nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒01‒24
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. On the Measurement of Economic Tail Risk By Steven Kou; Xianhua Peng
  2. Law-invariant risk measures: extension properties and qualitative robustness By Pablo Koch-Medina; Cosimo Munari
  3. Basel Norms and Analysis of Banking Risks; Performance and Future Prospects. By Bisht, Poonam
  4. Contextualizing Systemic Risk By Lukas Scheffknecht
  5. An application of capital allocation principles to operational risk By Urbina, Jilber; Guillén, Montserrat
  6. Equity Portfolio Diversification: How Many Stocks are Enough? Evidence from Five Developed Markets By Alexeev, Vitali; Tapon, Francis
  7. Surplus-invariant capital adequacy tests and their risk measures By Pablo Koch-Medina; Santiago Moreno-Bromberg; Cosimo Munari
  8. Unrisky business: Asset management cannot create systemic risk By Peter J. Wallison
  9. Risk aggregation and stochastic claims reserving in disability insurance By Boualem Djehiche; Bj\"orn L\"ofdahl
  10. "Optimal Hedging for Fund & Insurance Managers with Partially Observable Investment Flows" By Masaaki Fujii; Akihiko Takahashi
  11. Equity portfolio diversification with high frequency data By Alexeev, Vitali; Dungey, Mardi
  12. Quasi-Hadamard differentiability of general risk functionals and its application By Volker Kr\"atschmer; Alexander Schied; Henryk Z\"ahle
  13. Basel Accords and Islamic finance with special reference to Malaysia By Hasan, Zubair
  14. What Australian investors need to know to diversity their portfolios By Alexeev, Vitali; Tapon, Francis

  1. By: Steven Kou; Xianhua Peng
    Abstract: This paper attempts to provide a decision theoretical foundation for the measurement of economic tail risk, which is not only closely related to utility theory but also relevant to statistical model uncertainty. The main result of the paper is that the only tail risk measure that satisfies both a set of economic axioms proposed by Schmeidler (1989, Econometrica) and the statistical property of elicitability (i.e. there exists an objective function such that minimizing the expected objective function yields the risk measure; see Gneiting, 2011, J. Amer. Stat. Assoc.) is median shortfall, which is the median of the tail loss distribution. As an application, we argue that median shortfall is a better alternative than expected shortfall as a risk measure for setting capital requirements in Basel Accords.
    Date: 2014–01
  2. By: Pablo Koch-Medina; Cosimo Munari
    Abstract: We characterize when a convex risk measure associated to a law-invariant acceptance set in $L^\infty$ can be extended to $L^p$, $1\leq p
    Date: 2014–01
  3. By: Bisht, Poonam
    Abstract: The aim of this paper is to analysis in detailed the major financial risks which are faced by the banking sector in general and Indian banks in particular. For the purpose a loss function is devised to estimate the various components of the credit risk which result in the net losses for the banks. The study is supported by empirical analysis conducted on financial data of a cross section of banks in Public Sector, Private Sector and Foreign Banks operating in India. Suggestions are also put forward mainly to minimize the credit risk.
    Keywords: Credit risks, Market risks, Operational risks, Basel II, Basel III
    JEL: G20
    Date: 2013–12–25
  4. By: Lukas Scheffknecht
    Abstract: I analyze the rapidly growing literature about systemic risk in financial markets and find an important commonality. Systemic risk is regarded to be an endogenous outcome of interactions by rational agents on imperfect markets. Market imperfections give rise to systemic externalities which cause an excessive level of systemic risk. This creates a scope for welfare-increasing government interventions. Current policy debates usually refer to them as ’macroprudential regulation’. I argue that efforts undertaken in this direction - most notably the incipient implementation of Basel III- are insufficient. The problem of endogenous financial instability and excessive systemic risk remains an unresolved issue which carries unpleasant implications for central bankers. In particular, monetary policy is in danger of persistently getting burdened with the difficult task to simultaneously ensure macroeconomic and financial stability.
    Keywords: Systemic Risk, Systemic Externalities, Macroprudential Regulation, Basel III
    JEL: E44 E52 G01 G18
    Date: 2013–12
  5. By: Urbina, Jilber; Guillén, Montserrat
    Abstract: The cost of operational risk refers to the capital needed to a fford the loss generated by ordinary activities of a firm. In this work we demonstrate how allocation principles can be used to the subdivision of the aggregate capital so that the firm can distribute this cost across its various constituents that generate operational risk. Several capital allocation principles are revised. Proportional allocation allows to calculate a relative risk premium to be charged to each unit. An example of fraud risk in the banking sector is presented and some correlation scenarios between business lines are compared. Keywords: solvency, quantile, value at risk, copulas
    Keywords: Gestió del risc, 65 - Gestió i organització. Administració i direcció d'empreses. Publicitat. Relacions públiques. Mitjans de comunicació de masses,
    Date: 2013
  6. By: Alexeev, Vitali (School of Economics and Finance, University of Tasmania); Tapon, Francis
    Abstract: In this study of five developed markets we analyse the sizes of portfolios required for achieving most diversication benefits. Using daily data, we trace the year-to-year dynamic of these sizes between 1975 and 2011. We compute several widely-accepted measures of risk and use an extreme risk measure to account for black swan events. In addition to providing portfolio size recommendations for an average investor, we estimate confidence bands around central measures of risk and offer recommendations for attaining most diversification benefits 90 percent of the time instead of on average. We find that investors concerned with extreme risk can achieve diversification benefits with a relatively small number of stocks.
    Keywords: Portfolio diversification, international investing, heavy tailed risk, expected shortfall, time series standard deviation, terminal wealth standard deviation
    JEL: G11 G15 C63
    Date: 2013–11–20
  7. By: Pablo Koch-Medina; Santiago Moreno-Bromberg; Cosimo Munari
    Abstract: The theory of acceptance sets and their associated risk measures plays a key role in the design of capital adequacy tests. The objective of this paper is to investigate, in the context of bounded financial positions, the class of surplus-invariant acceptance sets. These are characterized by the fact that acceptability does not depend on the positive part, or surplus, of a capital position. We argue that surplus invariance is a reasonable requirement from a regulatory perspective, because it focuses on the interests of liability holders of a financial institution. We provide a dual characterization of surplus-invariant, convex acceptance sets, and show that the combination of surplus invariance and coherence leads to a narrow range of capital adequacy tests, essentially limited to scenario-based tests. Finally, we analyze the relationship between surplus-invariant acceptance sets and loss-based and excess-invariant risk measures, which have been recently studied by Cont, Deguest, and He, and by Staum.
    Date: 2014–01
  8. By: Peter J. Wallison (American Enterprise Institute)
    Abstract: In a September 2013 report, the Office of Financial Research (OFR), a US Treasury agency set up by the Dodd-Frank Act, suggested that the asset management industry could be a future source of systemic risk. However, the chances that an asset manager could trigger a systemic event is vanishingly small. The FSOC should spend its time elsewhere.
    Keywords: systemic risk,SIFIs,FSOC,Dodd-Frank Act
    JEL: A G
    Date: 2014–01
  9. By: Boualem Djehiche; Bj\"orn L\"ofdahl
    Abstract: We consider a large, homogeneous portfolio of life or disability annuity policies. The policies are assumed to be independent conditional on an external stochastic process representing the economic-demographic environment. Using a conditional law of large numbers, we establish the connection between claims reserving and risk aggregation for large portfolios. Further, we derive a partial differential equation for moments of present values. Moreover, we show how statistical multi-factor intensity models can be approximated by one-factor models, which allows for solving the PDEs very efficiently. Finally, we give a numerical example where moments of present values of disability annuities are computed using finite difference methods.
    Date: 2014–01
  10. By: Masaaki Fujii (Faculty of Economics, The University of Tokyo); Akihiko Takahashi (Faculty of Economics, The University of Tokyo)
    Abstract:    All the financial practitioners are working in incomplete markets full of unhedgeable risk-factors. Making the situation worse, they are only equipped with the imperfect information on the relevant processes. In addition to the market risk, fund and insurance managers have to be prepared for sudden and possibly contagious changes in the investment flows from their clients so that they can avoid the over- as well as under-hedging. In this work, the prices of securities, the occurrences of insured events and (possibly a network of) the investment flows are used to infer their drifts and intensities by a stochastic filtering technique. We utilize the inferred information to provide the optimal hedging strategy based on the mean-variance (or quadratic) risk criterion. A BSDE approach allows a systematic derivation of the optimal strategy, which is shown to be implementable by a set of simple ODEs and the standard Monte Carlo simulation. The presented framework may also be useful for manufactures and energy firms to install an efficient overlay of dynamic hedging by financial derivatives to minimize the costs.
  11. By: Alexeev, Vitali (School of Economics and Finance, University of Tasmania); Dungey, Mardi (School of Economics and Finance, University of Tasmania)
    Abstract: Investors wishing to achieve a particular level of diversification may be misled on how many stocks to hold in a portfolio by assessing the portfolio risk at different data frequencies. High frequency intradaily data provide better estimates of volatility, which translate to more accurate assessment of portfolio risk. Using 5-minute, daily and weekly data on S&P500 constituents for the period from 2003 to 2011 we ?nd that for an average investor wishing to diversify away 85% (90%) of the risk, equally weighted portfolios of 7 (10) stocks will suffice, irrespective of the data frequency used or the time period considered. However, to assure investors of a desired level of diversification 90% of the time, instead of on average, using low frequency data results in an exaggerated number of stocks in a portfolio when compared with the recommendation based on 5-minute data. This difference is magnified during periods when financial markets are in distress, as much as doubling during the 2007-2009 financial crisis
    Keywords: Portfolio diversification, high frequency, realized variance, realized correlation
    JEL: G11 C63
    Date: 2013–11–01
  12. By: Volker Kr\"atschmer; Alexander Schied; Henryk Z\"ahle
    Abstract: We apply a suitable modification of the functional delta method to statistical functionals that arise from law-invariant coherent risk measures. To this end we establish differentiability of the statistical functional in a relaxed Hadamard sense, namely with respect to a suitably chosen norm and in the directions of a specifically chosen "tangent space". We show that this notion of quasi-Hadamard differentiability yields both strong laws and limit theorems for the asymptotic distribution of the plug-in estimators. Our results can be regarded as a contribution to the statistics and numerics of risk measurement and as a case study for possible refinements of the functional delta method through fine-tuning the underlying notion of differentiability
    Date: 2014–01
  13. By: Hasan, Zubair
    Abstract: The worldwide colossal failures of financial institutions in the wake of the 2007–2010 financial turmoil the yesteryear advocates of liberalization and privatization converted almost overnight into vocal supporters of raising the safety walls around the interests of various stakeholders, especially the depositors. Admittedly, it was the heightened lure of leverage gains that led the financial institutions to expand credit beyond what the volume and quality of their capital assets warranted without crossing the limits of safety. The devastation led to a focus-shift so to say at the national and international levels in finance specifically to capital adequacy that financial institutions must observe for their own safety as also in the wider social interest. Stringent and regular watch was needed; it was felt, to make adequacy work. The Basel Committee on Banking Supervision (BCBS), an organ of the Bank for International Settlements (BIS) developed what are known as Accords i.e.agreements defining capital and its adequacy for banks to limit the risks they could take within reasonable confines. It is interesting to find that Malaysia was in a sense predictive to revamp and strengthen its own regulatory framework. Also, the IFSB was alert to announce some new standards.This paper briefly takes stock of these developments with a view to assess how far Basel Accords are likely to be absorbed by the Islamic system.
    Keywords: Islamic finance; Capital Adequacy; Basel Accords; Shari’ah compliance; Bank Negara action.
    JEL: G21 G28
    Date: 2014–01–15
  14. By: Alexeev, Vitali (School of Economics and Finance, University of Tasmania); Tapon, Francis
    Abstract: According to a report by the Australian Securities and Investments Commission in 2008, most (78%) of Australian investors had heard the term diversification. Nevertheless, around half of investors (49%) held only one type of investment (shares only) with the average number of holdings of 2.19 securities. More telling, a third (33%) of share owners acquired their shares passively (as part of a demutualisation or had received shares through an inheritance or gift), while almost two-thirds (63%) of share owners acquired the shares actively. One conclusion is that Australian investors, on average, own poorly diversified portfolios and leave themselves exposed to excessive diversifiable risk. To study this issue, we simulate portfolios using daily observations for all traded and delisted equities in Australia between 1975 and 2011. We calculate two measures of risk, including heavy tailed to account for extreme events. For each risk measure, we recommend the number of portfolio holdings that result in a 90% reduction in diversifiable risk for an average and a more conservative investor. We find that, on average, 24 to 30 stocks are sufficient to attain a well-diversified portfolio.
    Keywords: Portfolio diversification, expected shortfall, standard deviation, Australian equities.
    Date: 2013–11–20

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