New Economics Papers
on Risk Management
Issue of 2011‒04‒16
eight papers chosen by

  1. Theoretical Sensitivity Analysis for Quantitative Operational Risk Management By Takashi Kato
  2. Asymmetric Dependence in US Financial Risk Factors? By Chollete, Loran; Ning, Cathy
  3. Weather Derivatives as Risk Management Tool in Ecuador: A Case Study of Rice Production By Vedenov, Dmitry; Sanchez, Leonardo
  4. Do capital buffers mitigate volatility of bank lending? A simulation study By Heid, Frank; Krüger, Ulrich
  5. First-order (Conditional) Risk Aversion, Background Risk and Risk Diversification By Georges Dionne; Jingyuan Li
  6. Replicating Hedge Fund Indices with Optimization Heuristics By Manfred GILLI; Enrico SCHUMANN; Gerda CABEJ; Jonela LULA
  7. Montecarlo simulation of long-term dependent processes: a primer By Carlos Leóm; Alejandro Reveiz
  8. Impact of Interest Rates on Islamic and Conventional Banks: The Case of Turkey By Etem Hakan, Ergeç; Bengül Gülümser, Arslan

  1. By: Takashi Kato
    Abstract: We study an asymptotic behaviour of the difference between value-at-risks VaR(L) and VaR(L+S) for heavy-tailed random variables L and S as an application to sensitivity analysis of quantitative operational risk management in the framework of an advanced measurement approach (AMA) of Basel II. We have different types of results according to the magnitude relationship of thickness of tails of L and S. Especially if the tail of S is enough thinner than the one of L, then VaR(L + S) - VaR(L) is asymptotically equivalent to an expected loss of S when L and S are independent. We also give some generalized results without the assumption of independence.
    Date: 2011–04
  2. By: Chollete, Loran (University of Stavanger); Ning, Cathy (Ryerson University)
    Abstract: .
    Keywords: Asymmetric Dependence; Copulas; Diversification Failure; Risk Factor; Systemic Risk; Time-Varying Downside Risk
    JEL: C14 E44 G11
    Date: 2010–04–04
  3. By: Vedenov, Dmitry; Sanchez, Leonardo
    Abstract: This paper analyzes efficiency of weather derivatives as insurance instruments for rice in Ecuador. Weather derivatives were constructed for each county/season combination. Complicated weather models were estimated for the index, and a copula approach was used to get the probability distributions. We find Risk-reducing efficiency varies across county and season.
    Keywords: agricultural risk management, index insurance, weather derivatives, copula approach, rice production, Agribusiness, Crop Production/Industries, Risk and Uncertainty, Q14, Q59,
    Date: 2011
  4. By: Heid, Frank; Krüger, Ulrich
    Abstract: Critics claim that capital requirements can exacerbate credit cycles by restricting lending in an economic downturn. The introduction of Basel 2, in particular, has led to concerns that risksensitive capital charges are highly correlated with the business cycle. The Basel Committee is contemplating a revision of the Basel Accord by introducing counter-cyclical capital buffers. Others claim that capital buffers are already large enough to absorb fluctuations in credit risk. We address the question of the pro-cyclical effects of capital requirements in a general framework which takes into account banks' potential adjustment strategies. We develop a dynamic model of bank lending behavior and simulate different regulatory frameworks and macroeconomic scenarios. In particular, we address two related questions in our simulation study: How do business fluctuations affect capital requirements and bank lending? To what extent does the capital buffer absorb fluctuations in the level of mimimum required capital? --
    Keywords: Minimum capital requirements,regulatory capital,capital buffer,cyclical lending,pro-cyclicality
    JEL: C61 E32 E44 G21
    Date: 2011
  5. By: Georges Dionne; Jingyuan Li
    Abstract: In the literature, utility functions in the expected utility class are generically limited to second-order (conditional) risk aversion, while non-expected utility functions can exhibit either first-order or second-order (conditional) risk aversion. This paper extends the concepts of order of conditional risk aversion to orders of conditional dependent risk aversion. We show that first-order conditional dependent risk aversion is consistent with the framework of the expected utility hypothesis. We relate our results to risk diversification and provide additional insights into its application in different economic and finance examples.
    Keywords: Expected utility theory, first-order conditional dependent risk aversion, background risk, risk diversification
    JEL: D81
    Date: 2011
  6. By: Manfred GILLI (University of Geneva and Swiss Finance Institute); Enrico SCHUMANN (University of Geneva); Gerda CABEJ (University of Geneva); Jonela LULA (University of Geneva)
    Abstract: Hedge funds offer desirable risk-return profiles; but we also find high management fees, lack of transparency and worse, very limited liquidity (they are often closed to new investors and disinvestment fees can be prohibitive). This creates an incentive to replicate the attractive features of hedge funds using liquid assets. We investigate this replication problem using monthly data of CS Tremont for the period of 1999 to 2009. Our model uses historical observations and combines tracking accuracy, excess return, and portfolio correlation with the index and the market. Performance is evaluated considering empirical distributions of excess return, final wealth and correlations of the portfolio with the index and the market. The distributions are compiled from a set of portfolio trajectories computed by a resampling procedure. The nonconvex optimization problem arising from our model specification is solved with a heuristic optimization technique. Our preliminary results are encouraging as we can track the indices accurately and enhance performance (e.g. have lower correlation with equity markets).
    Keywords: Hedge Funds, Hedge Fund Replication, Asset Allocation, Portfolio Optimization, Optimization Heuristics, Drawdown
    JEL: G11 C61 C63
    Date: 2010–06
  7. By: Carlos Leóm; Alejandro Reveiz
    Abstract: As a natural extension to León and Vivas (2010) and León and Reveiz (2010) this paper briefly describes the Cholesky method for simulating Geometric Brownian Motion processes with long-term dependence, also referred as Fractional Geometric Brownian Motion (FBM). Results show that this method generates random numbers capable of replicating independent, persistent or antipersistent time-series depending on the value of the chosen Hurst exponent. Simulating FBM via the Cholesky method is (i) convenient since it grants the ability to replicate intense and enduring returns, which allows for reproducing well-documented financial returns’ slow convergence in distribution to a Gaussian law, and (ii) straightforward since it takes advantage of the Gaussian distribution ability to express a broad type of stochastic processes by changing how volatility behaves with respect to the time horizon. However, Cholesky method is computationally demanding, which may be its main drawback. Potential applications of FBM simulation include market, credit and liquidity risk models, option valuation techniques, portfolio optimization models and payments systems dynamics. All can benefit from the availability of a stochastic process that provides the ability to explicitly model how volatility behaves with respect to the time horizon in order to simulate severe and sustained price and quantity changes. These applications are more pertinent than ever because of the consensus regarding the limitations of customary models for valuation, risk and asset allocation after the most recent episode of global financial crisis.
    Keywords: Montecarlo simulation, Fractional Brownian Motion, Hurst exponent, Long-term Dependence, Biased Random Walk. Classification JEL: C15, C53, C63, G17, G14.
  8. By: Etem Hakan, Ergeç; Bengül Gülümser, Arslan
    Abstract: Identifying the impact of the interest rates upon Islamic banks is key to understand the contribution of such institutions to the financial stability, designing monetary policies and devising a proper risk management applicable to these institutions. This article analyzes and investigates the impact of interest rate shock upon the deposits and loans held by the conventional and Islamic banks with particular reference to the period between December 2005 and July 2009 based on Vector Error Correction (VEC) methodology. It is theoretically expected that the Islamic banks, relying on interest-free banking, shall not be affected by the interest rates; however, in concurrence with the previous studies, the article finds that the Islamic banks in Turkey are visibly influenced by interest rates.
    Keywords: Interest-free banking; monetary policy
    JEL: E52 G21
    Date: 2011–01

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