New Economics Papers
on Risk Management
Issue of 2012‒07‒29
eleven papers chosen by

  1. A network model of financial system resilience By Anand, Kartik; Gai, Prasanna; Kapadia, Sujit; Brennan, Simon; Willison, Matthew
  2. Catastrophic Medical Expenditure Risk By Gabriela Flores; Owen O'Donnell
  3. The savings paradox or managing financial, economic or financial risks By De Koning, Kees
  4. Fixed-income portfolio management in crisis period: Expected tail loss (ETL) approach By Mili, Mehdi
  5. Is there a 'race to the bottom' in central counterparties competition? By Siyi Zhu
  6. Determinants of default: Evidence from a sector-level panel of Irish SME loans. By Lawless, Martina; McCann, Fergal
  7. Adapting Macropudential Policies to Global Liquidity Conditions By Hyun Song Shin
  8. Some Financial Stability Indicators for Brazil By Adriana Soares Sales; Waldyr D. Areosa; Marta B. M. Areosa
  9. On the Relevance of Soft Information in Credit Rating: The Case of a Social Bank Financing Small Businesses By Simon Cornée
  10. Stochastic debt simulation using VAR models and a panel fiscal reaction function – results for a selected number of countries By João Medeiros
  11. An Anatomy of Credit Booms and their Demise By Enrique Mendoza; Marco Terrones

  1. By: Anand, Kartik (Technische Universitat Berlin); Gai, Prasanna (Department of Economics, University of Auckland and National University of Singapore, Risk Management Institute); Kapadia, Sujit (Bank of England); Brennan, Simon (Bank of England); Willison, Matthew (Bank of England)
    Abstract: We examine the role of macroeconomic fluctuations, asset market liquidity, and network structure in determining contagion and aggregate losses in a stylised financial system. Systemic instability is explored in a financial network comprising three distinct, but interconnected, sets of agents - domestic banks, overseas banks, and firms. Calibrating the model to advanced country banking sector data, this preliminary model generates broadly sensible aggregate loss distributions which are bimodal in nature. We demonstrate how systemic crises may occur and analyse how our results are influenced by fire-sale externalities and the feedback effects from curtailed lending in the macroeconomy. We also illustrate the resilience of our model financial system to stress scenarios with sharply rising corporate default rates and falling asset prices.
    Keywords: Contagion; financial crises; network models; systemic risk
    JEL: C63 G10 G17 G21
    Date: 2012–07–20
  2. By: Gabriela Flores (Institute of Health Economics and Management, University of Lausanne, and Institute of Health Policy and Management, Erasmus University Rotterdam); Owen O'Donnell (Erasmus School of Economics, Erasmus University Rotterdam, and University of Macedonia, Greece)
    Abstract: Medical expenditure risk can pose a major threat to living standards. We derive decomposable measures of catastrophic medical expenditure risk from reference-dependent utility with loss aversion. We propose a quantile regression based method of estimating risk exposure from cross-section data containing information on the means of financing health payments. We estimate medical expenditure risk in seven Asian countries and find it is highest in Laos and China, and is lowest in Malaysia. Exposure to risk is generally higher for households that have less recourse to self-insurance, lower incomes, wealth and education, and suffer from chronic illness.
    Keywords: medical expenditures; catastrophic payments; downside risk; reference-dependent utility; Asia
    JEL: D12 D31 D80 I15
    Date: 2012–07–24
  3. By: De Koning, Kees
    Abstract: Executive Summary included in the Paper
    Keywords: Savings Paradox; Collective Risk Management; Pension Dividend; Economic easing; Minister for Savings
    JEL: G12 F01 E44 E21 E61
    Date: 2012–07–18
  4. By: Mili, Mehdi
    Abstract: The purpose of this study is to develop an efficient strategy for managing fixed-income portfolios in crisis periods. We use the volatility ratio model of Briere and Szafarz (2008) and the Expected Tail Loss (ETL) approach of Litzenberger and Modest (2008). Our methodology is applied to U.S. and European markets of fixed-income products using interest rates at different maturities over the period 2002 through 2010. U.S. portfolio exhibits his optimum with small amounts of interest rates belonging to the short-term strategy and the European portfolio exhibits his optimum with small amounts belonging to the long-term strategy. The results show that the ETL is a better measure of the downside risk than the Value-at-Risk (VaR). For instance, the U.S. (European) portfolio has a VaR of -3.6% (-0.7%) against an ETL of -6% (-0.8%). Moreover, we find that, for these two geographical areas, the short-term interest rates make little contribution to the overall ETL of the American fixed-income portfolio and vice versa for the European portfolio. --
    Keywords: fixed-income portfolio,financial crisis,flight-to-quality,contagion,expected tail loss
    JEL: G11 G15 N20
    Date: 2012
  5. By: Siyi Zhu
    Abstract: The European trade and post-trade industries have seen increased competition in the past few years. As a result of the intensifying competitive market pressure, a series of tariff reduction and alterations of risk management models have been implemented by some central counterparties (CCPs) in Europe, which raises the concern of overseers and regulators that the fi nancial soundness and risk mitigation capacity of CCPs could be threatened, leading to a “race to the bottom”. To address the concern, this paper presents CCPs’ competitive responses both in the fi eld of tariffs and risk management based on the practices of the three CCPs in European equity market-LCH.Clearnet SA, EMCF and EuroCCP. It concludes that, 1) competition in the pan-European equity clearing industry has given rise to CCPs’ tariffs-cutting activities, which in part enhances market effi ciency; 2) there’s no fi tfor-all risk management mechanism: the CCPs studied apply a common framework while they employ certain different specifi cations in modeling and loss sharing procedures; 3) no solid evidence implies that competition among CCPs has led to a deterioration in the robustness of CCPs’ risk management.
    Keywords: Central counterparty; competition; risk management; loss mutualization
    Date: 2011–12
  6. By: Lawless, Martina (Central Bank of Ireland); McCann, Fergal (Central Bank of Ireland)
    Abstract: This paper uses unique SME loan-level data complete with quarterly loan ratings assigned by the lend- ing institution over the period 2008-2010. This allows us to examine the evolution of loan performance throughout the period of economic and financial crisis. We document the shift in the distribution of loans across ratings as economic conditions deteriorated, but also show that this effect was heteroge- neous across sectors. In panel data estimations, changes in employment across sectors are shown to be a leading indicator of loan performance, demonstrating the importance of the link between real economy demand and loan impairment. Levels of outstanding credit in a sector cannot explain cur- rent loan performance. However, in keeping with a growing literature on the dangers of post-boom debt overhang, we calculate a measure of excess credit using deviations from a long-run trend that is strongly associated with higher levels of current impairment. This provides new evidence on the effect of relaxed credit standards during a boom on crisis-era loan delinquency.
    Date: 2012–07
  7. By: Hyun Song Shin
    Abstract: This paper outlines an approach to macroprudential policy for open emerging economies that emphasizes banking sector balance sheet management as the key driver of risk premiums, capital flows and vulnerabilities to sudden reversals in global liquidity conditions. This paper argues for the usefulness of monitoring the "non-core liabilities" of the banking sector as a signal of lending standards and potential vulnerability of the financial system to shocks. The paper presents a taxonomy of macroprudential tools, ranging from orthodox tools for bank capital regulation to more novel "liabilities-side" tools, such as the levy on non-core liabilities recently introduced by South Korea.
    Date: 2012–07
  8. By: Adriana Soares Sales; Waldyr D. Areosa; Marta B. M. Areosa
    Abstract: We present a methodology to construct a Broad Financial Stability Indicator (FSIB) based on unobserved common factors and a Specific Financial Stability Indicator (FSIS) for the Brazilian economy combining observed credit, debt and exchange rate markets indicators. Rather than advocate a particular numerical indicator of financial stability, our main goal is methodological. Our indicators, calculated in sample and ex-post, seem to capture three periods of considerably high financial instability in Brazil: (i) the 1998/1999 speculative attack on the Real, (ii) the government transition of 2002/2003 and (iii) the intensification of the 2008/2009 subprime financial crisis triggered by the collapse of the Lehman Brothers. We also propose an alternative methodology that decomposes business cycle fluctuations in two components -- a Financial Factor (FF) and a Real Factor (RF) -- which are identified from co-movements of financial and non-financial variables. The results are similar to the ones pointed out by our FSIB and FSIS measures.
    Date: 2012–07
  9. By: Simon Cornée (University of Rennes 1 - CREM, UMR CNRS 6211)
    Abstract: Based on a unique hand-collected database of 389 loans obtained from a French social bank dealing with small businesses, this paper compares two predictive models of future default events: the first relies on soft information (SI model), the second on hard information (HI model). The results indicate that the SI model outperforms the HI model in terms of forecast quality and goodness of fit. In so doing, this paper provides further empirical evidence that, when they serve small businesses, small or decentralized banks have a greater ability to collect and act on soft information. This empirical conclusion conveys practical implication for social banks’ internal credit rating procedures, especially in their calibration of capital requirements.
    Keywords: Credit Rating, Debt Default, Small Business Lending, Relationship Lending, Social Banking
    JEL: G21 M21
    Date: 2012–06
  10. By: João Medeiros
    Abstract: This study uses vector auto-regression (VAR) models and a panel fiscal reaction function (FRF) to simulate debt ratios for fifteen EU Member States according to four regimes which are the product of the type of errors (normal or bootstrapped) with the assumption on the structural primary balance (unchanged or determined by a panel FRF). This methodology should be used to make probabilistic assessments on the debt ratio rather than for providing point estimates. Results suggest that debt ratio paths are not normally distributed being positively skewed, and; primary balances show "fiscal fatigue" and partial mean reversion to historical trends. Debt sustainability scenarios should also be run using a FRF or some equivalent "mean reversion" hypothesis.
    JEL: C53 E37 H68
    Date: 2012–07
  11. By: Enrique Mendoza; Marco Terrones
    Abstract: What are the stylized facts that characterize the dynamics of credit booms and the associated fluctuations in macro-economic aggregates? This paper answers this question by applying a method proposed in our earlier work for measuring and identifying credit booms to data for 61 emerging and industrialized countries over the 1960-2010 period. We identify 70 credit boom events, half of them in each group of countries. Event analysis shows a systematic relationship between credit booms and a boom-bust cycle in production and absorption, asset prices, real exchange rates, capital inflows, and external deficits. Credit booms are synchronized internationally and show three striking similarities between industrialized and emerging economies: (1) credit booms are similar in duration and magnitude, normalized by the cyclical variability of credit; (2) banking crises, currency crises or sudden stops often follow credit booms, and they do so at similar frequencies in industrialized and emerging economies; and (3) credit booms often follow surges in capital inflows, TFP gains, and financial reforms, and are far more common with managed than flexible exchange rates.
    Date: 2012–07

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