nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒01‒10
thirteen papers chosen by
Stan Miles
Thompson Rivers University

  1. What Influences Banks' Choice of Risk Management Tools?: Theory and Evidence By Dilek Bülbül; Hendrik Hakenes; Claudia Lambert
  2. What Is the Best Risk Measure in Practice? A Comparison of Standard Measures By Suzanne Emmer; Marie Kratz; Dirk Tasche
  3. Are Banks' Internal Risk Parameters Consistent? Evidence from Syndicated Loans By Firestone, Simon; Rezende, Marcelo
  4. Can taxes tame the banks? Evidence from European bank levies By Michael P. Devereux; Niels Johannesen; John Vella
  5. Misconceptions about Credit Ratings - An Empirical Analysis of Credit Ratings across Market Sectors and Agencies By Kerstin Lopatta; Magdalena Tchikov; Finn Marten Körner
  6. The Impact of Merger and Acquisition on Value at Risk (VaR): A Case Study of China Eastern Airline By Fung, Ka Wai Terence; Wan, Wilson
  7. Bankruptcy Risk Induced by Career Concerns of Regulators By Godfrey Charles-Cadogan; John A. Cole
  8. The adoption of stress testing: why the Basel capital measures were not enough By Wall, Larry D.
  9. Determinants of European telecommunication operators systematic risk By Chalmeau, Olivier
  10. Taxation and corporate risk-taking By Dominika Langenmayr; Rebecca Lester
  11. A probability-based stress test of Federal Reserve assets and income By Christensen, Jens H.E.; Lopez, Jose A.; Rudebusch, Glenn D.
  12. The Baltic Dry Index: Cyclicalities, Forecasting and Hedging Strategies By Fotis Papailias; Dimitrios D. Thomakos
  13. Political Risk Spreads By Geert Bekaert; Campbell R. Harvey; Christian T. Lundblad; Stephan Siegel

  1. By: Dilek Bülbül; Hendrik Hakenes; Claudia Lambert
    Abstract: This paper investigates the factors influencing banks' decision to engage in advanced risk management, from both a theoretical and an empirical perspective. In recent decades, credit risk management in banks has become highly sophisticated and banks have become more active and advanced in the management of credit risks. We identify two driving factors for risk management: bank competition and sector concentration in the loan market. We find empirical support for our hypotheses, using a unique data set of 249 German banks; parts of the data set are hand-collected. Bank competition pushes banks to implement advanced risk management. Sector concentration in the loan market promotes credit portfolio modeling, but inhibits credit risk transfer.
    Keywords: banking, risk management, credit risk, credit portfolio modeling, credit risk transfer
    Date: 2013
  2. By: Suzanne Emmer (CREAR - Center of Research in Econo-finance and Actuarial sciences on Risk / Centre de Recherche Econo-financière et Actuarielle sur le Risque - ESSEC Business School); Marie Kratz (SID - Information Systems / Decision Sciences Department - ESSEC Business School, MAP5 - Mathématiques appliquées Paris 5 - CNRS : UMR8145 - Université Paris V - Paris Descartes); Dirk Tasche (Prudential Regulation Authority - Bank of England)
    Abstract: Expected Shortfall (ES) has been widely accepted as a risk measure that is conceptually superior to Value-at-Risk (VaR). At the same time, however, it has been criticized for issues relating to backtesting. In particular, ES has been found not to be elicitable which means that backtesting for ES is less straight-forward than, e.g., backtesting for VaR. Expectiles have been suggested as potentially better alternatives to both ES and VaR. In this paper, we revisit commonly accepted desirable properties of risk measures like coherence, comonotonic additivity, robustness and elicitability. We check VaR, ES and Expectiles with regard to whether or not they enjoy these properties, with particular emphasis on Expectiles. We also consider their impact on capital allocation, an important issue in risk management. We find that, despite the caveats that apply to the estimation and backtesting of ES, it can be considered a good risk measure. In particular, there is no sufficient evidence to justify an all-inclusive replacement of ES by Expectiles in applications, especially as we provide an alternative way for backtesting of ES.
    Keywords: Backtesting; Capital Allocation; Coherence; Diversification; Elicitability; Expected Shortfall; Expectile; Forecasts; Probability Integral Transform (PIT); Risk Measure; Risk Management; Robustness; Value-at-Risk
    Date: 2013–12
  3. By: Firestone, Simon (Board of Governors of the Federal Reserve System (U.S.)); Rezende, Marcelo (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper examines consistency in the estimates of probability of default (PD) and loss given default (LGD) that nine large U.S. banks assign to syndicated loans for regulatory capital purposes. Using internal bank data on loans that had PDs and LGDs assigned by more than one bank, we find substantial dispersion in these parameters. Banks differ substantially in PDs, but only a few set PDs systematically higher or lower than the median bank. However, many banks differ from the median bank systematically in LGDs, and these differences affect their Basel II minimum regulatory capital significantly. The differences in LGDs imply that, for an identical loan portfolio, the bank that sets the highest LGDs would have Basel II minimum regulatory capital twice as large as the bank that sets the lowest LGDs. We argue that these differences in risk parameters across banks can be at least partially explained by bank behavior that complies with the Basel rules. We also find a negative relation between banks' LGDs and their shares in loan syndicates, suggesting that differences in risk parameters have implications beyond bank capital.
    Keywords: Probability of default; loss given default; bank capital
    Date: 2013–10–01
  4. By: Michael P. Devereux (Oxford University Centre for Business Taxation); Niels Johannesen (University of Copenhagen); John Vella (Oxford University Centre for Business Taxation)
    Abstract: In the wake of the fi?nancial crisis, a number of countries have introduced levies on bank borrowing with the aim of reducing risk in the ?financial sector. This paper studies the behavioural responses to the bank levies and evaluates the policy. We find 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 offset 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 fi?nancial stability.
    JEL: H25
    Date: 2013
  5. By: Kerstin Lopatta (University of Oldenburg - Accounting and Corporate Governance & ZenTra); Magdalena Tchikov (University of Oldenburg - Accounting and Corporate Governance & ZenTra); Finn Marten Körner (University of Oldenburg & ZenTra)
    Abstract: Rating agencies strive to assign reliable, objective and comparable credit ratings as an indicator on one consistent scale. We test empirically how rating agencies meet their promise of providing objective and comparable assessments of credit risk of an issuer and thus creditworthiness. Logistic regressions of ratings across agencies and market sectors point to highly significant differences of ratings for issuers in the 11 market sectors in our sample. Based on inter-sectoral comparisons, we detect a systematically positive rating bias for financial issuers, while issuers operating in the cyclical consumer goods sector face relatively disadvantageous credit ratings. Our results indicate that the current assessment models and measurement standards do not only contain issuers’ credit risk but to a considerable extent also an assessment of industry and operating risk. Credit ratings should therefore not be equated with the likelihood of default as is often done in empirical applications. Stakeholders and especially investors – as well as researchers – should be aware of this misconception and not refer to ratings as pure measures of default risk.
    Keywords: credit ratings, credit risk, default probabilities, comparability
    JEL: G14 G15 G24
    Date: 2013–11
  6. By: Fung, Ka Wai Terence; Wan, Wilson
    Abstract: This paper attempts to examine the impact of merger and acquisition on Value at Risk (VaR) of China Eastern Airline. The VaR is estimated for the whole sample and pre-merger periods by three methods: RiskMetrics , AR-GARCH and Generalized Extreme Value (GEV). The regression-based model reports the highest VaR followed by RiskMetrics and GEV. All models report a low VaR after the 11 June, 2009 merger, indicating a negative impact of merger and acquisition on VaR.
    Keywords: Value at Risk, merger and acquisition, GARCH
    JEL: G11 G3 G34
    Date: 2013
  7. By: Godfrey Charles-Cadogan; John A. Cole
    Abstract: We introduce a model in which a regulator employs mechanism design to embed her human capital beta signal(s) in a firm's capital structure, in order to enhance the value of her post career change indexed executive stock option contract with the firm. We prove that the agency cost of this revolving door behavior increases the firm's financial leverage, bankruptcy risk, and affects estimation of firm value at risk (VaR).
    Date: 2013–12
  8. By: Wall, Larry D. (Federal Reserve Bank of Atlanta)
    Abstract: The Basel capital adequacy ratios lost credibility with financial markets during the crisis. This paper argues that failure was the result of the reliance of the Basel standards on overstated asset values in reported equity capital. The United States’ stress tests were able to assist in restoring credibility, in part because they could capture deterioration in asset values. However, whether stress tests will prove equally valuable in the next crisis is not clear. Some of the weaknesses in the Basel ratios are being addressed. Moreover, the U.S. tests’ success was the result of a combination of circumstances that may not exist next time.
    Keywords: Basel capital ratios; stress test; financial crisis
    JEL: E50 G01 G21 G28
    Date: 2013–12–01
  9. By: Chalmeau, Olivier
    Abstract: This article studies the determinants of systematic risk for a panel of European telecommunication incumbent operators. The systematic risk (the beta coefficient) is estimated with the capital asset pricing model using different econometric methods (OLS, ML GARCH and Kalman Filter). Previous empirical literature has identified accounting variables as being determinants of systematic risk. These control variables serve as a basis to study the impact of regulation and competition on risk. The Polynomics regulatory index is used for regulation and Herfindahl-Hirschman Indexes for competition. The overall index of regulation doesn't have a clear impact on risk. However, subindexes indicating quantity regulation is associated with higher risk. By quantity, we mean regulatory constraints such as Universal service obligation or coverage obligation for mobile networks. In contrast, access regulation decreases the risk. The impact of the competition's intensity is different for the mobile and fixed markets. Results for mobile competition are not significant whereas more intense fixed competition is associated with less risk. These results are consistent with the interpretation that regulation and competition have reduced the investment of the sector. It is also consistent with the observation that competition has taken place on services rather than on infrastructures. --
    Date: 2013
  10. By: Dominika Langenmayr (University of Munich); Rebecca Lester (Massachusetts Institute of Technology)
    Abstract: In the recent period of low growth, many governments look for ways to encourage economic activity. Risky investment by firms is an important source of macroeconomic growth. This paper contributes to recent literature on firm risk-taking by exploring if the corporate tax system can provide incentives for firms to undertake risky investment. To do so, we first model that the effect of taxes on firm risk-taking depends on loss offset possibilities. We then confirm our predictions empirically using a large international firm-level dataset. We find that firm risk-taking is positively and significantly related to the length of the tax loss carryback and carryforward periods and that this relation increases with the level of the tax rate. For firms that cannot expect to offset losses, higher tax rates reduce risk-taking. If loss offset is probable, however, corporate tax rates have a significant and positive effect on risk-taking.
    Keywords: Corporate taxation, firm risk-taking, net operating losses
    JEL: H25 H32 G32
    Date: 2013
  11. By: Christensen, Jens H.E. (Federal Reserve Bank of San Francisco); Lopez, Jose A. (Federal Reserve Bank of San Francisco); Rudebusch, Glenn D. (Federal Reserve Bank of San Francisco)
    Abstract: To support the economy, the Federal Reserve amassed a large portfolio of long-term bonds. We assess the Fed’s associated interest rate risk — including potential losses to its Treasury securities holdings and declines in remittances to the Treasury. Unlike past examinations of this interest rate risk, we attach probabilities to alternative interest rate scenarios. These probabilities are obtained from a dynamic term structure model that respects the zero lower bound on yields. The resulting probability-based stress test finds that the Fed’s losses are unlikely to be large and remittances are unlikely to exhibit more than a brief cessation.
    Keywords: term structure modeling; zero lower bound; monetary policy; quantitative easing
    JEL: E43 E52 E58 G12
    Date: 2013
  12. By: Fotis Papailias (Queen's University Management School, UK); Dimitrios D. Thomakos (Department of Economics, University of Peloponnese, Greece; Rimini Centre for Economic Analysis, Rimini, Italy)
    Abstract: The cyclical properties of the annual growth of the Baltic Dry Index (BDI) and their implications for short-to-medium term forecasting performance are investigated. We show that the BDI has a cyclical pattern which has been stable except for a period after the 2007 crisis. This pattern has implications for improved forecasting and strategic management on the future path of the BDI. To illustrate the practicality of our results, we perform an investment exercise that depends on the predicted signs. The empirical evidence supports the presence of the cyclical component and the ability of using forecast signs for improved risk management.
    Keywords: Baltic Dry Index, Commodities, Concordance, Cyclical Analysis, Forecasting, Hedging, Turning Points
    Date: 2013–12
  13. By: Geert Bekaert; Campbell R. Harvey; Christian T. Lundblad; Stephan Siegel
    Abstract: We introduce a new, market-based and forward looking measure of political risk derived from the yield spread between a country’s U.S. dollar debt and an equivalent U.S. Treasury bond. We explain the variation in these sovereign spreads with four factors: global economic conditions, country-specific economic factors, liquidity of the country’s bond, and political risk. We then extract the part of the sovereign spread that is due to political risk, making use of political risk ratings. In addition, we provide new evidence that these political risk ratings are predictive, on average, of future risk realizations using data on political risk claims as well as a novel textual-based database of risk realizations. Our political risk spread measure does not make the mistake of double counting systematic risk in the evaluation of international investments as some conventional measures do. Furthermore, we show how to construct political risk spreads for countries that do not have sovereign bond data. Finally, we link our political risk spreads to foreign direct investment. We show that a one percent point reduction in the political risk spread is associated with a 12 percent increase in net-inflows of foreign direct investment.
    JEL: F21 F23 F36 G15 G31 H25 K33 M21 O16 O19
    Date: 2014–01

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