New Economics Papers
on Risk Management
Issue of 2013‒09‒24
fourteen papers chosen by

  1. A Fast Algorithm for Computing High-dimensional Risk Parity Portfolios By Griveau-Billion, Théophile; Richard, Jean-Charles; Roncalli, Thierry
  2. Introducing Expected Returns into Risk Parity Portfolios: A New Framework for Tactical and Strategic Asset Allocation By Roncalli, Thierry
  3. Market-Based Structural Top-Down Stress Tests of the Banking System By Jorge A. Chan-Lau
  4. Volatility linkages between energy and agricultural commodity prices By Brenda López Cabrera,; Franziska Schulz,; ;
  5. A Framework for Macroprudential Bank Solvency Stress Testing: Application to S-25 and Other G-20 Country FSAPs By Andreas A. Jobst; Li L. Ong; Christian Schmieder
  6. How Effective are Macroprudential Policies in China? By Bin Wang; Tao Sun
  7. Creating a Safer Financial System: Will the Volcker, Vickers, and Liikanen Structural Measures Help? By José Vinãls; Ceyla Pazarbasioglu; Jay Surti; Aditya Narain; Michaela Erbenova; Julian T. S. Chow
  8. Competition Policy for Modern Banks By Lev Ratnovski
  9. Malaysia: Financial Sector Stability Assessment By International Monetary Fund. Asia and Pacific Dept
  10. France: Financial Sector Assessment Program—Technical Note on Crisis Management and Bank Resolution Framework By International Monetary Fund. Monetary and Capital Markets Department
  11. Risk Exposures and Financial Spillovers in Tranquil and Crisis Times: Bank-Level Evidence By Hélène Poirson; Jochen M. Schmittmann
  12. Market-Based Bank Capital Regulation By Bulow, Jeremy I.; Klemperer, Paul
  13. Structured Debt Ratings: Evidence on Conflicts of Interest By Efing, Matthias; Hau, Harald
  14. Banks’ Liquidity Buffers and the Role of Liquidity Regulation By Clemens Bonner; Iman van Lelyveld; Robert Zymek

  1. By: Griveau-Billion, Théophile; Richard, Jean-Charles; Roncalli, Thierry
    Abstract: In this paper we propose a cyclical coordinate descent (CCD) algorithm for solving high dimensional risk parity problems. We show that this algorithm converges and is very fast even with large covariance matrices (n > 500). Comparison with existing algorithms also shows that it is one of the most efficient algorithms.
    Keywords: Risk parity, risk budgeting, ERC portfolio, cyclical coordinate descent algorithm, lasso
    JEL: C60 G11
    Date: 2013–09–01
  2. By: Roncalli, Thierry
    Abstract: Risk parity is an allocation method used to build diversified portfolios that does not rely on any assumptions of expected returns, thus placing risk management at the heart of the strategy. This explains why risk parity became a popular investment model after the global financial crisis in 2008. However, risk parity has also been criticized because it focuses on managing risk concentration rather than portfolio performance, and is therefore seen as being closer to passive management than active management. In this article, we show how to introduce assumptions of expected returns into risk parity portfolios. To do this, we consider a generalized risk measure that takes into account both the portfolio return and volatility. However, the trade-off between performance and volatility contributions creates some difficulty, while the risk budgeting problem must be clearly defined. After deriving the theoretical properties of such risk budgeting portfolios, we apply this new model to asset allocation. First, we consider long-term investment policy and the determination of strategic asset allocation. We then consider dynamic allocation and show how to build risk parity funds that depend on expected returns.
    Keywords: risk parity, risk budgeting, expected returns, ERC portfolio, value-at-risk, expected shortfall, tactical asset allocation, strategic asset allocation
    JEL: G11
    Date: 2013–07–01
  3. By: Jorge A. Chan-Lau
    Abstract: Despite increased need for top-down stress tests of financial institutions, performing them is challenging owing to the absence of granular information on banks’ trading and loan portfolios. To deal with these data shortcomings, this paper presents a market-based structural top-down stress testing methodology that relies in market-based measures of a bank's probability of default and structural models of default risk to infer the capital losses they could experience in stress scenarios. As an illustration, the methodology is applied to a set of banks in an advanced emerging market economy.
    Keywords: Stress testing;Banking systems;Financial institutions;Emerging markets;Financial sector;Economic models;Stress tests, banks, default risk, systemic risk, structural models, market prices
    Date: 2013–04–10
  4. By: Brenda López Cabrera,; Franziska Schulz,; ;
    Abstract: In this paper we investigate price and volatility risk originating in link- ages between energy and agricultural commodity prices in Germany and study their dynamics over time. We propose an econometric approach to quantify the volatility and correlation risk structure, which has a large impact for in- vestment and hedging strategies of market participants as well as for policy makers. Volatilities and their short and long run linkages (spillovers) are an- alyzed using a dynamic conditional correlation GARCH model as well as a multivariate multiplicative volatility model. Our approach provides a exible and accurate fitting procedure for volatility and correlation risk.
    Keywords: Energy, Agriculture, Biodiesel, Commodities, Interdependencies, Volatility Spillovers
    JEL: G19 G29 G22 Q14 Q49 Q59
    Date: 2013–09
  5. By: Andreas A. Jobst; Li L. Ong; Christian Schmieder
    Abstract: The global financial crisis has placed the spotlight squarely on bank stress tests. Stress tests conducted in the lead-up to the crisis, including those by IMF staff, were not always able to identify the right risks and vulnerabilities. Since then, IMF staff has developed more robust stress testing methods and models and adopted a more coherent and consistent approach. This paper articulates the solvency stress testing framework that is being applied in the IMF’s surveillance of member countries’ banking systems, and discusses examples of its actual implementation in FSAPs to 18 countries which are in the group comprising the 25 most systemically important financial systems (“S-25â€) plus other G-20 countries. In doing so, the paper also offers useful guidance for readers seeking to develop their own stress testing frameworks and country authorities preparing for FSAPs. A detailed Stress Test Matrix (STeM) comparing the stress test parameters applie in each of these major country FSAPs is provided, together with our stress test output templates.
    Keywords: Banking sector;Stress testing;Financial systems;Group of Twenty;Economic models;Risk management;Financial Sector Assessment Program;Basel III, Financial Sector Assessment Plan (FSAP), G-20, macroprudential, S-25, satellite models, solvency, stress testing, surveillance.
    Date: 2013–03–13
  6. By: Bin Wang; Tao Sun
    Abstract: This paper investigates macroprudential policies and their role in containing systemic risk in China. It shows that China faces systemic risk in both the time (procyclicality) and cross-sectional (contagion) dimensions. The former is reflected as credit and asset price risks, while the latter is reflected as the links between the banking sector and informal financing and local government financing platforms. Empirical analysis based on 171 banks shows that some macroprudential policy tools (e.g., the reserve requirement ratio and house-related policies) are useful, but they cannot guarantee protection against systemic risk in the current economic and financial environment. Nevertheless, better-targeted macroprudential policies have greater potential to contain systemic risk pertaining to the different sizes of the banks and their location in regions with different levels of economic development. Complementing macroprudential policies with further reforms, including further commercialization of large banks, would help improve the effectiveness of those policies in containing systemic risk in China.
    Keywords: Macroprudential Policy;China;Financial risk;Banking sector;Systemic risk, Macroprudential policies, Effectiveness
    Date: 2013–03–27
  7. By: José Vinãls; Ceyla Pazarbasioglu; Jay Surti; Aditya Narain; Michaela Erbenova; Julian T. S. Chow
    Abstract: The U.S., the U.K., and more recently, the E.U., have proposed policy measures directly targeting complexity and business structures of banks. Unlike other, price-based reforms (e.g., Basel 3 and G-SIFI surcharges), these proposals have been developed unilaterally with material differences in scope, design and implementation schedules. This may exacerbate cross-border regulatory arbitrage and put a further burden on consolidated supervision and cross-border resolution. This paper provides an analysis of the potential implications of implementing different structural policy measures. It proposes a pragmatic and coordinated approach to development of these policies to reduce risk of regulatory arbitrage and minimize unintended consequences. In doing so, it also aims to identify a set of common policy measures that countries could adopt to re-scope bank business models and corporate structures.
    Keywords: Banking sector;Bank resolution;Bank supervision;Bank reforms;Risk management;International financial system;Bank business models, capital, least cost resolution, risk reduction, structural measures
    Date: 2013–05–14
  8. By: Lev Ratnovski
    Abstract: Traditional bank competition policy seeks to balance efficiency with incentives to take risk. The main tools are rules guiding entry/exit and consolidation of banks. This paper seeks to refine this view in light of recent changes to financial services provision. Modern banking is largely market-based and contestable. Consequently, banks in advanced economies today have structurally low charter values and high incentives to take risk. In such an environment, traditional policies that seek to affect the degree of competition by focusing on market structure (i.e. concentration) may have limited effect. We argue that bank competition policy should be reoriented to deal with the too-big-to-fail (TBTF) problem. It should also focus on the permissible scope of activities rather than on market structure of banks. And following a crisis, competition policy should facilitate resolution by temporarily allowing higher concentration and government control of banks.
    Keywords: Banking;Banks;Competition;Risk management;Banks, Competition Policy, Macroprudential Policy, Systemic Risk.
    Date: 2013–05–23
  9. By: International Monetary Fund. Asia and Pacific Dept
    Keywords: Financial sector;Banks;Islamic banking;Financial institutions;Bank supervision;Bank resolution;Liquidity management;Deposit insurance;Risk management;Anti-money laundering;Combating the financing of terrorism;Financial system stability assessment;Malaysia;
    Date: 2013–02–28
  10. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Bank resolution;Central bank role;Bank supervision;Deposit insurance;Risk management;Crisis prevention;International cooperation;Financial Sector Assessment Program;France;
    Date: 2013–07–01
  11. By: Hélène Poirson; Jochen M. Schmittmann
    Abstract: For a sample of 83 financial institutions during 2003–2011, this paper attempts to answer three questions: first, what is the evolution of banks’ stock price exposure to country-level and global risk factors as approximated by equity indices; second, which bank-specific characteristics explain these risk exposures; third, are there clusters of banks with equity price linkages beyond market risk factors. The paper finds a rise in sensitivities to both country and global risk factors in 2011, although on average to levels still below those of the subprime crisis. The average sensitivity to European risk, specifically, has been steadily rising since 2008. Banks that are reliant on wholesale funding, have weaker capital levels and low valuations, and higher exposures to crisis countries are found to be the most vulnerable to shocks. The analysis of bank-to-bank linkages suggests that any “globalization†of the euro area crisis is likely to be channelled through U.K. and U.S. banks, with little evidence of direct spillover effects to other regions.
    Keywords: Banks;Financial institutions;United States;United Kingdom;Germany;France;Europe;Financial risk;Stock prices;Spillovers;Financial crisis;Cross country analysis;Financial sector; financial institutions; banks; Europe; financial crisis; spillovers.
    Date: 2013–06–05
  12. By: Bulow, Jeremy I.; Klemperer, Paul
    Abstract: Today’s regulatory rules, especially the easily-manipulated measures of regulatory capital, have led to costly bank failures. We design a robust regulatory system such that (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals (because the simplicity and clarity of such rules prevents gaming by firms, and forbearance by regulators, as well as because of the efficiency role of prices). One key innovation is “ERNs” (equity recourse notes--superficially similar to, but importantly distinct from, “cocos”) which gradually "bail in" equity when needed. Importantly, although our system uses market information, it does not rely on markets being “right”.
    Keywords: bail-in; bank; bank capital; bank crisis; capital requirements; contingent capital; contingent convertible bond; debt overhang; deposit insurance; living wills; regulatory capital; regulatory forbearance; SIFI; systemically important financial institution; too-big-to-fail
    JEL: G10 G21 G28 G32
    Date: 2013–08
  13. By: Efing, Matthias; Hau, Harald
    Abstract: This paper tests for conflicts of interest in the rating process of European asset- and mortgage-backed securities based on a new aggregation method for a deal's different tranche ratings. Controlling for a large set of determinants of credit risk, we find that credit rating agencies provide better credit ratings for the structured products of those issuers that provide them with more overall bilateral rating business. This effect is particularly pronounced in the run-up to the subprime crisis and for structured products with the worst collateral. Rating favors to the largest clients generate economically significant competitive distortion, foster issuer concentration and contribute to the "too big to fail" status of large issuer banks.
    Keywords: conflicts of interest; credit ratings; ratings inflation; structured debt
    JEL: G01 G10 G24
    Date: 2013–05
  14. By: Clemens Bonner; Iman van Lelyveld; Robert Zymek
    Abstract: We assess the determinants of banks’ liquidity holdings using balance sheet data for nearly 7000 banks from 30 OECD countries over a ten-year period. We highlight the role of several bank-specific, institutional and policy variables in shaping banks’ liquidity risk management. Our main question is whether the presence of liquidity regulation substitutes or complements banks’ incentives to hold liquid assets. Our results reveal that in the absence of liquidity regulation, the determinants of banks’ liquidity buffers are a combination of bank-specific (business model, profitability, deposit holdings, size) and country-specific (disclosure requirements, concentration of the banking sector) variables. While most incentives are substituted by liquidity regulation, a bank’s disclosure requirement and size remain significant. A key takeaway from our analysis is that the complementary nature of disclosure and liquidity requirements provides a strong rationale for considering them jointly in the design of regulation.
    Keywords: Liquidity; Regulation; Disclosure; Business Models
    JEL: G20 G21 G28
    Date: 2013–09

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