New Economics Papers
on Risk Management
Issue of 2012‒07‒23
sixteen papers chosen by

  1. Can Portfolio Diversification increase Systemic Risk? Evidence from the U.S and European Mutual Funds Market By Claudio Dicembrino; Pasquale Lucio Scandizzo
  2. On dependence consistency of CoVaR and some other systemic risk measures By Georg Mainik; Eric Schaanning
  3. Modeling risk in a dynamically changing world: from association to causation By Sokolov, Yuri
  4. Taming SIFIs By Xavier Freixas; Jean-Charles Rochet
  5. CDS Industrial Sector Indices, credit and liquidity risk By Monica Billio; Massimiliano Caporin; Loriana Pelizzon; Domenico Sartore
  6. Capital Requirements under Basel III in Latin America: The Cases of Bolivia, Colombia, Ecuador and Peru - Working Paper 296 By Liliana Rojas-Suarez, Arturo J. Galindo, and Marielle del Valle
  7. The Impact of Market Power at Bank Level in Risk-taking: the Brazilian case By Benjamin Miranda Tabak; Guilherme Maia Rodrigues Gomes; Maurício da Silva Medeiros Júnior
  8. Real Output Costs of Financial Crises: A Loss Distribution Approach By Daniel Kapp; Marco Vega
  9. Copula-Based Dynamic Conditional Correlation Multiplicative Error Processes By Taras Bodnar; Nikolaus Hautsch; ;
  10. Italy's ACE tax and its effect on a firm's leverage By Panteghini, Paolo; Parisi, Maria Laura; Pighetti, Francesca
  11. Modeling Multivariate Extreme Events Using Self-Exciting Point Processes By Oliver Grothe; Volodymyr Korniichuk; Hans Manner
  12. Identifying systemically important financial institutions: size and other determinants By Kyle Moore; Chen Zhou
  13. Credit rating agencies and unsystematic risk: Is there a linkage? By Pilar Abad Romero; María Dolores Robles Fernández
  14. Global Financial Crisis, Corporate Governance, and Firm Survival: The Case of Russia By Iwasaki, Ichiro
  15. On the effectiveness of mutual funds to cope with lasting market risks: The case of FMD in Brittany By Rault, Arnaud
  16. Where is the risk? Price, yield and cost risk in Swiss crop production By El Benni, Nadja; Finger, Robert

  1. By: Claudio Dicembrino (Enel SpA and Faculty of Economics, University of Rome "Tor Vergata"); Pasquale Lucio Scandizzo (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: This paper tests the hypothesis that portfolio diversification can increase the threat of systemic financial risk. The paper provides first a theoretical rationale for the possibility that systemic risk may be increased by the proliferation of financial instruments that lead operators to hold increasingly similar portfolios. Secondly, the paper tests the hypothesis that diversification may result in increasing systematic risk, by analyzing the portfolio dynamics of some of the major world open funds.
    Keywords: portfolio diversification, financial stability, systemic risk, CAPM
    JEL: G01 G11 G32
    Date: 2012–07–11
  2. By: Georg Mainik; Eric Schaanning
    Abstract: This paper is dedicated to the consistency of systemic risk measures with respect to stochastic dependence. It compares two alternative notions of Conditional Value-at-Risk (CoVaR) available in the current literature. These notions are both based on the conditional distribution of a random variable Y given a stress event for a random variable X, but they use different types of stress events. We derive representations of these alternative CoVaR notions in terms of copulas, study their general dependence consistency and compare their performance in several stochastic models. Our central finding is that conditioning on X>=VaR_\alpha(X) gives a much better response to dependence between X and Y than conditioning on X=VaR_\alpha(X). The theoretical results relate the dependence consistency of CoVaR using conditioning on X>=VaR_\alpha(X) to well established results on concordance ordering of multivariate distributions or their copulas. These results also apply to some other systemic risk measures. The counterexamples for CoVaR based on the stress event X=VaR_\alpha(X) include inconsistency with respect to correlation in the bivariate Gaussian model.
    Date: 2012–07
  3. By: Sokolov, Yuri
    Abstract: The current crisis causes numerous economic uncertainties, such as a break-up of the European currency union, and a Greek exit from the euro area to boost the competitiveness by means of devaluation of national currency. When a factor such as exchange rate is expected to have a significant effect on the borrowers’ creditworthiness or a shift in risk regime may have occurred, risk management models based on backward-looking statistical methods are inadequate. Unlike the other approaches to risk modeling, the discussed approach for dynamic risk modeling doesn't ignore causation in favor of correlation and thus it is far more proactive. In contrast to existing risk models, FX rate is considered as a causal factor, which induces a negative correlation among default realizations and reveals ex ante dangerous risk concentrations with the clear economic and behavioral content.
    Keywords: Correlation; causation; dynamic risk modeling; credit portfolio management; factor modeling; competitiveness; exchange rate; FEBA approach
    JEL: G28 G32 G30 E37 G21 E47 G20
    Date: 2012–07–16
  4. By: Xavier Freixas; Jean-Charles Rochet
    Abstract: We model a Systemically Important Financial Institution (SIFI) that is too big (or too interconnected) to fail. Without credible regulation and strong supervision, the shareholders of this institution might deliberately let its managers take excessive risk. We propose a solution to this problem, showing how insurance against systemic shocks can be provided without generating moral hazard. The solution involves levying a systemic tax needed to cover the costs of future crises and more importantly establishing a Systemic Risk Authority endowed with special resolution powers, including the control of bankers' compensation packages during crisis periods.
    Keywords: SIFI, dynamic moral hazard, risk taking
    JEL: G21 G32 G34
    Date: 2012–06
  5. By: Monica Billio (Department of Economics, University Of Venice Cà Foscari); Massimiliano Caporin; Loriana Pelizzon (Department of Economics, University Of Venice Cà Foscari); Domenico Sartore (Department of Economics, University Of Venice Cà Foscari)
    Abstract: This paper studies the risk spillover among US Industrial Sectors and focuses on the connection between credit and liquidity risks. The proposed methodology is based on quantile regressions and considers the movements of CDS Industrial Sector Indices depending on common risk factors such as equity risk, risk appetite, term spread and TED spread. We use CDS Industrial indexes and the market risk factor to identify the impact of market liquidity risk and market credit risk in the different US Industries and give evidence of the heterogeneity of this relation. We show that all the sectors are largely exposed to the non investment grade bond spread indicating that credit risk is largely a common factor rather than a sector specific factor. With a lower impact, we also find that market risk and interest rate risk are also common factors, as well as liquidity risk. These results indicate that diversification among sectors might collapse when credit, equity and liquidity events hit the market. The information extracted from CDS market could thus provide relevant information for sector allocation strategies.
    Keywords: Credit Risk, Common factors, liquidity risk
    JEL: F34 G12 G15
    Date: 2012
  6. By: Liliana Rojas-Suarez, Arturo J. Galindo, and Marielle del Valle
    Abstract: A number of banks in developed countries argue that the new capital requirements under Basel III are too stringent and that implementing the proposed regulation would require raising large amounts of capital, with adverse consequences on credit and the cost of finance. In contrast, many emerging market economies claim that their systems are adequately capitalized and that they have no problems with implementing the new capital requirements. This paper conducts a detailed calculation of capital held by the banks in four Latin American countries—known as the Andean countries: Bolivia, Colombia, Ecuador and Peru—and assesses the potential effects of full compliance with the capital requirements under Basel III. The conclusions are positive and show that while capital would decline somewhat in these countries after they make adjustments to comply with the new definition of capital under Basel III, they would still meet the Basel III recommendations on capital requirements. More importantly, these countries would hold Tier 1 capital to risk-weighted-asset ratios significantly above the 8.5 percent requirement under Basel III. That is, not only the quantity, but also the quality of capital is adequate in the countries under study. While encouraging, these results should not be taken as a panacea since the new regulations are only effective if coupled with appropriate risk management and supervision mechanisms to control the build-up of excessive risk-taking by banks. Further research into these areas is needed for a complete assessment of the strength of banks in the Andean countries.
    JEL: G21 G28 G32 G38
    Date: 2012–05
  7. By: Benjamin Miranda Tabak; Guilherme Maia Rodrigues Gomes; Maurício da Silva Medeiros Júnior
    Abstract: This paper aims to examine the competitive behavior of Brazilian banking industry and through a more individual analysis understand how risk-taking can be affected by banks' market power. Therefore, we compute market power at the bank-level and aggregate this variable in a risk-taking model. Our findings suggest that Brazilian banking industry presents a significant heterogeneity of banks' market power and is characterized as monopolistic competition. Another important result is that market power is positively related to risk-taking. We also verify that banks' capitalization has an important influence in market power, which affects risk-taking. An increase in capital leads banks with higher market power to assume less risk. We verify that an increase in capital makes banks with higher market power behave more conservative. These results are important for the design of proper financial regulation.
    Date: 2012–06
  8. By: Daniel Kapp (University of Paris 1-Pantheon-Sorbonne and the Paris School of Economics.); Marco Vega (Departamento de Economía - Pontificia Universidad Católica del Perú)
    Abstract: We study cross-country GDP losses due to nancial crises in terms of frequency (number of loss events per period) and severity (loss per occurrence). We perform the Loss Distribution Approach (LDA) to estimate a multi-country aggregate GDP loss probability density function and the percentiles associated to extreme events due to nancial crises. We nd that output losses arising from nancial crises are strongly heterogeneous and that currency crises lead to smaller output losses than debt and banking crises. Extreme global nancial crises episodes, occurring with a one percent probability every ve years, lead to losses between 2.95% and 4.54% of world GDP.
    Keywords: Financial Crisis, Severity, Frequency, Loss Distribution Approach
    JEL: C15 G01 G17 G22 G32
    Date: 2012
  9. By: Taras Bodnar; Nikolaus Hautsch; ;
    Abstract: We introduce a copula-based dynamic model for multivariate processes of (non-negative) high-frequency trading variables revealing time-varying conditional variances and correlations. Modeling the variables’ conditional mean processes using a multiplicative error model we map the resulting residuals into a Gaussian domain using a Gaussian copula. Based on high-frequency volatility, cumulative trading volumes, trade counts and market depth of various stocks traded at the NYSE, we show that the proposed copula-based transformation is supported by the data and allows disentangling (multivariate) dynamics in higher order moments. To capture the latter, we propose a DCC-GARCH specification. We suggest estimating the model by composite maximum likelihood which is sufficiently flexible to be applicable in high dimensions. Strong empirical evidence for time-varying conditional (co-)variances in trading processes supports the usefulness of the approach. Taking these higher-order dynamics explicitly into account significantly improves the goodness-of-fit of the multiplicative error model and allows capturing time-varying liquidity risks.
    Keywords: multiplicative error model, trading processes, copula, DCC-GARCH, liquidity risk
    JEL: C32 C58 C46
    Date: 2012–07
  10. By: Panteghini, Paolo; Parisi, Maria Laura; Pighetti, Francesca
    Abstract: This article describes the new ACE-type system implemented in Italy since 2012. The authors first show that this system reduces but does not eliminate the financial distortion due to interest deductibility. Using a dataset of Italian companies, the authors analyze the impact of this relief on Italian firm capital structure. Despite the permanence of a tax advantage and its gradual implementation, the ACE relief is estimated to reduce significantly leverage. By decreasing default risk it is also expected to reduce systemic risk. --
    Keywords: ACE,business taxation,leverage
    JEL: H25 H32
    Date: 2012
  11. By: Oliver Grothe (Department of Economic and Social Statistics, University of Cologne); Volodymyr Korniichuk (CGS, University of Cologne); Hans Manner (Department of Economic and Social Statistics, University of Cologne)
    Abstract: We propose a new model that can capture the typical features of multivariate extreme events observed in financial time series, namely clustering behavior in magnitudes and arrival times of multivariate extreme events, and time-varying dependence. The model is developed in the framework of the peaks-over-threshold approach in extreme value theory and relies on a Poisson process with self-exciting intensity. We discuss the properties of the model, treat its estimation, deal with testing goodness-of-fit, and develop a simulation algorithm. The model is applied to return data of two stock markets and four major European banks.
    Keywords: Time Series, Peaks Over Threshold, Hawkes Processes, Extreme Value Theory
    JEL: C32 C51 C58 G15
    Date: 2012–06–27
  12. By: Kyle Moore; Chen Zhou
    Abstract: This paper analyzes the conditions under which a financial institution is systemically important. Measuring the level of systemic importance of financial institutions, we find that size is a leading determinant confirming the usual “Too Big To Fail” argument. Nevertheless, the relation is non-linear during the recent global financial crisis. Moreover, since 2003, other determinants of systemic importance emerge. For example, decisions made by financial institutions on their choice of asset holdings, methods of funding, and sources of income have had a significant effect on the level of systemic importance during the global financial crises starting in 2008. These findings help to identify systemically important financial institutions by examining their relevant banking activities and to further design macro-prudential regulation towards reducing the systemic risk in the financial system.
    JEL: G01 G21 G28
    Date: 2012–07
  13. By: Pilar Abad Romero (Departamento de Fundamentos del Análisis Económico. Universidad Rey Juan Carlos); María Dolores Robles Fernández (Departamento de Fundamentos y Análisis Económico II. Universidad Complutense de Madrid.)
    Abstract: This study analyzes the effects of six different credit rating announcements on systematic and unsystematic risk in Spanish companies listed on the Electronic Continuous Stock Market from 1988 to 2010. We use an extension of the event study dummy approach that includes direct effects on beta risk and on volatility. We find effects in both kinds of risk, indicating that rating agencies provide information to the market. Rating actions that imply an improvement in credit quality cause lower systematic and unsystematic risk. Conversely, ratings announcements that imply credit quality deterioration cause a rebalance in both types of risk, with higher beta risk being joined with lower diversifiable risk. Although the event characteristics were not important to determine how the two types of risk reacted to rating actions, the 2007 economic and financial crises increase the market’s sensitivity to these characteristics.
    Keywords: Credit rating agencies, Rating changes, Market model, GARCH, Stock Returns, Systematic risk, Unsystematic The information provided by Fitch and Moody’s is appreciated. Any errors are solely the responsibility of the authors. This work has been funded by the Spanish Ministerio de Ciencia y Tecnología (ECO2009-10398/ECON and ECO2011-23959), Junta de Comunidades de Castilla-La Mancha (PCI08-0089) and Banco de Santander (UCM940063).
    JEL: G12 G14 G24 C22
    Date: 2012–07
  14. By: Iwasaki, Ichiro
    Abstract: Using a unique dataset obtained from large-scale panel enterprise surveys conducted in 2005 and 2009, we clarify the survival status of Russian industrial firms before and after the global financial crisis and empirically examine the determinants of firm survival. The estimation of the Cox proportional hazard model provided evidence that the independence of company’s governance bodies, their human resource abundance, and assertiveness in corporate management are statistically significant factors affecting the survival probability of the surveyed firms. In particular, the board of directors and the board of auditors are likely to play a vital role in reducing the potential exit risk. We also found that there is a significant difference in the viewpoints of economic logic for firm survival held by independent firms and group companies
    Keywords: global financial crisis, firm survival, corporate governance, business group, Russia
    JEL: D22 G01 G33 G34 P34
    Date: 2012–07
  15. By: Rault, Arnaud
    Abstract: Foot and Mouth disease, like other epizootic outbreaks, can have wide and lasting impacts exceeding the agricultural field. Within Europe various ad hoc policies exist to cope with these consequences. In this paper we develop a dynamic CGE model allowing us to simulate a FMD outbreak, its economic consequences and the effect of the implementation of a mutual fund as a structural risk management policy. Our results show that a financial support to farmers thanks to the mutual fund may encourage a quicker recovery from the market losses, especially helping to rebuild the cattle herds after a period of trade bans. However, counterproductive effects may be encountered in the case of mandatory participation of farmers to finance the mutual fund.
    Keywords: dynamic CGE, catastrophic event, animal disease, risk management policy, Agricultural and Food Policy, Agricultural Finance, Risk and Uncertainty, Q11, Q18,
    Date: 2012–06
  16. By: El Benni, Nadja; Finger, Robert
    Abstract: Risk management strategies are of increasing importance in agriculture. An important question is, what type of risk management strategies are required to reduce farmers’ income risks. Applying a variance decomposition approach using data of more than 3000 Swiss farms over a five year time period, this paper quantifies the direct and indirect effects of yields, prices and costs on net revenue variability at the farm‐level. We find that costs play only a minor role in determining income variability but price and yield risks are of outmost importance and very crop‐specific. For instance, price risks dominate for intensive wheat and sugar beet producer; while corn and barley producer tend to suffer more form production risks. Group comparisons and logistic regressions results show that more intensively producing farms tend to suffer more from price risk, while yield risks are dominant for less intensive producers.
    Keywords: variance decomposition, revenue risk, cost risk, crop production, natural hedge, Crop Production/Industries, Risk and Uncertainty, Q12, Q10,
    Date: 2012

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.