nep-rmg New Economics Papers
on Risk Management
Issue of 2013‒07‒28
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. An Alternative Model to Basel Regulation By Sofiane Aboura; Emmanuel Lépinette
  2. Risco Sistêmico no Mercado Bancário Brasileiro - Uma abordagem pelo método CoVar By Gustavo Silva Araújo; Sérgio Leão
  3. Quantifying the Impact of Leveraging and Diversification on Systemic Risk By Tasca, Paolo; Mavrodiev, Pavlin; Schweitzer, Frank
  4. Converting the NPL Ratio into a Comparable Long Term Metric By Rodrigo Lara Pinto; Gilneu Francisco Astolfi Vivan
  5. Are benefits from oil - stocks diversification gone? A new evidence from a dynamic copulas and high frequency data By Krenar Avdulaj; Jozef Barunik
  6. A liquidity risk index as a regulatory tool for systemically important banks? An empirical assessment across two financial crises By Gianfranco Gianfelice; Giuseppe Marotta; Costanza Torricelli
  7. A Benchmark Approach to Risk-Minimization under Partial Information By Claudia Ceci; Katia Colaneri; Alessandra Cretarola
  8. How does risk management influence production decisions? evidence from a field experiment By Cole, Shawn; Gine, Xavier; Vickery, James
  9. Global Financial Regulatory Trends and Challenges for Insurance and Pensions By Javier Alonso; Tatiana Alonso; Santiago Fernandez de Lis; Cristina Rohde; David Tuesta

  1. By: Sofiane Aboura (CEREG - Centre de Recherche sur la gestion et la Finance - DRM UMR 7088 - Université Paris IX - Paris Dauphine); Emmanuel Lépinette (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine)
    Abstract: The post-crisis financial reforms address the need for systemic regulation, focused not only on individual banks but also on the whole financial system. The regulator principal objective is to set banks' capital requirements equal to international minimum standards in order to mimimise systemic risk. Indeed, Basel agreement is designed to guide a judgement about minimum universal levels of capital and remains mainly microprudential in its focus rather than being macroprudential. An alternative model to Basel framework is derived where systemic risk is taken into account in each bank's dynamic. This might be a new departure for prudential policy. It allows for the regulator to compute capital and risk requirements for controlling systemic risk. Moreover, bank regulation is considered in a two-scale level, either at the bank level or at the system-wide level. We test the adequacy of the model on a data set containing 19 banks of 5 major countries from 2005 to 2012. We compute the capital ratio threshold per year for each bank and each country and we rank them according to their level of fragility. Our results suggest to consider an alternative measure of systemic risk that requires minimal capital ratios that are bank-specific and time-varying.
    Keywords: Systemic risk; Bank Regulation; Basel Accords
    Date: 2013–07–19
  2. By: Gustavo Silva Araújo; Sérgio Leão
    Abstract: The 2007-2009 global financial crisis has highlighted the need for a review of the practices of banking supervision. The trend of the post-crisis is a macro-prudential regulation in order to smooth out economic cycles and mitigate systemic risk. Accordingly, Adrian & Brunnermeier (2011) propose a measure of systemic risk - the CoVaR. Basically, the CoVaR of an institution represents the value at risk of the financial system conditional on the institution being under distress. They also define the institution's contribution to systemic risk as the difference between CoVaR conditional on the institution being under distress and the CoVaR in the median state of the institution. The aim of this paper is to evaluate the application of the CoVaR measure in the Brazilian banking system. The results for the Brazilian market indicate that: i) VaR is a poor measure to capture the systemic risk of an institution; ii) although larger institutions have less individual risks, they offer higher systemic risks; iii) some smaller institutions are also among the ones offering higher systemic risks; iv) on average, one unit of a larger institution individual risk increases more the systemic risk than one unit of a small institution individual risk; v) on average, the systemic risk is lower for public financial institutions. Furthermore, the findings (ii) and (iv) indicate that, on average, institutions with higher individual risk have minor marginal contributions to the systemic risk.
    Date: 2013–07
  3. By: Tasca, Paolo; Mavrodiev, Pavlin; Schweitzer, Frank
    Abstract: Excessive leverage, i.e. the abuse of debt financing, is considered one of the  primary factors in the default of financial institutions. Systemic risk results from correlations between individual default probabilities that cannot be considered independent. Based on the structural framework by Merton (1974), we discuss a model in which these  correlations arise from overlaps in banks' portfolios. Portfolio  diversification is used as a strategy to mitigate losses from investments in risky projects. We calculate an optimal level of  diversification that has to be reached for a given level of excessive leverage to still mitigate an increase in systemic risk. In our  model, this optimal diversification further depends on the market size and the market conditions (e.g. volatility). It allows to distinguish between a safe regime, in which excessive leverage does not result in an increase of systemic risk, and a risky regime, in which excessive leverage cannot be mitigated leading to an increased systemic risk. Our results are of relevance for financial regulators.
    Keywords: Business, Systemic Risk, Leverage, Diversification
    Date: 2013–03–22
  4. By: Rodrigo Lara Pinto; Gilneu Francisco Astolfi Vivan
    Abstract: The NPL ratio is probably the most widely used metric to measure the credit risk present in the loan portfolio of financial institutions. However, factors other than credit risk, such as the time a loan remains in the NPL condition, the distribution of defaults over time within a certain vintage, the growth rate of the loan portfolio and its term to maturity, may influence its dynamics. Moreover, accounting differences related to recognition and definition of an event of default makes it difficult to compare this metric across different countries. In this paper, we propose an alternative metric to assess the dynamics of credit risk in the loan portfolio. Based on a theoretical portfolio, we develop an analytical model in order to estimate the weighted average of lifetime default ratios of all vintages where the weight is assigned based on the contribution of each vintage to the current stock of loans. We call it implied NPL ratio, which consists of a transformation that adjusts the observed NPL ratio for the effects of changes in the portfolio growth rate and in its average term to maturity, and also takes into account differences in the default distribution across time and the amount of time a past due loan remains in the balance sheet. The results of applying this transformation to the three most relevant types of loans to households in Brazil (auto loans, housing financing and payroll-deducted loans) demonstrate that (a) the implied NPL ratio was a good forecast of the portfolio lifetime default; (b) changes in the components mentioned above affected the dynamics of the NPL ratio and therefore compromised the assessment of credit risk based on this metric (c) the analysis of differences in the evolution of NPL and INPL gives rise to important insights regarding the dynamics of credit risk.
    Date: 2013–07
  5. By: Krenar Avdulaj; Jozef Barunik
    Abstract: Oil is widely perceived as a good diversification tool for stock markets. To fully understand the potential, we propose a new empirical methodology which combines generalized autoregressive score copula functions with high frequency data, and allows us to capture and forecast the conditional time-varying joint distribution of the oil -- stocks pair accurately. Our realized GARCH with time-varying copula yields statistically better forecasts of the dependence as well as quantiles of the distribution when compared to competing models. Using recently proposed conditional diversification benefits measure which take into account higher-order moments and nonlinear dependence, we document reducing benefits from diversification over the past ten years. Diversification benefits implied by our empirical model are moreover strongly varying over time. These findings have important implications for portfolio management.
    Date: 2013–07
  6. By: Gianfranco Gianfelice; Giuseppe Marotta; Costanza Torricelli
    Abstract: We provide an assessment of the IMF suggestion, based on Severo (2012), to use an index of systemic liquidity risk (SLRI) that could help to estimate a Pigouvian tax on large banks for the externality on the international banking system out of their risk exposure. To this end we compute a parsimonious and fully documented SLRI and investigate its statistical significance in explaining level and variability of stock returns for a group of large international banks during the subprime financial and the Eurozone sovereign debt crises. The empirical investigation consistently fails to detect, within and across the two crises, a core group among the systemically important banks listed by the Financial Stability Board and thus supports a sceptical assessment of the proposal.
    Keywords: subprime crisis, Eurozone sovereign crisis, systemic risk, banks’ stock returns, macroprudential regulation
    JEL: C58 G01 G12 G13
    Date: 2013–07
  7. By: Claudia Ceci; Katia Colaneri; Alessandra Cretarola
    Abstract: In this paper we study a risk-minimizing hedging problem for a semimartingale incomplete financial market where d+1 assets are traded continuously and whose price is expressed in units of the num\'{e}raire portfolio. According to the so-called benchmark approach, we investigate the (benchmarked) risk-minimizing strategy in the case where there are restrictions on the available information. More precisely, we characterize the optimal strategy as the integrand appearing in the Galtchouk-Kunita-Watanabe decomposition of the benchmarked claim under partial information and provide its description in terms of the integrands in the classical Galtchouk-Kunita-Watanabe decomposition under full information via dual predictable projections. Finally, we apply the results in the case of a Markovian jump-diffusion driven market model where the assets prices dynamics depend on a stochastic factor which is not observable by investors.
    Date: 2013–07
  8. By: Cole, Shawn; Gine, Xavier; Vickery, James
    Abstract: Weather is a key source of income risk for many firms and households, particularly in emerging market economies. This paper uses a randomized controlled trial approach to study how an innovative risk management instrument for hedging rainfall risk affects production decisions among a sample of Indian agricultural firms. The analysis finds that the provision of insurance induces farmers to shift production toward higher-return but higher-risk cash crops, particularly among more-educated farmers. The results support the view that financial innovation may help mitigate the real effects of uninsured production risk. In a second experiment, the study elicits willingness to pay for insurance policies that differ in their contract terms, using the Becker-DeGroot-Marshak mechanism. Willingness-to-pay is increasing in the actuarial value of the insurance, but substantially less than one-for-one, suggesting that farmers'valuations are inconsistent with a fully rational benchmark.
    Keywords: Climate Change Economics,Labor Policies,Debt Markets,Insurance Law,Non Bank Financial Institutions
    Date: 2013–07–01
  9. By: Javier Alonso; Tatiana Alonso; Santiago Fernandez de Lis; Cristina Rohde; David Tuesta
    Abstract: The financial system is undergoing an important regulatory overhaul, gradually increased during the last five years. Solvency II and Basel III are two of the most relevant global initiatives that try to reformulate the future landscape for finance. Under this scenario the Insurance and Pensions (I&P) industry, less affected in the crisis, is undergoing important changes that come from different channels. In this regard, this paper focuses on the main global regulatory trends affecting I&P, either directly from its own regulation or indirectly from changes in the banking sector regulation and strategies. After discussing the relevant characteristics of the different pieces of regulation, this study concludes that there is a great disparity among countries in the initial situation of the I&P sectors, both in terms of solvency levels and the diversification/riskiness of investment portfolios, which will cause different effects from a country base perspective: Notwithstanding this, there is a common challenge about how to reconcile more risk-sensitive regulation with the search for a yield in a world with consistently low interest rates. As a consequence of these new pieces of regulation, it is possible to anticipate a scenario of: higher fees; lower appetite for corporate debt; higher cost of derivatives hedging; reduced securitisation activity, an I&P industry more involved in infrastructure funding, and more real estate financing activity from the insurance sector. As regards sovereign debt, the present regulatory statu quo favours a higher demand of these securities by I&P, but the debate on whether to maintain its zero risk weight in Basel III and Solvency II may imply some changes in the future. What is clear in the near future is that regulators of banks, pensions and insurance sectors should analyse the interactions of new regulations; the associated trade-offs and risks and their consistency with a view to avoid creating wrong incentives for the long run.
    Keywords: Basel III, Solvency II, Regulation, Insurance, Pensions, Banking
    JEL: G18 G28 G38
    Date: 2013–06

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