nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒04‒29
eight papers chosen by
Stan Miles
Thompson Rivers University

  1. Banking stress test effects on returns and risks By Ekaterina Neretina; Cenkhan Sahin; Jakob de Haan
  2. CoMargin By Jorge Cruz Lopez; Jeffrey Harris; Christophe Hurlin; Christophe Pérignon
  3. Accounting for severity of risk when pricing insurance products By Ramon Alemany; Catalina Bolance; Montserrat Guillen
  4. Women are from Venus, Men are from Mars: But Do the Financial Markets Know It? By Amélie Charles; Etienne Redor
  5. Approximate hedging with proportional transaction costs in stochastic volatility models with jumps By Huu Thai Nguyen; Serguei Pergamenchtchikov
  6. Bank Leverage, Financial Fragility and Prudential Regulation By Olivier Bruno; André Cartapanis; Eric Nasica
  7. Hierarchical maximum likelihood parameter estimation for cumulative prospect theory: Improving the reliability of individual risk parameter estimates By Ryan O. Murphy; Robert H.W. ten Brincke
  8. Capital Buffers Based on Banks' Domestic Systemic Importance: Selected Issues By Michal Skorepa; Jakub Seidler

  1. By: Ekaterina Neretina; Cenkhan Sahin; Jakob de Haan
    Abstract: We investigate the effects of the announcement and the disclosure of the clarification, methodology, and outcomes of the US banking stress tests on banks' equity prices, credit risk, systematic risk, and systemic risk during the 2009-13 period. We find only weak evidence that stress tests after 2009 affected equity returns of large US banks. In contrast, CDS spreads declined in response to the disclosure of stress test results. We also find that bank systematic risk, as measured by betas, declined in some years after the publication of stress test results. Our evidence suggests that stress tests affect systemic risk.
    Keywords: stress tests; bank equity returns; CDS spreads; bank betas; systemic risk
    JEL: G21 G28
    Date: 2014–04
  2. By: Jorge Cruz Lopez (Bank of Canada - Bank of Canada); Jeffrey Harris (American University Washington - American University Washington); Christophe Hurlin (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Pérignon (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - GROUPE HEC - CNRS : UMR2959)
    Abstract: We present CoMargin, a new methodology to estimate collateral requirements in derivatives central counterparties (CCPs). CoMargin depends on both the tail risk of a given market participant and its interdependence with other participants. Our approach internalizes trading externalities and enhances the stability of CCPs, thus, reducing systemic risk concerns. We assess our methodology using proprietary data from the Canadian Derivatives Clearing Corporation that includes daily observations of the actual trading positions of all of its members from 2003 to 2011. We show that CoMargin outperforms existing margining systems by stabilizing the probability and minimizing the shortfall of simultaneous margin-exceeding losses.
    Keywords: Collateral; Central Counterparties (CCPs); Derivatives Markets; Extreme Dependence
    Date: 2014–03–07
  3. By: Ramon Alemany (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona); Catalina Bolance (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona); Montserrat Guillen (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona)
    Abstract: We design a system for improving the calculation of the price to be charged for an insurance product. Standard pricing techniques generally take into account the expected severity of potential losses. However, the severity of a loss can be extremely high and the risk of a severe loss is not homogeneous for all policy holders. We argue that risk loadings should be based on risk evaluations that avoid too many model assumptions. We apply a nonparametric method and illustrate our contribution with a real problem in the area of motor insurance.
    Keywords: quantile, value-at-risk, loss models, extremes
    Date: 2014–04
  4. By: Amélie Charles (Audencia Recherche - Audencia); Etienne Redor (Audencia Recherche - Audencia)
    Abstract: Although existing research has documented in very wide and detailed terms the impact of the presence of female directors on the financial performance of firms, very little is known about the link between board composition and corporate risk-taking. Drawing from the academic literature demonstrating that women are more risk averse than men, herein, we analyze the relationship between gender diversity and firm risk. In particular, we study whether the appointment of female directors affects firm risk level. We use three different measures of risk (total risk, systematic risk, and unsystematic risk) and compare firm risk level before the addition of new members (both male and female) to the corporate board to the risk level after such additions. Our results indicate that there is no significant gender difference in the risk level before and after the appointment of a director, when the whole sample is considered. However, some differences appear when the analysis is conducted by industry. Similarly, we show that the appointment of a female director has a greater impact on firm risk in female-director-friendly firm.
    Date: 2014–03–31
  5. By: Huu Thai Nguyen (LMRS - Laboratoire de Mathématiques Raphaël Salem - CNRS : UMR6085 - Université de Rouen); Serguei Pergamenchtchikov (LMRS - Laboratoire de Mathématiques Raphaël Salem - CNRS : UMR6085 - Université de Rouen)
    Abstract: We extend the resutls for the problem of option replication under proportional transaction costs in \cite{Nguyen} to more general frameworks where stochastic volatility and jumps are combined to capture market's important features. In particular, we study the hedging error due to discrete readjustments by applying the Leland adjusting volatility principle to compensate transaction costs. In such contexts, jumps risk is approximately eliminated and the results established in \cite{Nguyen} are recovered.
    Keywords: transaction costs. jump models; stochastic volatility; approximate hedging; theorem limit; super-hedging; quantile hedging
    Date: 2014–04–15
  6. By: Olivier Bruno (GREDEG CNRS; University of Nice Sophia Antipolis, France; SKEMA Business School; OFCE-DRIC); André Cartapanis (Sciences Po Aix-en-Provence; GREDEG CNRS; CHERPA-Sciences Po Aix-en-Provence); Eric Nasica (GREDEG CNRS; University of Nice Sophia Antipolis, France)
    Abstract: We analyse the determinants of bank balance-sheets and leverage-ratio dynamics, and their role in increasing financial fragility. Our results are twofold. First, we show that there is a value of bank leverage that minimises financial fragility. Second, we show that this value depends on the overall business climate, the expected value of the collateral provided by firms, and the risk-free interest rate. These results lead us to advocate for the establishment of an adjustable leverage ratio depending on economic conditions, rather than the fixed ratio provided for under the new Basel III regulation.
    Keywords: Bank leverage, Leverage ratio, Financial instability, Prudential regulation
    JEL: E44 G28
    Date: 2014–04
  7. By: Ryan O. Murphy; Robert H.W. ten Brincke
    Abstract: Individual risk preferences can be identified by using decision models with tuned parameters that maximally fit a set of risky choices made by a decision maker. A goal of this model fitting procedure is to isolate parameters that correspond to stable risk preferences. These preferences can be modeled as an individual difference, indicating a particular decision maker's tastes and willingness to tolerate risk. Using hierarchical statistical methods we show significant improvements in the reliability of individual risk preference parameters over other common estimation methods. This hierarchal procedure uses population level information (in addition to an individual's choices) to break ties (or near-ties) in the fit quality for sets of possible risk preference parameters. By breaking these statistical ``ties'' in a sensible way, researchers can avoid overfitting choice data and thus better measure individual differences in people's risk preferences.
    Keywords: Prospect theory, Risk preference, Decision making under risk, Hierarchical parameter estimation, Maximum likelihood
  8. By: Michal Skorepa; Jakub Seidler
    Abstract: Regulators in many countries are currently considering ways to impose domestic systemic importance-based capital requirements on banks. Aiming to assist these considerations, this article discusses a number of issues concerning the calculation of a bank's systemic importance to the domestic banking sector, such as the choice of indicators used and the pros and cons of focusing on an individual or consolidated level. Also, the 'equal expected impact' procedure for determining adequate additional capital requirements is presented in detail and some of its properties are discussed. As an illustrative example of the practical use of the procedures presented, systemic importance scores and implied capital buffers are calculated for banks in the Czech Republic. The article also stresses the crucial role of public communication of the motivation for the buffers: regulators should make every effort to explain that the imposition of a non-zero systemic importance-based capital buffer on a bank is not to be interpreted by the markets as a signal that the bank is too big to fail and would therefore be guaranteed a public bail-out if it got into difficulties.
    Keywords: Bank failure, Basel III, capital adequacy, consolidation, systemic importance, public support
    JEL: G21 G28
    Date: 2014–03

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