nep-rmg New Economics Papers
on Risk Management
Issue of 2013‒12‒06
fifteen papers chosen by
Stan Miles
Thompson Rivers University

  1. The impact of systemic risk on the diversification benefits of a risk portfolio By Marc Busse; Michel Dacorogna; Marie Kratz
  2. Non-parametric Estimation of Operational Risk and Expected Shortfall By Ainura Tursunalieva; Param Silvapulle
  3. Disaster Risk Management at the National Level By Ishiwatari, Mikio
  4. Testing extreme value copulas to estimate the quantile By Zuhair Bahraou; Catalina Bolancé; Ana M. Pérez-Marín
  5. Differentiation of Market Risk Characteristics among Sharia Compliant and Conventional Equities listed on the Pakistani Capital Market - KSE 100 Index over a selective time period. By Syed Adeel Hussain
  6. Deposit Insurance Adoption and Bank Risk-Taking: the Role of Leverage By Mathias Lé
  7. An asymmetric approach to the cost of equity estimation: empirical evidence from Russia By Yury Dranev; Sofya Fomkina
  8. Introducing time-changing economics into credit scoring By Maria Rocha Sousa; João Gama; Elísio Brandão
  9. Smile from the Past: A general option pricing framework with multiple volatility and leverage components By Majewski, A. A.; Bormetti, G.; Corsi, F.
  10. Disaster Risk Management at the Regional Level: The Case of Asia and the Pacific By Jeggle, Terry
  11. Bank reactions after capital shortfalls By Kok, Christoffer; Schepens, Glenn
  12. Entrepreneurial tail risk: implications for employment dynamics By Thorsten Drautzburg
  13. On the prediction of corporate financial distress in the light of the financial crisis: empirical evidence from Greek listed firms By Evangelos C. Charalambakis
  14. Risk- and ambiguity-averse portfolio optimization with quasiconcave utility functionals By Sigrid K\"allblad
  15. Optimal insurance purchase strategies via optimal multiple stopping times By Rodrigo S. Targino; Gareth W. Peters; Georgy Sofronov; Pavel V. Shevchenko

  1. By: Marc Busse; Michel Dacorogna; Marie Kratz
    Abstract: Risk diversification is the basis of insurance and investment. It is thus crucial to study the effects that could limit it. One of them is the existence of systemic risk that affects all the policies at the same time. We introduce here a probabilistic approach to examine the consequences of its presence on the risk loading of the premium of a portfolio of insurance policies. This approach could be easily generalized for investment risk. We see that, even with a small probability of occurrence, systemic risk can reduce dramatically the diversification benefits. It is clearly revealed via a non-diversifiable term that appears in the analytical expression of the variance of our models. We propose two ways of introducing it and discuss their advantages and limitations. By using both VaR and TVaR to compute the loading, we see that only the latter captures the full effect of systemic risk when its probability to occur is low
    Date: 2013–12
  2. By: Ainura Tursunalieva; Param Silvapulle
    Abstract: This paper proposes improvements to advanced measurement approach (AMA) to estimating operational risks, and applies the improved methods to US business losses categorised into five business lines and three event types operational losses. The AMA involves, among others, modelling a loss severity distribution and estimating the Expected Loss and the 99.9% operational value-at-risk (OpVaR). These measures form a basis for calculating the levels of regulatory and economic capitals required to cover risks arising from operational losses. In this paper, Expected Loss and OpVaR are estimated consistently and efficiently by nonparametric methods, which use the large (tail) losses as primary inputs. In addition, the 95% intervals for the underlying true OpVaR are estimated by the weighted empirical likelihood method. As an alternate measure to OpVaR, the Expected Shortfall - a coherent risk- is also estimated. The empirical findings show that the interval estimates are asymmetric, with very large upper bounds, highlighting the extent of uncertainties associated with the 99.9% OpVaR point estimates. The Expected Shortfalls are invariably greater than the corresponding OpVaRs. The heavier the loss severity distribution the greater the difference between OpVaR and Expected Shortfall, from which we infer that the latter would provide the right level of capital to cover risks than would the former, particularly during
    Keywords: Heavy-tailed distribution, Loss severity distribution, Data tilting method, OpVaR, Expected shortfall
    Date: 2013
  3. By: Ishiwatari, Mikio (Asian Development Bank Institute)
    Abstract: National governments are supposed to play a pivotal role in disaster risk management (DRM). This paper reviews trends and patterns in developing governance and institutions in DRM in the Asia and the Pacific region. The paper then derives recommendations on how to establish disaster risk governance for developing countries, including mainstreaming DRM into development plans and policies. A four-pronged approach is presented: First, strengthen the DRM coordination role of the national government. Second, develop an enhanced legal framework. Third, establish a DRM focal point agency. Fourth, build a flexible cooperation system among concerned organizations and all levels of government.
    Keywords: disaster risk management; asia; pacific; disaster risk governance
    JEL: H84 Q54
    Date: 2013–11–26
  4. By: Zuhair Bahraou (Department of Econometrics, Riskcenter-IREA, University of Barcelona, Av. Diagonal, 690, 08034 Barcelona, Spain); Catalina Bolancé (Department of Econometrics, Riskcenter-IREA, University of Barcelona, Av. Diagonal, 690, 08034 Barcelona, Spain); Ana M. Pérez-Marín (Department of Econometrics, Riskcenter-IREA, University of Barcelona, Av. Diagonal, 690, 08034 Barcelona, Spain)
    Abstract: Testing weather or not data belongs could been generated by a family of extreme value copulas is difficult. We generalize a test and we prove that it can be applied whatever the alternative hypothesis. We also study the effect of using different extreme value copulas in the context of risk estimation. To measure the risk we use a quantile. Our results have motivated by a bivariate sample of losses from a real database of auto insurance claims. Methods are implemented in R.
    Keywords: Extreme value copula, Extreme value distributions, Quantile
    Date: 2013–11
  5. By: Syed Adeel Hussain
    Abstract: This technical paper highlights the substantive and notable Market Risk difference among Islamic and Conventional Securities with respect to their Actual Price Volatility Risk Characteristics in context of Listed Pakistani Capital Markets. The data analyzes market risk of each listed security based on price series of the last five years drawn from the KSE 100 Index. We have used KMI 30 Index within KSE 100 Index to separate Islamic Stocks from their conventional counterparts. The study has applied two different market risk measurement methods of VaR - Value at Risk calculation such as Historical Simulation and VCV â Variance Covariance. In this paper three different confidence intervals are applied distinctly but simultaneously to both methods of VaR Calculation and groups of stocks ie (Islamic/Sharia Compliant and Conventional Equities). At the end, Percentiles are used to classify VaR measurements belonging to each group of stock. The Null Hypothesis is tested using a difference between means of two populationsâ z test statistic model at given 5% level of significance. The intention of writing this paper was to technically âfill the literature gapâ which exists within the purview of literature review covering both areas in Risk Finance and Islamic Finance.
    JEL: G1
    Date: 2013–12–02
  6. By: Mathias Lé (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales [EHESS] - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris - Institut national de la recherche agronomique (INRA), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, ACPR - Autorité de Contrôle Prudentiel et de Résolution - Autorité de Contrôle Prudentiel et de Résolution)
    Abstract: Explicit deposit insurance is a crucial ingredient of modern financial safety nets. This paper investigates the effect of deposit insurance adoption on individual bank leverage. Using a panel of banks across 117 countries during the period 1986-2011, I show that deposit insurance adoption pushes banks to increase significantly their leverage by reducing their capital buffer. This increase in bank leverage then translates into higher probability of insolvency. Most importantly, I bring evidence that deposit insurance adoption has important competitive effects: I show that large, systemic and highly leveraged banks are unresponsive to deposit insurance adoption.
    Keywords: Deposit Insurance; Bank Risk-Taking; Leverage; Systemic Bank; Capital Buffer
    Date: 2013–11
  7. By: Yury Dranev (National Research University Higher School of Economics); Sofya Fomkina (National Research University Higher School of Economics)
    Abstract: The choice of an appropriate model for the estimation of the cost of equity in emerging markets is still a very challenging problem. Market inefficiency, limited opportunities for diversification, as well as liquidity issues inspire researches to look for risk characteristics beyond the traditional framework of the classical capital asset pricing model. Various models have been developed over the past several decades proposing new ways of risk assessment. However, the empirical evidence of these models requires careful consideration. Most asset pricing models were developed in terms of either a symmetric mean-variance or a folded mean-semivariance framework. These models have several drawbacks in capturing investors’ attitudes to stock price movements. We provide a brief description of the recently proposed entropic risk characteristics which assign greater weight to the downside movements of asset prices and smaller weight to the upside movements. The goal of this study is to determine which model has better explanatory power for returns in the Russian capital market. We compare the performance of risk measures in the Russian stock market on a dataset of 63 stocks for the period from 2003 to 2012. Empirical results show certain advantages of entropic risk characteristics over other risk measures in explaining returns on Russian equities.
    Keywords: rate of return, cost of equity, CAPM, entropic variance.
    JEL: G12 G32
    Date: 2013
  8. By: Maria Rocha Sousa (School of Economics and Management, University of Porto); João Gama (LIAAD-INESC TEC; School of Economics and Management, University of Porto); Elísio Brandão (School of Economics and Management, University of Porto)
    Abstract: We propose a two-stage model for dealing with the temporal degradation of credit scoring models. First, we develop a model from a classical framework, with a static supervised learning setting and binary output. Then, we introduce the time-changing economic factors, using a regression between the macroeconomic data and the internal default in the portfolio. In so doing, the specific risk is captured from the bank internal database, and the movement of systemic risk is determined with the regression. This methodology produced motivating results in a 1-year horizon, for a portfolio of customers with credit cards in a financial institution operating in Brazil. We anticipate that it can be extended to other applications of risk assessment with great success. This methodology can be further improved if more information about the economic cycles is integrated in the forecasting of default.
    Keywords: risk assessment; credit scoring; temporal degradation; score adjustment; time-changing economics
    JEL: C5 C8
    Date: 2013–11
  9. By: Majewski, A. A.; Bormetti, G.; Corsi, F.
    Abstract: In the current literature, the analytical tractability of discrete time option pricing models is guarantee only for rather specific type of models and pricing kernels. We propose a very general and fully analytical option pricing framework encompassing a wide class of discrete time models featuring multiple components structure in both volatility and leverage and a flexible pricing kernel with multiple risk premia. Although the proposed framework is general enough to include either GARCH-type volatility, Realized Volatility or a combination of the two, in this paper we focus on realized volatility option pricing models by extending the Heterogeneous Autoregressive Gamma (HARG) model of Corsi et al. (2012) to incorporate heterogeneous leverage structures with multiple components, while preserving closed-form solutions for option prices. Applying our analytically tractable asymmetric HARG model to a large sample of S&P 500 index options, we evidence its superior ability to price out-of-the-money options compared to existing benchmarks.
    Date: 2013
  10. By: Jeggle, Terry (Asian Development Bank Institute)
    Abstract: Hazards have no respect for the political boundaries of countries, so it is essential for disaster risk management (DRM) to be developed with a strong regional perspective. This paper describes a wide range of regional initiatives in Asia and the Pacific that rely on innovative solutions being adopted within a holistic approach and that link national governments, regional organizations, diverse sectors, and public and private bodies. The study illustrates how crucial the regional scale of engagement is for concentrating the common interests of individual government policy commitments to DRM, while supplementing countries’ own resources with expanded institutional relationships to energize a more sustained impetus to reduce disaster risks throughout the region. Regional attributes include the beneficial attention of distributed specialist technical, scientific, and academic institutions that are motivated by interests beyond disaster concerns.
    Keywords: disaster risk management; regional cooperation; asia; pacific
    JEL: H84 Q54
    Date: 2013–11–26
  11. By: Kok, Christoffer; Schepens, Glenn
    Abstract: This paper investigates whether European banks have capital targets and how deviations from the target impact their equity composition and activity mix. Using quarterly data for a sample of large European banks between 2004 and 2011, we show that there are notable asymmetries in banks' reactions to deviations from optimal capital levels. Banks prefer to reshuffle risk-weighted assets or increase asset holdings when being above their optimal Tier 1 ratio, whereas they rather try to increase equity levels or reshuffle risk-weighted assets without changing asset holdings when being below target. At the same time, focusing instead on a unweighted equity ratio target, we find evidence of deleveraging and lower loan growth for undercapitalized banks during the recent financial crisis, whereas in the pre-crisis periods banks primarily reacted to deviations from their optimal target by adjusting equity levels. JEL Classification: D22, E44, G20, G21, G28
    Keywords: bank capital optimisation, banking, capital structure, deleveraging, financial regulation
    Date: 2013–11
  12. By: Thorsten Drautzburg
    Abstract: New businesses are important for job creation and have contributed more than proportionally to the expansion in the 1990s and the decline of employment after the 2007 recession. This paper provides a framework for analyzing determinants of business creation in a world where new business owners are exposed to idiosyncratic risk due to initial imperfect diversification. This paper uses this framework to analyze how entrepreneurial risk has changed over time and how this has affected employment in the US. Conditions are provided under which entrepreneurial risk can be identified using micro data on the size distribution of new businesses and their exit rates. The baseline model considers both upside and downside risk. Applied to US time series data, structural estimates suggest that higher upside risk explains much of the high job creation in the late 1990s. Time variation in risk explains around 40% of the variation in employment of new businesses. Reduced form results show that this relationship is strongest in IT-related industries. When restricting the model to a single risk factor, the explanatory power for employment drops by 25% to 50% compared to the baseline estimates.
    Keywords: Employment ; Entrepreneurship ; Risk
    Date: 2013
  13. By: Evangelos C. Charalambakis (Bank of Greece)
    Abstract: This paper evaluates the impact of accounting and market-driven information on the prediction of bankruptcy for Greek firms using the discrete hazard approach. The findings show that a hazard model that incorporates three accounting ratio components of Z-score and three market-driven variables is the most appropriate model for the prediction of corporate financial distress in Greece. This model outperforms a univariate model that uses the expected default frequency (EDF) derived from the Merton distance to default model, a multivariate model that is exclusively based on accounting variables, a model that combines EDF and accounting variables and a multivariate model that uses only market-driven variables. In-sample forecast accuracy tests confirm the main results. The out-of-sample evidence also suggests that the model yields the highest predictive ability during financial crisis when using data prior to the financial crisis.
    Keywords: financial distress; financial forecasting; hazard model; expected default frequency
    JEL: G13 G17 G33 C41
    Date: 2013–10
  14. By: Sigrid K\"allblad
    Abstract: Motivated by recent axiomatic developments, we study the risk- and ambiguity-averse investment problem where trading takes place over a fixed finite horizon and terminal payoffs are evaluated according to a criterion defined in terms of a quasiconcave utility functional. We extend to the present setting certain existence and duality results established for the so-called variational preferences by Schied (2007). The results are proven by building on existing results for the classical utility maximization problem.
    Date: 2013–11
  15. By: Rodrigo S. Targino; Gareth W. Peters; Georgy Sofronov; Pavel V. Shevchenko
    Abstract: In this paper we study a class of insurance products where the policy holder has the option to insure $k$ of its annual Operational Risk losses in a horizon of $T$ years. This involves a choice of $k$ out of $T$ years in which to apply the insurance policy coverage by making claims against losses in the given year. The insurance product structure presented can accommodate any kind of annual mitigation, but we present three basic generic insurance policy structures that can be combined to create more complex types of coverage. Following the Loss Distributional Approach (LDA) with Poisson distributed annual loss frequencies and Inverse-Gaussian loss severities we are able to characterize in closed form analytical expressions for the multiple optimal decision strategy that minimizes the expected Operational Risk loss over the next $T$ years. For the cases where the combination of insurance policies and LDA model does not lead to closed form expressions for the multiple optimal decision rules, we also develop a principled class of closed form approximations to the optimal decision rule. These approximations are developed based on a class of orthogonal Askey polynomial series basis expansion representations of the annual loss compound process distribution and functions of this annual loss.
    Date: 2013–12

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