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on Risk Management |
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Issue of 2012‒03‒28
ten papers chosen by |
| By: | Acharya, Viral V; Pedersen, Lasse H; Philippon, Thomas; Richardson, Matthew P |
| Abstract: | We present a simple model of systemic risk and we show that each financial institution's contribution to systemic risk can be measured as its systemic expected shortfall (SES), i.e., its propensity to be undercapitalized when the system as a whole is undercapitalized. SES increases with the institution's leverage and with its expected loss in the tail of the system's loss distribution. Institutions internalize their externality if they are ‘taxed’ based on their SES. We demonstrate empirically the ability of SES to predict emerging risks during the financial crisis of 2007-2009, in particular, (i) the outcome of stress tests performed by regulators; (ii) the decline in equity valuations of large financial firms in the crisis; and, (iii) the widening of their credit default swap spreads. |
| Keywords: | bailout; financial regulation; systemic risk; value at risk |
| JEL: | G01 G18 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8824&r=rmg |
| By: | Köksal, Bülent; Orhan, Mehmet |
| Abstract: | This study compares the performance of the widely used risk measure Value-at-Risk (VaR) across a large sample of developed and developing countries. The performance of the VaR is assessed by both unconditional and conditional tests of Kupiec and Christoffersen, respectively, as well as the Quadratic Loss Function. Results indicate that the performance of VaR as a measure of risk is much worse for developed countries than the developing ones during our sample period. One possible reason might be the deeper initial impact of global financial crisis on developed countries than emerging markets. Results also provide evidence of decoupling between emerging and developed countries in terms of market risk during the global financial crisis. |
| Keywords: | Value-at-Risk (VaR); Developed Countries; Emerging Markets; ARCH/GARCH Estimation; Kupiec Test; Christoffersen Test; Quadratic Loss Function |
| JEL: | C32 C51 G32 G01 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:37523&r=rmg |
| By: | Demange, Gabrielle |
| Abstract: | An intricate web of claims and obligations ties together the balance sheets of a wide variety of financial institutions. Under the occurrence of default, these interbank claims generate externalities across institutions and possibly disseminate defaults and bankruptcy. Building on a simple model for the joint determination of the repayments of interbank claims, this paper introduces a measure of the threat that a bank poses to the system. Such a measure, called threat index, may be helpful to determine how to inject cash into banks so as to increase debt reimbursement, or to assess the contributions of individual institutions to the risk in the system. Although the threat index and the default level of a bank both reflect some form of weakness and are affected by the whole liability network, the two indicators differ. As a result, injecting cash into the banks with the largest default level may not be optimal. |
| Keywords: | bankruptcy; contagion; Contagion in financial networks : a threat index; financial linkages; systemic risk |
| JEL: | G01 G21 G28 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8793&r=rmg |
| By: | Walter Farkas; Pablo Koch-Medina; Cosimo-Andrea Munari |
| Abstract: | We consider financial positions belonging to the Banach lattice of bounded measurable functions on a given measurable space. We discuss risk measures generated by general acceptance sets allowing for capital injections to be invested in a pre-specified eligible asset with an everywhere positive payoff. Risk measures play a key role when defining required capital for a financial institution. We address the three critical questions: when is required capital a well-defined number for any financial position? When is required capital a continuous function of the financial position? Can the eligible asset be chosen in such a way that for every financial position the corresponding required capital is lower than if any other asset had been chosen? In contrast to most of the literature our discussion is not limited to convex or coherent acceptance sets and allows for eligible assets that are not necessarily bounded away from zero. This generality uncovers some unexpected phenomena and opens up the field for applications to acceptance sets based both on Value-at-Risk and on Tail Value-at-Risk. |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1203.4610&r=rmg |
| By: | Alessandro Bucciol (Department of Economics (University of Verona)); Raffaele Miniaci (University of Brescia) |
| Abstract: | We exploit the US Survey of Consumer Finances from 1998 to 2007 to study households’ portfolio risk bearing. We compare four alternative measures of risk, two based on a financial portfolio and two based on a broader portfolio also including – as illiquid assets – human capital, real estate, business wealth and related debt. The measures provide a different ranking of household risk bearing, but they consistently show that risk bearing fell after 2001, and it positively correlates with wealth, income and financial sophistication. Furthermore, the risk-age profile is sensitive to the definition of portfolio, although it looks flat for many years. |
| Keywords: | household finance, risk bearing, background risk, real estate, human capital |
| JEL: | D81 G11 D14 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:ver:wpaper:15/2011&r=rmg |
| By: | Acharya, Viral V; Mehran, Hamid; Schuermann, Til; Thakor, Anjan |
| Abstract: | We address the following questions concerning bank capital: why are banks so highly levered, what are the consequences of this leverage for the economy as a whole, and how can robust capital regulation be designed to restrict bank leverage to levels that do not generate excessive systemic risk? Bank leverage choices are a delicate balancing act: credit discipline argues for more leverage so that creditors have adequate skin in the game, while balance-sheet opacity and ease of asset substitution by bank managers and shareholders argue for less. Disturbing this balance are regulatory safety nets that promote ex post financial stability but also create perverse incentives for banks to engage in correlated asset choices ex ante and thus hold little equity capital. We discuss how a two-tier capital requirement can cope with these distortions: a core capital requirement like existing capital requirements, and a special capital account that must be invested in Treasuries, accrues to the bank’s shareholders as long as the bank is solvent, and accrues to the regulators (rather than the creditors) if the bank fails. The special capital account requirement ensures creditors have skin in the game and also provides the second margin of safety in the calculation of capital adequacy--a buffer for the regulator’s own "model risk" in calculations of needed capital buffers. |
| Keywords: | capital requirements; leverage; market discipline; model risk; systemic risk |
| JEL: | G12 G21 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8792&r=rmg |
| By: | Greenwood, Robin; Landier, Augustin; Thesmar, David |
| Abstract: | When a bank experiences an adverse shock to its equity capital, one way to return to target leverage is to sell assets. The price impact of the fire sale may impact other institutions with common exposures, resulting in contagion. We propose a simple framework that accounts for this effect. This framework explains how the distribution of leverage and risk exposures across banks contributes to systemic risk. We use it to compute a bank's exposure to sector-wide deleveraging, as well as the spillover of a bank's deleveraging onto other banks. We explain how the model can be used to evaluate a variety of policy proposals, such as caps on size or leverage, mergers of good and bad banks, and equity injections. We then apply the framework to measure (a) the vulnerability of European banks to sovereign risk in 2010 and 2011, and (b) the vulnerability of US financial institutions between 2001 and 2010. In our model, \microprudential" interventions, which target the solvency of individual banks are always less effective than \macroprudential", policies which aim to minimize spillovers across firms. |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:ide:wpaper:25524&r=rmg |
| By: | Maxim Zagonov (Toulouse Business School, University of Toulouse) |
| 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; Securitisation |
| JEL: | G21 G28 E52 C23 |
| Date: | 2011–11–23 |
| URL: | http://d.repec.org/n?u=RePEc:nos:wuwpfi:zagonov-wpsz2011&r=rmg |
| By: | Repullo, Rafael; Suarez, Javier |
| Abstract: | We develop and calibrate a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period and the business cycle is a Markov process that determines loans' probabilities of default. Banks anticipate that shocks to their earnings and the possible variation of capital requirements over the cycle can impair their future lending capacity and, as a precaution, hold capital buffers. We compare the relative performance of several capital regulation regimes, including one that maximizes a measure of social welfare. We show that Basel II is significantly more procyclical than Basel I, but makes banks safer. For this reason, it dominates Basel I in terms of welfare except for small social costs of bank failure. We also show that for high values of this cost, Basel III points in the right direction, with higher but less cyclically-varying capital requirements. |
| Keywords: | Banking regulation; Basel capital requirements; Capital market frictions; Credit rationing; Loan defaults; Relationship banking; Social cost of bank failure |
| JEL: | E44 G21 G28 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8897&r=rmg |
| By: | Juan Carlos Escanciano (Indiana University); Pei Pei (Indiana University and Chinese Academy of Finance and Development, Central University of Finance and Economics) |
| Abstract: | Historical Simulation (HS) and its variant, the Filtered Historical Simulation (FHS), are the most widely used Value-at-Risk forecast methods at commercial banks. These forecast methods are traditionally evaluated by means of the unconditional backtest. This paper formally shows that the unconditional backtest is always inconsistent for backtesting HS and FHS models, with a power function that can be even smaller than the nominal level in large samples. Our ndings have fundamental implications in the determination of market risk capital requirements, and also explain Monte Carlo and empirical ndings in previous studies. We also propose a data-driven weighted backtest with good power properties to evaluate HS and FHS forecasts. Finally, our theoretical ndings are conrmed in a Monte Carlo simulation study and an empirical application with three U.S. stocks. The empirical application shows that multiplication factors computed under the current regulatory framework are downward biased, as they inherit the inconsistency of the unconditional backtest. |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2012-003&r=rmg |