nep-rmg New Economics Papers
on Risk Management
Issue of 2013‒04‒27
thirteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Censored Posterior and Predictive Likelihood in Bayesian Left-Tail Prediction for Accurate Value at Risk Estimation By Lukasz Gatarek; Lennart Hoogerheide; Koen Hooning; Herman K. van Dijk
  2. Monitoring of Credit Risk through the Cycle: Risk Indicators By Yashkir, Olga; Yashkir, Yuriy
  3. Systemic Risk Contribution of Individual Banks By Huseyin Cagri Akkoyun; Ramazan Karasahin; Gursu Keles
  4. Risk measures for processes and BSDEs By Irina Penner; Anthony Reveillac
  5. Testing Macroprudential Stress Tests: The Risk of Regulatory Risk Weights By Viral V. Acharya; Robert Engle; Diane Pierret
  6. New bank equity capital rules in the European Union: A critical evaluation By Schuster, Thomas; Kövener, Felix; Matthes, Jürgen
  7. Why do banks optimize risk weights? The relevance of the cost of equity capital. By Beltratti, Andrea; Paladino, Giovanna
  8. Distortion risk measures, ambiguity aversion and optimal effort By Christian Robert; Pierre-Emmanuel Thérond
  9. Uses And Motivations For Credit Derivatives: An Empirical Investigation Into Italian Banks By Eleonora Broccardo; Maria Mazzuca; Elmas Yaldiz
  10. How Do Firms Hedge Risks? Empirical Evidence from U.S. Oil and Gas Producers By Mohamed Mnasri; Georges Dionne; Jean-Pierre Gueyie
  11. On the inefficiency of Brownian motions and heavier tailed price processes By Alejandro Balbás; Beatriz Balbás; Raquel Balbás
  12. On financial risk and the safe haven characteristics of Swiss franc exchange rates By Christian Grisse; Thomas Nitschka
  13. Hedging in bond markets by the Clark-Ocone formula By Nicolas Privault; Timothy Robin Teng

  1. By: Lukasz Gatarek (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam); Lennart Hoogerheide (VU University Amsterdam); Koen Hooning (Delft University of Technology); Herman K. van Dijk (Econometric Institute, Erasmus University Rotterdam, and VU University Amsterdam)
    Abstract: Accurate prediction of risk measures such as Value at Risk (VaR) and Expected Shortfall (ES) requires precise estimation of the tail of the predictive distribution. Two novel concepts are introduced that offer a specific focus on this part of the predictive density: the censored posterior, a posterior in which the likelihood is replaced by the censored likelihood; and the censored predictive likelihood, which is used for Bayesian Model Averaging. We perform extensive experiments involving simulated and empirical data. Our results show the ability of these new approaches to outperform the standard posterior and traditional Bayesian Model Averaging techniques in applications of Value-at-Risk prediction in GARCH models.
    Keywords: censored likelihood; censored posterior; censored predictive likelihood; Bayesian Model Averaging; Value at Risk; Metropolis-Hastings algorithm.
    JEL: C11 C15 C22 C51 C53 C58 G17
    Date: 2013–04–15
  2. By: Yashkir, Olga; Yashkir, Yuriy
    Abstract: The new Credit Risk Indicator (CRI) based on credit rating migration matrices is introduced. We demonstrate strong correlation between CRI and a number of defaults through several business cycles. The new model for the simulation of the annual number of defaults, based on the 1st quarter CRI data, is proposed.
    Keywords: Credit Risk, Risk Indicator, Correlation, Business Cycle, Default Rate
    JEL: E32 E37 G17
    Date: 2013–03–02
  3. By: Huseyin Cagri Akkoyun; Ramazan Karasahin; Gursu Keles
    Abstract: In this study, we measure systemic importance of individual banks that are listed in the Istanbul Stock Exchange. Regarding the whole system as a portfolio of individual banks, we calculate the system-wide risk via contingent claims analysis. Using Shapley values, we assess the systemicimportance of each bank according to its marginal contribution to the calculated system wide risk measure, expected shortfall of the system. Our calculations reveal that market participants perceived 2000 and 2001 banking crises to be devastating for the Turkish banking sector. Since 2002, the banking sector seems to do a good job in eliminating idiosyn- cratic shocks within the system.
    Keywords: Systemic Risk, Contingent Claims Analysis, Shapley Value
    JEL: G10 G13 C71
    Date: 2013
  4. By: Irina Penner (Institut für Mathematik - Humboldt Universität zu Berlin); Anthony Reveillac (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine)
    Abstract: The paper analyzes risk assessment for cash flows in continuous time using the notion of convex risk measures for processes. By combining a decomposition result for optional measures, and a dual representation of a convex risk measure for bounded \cd processes, we show that this framework provides a systematic approach to the both issues of model ambiguity, and uncertainty about the time value of money. We also establish a link between risk measures for processes and BSDEs.
    Keywords: Convex risk measures for processes; Discounting ambiguity; Model ambiguity; Cash subadditivity; Decomposition of optional measures, BSDEs
    Date: 2013–04–17
  5. By: Viral V. Acharya; Robert Engle; Diane Pierret
    Abstract: Macroprudential stress tests have been employed by regulators in the United States and Europe to assess and address the solvency condition of financial firms in adverse macroeconomic scenarios. We provide a test of these stress tests by comparing their risk assessments and outcomes to those from a simple methodology that relies on publicly available market data and forecasts the capital shortfall of financial firms in severe market-wide downturns. We find that: (i) The losses projected on financial firm balance-sheets compare well between actual stress tests and the market-data based assessments, and both relate well to actual realized losses in case of future stress to the economy; (ii) In striking contrast, the required capitalization of financial firms in stress tests is found to be rather low, and inadequate ex post, compared to that implied by market data; (iii) This discrepancy arises due to the reliance on regulatory risk weights in determining required levels of capital once stress-test losses are taken into account. In particular, the continued reliance on regulatory risk weights in stress tests appears to have left financial sectors under-capitalized, especially during the European sovereign debt crisis, and likely also provided perverse incentives to build up exposures to low risk-weight assets.
    JEL: G01 G11 G21 G28
    Date: 2013–04
  6. By: Schuster, Thomas; Kövener, Felix; Matthes, Jürgen
    Abstract: This paper presents and critically evaluates the bank capital requirement rules proposed by the European Union - the capital requirements directive CRD IV and the capital requirements regulation CRR. First, the rules of the Basel III accord about equity capital standards of banks are briefly described. Second, the EU proposal based on Basel III is presented. The article differentiates between rules fully in line with Basel III, modified rules, and new rules not covered by Basel III. Third, the EU proposals are critically evaluated. The paper concludes that the proposals lead in the right direction, but there is still much room for improvement. In fact, some of the planned rules should be urgently revised. Above all, risk weights for member state government bonds must be introduced, liquidity requirements should not overly favour government bonds, and member states should be able to set capital requirements which are greater than 18% of risk-weighted assets. --
    Keywords: Banken und Versicherungen,Europäische Währungsunion,Finanzmärkte,Finanzmarktregulierung
    JEL: G21 G18 G32
    Date: 2013
  7. By: Beltratti, Andrea; Paladino, Giovanna
    Abstract: Banks use internal models to optimize risk weights and better account for the specific risk of each asset class. As the choice of a set of risk weights directly amounts to affecting the regulatory capital ratio, economic theory suggests that banks should optimize their risk weights also with respect to the cost and benefit of holding equity capital. Banks with a higher cost of capital, and banks with better growth opportunities, should be more aggressive in reducing risk weights. We consider a large panel of international banks and find that, after controlling for a number of bank and country characteristics, banks do respond to the cost and benefit of holding capital when selecting their average risk weights. We also find that banks that are more aggressive in terms of such optimization have a subsequent lower return on equity and are more likely to have raised capital during the credit crisis.
    Keywords: Basel Accord, risk-weighted assets, internal rating models, panel OLS, dynamic system GMM.
    JEL: C23 G18 G21
    Date: 2013–04–21
  8. By: Christian Robert (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Pierre-Emmanuel Thérond (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: We consider the class of concave distortion risk measures to study how choice is influenced by the decision-maker's attitude to risk and provide comparative static results. We also assume ambiguity about the probability distribution of the risk and consider a framework à la Klibanoff, Marinacci and Mukerji (2005) to study the value of information that resolves ambiguity. We show that this value increases with greater ambiguity, with greater ambiguity aversion, and in some cases with greater risk aversion. Finally we examine whether a more risk-averse and a more ambiguity-averse individual will invest in more effort to shift his initial risk distribution to a better target distribution.
    Keywords: Ambiguity ; dual theory ; risk measures ;distorsion ; optimal effort
    Date: 2013–02–07
  9. By: Eleonora Broccardo; Maria Mazzuca; Elmas Yaldiz
    Abstract: This study examines the extent to which Italian banks use credit derivatives (CD), whether there are differences between users and nonusers, and the underlying motivations for the use of CD. The results show that a limited number of credit institutions use CD, and that this usage varies over time (2007 seems to be a peak year). Differences exist between users and nonusers (with reference to the risk and capitalization, attitude in hedging, and profitability, and the fact that users tend to be larger, listed and commercial banks). To test the determinants of CD use, we identify two main incentives: managing credit risk, and increasing the bankÕs income diversification. The results seem not to support the hedging hypothesis, and signals emerge for the fact that users employ CD for different/speculative purposes. The findings seem to indicate a direct relationship between the probability of using CD and the banksÕ financial distress costs. The probability of using CD increases in the case of larger and listed banks. The findings regarding the separate estimates for small/large banks and for listed/unlisted banks show that the probability of using CD varies when different sub-samples are considered. Finally, relevant differences emerge between the pre- and post-crisis period.
    Keywords: credit derivatives, credit default swaps, Italian banks
    JEL: G20 G21 G28
    Date: 2013
  10. By: Mohamed Mnasri; Georges Dionne; Jean-Pierre Gueyie
    Abstract: Using a unique, hand-collected data set on hedging activities of 150 US oil and gas producers, we study the determinants of hedging strategy choice. We also examine the economic effects of hedging strategy on firms’ risk, value and performance. We model hedging strategy choice as a multi-state process and use several dynamic discrete choice frameworks with random effects to mitigate the unobserved individual heterogeneity problem and the state dependence phenomena. We find strong evidence that hedging strategy is influenced by investment opportunities, oil and gas market conditions, financial constraints, the correlation between internal funds and investment expenditures, and oil and gas production specificities (i.e., production uncertainty, production cost variability, production flexibility). Finally, we present novel evidence of the real implications of hedging strategy on firms’ stock return and volatility sensitivity to oil and gas price fluctuations, along with their accounting and operational performance
    Keywords: Risk management, derivative choice determinants, hedging strategies, linear and non-linear hedging, state dependence, dynamic discrete choice models, economic effects, oil and gas industry
    JEL: D8 G32
    Date: 2013
  11. By: Alejandro Balbás; Beatriz Balbás; Raquel Balbás
    Abstract: Recent literature has shown the existence of pathologies if one combines the most important models for pricing and hedging derivatives and coherent risk measures. There may exist portfolios (good deals) whose (return; risk) is as close as desired to (1; ??1). This paper goes beyond existence properties and looks for explicit constructions and empirical tests. It will be shown that the good deal above may be a combination of European and digital options, very easy to replicate in practice. This theoretical nding will enable us to implement empirical experiments involving three international stock indices (S&P_500, Eurostoxx_50 and DAX) and three commodity futures (Gold, Brent and DJ ?? UBSCI). According to the empirical results, the good deal always outperforms the underlying index/commodity. The good deal is built in full compliance with the standard Derivative Pricing Theory. Properties of classical pricing models totally inspire and lead the good deal construction. This is a very interesting di¤erence with respect to previous literature attempting to outperform a benchmark. Besides, the selected pricing models satisfy the existence of risk neutral probabilities such that self- nancing price processes become martingales. According to recent results, while local martin- gales characterize the absence of arbitrage, martingales characterize the existence of equilibrium. However, this equilibrium is di¢ cult to imagine, because for every portfolio traders can build a new one with identical price, higher return and lower risk. Perhaps dynamic arbitrage free pricing models contradict other important achievements of Financial Economics related to e¢ ciency and equilibrium, and further research is required to recover consistency.
    Keywords: Market efficiency, Derivative pricing, Risk measure, Good deal
    JEL: G11 G13 G14 G32
    Date: 2013–04
  12. By: Christian Grisse; Thomas Nitschka
    Abstract: We analyse bilateral Swiss franc exchange rate returns in an asset pricing framework to evaluate the Swiss franc's safe haven characteristics. A "safe haven" currency is a currency that offers hedging value against global risk, both on average and in particular in crisis episodes. To explore these issues we estimate the relationship between exchange rate returns and risk factors in augmented UIP regressions, using recently developed econometric methods to account for the possibility that the regression coefficients may be changing over time. Our results highlight that in response to increases in global risk the Swiss franc appreciates against the euro as well as against typical carry trade investment currencies such as the Australian dollar, but depreciates against the US dollar, the Yen and the British pound. Thus, the Swiss franc exhibits safe-haven characteristics against many, but not all other currencies. We find statistically significant time variation in the relationship between Swiss franc returns and risk factors, with this link becoming stronger in times of stress.
    Keywords: Exchange rate, monetary policy, risk factors, safe haven, Swiss franc, uncovered interest rate parity
    JEL: E32 F44 G15
    Date: 2013
  13. By: Nicolas Privault; Timothy Robin Teng
    Abstract: Hedging strategies in bond markets are computed by martingale representation and the Clark-Ocone formula under the choice of a suitable of numeraire, in a model driven by the dynamics of bond prices. Applications are given to the hedging of swaptions and other interest rate derivatives, and our approach is compared to delta hedging when the underlying swap rate is modeled by a diffusion process.
    Date: 2013–04

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