nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒05‒29
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Financial Risk Measurement for Financial Risk Management By Torben G. Andersen; Tim Bollerslev; Peter F. Christoffersen; Francis X. Diebold
  2. Involving copula functions in Conditional Tail Expectation By Brahim Brahimi
  3. Insurance portfolio risk aggregation and solvency capital computation with mathematical copula techniques By Zvezdov, Ivelin
  4. Contagion in financial networks: a threat index By Gabrielle Demange
  5. Structured portfolio analysis under SharpeOmega ratio By Rania Hentati; Jean-Luc Prigent
  6. Rational and mechanics of a peak risk variance swap for a property insurance portfolio By Zvezdov, Ivelin
  7. Single-name concentration risk in credit portfolios: a comparison of concentration indices By Raffaella Calabrese; Francesco Porro
  8. Realized Copula By Matthias R. Fengler; Ostap Okhrin;
  9. Measuring and managing the impact of risk on organizations: The Case of Kosovo By Govori, Arbiana
  10. The perverse effect of government credit subsidies on banking risk By Riccardo De Bonis; Matteo Piazza; Roberto Tedeschi
  11. Were multinational banks taking excessive risks before the recent financial crisis? By Mohamed Azzim Gulamhussen; Carlos Pinheiro; Alberto Franco Pozzolo
  12. Predicting rating changes for banks: How accurate are accounting and stock market indicators? By Distinguin, Isabelle; Hasan, Iftekhar; Tarazi , Amine
  13. Italian real estate investment funds: market structure and risk measurement By Michele Leonardo Bianchi; Agostino Chiabrera
  14. Addressing Catastrophic Risks: Disparate Anatomies Require Tailored Therapies By Viscusi, Kip W.; Zeckhauser, Richard Jay

  1. By: Torben G. Andersen; Tim Bollerslev; Peter F. Christoffersen; Francis X. Diebold
    Abstract: Current practice largely follows restrictive approaches to market risk measurement, such as historical simulation or RiskMetrics. In contrast, we propose flexible methods that exploit recent developments in financial econometrics and are likely to produce more accurate risk assessments, treating both portfolio-level and asset-level analysis. Asset-level analysis is particularly challenging because the demands of real-world risk management in financial institutions – in particular, real-time risk tracking in very high-dimensional situations – impose strict limits on model complexity. Hence we stress powerful yet parsimonious models that are easily estimated. In addition, we emphasize the need for deeper understanding of the links between market risk and macroeconomic fundamentals, focusing primarily on links among equity return volatilities, real growth, and real growth volatilities. Throughout, we strive not only to deepen our scientific understanding of market risk, but also cross-fertilize the academic and practitioner communities, promoting improved market risk measurement technologies that draw on the best of both.
    JEL: C1 G1
    Date: 2012–05
  2. By: Brahim Brahimi
    Abstract: We discuss a new notion of risk measures that preserve the property of coherence called Copula Conditional Tail Expectation (CCTE). This measure describes the expected amount of risk that can be experienced given that a potential bivariate risk exceeds a bivariate threshold value, and provides an important measure for right-tail risk. Our goal is to propose an alternative risk measure which takes into account the fluctuations of losses and possible correlations between random variables.
    Date: 2012–05
  3. By: Zvezdov, Ivelin
    Abstract: Contents 1. Portfolio structuring; risk factor category identification and mapping 2. Risk aggregation of single risk losses within each risk factor category a. Methodology identification and brief technical review b. SCR computation by risk factor category 3. The portfolio view and SCR. 4. Conclusion: coherence, stress testing and benchmarks
    Keywords: insurance portfolio risk aggregation; solvency capital requirement; mathematical copulas
    JEL: G11 G22 C15
    Date: 2012–02–07
  4. By: Gabrielle Demange (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    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: Contagion ; Systemic risk ; Financial linkages ; Bankruptcy
    Date: 2012–01
  5. By: Rania Hentati (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Jean-Luc Prigent (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)
    Abstract: This paper deals with performance measurement of financial structured products. For this purpose, we introduce the SharpeOmega ratio, based on put as downside risk measure. This allows to take account of the asymmetry of the return probability distribution. We provide general results about the optimization of some standard structured portfolios with respect to the SharpeOmega ratio. We determine in particular the optimal combination of risk free, stock and call/put instruments with respect to this performance measure. We show that, contrary to Sharpe ratio maximization (Goetzmann et al., 2002), the payoff of the optimal structured portfolio is not necessarily increasing and concave. We also discuss about the interest of the asset management industry to reward high Sharpe Omega ratios.
    Keywords: Structured portfolio, Performance measure, SharpeOmega ratio.
    Date: 2012–01
  6. By: Zvezdov, Ivelin
    Abstract: In this technical report we explore the motivation, structuring and detailed mechanics of a variance swap contract adapted for a property insurance portfolio. We structure, price and test sensitivities of the swap contract using real event historical and modeled natural catastrophe loss data. Our key motivation is to propose an element of financial engineering innovation to insurance portfolio risk management to allow for constructing hedging strategies that may not be possible to achieve with traditional reinsurance treaties and contracts.
    Keywords: variance swap; peak catastrophe risk hedging; insurance portfolio risk management and risk transfer
    JEL: G22 G24
    Date: 2012–04–07
  7. By: Raffaella Calabrese (University College Dublin); Francesco Porro (Universit`a degli Studi di Milano-Bicocca)
    Abstract: For assessing the effect of undiversified idiosyncratic risk, Basel II has established that banks should measure and control their credit concentration risk. Concentration risk in credit portfolios comes into being through an uneven distribution of bank loans to individual borrowers (single-name concentration) or through an unbalanced allocation of loans in productive sectors and geographical regions (sectoral concentration). To evaluate single-name concentration risk in the literature concentration indices proposed in welfare (Gini Index) and monopoly theory (Herfindahl- Hirschman index, Theil entropy index, Hannah-Kay index, Hall-Tidemann index) have been used. In this paper such concentration indices are compared by using as benchmark six properties that ensure a consistent measurement of single-name concentration. Finally, the indices are compared on some portfolios of loans.
    Keywords: credit concentration risk, bank loans, single-name concentration
    Date: 2012–05–22
  8. By: Matthias R. Fengler; Ostap Okhrin;
    Abstract: We introduce the notion of realized copula. Based on assumptions of the marginal distri- butions of daily stock returns and a copula family, realized copula is dened as the copula structure materialized in realized covariance estimated from within-day high-frequency data. Copula parameters are estimated in a method-of-moments type of fashion through Hoeding's lemma. Applying this procedure day by day gives rise to a time series of copula parameters that is suitably approximated by an autoregressive time series model. This allows us to capture time-varying dependency in our framework. Studying a portfolio risk-management applica- tion, we find that time-varying realized copula is superior to standard benchmark models in the literature.
    Keywords: realized variance, realized covariance, realized copula, multivariate dependence
    JEL: G12 C13 C14 C22 C50
    Date: 2012–05
  9. By: Govori, Arbiana
    Abstract: After the 2008 events that occurred in world financial markets, all organizations have increased interest in risk management. It is very clear that risk management brings benefits to the organization. By taking a proactive approach to risk and risk management, organizations will be able to manage to improve performance and results in the areas of the operations performance, the development of processes and projects, and the selection and implementation of alternative development strategies. Business firms in Kosovo have changed their approach to risk management in recent times. Reasons for that ‘approach evolution’ are based on recent losses in some of commercial banks, insurance companies, pension trust, and some negative trends in Kosovo real economy.
    Keywords: Risk; returns; organization; operations; processes; strategy; rsik quantification; risk management; risk insurance
    JEL: D81 M1 D8 M2 G3
    Date: 2012–05–05
  10. By: Riccardo De Bonis (Banca d'Italia, Economics and International Relations Area); Matteo Piazza (Banca d'Italia, Economics and International Relations Area); Roberto Tedeschi (Banca d'Italia, Economics and International Relations Area)
    Abstract: Government intervention in credit markets has been criticized as potentially conducive to distortions in the behaviour of both banks and firms. We argue that credit subsidies may lead to a decline in the level of screening performed by banks. This effect was at work in Italy in the early 1990s when subsidized lending was still important and several intermediaries experienced a deterioration in their loan portfolios. The novelty of the paper is to show that the share of government subsidized credit on a bank's loan portfolio contributes to explaining the overall credit risk of the intermediary.
    Keywords: banks, credit risk, government subsidies
    JEL: E44 G21
    Date: 2012–05
  11. By: Mohamed Azzim Gulamhussen (Lisbon University Institute); Carlos Pinheiro (Caixa Geral de Dep¢sitos); Alberto Franco Pozzolo (University of Molise, Centro Studi Luca d'Agliano)
    Abstract: The recent financial crisis has clearly shown that the relationship between bank internationalization and risk is complex. Multinational banks can benefit from portfolio diversification, reducing their overall riskiness, but this effect can be offset by incentives going in the opposite direction, leading them to take on excessive risks. Since both effects are grounded on solid theoretical arguments, the answer of what is the actual relationship between bank internationalization and risk is left to the empirical analysis. In this paper, we study such relationship in the period leading to the financial crisis of 2007-2008. For a sample of 384 listed banks from 56 countries, we calculate two measures of risk for the period from 2001 to 2007 - the expected default frequency (EDF), a market-based and forward-looking indicator, and the Z-score, a balance-sheet-based and backward-looking measure - and relate them to their degree of internationalization. We find robust evidence that international diversification increases bank risk.
    Keywords: Banks, Economic integration, Market structure, Multinational banking, Risk
    JEL: F23 F36 G21 G32 L22
    Date: 2012–05
  12. By: Distinguin, Isabelle (Université de Limoges, LAPE); Hasan, Iftekhar (Fordham University and Bank of Finland); Tarazi , Amine (Université de Limoges, LAPE)
    Abstract: We aim to assess how accurately accounting and stock market indicators predict rating changes for Asian banks. We conduct a stepwise process to determine the optimal set of early indicators by tracing upgrades and downgrades from rating agencies, as well as other relevant factors. Our results indicate that both accounting and market indicators are useful leading indicators but are more effective in predicting upgrades than downgrades, especially for large banks. Moreover, early indicators are only significant in predicting rating changes for banks that are more focused on traditional banking activities such as deposit and loan activities. Finally, a higher reliance of banks on subordinated debt is associated with better accuracy of early indicators.
    Keywords: bank failure; bank risk; ratings; emerging market
    JEL: G21 G28
    Date: 2012–04–12
  13. By: Michele Leonardo Bianchi (Banca d'Italia); Agostino Chiabrera (Banca d'Italia)
    Abstract: This paper describes the Italian real estate investment funds industry, providing an overview of the distinctive features and risk factors of this sector. By using accounting and supervisory data, we: (1) compute the returns of the real estate assets in the portfolio of these funds; (2) construct a price index and a total return index of the real estate assets held by the Italian funds; (3) define a risk assessment process based on three different aspects - their financial profile, income structure and property price behaviour. This analysis allows us to select funds with a weak financial structure, poor returns, and a high probability that in a three-year interval their property portfolio will fall below their net liabilities (defined as the difference between debt and liquid assets). The proposed risk assessment can be seen as the first step towards a more intensive supervisory analysis and can also be useful for investment purposes.
    Keywords: real estate investment funds, asset management, firm value model, non-normal distributions, Monte Carlo simulation
    JEL: G21
    Date: 2012–04
  14. By: Viscusi, Kip W.; Zeckhauser, Richard Jay
    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.
    Date: 2011

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