nep-rmg New Economics Papers
on Risk Management
Issue of 2011‒06‒18
eleven papers chosen by
Stan Miles
Thompson Rivers University

  1. Financial stability, new macro prudential arrangements and shadow banking: regulatory arbitrage and stringent Basel III regulations By Ojo, Marianne
  2. CRRA Utility Maximization under Risk Constraints By Santiago Moreno-Bromberg; Traian Pirvu; Anthony R\'eveillac
  3. Aplicaciones del Modelo Binomial para el Análisis de Riesgo By Rodrigo A. Alfaro.; Andrés Sagner; Carmen G. Silva.
  4. On the Impossibility of Fair Risk Allocation By Peter Csoka; Miklos Pinter
  5. Bank optimal portfolio risk level under various regulatory requirements By Alexandra Girod; Olivier Bruno
  6. El Índice Cartera Vencida como Medida de Riesgo de Crédito: Análisis y Aplicación al Caso de Chile By Andrés Sagner
  7. Who Borrows and Who May Not Repay? By Alena Bicakova; Zuzana Prelcova; Renata Pasalicova
  8. Volatility Patterns of CDS, Bond and Stock Markets Before and During the Financial Crisis – Evidence from Major Financial Institutions By Ansgar Belke; Christian Gokus
  9. Financial factor influence on scaling and memory of trading volume in stock market By Wei Li; Fengzhong Wang; Shlomo Havlin; H. Eugene Stanley
  10. Are credit default swaps associated with higher corporate defaults? By Stavros Peristiani; Vanessa Savino
  11. THE VERACITY OF THE ERM IMPLEMENTATION: AN INTERNAL AUDITING PERSPECTIVE By Mohd Ariff Kasim; Siti Rosmaini Mohd Hanafi; Azwan Abdul Rashid; Nik Mohamad Zaki Nik Salleh; Asmah Abdul Aziz; Isahak Kasim

  1. By: Ojo, Marianne
    Abstract: Despite Basel III’s efforts to address capital and liquidity requirements, will the risks linked to regulatory arbitrage increase as a result of Basel III’s more stringent capital and liquidity rules? As well as Basel III reforms which are geared towards greater facilitation of financial stability on a macro prudential basis, further efforts and initiatives aimed at mitigating systemic risks – hence fostering financial stability, have been promulgated through the establishment of the De Larosiere Group, the European Systemic Risk Board, and a working group comprising of “international standard setters and authorities responsible for the translation of G20 commitments into standards.” This paper aims to investigate the impact of Basel III on shadow banking and its facilitation of regulatory arbitrage as well as consider the response of various jurisdictions and standard setting bodies to aims and initiatives aimed at improving their macro prudential frameworks. Furthermore, it will also aim to illustrate why immense work is still required at European level – as regards efforts to address systemic risks on a macro prudential basis. This being the case even though significant efforts and steps have been taken to address the macro prudential framework. In so doing, the paper will also attempt to address how coordination within the macro prudential framework – as well as between micro and macro prudential supervision could be enhanced.
    Keywords: counter party risks; liquidity; European Systemic Risk Board; stability; systemic risk; Shadow Banking; central banks; regulatory arbitrage; OTC derivatives; European Central Bank; supervision; coordination
    JEL: E0 D0 K2 D8
    Date: 2011–06–10
  2. By: Santiago Moreno-Bromberg; Traian Pirvu; Anthony R\'eveillac
    Abstract: This paper studies the problem of optimal investment with CRRA (constant, relative risk aversion) preferences, subject to dynamic risk constraints on trading strategies. The market model considered is continuous in time and incomplete; furthermore, financial assets are modeled by It\^{o} processes. The dynamic risk constraints (time, state dependent) are generated by risk measures. The optimal trading strategy is characterized by a quadratic BSDE. Special risk measures (\textit{Value-at-Risk}, \textit{Tail Value-at-Risk} and \textit{Limited Expected Loss}) are considered and a three--fund separation result is established in these cases. Numerical results emphasize the effect of imposing risk constraints on trading.
    Date: 2011–06
  3. By: Rodrigo A. Alfaro.; Andrés Sagner; Carmen G. Silva.
    Abstract: In this paper we analyze two risk measures using the Binomial Model. In one case we show that the distance-to-default measure is indeed a Z-statistic. In an empirical application we estimate the probability of default for Chilean banks. Our second measure is a pseudo implied volatility which is obtained from a question. From a small survey we find that results are consistent with market values. Finally, we consider the worst case scenario analysis applied to Value at Risk and to callable bonds.
    Date: 2011–05
  4. By: Peter Csoka (Institute of Economics - Hungarian Academy of Sciences); Miklos Pinter (Department of Mathematics - Corvinus University of Budapest)
    Abstract: Measuring and allocating risk properly are crucial for performance evaluation and internal capital allocation of portfolios held by banks, insurance companies, investment funds and other entities subject to financial risk. We show that by using coherent measures of risk it is impossible to allocate risk satisfying the natural requirements of (Solution) Core Compatibility, Equal Treatment Property and Strong Monotonicity. To obtain the result we characterize the Shapley value on the class of totally balanced games and also on the class of exact games. Our result can also be seen as a downside of coherent measures of risk.
    Keywords: Coherent Measures of Risk, Risk Allocation Games, Totally Balanced Games, Exact Games, Shapley value, Solution core
    JEL: C71 G10
    Date: 2011–04
  5. By: Alexandra Girod (University of Nice); Olivier Bruno (University of Nice)
    Date: 2011–03
  6. By: Andrés Sagner
    Abstract: This paper proposes the non-performing loans (NPL) ratio, defined as the change in the stock of NPL adjusted by write-offs and standardized by loans, as the main measure to be used for modeling the credit risk of the Chilean banking system. In particular, the paper identifies certain statistical and conceptual advantages of this measure with respect to loan loss provisions (LLP), which support this idea. First, the NPL ratio by type of credit covers a greater time span than LLP. Second, the forward-looking nature of LLP –one of its main advantages over the NPL ratio– is applicable only from 2004 onward due to various changes in Chilean reporting standards. Third, LLP is discretionary because provisioning is made on the basis of relative risk aversion of banks. Fourth, the NPL ratio produces smoother series than LLP for consumer and mortgage loans. In addition, the dynamic structure observed in both time series does not differ significantly. The econometric model estimated for the period January 1997 to June 2010 shows that the NPL ratio has statistically significant relations with macroeconomic aggregates such as the annual output growth, the short and long term interest rates, the annual inflation rate, the peso-dollar exchange rate, and the surprises in credit growth. Finally, the out-of-sample forecasts indicate differences between the actual and projected NPL ratios that are economically significant only in the case of mortgage credit. For the remaining portfolios, the evolution of this ratio during the period of July 2008 to June 2010 does not differ significantly from that predicted by the econometric model.
    Date: 2011–03
  7. By: Alena Bicakova; Zuzana Prelcova; Renata Pasalicova
    Abstract: In this paper we use Household Budget Survey data to analyze the evolution of the household credit market in the Czech Republic over the period 2000–2008. While the share of households that borrow remained stable and below 40%, the amount of debt outstanding increased. We estimate a series of models of the determinants of borrowing. We next merge our data with the Statistics on Income and Living Conditions in 2005–2008, which contain direct information on repayment behavior, in order to test the validity of the standard debt burden measure as a predictor of default. We propose an alternative indicator – the adjusted debt burden (ADB), defined as the ratio of loan repayments to discretionary income, constructed as net income minus the living minimum (the minimum cost of living for a given household composition as set by the Czech Statistical Office), which turns out to be a superior predictor of default risk. Limited by the data, we use a fairly broad concept of default, namely, the inability to make loan repayments on time. Based on the distribution of default risk across the levels of the adjusted debt burden, we suggest that a 30% ADB threshold should be used as the definition of overindebtedness, with an average default risk of 17%. Finally, we show that overindebtedness and local economic shocks are closely related, suggesting that default risk should be always considered in the context of regional economic conditions.
    Keywords: Debt burden, household credit, regional default risk, repayment.
    JEL: D12 D14 G21 R29
    Date: 2010–12
  8. By: Ansgar Belke; Christian Gokus
    Abstract: This study is motivated by the development of credit-related instruments and signals of stock price movements of large banks during the recent financial crisis. What is common to most of the empirical studies in this field is that they concentrate on modeling the conditional mean. However, financial time series exhibit certain stylized features such as volatility clustering. But very few studies dealing with credit default swaps account for the characteristics of the variances. Our aim is to address this issue and to gain insights on the volatility patterns of CDS spreads, bond yield spreads and stock prices. A generalized autoregressive conditional heteroscedasticity (GARCH) model is applied to the data of four large US banks over the period ranging from January 01, 2006, to December 31, 2009. More specifically, a multivariate GARCH approach fits the data very well and also accounts for the dependency structure of the variables under consideration. With the commonly known shortcomings of credit ratings, the demand for market-based indicators has risen as they can help to assess the creditworthiness of debtors more reliably. The obtained findings suggest that volatility takes a significant higher level in times of crisis. This is particularly evident in the variances of stock returns and CDS spread changes. Furthermore, correlations and covariances are time-varying and also increased in absolute values after the outbreak of the crisis, indicating stronger dependency among the examined variables. Specific events which have a huge impact on the financial markets as a whole (e.g. the collapse of Lehman Brothers) are also visible in the (co)variances and correlations as strong movements in the respective series.
    Keywords: Bond markets; credit default swaps; credit risk; financial crisis; GARCH; stock markets; volatility
    JEL: C53 G21 G24
    Date: 2011–02
  9. By: Wei Li; Fengzhong Wang; Shlomo Havlin; H. Eugene Stanley
    Abstract: We study the daily trading volume volatility of 17,197 stocks in the U.S. stock markets during the period 1989--2008 and analyze the time return intervals $\tau$ between volume volatilities above a given threshold q. For different thresholds q, the probability density function P_q(\tau) scales with mean interval <\tau> as P_q(\tau)=<\tau>^{-1}f(\tau/<\tau>) and the tails of the scaling function can be well approximated by a power-law f(x)~x^{-\gamma}. We also study the relation between the form of the distribution function P_q(\tau) and several financial factors: stock lifetime, market capitalization, volume, and trading value. We find a systematic tendency of P_q(\tau) associated with these factors, suggesting a multi-scaling feature in the volume return intervals. We analyze the conditional probability P_q(\tau|\tau_0) for $\tau$ following a certain interval \tau_0, and find that P_q(\tau|\tau_0) depends on \tau_0 such that immediately following a short/long return interval a second short/long return interval tends to occur. We also find indications that there is a long-term correlation in the daily volume volatility. We compare our results to those found earlier for price volatility.
    Date: 2011–06
  10. By: Stavros Peristiani; Vanessa Savino
    Abstract: Are companies with traded credit default swap (CDS) positions on their debt more likely to default? Using a proportional hazard model of bankruptcy and Merton’s contingent claims approach, we estimate the probability of default for U.S. nonfinancial firms. Our analysis does not generally find a persistent link between CDS and default over the entire period 2001-08, but does reveal a higher probability of default for firms with CDS over the last few years of that period. Further, we find that firms trading in the CDS market exhibited a higher Moody’s KMV expected default frequency during 2004-08. These findings are consistent with those of Henry Hu and Bernard Black, who argue that agency conflicts between hedged creditors and debtors would increase the likelihood of corporate default. In addition, our paper highlights other explanations for the higher defaults of CDS firms. Consistent with fire-sale spiral theories, we find a positive link between institutional ownership exposure and corporate distress, with CDS firms facing stronger selling pressures during the recent financial turmoil.
    Date: 2011
  11. By: Mohd Ariff Kasim; Siti Rosmaini Mohd Hanafi; Azwan Abdul Rashid (College of Business Management and Accounting, Universiti Tenaga Nasional); Nik Mohamad Zaki Nik Salleh (Faculty of Management, Multimedia University); Asmah Abdul Aziz (Faculty of Accountancy, Universiti Teknologi MARA); Isahak Kasim (Faculty of Computer and Quantitative Sciences, Universiti Teknologi MARA)
    Abstract: The internal audit profession has become a focal point after the collapse of various giant corporations. The primary research objective of the study is to investigate the extent of the internal auditors’ roles in the implementation of the Enterprise Risk Management (ERM). The primary data collection was through a questionnaire survey. The results of the hierarchical multiple regressions indicated that the degree of the internal auditors’ roles in the ERM could strengthen the relationship between the internal audit effectiveness and ERM implementation. The nature of the internal auditors’ involvement in the ERM implementation was consistent with the recommendations in the position paper on the role of internal auditors in the ERM
    Keywords: Internal Audit Practices, Professional Practice Framework, ERM, Internal auditing, COSO ERM Framework
    JEL: M0
    Date: 2011–03

This nep-rmg issue is ©2011 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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