nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒05‒04
thirteen papers chosen by
Stan Miles
Thompson Rivers University

  1. The Effectiveness Of Different Trading Strategies For Price-Takers By Liudmila G. Egorova
  2. A Survey of Systemic Risk Measures: Methodology and Application to the Japanese Market By Akio Hattori; Kentaro Kikuchi; Fuminori Niwa; Yoshihiko Uchida
  3. Credit Risk Modeling under Conditional Volatility By Rohde, Johannes; Sibbertsen, Philipp
  4. Model Risk in Backtesting Risk Measures By Evers, Corinna; Rohde, Johannes
  5. Properties of a risk measure derived from the expected area in red By Stéphane Loisel; Julien Trufin
  6. Systemic Risk and Regulation of the U.S. Insurance Industry By J. David Cummins; Mary A. Weiss
  7. Understanding return and volatility spillovers among major agricultural commodities By Amine Lahiani; Duc Khuong Nguyen; Thierry Vo
  8. Statistical Risk Analysis for Real Estate Collateral Valuation using Bayesian Distributional and Quantile Regression By Alexander Razen; Wolfgang Brunauer; Nadja Klein; Thomas Kneib; Stefan Lang; Nikolaus Umlauf
  9. On the dynamic dependence between US and other developed stock markets: An extreme-value time-varying copula approach By Heni Boubaker; Nadia Sghaier
  10. Ex Ante Capital Position, Changes in the Different Components of Regulatory Capital and Bank Risk By Boubacar Camara; Laetitia Lepetit; Amine Tarazi
  11. Insurance Contracts and Derivatives that Substitute for Them: How and Where Should Their Systemic and Nonperformance Risks be Regulated? By Edward J. Kane
  12. Forecasting the Volatility of the Dow Jones Islamic Stock Market Index: Long Memory vs. Regime Switching By Adnen Ben Nasr; Thomas Lux; Ahdi Noomen Ajmi; Rangan Gupta
  13. On an asymptotic rule A+B/u for ultimate ruin probabilities under dependence by mixing By Christophe Dutang; Claude Lefèvre; Stéphane Loisel

  1. By: Liudmila G. Egorova (National Research University Higher School of Economics)
    Abstract: Simulation models of the stock exchange are developed to explore the dependence between a trader’s ability to predict future price movements and her wealth and probability of bankruptcy, to analyze the consequences of margin trading with different leverage rates and to compare different investment strategies for small traders. We show that in the absence of margin trading the rate of successful predictions should be slightly higher than 50% to guarantee with high probability that the final wealth is greater than the initial and to assure very little probability of bankruptcy, and such a small value explains why so many people try to trade on the stock exchange. However if trader uses margin trading, this rate should be much higher and high rate leads to the risk of excessive losses.
    Keywords: agent-based system, simulation, stock exchange, trading strategies.
    JEL: G02 G17
    Date: 2014
  2. By: Akio Hattori (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Kentaro Kikuchi (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, Lecturer, Faculty of Economics, Shiga University, E-mail: kentaro-kikuchi@biwako.; Fuminori Niwa (Deputy Director and Economist, Institute for Monetary and Economic Studies (currently, Financial Markets Department), Bank of Japan (E-mail:; Yoshihiko Uchida (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: The recent financial crisis has prompted academia, country authorities, and international bodies to study quantitative tools to monitor the financial system, especially systemic risk measures. This paper aims to outline these measures and apply them to Japanfs financial system. The paper demonstrates that they are effective tools for monitoring the robustness of financial system on a real-time basis, although there are some caveats.
    Keywords: Systemic risk, Risk measure, Early warning indicators, Stress test, Scenario analysis, Macro-prudence, Financial crisis
    JEL: C51 G01 G19
    Date: 2014–04
  3. By: Rohde, Johannes; Sibbertsen, Philipp
    Abstract: The accuracy of measuring credit risk directly decides on the interest on credit, which has to be paid when raising a credit, and the amount of capital to keep in reserve by a firm. The structural credit risk model proposed by Merton (1974) lays the groundwork for the assessment of a firm's credit risk by its default probability. Doubtlessly, the volatility of the firm's equity represents the most sensitive parameter influencing the default probability. By combining the Merton approach with conditional volatility models, we empirically examine in this article that the specification of conditional volatility affects the probability of default and therefor the credit rating. More precisely, we show on German stock market data that financial market data properties (i.e. asymmetric response of conditional volatility to return shocks and long-range dependencies within the conditional volatility) may not be neglected within the computation of credit risk. Moreover, the influence on the default probability by the type of conditional distribution is pointed out.
    Keywords: Credit risk, Merton model, conditional volatility, default probability, stylized facts
    JEL: C22 C58 G24
    Date: 2014–04
  4. By: Evers, Corinna; Rohde, Johannes
    Abstract: Under the Basel II regulatory framework non-negligible statistical problems arise when backtesting risk measures. In this setting backtests often become infeasible due to a low number of violations leading to heavy size distortions. According to Escanciano and Olmo (2010, 2011) these problems persist when incorporating estimation and model risk by adjusting the asymptotic variance of the test statistics. In this paper, we analyze backtests based on hit and duration sequences in a univariate framework by running a simulation study in order to identify the problems of backtests that examine the adequacy of Value at Risk measures. One main finding indicates that backtests of all classes show heavy size distortions. These problems for the relevant Basel II set-up, however, cannot be alleviated by modifying backtests in a way that accounts for estimation risk or misspecification risk.
    Keywords: Model risk, backtesting, Value at risk
    JEL: C12 C52 G32
    Date: 2014–04
  5. By: Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Julien Trufin (Ecole d'Actuariat - Universite Laval (Quebec) - Canada)
    Abstract: This paper studies a new risk measure derived from the expected area in red introduced in Loisel (2005). Specifically, we derive various properties of a risk measure defined as the smallest initial capital needed to ensure that the expected time-integrated negative part of the risk process on a fixed time interval [0; T] (T can be infinite) is less than a given predetermined risk limit. We also investigate the optimal risk limit allocation: given a risk limit set at company level for the sum of the expected areas in red of all lines, we determine the way(s) to allocate this risk limit to the subsequent business lines in order to minimize the overall capital needs.
    Keywords: Ruin probability; risk measure; expected area in red; stochastic ordering; risk limit
    Date: 2014–03
  6. By: J. David Cummins; Mary A. Weiss
    Abstract: This paper analyzes the characteristics of U.S. insurers for purposes of determining whether they are systemically risky. More specifically, primary factors (size, interconnectedness, and lack of substitutability) and contributing factors (leverage, liquidity risk and maturity mismatch, complexity and government regulation) associated with systemic risk are assessed for the insurance sector. A distinction is made between the core activities of insurers (e.g., underwriting, reserving, claims settlement, etc.) and non-core activities (such as providing financial guarantees). Statistical analysis of insurer characteristics and their relationship with a well-known systemic risk measure, systemic expected shortfall, is provided. Consistent with other research, the core activities of propertycasualty insurers are found not to be systemically risky. However, we do find evidence that some core activities of life insurers, particularly separate accounts and group annuities, may be associated with systemic risk. The non-core activities of both property-casualty and life insurers can contribute to systemic risk. However, research findings indicate that generally insurers are victims rather than propagators of systemic risk events. The study also finds that insurers may be susceptible to intrasector crises such as reinsurance crises arising from counterparty credit risk. New and proposed state and federal regulation are reviewed in light of the potential for systemic risk for this sector.
    Keywords: Systemic risk, Insurance regulation, Financial Stability Oversight Council
    JEL: G20 G22
    Date: 2013–03
  7. By: Amine Lahiani; Duc Khuong Nguyen; Thierry Vo
    Abstract: We provide comprehensive evidence of return and volatility spillovers for the four major agricultural commodi- ties including sugar, wheat, corn and cotton over the recent period 2003-2010. Our results from the recent VAR- GARCH model of Ling and McAleer (2003) that allows for simultaneous shock transmissions of conditional volatilities of returns across commodities show the existence of substantial volatility spillover linkages between agricultural commodity returns and volatilities. Our findings are also particularly insightful for optimal portfolio designs and risk management through the computation of optimal weights and hedge ratios.
    Keywords: agricultural commodities, volatility spillovers, optimal hedging, VAR-GARCH.
    JEL: C32 Q14
    Date: 2014–04–28
  8. By: Alexander Razen; Wolfgang Brunauer; Nadja Klein; Thomas Kneib; Stefan Lang; Nikolaus Umlauf
    Abstract: The Basel II framework strictly defines the conditions under which financial institutions are authorized to accept real estate as collateral in order to decrease their credit risk. A widely used concept for its valuation is the hedonic approach. It assumes, that a property can be characterized by a bundle of covariates that involves both individual attributes of the building itself and locational attributes of the region where the building is located in. Each of these attributes can be assigned an implicit price, summing up to the value of the entire property. With respect to value-at-risk concepts financial institutions are often not only interested in the expected value but also in different quantiles of the distribution of real estate prices. To meet these requirements, we develop and compare multilevel structured additive regression models based on GAMLSS type approaches and quantile regression, respectively. Our models involve linear, nonlinear and spatial effects. Nonlinear effects are modeled with P-splines, spatial effects are represented by Gaussian Markov random fields. Due to the high complexity of the models statistical inference is fully Bayesian and based on highly efficient Markov chain Monte Carlo simulation techniques.
    Keywords: Bayesian hierarchical models, hedonic pricing models, GAMLSS, distributional regression quantile regression, multilevel models, MCMC, P-splines, value-at-risk
    Date: 2014–04
  9. By: Heni Boubaker; Nadia Sghaier
    Abstract: This paper examines the dynamic dependence between American and four developed stock markets, namely, Japan, United Kingdom, Germany and France during a recent period including the global financial crisis 2007-2009. The econometric approach is based on the extreme-value time-varying copula functions. Specifically, the marginal distributions are reproduced by an extreme-value based model while the joint distribution is explored using time-varying Normal and SJC copulas. The empirical results show that the dynamic dependence between American and Japanese stock markets is symmetric while that between American and European stock markets is asymmetric. In particular, this dependence seems to be related to geographic position.
    Keywords: dependence, stock markets, extreme value theory, time-varing copulas.
    Date: 2014–04–29
  10. By: Boubacar Camara (LAPE - Laboratoire d'Analyse et de Prospective Economique - Université de Limoges : EA1088 - Institut Sciences de l'Homme et de la Société); Laetitia Lepetit (LAPE - Laboratoire d'Analyse et de Prospective Economique - Université de Limoges : EA1088 - Institut Sciences de l'Homme et de la Société); Amine Tarazi (LAPE - Laboratoire d'Analyse et de Prospective Economique - Université de Limoges : EA1088 - Institut Sciences de l'Homme et de la Société)
    Abstract: We investigate the impact of changes in capital of European banks on their risk- taking behavior from 1992 to 2006, a time period covering the Basel I capital requirements. We specifically focus on the initial level and type of regulatory capital banks hold. First, we assume that risk changes depend on banks' ex ante regulatory capital position. Second, we consider the impact of an increase in each component of regulatory capital on banks' risk changes. We find that, for highly capitalized and strongly undercapitalized banks, an increase in equity positively affects risk; but an increase in subordinated debt has the opposite effect namely for undercapitalized banks. Moderately undercapitalized banks tend to invest in less risky assets when their equity ratio increases but not when they improve their capital position by extending hybrid capital. Hybrid capital and equity have the same impact for banks with low capital buffers. On the whole, our conclusions support the need to implement more explicit thresholds to classify European banks according to their capital ratios but also to clearly distinguish pure equity from hybrid and subordinated instruments.
    Date: 2013
  11. By: Edward J. Kane
    Abstract: Traditionally, individual states have shared responsibility for regulating the US insurance industry. The Dodd-Frank Act changes this by tasking the Federal Reserve with regulating the systemic risks that particularly large insurance organizations might pose and assigning the regulation of swap-based substitutes for insurance and reinsurance products to the SEC and CFTC. This paper argues that prudential regulation of large insurance firms and weaknesses in federal swaps regulation could reduce the effectiveness of state-based systems for protecting policyholders and taxpayers from nonperformance in the insurance industry. Swap-based substitutes for traditional insurance and reinsurance contracts offer protection sellers a way to transfer responsibility for guarding against nonperformance into potentially less-effective hands. The CFTC and SEC lack the focus, expertise, experience, and resources to manage adequately the ways that swaps transactions can affect US taxpayers’ equity position in global safety nets, while regulators at the Fed refuse to recognize that conscientiously monitoring accounting capital at financial holding companies will not adequately protect taxpayers and policyholders until and unless it is accompanied by severe penalties for managers that willfully hide their firm's exposure to destructive tail risks.
    Keywords: Dodd-Frank Act, systemic risk, nonperformance risk, regulatory culture, financial reform
    JEL: E61 G21 G22 G28 K42
    Date: 2014–04
  12. By: Adnen Ben Nasr; Thomas Lux; Ahdi Noomen Ajmi; Rangan Gupta
    Abstract: The financial crisis has fueled interest in alternatives to traditional asset classes that might be less affected by large market gyrations and, thus, provide for a less volatile development of a portfolio. One attempt at selecting stocks that are less prone to extreme risks, is obeyance of Islamic Sharia rules. In this light, we investigate the statistical properties of the DJIM index and explore its volatility dynamics using a number of up-to-date statistical models allowing for long memory and regime-switching dynamics. We find that the DJIM shares all stylized facts of traditional asset classes, and estimation results and forecasting performance for various volatility models are also in line with prevalent findings in the literature. Overall, the relatively new Markov-switching multifractal model performs best under the majority of time horizons and loss criteria. Long memory GARCH-type models always improve upon the short-memory GARCH specification and additionally allowing for regime changes can further improve their performance.
    Keywords: Islamic finance, volatility dynamics, long memory, multifractals. Tals.
    JEL: G15 G17 G23
    Date: 2014–04–28
  13. By: Christophe Dutang (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429, IRMA - Institut de Recherche Mathématique Avancée - CNRS : UMR7501 - Université de Strasbourg); Claude Lefèvre (ULB - Département de Mathématique [Bruxelles] - Université Libre de Bruxelles); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: The purpose of this paper is to point out that an asymptotic rule "A+B/u" for the ultimate ruin probability applies to a wide class of dependent risk models, in discrete and continuous time. Dependence is incorporated through a mixing approach among claim amounts or claim inter-arrival times, leading to a systemic risk behavior. Ruin corresponds here either to classical ruin, or to stopping the activity after realizing that it is not pro table at all, when one has little possibility to increase premium income rate. Several special cases for which closed formulas are derived, are also investigated in some detail.
    Date: 2013

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