nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒04‒17
six papers chosen by
Stan Miles
Thompson Rivers University

  1. Model Implied Credit Spreads By Gunnar Grass
  2. Comparative and qualitative robustness for law-invariant risk measures By Volker Kr\"atschmer; Alexander Schied; Henryk Z\"ahle
  3. Modelling Default Correlations in a Two-Firm Model with Dynamic Leverage Ratios By Carl Chiarella; Chi-Fai Lo; Ming Xi Huang
  4. Forecasting Value-at-Risk Using Block Structure Multivariate Stochastic Volatility Models By Michael McAleer; Manabu Asai; Massimiliano Caporin
  5. Are private banks the better banks? An insight into the principal-agent structure and risk-taking behavior of German banks. By Frank Schmielewski; Thomas Wein
  6. Description of the Operational Mechanics of a Basel Regulated Banking System By Jacky Mallett

  1. By: Gunnar Grass
    Abstract: I propose a new measure of credit risk, model implied credit spreads (MICS), which can be extracted from any structural credit risk model in which debt values are a function of asset risk and the payout ratio. I implement MICS assuming a barrier option framework nesting the Merton (1974) model of capital structure. MICS are the increase in the payout to creditors necessary to offset the impact of an increase in asset variance on the option value of debt. Endogenizing asset payouts, my measure (i) predicts higher credit risk for safe firms and lower credit risk for firms with high volatility and leverage than a standard distance to default (DD) measure and (ii) clearly outperforms the DD measure when used to predict corporate default or to explain variations in credit spreads.
    Keywords: Structural Credit Risk Models, Bankruptcy Prediction, Risk-Neutral Pricing
    JEL: G33 G13 G32
    Date: 2012
  2. By: Volker Kr\"atschmer; Alexander Schied; Henryk Z\"ahle
    Abstract: When estimating the risk of a P&L from historical data or Monte Carlo simulation, the robustness of the estimate is important. We argue here that Hampel's classical notion of qualitative robustness is not suitable for risk measurement and we propose and analyze a refined notion of robustness that applies to tail-dependent law-invariant convex risk measures on Orlicz space. This concept of robustness captures the tradeoff between robustness and sensitivity and can be quantified by an index of qualitative robustness. By means of this index, we can compare various risk measures, such as distortion risk measures, in regard to their degree of robustness. Our analysis also yields results that are of independent interest such as continuity properties and consistency of estimators for risk measures, or a Skorohod representation theorem for {\psi}-weak convergence.
    Date: 2012–04
  3. By: Carl Chiarella (Finance Discipline Group, UTS Business School, University of Technology, Sydney); Chi-Fai Lo (Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong); Ming Xi Huang (Finance Discipline Group, UTS Business School, University of Technology, Sydney)
    Abstract: This article provides a generalized two-firm model of default correlation, based on the structural approach that incorporates interest rate risk. In most structural models default is driven by the firms' asset dynamics. In this article, a two-firm model of default is instead driven by the dynamic leverage ratios, which combines the measure of risks of the firms' total liabilities and assets. This article investigates analytical methods and numerical tools to solve the two-dimensional first passage time problem with time-dependent parameters. We carry out a comparative analysis of the impact of model parameters and provide some insights of their effects on joint survival probabilities and default correlations.
    Keywords: credit risk; default correlations; default probabilities; first passage time
    JEL: C60 G13 G32
    Date: 2012–03–01
  4. By: Michael McAleer (Erasmus University Rotterdam,Tinbergen Institute,Kyoto University,Complutense University of Madrid); Manabu Asai (Faculty of Economics Soka University); Massimiliano Caporin (Department of Economics and Management “Marco Fanno”University of Padova)
    Abstract: Most multivariate variance or volatility models suffer from a common problem, the “curse of dimensionality”. For this reason, most are fitted under strong parametric restrictions that reduce the interpretation and flexibility of the models. Recently, the literature has focused on multivariate models with milder restrictions, whose purpose was to combine the need for interpretability and efficiency faced by model users with the computational problems that may emerge when the number of assets is quite large. We contribute to this strand of the literature proposing a block-type parameterization for multivariate stochastic volatility models. The empirical analysis on stock returns on US market shows that 1% and 5 % Value-at-Risk thresholds based on one-step-ahead forecasts of covariances by the new specification are satisfactory for the period includes the global financial crisis.
    Keywords: block structures; multivariate stochastic volatility; curse of dimensionality; leverage effects; multi-factors; heavy-tailed distribution.
    JEL: C32 C51 C10
    Date: 2012–04
  5. By: Frank Schmielewski (Leuphana University of Lüneburg, Germany); Thomas Wein (Leuphana University of Lueneburg, Germany)
    Abstract: In this study, we propose our hypothesis that the distinguishable principal-agent relationships of German banks are significantly influencing the risk-taking attitudes of bank managers. Particularly, we intend to substantiate the theory that banks owned by dispersed shareholders or federal state authorities face a higher relevance of principal-agent problems than other banking sectors due to a missing ability to monitor bank managers. Our results underline that these problems appear to mislead bank managers showing an unreasonable risk-taking behavior. In a first stage, we rely on a theoretical model explaining that from the bank owners’ viewpoint three factors of the principal-agent relationships are determining the probability of choosing the optimal portfolio of risky assets. These factors cover the ability to control bank managers, the risk pooling capabilities of bank owners and bank managers, and the incentives of seeking high returns. To support our hypothesis we apply an empirical study to the distances-to-default of different German banking sectors. This demonstrates that risktaking attitudes of banks are closely related to banks’ ownership. Consequently, our findings offer evidence, that legislative and regulatory authorities should increase their vigilance in terms of principal-agent problems within certain sectors of the banking industry.
    Keywords: Financial crises; risk-taking behavior; risk aversion; efficient portfolios; information asymmetries and market efficiency; government policy and regulation; risk pooling; seeking for high returns; monitoring capabilities; capital and ownership structure; distance-to-default; capital asset ratio; return on assets
    JEL: G01 G12 G14 G28 G15 G32
    Date: 2012–04
  6. By: Jacky Mallett
    Abstract: This paper presents a description of the mechanical operations of banking as used in modern banking systems regulated under the Basel Accords, in order to provide support for a verifiable and complete description of the banking system suitable for computer simulation. Feedback is requested on the contents of this document, both with respect to the operations described here, and any known national, regional or local variations in their structure and practice.
    Date: 2012–04

This nep-rmg issue is ©2012 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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.