New Economics Papers
on Risk Management
Issue of 2012‒03‒21
ten papers chosen by

  1. From Stress to CoStress: Stress Testing Interconnected Banking Systems By Rodolfo Maino; Kalin Tintchev
  2. Systemic Real and Financial Risks: Measurement, Forecasting, and Stress Testing By Gianni De Nicoló; Marcella Lucchetta
  3. Managing risk exposures using the risk budgeting approach By Bruder, Benjamin; Roncalli, Thierry
  4. Empirical Evidence for the Structural Recovery Model By Alexander Becker; Alexander F. R. Koivusalo; Rudi Sch\"afer
  5. Short-term Wholesale Funding and Systemic Risk: A Global CoVaR Approach By Laura Valderrama; German Lopez-Espinosa; Antonio Moreno; Antonio Rubia
  6. On Risk, Leverage and Banks: Do highly Leveraged Banks take on Excessive Risk? By Martin Koudstaal; Sweder van Wijnbergen
  7. Regression Model for Proportions with Probability Masses at Zero and One By Raffaella Calabrese
  8. Counterparty Risk Valuation: A Marked Branching Diffusion Approach By Pierre Henry-Labordere
  9. Macroprudential Approach to Regulation—Scope and Issues By Shyamala Gopinath
  10. Banking on Regulations? By Larsson, Bo; Wijkander, Hans

  1. By: Rodolfo Maino; Kalin Tintchev
    Abstract: This paper presents an integrated framework for assessing systemic risk. The framework models banks’ capital asset ratios as a function of future losses and credit growth using a generalized method of moments to calibrate shocks to credit quality and credit growth. The analysis is complemented by a simple measure of systemic risk, which captures tail risk comovement among banks in the system. The main contribution of this paper is to advance a simple framework to integrate systemic risk scenarios that assess the impact of aggregate and idiosyncratic factors. The analysis is based on CreditRisk+, which uses analytical techniques—similar to those applied in the insurance industry - to estimate banks’ credit portfolio loss distributions, making no assumptions about the cause of default.
    Keywords: Banking systems , Credit expansion , Credit risk , Economic models , External shocks , Risk management ,
    Date: 2012–02–16
  2. By: Gianni De Nicoló; Marcella Lucchetta
    Abstract: This paper formulates a novel modeling framework that delivers: (a) forecasts of indicators of systemic real risk and systemic financial risk based on density forecasts of indicators of real activity and financial health; (b) stress-tests as measures of the dynamics of responses of systemic risk indicators to structural shocks identified by standard macroeconomic and banking theory. Using a large number of quarterly time series of the G-7 economies in 1980Q1-2010Q2, we show that the model exhibits significant out-of sample forecasting power for tail real and financial risk realizations, and that stress testing provides useful early warnings on the build-up of real and financial vulnerabilities.
    Keywords: Economic indicators , Financial risk , Forecasting models , Group of seven , Time series ,
    Date: 2012–02–28
  3. By: Bruder, Benjamin; Roncalli, Thierry
    Abstract: The ongoing economic crisis has profoundly changed the industry of the asset management, by putting risk management at the heart of most investment processes. This new risk-based investment style does not rely on returns forecasts and is therefore assumed to be more robust. In 2011, it has particularly encountered a great success with the achievement of minimum variance, ERC and risk parity strategies in portfolios of several large institutional investors. These portfolio constructions are special cases of a more general class of allocation models, known as the risk budgeting approach. In a risk budgeting portfolio, the risk contribution from each component is equal to the budget of risk defined by the portfolio manager. Unfortunately, even if risk budgeting techniques are widely used by market practitioners, they are few results about the behavior of such portfolios in the academic literature. In this paper, we derive the theoretical properties of the risk budgeting portfolio and show that its volatility is located between those of minimum variance and weight budgeting portfolios. We also discuss the existence, uniqueness and optimality of such a portfolio. In a second part of the paper, we propose several applications of risk budgeting techniques for risk-based allocation, like risk parity funds and strategic asset allocation, and equity and bond alternative indexations.
    Keywords: Risk budgeting; risk management; risk-based allocation; equal risk contribution; diversification; concentration; risk parity; alternative indexation; strategic asset allocation
    JEL: G11 C60
    Date: 2012–01
  4. By: Alexander Becker; Alexander F. R. Koivusalo; Rudi Sch\"afer
    Abstract: While defaults are rare events, losses can be substantial even for credit portfolios with a large number of contracts. Therefore, not only a good evaluation of the probability of default is crucial, but also the severity of losses needs to be estimated. The recovery rate is often modeled independently with regard to the default probability, whereas the Merton model yields a functional dependence of both variables. We use Moody's Default and Recovery Database in order to investigate the relationship of default probability and recovery rate for senior secured bonds. The assumptions in the Merton model do not seem justified by the empirical situation. Yet the empirical dependence of default probability and recovery rate is well described by the functional dependence found in the Merton model.
    Date: 2012–03
  5. By: Laura Valderrama; German Lopez-Espinosa; Antonio Moreno; Antonio Rubia
    Abstract: In this paper we identify some of the main factors behind systemic risk in a set of international large-scale complex banks using the novel CoVaR approach. We find that short-term wholesale funding is a key determinant in triggering systemic risk episodes. In contrast, we find no evidence that a larger size increases systemic risk within the class of large global banks. We also show that the sensitivity of system-wide risk to an individual bank is asymmetric across episodes of positive and negative asset returns. Since short-term wholesale funding emerges as the most relevant systemic factor, our results support the Basel Committee’s proposal to introduce a net stable funding ratio, penalizing excessive exposure to liquidity risk.
    Keywords: Economic models , Financial institutions , Financial risk , International banks , Liquidity ,
    Date: 2012–02–09
  6. By: Martin Koudstaal (Double Effect); Sweder van Wijnbergen (Unversity of Amsterdam)
    Abstract: This paper deals with the relation between excessive risk taking and capital structure in banks. Examining a quarterly dataset of U.S. banks between 1993 and 2010, we find that equity is valued higher when more risky portfolios are chosen when leverage is high, and that more risk taking has a negative impact on valuation of the debt of highly leveraged banks. We find no evidence that deposit insurance is encouraging risk taking behaviour. We do find that banks with a more troubled loan portfolio take on more risk. Banks whose share price has slumped tend to gamble for resurrection by increasing the riskiness of their asset portfolios. The results suggest that incentives embedded in the capital structure of banks contribute to systemic fragility, and so support the Basel III proposals towards less leverage and higher loss absorption capacity of capital.
    Keywords: bank fragility; risk shifting; deposit insurance; gambles for resurrection
    JEL: G21 G28 G32
    Date: 2012–03–12
  7. By: Raffaella Calabrese (Geary Dynamics Lab, Geary Institute, University College Dublin)
    Abstract: In many settings, the variable of interest is a proportion with high concentration of data at the boundaries. This paper proposes a regression model for a fractional variable with nontrivial probability masses at the extremes. In particular, the dependent variable is assumed to be a mixed random variable, obtained as the mixture of a Bernoulli and a beta random variables. The extreme values of zero and one are modelled by a logistic regression model. The values belonging to the interval (0,1) are assumed beta distributed and their mean and dispersion are jointly modelled by using two link functions. The regression model here proposed accommodates skewness and heteroscedastic errors. Finally, an application to loan recovery process of Italian banks is also provided.
    Keywords: proportions, mixed random variable, beta regression, skewness, heteroscedasticity
    JEL: B14
    Date: 2012–03–14
  8. By: Pierre Henry-Labordere (SOCIETE GENERALE - Equity Derivatives Research Societe Generale - Société Générale)
    Abstract: The purpose of this paper is to design an algorithm for the computation of the counterparty risk which is competitive in regards of a brute force ''Monte-Carlo of Monte-Carlo" method (with nested simulations). This is achieved using marked branching diffusions describing a Galton-Watson random tree. Such an algorithm leads at the same time to a computation of the (bilateral) counterparty risk when we use the default-risky or counterparty-riskless option values as mark-to-market. Our method is illustrated by various numerical examples.
    Keywords: Counterparty risk valuation; BSDE; branching diffusions; semi-linear PDE; Galton-Watson tree
    Date: 2012
  9. By: Shyamala Gopinath (Asian Development Bank Institute (ADBI))
    Abstract: This paper provides an overview of the Reserve Bank of India’s approach to macroprudential regulation and systemic risk management, and reviews lessons drawn from the Indian experience. It emphasizes the need for harmonization of monetary policy and prudential objectives, which may not be possible if banking supervision is separated from central banks. It also notes that supervisors need to have the necessary independence and flexibility to act in a timely manner on the basis of available information. Macroprudential regulation is an inexact science with limitations and needs to be used in conjunction with other policies to be effective.
    Keywords: Macroprudential regulation, Reserve Bank of India, systemic risk managemen, banking supervision
    JEL: E52 E58 G28
    Date: 2011–06
  10. By: Larsson, Bo (Dept. of Economics, Stockholm University); Wijkander, Hans (Dept. of Economics, Stockholm University)
    Abstract: The financial crisis that erupted 2007-2008 has reinforced demand for regulation of banks. The Basle III accord which is to be implemented January first 2013 encompasses two types of regulations with the goal to enforce more prudence among banks. One is capital adequacy regulation which stipulates a lowest ratio between bank capital and bank assets. The other is constraints on dividends and bonuses payments. Banking on these regulations to raise prudence regarding risk taking among banks may lead to disappointment. Within a dynamic model of a value maximizing bank we find that both regulations lower bank value, also in situations where regulations do not bind. None of the regulations leads to increased optimal ratio between common equity and lending. Capital adequacy regulation reinforces credit squeeze when binding. More frequent dividend payouts leads to higher equilibrium bank capital.
    Keywords: Banking; Dynamic Banking; Banking regulation; Capital adequacy; Dividends
    JEL: C61 G21 G22
    Date: 2012–03–12

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.