New Economics Papers
on Risk Management
Issue of 2011‒03‒19
sixteen papers chosen by

  1. Systematic risk under extremely adverse market condition By Maarten van Oordt; Chen Zhou
  2. Credit Risk and Real Capital: An Examination of Swiss Banking Sector Default Risk Using CVaR By Robert Powell; David E Allen
  3. The Fluctuating Default Risk of Australian Banks By David E Allen; Robert Powell
  4. CAViaR and the Australian Stock Markets: An Appetiser By David E Allen; Abhay Kumar Singh
  5. Beyond Coping. Risk Management in the West Bank By Silvia Jarauta Bernal
  6. Fair value accounting and procyclicality: mitigating regulatory and accounting policy differences through regulatory structure reforms and Enforced Self Regulation By Ojo, Marianne
  7. Statistiques des valeurs extrêmes dans le cas de lois discrètes By Borchani, Anis
  8. The Price and Risk Effects of Option Introductions on the Nordic Markets By Staffan Linden
  9. The macroeconomic impact of Basel III on the Italian economy By Alberto Locarno
  10. Path modeling to bankruptcy: causes and symptoms of the banking crisis By Carlos Serrano-Cinca; Y. Fuertes-Callén; Begoña Gutiérrez-Nieto; B. Cuéllar-Fernández
  11. "Approximate Derivative Pricing for Large Classes of Homogeneous Assets with Systematic Risk" By Patrick GAGLIARDINI ; Christian GOURIEROUX
  12. Basel III: Long-term impact on economic performance and fluctuations By Paolo Angelini; Laurent Clerc; Vasco Cúrdia; Leonardo Gambacorta; Andrea Gerali; Alberto Locarno; Roberto Motto; Werner Roeger; Skander Van den Heuvel; Jan Vlcek
  13. Revisiting the Fisher and Statman Study on Market Timing By Pfau, Wade Donald
  14. Arbitrage and Hedging in a non probabilistic framework By Alexander Alvarez; Sebastian Ferrando; Pablo Olivares
  15. The Financial Crisis and Intraday Volatility: Comparative Analysis on China, Japan and the US Stock Markets By Yusaku Nishimura; Yoshiro Tsutsui; Kenjiro Hirayama
  16. Do firms share the same functional form of their growth rate distribution? A new statistical test By Jos\`e T. Lunardi; Salvatore Miccich\`e; Fabrizio Lillo; Rosario N. Mantegna; Mauro Gallegati

  1. By: Maarten van Oordt; Chen Zhou
    Abstract: Extreme losses are the major concern in risk management. The dependence between financial assets and the market portfolio changes under extremely adverse market conditions. We develop a measure of systematic tail risk, the tail regression beta , defined by an asset’s sensitivity to large negative market shocks, and establish the estimation methodology. We compare it to regular systematic risk measures: the market beta and the downside beta. Furthermore, the tail regression beta is a useful instrument in both portfolio risk management and systemic risk management. We demonstrate its applications in analyzing Value-at-Risk (VaR) and Conditional Value-at-Risk (CoVaR).
    Keywords: Tail regression beta; downside risk; Extreme Value Theory; tail dependence; risk management
    JEL: C14 G11
    Date: 2011–03
  2. By: Robert Powell (School of Accounting Finance & Economics, Edith Cowan University); David E Allen (School of Accounting Finance & Economics, Edith Cowan University)
    Abstract: The global financial crisis (GFC) has placed the creditworthiness of banks under intense scrutiny. In particular, capital adequacy has been called into question. Current capital requirements make no allowance for capital erosion caused by movements in the market value of assets. This paper examines default probabilities of Swiss banks under extreme conditions using structural modeling techniques. Conditional Value at Risk (CVaR) and conditional probability of default (CPD) techniques are used to measure capital erosion. Significant increase in probability of default (PD) is found during the GFC period. The market asset value based approach indicates a much higher PD than external ratings indicate. Capital adequacy recommendations are formulated which distinguish between real and nominal capital based on asset fluctuations.
    Keywords: Real capital; Financial crisis; Conditional value at risk; Credit risk; Banks; Probability of default; Capital adequacy
    Date: 2010–10
  3. By: David E Allen (School of Accounting Finance & Economics, Edith Cowan University); Robert Powell (School of Accounting Finance & Economics, Edith Cowan University)
    Abstract: Australian banks are widely considered to have fared far better during the Global Financial Crisis (GFC) than their global counterparts, continuing to display solid earnings, good capitalisation and strong credit ratings. Nonetheless, Australian banks experienced significant deterioration in the market values of assets. We use the KMV/Merton structural methodology, which incorporates market asset values, to examine default probabilities of Australian banks. We also modify the model to incorporate conditional probability of default which measures extreme credit risk. We find that, during the GFC, based on extreme asset value fluctuations, Australian bank default probabilities fare only slightly better than their global counterparts.
    Keywords: Financial crisis; Credit risk; Banks; Default; Capital adequacy
    Date: 2010–09
  4. By: David E Allen (School of Accounting Finance & Economics, Edith Cowan University); Abhay Kumar Singh (School of Accounting Finance & Economics, Edith Cowan University)
    Abstract: Value-at-Risk (VaR) has become the universally accepted metric adopted internationally under the Basel Accords for banking industry internal control and for regulatory reporting. This has focused attention on methods of measuring, estimating and forecasting lower tail risk. One promising technique is Quantile Regression which holds the promise of efficiently calculating (VAR). To this end, Engle and Manganelli in (2004) developed their CAViaR model (Conditional Autoregressive Value at Risk). In this paper we apply their model to Australian Stock Market indices and a sample of stocks, and test the efficacy of four different specifications of the model in a set of in and out of sample tests. We also contrast the results with those obtained from a GARCH(1,1) model, the RiskMetricsTM model and an APARCH model
    Keywords: VaR; Quantile regressions; Autoregressive; CAViaR
    Date: 2010–09
  5. By: Silvia Jarauta Bernal
    Abstract: Concerned with the equation of risk management behaviours, the research analyses whether risk management in context of armed conflict is different to that observed during natural disasters and economic crises. Based on the case study of the West Bank during 2000-2004, this investigation uses primary data about household’s perceptions, the Palestinian Expenditure and Consumption Survey and a conflict data set to explore how the characteristics of the occupationproduced shocks unfold into the household’s risk management. The distinctive features observed in the risk-related behaviour of West Bank Palestinians indicate that the standard risk management framework needs to be adapted to intregate the endogenous, multidimensional and dynamic nature of conflict-produced shocks.
    Date: 2011
  6. By: Ojo, Marianne
    Abstract: In what ways can changes to the structure of regulation (as well as other regulatory reforms) mitigate the effects of policies which trigger financial instability? More specifically policies, information asymmetries or externalities which could give rise to bank contagion, systemic/liquidity risks or procyclical effects? Whilst acknowledging that accounting standards play a fundamental role in addressing problems which could contribute to information asymmetries and ultimately systemic risks, this paper also highlights why the type of regulatory structure, clear allocation of responsibilities between regulators, as well as measures aimed at fostering accountability, constitute vital elements which could serve as safeguards in mitigating procyclical effects (as well as other factors) which could trigger financial instability. In achieving this aim, the paper focusses on the rationale for fair value accounting, as well as problematic issues arising from its implementation. The adoption of international accounting standards is considered to have a vital role in contributing to financial stability. This paper will also illustrate how the implementation of accounting standards and policies, in certain instances, have contrasted with Basel Committee initiatives aimed at mitigating procyclicality and facilitating forward looking provisioning. More importantly, the paper will highlight how and why differences between regulatory and accounting policies could (and should) be mitigated.
    Keywords: stability; liquidity risks; systemic risks; pro cyclicality; fair values; information; certainty; regulation; central banks; accountability; macro prudential regulation
    JEL: K2 D8 M4 E3
    Date: 2011–03–05
  7. By: Borchani, Anis (ESSAI (Ecole Supérieure de la Statistique et de l’Analyse de l’Informatio), Tunis)
    Abstract: We propose a method to generate a warning system for the early detection of time clusters in discrete time series. Two approaches are developed, one using an approximation of the return period of an extreme event, independently of the nature of the data, the other using an estimation of the return period via standard EVT tools after a smoothing of our discrete data into continuous ones. This method allows us to define a surveillance and prediction system which is applied to finance and public health surveillance
    Keywords: applications in insurance and finance; clusters; epidemiology; Extreme Value Theory; extreme quantile; outbreak detection; return level; return period; surveillance
    JEL: C22 I10
    Date: 2010–12
  8. By: Staffan Linden
    Abstract: This paper examines the effects of option introductions on the price and risk of the underlying assets. The data, covering 58 introductions during the period 1985-1997, have been collected from the Nordic markets (Denmark, Finland, Norway, and Sweden). A persistent increase of stock returns is found right after the announcement date, rather than at the introduction date, as in US data. The volatility is found to decrease continuously over the ten-month period following the introduction of stock options.
    JEL: G12 G13 G14 G15
    Date: 2010–12
  9. By: Alberto Locarno (Banca d'Italia)
    Abstract: This paper provides an assessment of the costs of complying with Basel III for the Italian economy. The main findings are the following. For each percentage point increase in the capital ratio implemented over an eight-year horizon, the level of GDP would decline by 0.00-0.33% (0.03-0.39% if credit rationing is also accounted for), corresponding to a reduction of annual output growth in the transition period of 0.00-0.04% (0.00-0.05% if credit rationing is considered as well). Compliance with the new liquidity standards causes an additional slowdown of annual GDP growth of at most 0.02%. If banks felt forced to speed up the transition to the new capital rules by the beginning of 2013, the fall in output would be larger and would take place beforehand. Long-run costs of achieving the new capital standards are even lower, slightly less than 0.2%; those needed to comply with the target liquidity ratio are of a similar size. The above estimates suggest that the economic costs of Basel III are not huge and become negligible if compared with the potential benefits that can be reaped from reducing the frequency of systemic crises and the amplitude of boom-bust cycles.
    Keywords: Basel III, Modigliani-Miller theorem, flow/stock costs of equity finance, capital/liquidity requirements
    JEL: E44 E61 G21 G38
    Date: 2011–02
  10. By: Carlos Serrano-Cinca; Y. Fuertes-Callén; Begoña Gutiérrez-Nieto; B. Cuéllar-Fernández
    Abstract: This paper studies the bankruptcy of USA banks since 2009. It first analyzes the financial symptoms that precede bankruptcy, such as low profitability, insufficient revenue, or low solvency ratios. It also goes into the causes of these symptoms. It poses several hypotheses on causes of failure, such as loans growth (some of them risky), specialization (in this case concentration in real estate), and the pursuit of a turnover-driven strategy neglecting margin. It presents and tests a path modeling to bankruptcy based on structural equations, hypotheses tests and logistic regression. Results show that, five years before the crisis, failed banks had, compared to solvent banks, the following: higher loan growths, higher concentration on real estate loans, higher risk ratios, higher turnover, but lower margins. A relationship is found between symptoms and causes. Failed banks present a significant relationship between the percentage of real estate loans and risk. This relationship is negative in excellent banks, confirming that they allocated less real estate loans with higher quality. Non-failed banks compensated increases in risk by strengthening their core capital.
    Keywords: Bankruptcy; Financial ratios; banking crisis; solvency; PLS-Path
    Date: 2011–03
  11. By: Patrick GAGLIARDINI ; Christian GOURIEROUX (Crest)
    Abstract: We consider a homogeneous class of assets, whose returns are driven by an unobservable factor representing systematic risk. We derive approximated pricing formulas for the future factor values and their proxies, when the size n of the class is large. Up to order 1=n, these closed form approximations involve well-chosen summary statistics of the basic asset returns, but not the current and lagged factor values. The potential of the closed form approximation formulas seems quite large, especially for credit risk analysis, which considers large portfolios of individual loans or corporate bonds, and for longevity risk analysis, which involves large portfolios of life insurance contracts.
    Keywords: optimal matching
    Date: 2010–07
  12. By: Paolo Angelini (Bank of Italy); Laurent Clerc (Banque de France); Vasco Cúrdia (Federal Reserve Bank of New York); Leonardo Gambacorta (Bank for International Settlements); Andrea Gerali (Bank of Italy); Alberto Locarno (Bank of Italy); Roberto Motto (European Central Bank); Werner Roeger (European Commission); Skander Van den Heuvel (Board of Governors of the Federal Reserve System); Jan Vlcek (International Monetary Fund)
    Abstract: We assess the long-term economic impact of the new regulatory standards (the Basel III reform), answering the following questions. (1) What is the impact of the reform on long-term economic performance? (2) What is the impact of the reform on economic fluctuations? (3) What is the impact of the adoption of countercyclical capital buffers on economic fluctuations? The main results are the following. (1) Each percentage point increase in the capital ratio causes a median 0.09 percent decline in the level of steady state output, relative to the baseline. The impact of the new liquidity regulation is of a similar order of magnitude, at 0.08 percent. This paper does not estimate the benefits of the new regulation in terms of reduced frequency and severity of financial crisis, analysed in Basel Committee on Banking Supervision (BCBS, 2010b). (2) The reform should dampen output volatility; the magnitude of the effect is heterogeneous across models; the median effect is modest. (3) The adoption of countercyclical capital buffers could have a more sizeable dampening effect on output volatility. These conclusions are fully consistent with those of reports by the Long-term Economic Impact group (BCBS, 2010b) and Macro Assessment Group (MAG, 2010b).
    Keywords: Basel III, countercyclical capital buffers, financial (in)stability, procyclicality, macroprudential
    JEL: E44 E61 G21
    Date: 2011–02
  13. By: Pfau, Wade Donald
    Abstract: Valuation-based market timing demonstrates greater potential to improve risk-adjusted returns for conservative long-term investors than given credit by Fisher and Statman (2006). On a risk-adjusted basis, market-timing strategies provide comparable returns as a 100 percent stocks buy-and-hold strategy but with substantially less risk. Meanwhile, market timing provides comparable risks and the same average asset allocation as a 50/50 fixed allocation strategy, but with much higher returns. Also, defining market timing as either 100 percent stocks or 100 percent Treasury bills does not provide a hedge against the possibility that valuations may depart from their historical averages for extended periods.
    Keywords: market valuations; cyclically-adjusted price-earnings ratio; PE10; stock returns; market timing; long term; tactical asset allocation; buy and hold
    JEL: G14 G11 N22 C15 N21 D14
    Date: 2011–03–09
  14. By: Alexander Alvarez (Ryerson University, Toronto); Sebastian Ferrando (Ryerson University, Toronto); Pablo Olivares (Ryerson University, Toronto)
    Abstract: The paper studies the concepts of hedging and arbitrage in a non probabilistic framework. It provides conditions for non probabilistic arbitrage based on the topological structure of the trajectory space and makes connections with the usual notion of arbitrage. Several examples illustrate the non probabilistic arbitrage as well perfect replication of options under continuous and discontinuous trajectories, the results can then be applied in probabilistic models path by path. The approach is related to recent financial models that go beyond semimartingales, we remark on some of these connections and provide applications of our results to some of these models.
    Date: 2011–03
  15. By: Yusaku Nishimura (Institute of International Economy, University of International Business and Economics); Yoshiro Tsutsui (Graduate School of Economics, Osaka University); Kenjiro Hirayama (School of Economics, Kwansei Gakuin University)
    Abstract: This paper analyzes intraday volatility of the stock markets of mainland China, Hong Kong, Japan, and the US for the period of two months around the Lehman crisis. Specifically, dividing the observation period from July 15 to November 28, 2008 into two sub-periods at the failure of Lehman Brothers, we investigate how intraday volatility changes and whether the changes are different among the stock markets. The results reveal the followings: First, although intraday volatility rapidly increases in all the markets, the effect on Chinese market is limited. Second, after the failure, the long-memory features were strengthened further and the effect of price-down shock on the volatility was mitigated. Finally, FFF regression effectively removes the intraday periodicity of volatility for all the markets.
    Keywords: Lehman crisis, high-frequency data, FIAPARCH model, intraday periodicity, FFF regression
    JEL: C22 G14
    Date: 2010–12
  16. By: Jos\`e T. Lunardi; Salvatore Miccich\`e; Fabrizio Lillo; Rosario N. Mantegna; Mauro Gallegati
    Abstract: We introduce a new statistical test of the hypothesis that a balanced panel of firms have the same growth rate distribution or, more generally, that they share the same functional form of growth rate distribution. We applied the test to European Union and US publicly quoted manufacturing firms data, considering functional forms belonging to the Subbotin family of distributions. While our hypotheses are rejected for the vast majority of sets at the sector level, we cannot rejected them at the subsector level, indicating that homogenous panels of firms could be described by a common functional form of growth rate distribution.
    Date: 2011–03

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