nep-rmg New Economics Papers
on Risk Management
Issue of 2013‒01‒07
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. A unified approach to pricing and risk management of equity and credit risk By Claudio Fontana; Juan Miguel A. Montes
  2. Transatlantic systemic risk By Trapp, Monika; Wewel, Claudio
  3. Derivatives Holdings and Systemic Risk in the U.S. Banking Sector By María Rodríguez-Moreno; Sergio Mayordomo; Juan Ignacio Peña
  4. Bilateral Exposures and Systemic Solvency Risk. By Gourieroux, C.; Heam, J.C.; Monfort, A.
  5. An Autocorrelated Loss Distribution Approach : back to the time series. By Dominique Guegan; Bertrand K. Hassani
  6. Measuring the Systemic Risk in Interfirm Transaction Networks By Hazama, Makoto; Uesugi, Iichiro
  7. A Fourier Approach to the Computation of CV@R and Optimized Certainty Equivalents By Samuel Drapeau; Michael Kupper; Antonis Papapantoleon
  8. Maintaining Confidence By David Murphy
  9. Risk Measures in a Regime Switching Model Capturing Stylized Facts By Rainer Haidinger; Richard Warnung
  10. Insurance risk transfer and categorization of reinsurance contracts By Gurenko, Eugene N.; Itigin, Alexander; Wiechert, Renate
  11. Multi-portfolio time consistency for set-valued convex and coherent risk measures By Zachary Feinstein; Birgit Rudloff
  12. Portfolio optimization based on divergence measures By Chalabi, Yohan; Wuertz, Diethelm
  13. When the cat's away the mice will play: does regulation at home affect bank risk taking abroad? By Steven Ongena; Alexander Popov; Gregory F. Udell
  14. How to use demand systems to evaluate risky projects, with an application to automobile production By Friberg, Richard; Huse, Cristian

  1. By: Claudio Fontana; Juan Miguel A. Montes
    Abstract: We propose a unified framework for equity and credit risk modeling, where the default time is a doubly stochastic random time with intensity driven by an underlying affine factor process. This approach allows for flexible interactions between the defaultable stock price, its stochastic volatility and the default intensity, while maintaining full analytical tractability. We characterise all risk-neutral measures which preserve the affine structure of the model and show that risk management as well as pricing problems can be dealt with efficiently by shifting to suitable survival measures. As an example, we consider a jump-to-default extension of the Heston stochastic volatility model.
    Date: 2012–12
  2. By: Trapp, Monika; Wewel, Claudio
    Abstract: In this paper we study systemic risk for North America and Europe. We show that banks' exposures to common risk factors are crucial for systemic risk. We come to this conclusion by first showing that relations between North American and European banks are smaller than within each region. We then show that European banks react more strongly to the onset of the financial crisis than North American ones. Regarding the consequences of systemic risk, we show that dependence between the banking sector and a wide range of real sectors is limited. Our results imply that regulators and supervisors should address international bank dependencies arising from common risk factors, while recessions in real sectors due to bank defaults should be a secondary concern. --
    Keywords: systemic risk,banking sector,real sectors,international,copula
    JEL: G01 G15 G18 G21 G28
    Date: 2012
  3. By: María Rodríguez-Moreno (European Central Bank); Sergio Mayordomo (School of Economics and Business Administration, University of Navarra); Juan Ignacio Peña (Department of Business Administration, Universidad Carlos III de Madrid)
    Abstract: This paper studies the impact of the banks’ portfolio holdings of financial derivatives on the banks’ individual contribution to systemic risk over and above the effect of variables related to size, interconnectedness, substitutability, and other balance sheet information. Using a sample of 91 U.S. bank holding companies from 2002 to 2011, we compare five measures of the banks’ contribution to systemic risk and find that the new measure proposed in this study, Net Shapley Value, outperforms the others. Using this measure we find that the banks’ holdings of foreign exchange and credit derivatives increase the banks contributions to systemic risk whereas holdings of interest rate derivatives decrease it. Nevertheless, the proportion of non-performing loans over total loans and the leverage ratio have much stronger impact on systemic risk than derivatives holdings. We find that before the subprime crisis credit derivatives decreased systemic risk whereas during the crisis increased it. So, credit derivatives seemed to change their role from shock absorbers to shock issuers. This effect is not observed in the other types of derivatives.
    Keywords: Systemic risk, derivatives, Shapley value
    JEL: C32 G01 G21
    Date: 2012–12–21
  4. By: Gourieroux, C.; Heam, J.C.; Monfort, A.
    Abstract: By introducing a structure of the balance sheets of the banks, which takes into account their bilateral exposures in terms of stocks or lendings, we get a structural model for default analysis. This model allows distinguishing the exogenous and endogenous default dependence. We prove the existence and uniqueness of the liquidation equilibrium, we study the consequences of exogenous shocks on the banking system and we measure contagion phenomena. This approach is illustrated by an application to the French banking system.
    Keywords: Contagion, Systemic Risk, Solvency, Clearing, Liquidation Equilibrium, Impulse Response, Value-of-the Firm Model.
    JEL: G21 G28 G18 G33
    Date: 2012
  5. By: Dominique Guegan (Centre d'Economie de la Sorbonne - Paris School of Economics); Bertrand K. Hassani (Santander UK et Centre d'Economie de la Sorbonne)
    Abstract: The Advanced Measurement Approach requires financial institutions to develop internal models to evaluate regulatory capital. Traditionally, the Loss Distribution Approach (LDA) is used mixing frequencies and severities to build a Loss Distribution Function (LDF). This distribution represents annual losses, consequently the 99.9 percentile of the distribution providing the capital charge denotes the worst year in a thousand. The traditional approach approved by the regulator implemented by financial institutions assumes the independence of the losses. This paper proposes a solution to address the issues arising when autocorrelations are detected between the losses. Our approach suggests working with the losses considered as time series. Thus, the losses are aggregated periodically and several models are adjusted on the related time series among AR, ARFI and Gegenbauer processes, and a distribution is fitted on the residuals. Finally a Monte Carlo simulation enables constructing the LDF, and the pertaining risk measures are evaluated. In order to show the impact of internal models retained by financial institutions on the capital charges, the paper draws a parallel between the static traditional approach and an appropriate dynamical modelling. If by implementing the traditional LDA, no particular distribution proves its adequacy to the data - as soon as the goodness-of-fit tests reject them - keeping the LDA corresponds to an arbitrary choice. This paper suggests an alternative and robust approach. For instance, for the two data sets explored in this paper, with the introduced time series strategies, the independence assumption is released and the autocorrelations embedded within the losses are captured. The construction of the related LDF enables the computation of the capital charges and therefore permits to comply with the regulation taking into account at the same time the large losses with adequate distributions on the residuals, and the correlations between the losses with the time series processes.
    Keywords: Operational risk, time series, Gegenbauer processes, Monte Carlo, risk measures.
    JEL: C18
    Date: 2012–12
  6. By: Hazama, Makoto; Uesugi, Iichiro
    Abstract: Using a unique and massive data set that contains information on interfirm transaction relationships, we examine default propagation along the trade credit channel and for the first time provide direct and systematic evidence of its existence and relevance. Not only do we implement simulations in order to detect prospective defaulters, we also estimate the probabilities of actual firm bankruptcies and compare the predicted defaults and actual defaults. We find, first, that an economically sizable number of firms are predicted to fail when their customers default on their trade debt. Second, these prospective defaulters are indeed more likely to go bankrupt than other firms. Third, a certain type of firm-bank relationships, in which a bank extends loans to many of the firms in the same supply chain, significantly reduces firms' bankruptcy probability, providing evidence for the existence and relevance of ”deep pockets” as documented in Kiyotaki and Moore (1997).
    Keywords: interfirm networks, trade credit, default propagation
    JEL: E32 G21 G32 G33
    Date: 2012–12
  7. By: Samuel Drapeau; Michael Kupper; Antonis Papapantoleon
    Abstract: We consider the class of risk measures associated with optimized certainty equivalents. This class includes several popular examples, such as CV@R and the entropic risk measure. We develop numerical schemes for the computation of such risk measures using Fourier transform methods. This leads to a very competitive method for the calculation of CV@R in particular, which is comparable in computational time to the calculation of V@R.
    Date: 2012–12
  8. By: David Murphy
    Abstract: This paper proposes the solvency/liquidity spiral as an failure mode affecting large financial institutions in the recent crisis. The essential features of this mode are that a combination of funding liquidity risk and investor doubts over the solvency of an institution can lead to its failure. We analyse the failures of Lehman Brothers and RBS in detail, and find considerable support for the spiral model of distress. Our model suggests that a key determinant of the financial stability of many large banks is the confidence of the funding markets. This has consequences for the design of financial regulation, suggesting that capital requirements, liquidity rules, and disclosure should be explicitly constructed so as not just to mitigate solvency risk and liquidity risk, but also to be seen to do so even in stressed conditions.
    Date: 2012–12
  9. By: Rainer Haidinger; Richard Warnung
    Abstract: We pick up the regime switching model for asset returns introduced by Rogers and Zhang. The calibration involves various markets including implied volatility in order to gain additional predictive power. We focus on the calculation of risk measures by Fourier methods that have successfully been applied to option pricing and analyze the accuracy of the results.
    Date: 2012–12
  10. By: Gurenko, Eugene N.; Itigin, Alexander; Wiechert, Renate
    Abstract: Despite the existence of numerous quantitative approaches to the categorization of financial reinsurance contracts, often insurance regulators may find the practical implementation of the task to be technically challenging. This research paper develops a simple, affordable, and robust regulatory method that can help insurance regulators to categorize financial reinsurance contracts as reinsurance or financial instruments. By reviewing real examples of different categorization methods, this paper explains how the proposed method standardizes such categorization. It also summarizes the existing pertinent literature on the subject with the view to helping insurance regulators to first apply some simple indicators to flag the main issues with financial reinsurance contracts that may need further reviews. Having identified the suspicious reinsurance contracts, supervisors may consider several solutions provided by the authors and, in some cases, requiring further quantitative testing of risk transfer contracts for categorization purposes, supervisors may also consider adopting the Standardized Expected Reinsurer's Deficit approach to contract testing presented in this paper. The approach advocates the use of a simple standardized stochastic method that would allow market participants and regulators to perform robust quantitative tests quickly and at an affordable cost. Besides addressing the obvious drawbacks of the"10-10"test, the proposed alternative method allows a great reduction in the technical challenges posed to the users of the Expected Reinsurer's Deficit approach based on full stochastic models with only a minimum loss of predictive accuracy.
    Keywords: Insurance&Risk Mitigation,Debt Markets,Hazard Risk Management,Insurance Law,Labor Policies
    Date: 2012–12–01
  11. By: Zachary Feinstein; Birgit Rudloff
    Abstract: Equivalent characterizations of multi-portfolio time consistency are deduced for closed convex and coherent set-valued risk measures on L^p_d. In the convex case, multi-portfolio time consistency is equivalent to a condition on the sum of minimal penalty functions. The proof of this results is entirely different from the proof in the scalar case as the scalar method cannot be applied here. In the coherent case, multi-portfolio time consistency is equivalent to a generalized version of stability of the dual variables. As examples, the set of superhedging portfolios in markets with transaction costs is shown to have the stability property and a multi-portfolio time consistent version of the set-valued average value at risk, the composed AV@R, is given and its dual representation deduced.
    Date: 2012–12
  12. By: Chalabi, Yohan; Wuertz, Diethelm
    Abstract: A new portfolio selection framework is introduced where the investor seeks the allocation that is as close as possible to his "ideal" portfolio. To build such a portfolio selection framework, the f-divergence measure from information theory is used. There are many advantages to using the f-divergence measure. First, the allocation is made such that it is in agreement with the historical data set. Second, the divergence measure is a convex function, which enables the use of fast optimization algorithms. Third, the objective value of the minimum portfolio divergence measure provides an indication distance from the ideal portfolio. A statistical test can therefore be constructed from the value of the objective function. Fourth, with adequate choices of both the target distribution and the divergence measure, the objective function of the f-portfolios reduces to the expected utility function.
    Keywords: Portfolio weights modeling; Divergence measures; Dual divergence; Information theory; Minimax optimization problems
    JEL: C13 C43 G11 C12 C61
    Date: 2012–11
  13. By: Steven Ongena (Tilburg University; CEPR - Centre for Economic Policy Research); Alexander Popov (European Central Bank); Gregory F. Udell (Indiana University Bloomington)
    Abstract: This paper provides the first empirical evidence that bank regulation is associated with cross-border spillover effects through the lending activities of large multinational banks. We analyze business lending by 155 banks to 9613 firms in 1976 different localities across 16 countries. We find that lower barriers to entry, tighter restrictions on bank activities, and higher minimum capital requirements in domestic markets are associated with lower bank lending standards abroad. The effects are stronger when banks are less efficiently supervised at home, and are observed to exist independently from the impact of host-country regulation. JEL Classification: G21, G28, G32
    Keywords: Bank regulation, cross-border financial institutions, lending standards, financial risk
    Date: 2012–11
  14. By: Friberg, Richard; Huse, Cristian
    Abstract: This article introduces a method to quantify the effect of a firm’s strategic choices on the risk profile of its profits at different horizons. We combine a demand system for differentiated products with counterfactual paths of risk factors. Prices, costs and quantities respond endogenously to the counterfactual state of the world. The draws on risk factors are generated using copulas, in a way that flexibly can be adapted to the risks faced in various industries. We illustrate the method by studying how the US operations of German carmakers BMW and Porsche are affected by the decision to relocate production, i.e. operational hedging. We find that for plausible costs of building a plant, production in the US is attractive for BMW, but not for Porsche.
    Keywords: demand estimation; Exchange rate exposure; operational hedging; risk management
    JEL: F23 L16 L62
    Date: 2012–12

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