nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒01‒03
eight papers chosen by
Stan Miles
Thompson Rivers University

  1. Banking risk and regulation: Does one size fit all? By Jeroen Klomp; Jakob de Haan
  2. Harmonising Basel III and the Dodd Frank Act By Ojo, Marianne
  3. Bayesian estimation of probabilities of default for low default portfolios By Dirk Tasche
  4. Bank systemic risk and the business cycle: An empirical investigation using Canadian data By Christian Calmès; Raymond Théoret
  5. Minimal Cost of a Brownian Risk without Ruin By Shangzhen Luo; Michael Taksar
  6. An Industrial Organization Theory of Risk Sharing By M. Martin Boyer; Charles M. Nyce
  7. Addressing Catastrophic Risks: Disparate Anatomies Require Tailored Therapies By Viscusi, W. Kip; Zeckhauser, Richard J.
  8. Financial Systemic Risk: Taxation or Regulation? By Donato Masciandaro, Francesco Passarelli

  1. By: Jeroen Klomp; Jakob de Haan
    Abstract: Using data for more than 200 banks from 21 OECD countries for the period 2002 to 2008, we examine the impact of bank regulation and supervision on banking risk using quantile regressions. In contrast to most previous research, we find that banking regulation and supervision has an effect on the risks of high-risk banks. However, most measures for bank regulation and supervision do not have a significant effect on low-risk banks. As banking risk and bank regulation and supervision are multifaceted concepts, our measures for both concepts are constructed using factor analysis.
    Keywords: Financial soundness; Bank regulation and supervision; Banking risk; Quantile regression
    JEL: E44 G2
    Date: 2011–11
  2. By: Ojo, Marianne
    Abstract: This paper aims to highlight why the harmonization of two major legislative frameworks, namely, Basel III and the Dodd Frank Act, will contribute immensely to resolving future global as well as regional financial crises. More specifically, the paper also aims to highlight the significance and importance of addressing the main transmission channels of financial instability and systemic risks at micro and macro prudential level as well as the need for consideration and redress of the obstacles confronted by Basel III – with particular regards to the impediment imposed by the Dodd Frank Wall Street Reform and Consumer Protection Act.
    Keywords: Basel III; Dodd Frank; credit ratings; financial crises; regulation; financial stability; systemic risks
    JEL: E02 K2 G2 D8 G01
    Date: 2011–12–19
  3. By: Dirk Tasche
    Abstract: The estimation of probabilities of default (PDs) for low default portfolios by means of upper confidence bounds is a well established procedure in many financial institutions. However, there are often discussions within the institutions or between institutions and supervisors about which confidence level to use for the estimation. The Bayesian estimator for the PD based on the uninformed, uniform prior distribution is an obvious alternative that avoids the choice of a confidence level. In this paper, we demonstrate that in the case of independent default events the upper confidence bounds can be represented as quantiles of a Bayesian posterior distribution based on a prior that is slightly more conservative than the uninformed prior. We then describe how to implement the uninformed and conservative Bayesian estimators in the dependent one- and multi-period default data cases and compare their estimates to the upper confidence bound estimates. The comparison leads us to suggest a constrained version of the uninformed (neutral) Bayesian estimator as an alternative to the upper confidence bound estimators.
    Date: 2011–12
  4. By: Christian Calmès (Chaire d'information financière et organisationnelle ESG-UQAM, Laboratory for Research in Statistics and Probability, Université du Québec (Outaouais)); Raymond Théoret (Chaire d'information financière et organisationnelle ESG-UQAM, Université du Québec (Montréal), Université du Québec (Outaouais))
    Abstract: Since financial institutions are subjected to increasingly tighter requirements regarding the way they conduct their loan business, we could assume that built-in regulatory pressures induce them to adopt collective business strategies, with the unintended consequence of persistently weakening the banking system ability to cope with external shocks. Surprisingly, we find rather the opposite. This paper documents how banks, as a group, react to macroeconomic risk and uncertainty, and more specifically the way banks systemic behaviour evolves over the business cycle. Adopting the methodology of Beaudry et al. (2001), our results clearly indicate that the dispersion across banks traditional portfolios has actually increased through time. We introduce an estimation procedure based on EGARCH and re-fine Baum et al. (2002, 2004, 2009) and Quagliariello (2007, 2009) framework to analyze the question in the new industry context, i.e. shadow banking. Consistent with finance theory, we first confirm that banks tend to behave homogeneously vis-à-vis macroeconomic uncertainty. Additionally, we find that the cross-sectional dispersions of loans to assets and non-traditional activities shrink essentially during downturns, when the resilience of the banking system is at its lowest. Our results also indicate that banks herd-like behaviour remains predominantly a cyclical phenomenon, almost unaffected by the new banking environment. Most importantly however, the cross-sectional dispersion of market-oriented ac-tivities appears to be both more volatile and sensitive to the business cycle than the dispersion of the traditional banking business lines.
    Keywords: Basel III; Banking stability; Macroprudential policy; Herding; Macroeconomic uncertainty.
    JEL: C32 G20 G21
    Date: 2011–12–19
  5. By: Shangzhen Luo; Michael Taksar
    Abstract: In this paper, we study a risk process modeled by a Brownian motion with drift (the diffusion approximation model). The insurance entity can purchase reinsurance to lower its risk and receive cash injections at discrete times to avoid ruin. Proportional reinsurance and excess-of-loss reinsurance are considered. The objective is to find the optimal reinsurance and cash injection strategy that minimizes the total cost to keep the company's surplus process non-negative, i.e. without ruin, where the cost function is defined as the total discounted value of the injections. The optimal solution is found explicitly by solving the according quasi-variational inequalities (QVIs).
    Date: 2011–12
  6. By: M. Martin Boyer; Charles M. Nyce
    Abstract: Examining the global reinsurance market for catastrophic losses, we propose a new theory of optimal risk sharing that finds its inspiration in the economic theory of the firm. Our model offers a theoretical foundation for the vertical and horizontal tranching of insurance contracts (also known respectively as proportional and excess of loss reinsurance contracts). Using a two-factor production model popular in industrial economics, we show how reinsurance should be optimally layered (with attachment and detachment points) for a given book of business. This allows us to find the minimum insurance premium necessary to cover the cost of catastrophic events. We conclude with public policy implications by showing the conditions under which government intervention in the catastrophic loss insurance industry can reduce the cost to society of bearing risk and increase its welfare. <P>
    Keywords: Reinsurance; Cost of capital; Catastrophic risk; Government intervention in insurance markets,
    JEL: G22 G28
    Date: 2011–12–01
  7. By: Viscusi, W. Kip (Vanderbilt University); Zeckhauser, Richard J. (Harvard University)
    Abstract: Catastrophic risks differ in terms of their natural or human origins, their possible amplification by human behaviors, and the relationships between those who create the risks and those who suffer the losses. Given their disparate anatomies, catastrophic risks generally require tailored therapies, with each prescribed therapy employing a specific portfolio of policy strategies. Given that catastrophic risks occur rarely, and impose extreme losses, traditional mechanisms for controlling risks--bargaining, regulation, liability--often function poorly. Commons catastrophes arise when a group of actors collectively impose such risks on themselves. When the commons is balanced, that is, when the parties are roughly symmetrically situated, a range of regulatory mechanisms can perform well. However, unbalanced commons--such as exist with climate change--will challenge any control mechanism with the disparate parties putting forth proposals to limit their own burdens. When humans impose catastrophic risks predominantly on others--as with deepwater oil spills--the risks are external. For those risks, the analysis shows, a single responsible party should be identified. Primary emphasis should then be placed on a two-tier liability system. Parties engaged in activities posing such catastrophic risks would be subject to substantial minimum financial requirements, strict liability for all damages, and a risk-based tax for expected losses that would exceed the responsible party's ability to pay. Utilizing the financial incentives of this two-tier liability system would decrease the current reliance on regulatory policy, and would alter the role of regulators with a tilt toward financial oversight efforts and away from direct control. Catastrophic risks will always be with us. But as rare, extreme events, society has little experience with them, and current mechanisms are poorly designed to control them. Only a tailored therapy approach offers promise of significant improvement.
    JEL: G22 H00 K32 Q30
    Date: 2011–11
  8. By: Donato Masciandaro, Francesco Passarelli
    Abstract: In this paper we describe systemic financial risk as a pollution issue. Free riding leads to excess risk production. This problem may be solved, at least partially, either with financial regulation or taxation. From a normative viewpoint taxation is superior in many respects. However, reality shows that financial regulation is more frequently adopted. In this paper we make a positive, politico-economic argument. If the majority chooses a tax, then it is likely to be too low. If it chooses regulation it will possibly be too harsh. Moreover, a majority of low polluting portfolio owners may strategically use regulation in order to charge the minority a larger share of the externality reduction.
    Keywords: financial crises, banking regulation, financial transaction taxes
    JEL: D62 D72 G21
    Date: 2011–12

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