nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒09‒03
four papers chosen by
Stan Miles
Thompson Rivers University

  1. Investment horizon dependent CAPM: Adjusting beta for long-term dependence By Carlos León; Karen Leiton; Alejandro Reveiz
  2. Validierung von Konzepten zur Messung des Marktrisikos: Insbesondere des Value at Risk und des Expected Shortfall By Mehmke, Fabian; Cremers, Heinz; Packham, Natalie
  3. Register, issue, cap and trade: A proposal for ending current and future financial crises By Milne, Alistair
  4. No Puzzle: The Foreign Exchange Exposure of Australian Firms By Dirk G Baur; Isaac Miyakawa

  1. By: Carlos León; Karen Leiton; Alejandro Reveiz
    Abstract: Financial basics and intuition stresses the importance of investment horizon for risk management and asset allocation. However, the beta parameter of the Capital Asset Pricing Model (CAPM) is invariant to the holding period. Such contradiction is due to the assumption of long-term independence of financial returns; an assumption that has been proven erroneous. Following concerns regarding the impact of the long-term dependence assumption on risk (Holton, 1992), this paper quantifies and fixes the CAPM’s bias resulting from this abiding –but flawed- assumption. The proposed procedure is based on Greene and Fielitz (1980) seminal work on the application of fractional Brownian motion to CAPM, and on a revised technique for estimating time-series’ fractal dimension with the Hurst exponent (León and Vivas, 2010; León and Reveiz, 2011a). Using a set of 85 stocks from the S&P100, this paper finds that relaxing the long-term independence assumption results in significantly different estimations of beta. According to three tests herein implemented with a 99% confidence level, more than 60% of the stocks exhibit significantly different beta parameters. Hence, expected returns are biased; on average, the bias is about ±60bps for a contemporary one-year investment horizon. Thus, as emphasized by Holton (1992), risk is a two-dimensional quantity, with holding period almost as important as asset class. The procedure herein proposed is valuable since it parsimoniously achieves an investment
    Keywords: CAPM, Hurst exponent, long-term dependence, fractional Brownian motion, asset allocation, investment horizon. Classification JEL: G12, G14, G32, G20, C14
    Date: 2012–08
  2. By: Mehmke, Fabian; Cremers, Heinz; Packham, Natalie
    Abstract: -- Market risk management is one of the key factors to success in managing financial institutions. Underestimated risk can have desastrous consequences for individual companies and even whole economies, not least as could be seen during the recent crises. Overestimated risk, on the other side, may have negative effects on a company's capital requirements. Companies as well as national authorities thus have a strong interest in developing market risk models that correctly quantify certain key figures such as Value at Risk or Expected Shortfall. This paper presents several state of the art methods to evaluate the adequacy of almost any given market risk model. Existing models are enhanced by in-depth analysis and simulations of statistical properties revealing some previously unknown effects, most notably inconsistent behaviour of alpha and beta errors. Furthermore, some new market risk validation models are introduced. In the end, a simulation with various market patterns demonstrates strenghts and weaknesses of each of the models presented under realistic conditions.
    Keywords: Backtesting,Market Risk,Value at Risk,Expected Shortfall,Validation,Alpha Error,Beta Error,Time Until First Failure,Proportion of Failure,Traffic Light Approach,Magnitude of Loss Function,Markow-Test,Gauss-Test,Rosenblatt,Kuiper,Kolmogorov-Smirnov,Jarque-Bera,Regression,Likelihood Ratio,Truncated Distribution,Censored Distribution,Simulation
    JEL: C01 C02 C12 C13 C14 C15 C32 G32 G38
    Date: 2012
  3. By: Milne, Alistair
    Abstract: A fundamental cause of the global financial crisis was excessive creation of short-term money-like liabilities (quasi-money), notably in shadow banking holdings of sub-prime MBS and other US dollar structured credit instruments and in cross-border flow of capital to the uncompetitive Euro area periphery. This paper proposes a registration system for: (i) controlling quasi-money and resulting economic externalities and systemic risks; and (ii) supporting public sector monetary issue to counter collapse of private sector credit in the aftermath of crises. This policy would trigger a profound but also economically beneficial change in the business models of both banks and long-term investors. --
    Keywords: Basel III,debt deflation,endogenous money,financial regulation,global financial crisis,limited purpose banking,maturity mismatch,narrow money,Pigouvian taxes,ring fencing,systemic financial risk,systemic financial externalities,Tobin tax
    JEL: E44 G21 G28
    Date: 2012
  4. By: Dirk G Baur (Finance Discipline Group, UTS Business School, University of Technology, Sydney); Isaac Miyakawa (Finance Discipline Group, UTS Business School, University of Technology, Sydney)
    Abstract: In this paper we analyze the influence of currency movements on the value of Australian firms listed on the S&P/ASX 100 index for a period from 1980 - 2010 using daily, weekly, monthly and quarterly returns. The study estimates unconditional and conditional, time-varying and asymmetric, exchange rate exposure. We find a strong cross-sectional dispersion of excess exposure coefficients around a weakly positive average exposure. Also, the strength of the FX exposure increases from daily to quarterly sample frequencies and across time. We argue that the weak positive exposure of firms on average is consistent with the Australian dollar being a commodity currency and with theoretical predictions.
    Keywords: exchange rate risk; excess exposure; totoal exposure; pass-through
    JEL: F23 F31 G15
    Date: 2012–08–01

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