nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒12‒06
twelve papers chosen by
Stan Miles
Thompson Rivers University

  1. Market-based Eurobonds Without Cross-Subsidisation By Manasa Gopal; Markus Pasche
  2. Sovereign Risk : A Macro-Financial Perspective By Udaibir S. Das; Maria A. Oliva; Takahiro Tsuda
  3. Integration des Marktliquiditätsrisikos in das Risikoanalysekonzept des Value at Risk By Völker, Florian; Cremers, Heinz; Panzer, Christof
  4. Financial crisis: a new measure for risk of pension funds assets By M. Cadoni; Roberta Melis; A. Trudda
  5. On the Risk Management with Application of Econophysics Analysis in Central Banks and Financial Institutions By Dimitri O. Ledenyov; Viktor O. Ledenyov
  6. Closed form solutions of measures of systemic risk By Manfred Jaeger-Ambrozewicz
  7. The Calculus of Expected Loss: Backtesting Expected Loss with Actual Impact of Risk in a Basel II Framework By Wolfgang Reitgruber
  8. Vulnerable Banks By Robin Greenwood; Augustin Landier; David Thesmar
  9. The Dodd-Frank Act and Basel III : Intentions, Unintended Consequences, and Lessons for Emerging Markets By Viral V. Acharya
  10. An Empirical Study on the Impact of Basel III Standards on Banks? Default Risk: The Case of Luxembourg By Gaston Giordana; Ingmar Schumacher
  11. Italian nonfinancial firms and derivatives By Mariano Graziano
  12. Fiscal Sustainability in the Presence of Systemic Banks : the Case of EU Countries. By Agnès Bénassy-Quéré; Guillaume Roussellet

  1. By: Manasa Gopal (Birla Institute of Technology & Science, Pilani); Markus Pasche (Friedrich Schiller University Jena, School of Economics and Business Admistration)
    Abstract: Most current Eurobond proposals imply substantial cross-subsidisation since some countries partially pay the risk premia for others, thus creating moral hazard and disincentives for fiscal discipline. We suggest, instead, to use standard technologies of financial intermediation like pooling and collateralizing risks. The proposed Eurobond system decreases the costs for all participating nations which is Pareto improving. Since collateral requirements are calculated on individual risk, we eliminate cross-subsidisation. It is essential for the model that a significant fraction of governmental bonds is still issued individually since the model utilizes the risk perception abilities and disciplinating functions of the private capital market. We also discuss institutional issues of possible implementations.
    Keywords: sovereign debt, Eurobond, collateral, pooling, cross-subsidisation
    JEL: E62 E63 H63
    Date: 2012
  2. By: Udaibir S. Das (Asian Development Bank Institute (ADBI)); Maria A. Oliva; Takahiro Tsuda
    Abstract: We examine some of the macro-financial dimensions of sovereign risk and propose a conceptual framework that captures risks other than just the default risk. Morphed under a multi-dimensional notion of sovereign risk, we argue that the existing empirical methodologies to measure sovereign risk cover only partial aspects of sovereign risk and fail to capture its macro-financial dimensions. We highlight a menu of tools that could be used to tackle the broader notion of sovereign risk, and suggest that authorities should actively use them to manage the macro-financial dimensions of sovereign risk before those risks feed into the real economy.
    Keywords: sovereign risk, macro-financial dimensions, default risk
    JEL: F30 F34 E43
    Date: 2012–10
  3. By: Völker, Florian; Cremers, Heinz; Panzer, Christof
    Abstract: -- Most traditional Value at Risk models neglect market liquidity risk and hence only consider the market price risk (i.e. risk associated with holding a certain position). In order to fully capture the market risk associated to holding and trading a position, we first define market liquidity risk, its dimensions (tightness, depth, resiliency, immediacy) and causes (exogenous / endogenous). We then present and evaluate different liquidity-adjusted Value at Risk models which capture one or more dimensions of market liquidity risk and thereby present a more true view on the overall market risk. This paper also spotlights how Basel III regulation defines liquid assets, derived from the Liquidity Coverage Ratio (LCR) framework, and evaluates if this regulation adequately reflects market liquidity risk. We conclude that the LCR concept is flawed as the defined buckets of liquid assets do not reflect the true liquidity of certain assets. Furthermore it can be said that the defined buckets might result in heightened systematic risk as banks will focus on certain asset classes. Additionally the corporate fixed income sector might experience a crowding out as these assets will appear less rewarding to banks.
    Keywords: Market Risk,Market Liquidity Risk,Market Microstructure,Liquidity-adjusted Value-at-Risk,Basel III,Liquidity Coverage Ratio,Liquid Assets
    JEL: C1 C14 C16 D4 G1 G32
    Date: 2012
  4. By: M. Cadoni; Roberta Melis; A. Trudda
    Abstract: It has been debated that pension funds should have limitations on their asset allocation, based on the risk profile of the different financial instruments available on the financial markets. This issue proves to be highly relevant at times of market crisis, when a regulation establishing limits to risk taking for pension funds could prevent defaults. In this paper we present a framework for evaluating the risk level of a single financial instrument or a portfolio. By assuming that asset returns can be described by a multifractional Brownian motion, we evaluate the risk using the time dependent Hurst parameter H(t) which models volatility. To provide a measure of the risk, we model the Hurst parameter with a random variable with beta distribution. We prove the efficacy of the methodology by implementing it on different risk level financial instruments and portfolios.
    Keywords: Pension Funds; risk control; multifractional Brownian motion
    JEL: C22 G11 G23
    Date: 2012
  5. By: Dimitri O. Ledenyov; Viktor O. Ledenyov
    Abstract: The purpose of this research article is to discover how the econophysics analysis can complement the econometrics models in application to the risk management in the central banks and financial institutions, operating within the nonlinear dynamical financial system. We consider the modern risk management models and show the appropriate techniques to calculate the various existing risks in the finances. We make a few comments on the possible limitations in the models of statistical modeling of volatility such as the Autoregressive Conditional Heteroskedasticity (GARCH) model, because of the nonlinearities appearance in the nonlinear dynamical financial systems. We propose that the various types of nonlinearities, which can originate in the financial and economical systems, have to be taken to the detailed consideration during the Cost of Capital calculation in the finances and economics. We propose the new theory of nonlinear dynamic volatilities and the new nonlinear dynamic chaos (NDC) volatility model for the statistical modeling of financial volatility with the aim to determine the Value at Risk.
    Date: 2012–11
  6. By: Manfred Jaeger-Ambrozewicz
    Abstract: This paper derives -- considering a Gaussian setting -- closed form solutions of the statistics that Adrian and Brunnermeier and Acharya et al. have suggested as measures of systemic risk to be attached to individual banks. The statistics equal the product of statistic specific Beta-coefficients with the mean corrected Value at Risk. Hence, the measures of systemic risks are closely related to well known concepts of financial economics. Another benefit of the analysis is that it is revealed how the concepts are related to each other. Also, it may be relatively easy to convince the regulators to consider a closed form solution, especially so if the statistics involved are well known and can easily be communicated to the financial community.
    Date: 2012–11
  7. By: Wolfgang Reitgruber
    Abstract: The dependency structure of credit risk parameters is a key driver for capital consumption and receives regulatory and scientific attention. The impact of parameter imperfections on the quality of expected loss in the sense of a fair, unbiased estimate of risk expenses however is barely covered. So far there are no established backtesting procedures for EL, quantifying its impact with regards to pricing or risk adjusted profitability measures, such as RARORAC. In this paper, a practically oriented, top-down approach to assess the quality of EL by backtesting with actually observed risk impact on capital is introduced. In a first step, the concept of risk expenses (Cost of Risk) has to be extended beyond the classical provisioning (P&L) view, towards a more adequate capital consumption approach (Impact of Risk, IoR). On this basis, the difference between parameter-based EL and actually reported Impact of Risk is decomposed into its key components (PL Backtest and NPL Backtest). The proposed method will deepen the understanding of practical properties of EL, aligns the EL with actually observed risk impact on capital and has the potential to improve the quality of EL-based business decisions. Besides assumptions on the stability of parameter estimates and default identification, there are no further requirements on the underlying credit risk parameters. The method is robust irrespective whether parameters are simple, expert based values or highly predictive and perfectly calibrated IRBA compliant methods.
    Date: 2012–11
  8. By: Robin Greenwood; Augustin Landier; David Thesmar
    Abstract: When a bank experiences a negative shock to its equity, one way to return to target leverage is to sell assets. If asset sales occur at depressed prices, then one bank’s sales may impact other banks with common exposures, resulting in contagion. We propose a simple framework that accounts for how this effect adds up across the banking sector. Our framework explains how the distribution of bank leverage and risk exposures contributes to a form of systemic risk. We compute bank exposures to system-wide deleveraging, as well as the spillover of a single bank’s deleveraging onto other banks. We show how our model can be used to evaluate a variety of crisis interventions, such as mergers of good and bad banks and equity injections. We apply the framework to European banks vulnerable to sovereign risk in 2010 and 2011.
    JEL: G01 G21 G38
    Date: 2012–11
  9. By: Viral V. Acharya (Asian Development Bank Institute (ADBI))
    Abstract: This paper is an attempt to explain the changes to finance sector reforms under the Dodd-Frank Act in the United States and Basel III requirements globally; their unintended consequences; and lessons for currently fast-growing emerging markets concerning finance sector reforms, government involvement in the finance sector, possible macroprudential safeguards against spillover risks from the global economy, and, finally, management of government debt and fiscal conditions. The paper starts with a summary of reforms under the Dodd-Frank Act and highlights four of its primary shortcomings. It then focuses on the new capital and liquidity requirements under Basel III reforms, arguing that, like its predecessors, Basel III is fundamentally flawed as a way of designing macroprudential regulation of the finance sector. In contrast, the Dodd-Frank Act has several redeeming features, including requirements of stress-test-based macroprudential regulation and explicit investigation of systemic risk in designating some financial firms as systemically important. It argues that India should resist the call for blind adherence to Basel III and persist with its (Reserve Bank of India) asset-level leverage restrictions and dynamic sector risk-weight adjustment approach. It concludes with some important lessons for regulation of the finance sector in emerging markets based on the global financial crisis and proposed reforms that have followed in the aftermath.
    Keywords: The Dodd-Frank Act, Basel III, Emerging Markets, spillover risks, Macroprudential regulation, global financial crisis
    JEL: G2 G21 G28
    Date: 2012–10
  10. By: Gaston Giordana; Ingmar Schumacher
    Abstract: We study how the Basel III regulations, namely the Capital-to-assets ratio (CAR), the Net Stable Funding Ratio (NSFR) and the Liquidity Coverage Ratio (LCR), are likely to impact the banks? profitabilities (i.e. ROA), capital levels and default. We estimate historical series of the new Basel III regulations for a panel of Luxembourgish banks for a period covering 2003q2 to 2011q3. We econometrically investigate whether historical LCR and NSFR components as well as CAR positions are able to explain the variation in a measure of a bank?s default risk (proxied by Z-Score), and how these effects make their way through banks? ROA and CAR. We find that the liquidity regulations induce a decrease in average probabilities of default. Conversely, while we find that the LCR has an insignificant impact on banks? profitability, those banks with higher NSFR (through lower required stable funding, the NSFR denominator) are found to be more profitable. Additionally, we use a model of bank behavior to simulate the banks? optimal adjustments of their balance sheets as if they had had to adhere to the regulations starting in 2003q2. Then we predict, using our preferred econometric model and based on the simulated data, the banks? Z-Score and ROA. The simulation exercise suggests that basically all banks would have seen a decrease in their default risk if they had previously adhered to Basel III.
    Keywords: Basel III, bank default, Z-Score, profitability, ROA, GMM estimator, simulation, Luxembourg
    JEL: G21 G28
    Date: 2012–10
  11. By: Mariano Graziano (Banca d'Italia)
    Abstract: This paper studies the characteristics of the Italian nonfinancial firms using derivatives and the purpose of the derivatives use according to the most important literature in financial risk management. By using the Italian credit register and balance sheet data this study extends for the first time the derivatives analysis to small and medium firms. The paper finds that derivatives are used frequently among nonfinancial firms. Firms using derivatives are the most exposed to financial risks and have different economic and financial characteristics with respect to non-using ones. By examining some financial risk indicators the analysis finds a relation between high derivative exposure and financial distress. In the use of derivatives bank-firm relationship is more concentrated than in the loan relationship.
    Keywords: derivatives, banks, risk management
    JEL: G32 G21 G30
    Date: 2012–10
  12. By: Agnès Bénassy-Quéré (Centre d'Economie de la Sorbonne - Paris School of Economics); Guillaume Roussellet (CREST-ENSAE)
    Abstract: We provide a first attempt to include off-balance sheet, implicit insurance to SIFIs into a consistent assessment of fiscal sustainability, for 27 countries of the European Union. We first calculate tax gaps à la Blanchard (1990) and Blanchard et al. (1990). We then introduce two alternative measures of implicit off-balance sheet liabilities related to the risk of a systemic bank crisis. The first one relies of microeconomic data at the bank level. The second one relies on econometric estimations of the probability and the cost of a systemic banking crisis, based on historical data. The former approach provides an upper evaluation of the fiscal cost of systemic banking crises, whereas the latter one provides a lower one. Hence, we believe that the combined use of these two methodologies helps to gauge the range of fiscal risk.
    Keywords: Fiscal sustainability, tax gap, systemic banking risk, off-balance sheet liabilities.
    JEL: H21 H23 J41
    Date: 2012–11

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