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on Risk Management |
| By: | Maarten van Oordt; Chen Zhou |
| Abstract: | We test for the presence of a systematic tail risk premium in the cross-section of expected returns by applying a measure on the sensitivity of assets to extreme market downturns, the tail beta. Empirically, historical tail betas help to predict the future performance of stocks under extreme market downturns. During a market crash, stocks with historically high tail betas suffer losses that are approximately 2 to 3 times larger than their low tail beta counterparts. However, we find no evidence of a premium associated with tail betas. The theoretically additive and empirically persistent tail betas can help to assess portfolio tail risks. |
| Keywords: | Tail beta; systematic risk; asset pricing; Extreme Value Theory; risk management |
| JEL: | G11 G12 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:400&r=rmg |
| By: | Dong Hwan Oh; Andrew J. Patton |
| Abstract: | This paper proposes a new class of copula-based dynamic models for high dimension conditional distributions, facilitating the estimation of a wide variety of measures of systemic risk. Our proposed models draw on successful ideas from the literature on modeling high dimension covariance matrices and on recent work on models for general time-varying distributions. Our use of copula-based models enable the estimation of the joint model in stages, greatly reducing the computational burden. We use the proposed new models to study a collection of daily credit default swap (CDS) spreads on 100 U.S. firms over the period 2006 to 2012. We find that while the probability of distress for individual firms has greatly reduced since the financial crisis of 2008-09, the joint probability of distress (a measure of systemic risk) is substantially higher now than in the pre-crisis period. |
| Keywords: | correlation, tail risk, financial crises, DCC |
| JEL: | C32 C58 G01 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:duk:dukeec:13-30&r=rmg |
| By: | Marcelo Bianconi; Xiaxin Hua; Chih Ming Tan |
| Abstract: | We study the effects of two measures of information dissemination on the determination of systemic risk. One measure is print-media consumer sentiment based while the other is volatility based. We find evidence that while the volatility measure (VIX) of future expectations has a more significant direct impact upon systemic risk of financial firms under distress, a consumer sentiment measure based on print-media news does impact upon firm's financial stress via the externality of other firm's financial stress. This latter effect is robust even though the VIX and the consumer sentiment have dynamic feedback in the short one and two-day horizon in levels, and contemporaneously in volatility. In reference to the internet bubble of the 1990s, the consumer sentiment measure predicts larger systemic risk in the whole period of exuberance while the VIX predicts a sharp larger systemic risk in the height of the bubble. Our evidence suggests that print-media consumer sentiment might be dominated by the VIX when predicting systemic risk. |
| Keywords: | conditional value-at-risk, VIX, externality, consumer sentiment |
| JEL: | G00 G14 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:tuf:tuftec:0776&r=rmg |
| By: | Silva Buston, C.F. (Tilburg University, Center for Economic Research) |
| Abstract: | Abstract: This paper analyzes the net impact of two opposing effects of active risk management at banks on their stability: higher risk-taking incentives and better isolation of credit supply from varying economic conditions. We present a model where banks actively manage their portfolio risk by buying and selling credit protection. We show that anticipation of future risk management opportunities allows banks to operate with riskier balance sheets. However, since they are better insulated from shocks than banks without active risk management, they are less prone to insolvency. Empirical evidence from US bank holding companies broadly supports the theoretical predictions. In particular, we fi nd that active risk management banks were less likely to become insolvent during the crisis of 2007-2009, even though their balance sheets displayed higher risktaking. These results provide an important message for bank regulation, which has mainly focused on balance-sheet risks when assessing fi nancial stability. |
| Keywords: | Financial innovation;credit derivatives;financial stability;financial crisis |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2013068&r=rmg |
| By: | M. Falagiarda; A. Saia |
| Abstract: | This paper proposes a new Dynamic Stochastic General Equilibrium (DSGE) model with credit frictions and a banking sector, which endogenizes loan-to-value (LTV) ratios of households and banks by expressing them as a function of systemic and idiosyncratic proxies for risk. Moreover, the model features endogenous balance sheet choices and a novel formulation of the targeted leverage ratio, in which assets are risk-weighted by risk-sensitivity measures. The results highlighted in this paper are important along two dimensions. First of all, the presence of endogenous LTV ratios exacerbates the procyclicality of lending conditions. Second, the model contributes to deeper understand the role of prudential regulatory frameworks in affecting business cycle fluctuations and in restoring macroeconomic and financial stability. The results suggest that when the economy is severely stressed by shocks originating in the financial sector, prudential regimes such as Basel II and Basel III are capable of downsizing substantially aggregate volatility, with Basel III found to be significantly more effective than Basel II. |
| JEL: | E32 E44 E61 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:bol:bodewp:wp916&r=rmg |
| By: | Xu, Guo; Wing-Keung , Wong; Lixing, Zhu |
| Abstract: | This paper investigates the impact of background risk on an investor’s portfolio choice in a mean-VaR, mean-CVaR and mean-variance framework, and analyzes the characterizations of the mean-variance boundary and mean-VaR efficient frontier in the presence of background risk. We also consider the case with a risk-free security. |
| Keywords: | Background risk; Portfolio selection; VaR; CVaR |
| JEL: | C00 G11 |
| Date: | 2013–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:51827&r=rmg |
| By: | Zhongliang Tuo |
| Abstract: | By adopting the polynomial interpolation method, we propose an approach to hedge against the interest-rate risk of the default-free bonds by measuring the nonparallel movement of the yield-curve, such as the translation, the rotation and the twist. The empirical analysis shows that our hedging strategies are comparable to traditional duration-convexity strategy, or even better when we have more suitable hedging instruments on hand. The article shows that this strategy is flexible and robust to cope with the interest-rate risk and can help ?fine-tune a position as time changes. |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1312.6841&r=rmg |
| By: | Michael P. Devereux (Centre for Business Taxation, Oxford University); Niels Johannesen (Copenhagen University); John Vella (Centre for Business Taxation, Oxford University) |
| Abstract: | In the wake of the ?nancial crisis, a number of countries have introduced levies on bank borrowing with the aim of reducing risk in the ?nancial sector. This paper studies the behavioral responses to the bank levies and evaluates the policy. We ?nd that the levies induced banks to borrow less but also to hold more risky assets. The reduction in funding risk clearly dominates for banks with high capital ratios but is exactly o¤set by the increase in portfolio risk for banks with low capital ratios. This suggests that while the levies have reduced the total risk of relatively safe banks, they have done nothing to curb the risk of relatively risky banks, which presumably pose the greatest threat to ?nancial stability. |
| Date: | 2013–12–09 |
| URL: | http://d.repec.org/n?u=RePEc:kud:epruwp:1315&r=rmg |
| By: | Schaeck, K.; Silva Buston, C.F.; Wagner, W.B. (Tilburg University, Center for Economic Research) |
| Abstract: | Abstract: We decompose the correlation of bank stock returns into a systemic risk component and a component arising from diversi cation activities. Estimation for U.S. Bank Holding Companies (BHCs) shows the diversification component to be large and positively related to BHC performance during the crisis of 2007-2009. This suggests that it is important to distinguish between the two sources of interbank correlations when quantifying systemic risk at banks. Our decomposition also permits us to estimate the marginal gains from diversfication, which turn out to be rapidly declining with bank size. Since large banks are additionally found to display high levels of the systemic risk component, they are hence predominantly exposed to the undesirable source of interbank correlation. |
| Keywords: | systemic risk;interbank correlation;diversification |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2013077&r=rmg |
| By: | Eric Ghysels; Pierre Guérin; Massimiliano Marcellino |
| Abstract: | This paper deals with the estimation of the risk-return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk-return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk-return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk-return relation is reversed, whereas the intuitive positive risk-return trade-off holds in the second regime. The first regime is interpreted as a “flight-to-quality” regime. |
| Keywords: | Econometric and statistical methods; Financial markets |
| JEL: | G10 G12 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:13-51&r=rmg |
| By: | Xavier Gine (World Bank); James Vickery (Federal Reserve Bank of New York); Shawn Cole (Harvard Business School) |
| Abstract: | Rainfall variation and other weather shocks are a key source of risk for many firms and households, particularly in the developing world. We study how the availability of risk management instruments designed to hedge rainfall risk affects investment and production decisions of small- and medium-scale Indian farmers. We use a field experiment approach, involving randomized provision of rainfall insurance to farmers. While we find little effect on total expenditures, increased insurance induces farmers to substitute production activities towards high-return but higher-risk cash crops, consistent with theoretical predictions. Our results support the view that financial innovation may help ameliorate costs associated with weather variability and other types of risk. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:676&r=rmg |
| By: | Marcelo Madureira Prates |
| Abstract: | In this paper, we suggest that the regulation of the financial system, especially if the aim is to prevent financial crises, should be focused on dealing with the consequences of the crises, not on trying to avoid their causes, although it may seem counterintuitive at first sight. Contrary to the majority of opinions in the field, we firmly believe that more important than organizing the best possible prudential regulation is having a solid and well-developed financial safety net. Building a strong safety net might not only boost confidence in the financial system and contribute to its stability, but also create the right incentives to avoid reckless risk-taking, mainly if there are rules establishing that other financial institutions, creditors and even executives could be held responsible for the trouble caused by any failed financial institution |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:335&r=rmg |