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on Risk Management |
| By: | Younes Kchia; Martin Larsson |
| Abstract: | The classical reduced-form and filtration expansion framework in credit risk is extended to the case of multiple, non-ordered defaults, assuming that conditional densities of the default times exist. Intensities and pricing formulas are derived, revealing how information driven default contagion arises in these models. We then analyze the impact of ordering the default times before expanding the filtration. While not important for pricing, the effect is significant in the context of risk management, and becomes even more pronounced for highly correlated and asymmetrically distributed defaults. Finally, we provide a general scheme for constructing and simulating the default times, given that a model for the conditional densities has been chosen. |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1104.5272&r=rmg |
| By: | Kiema , Ilkka (University of Helsinki, Department of Political and Economic Studies); Jokivuolle, Esa (Aalto University School of Economics, Department of Finance and Bank of Finland, Monetary Policy and Research) |
| Abstract: | We study the effects on credit allocation and bank stability of introducing a leverage ratio requirement (LRR) on top of risk-based capital requirements, as in Basel III. For the current 3% LRR, both low-risk and high-risk loan rates and volumes remain essentially unchanged, because banks previously specializing in low-risk lending can adapt by granting both low-risk and high-risk loans. For sufficiently high LRRs, low-risk lending rates would significantly increase and high-risk lending rates would fall. In the presence of severe ‘model risk’ concerning low-risk loans, as happened in the subprime crisis, the current 3% LRR might even reduce bank stability, counter to regulatory intentions. This is because the allocational effect caused by the LRR, which makes bank loan portfolios more alike, may turn beneficial risk spreading into harmful risk contamination. For higher levels of LRR, however, bank stability is likely to be improved even in the presence of model risk. |
| Keywords: | bank regulation; Basel III; capital requirements; credit risk; leverage ratio |
| JEL: | D41 D82 G14 G21 G28 |
| Date: | 2011–04–21 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2011_010&r=rmg |
| By: | Clara Cardone Riportella; Antonio Trujillo; Anahí Briozzo |
| Abstract: | This paper analyses the impact of the new Basel Capital Accords (Basel II and Basel III) on the bank’s capital requirements in a portfolio of Small and Medium-sized Enterprises (SMEs) when the internal ratings-based (IRB) approach is used. To do this, the study uses a large database of Spanish firms and covers the period from 2005 to 2009. We also examine the effect on the credit risk premium charged by banks of the guarantee offered by a Loan Guarantee Association (LGA) to a SME; and whether this foreseeable decrease in the interest rates applicable to the SME is compensated by the cost of this guarantee |
| Keywords: | Bank capital requirements, Credit risk mitigation, Bank financing of SMEs, Basel II, Basel III Loan Guarantee Association |
| JEL: | G21 G32 |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wbrepe:wb111004&r=rmg |
| By: | Shawkat Hammoudeh (Lebow College of Business, Drexel University); Tengdong Liu (Lebow College of Business, Drexel University); Chia-Lin Chang (Department of Applied Economics, Department of Finance, National Chung Hsing University); Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, Complutense University of Madrid, and Institute of Economic Research, Kyoto University) |
| Abstract: | This paper examines risk transmission and migration among six US measures of credit and market risk during the full period 2004-2011 period and the 2009-2011 recovery subperiod, with a focus on four sectors related to the highly volatile oil price. There are more long-run equilibrium risk relationships and short-run causal relationships among the four oil-related Credit Default Swaps (CDS) indexes, the (expected equity volatility) VIX index and the (swaption expected volatility) SMOVE index for the full period than for the recovery subperiod. The auto sector CDS spread is the most error-correcting in the long run and also leads in the risk discovery process in the short run. On the other hand, the CDS spread of the highly regulated, natural monopoly utility sector does not error correct. The four oil-related CDS spread indexes are responsive to VIX in the short- and long-run, while no index is sensitive to SMOVE which, in turn, unilaterally assembles risk migration from VIX. The 2007-2008 Great Recession seems to have led to "localization" and less migration of credit and market risk in the oil-related sectors. |
| Keywords: | Risk, Sectoral CDS, VIX, SMOVE, MOVE, Adjustments. |
| JEL: | C13 C22 G1 G12 Q40 |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:kyo:wpaper:772&r=rmg |
| By: | Orth, Walter |
| Abstract: | In credit default prediction models, the need to deal with time-varying covariates often arises. For instance, in the context of corporate default prediction a typical approach is to estimate a hazard model by regressing the hazard rate on time-varying covariates like balance sheet or stock market variables. If the prediction horizon covers multiple periods, this leads to the problem that the future evolution of these covariates is unknown. Consequently, some authors have proposed a framework that augments the prediction problem by covariate forecasting models. In this paper, we present simple alternatives for multi-period prediction that avoid the burden to specify and estimate a model for the covariate processes. In an application to North American public firms, we show that the proposed models deliver high out-of-sample predictive accuracy. |
| Keywords: | Credit default; multi-period predictions; hazard models; panel data; out-of-sample tests |
| JEL: | C53 C41 G32 |
| Date: | 2011–03–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:30507&r=rmg |
| By: | Viral V. Acharya; Sergei A. Davydenko; Ilya A. Strebulaev |
| Abstract: | Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal cash reserves are positively related to credit risk, resulting in a positive correlation between cash and spreads. In contrast, spreads are negatively related to the "exogenous'' component of cash holdings that is independent of credit risk factors. Similarly, although firms with higher cash reserves are less likely to default over short horizons, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk. |
| JEL: | G32 G33 |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16995&r=rmg |
| By: | Damir Filipovi\'c; Eberhard Mayerhofer; Paul Schneider |
| Abstract: | We introduce closed-form transition density expansions for multivariate affine jump-diffusion processes. The expansions rely on a general approximation theory which we develop in weighted Hilbert spaces for random variables which possess all polynomial moments. We establish parametric conditions which guarantee existence and differentiability of transition densities of affine models and show how they naturally fit into the approximation framework. Empirical applications in credit risk, likelihood inference, and option pricing highlight the usefulness of our expansions. The approximations are extremely fast to evaluate, and they perform very accurately and numerically stable. |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1104.5326&r=rmg |
| By: | Olesia Verchenko (Kyiv School of Economics, Kyiv Economic Institute) |
| Abstract: | This paper examines the empirical performance of several complete and incomplete market models of stock price dynamics using S&P 500 options and stock market data. The main contribution of this work is that it suggests and implements an empirical approach to estimating a complete model with uncertain volatility, and then judges it against other popular option pricing processes. The performance of alternative models is evaluated from four perspectives: (1) in-sample fit to stock returns data, (2) in-sample fit to options data, (3) consistency of physical and risk-neutral parameter estimates and (4) out-of-sample option pricing. Overall, the complete model with uncertain volatility is found to .t the data much better than models with constant and price-level-dependent volatilities, and the variance gamma process, and its performance is comparable to that of a stochastic volatility model. |
| Keywords: | Option pricing, complete and incomplete markets, stochastic volatility |
| JEL: | G13 |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:kse:dpaper:38&r=rmg |