New Economics Papers
on Risk Management
Issue of 2013‒09‒28
twenty papers chosen by

  1. Evaluating the Net Benefits of Macroprudential Policy: A Cookbook By Nicolas Arregui; Jaromir Benes; Ivo Krznar; Srobona Mitra; Andre Santos
  2. Republic of Poland: Technical Note on Stress Testing the Banking Sector By International Monetary Fund. Monetary and Capital Markets Department
  3. Systemic Risk Monitoring ("SysMo") Toolkit—A User Guide By Nicolas R. Blancher; Srobona Mitra; Hanan Morsy; Akira Otani; Tiago Severo; Laura Valderrama
  4. Credibility and Crisis Stress Testing By Li L. Ong; Ceyla Pazarbasioglu
  5. Default Probability Estimation via Pair Copula Constructions By Luciana Dalla Valle; Maria Elena De Giuli; Claudio Manelli; Claudia Tarantola
  6. Interactions Between Risk-Taking, Capital, and Reinsurance for Property-Liability Insurance Firms By Selim Mankaï; Aymen Belgacem
  7. International Evidence on Government Support and Risk Taking in the Banking Sector By Luís Brandão Marques; Ricardo Correa; Horacio Sapriza
  8. Equity, commodity and interest rate volatility derivatives By Alejandro Balbás; Iván Blanco; Eliseo Navarro
  9. The Impact of the Federal Reserve's Large-Scale Asset Purchase Programs on Corporate Credit Risk By Simon Gilchrist; Egon Zakrajsek
  10. Credit Contagion in Financial Markets: A Network-Based Approach By Steinbacher, Matjaz; Steinbacher, Mitja; Steinbacher, Matej
  11. Stock Prices and Stock Return Volatilities Implied by the Credit Market By Byström, Hans
  12. Near-Coincident Indicators of Systemic Stress By Ivailo Arsov; Elie Canetti; Laura E. Kodres; Srobona Mitra
  13. Rating Through-the-Cycle: What does the Concept Imply for Rating Stability and Accuracy? By John Kiff; Michael Kisser; Liliana Schumacher
  14. Survey of Reserve Managers: Lessons from the Crisis By Aideen Morahan; Christian B. Mulder
  15. European Union: Financial Sector Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  16. France: Financial Sector Assessment Program—Technical Note on Housing Prices and Financial Stability By International Monetary Fund. Monetary and Capital Markets Department
  17. Uruguay: Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  18. Bangladesh: First Review Under the Three-Year Arrangement Under the Extended Credit Facility and Request for Waiver of Nonobservance of a Performance Criterion—Staff Report, Staff Statements and Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Bangladesh By International Monetary Fund. Asia and Pacific Dept
  19. Belgium: Technical Note on Stress Testing the Banking and Insurance Sectors By International Monetary Fund. European Dept.
  20. Belgium: Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department

  1. By: Nicolas Arregui; Jaromir Benes; Ivo Krznar; Srobona Mitra; Andre Santos
    Abstract: The paper proposes a simple, new, analytical framework for assessing the cost and benefits of macroprudential policies. It proposes a measure of net benefits in terms of parameters that can be estimated: the probability of crisis, the loss in output given crisis, policy effectiveness in bringing down both the probability and damage during crisis, and the output-cost of a policy decision. It discusses three types of policy leakages and identifies instruments that could best minimize the leakages. Some rules of thumb for policymakers are provided.
    Keywords: Macroprudential Policy;Financial sector;Financial risk;Financial crisis;Risk management;Macroprudential Policy, Cost and Benefits, Policy Effectiveness
    Date: 2013–07–17
  2. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Stress testing;Banking sector;Credit risk;Risk management;Bank supervision;Poland;
    Date: 2013–08–15
  3. By: Nicolas R. Blancher; Srobona Mitra; Hanan Morsy; Akira Otani; Tiago Severo; Laura Valderrama
    Abstract: There has recently been a proliferation of new quantitative tools as part of various initiatives to improve the monitoring of systemic risk. The "SysMo" project takes stock of the current toolkit used at the IMF for this purpose. It offers detailed and practical guidance on the use of current systemic risk monitoring tools on the basis of six key questions policymakers are likely to ask. It provides "how-to" guidance to select and interpret monitoring tools; a continuously updated inventory of key categories of tools ("Tools Binder"); and suggestions on how to operationalize systemic risk monitoring, including through a systemic risk "Dashboard." In doing so, the project cuts across various country-specific circumstances and makes a preliminary assessment of the adequacy and limitations of the current toolkit.
    Keywords: Financial sector;Financial risk;Financial institutions;Spillovers;Financial crisis;Cross country analysis;Sytemic Risk; Risk Indicators; Risk Monitoring; Macroprudential Policy
    Date: 2013–07–17
  4. By: Li L. Ong; Ceyla Pazarbasioglu
    Abstract: Credibility is the bedrock of any crisis stress test. The use of stress tests to manage systemic risk was introduced by the U.S. authorities in 2009 in the form of the Supervisory Capital Assessment Program. Since then, supervisory authorities in other jurisdictions have also conducted similar exercises. In some of those cases, the design and implementation of certainelements of the framework have been criticized for their lack of credibility. This paper proposes a set of guidelines for constructing an effective crisis stress test. It combines financial markets impact studies of previous exercises with relevant case study information gleaned from those experiences to identify the key elements and to formulate their appropriate design. Pertinent concepts, issues and nuances particular to crisis stress testing are also discussed. The findings may be useful for country authorities seeking to include stress tests in their crisis management arsenal, as well as for the design of crisis programs.
    Keywords: Stress testing;Banking systems;Transparency;Bank supervision;Risk management;Asset quality review, crisis, disclosure, financial backstop, hurdle rates, liquidity risk, restructuring, solvency, transparency, CCAR, CEBS, EBA, PCAR, SCAP.
    Date: 2013–08–09
  5. By: Luciana Dalla Valle (School of Computing and Mathematics, Plymouth University); Maria Elena De Giuli (Department of Economics and Management, University of Pavia); Claudio Manelli (List S.p.A); Claudia Tarantola (Department of Economics and Management, University of Pavia)
    Abstract: In this paper we present a novel Bayesian approach for default probability estimation. The methodology is based on multivariate contingent claim analysis and pair copula theory. Balance sheet data are used to asses the firm value and to compute its default probability. The firm pricing function is obtained via a pair copula approach, and Monte Carlo simulations are used to calculate the default probability distribution. The methodology is illustrated through an application to defaulted firms data.
    Keywords: Bayesian analysis, Pair Copula, Default Risk, Multivariate Contingent Claim, Markov Chain Monte Carlo, Vines.
    JEL: E02 H63
    Date: 2013–07
  6. By: Selim Mankaï; Aymen Belgacem
    Abstract: Theory and empirical evidence suggest short-run interactions between capital and risk. This paper analyzes the effects of reinsurance, as a new endogenous decision variable, on this policy mix. We examine this issue using a system of simultaneous equations applied to the U.S. property-liability insurance industry. The results identify significant interactions between capital, risk and reinsurance. The relationship between risk and capital is positive, indicating the effectiveness of regulatory mechanisms. Reinsurance is negatively associated with capital, for which it appears to act as a substitute. These results are sensitive to the level of capital held in excess of the regulatory minimum requirements. Weakly capitalized firms adjust their reinsurance and risk levels more quickly and try to rebuild an appropriate capital buffer. Unlike other decision variables, the capital ratio converges toward a long-run target level.
    Keywords: Risk-taking, Capital based Regulation, Insurance, Simultaneous Equations, Instrumental Variables
    JEL: G22 G28 G32
    Date: 2013
  7. By: Luís Brandão Marques; Ricardo Correa; Horacio Sapriza
    Abstract: Government support to banks through the provision of explicit or implicit guarantees affects the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of bank data and government support to banks for the periods 2003-2004 and 2009-2010. We find that more government support is associated with more risk taking by banks, especially during the financial crisis (2009-10). We also find that restricting banks' range of activities ameliorates the moral hazard problem. We conclude that strengthening market discipline in the banking sector is needed to address this moral hazard problem.
    Keywords: Banking sector;Bank supervision;Bank regulations;Risk management;Bank risk, Market Discipline, Government Support, Bank Regulation.
    Date: 2013–05–02
  8. By: Alejandro Balbás; Iván Blanco; Eliseo Navarro
    Abstract: A new methodology to construct synthetic volatility derivatives is presented. The underlying asset price process is very general, since equity, commodities and interest rates are included. The focus is on volatility swaps and volatility swap options, but much more derivatives may be considered. The proposed methods optimize the conditional value at risk of the non-hedged risk, and yields both bid and ask prices, as well as optimal hedging strategies for both purchases and sales. Upper bounds for the broker capital losses under very negative scenarios are given. Numerical experiments are presented so as to illustrate the performance in practice of this new approach.
    Keywords: Incomplete and imperfect market, Risk measure, Volatility derivative, ommodity, Interest rate
    Date: 2013–09
  9. By: Simon Gilchrist; Egon Zakrajsek
    Abstract: Estimating the effect of Federal Reserve’s announcements of Large-Scale Asset Purchase (LSAP) programs on corporate credit risk is complicated by the simultaneity of policy decisions and movements in prices of risky financial assets, as well as by the fact that both interest rates of assets targeted by the programs and indicators of credit risk reacted to other common shocks during the recent financial crisis. This paper employs a heteroskedasticity-based approach to estimate the structural coefficient measuring the sensitivity of market-based indicators of corporate credit risk to declines in the benchmark market interest rates prompted by the LSAP announcements. The results indicate that the LSAP announcements led to a significant reduction in the cost of insuring against default risk—as measured by the CDX indexes—for both investment- and speculative-grade corporate credits. While the unconventional policy measures employed by the Federal Reserve to stimulate the economy have substantially lowered the overall level of credit risk in the economy, the LSAP announcements appear to have had no measurable effect on credit risk in the financial intermediary sector.
    JEL: E44 E58 G2
    Date: 2013–08
  10. By: Steinbacher, Matjaz; Steinbacher, Mitja; Steinbacher, Matej
    Abstract: We propose a network-based model of credit contagion and examine the e�ects of idiosyncratic and systemic shocks to individual banks and the banking system. The banking system is built as a network in which banks are connected to each other through the interbank market. The microstructure captures the relation between debtors and creditors, and the macroeconomic events capture the sensitivity of the banks' �nancial strenght to macroeconomic events, such as housing. We have demonstrated that while idiosyncratic shocks do not have a potential to substantially disturb the banking system, macroeconomic events of higher magnitudes could be highly harmful, especially if they also spur contagion. In a concerted default of more banks, the stability of a banking system tends to decrease disproportionately. In addition, credit risk analysis is highly sensitive to the network topology and exhibits a nonlinear characteristic. Capital ratio and recovery rates are two additional factors that contribute to the stability of the �nancial system.
    Keywords: credit contagion; network models; credit risk; structural models; fi�nancial stability; alpha-criticality index
    JEL: C63 G01
    Date: 2013
  11. By: Byström, Hans (Department of Economics, Lund University)
    Abstract: In this paper we compare equity- and credit investors’ opinions on the price formation in the equity market. More exactly, we invert the CreditGrades model in order to back out credit-implied stock prices and stock return volatilities from credit default swap spreads for the firms in the DJIA index. The credit-implied stock prices often deviate significantly from actual stock prices over the longer term. Meanwhile, their day-to-day movements are significantly correlated with actual stock returns for most firms in the DJIA index. In an attempt to demonstrate potential applications of credit-implied stock prices we construct simple “capital structure arbitrage” trading strategies based on past credit-implied prices. Our strategies only require the buying and selling of stocks and differ from traditional cross-capital structure strategies by being suitable for retail investors and other investors without access to the credit derivatives market. The credit-implied volatilities, in turn, behave rather similarly to observed stock market volatilities but without any ghost effects. We demonstrate how an alternative credit-based “fear gauge”, comparable to the VIX index but emanating from the credit market, can be constructed using the credit-implied volatilities. We call this implied volatility index the Credit-Implied Volatility Index (CIVIX) index. Finally, a plot of the entire term-structure of implied volatilities demonstrates a distinct maturity volatility skew.
    Keywords: credit default swaps; implied volatility; implied stock prices; CreditGrades; VIX
    JEL: G10
    Date: 2013–08–14
  12. By: Ivailo Arsov; Elie Canetti; Laura E. Kodres; Srobona Mitra
    Abstract: The G-20 Data Gaps Initiative has called for the IMF to develop standard measures of tail risk, which we identify in this paper with systemic risk. To understand the conditions under which tail risk is present, it is first necessary to develop a measure of what constitutes a systemic stress, or tail, event. We develop such a measure and uses it to assess the performance of eleven near-term systemic risk indicators as ‘early’ warning of distress among top financial institutions in the United States and the euro area. Two indicators perform particularly well in both regions, and a couple of other simple indicators do well across a number of criteria. We also find that the sizes of institutions do not necessarily correspond with their contribution to spillover risk. Some practical guidance for policies is provided.
    Keywords: International financial system;Financial institutions;Financial risk;Risk management;Coincident Indicator; Early Warning; Financial Stress; Systemic Risk; Tail Risk
    Date: 2013–05–17
  13. By: John Kiff; Michael Kisser; Liliana Schumacher
    Abstract: Credit rating agencies face a difficult trade-off between delivering both accurate and stable ratings. In particular, its users have consistently expressed a preference for rating stability, driven by the transactions costs induced by trading when ratings change frequently. Rating agencies generally assign ratings on a through-the-cycle basis whereas banks' internal valuations are often based on a point-in-time performance, that is they are related to the current value of the rated entity's or instrument's underlying assets. This paper compares the two approaches and assesses their impact on rating stability and accuracy. We find that while through-the-cycle ratings are initially more stable, they are prone to rating cliff effects and also suffer from inferior performance in predicting future defaults. This is because they are typically smooth and delay rating changes. Using a through-the-crisis methodology that uses a more stringent stress test goes halfway toward mitigating cliff effects, but is still prone to discretionary rating change delays.
    Keywords: Credit risk;Business cycles;Forecasting models;Credit ratings; Credit rating agencies; Credit rating migration
    Date: 2013–03–08
  14. By: Aideen Morahan; Christian B. Mulder
    Abstract: This paper reports in detail on a survey that was circulated to reserve managing central banks of IMF member countries in April 2012. The survey aims to gain further insight into how reserve managers have reacted to the crisis to date. The survey also aims to understand how reserve managers arrive at their strategic asset allocation and how they operate their risk management frameworks in practice. Some of the key themes that emerge from the survey include potential procyclical and counter cyclical behavior by reserve managers, increased focus placed on returns and wide variability across countries in how the currency composition of reserves is derived.
    Keywords: Central banks;Reserves;Risk management;Asset management;International Reserves, Foreign Currency Reserves, Official Reserves
    Date: 2013–05–08
  15. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Financial system stability assessment;European Union;Financial sector;Banks;Financial institutions;Bank supervision;Bank resolution;Deposit insurance;Monetary policy;Insurance supervision;Risk management;European Economic and Monetary Union;Europe;
    Date: 2013–03–15
  16. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Housing prices;Credit demand;Banks;Credit risk;Risk management;Financial stability;Financial Sector Assessment Program;France;
    Date: 2013–07–01
  17. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Financial sector;Public enterprises;Commercial banks;Stress testing;Bank supervision;Bank resolution;Basel Core Principles;Deposit insurance;Risk management;Pension funds;Payment systems;Financial system stability assessment;Reports on the Observance of Standards and Codes;Uruguay;
    Date: 2013–05–31
  18. By: International Monetary Fund. Asia and Pacific Dept
    Keywords: Extended Credit Facility;Performance criteria waivers;Staff Reports;Press releases;Economic reforms;Economic stabilization;Fiscal policy;Debt management;Monetary policy;Exchange rate policy;Investment policy;Economic indicators;Risk management;Economic growth;External shocks;Financial soundness indicators;Bangladesh;
    Date: 2013–03–11
  19. By: International Monetary Fund. European Dept.
    Keywords: Banking sector;Liquidity;Insurance;Stress testing;Risk management;Financial Sector Assessment Program;Belgium;
    Date: 2013–05–24
  20. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Financial system stability assessment;Financial sector;Banks;Insurance;Stress testing;Risk management;Bank supervision;Basel Core Principles;Insurance supervision;Corporate sector;Anti-money laundering;Combating the financing of terrorism;Reports on the Observance of Standards and Codes;Belgium;
    Date: 2013–05–17

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