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on Risk Management |
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Issue of 2013‒03‒23
ten papers chosen by |
| By: | Georges Dionne |
| Abstract: | The study of risk management began after World War II. Risk management has long been associated with the use of market insurance to protect individuals and companies from various losses associated with accidents. Other forms of risk management, alternatives to market insurance, surfaced during the 1950s when market insurance was perceived as very costly and incomplete for protection against pure risk. The use of derivatives as risk management instruments arose during the 1970s, and expanded rapidly during the 1980s, as companies intensified their financial risk management. International risk regulation began in the 1990s, and financial firms developed internal risk management models and capital calculation formulas to hedge against unanticipated risks and reduce regulatory capital. Concomitantly, governance of risk management became essential, integrated risk management was introduced and the first corporate risk officer positions were created. Nonetheless, these regulations, governance rules and risk management methods failed to prevent the financial crisis that began in 2007. |
| Keywords: | Risk management, derivatives, regulation, financial crisis, insurance market, self-protection, self-insurance, governance |
| JEL: | D81 G21 G22 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1302&r=rmg |
| By: | Tasca, Paolo; Battiston, Stefano |
| Abstract: | We model the systemic risk associated with the so-called balance-sheet amplification mechanism in a system of banks with interlocked balance sheets and with positions in real-economy-related assets. Our modeling framework integrates a stochastic price dynamics with an active balance-sheet management aimed to maintain the Value-at-Risk at a target level. We find that a strong compliance with capital requirements, usually alleged to be procyclical, does not increase systemic risk unless the asset market is illiquid. Conversely, when the asset market is illiquid, even a weak compliance with capital requirements increases significantly systemic risk. Our findings have implications in terms of possible macro-prudential policies to mitigate systemic risk. |
| Keywords: | Systemic risk, Procyclicality, Leverage, Market liquidity, Network models |
| JEL: | G20 G28 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:45156&r=rmg |
| By: | Tobias Adrian; Daniel Covitz; Nellie J. Liang |
| Abstract: | While the Dodd-Frank Act (DFA) broadens the regulatory reach to reduce systemic risks to the U.S. financial system, it does not address some important risks that could migrate to or emanate from entities outside the federal safety net. At the same time, it limits the types of interventions by financial authorities to address systemic events when they occur. As a result, a broad and forward-looking monitoring program, which seeks to identify financial vulnerabilities and guide the development of preemptive policies to help mitigate them, is essential. Systemic vulnerabilities arise from market failures that can lead to excessive leverage, maturity transformation, interconnectedness, and complexity. These vulnerabilities, when hit by adverse shocks, can lead to fire-sale dynamics, negative feedback loops, and inefficient contractions in the supply of credit. We present a framework that centers on the vulnerabilities that propagate adverse shocks, rather than shocks themselves, which are difficult to predict. Vulnerabilities can emerge in four areas: 1) systemically important financial institutions (SIFIs), 2) shadow banking, 3) asset markets, and 4) the nonfinancial sector. This framework also highlights how policies that reduce the likelihood of systemic crises may do so only by raising the cost of financial intermediation in noncrisis periods. |
| Keywords: | Financial stability ; Systemic risk ; Financial risk management ; Financial Institutions Monitoring System |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:601&r=rmg |
| By: | Rama Cont (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Paris VI - Pierre et Marie Curie - Université Paris VII - Paris Diderot); Andreea Minca (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Paris VI - Pierre et Marie Curie - Université Paris VII - Paris Diderot) |
| Abstract: | We propose a stable non-parametric algorithm for the calibration of pricing models for portfolio credit derivatives: given a set of observations of market spreads for CDO tranches, we construct a risk-neutral default intensity process for the portfolio underlying the CDO which matches these observations, by looking for the risk neutral loss process 'closest' to a prior loss process, verifying the calibration constraints. We formalize the problem in terms of minimization of relative entropy with respect to the prior under calibration constraints and use convex duality methods to solve the problem: the dual problem is shown to be an intensity control problem, characterized in terms of a Hamilton--Jacobi system of differential equations, for which we present an analytical solution. We illustrate our method on ITRAXX index data: our results reveal strong evidence for the dependence of loss transitions rates on the past number of defaults, thus offering quantitative evidence for contagion effects in the risk--neutral loss process. |
| Keywords: | intensity control; stochastic control; point process; inverse problem; nonparametric methods; credit risk; CDO; contagion; |
| Date: | 2013–01–03 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-00413730&r=rmg |
| By: | Thomas M. Eisenbach |
| Abstract: | Why does the market discipline that banks face seem too weak during good times and too strong during bad times? This paper shows that using rollover risk as a disciplining device is effective only if all banks face purely idiosyncratic risk. However, if banks' assets are correlated, a two-sided inefficiency arises: Good aggregate states have banks taking excessive risks, while bad aggregate states suffer from fire sales. The driving force behind this inefficiency is an amplifying feedback loop between asset liquidation values and market discipline. This feedback loop operates in both good and bad aggregate states, but with opposite effects. |
| Keywords: | Risk management ; Bank investments ; Risk assessment ; Financial markets |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:597&r=rmg |
| By: | Kris James Mitchener; Gary Richardson |
| Abstract: | This essay examines how the Banking Acts of the 1933 and 1935 and related New Deal legislation influenced risk taking in the financial sector of the U.S. economy. The analysis focuses on contingent liability of bank owners for losses incurred by their firms and how the elimination of this liability influenced leverage and lending by commercial banks. Using a new panel data set, we find contingent liability reduced risk taking. In states with contingent liability, banks used less leverage and converted each dollar of capital into fewer loans, and thus could survive larger loan losses (as a fraction of their portfolio) than banks in limited liability states. In states with limited liability, banks took on more leverage and risk, particularly in states that required banks with limited liability to join the Federal Deposit Insurance Corporation. In the long run, the New Deal replaced a regime of contingent liability with deposit insurance, stricter balance sheet regulation, and increased capital requirements, shifting the onus of risk management from bankers to state and federal regulators. |
| JEL: | E44 G28 G33 N22 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18895&r=rmg |
| By: | Sofiane Aboura; Björn van Roye |
| Abstract: | In this paper, we develop a financial stress index for France that can be used as a real-time composite indicator for the state of financial stability in France. We take 17 financial variables from different market segments and extract a common stress component using a dynamic approximate factor model. We estimate the model with a combined maximum-likelihood and Expectation-Maximization algorithm allowing for mixed frequencies and an arbitrary pattern of missing data. Using a Markov-Switching Bayesian VAR model, we show that an episode of high financial stress is associated with significantly lower economic activity, whereas movements in the index in a low-stress regime do not incur significant changes in economic activity. Therefore, this index can be used in real time as an early warning signal of systemic risk in the French financial sector |
| Keywords: | Financial stress index, Financial Systems, Recessions, Slowdowns, Financial Crises |
| JEL: | E44 F3 G01 G20 G14 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1834&r=rmg |
| By: | Irfan Akbar Kazi; Suzanne Salloy |
| Abstract: | This article investigates the dynamics of conditional correlation among the G14 banks’ dealer for the credit default swap market from January 2004 until May 2009. By using the asymmetric dynamic conditional correlation model developed by Cappiello, Engle and Sheppard (2006), we examine if there is contagion during the global financial crisis, following Lehman Brothers’ bankruptcy of September 15th, 2008. The main contribution of this article is to analyze if the interdependence structure between the G14 banks changed significantly during the crisis period. We try to identify the banks which were the most or the least affected by losses induced by the crisis and we draw some conclusions in terms of their vulnerability to financial shocks. We find that all banks became highly interdependent during Lehman Brothers’ bankruptcy (short term impact), but only some banks faced high contagion during the global financial crisis (long term impact). Regulators who try to reinforce banks’ stability with the Basel 3 reforms proposals should be interested by these results. |
| Keywords: | Financial Crisis, Contagion, Credit Default Swap, Lehman Brothers, Asymmetric Dynamic Conditional Correlation |
| JEL: | G01 G15 G21 G33 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2013-6&r=rmg |
| By: | Zhang, Lei (University of Warwick); Zhang, Lin (Southwestern University of Finance and Economics); Zheng, Yong (Southwestern University of Finance and Economics) |
| Abstract: | We use the global games approach to study key factors a?ecting the credit risk associated with roll-over of bank debt. When creditors are heterogenous, these include the extent of short-term borrowing and capital market liquidity for repo ?nancing. Speci?cally, in a model with a large institutional creditor and a continuum of small creditors independently making their roll-over decisions based on private information, we ?nd that increasing the proportion of short-term debt and/or decreasing market liquidity reduces the willingness of creditors to roll over. This raises credit risk in equilibrium. The presence of a large creditor does not always reduce credit risk, however, unless it is better informed. |
| Keywords: | Credit Risk; Coordination; Debt Crisis; Private information; Global games |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:cge:warwcg:123&r=rmg |
| By: | El-Khatib, Youssef; Hatemi-J, Abdulnasser |
| Abstract: | Option pricing is an integral part of modern financial risk management. The well-known Black and Scholes (1973) formula is commonly used for this purpose. This paper is an attempt to extend their work to a situation in which the unconditional volatility of the original asset is increasing during a certain period of time. We consider a market suffering from a financial crisis. We provide the solution for the equation of the underlying asset price as well as finding the hedging strategy. In addition, a closed formula of the pricing problem is proved for a particular case. The suggested formulas are expected to make the valuation of options and the underlying hedging strategies during financial crisis more precise. |
| Keywords: | Asset Pricing and Hedging, Options, Financial Crisis, Black and Scholes formula. |
| JEL: | C02 C11 C12 G01 G11 |
| Date: | 2013–03–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:45272&r=rmg |