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on Risk Management |
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Issue of 2012‒09‒22
twelve papers chosen by |
| By: | Mike Mariathasan; Ouarda Merrouche |
| Abstract: | In this paper, we analyse a novel panel data set to compare the relevance of alternative measures of capitalisation for bank failure during the 2007-10 crisis, and to search for evidence of manipulated Basel risk-weights. Compared with the unweighted leverage ratio, we find the risk-weighted asset ratio to be a superior predictor of bank failure when banks operate under the Basel II regime, provided that the risk of a crisis is low. When the risk of a crisis is high, the unweighted leverage ratio is the more reliable predictor. However, when banks do not operate under Basel II rules, both ratios perform comparably, independent of the risk of a crisis. Furthermore, we find a strong decline in the risk-weighted asset ratio leading up to the crisis. Several empirical findings indicate that this decline is driven by the strategic use of internal risk models under the Basel II advanced approaches. Evidence of manipulation is stronger in less competitive banking systems, in banks with low initial levels of Tier 1 capital and in banks that adopted Basel II rules early. We find tangible common equity and Tier 1 ratios to be better predictors of bank distress than broader measures of capital, and identify market-based measures of capitalisation as poor indicators. We find no relationship between the probability of a bank being selected into a public recapitalisation plan and regulatory measures of capital. |
| Keywords: | Banks, Basel risk-weights, Capital, Regulation |
| JEL: | G20 G21 G28 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:621&r=rmg |
| By: | Baldan, Cinzia; Zen, Francesco; Rebonato, Tobia |
| Abstract: | The present study aims at ascertaining whether a relationship exists between the liquidity risk and the interest rate risk of credit institutions. By analysing the balance sheet of a small Italian bank during the years 2009 and 2010, we outlined its liquidity profile, the variables that influenced its dynamics and their effects on the bank’s global management, with particular attention to the interest margin and the interest rate risk in the banking book. We would like to fill a gap identified in the literature, shedding light on how a set of decisions designed mainly to reduce the liquidity risk and comply with the new parameters established by the Basel III Framework enables a more effective management of the regulatory capital and helps the bank to achieve a solid balance between profitability and solvency. Our main findings demonstrate that the bank succeeded in modifying its liquidity profile in order to comply with the incoming constraints imposed by the Basel III framework; the actions taken to reduce the liquidity risk also lowered its interest margin, but also enabled the bank to reduce the amount of capital absorbed by the interest rate risk, giving rise to a globally positive effect. |
| Keywords: | Asset and Liability Management; Basel III Framework; Integration of Liquidity Risk and Interest Rate Risk; Risk Management |
| JEL: | G2 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:41323&r=rmg |
| By: | Markus K. Brunnermeier; Martin Oehmke |
| Abstract: | This chapter surveys the literature on bubbles, financial crises, and systemic risk. The first part of the chapter provides a brief historical account of bubbles and financial crisis. The second part of the chapter gives a structured overview of the literature on financial bubbles. The third part of the chapter discusses the literatures on financial crises and systemic risk, with particular emphasis on amplification and propagation mechanisms during financial crises, and the measurement of systemic risk. Finally, we point toward some questions for future research. |
| JEL: | G00 G01 G20 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18398&r=rmg |
| By: | Amaya, Diego (UQAM); Gauthier, Geneviève (HEC Montréal); Léautier, Thomas-Olivier (TSE,IAE) |
| Abstract: | This paper develops a dynamic risk management model to determine a firm's optimal risk management strategy. The risk management strategy has two elements: first, until leverage is very high, the firm fully hedges its operating cash how exposure, due to the convexity in its cost of capital. When leverage exceeds a very high threshold, the firm gambles for resurrection and stops hedging. Second, the firm manages its capital structure through dividend distributions and investment. When leverage is very low, the firm fully replaces depreciated assets, fully invests in opportunities if they arise, and distribute dividends to reach its optimal capital structure. As leverage increases, the firm stops paying dividends, while fully investing. After a certain leverage, the firm also reduces investment, until it stop investing completely. The model predictions are consistent with empirical observations. |
| JEL: | C61 G32 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:26110&r=rmg |
| By: | Hui Chen; Yu Xu; Jun Yang |
| Abstract: | We build a dynamic capital structure model to study the link between systematic risk exposure and debt maturity, as well as their joint impact on the term structure of credit spreads. Our model allows for time variation and lumpiness in the maturity structure. Relative to short-term debt, long-term debt is less prone to rollover risks, but its illiquidity raises the costs of financing. The risk premium embedded in the bankruptcy costs causes firms with high systematic risk to favour longer debt maturity, as well as a more stable maturity structure over the business cycle. Pro-cyclical debt maturity amplifies the impact of aggregate shocks on the term structure of credit spreads, especially for firms with high leverage or high beta, and for firms with a large amount of long-term debt maturing when the aggregate shock arrives. However, endogenous maturity choice can also reduce and even reverse the effect of rollover risk on credit spreads. We provide empirical evidence for the model predictions on both debt maturity and credit spreads. |
| Keywords: | Asset Pricing; Debt Management |
| JEL: | G32 G33 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:12-27&r=rmg |
| By: | Noy, I |
| Abstract: | I focus on three issues that are, in my view, the most pertinent to addressing the need to deal with catastrophic, low-probability storms and earthquakes (most likely to occur in Asia and/or the Caribbean): (1) the large benefits and benefit/cost ratios from early-warning systems; (2) the feasibility of an international disaster risk reduction intervention fund and its guiding principles, and (3) an evaluation of the Copenhagen Consensus methodology that relate to the Kunreuther and Michel-Kerjan challenge paper. |
| Keywords: | disasters, risk reduction, funding, Copenhagen Consensus methodology, early-warning systems, |
| Date: | 2012–08–22 |
| URL: | http://d.repec.org/n?u=RePEc:vuw:vuwecf:2390&r=rmg |
| By: | Gabrisch, Hubert; Pusch, Toralf; Orlowski, Lucjan T |
| Abstract: | This study examines the key drivers of sovereign default risk in five euro area periphery countries and three euro-candidates that are currently pursuing independent monetary policies. We argue that the recent proliferation of sovereign risk premiums stems from both domestic and international sources. We focus on contagion effects of external financial crisis on sovereign risk premiums in these countries, arguing that the countries with weak fundamentals and fragile financial institutions are particularly vulnerable to such effects. The domestic fiscal vulnerabilities include: economic recession, less efficient government spending and a rising public debt. External ‘push’ factors entail increasing liquidity- and counter-party risks in international banking, as well as risk-hedging appetites of international investors embedded in local currency depreciation against the US Dollar. We develop a model capturing the internal and external determinants of sovereign risk premiums and test for the examined country groups. The results lead us to caution against premature fiscal consolidation in the aftermath of the global economic crisis, since such policy might actually worsen sovereign default risk. The model works well for the euro-periphery countries; it is less robust for the euro-candidates that upon a future euro adoption will have to pursue real economy growth oriented policies in order to mitigate a potential increase in sovereign default risk. |
| Keywords: | sovereign default risk; euro area; euro-candidate countries; public debt; liquidity risk; counter-party risk |
| JEL: | E43 E63 G13 |
| Date: | 2012–09–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:41265&r=rmg |
| By: | Amy Khuu (Business School, University of Western Australia); Ernst Juerg Weber (Business School, University of Western Australia) |
| Abstract: | Farm survey data show that the risk aversion of West Australian farmers is comparable to that of other asset holders. An increase in the variability of crop yield by 20%, which may be caused by future climate change, would raise their willingness to pay for crop insurance almost one-to-one by 19%. West Australian farmers can insure against hail, fire and some other perils but not against the greatest risk – drought. The farm survey indicates that adverse selection does not arise in the existing market for crop insurance because insurance premiums reflect the risk of crop failure. However, a future supplier of drought insurance must take into consideration that drought insurance might give rise to moral hazard, changing the risk management practices of farmers. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:uwa:wpaper:12-07&r=rmg |
| By: | John Y. Campbell; Tarun Ramadorai; Benjamin Ranish |
| Abstract: | To understand the effects of regulation on mortgage risk, it is instructive to track the history of regulatory changes in a country rather than to rely entirely on cross-country evidence that can be contaminated by unobserved heterogeneity. However, in developed countries with fairly stable systems of financial regulation, it is difficult to track these effects. We employ loan-level data on over a million loans disbursed in India over the 1995 to 2010 period to understand how fast-changing regulation impacted mortgage lending and risk. We find evidence that regulation has important effects on mortgage rates and delinquencies in both the time-series and the cross-section. |
| JEL: | G21 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18394&r=rmg |
| By: | Matteo Luciani (Université Libre de Bruxelles); David Veredas (Université Libre de Bruxelles) |
| Abstract: | Realized volatilities, when observed over time, share the following stylised facts: comovements, clustering, long-memory, dynamic volatility, skewness and heavy-tails. We propose a dynamic factor model that captures these stylised facts and that can be applied to vast panels of volatilities as it does not suffer from the curse of dimensionality. It is an enhanced version of Bai and Ng (2004) in the following respects: i) we allow for longmemory in both the idiosyncratic and the common components, ii) the common shocks are conditionally heteroskedastic, and iii) the idiosyncratic and common shocks are skewed and heavy-tailed. Estimation of the factors, the idiosyncratic components and the parameters is simple: principal components and low dimension maximum likelihood estimations. A Monte Carlo study shows the usefulness of the approach and an application to 90 daily realized volatilities, pertaining to S&P100, from January 2001 to December 2008, evinces, among others, the following findings: i) All the volatilities have long-memory, more than half in the nonstationary range, that increases during financial turmoils. ii) Tests and criteria point towards one dynamic common factor driving the co-movements. iii) The factor has larger long-memory than the assets volatilities, suggesting that long–memory is a market characteristic. iv) The volatility of the realized volatility is not constant and common to all. v) A forecasting horse race against 8 competing models shows that our model outperforms, in particular in periods of stress. |
| Keywords: | Realized volatilities, vast dimensions, factor models, long–memory, forecasting |
| JEL: | C32 C51 G01 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1230&r=rmg |
| By: | Léautier, Thomas-Olivier (TSE,IAE); Rochet, Jean-Charles (TSE, University of Zurich) |
| Abstract: | This article examines how firms facing volatile input prices and holding some degree of market power in their product market link their risk management and production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where risk averse firms decide on their hedging strategies before their product market strategies. We find that hedging modifies the pricing and production strategies of firms. This strategic effect is channelled through the expected risk-adjusted cost, i.e., the expected marginal cost under the measure induced by investors'risk aversion, and has diametrically opposed impacts depending on the nature of product market competition: hedging toughens quantity competition while it softens price competition. Finally, committing to a hedging strategy is always a best response to non committing, and is a dominant strategy if firms compete à la Hotelling. |
| JEL: | G32 L13 |
| Date: | 2012–09–03 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:26123&r=rmg |
| By: | Bozic, Marin; Newton, John; Thraen, Cameron S.; Gould, Brian W. |
| Abstract: | With increased volatility of feed prices dairy farm managers are no longer concerned with managing just milk price volatility but are considering the adoption of risk management programs that address income over feed cost (IOFC) margin risk. Successful margin risk management should be founded on understanding of the behavior of IOFC margins. To that end, we construct forward IOFC margins using Class III milk, corn and soybean meal futures prices. We focus on the characteristics of the term structure of forward IOFC margins, i.e. the sequence of forward margins for consecutive calendar months, all observed on the same trading day. What is apparent from shapes of these term structures is that both in times when margins were exceptionally high and when they were disastrously low, market participants expected that a reversal back to average margin levels would not come quickly, but would rather take up to 9 months. Slopes of the forward margin term structure prior to and after most of the major swings in IOFC indicate these shocks were mostly unanticipated, while time needed for recovery to normal margin levels was successfully predicted. This suggests that IOFC margins may exhibit slow mean-reverting, rather than predictable cyclical behavior, as is often suggested in the popular press. This finding can be exploited to design a successful catastrophic risk management program by initiating protection at 9 to 12 months prior to futures contract maturity. As a case study, we analyze risk management strategies for managing IOFC margins that utilize Livestock Gross Margin for Dairy Cattle (LGM-Dairy) insurance contracts. We created two farm profiles where the first one represents dairy farms that grow most of their feed. The second profile is designed to capture the risk exposure of a dairy farm that purchases all their dairy herd, dry cow, and heifer feed. Our case study of this program encompasses the 2009 period which was characterized by exceptionally poor IOFC margin conditions. We analyzed the dynamics of realized IOFC margins in 2009 under four different risk management strategies, and found that optimal strategies that are founded on principles delineated above succeeded in reducing the decline IOFC margins in 2009 by 93% for home-feed and 47% for market-feed profile, and performed substantially better than alternative strategies suggested by earlier literature. |
| Keywords: | risk management, income over feed cost margin, Livestock Gross Margin for Dairy Cattle program, Agricultural Finance, Risk and Uncertainty, |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:ags:umaesp:132379&r=rmg |