nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒04‒10
seven papers chosen by
Stan Miles
Thompson Rivers University

  1. Dynamic Hedging in Incomplete Markets: A Simple Solution By Suleyman Basak; Georgy Chabakauri
  2. The Mathematics of the Relationship between the Default Risk and Yield-to-Maturity of Coupon Bonds By Sara Cecchetti; Antonio Di Cesare
  3. Capital Requirements under Basel III in Andean Countries: The Cases of Bolivia, Colombia, Ecuador and Peru By Arturo Galindo; Liliana Rojas-Suárez; Marielle del Valle
  4. Business credit information sharing and default risk of private firms By Maik Dierkes; Carsten Erner; Thomas Langer; Lars Norden
  5. Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects By Gropp, R.; Grundl, C.; Guttler, A.
  6. On the Empirics of China's Inter-regional Risk Sharing By Li, Jia
  7. An Economic Index of Relative Riskiness By Amnon Schreiber

  1. By: Suleyman Basak; Georgy Chabakauri
    Abstract: Despite much work on hedging in incomplete markets, the literature still lacks tractable dynamic hedges in plausible environments. In this article, we provide a simple solution to this problem in a general incomplete-market economy in which a hedger, guided by the traditional minimum-variance criterion, aims at reducing the risk of a non-tradable asset or a contingent claim. We derive fully analytical optimal hedges and demonstrate that they can easily be computed in various stochastic environments. Our dynamic hedges preserve the simple structure of complete-market perfect hedges and are in terms of generalized \Greeks," familiar in risk management applications, as well as retaining the intuitive features of their static counterparts. We obtain our time-consistent hedges by dynamic programming, while the extant literature characterizes either static or myopic hedges, or dynamic ones that minimize the variance criterion at an initial date and from which the hedger may deviate unless she can pre-commit to follow them. We apply our results to the discrete hedging problem of derivatives when trading occurs infrequently. We determine the corresponding optimal hedge and replicating portfolio value, and show that they have structure similar to their complete market counterparts and reduce to generalized Black-Scholes expressions when specialized to the Black-Scholes setting. We also generalize our results to richer settings to study dynamic hedging with Poisson jumps, stochastic correlation and portfolio management with benchmarking.
    Date: 2011–05
  2. By: Sara Cecchetti; Antonio Di Cesare
    Abstract: The paper analyzes the mathematics of the relationship between the default risk and yield-to-maturity of a coupon bond. It is shown that the yield-to-maturity is driven not only by the default probability and recovery rate of the bond but also by other contractual characteristics of the bond that are not commonly associated with default risk, such as the maturity and coupon rate of the bond. In particular, for given default probability and recovery rate, both the level and slope of the yield-to-maturity term structure depend on the coupon rate, as the higher the coupon rate the higher the yield-to-maturity term structure. In addition, the yield-to-maturity term structure is upward or downward sloping depending on whether the coupon rate is high or low enough. Similar qualitative results also holds for CDS spreads. Consequently, the yield-to-maturity is an indicator that must be used cautiously as a proxy for default risk.
    Date: 2012–03
  3. By: Arturo Galindo; Liliana Rojas-Suárez; Marielle del Valle
    Abstract: Since the eruption of the global financial crisis in 2008 international setting bodies and local regulators around the world have been hard at work designing and implementing new regulatory frameworks to deal with the regulatory deficiencies that were exposed during the crisis. In particular, there is now a consensus that existing regulations in developed countries were not able to contain excessive risk-taking activities by financial institutions in this group of countries during the pre-crisis period. Among these regulations, the newly proposed set of reform measures developed by the Basel Committee on Banking Supervision (BCBS): "Basel III: A global regulatory framework for more resilient banks and banking systems" (2011) is perhaps the one that has attracted most attention worldwide because a central focus of the recommendations lies on important changes in banks' regulatory capital requirements. Where does Latin America stand with respect to capital requirements? Can banks in the region satisfy with ease the new capital requirements of Basel III or will the implementation of this new set of capital recommendations require large efforts from banks in the region? This paper deals with these questions for the case of four Andean countries: Bolivia, Colombia, Ecuador and Peru.
    Keywords: Financial Sector :: Financial Policy, Capital Requirements under Basel III, financial framework, financial reform
    Date: 2011–12
  4. By: Maik Dierkes (Finance Center Mnster, University of Mnster); Carsten Erner (Finance Center Mnster, University of Mnster); Thomas Langer (Finance Center Mnster, University of Mnster); Lars Norden (Rotterdam School of Management, Erasmus University)
    Abstract: We investigate whether and how business credit information sharing helps to better assess the default risk of private firms. Private firms represent an ideal testing ground because they are smaller, more informationally opaque, riskier, and more dependent on trade credit and bank loans than public firms. Based on a representative panel dataset that comprises private firms from all major industries, we find that business credit information sharing substantially improves the quality of default predictions. The improvement is stronger for older firms and those with limited liability, and depends on the sharing of firms' payment history and the number of firms covered by the local credit bureau office. The value of soft business credit information is higher for smaller and less distant firms. Furthermore, in spatial and industry analyses we show that the higher the value of business credit information the lower the realized default rates. Our study highlights the channel through which business credit information sharing adds value and the factors that influence its strength.
    Keywords: Asymmetric information, Credit bureau, Credit risk, Hard and soft information, Private firms
    JEL: D82 G21 G32 G33
    Date: 2012–03
  5. By: Gropp, R.; Grundl, C.; Guttler, A. (Tilburg University, Center for Economic Research)
    Abstract: In this paper we analyze whether discretionary lending increases bank risk. We use a panel dataset of matched bank and borrower data. It offers the chief advantages that we can directly identify soft information in banks’ lending decisions and that we observe ex post defaults of borrowers.Consistent with the previous literature, we find that smaller banks use more discretion in lending. We also show that borrowers self-select to banks depending on whether their soft information is positive or negative. Financially riskier borrowers with positive soft information are more likely to obtain credit from relationship banks. Risky borrowers with negative soft information have the same chance to receive a loan from a relationship or a transaction bank. These selection effects are stronger in more competitive markets, as predicted by theory. However, while relationship banks have financially riskier borrowers, ex post default is not more probable compared to borrowers at transaction banks. As a consequence, relationship banks do not have higher credit risk levels. Loan officers at relationship banks thus do not use discretion in lending to grant loans to ex post riskier borrowers.
    Keywords: soft information;discretionary lending;relationship bank;bank risk.
    JEL: G21 G28 G32
    Date: 2012
  6. By: Li, Jia
    Abstract: This study provides a comprehensive investigation on the mechanisms of risk sharing among China's provinces over the period 1995-2009. Using three empirical techniques, we found that, first, the extent of risk sharing attained by the provinces is relatively limited, and the financial liberalization since the late 1990s has not helped improve the degree of risk sharing. Second, credit market, compared to capital market, capital depreciation, and tax-transfer system, has been the single operative channel of risk sharing in China. Third, there are possibilities for China to gain the benefits of risk sharing from various institutional factors. In particular, though still insignificant, rural-urban migration, formal financial system and fiscal transfer appear to start to promote risk sharing recently. In contrast, FDI seems to be a dis-smoothing factor in China.
    Keywords: Risk sharing; financial liberalization; China
    JEL: E2 C0 G0 C2
    Date: 2012–03
  7. By: Amnon Schreiber
    Abstract: In their seminal works, Arrow (1965) and Pratt (1964) defined two aspects of risk aversion: absolute risk aversion and relative risk aversion. Based on their definitions, we define two aspects of risk: absolute risk and relative risk. We consider situations in which, by making an investment, an agent exchanges a certain amount of wealth w by a random distributed level of wealth W. In such situations, we define absolute risk as the riskiness of a gamble that is distributed as W-w, and relative risk as the riskiness of a security that is distributed as W/w. We measure absolute risk by the Aumann and Serrano (2008) index of riskiness and relative risk by an equivalent index that we develop in this paper. The two concepts of risk do not necessarily agree on which one of two investments is riskier, and hence they capture two different aspects of risk.
    Date: 2012–01–31

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