nep-rmg New Economics Papers
on Risk Management
Issue of 2011‒04‒23
ten papers chosen by
Stan Miles
Thompson Rivers University

  1. Risk Management of Risk under the Basel Accord Forecasting Value-at-Risk of VIX Futures By Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Michael McAleer; Teodosio Pérez-Amaral
  2. Conditional Value-at-Risk and Average Value-at-Risk: Estimation and Asymptotics By Chun, So Yeon; Shapiro, Alexander; Uryasev, Stan
  3. Systemic risk diagnostics: coincident indicators and early warning signals By Bernd Schwaab; Siem Jan Koopman; André Lucas
  4. Default Clustering in Large Portfolios: Typical and Atypical Events By Kay Giesecke; Konstantinos Spiliopoulos; Richard B. Sowers
  5. Stress Tests for Banking Sector: A Technical Note By Rodrigo Alfaro; Andrés Sagner
  6. Collateralized CDS and Default Dependence -Implications for the Central Clearing- By Masaaki Fujii; Akihiko Takahashi
  7. The predictive accuracy of credit ratings: Measurement and statistical inference By Orth, Walter
  8. Market-Based Measures of Bank Risk and Bank Aggressiveness. By Knaup, M
  9. Market structures and systemic risks of exchange-traded funds By Srichander Ramaswamy
  10. The Determinants of Household Debt Defa By Rodrigo Alfaro; Natalia Gallardo; Roberto Stein

  1. By: Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Michael McAleer; Teodosio Pérez-Amaral
    Abstract: The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. McAleer, Jimenez-Martin and Perez-Amaral (2009) proposed a new approach to model selection for predicting VaR, consisting of combining alternative risk models, and comparing conservative and aggressive strategies for choosing between VaR models. This paper addresses the question of risk management of risk, namely VaR of VIX futures prices. We examine how different risk management strategies performed during the 2008-09 global financial crisis (GFC). We find that an aggressive strategy of choosing the Supremum of the single model forecasts is preferred to the other alternatives, and is robust during the GFC. However, this strategy implies relatively high numbers of violations and accumulated losses, though these are admissible under the Basel II Accord.
    Keywords: Median strategy; Value-at-Risk (VaR); daily capital charges; violation penalties; optimizing strategy; aggressive risk management; conservative risk management; Basel II Accord; VIX futures; global financial crisis (GFC)
    JEL: G32 G11 C53 C22
    Date: 2011–02–01
  2. By: Chun, So Yeon; Shapiro, Alexander; Uryasev, Stan
    Abstract: We discuss linear regression approaches to conditional Value-at-Risk and Average Value-at-Risk (Conditional Value-at-Risk, Expected Shortfall) risk measures. Two estimation procedures are considered for each conditional risk measure, one is direct and the other is based on residual analysis of the standard least squares method. Large sample statistical inference of the estimators obtained is derived. Furthermore, finite sample properties of the proposed estimators are investigated and compared with theoretical derivations in an extensive Monte Carlo study. Empirical results on the real-data (different financial asset classes) are also provided to illustrate the performance of the estimators.
    Keywords: Value-at-Risk; Average Value-at-Risk; Conditional Value-at-Risk; Expected Shortfall; linear regression; least squares residual; quantile regression; conditional risk measures; statistical inference
    JEL: C53 D81 G32 C15 C1
    Date: 2011–04–03
  3. By: Bernd Schwaab (European Central Bank, Financial Markets Research, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Siem Jan Koopman (Department of Econometrics, VU University Amsterdam and Tinbergen Institute.); André Lucas (Department of Finance, VU University Amsterdam, and Duisenberg school of finance.)
    Abstract: We propose a novel framework to assess financial system risk. Using a dynamic factor framework based on state-space methods, we construct coincident measures (‘thermometers’) and a forward looking indicator for the likelihood of simultaneous failure of a large number of financial intermediaries. The indicators are based on latent macro-financial and credit risk components for a large data set comprising the U.S., the EU-27 area, and the respective rest of the world. Credit risk conditions can significantly and persistently de-couple from macro-financial fundamentals. Such decoupling can serve as an early warning signal for macro-prudential policy. JEL Classification: G21, C33.
    Keywords: financial crisis, systemic risk, credit portfolio models, frailty-correlated defaults, state space methods.
    Date: 2011–04
  4. By: Kay Giesecke; Konstantinos Spiliopoulos; Richard B. Sowers
    Abstract: We develop a dynamic point process model of correlated default timing in a portfolio of firms, and analyze typical and atypical default profiles in the limit as the size of the pool grows. In our model, a name defaults at a stochastic intensity that is influenced by an idiosyncratic risk process, a systematic risk process common to all names, and past defaults. We prove a law of large numbers for the default rate in the pool, which describes the "typical" behavior of defaults. Large deviation arguments are then used to identify the way that atypically large (i.e., "rare") default clusters are most likely to occur. Our results give insights into how different sources of default correlation interact to generate excessive portfolio losses.
    Date: 2011–04
  5. By: Rodrigo Alfaro; Andrés Sagner
    Abstract: Credit and market risks are crucial for financial institutions. In this paper we present the model used by the Central Bank of Chile to conduct the stress tests for commercial banks in Chile. Market risk uses a balance-sheet approach that is consistent with the credit risk. For exchange rate risk we consider a change in the value of the portfolio under an unexpected change in the exchange rate by X%, meanwhile the interest rate risk is computed using a model for the whole yield curve. In particular, the modeling of this risk follows Nelson and Siegel (1987). Credit risk is computed using a non-linear VAR that relates banking system aggregates (loan loss provisions, credit growth, and write-offs) with macroeconomics variables (output growth, short and long term interest rates, terms of trade, and unemployment). For each Financial Stability Report (FSR) the model is calibrated using data from 1997 to the most recent date at monthly frequency. The effect on individual banks is computed adjusting the loan loss provision and total loans of each bank with the forecast value for the system. Given that forecasts are separated by type of loans (commercial, mortgage, and consumer) then the final effect on a particular bank depend on its initial composition.
    Date: 2011–02
  6. By: Masaaki Fujii (Faculty of Economics, University of Tokyo); Akihiko Takahashi (Faculty of Economics, University of Tokyo)
    Abstract: In this paper, we have studied the pricing of a continuously collateralized CDS. We have made use of the hsurvival measureh to derive the pricing formula in a straightforward way. As a result, we have found that there exists irremovable trace of the counter party as well as the investor in the price of CDS through their default dependence even under the perfect collateralization, although the hazard rates of the two parties are totally absent from the pricing formula. As an important implication, we have also studied the situation where the investor enters an offsetting back-to-back trade with another counter party. We have provided simple numerical examples to demonstrate the change of a fair CDS premium according to the strength of default dependence among the relevant names, and then discussed its possible implications for the risk management of the central counter parties.
    Date: 2011–04
  7. By: Orth, Walter
    Abstract: Credit ratings are ordinal predictions for the default risk of an obligor. To evaluate the accuracy of such predictions commonly used measures are the Accuracy Ratio or, equivalently, the Area under the ROC curve. The disadvantage of these measures is that they treat default as a binary variable thereby neglecting the timing of the default events and also not using the full information from censored observations. We present an alternative measure that is related to the Accuracy Ratio but does not suffer from these drawbacks. As a second contribution, we study statistical inference for the Accuracy Ratio and the proposed measure in the case of multiple cohorts of obligors with overlapping lifetimes. We derive methods that use more sample information and lead to more powerful tests than alternatives that filter just the independent part of the dataset. All procedures are illustrated in the empirical section using a dataset of S\&P Long Term Credit Ratings.
    Keywords: Ratings; predictive accuracy; Accuracy Ratio; Harrell's C; overlapping lifetimes
    JEL: C41 G32 G24
    Date: 2010–03–22
  8. By: Knaup, M (Tilburg University)
    Date: 2011
  9. By: Srichander Ramaswamy
    Abstract: Crisis experience has shown that as the financial intermediation chain lengthens, it becomes complicated to assess the risks of financial products due to a lack of transparency as to how risks are managed at different levels of the intermediation chain. Exchange-traded funds, which have become popular among investors seeking exposure to a diversified portfolio of assets, share this characteristic, especially when their returns are replicated using derivative products. As the volume of such products grows, such replication strategies can lead to a build-up of systemic risks in the financial system. This article examines the operational frameworks of exchange-traded funds and identifies potential channels through which risks to financial stability can materialise.
    Keywords: Mutual funds, total return swaps, securities lending, systemic risk
    Date: 2011–04
  10. By: Rodrigo Alfaro; Natalia Gallardo; Roberto Stein
    Abstract: Based on a new dataset obtained from survey data, we study household debt default behavior in Chile. Previous research in this area suggests financial and personal variables that can help estimate individual and group probabilities of default. We study mortgage and consumer default separately, as the default decisions and overall borrower behavior are different for each type of debt. Our study finds that income and income-related variables are the only significant and robust variables that explain default for both types of debt. Demographic or personal variables are specific to one or the other type of debt but not to both. For example, level of education is a factor that affects mortgage default, whereas the determinants of consumer debt default include the age of the household head, and the number of people within the household that contribute to the total family income. We derive threshold probabilities of default for each type of debt and compare them to those obtained from results of previous work based on the same Chilean data, but with a different approach. We find that the probability of default decreases as the family income increases, and that our estimates are consistent with other studies similar to ours. Also consistently with previous research, we find that, in terms of the distribution of debt and default risk, the largest portion of the country’s household debt is in the hands of families in the upper quintiles, who have the lowest risk of default. This implies that the overall financial system should be relatively stable, even in the face of moderate macroeconomic shocks.
    Date: 2010–05

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