 2008 (Subprime Mortgage Crisis), which mark some of the largest downturns of financial markets in the last three decades. |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1102.1339&r=rmg |
| By: | Michael C. M\"unnix; Rudi Sch\"afer |
| Abstract: | We analyze the statistical dependency structure of the S&P 500 constituents in the 4-year period from 2007 to 2010 using intraday data from the New York Stock Exchange's TAQ database. With a copula-based approach, we find that the statistical dependencies are very strong in the tails of the marginal distributions. This tail dependence is higher than in a bivariate Gaussian distribution, which is implied in the calculation of many correlation coefficients. We compare the tail dependence to the market's average correlation level as a commonly used quantity and disclose an neraly linear relation. |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1102.1099&r=rmg |
| By: | Karl Aiginger (WIFO) |
| Abstract: | The growth performance of countries proved to be very different during the recent crisis. We apply principal component analysis to derive a single ordinal indicator on growth performance and to analyse whether initial conditions of economies or structural characteristics can explain the differences in growth performance. As initial conditions at the start of the crisis we use fiscal situation, trade competitiveness, output and credit growth, as structural characteristics we test size, openness, share of sectors and per-capita income. The task has proved to be as difficult as expected as causality often works in two ways and policy variables have intervened, which themselves are dependent on the initial conditions and structural characteristics. The three indicators that end up as the best predictors for the depth of the crisis are correlated with one another and thus difficult to disentangle. |
| Date: | 2011–02–08 |
| URL: | http://d.repec.org/n?u=RePEc:wfo:wpaper:y:2011:i:387&r=rmg |