New Economics Papers
on Risk Management
Issue of 2013‒06‒30
ten papers chosen by

  1. Implied Risk Exposures By Sylvain Benoit; Christophe Hurlin; Christophe Pérignon
  2. Computational Dynamic Market Risk Measures in Discrete Time Setting By Babacar Seck; Robert J. Elliott; Jean-Pierre Gueyie
  3. Conditional euro area sovereign default risk By Lucas, André; Schwaab, Bernd; Zhang, Xin
  4. Distortions of multivariate distribution functions and associated level curves: applications in multivariate risk theory By Elena Di Bernardino; Didier Rullière
  5. Policy in adaptive financial markets—the use of systemic risk early warning tools By Dieter Gramlich; Mikhail V. Oet; Stephen J. Ong
  6. An extension of Davis and Lo's contagion model By Didier Rullière; Diana Dorobantu; Areski Cousin
  7. Compound Wishart Matrices and Noisy Covariance Matrices: Risk Underestimation By Beno\^it Collins; David McDonald; Nadia Saad
  8. On Modeling Economic Default Time: A Reduced-Form Model Approach By Jia-Wen Gu; Bo Jiang; Wai-Ki Ching; Harry Zheng
  9. Dynamic Term Structure Modelling with Default and Mortality Risk: New Results on Existence and Monotonicity By Stefan Tappe; Thorsten Schmidt
  10. Commodities Inventory Effect By Jean-François Carpantier; Arnaud Dufays

  1. By: Sylvain Benoit (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Hurlin (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Pérignon (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - GROUPE HEC - CNRS : UMR2959)
    Abstract: Bank risk disclosures, such as Value-at-Risk (VaR), are affected by both changes in market volatility and bank's risk exposures. While the latter is typically unknown to the public, we show how to estimate it from public data on VaR and volatility. We propose a methodology, which we call Factor Implied Risk Exposure (FIRE), that breakdowns a change in risk disclosure into an exogenous volatility component and an endogenous risk exposure component. In a study of large US and international banks, we show that (1) the main driving force of bank risk disclosures is the shifts in risk exposures, (2) changes in risk exposures are negatively correlated with volatility changes, which suggests that banks reduce risk taking when volatility increases, and that (3) changes in risk exposures are positively correlated among banks, which is consistent with banks exhibiting herding behavior in trading.
    Keywords: Herding, Risk Disclosure, (Stressed) Value-at-Risk, Regulatory Capital
    Date: 2013–06–20
  2. By: Babacar Seck; Robert J. Elliott; Jean-Pierre Gueyie
    Abstract: Different approaches to defining dynamic market risk measures are available in the literature. Most are focused or derived from probability theory, economic behavior or dynamic programming. Here, we propose an approach to define and implement dynamic market risk measures based on recursion and state economy representation. The proposed approach is to be implementable and to inherit properties from static market risk measures.
    Date: 2013–06
  3. By: Lucas, André (VU University Amsterdam and Tinbergen Institute); Schwaab, Bernd (European Central Bank); Zhang, Xin (Research Department, Central Bank of Sweden)
    Abstract: We propose an empirical framework to assess the likelihood of joint and conditional sovereign default from observed CDS prices. Our model is based on a dynamic skewed-t distribution that captures all salient features of the data, including skewed and heavytailed changes in the price of CDS protection against sovereign default, as well as dynamic volatilities and correlations that ensure that uncertainty and risk dependence can increase in times of stress. We apply the framework to euro area sovereign CDS spreads during the euro area debt crisis. Our results reveal significant time-variation in distress dependence and spill-over effects for sovereign default risk. We investigate market perceptions of joint and conditional sovereign risk around announcements of Eurosystem asset purchases programs, and document a strong impact on joint risk.
    Keywords: sovereign credit risk; higher order moments; time-varying parameters; financial stability
    JEL: C32 G32
    Date: 2013–05–01
  4. By: Elena Di Bernardino (CEDRIC - Centre d'Etude et De Recherche en Informatique du Cnam - Conservatoire National des Arts et Métiers (CNAM)); Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: In this paper, we propose a parametric model for multivariate distributions. The model is based on distortion functions, i.e. some transformations of a multivariate distribution which permit to generate new families of multivariate distribution functions. We derive some properties of considered distortions. A suitable proximity indicator between level curves is introduced in order to evaluate the quality of candidate distortion parameters. Using this proximity indicator and properties of distorted level curves, we give a speci c estimation procedure. The estimation algorithm is mainly relying on straightforward univariate optimizations, and we nally get parametric representations of both multivariate distribution functions and associated level curves. Our results are motivated by applications in multivariate risk theory. The methodology is illustrated on simulated and real examples.
    Keywords: Multivariate probability distortions, Level sets estimation , Iterated compositions, Hyperbolic conversion functions , Multivariate risk measures.
    Date: 2013–05–04
  5. By: Dieter Gramlich; Mikhail V. Oet; Stephen J. Ong
    Abstract: How can a systemic risk early warning system (EWS) facilitate the financial stability work of policymakers? In the context of evolving financial market dynamics and limitations of microprudential policy, this study examines new directions for financial macroprudential policy. A flexible macroprudential approach is anchored in strategic capacities of systemic risk EWSs. Tactically, macroprudential applications are founded on information about the level, structure, and institutional drivers of systemic financial stress and aim to manage the financial system risk and imbalances in two dimensions: across time and institutions. Time-related EWS policy applications are analyzed in pursuit of prevention and mitigation. EWS applications across institutions are considered via common exposures and interconnectedness. Care must be taken in the calibration of macroprudential applications, given their reliance on quality of the underlying systemic risk-modeling framework.
    Keywords: Business cycles ; Regulation ; Financial stability
    Date: 2013
  6. By: Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Diana Dorobantu (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Areski Cousin (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: The present paper provides a multi-period contagion model in the credit risk field. Our model is an extension of Davis and Lo's infectious default model. We consider an economy of n firms which may default directly or may be infected by other defaulting firms (a domino effect being also possible). The spontaneous default without external influence and the infections are described by not necessarily independent Bernoulli-type random variables. Moreover, several contaminations could be required to infect another firm. In this paper we compute the probability distribution function of the total number of defaults in a dependency context. We also give a simple recursive algorithm to compute this distribution in an exchangeability context. Numerical applications illustrate the impact of exchangeability among direct defaults and among contaminations, on different indicators calculated from the law of the total number of defaults. We then examine the calibration of the model on iTraxx data before and during the crisis. The dynamic feature together with the contagion effect seem to have a significant impact on the model performance, especially during the recent distressed period.
    Keywords: credit risk; contagion model; dependent defaults; default distribution; exchangeability; CDO tranches
    Date: 2013
  7. By: Beno\^it Collins; David McDonald; Nadia Saad
    Abstract: In this paper, we obtain a property of the expectation of the inverse of compound Wishart matrices which results from their orthogonal invariance. Using this property as well as results from random matrix theory (RMT), we derive the asymptotic effect of the noise induced by estimating the covariance matrix on computing the risk of the optimal portfolio. This in turn enables us to get an asymptotically unbiased estimator of the risk of the optimal portfolio not only for the case of independent observations but also in the case of correlated observations. This improvement provides a new approach to estimate the risk of a portfolio based on covariance matrices estimated from exponentially weighted moving averages of stock returns.
    Date: 2013–06
  8. By: Jia-Wen Gu; Bo Jiang; Wai-Ki Ching; Harry Zheng
    Abstract: In the aftermath of the global financial crisis, much attention has been paid to investigating the appropriateness of the current practice of default risk modeling in banking, finance and insurance industries. A recent empirical study by Guo et al.(2008) shows that the time difference between the economic and recorded default dates has a significant impact on recovery rate estimates. Guo et al.(2011) develop a theoretical structural firm asset value model for a firm default process that embeds the distinction of these two default times. To be more consistent with the practice, in this paper, we assume the market participants cannot observe the firm asset value directly and developed a reduced-form model to characterize the economic and recorded default times. We derive the probability distribution of these two default times. The numerical study on the difference between these two shows that our proposed model can both capture the features and fit the empirical data.
    Date: 2013–06
  9. By: Stefan Tappe; Thorsten Schmidt
    Abstract: This paper considers general term structure models like the ones appearing in portfolio credit risk modelling or life insurance. We give a general model starting from families of forward rates driven by infinitely many Brownian motions and an integer-valued random measure, generalizing existing approaches in the literature. Then we derive drift conditions which are equivalent to no asymptotic free lunch on the considered market. Existence results are also given. In practice, models possessing a certain monotonicity are favorable and we study general conditions which guarantee this. The setup is illustrated with some examples.
    Date: 2013–06
  10. By: Jean-François Carpantier (CREA, University of Luxembourg); Arnaud Dufays (Université Catholique de Louvain)
    Abstract: Does commodity price volatility increase when inventories are low? We are the first ones to document this relationship. To that aim, we estimate asym- metric volatility models for a large set of commodities over 1994-2011. Since inventories are hard to measure, especially for high frequency data, we use positive return shocks as a new original proxy for inventories and find that asymmetric GARCH models reveal a significant inventory effect for many commodities. The results look robust. They hold if we allow the uncondi- tional variance to vary over time and if we relax the parametric form.
    Keywords: Asymmetries, Commodities, Inventory, Spline GARCH, VaR.
    Date: 2013

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