New Economics Papers
on Risk Management
Issue of 2013‒05‒11
seven papers chosen by

  1. Network versus portfolio structure in financial systems By Teruyoshi Kobayashi
  2. Regulatory capital determination and Its implications for internal ratings-based credit risk model development and validation By Cao, Honggao
  3. Identifying, ranking and tracking systemically important financial institutions (SIFIs), from a global, EU and Eurozone perspective By Masciantonio, Sergio
  4. A comparison of techniques for dynamic risk measures with transaction costs By Zachary Feinstein; Birgit Rudloff
  5. Comonotonic measures of multivariate risks. By Galichon, Alfred; Ekeland, Ivar
  6. Assessing Municipal Bond Default Probabilities By Holian, Matthew; Joffe, Marc
  7. On the epidemic of financial crises By Demiris, Nikolaos; Kypraios, Theodore; Smith, L. Vanessa

  1. By: Teruyoshi Kobayashi (Graduate School of Economics, Kobe University)
    Abstract: The question of how to stabilize financial systems has attracted considerable attention since the global financial crisis of 2007-2009. Recently, Beal et al. (gIndividual versus systemic risk and the regulator's dilemmah, Proc Natl Acad Sci USA 108: 12647-12652, 2011) demonstrated that higher portfolio diversity among banks would reduce systemic risk by decreasing the risk of simultaneous defaults at the expense of a higher likelihood of individual defaults. In practice, however, a bank default has an externality in that it undermines other banks' balance sheets. This paper explores how each of these different sources of risk, simultaneity risk and externality, contributes to systemic risk. The results show that the allocation of external assets that minimizes systemic risk varies with the topology of the financial network as long as asset returns have negative correlations. In the model, a well-known centrality measure, PageRank, reflects an appropriately defined ginfectivenessh of a bank. An important result is that the most infective bank need not always be the safest bank. Under certain circumstances, the most infective node should act as a firewall to prevent large collective defaults. The introduction of a counteractive portfolio structure will significantly reduce systemic risk.
    Keywords: Systemic risk, financial crisis, financial network, macro-prudential policy
    JEL: G18
    Date: 2013–04
  2. By: Cao, Honggao
    Abstract: Focusing on the interconnections between the Basel regulatory capital formula and several well-specified statistical models, this working paper seeks to understand some of the important issues embedded in the Basel Accord. These include: Where does this formula come from? What risks does it try to capture? Why does the Basel Accord stipulate that the formula be implemented on a basis of homogeneous segments for retail exposures or similar risk ratings of wholesale obligors? Is there any desirable property on the number of loans for a segment (or obligor group)? Why is LGD treated as a constant as opposed to a random variable? When covering expected loss – and determined independently – how is the loss reserve related to the minimum regulatory capital? Answers to these questions have some important implications for Basel model development and validation.
    Keywords: Basel, Basel Model Development, Basel Model Validation, Regulatory Capital, Credit Risk Model, Basel Capital Formula
    JEL: G1 G18 G32 G38
    Date: 2012–10
  3. By: Masciantonio, Sergio
    Abstract: This paper develops a methodology to identify systemically important financial institutions building on that developed by the BCBS (2011) and used by the Financial Stability Board in its yearly G-SIFIs identification. This methodology is based on publicly available data, providing fully transparent results with a G-SIFIs list that helps to bridge the gap between market knowledge and supervisory decisions. Moreover the results encompass a complete ranking of the banks considered, according to their systemic importance scores. The methodology has then been applied to EU and Eurozone samples of banks to obtain their systemic importance ranking and SIFIs lists. A statistical analysis and some geographical and historical evidence provide further insight into the notion of systemic importance, its policy implications and the future applications of this methodology.
    Keywords: banks, balance sheets, systemic risk, SIFIs, financial stability, regulation
    JEL: C81 G01 G10 G18 G20 G21 G28
    Date: 2013–04–01
  4. By: Zachary Feinstein; Birgit Rudloff
    Abstract: This paper contains an overview of results for dynamic risk measures in markets with transaction costs. We provide the main results of four different approaches. We will prove under which assumptions results within these approaches coincide, and how properties like primal and dual representation and time consistency in the different approaches compare to each other.
    Date: 2013–05
  5. By: Galichon, Alfred (Département d'économie); Ekeland, Ivar
    Abstract: We propose amultivariate extension of awell-known characterization by S.Kusuoka of regular and coherent risk measures as maximal correlation functionals. This involves an extension of the notion of comonotonicity to random vectors through generalized quantile functions.Moreover, we propose to replace the current law invariance, subadditivity, and comonotonicity axioms by an equivalent property we call strong coherence and that we argue has more natural economic interpretation. Finally, we reformulate the computation of regular and coherent risk measures as an optimal transportation problem, for which we provide an algorithm and implementation.
    JEL: C61 G12
    Date: 2012
  6. By: Holian, Matthew; Joffe, Marc
    Abstract: In response to a request from the California Debt and Investment Advisory Commission, we propose a model to estimate default probabilities for bonds issued by cities. The model can be used with financial data available in Comprehensive Annual Financial Reports that cities are required to publish. The study includes modeled default probability estimates for 261 California cities with population over 25,000. Our model relies on case study evidence, logistic regression analysis of major city financial statistics from the Great Depression – the last time a large number of cities defaulted – as well as logistic regression analysis of more recent city financial statistics. Independent variables in our model include (1) the ratio of interest and pension expenses to total revenue, (2) the annual change in total revenue, (3) the ratio of general fund surplus (or deficit) to general fund revenues and (4) the ratio of general fund balance to general fund expenditures.
    Keywords: municipal bonds, municipal bankruptcy, default probability model
    JEL: C35 H74 R51
    Date: 2013–04–30
  7. By: Demiris, Nikolaos; Kypraios, Theodore; Smith, L. Vanessa
    Abstract: This paper proposes a framework for modelling financial contagion that is based on SIR (Susceptible-Infected-Recovered) transmission models from epidemic theory. This class of models addresses two important features of contagion modelling, which are a common shortcoming of most existing empirical approaches, namely the direct modelling of the inherent dependencies involved in the transmission mechanism, and an associated canonical measure of crisis severity. The proposed methodology naturally implies a control mechanism, which is required when evaluating prospective immunisation policies that intend to mitigate the impact of a crisis. It can be implemented not only as a way of learning from past experiences, but also at the onset of a contagious financial crisis. The approach is illustrated on a number of currency crisis episodes, using both historical final outcome and temporal data. The latter require the introduction of a novel hierarchical model that we call the Hidden Epidemic Model (HEM), and which embeds the stochastic financial epidemic as a latent process. The empirical results suggest, among others, an increasing trend for global transmission of currency crises over time.
    Keywords: Financial crisis, contagion, stochastic epidemic model, random graph, MCMC
    JEL: C11 C15 C51 G01 G15
    Date: 2012–11

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