nep-rmg New Economics Papers
on Risk Management
Issue of 2011‒12‒13
twenty papers chosen by
Stan Miles
Thompson Rivers University

  1. The role of high frequency intra-daily data, daily range and implied volatility in multi-period Value-at-Risk forecasting By Louzis, Dimitrios P.; Xanthopoulos-Sisinis, Spyros; Refenes, Apostolos P.
  2. Risk measures for autocorrelated hedge fund returns By Antonio Di Cesare; Philip A. Stork; Casper G. de Vries
  3. A hierarchical Archimedean copula for portfolio credit risk modelling By Puzanova, Natalia
  4. Financial Management of Weather Risk with Energy Derivatives By Janda, Karel; Vylezik, Tomas
  5. Küresel Kriz ve Finansal Aracılarda Risk Yönetimi: Beyaz Sayfa Mı? (Global Financial Crisis and Risk Management in Financial Intermediaries: Is It White Page?) By Coskun, Yener; Kayacan, Murad
  6. A Mathematical Method for Deriving the Relative Effect of Serviceability on Default Risk By Graham Andersen; David Chisholm
  7. Is Default Risk Priced in Equity Returns? By Nielsen, Caren Yinxia Guo
  8. Multivariate Semi-Markov Process for Counterparty Credit Risk By Guglielmo D'Amico; Raimondo Manca; Giovanni Salvi
  9. The Good, The Bad and The Impaired - A Credit Risk Model of the Irish Mortgage Market By Kelly, Robert
  10. Can portfolio diversification increase systemic risk? evidence from the U.S and European mutual funds market By Dicembrino, Claudio; Scandizzo, Pasquale Lucio
  11. Monitoring Leverage By John Geanakoplos; Lasse H. Pedersen
  12. Credit Constraints, Heterogeneous Firms and Loan Defaults By Jarko Fidrmuc; Pavel Ciaian; d'Artis Kancs; Jan Pokrivcak
  13. Privacy-Preserving Methods for Sharing Financial Risk Exposures By Emmanuel A. Abbe; Amir E. Khandani; Andrew W. Lo
  14. The Dynamic International Optimal Hedge Ratio By Liu, Xiaochun; Jacobsen, Brian
  15. Estimation of Equicorrelated Diffusions from Incomplete Data By Robert A. Jones; Mohammad Zanganeh
  16. An econometric Study for Vine Copulas By Dominique Guegan; Pierre-André Maugis
  17. Quantiles of the Realized Stock-Bond Correlation By Aslanidis, Nektarios; Christiansen, Charlotte
  18. Financial and Economic Determinants of Firm Default By Giulio Bottazzi; Marco Grazzi; Angelo Secchi; Federico Tamagni
  19. Securitization and bank intermediation function By Zagonov, Maxim
  20. Invoice Currency Choice and Exchange Rate Risk Management in Japanese Firms' Trade Network: "RIETI Survey on Japanese Overseas Subsidiaries 2010" (Japanese) By ITO Takatoshi; KOIBUCHI Satoshi; SATO Kiyotaka; SHIMIZU Junko

  1. By: Louzis, Dimitrios P.; Xanthopoulos-Sisinis, Spyros; Refenes, Apostolos P.
    Abstract: In this paper, we assess the informational content of daily range, realized variance, realized bipower variation, two time scale realized variance, realized range and implied volatility in daily, weekly, biweekly and monthly out-of-sample Value-at-Risk (VaR) predictions. We use the recently proposed Realized GARCH model combined with the skewed student distribution for the innovations process and a Monte Carlo simulation approach in order to produce the multi-period VaR estimates. The VaR forecasts are evaluated in terms of statistical and regulatory accuracy as well as capital efficiency. Our empirical findings, based on the S&P 500 stock index, indicate that almost all realized and implied volatility measures can produce statistically and regulatory precise VaR forecasts across forecasting horizons, with the implied volatility being especially accurate in monthly VaR forecasts. The daily range produces inferior forecasting results in terms of regulatory accuracy and Basel II compliance. However, robust realized volatility measures such as the adjusted realized range and the realized bipower variation, which are immune against microstructure noise bias and price jumps respectively, generate superior VaR estimates in terms of capital efficiency, as they minimize the opportunity cost of capital and the Basel II regulatory capital. Our results highlight the importance of robust high frequency intra-daily data based volatility estimators in a multi-step VaR forecasting context as they balance between statistical or regulatory accuracy and capital efficiency.
    Keywords: Realized GARCH; Value-at-Risk; multiple forecasting horizons; alternative volatility measures; microstructure noise; price jumps
    JEL: C53
    Date: 2012–10–29
  2. By: Antonio Di Cesare (Bank of Italy); Philip A. Stork (VU University Amsterdam); Casper G. de Vries (Erasmus University Rotterdam)
    Abstract: Standard risk metrics tend to underestimate the true risks of hedge funds because of serial correlation in the reported returns. Getmansky, Lo, and Makarov(2004) derive mean, variance, Sharpe ratio, and beta formulae adjusted for serial correlation. Following their lead, we derive adjusted downside and global measures of individual and systemic risks. We distinguish between normally and fat tailed distributed returns and show that adjustment is particularly relevant for downside risk measures in the case of fat tails. A hedge fund case study reveals that the unadjusted risk measures considerably underestimate the true extent of individual and systemic risks.
    Keywords: hedge funds, serial correlation, systemic risk, VaR, Pareto distribution
    JEL: G12 G23 G28
    Date: 2011–11
  3. By: Puzanova, Natalia
    Abstract: I introduce a novel, hierarchical model of tail dependent asset returns which can be particularly useful for measuring portfolio credit risk within the structural framework. To allow for a stronger dependence within sub-portfolios than between them, I utilise the concept of nested Archimedean copulas, but modify the nesting procedure to ensure the compatibility of copula generators by construction. This makes sampling straightforward. Moreover, I provide details on a particular specification based on a gamma mixture of powers. This model allows for lower tail dependence, resulting in a more conservative credit risk assessment than a comparable Gaussian model. I illustrate the extent of model risk when calculating VaR or Expected Shortfall for a credit portfolio. --
    Keywords: portfolio credit risk,nested Archimedean copula,tail dependence,hierarchical dependence structure
    JEL: C46 C63 G21
    Date: 2011
  4. By: Janda, Karel; Vylezik, Tomas
    Abstract: In this paper we describe the major issues in the weather risk management. We focus on the management of financial risks connected with weather. We first provide a general discussion of the impact of weather on the economy. Then we follow with the overview of the development of the weather risk management. The core of the paper in then devoted to the role of weather derivatives as financial tools for weather risk management.
    Keywords: Financial risk; Weather risk; Derivatives; Energy
    JEL: G12 G13 Q4
    Date: 2011–11–26
  5. By: Coskun, Yener; Kayacan, Murad
    Abstract: Abstract One of the impacts of financial liberalisation/deregulation to the risk management and regulation mechanisms is self regulation. In the context of self regulation, it is expected that financial intermediaries may internally develop risk management rules, define capital level based on economic capital (instead of required capital) and develop corrective measures to firm wide risk managament problems, before regulators. In this article, the authors analyse whether self regulation approach is succesfull. In the light of literature and lessons of firm/system wide financial failures, we also analyze the risk discipline methods of self and official disciplines and their degree of efficieny. In this framework, we first conclude, however it may not provide optimal solutions to the risk management problems of financial intermediaries, more efficient risk management standards should develop. Secondly, based on observations of various firm/system wide failures in financial intermediaries, the authors believe more self regulation may increase risks of financial failures and systemic crisis.
    Keywords: Risk, risk management, finansal intermediares, bankruptcy, financial failure
    JEL: G32 G21 G01
    Date: 2011–10–20
  6. By: Graham Andersen; David Chisholm
    Abstract: The writers propose a mathematical Method for deriving risk weights which describe how a borrower's income, relative to their debt service obligations (serviceability) affects the probability of default of the loan. The Method considers the borrower's income not simply as a known quantity at the time the loan is made, but as an uncertain quantity following a statistical distribution at some later point in the life of the loan. This allows a probability to be associated with an income level leading to default, so that the relative risk associated with different serviceability levels can be quantified. In a sense, the Method can be thought of as an extension of the Merton Model to quantities that fail to satisfy Merton's 'critical' assumptions relating to the efficient markets hypothesis. A set of numerical examples of risk weights derived using the Method suggest that serviceability may be under-represented as a risk factor in many mortgage credit risk models.
    Date: 2011–11
  7. By: Nielsen, Caren Yinxia Guo (Department of Economics, Lund University)
    Abstract: Fama and French (1992, 1993, 1995 and 1996) declare that size and book-to-market equity (BM) have strong explanatory power for the cross-section of stock returns, and the risk captured by size and BM is the relative distress of small stocks and value stocks. Firstly, this study examines the pricing power of the default risk, measured by the market revealed credit default swap premiums for individual U.S. firms from 2004 to 2010, in average returns across stocks; secondly, it explores whether the size and BM effects are due to that they proxy for the default risk effect. The tests demonstrate that size effect dominates the joint effect of size and default risk, while both BM and default risk co-work for the joint effect of BM and default risk. Therefore, part of the size and BM effects can be interpreted as default risk effect. As expected, size is priced with a negative risk premium, and BM is priced with a positive risk premium. However, higher default risk is priced with higher expected stock returns only when BM is below a certain level and BM is not priced. Additionally, size indeed proxies for the sensitivity to the default risk factor. Furthermore, the Fama-French factors SMB (small-minus-big) and HML (high-minus-low), mimicking the risks related to size and BM, share some common information with the default risk factor in the asset pricing tests.
    Keywords: Asset Pricing; Equity Returns; Size Effect; Book-to-Market Effect; Default Risk Effect; Credit Default Swap Premium
    JEL: G12
    Date: 2011–11–04
  8. By: Guglielmo D'Amico; Raimondo Manca; Giovanni Salvi
    Abstract: In this work we define a multivariate semi-Markov process. We derive an explicit expression for the transition probability of this multivariate semi-Markov process in the discrete time case. We apply this multivariate model to the study of the counterparty credit risk, with regard to correlation in a CDS contract. The financial crisis has stressed the importance of the study of the correlation in the financial market. In this regard, the study of the risk of default of the counterparty in any financial contract has become crucial in the credit risk. Many works has been done to trying to describe the counterparty risk in a CDS contract, but all this work are based on the Markovian approach to risk. In the our opinion this kind of model are too restrictive, because they require that the distribuction function of the waiting times has to be exponential or geometric, for discrete time. In the our model, we describe the evolution of credit rating of the financial subjects like a multivariate semi-Markov model, so we allow for arbitrarily distributed sojourn time. The age state dependency, typical of the semi-Markov environment, allow us to insert the correlation in a dynamical way. In particular, suppose that A is a default-free bondholder and C is the relative firm. The bondholder buy protection against C's default by another defaultable subject, say B the protection seller. Our model describe the evolution of the credit rating of the couple B and C. We admit for simultaneus default of C and B, the single default of C or single default of B.
    Date: 2011–12
  9. By: Kelly, Robert (Central Bank of Ireland)
    Abstract: Using a uniquely constructed loan-level dataset of the residential mortgage book of Irish financial institutions, this paper provides a framework for estimating default probabilities of individual mortgages. In particular, the paper examines the progression of mortgages in arrears from 90 days to 360 days. This question is of major financial stability concern in an Irish context as the uncertainty concerning the quality of the loan books of the Irish financial institutions is due, in the main, to the perceived impaired nature of the residential mortgage book. Using this approach, default probabilities are shown to be “hump shaped” when conditioned on loan vintage, with loans originating between 2004 and 2006 are most likely to default.
    Keywords: Probability of Default, Mortgages, Irish Banking System
    JEL: G01 G12 G21
    Date: 2011–11
  10. By: Dicembrino, Claudio; Scandizzo, Pasquale Lucio
    Abstract: This paper tests the hypothesis that portfolio diversification can increase the threat of systemic financial risk. The paper provides first a theoretical rationale for the possibility that systemic risk may be increased by the proliferation of financial instruments that lead operators to hold increasingly similar portfolios. Secondly, the paper tests the hypothesis that diversification may result in increasing systematic risk, by analyzing the portfolio dynamics of some of the major world open funds.
    Keywords: Systemic Risk; Portfolio Diversification; Mutual Funds; CAPM
    JEL: G11 G32 G10
    Date: 2011–11–30
  11. By: John Geanakoplos (Cowles Foundation, Yale University); Lasse H. Pedersen (Stern School of Business, NYU)
    Abstract: We discuss how leverage can be monitored for institutions, individuals, and assets. While traditionally the interest rate has been regarded as the important feature of a loan, we argue that leverage is sometimes even more important. Monitoring leverage provides information about how risk builds up during booms as leverage rises and how crises start when leverage on new loans sharply declines. Leverage data is also a crucial input for crisis management and lending facilities. Leverage at the asset level can be monitored by down payments or margin requirement or and haircuts, giving a model-free measure that can be observed directly, in contrast to other measures of systemic risk that require complex estimation. Asset leverage is a fundamental measure of systemic risk and so is important in itself, but it is also the building block out of which measures of institutional leverage and household leverage can be most accurately and informatively constructed.
    Keywords: Leverage, Loan to value, Margins, Haircuts, Monitor, Regulate, Leverage on new loans, Asset leverage, Investor leverage
    JEL: D52 D53 E44 G01 G10 G12
    Date: 2011–12
  12. By: Jarko Fidrmuc; Pavel Ciaian; d'Artis Kancs; Jan Pokrivcak
    Abstract: In light of the recent financial and economic crisis the present paper analyzes the determinants of loan default. We employ a unique firm-level panel data of 700 bank loans given to small and medium sized enterprises in Slovakia between 2000 and 2005 to investigate three loan default hypothesis. Testing the Sector-Risk Hypothesis, we find that agro-food industry does not exhibit higher default rate than other sectors. Testing the Firm-Risk Hypothesis, we find that highly indebted firms are more likely to default on their loan than other firms. Testing the EU Subsidy Hypothesis we find that the newly introduced subsidy system, which is decoupled from production, provides a secure source of income and hence reduces the probability of loan default.
    Keywords: Bank credit, loan default, credit constraints, heterogeneous firms.
    JEL: G33 G21 C25 Q14
    Date: 2011–11–17
  13. By: Emmanuel A. Abbe; Amir E. Khandani; Andrew W. Lo
    Abstract: Unlike other industries in which intellectual property is patentable, the financial industry relies on trade secrecy to protect its business processes and methods, which can obscure critical financial risk exposures from regulators and the public. We develop methods for sharing and aggregating such risk exposures that protect the privacy of all parties involved and without the need for a trusted third party. Our approach employs secure multi-party computation techniques from cryptography in which multiple parties are able to compute joint functions without revealing their individual inputs. In our framework, individual financial institutions evaluate a protocol on their proprietary data which cannot be inverted, leading to secure computations of real-valued statistics such a concentration indexes, pairwise correlations, and other single- and multi-point statistics. The proposed protocols are computationally tractable on realistic sample sizes. Potential financial applications include: the construction of privacy-preserving real-time indexes of bank capital and leverage ratios; the monitoring of delegated portfolio investments; financial audits; and the publication of new indexes of proprietary trading strategies.
    Date: 2011–11
  14. By: Liu, Xiaochun; Jacobsen, Brian
    Abstract: Instead of modeling asset price and currency risks separately, this paper derives the international hedge portfolio, hedging asset price and currency risk simultaneously for estimating the dynamic international optimal hedge ratio. The model estimation is specified in a multivariate GARCH setting with vector error correction terms and estimated for the commodity and stock markets of the U.S., the U.K., and Japan.
    Keywords: Optimal Hedge Ratio; International Hedging; Multivariate GARCH; Currency
    JEL: G11
    Date: 2011–02
  15. By: Robert A. Jones (Simon Fraser University); Mohammad Zanganeh (Simon Fraser University)
    Abstract: The paper derives maximum likelihood parameter estimators for symmetrically correlated Weiner processes observed at discrete intervals. Such processes arise when pricing and determining Value-at-Risk for portfolio derivatives. Cases of driftless and mean-reverting state variables are considered. The procedure is applicable to samples with missing data of any pattern and to high dimensional systems. The estimation procedure is illustrated using a sample of stock prices.
    Keywords: Maximum likelihood; Equicorrelation; Correlated diusions; Wiener process; Missing data
    JEL: C51 C58 G11 G21
    Date: 2011–10
  16. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Pierre-André Maugis (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: We present a new recursive algorithm to construct vine copulas based on an underlying tree structure. This new structure is interesting to compute multivariate distributions for dependent random variables. We proove the asymptotic normality of the vine copula parameter estimator and show that all vine copula parameter estimators have comparable variance. Both results are crucial to motivate any econometrical work based on vine copulas. We provide an application of vine copulas to estimate the VaR of a portfolio, and show they offer significant improvement as compared to a benchmark estimator based on a GARCH model.
    Keywords: Vines - multivariate copulas - risk management.
    Date: 2011
  17. By: Aslanidis, Nektarios; Christiansen, Charlotte
    Abstract: Abstract: We scrutinize the realized stock-bond correlation based upon high frequency returns. We use quantile regressions to pin down the systematic variation of the extreme tails over their economic determinants. The correlation dependence behaves differently when the correlation is large negative and large positive. The important explanatory variables at the extreme low quantile are the short rate, the yield spread, and the volatility index. At the extreme high quantile the bond market liquidity is also important. The empirical fi…ndings are only partially robust to using less precise measures of the stock-bond correlation. The results are not caused by the recent …financial crisis. Keywords: Extreme returns; Financial crisis; Realized stock-bond correlation; Quantile regressions; VIX. JEL Classifi…cations: C22; G01; G11; G12
    Keywords: Cartera de valors -- Gestió, Actius financers, 336 - Finances. Banca. Moneda. Borsa,
    Date: 2011
  18. By: Giulio Bottazzi (LEM - Laboratory of Economics and Management - Sant'Anna School of Advanced Studies); Marco Grazzi (LEM - Laboratory of Economics and Management - Sant'Anna School of Advanced Studies); Angelo Secchi (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Federico Tamagni (LEM - Laboratory of Economics and Management - Sant'Anna School of Advanced Studies)
    Abstract: This paper investigates the relevance of financial and economic variables as determinants of firm default. Our analysis cover a large sample of medium-sized limited liability firms. Since default might lead, through bankruptcy or radical restructuring, to firm's exit, our work also relates with previous contributions on industrial demography. Using non parametric tests we assess to what extent defaulting firms differ from the non-defaulting group. Bootstrap probit regressions confirm that economic variables, in addition to standard financial indicators, play both a long and short term effect. Our findings are robust with respect to the inclusion of Distance to Default and risk ratings among the regressors.
    Date: 2011
  19. By: Zagonov, Maxim
    Abstract: The move from the originate-to-hold to originate-to-distribute model of lending profoundly transformed the functioning of credit markets and weakened the natural asset transformation function performed by financial intermediaries for centuries. This shift also compromised the role of banks in channeling monetary policy initiatives, and undermined the importance of traditional asset-liability practices of interest rate risk management. The question is, therefore, whether securitisation is conducive to the optimal hedging of bank interest rate risk. The empirical results reported in this work suggest that banks resorting to securitisation do not, on average, achieve an unambiguous reduction in their exposure to the term structure fluctuations. Against this background, banks with very high involvement in the originate-to-distribute market enjoy lower interest rate risk. This however by no means implies superior risk management practices in these institutions but is merely a result of disintermediation.
    Keywords: Banks; Interest rate risk; Securitization
    JEL: C23 E52 G28 G21
    Date: 2011–09
  20. By: ITO Takatoshi; KOIBUCHI Satoshi; SATO Kiyotaka; SHIMIZU Junko
    Abstract: This paper provides a summary of the invoice currency choice and the exchange rate risk management of Japanese overseas subsidiaries based on the questionnaire survey sent and responded in August 2010. Our survey results show that the growing overseas production and sales network promotes U.S. dollar invoicing rather than Japanese yen invoicing, especially in Asia. Regarding currency risk management, most of the Japanese overseas subsidiaries, particularly located in Asia, manage currency risk on the basis of their own judgment. Under the circumstance that the world economy faces a turning point, these findings will give us important insights into the desirable currency regime of Asian countries and also provide meaningful policy implications for possible monetary cooperation in the region.
    Date: 2011–11

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