nep-rmg New Economics Papers
on Risk Management
Issue of 2012‒12‒22
seven papers chosen by
Stan Miles
Thompson Rivers University

  1. Measuring option implied degree of distress in the US financial sector using the entropy principle By Matros, Philipp; Vilsmeier, Johannes
  2. A dynamic default dependence model By Sara Cecchetti; Giovanna Nappo
  3. Start-up banks’ default and the role of capital By Massimo Libertucci; Francesco Piersante
  4. Euro at Risk: The Impact of Member Countries’ Credit Risk on the Stability of the Common Currency By Bekkour, Lamia; Jin, Xisong; Lehnert, Thorsten; Rasmouki, Fanou; Wolff, Christian C
  5. Unmitigated disasters? New evidence on the macroeconomic cost of natural catastrophes By Goetz von Peter; Sebastian von Dahlen; Sweta C Saxena
  6. How does deposit insurance affect bank risk ? evidence from the recent crisis By Anginer, Deniz; Demirguc-Kunt, Asli; Zhu, Min
  7. Which banks are more risky? The impact of loan growth and business model on bank risk-taking By Köhler, Matthias

  1. By: Matros, Philipp; Vilsmeier, Johannes
    Abstract: We estimate time series of option implied Probabilities of Default (PoDs) for 19 major US financial institutions from 2002 to 2012. These PoDs are estimated as mass points of entropy based risk neutral densities and subsequently corrected for maturity dependence. The obtained time series are evaluated with regard to their consistency and predictive power and their properties are compared to Credit Default Swap Spreads (CDS). Moreover, we also derive an indicator for the systemic risk in the US financial sector. We find that the PoDs are superior to CDS in identifying the high risk banks prior to the Lehman crisis. --
    Keywords: Entropy Principle,Risk Neutral Density,Probability of Default,Financial Stability Indicator,Credit Default Swaps
    JEL: C14 C32 G01 G21
    Date: 2012
  2. By: Sara Cecchetti (Bank of Italy); Giovanna Nappo (Sapienza, University of Rome)
    Abstract: We develop a dynamic multivariate default model for a portfolio of credit-risky assets in which default times are modelled as random variables with possibly different marginal distributions, and Lévy subordinators are used to model the dependence among default times. In particular, we define a cumulative dynamic hazard process as a Lévy subordinator, which allows for jumps and induces positive probabilities of joint defaults. We allow the main asset classes in the portfolio to have different cumulative default probabilities and corresponding different cumulative hazard processes. Under this heterogeneous assumption we compute the portfolio loss distribution in closed form. Using an approximation of the loss distribution, we calibrate the model to the tranches of the iTraxx Europe. Once the multivariate default distribution has been estimated, we analyse the distress dependence in the portfolio by computing indicators of systemic risk, such as the Stability Index, the Distress Dependence Matrix and the Probability of Cascade Effects.
    Keywords: Lévy subordinators, joint default probability, copula
    JEL: B26 C02 C53
    Date: 2012–11
  3. By: Massimo Libertucci (Bank of Italy); Francesco Piersante (Bank of Italy)
    Abstract: Regulation requires banks to hold a minimum capital endowment upon their establishment. But what role does initial capital play in a bank’s lifecycle? This paper addresses the issue for start-up banks. We use both survival-time and binary choice models for a sample of newly-established Italian banks in the period 1994-2006, controlling for a broad set of possible drivers of default, such as market, managerial and financial variables. Our results suggest that initial capital does play a leading role in explaining both the timing and the likelihood of a failure. Other important drivers are organisation and a balanced growth path, while market and management variables appear to play a minor role. We then turn to a quasi-experimental design: exploiting a regulatory shift in 1999 we run a counterfactual analysis of the impact of a regulatory tightening of initial capital, which affected only a subsample of banks. The set of results suggests that the effect on banks’ survival may be significant.
    Keywords: bank capital, survival analysis, probability of default analysis, start-up banks, counterfactual analysis
    JEL: G21 G28
    Date: 2012–11
  4. By: Bekkour, Lamia; Jin, Xisong; Lehnert, Thorsten; Rasmouki, Fanou; Wolff, Christian C
    Abstract: In this paper, we empirically investigate the impact of the credit risk of Eurozone member countries on the stability of the Euro. In the absence of a common euro bond, euro-area credit risk is induced though the credit default swaps of the member countries. The stability of the euro is examined by decomposing dollar-euro exchange rate options into the moments of the risk-neutral distribution. We document that during the sovereign debt crisis changes in the creditworthiness of member countries have significant impact on the stability of the euro. In particular, an increase in member countries’ credit risk results in an increase of volatility of the dollar-euro exchange rate along with soaring tail risk induced through the risk-neutral kurtosis. We find that member countries’ credit risk is a major determinant of the euro crash risk as measured by the risk-neutral skewness. We propose a new indicator for currency stability by combining the risk-neutral moments into an aggregated risk measure and show that our results are robust to this change in measure. Noticeable is the fact that during the sovereign debt crisis, the creditworthiness of countries with vulnerable fiscal positions is the main risk-endangering factor of the euro-stability.
    Keywords: credit default swaps; currency options; currency stability; European sovereign debt crisis; risk-neutral distribution
    JEL: G1
    Date: 2012–11
  5. By: Goetz von Peter; Sebastian von Dahlen; Sweta C Saxena
    Abstract: This paper presents a large panel study on the macroeconomic consequences of natural catastrophes and analyzes the extent to which risk transfer to insurance markets facilitates economic recovery. Our main results are that major natural catastrophes have large and signi cant negative e ects on economic activity, both on impact and over the longer run. However, it is mainly the uninsured losses that drive the subsequent macroeconomic cost, whereas sufficiently insured events are inconsequential in terms of foregone output. This result helps to disentangle conicting ndings in the literature, and puts the focus on risk transfer mechanisms to help mitigate the macroeconomic costs of natural catastrophes.
    Keywords: natural catastrophes, disasters, economic growth, insurance, risk transfer, reinsurance, recovery, development
    Date: 2012–12
  6. By: Anginer, Deniz; Demirguc-Kunt, Asli; Zhu, Min
    Abstract: Deposit insurance is widely offered in a number of countries as part of a financial system safety net to promote stability. An unintended consequence of deposit insurance is the reduction in the incentive of depositors to monitor banks, which leads to excessive risk-taking. This paper examines the relation between deposit insurance and bank risk and systemic fragility in the years leading to and during the recent financial crisis. It finds that generous financial safety nets increase bank risk and systemic fragility in the years leading up to the global financial crisis. However, during the crisis, bank risk is lower and systemic stability is greater in countries with deposit insurance coverage. The findings suggest that the"moral hazard effect"of deposit insurance dominates in good times while the"stabilization effect"of deposit insurance dominates in turbulent times. Nevertheless, the overall effect of deposit insurance over the full sample remains negative since the destabilizing effect during normal times is greater in magnitude compared with the stabilizing effect during global turbulence. In addition, the analysis finds that good bank supervision can alleviate the unintended consequences of deposit insurance on bank systemic risk during good times, suggesting that fostering the appropriate incentive framework is very important for ensuring systemic stability.
    Keywords: Banks&Banking Reform,Debt Markets,Deposit Insurance,Emerging Markets,Bankruptcy and Resolution of Financial Distress
    Date: 2012–12–01
  7. By: Köhler, Matthias
    Abstract: In this paper, we analyze the impact of loan growth and business model on bank risk in 15 EU countries. In contrast to the literature, we include a large number of unlisted banks in our sample which represent the majority of banks in the EU. We show that banks with high rates of loan growth are more risky. Moreover, we find that banks will become more stable if they increase their non-interest income share due to a better diversification of income sources. The effect, however, decreases with bank size possibly because large banks are more active in volatile trading and off-balance sheet activities such as securitization that allow them to increase their leverage. Our results further indicate that banks become more risky if aggregate credit growth is excessive. This even affects those banks that do not exhibit high rates of individual loan growth compared to their competitors. Overall, our results indicate that differences in the lending activities and business models of banks help to identify risks, which would only materialize in the long-term or in the event of a shock. --
    Keywords: banks,risk-taking,business model,loan growth
    JEL: G20 G21 G28
    Date: 2012

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