New Economics Papers
on Risk Management
Issue of 2014‒07‒13
28 papers chosen by

  1. Canada: Financial Sector Stability Assessment By International Monetary Fund. Western Hemisphere Dept.
  2. Crowded Trades: An Overlooked Systemic Risk for Central Clearing Counterparties By Albert J. Menkveld
  3. Risk Appetite in Practice: Vulgaris Mathematica. By Bertrand K Hassani
  4. On a Transform Method for the Efficient Computation of Conditional VaR (and VaR) with Application to Loss Models with Jumps and Stochastic Volatility By Alessandro Ramponi
  5. Risk Measurement and Risk Modelling using Applications of Vine Copulas By David E. Allen; Michael McAleer; Abhay K. Singh
  6. Asymmetric Realized Volatility Risk By David E. Allen; Michael McAleer; and Marcel Scharth
  7. Malaysia: Financial Sector Assessment Program Banking System Spillovers-Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  8. A new approach to the unconditional measurement of default risk By Alex Ferrer; José Casals; Sonia Sotoca
  9. Austria: Publication of Financial Sector Assessment Program Documentation—Technical Note on Stress Testing the Banking Sector By International Monetary Fund. Monetary and Capital Markets Department
  10. Gestion et titrisation des risques de catastrophe naturelle par les options By Adlane HAFFAR; Lubica HIKKEROVA
  11. Financial Soundness Indicators and the Characteristics of Financial Cycles By Natasha Xingyuan Che; Yoko Shinagawa
  12. Governance, Risk Management, and Risk-Taking in Banks By René M. Stulz
  13. Bank Size and Systemic Risk By Luc Laeven; Lev Ratnovski; Hui Tong
  14. Bolivia: Fiscal Transparency Assessment By International Monetary Fund. Fiscal Affairs Dept.
  15. People’s Republic of China––Hong Kong Special Administrative Region: Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  16. The Net Stable Funding Ratio: Impact and Issues for Consideration By Jeanne Gobat; Mamoru Yanase; Joseph Maloney
  17. Macroprudential Policy in the GCC Countries By Zsofia Arvai; Ananthakrishnan Prasad; Kentaro Katayama
  18. Switzerland: Financial Sector Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  19. Barbados: Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  20. Conditional coverage and its role in determining and assessing long-term capital requirements By Alex Ferrer; José Casals; Sonia Sotoca
  21. Advances in Financial Risk Management andEconomic Policy Uncertainty: An Overview By Shawkat Hammoudeh; Michael McAleer
  22. The Regulatory Responses to the Global Financial Crisis: Some Uncomfortable Questions By Stijn Claessens; Laura E. Kodres
  23. Volatility forecasting and risk management for commodity markets in the presence of asymmetry and long memory By Walid Chkili; Shawkat Hammoudeh; Duc Khuong Nguyen
  24. Transmission of Financial Stress in Europe: The Pivotal Role of Italy and Spain, but not Greece By Brenda González-Hermosillo; Christian A Johnson
  25. Does historical volatility term structure contain valuable in-formation for predicting volatility index futures? By Juliusz Jabłecki; Ryszard Kokoszczyński; Paweł Sakowski; Robert Ślepaczuk; Piotr Wójcik
  26. Algeria: Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  27. Taxation and Corporate Risk-Taking By Langenmayr, Dominika; Lester, Rebecca
  28. El Salvador: Technical Note on Safety Nets and Crisis Management Arrangements By International Monetary Fund. Monetary and Capital Markets Department

  1. By: International Monetary Fund. Western Hemisphere Dept.
    Abstract: In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
    Keywords: Financial system stability assessment;Banking sector;Insurance;Stress testing;Bank supervision;Insurance supervision;Securities regulations;Housing;Financial safety nets;Canada;mortgage insurance, credit risk, market risk, life insurance, life insurers, risk assessment, securities markets, insurance companies, deposit insurance, mortgage insurers, regulatory agencies, capital requirements, policyholders, risk-weighted assets, supervisory framework, life insurance companies, underwriting, casualty insurance, risk management, insurance system, insurance industry, risk premium, supervisory authorities, portfolio insurance, financial systems, motor insurance, supervisory agencies, regulatory approaches, emerging markets, international supervisory standards, health insurance, internal controls, government insurance, contingency planning, consumer protection, risk transfer, risk sharing, level playing field, risk assessments, insurance regulation, pension funds, insurance agents, underwriting standards, insurance products
    Date: 2014–02–03
  2. By: Albert J. Menkveld (VU University Amsterdam, the Netherlands)
    Abstract: Counterparty default risk might hamper trade and trigger a financial crisis. The introduction of a central clearing counterparty (CCP) benefits trading but pushes systemic risk into CCP default. Standard risk management strategies at CCPs currently overlook a risk associated with crowded trades. This paper identifies it, measures it, and proposes a margin methodology that accounts for it. The application to actual CCP data illustrates that this hidden risk can become large, in particular at times of high CCP risk.
    Keywords: Financial economics
    JEL: G00
    Date: 2014–06–02
  3. By: Bertrand K Hassani (Grupo Santander et Centre d'Economie de la Sorbonne)
    Abstract: The ultimate goal of risk management is the generation of efficient incomes. The objective is to generate the maximum return for a unit of risk taken or to minimise the risk taken to generate the return expected i.e. it is the optimisation of a financial institution strategy. Therefore, by measuring its exposure against its appetite, a financial institution is assessing its couple risk-return. But this taskk may be difficult as banks face various types of risks, for instance, Operational, Market, Credit, Liquidity, etx. and these cannot be evaluated on a stand alone basis, interaction and contagion effects should be taken into account. In this paper, methodologies to evaluate banks' exposures are presented along their management implications, as the purpose of the risk appetite evaluation process is the transformation of risk metrics into effective management decisions.
    Keywords: Risk Management, Risk Measures, Risk Appetite, Interdependencies.
    JEL: G17 G21 C10 C65 C80
    Date: 2014–04
  4. By: Alessandro Ramponi
    Abstract: In this paper we consider Fourier transform techniques to efficiently compute the Value-at-Risk and the Conditional Value-at-Risk of an arbitrary loss random variable, characterized by having a computable generalized characteristic function. We exploit the property of these risk measures of being the solution of an elementary optimization problem of convex type in one dimension for which Fast and Fractional Fourier transform can be implemented. An application to univariate loss models driven by L\'{e}vy or stochastic volatility risk factors dynamic is finally reported.
    Date: 2014–07
  5. By: David E. Allen (School of Mathematics and Statistics, Sydney University, NSW, and Centre for Applied Financial Studies, University of South Australia, Adelaide, SA, Australia); Michael McAleer (National Tsing Hua University, Taiwan, and Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam, and Tinbergen Institute, the Netherlands, and Department of Quantitative Economics, Complutense University of Madrid, Spain); Abhay K. Singh (School of Business, Edith Cowan University, Joondalup, WA, Australia)
    Abstract: This paper features an application of Regular Vine copulas which are a novel and recently developed statistical and mathematical tool which can be applied in the assessment of composite nancial risk. Copula-based dependence modelling is a popular tool in nancial applications, but is usually applied to pairs of securities. By contrast, Vine copulas provide greater exibility and permit the modelling of complex dependency patterns using the rich variety of bivariate copulas which may be arranged and analysed in a tree structure to explore multiple dependencies. The paper features the use of Regular Vine copulas in an analysis of the co-dependencies of 10 major European Stock Markets, as represented by individual market indices and the composite STOXX 50 index. The sample runs from 2005 to the end of 2011 to permit an exploration of how correlations change indierent economic circumstances using three dierent sample periods: pre-GFC pre-GFC (Jan 2005- July 2007), GFC (July 2007-Sep 2009), and post-GFC periods (Sep 2009 - Dec 2011). The empirical results suggest that the dependencies change in a complex manner, and are subject to change in dierent economic circumstances. One of the attractions of this approach to risk modelling is the exibility in the choice of distributions used to model co-dependencies. The practical application of Regular Vine metrics is demonstrated via an example of the calculation of the VaR of a portfolio made up of the indices.
    Keywords: Regular Vine Copulas, Tree structures, Co-dependence modelling, European stock markets
    JEL: G11 C02
    Date: 2014–05–08
  6. By: David E. Allen (University of Sydney, and University of South Australia, Australia); Michael McAleer (National Tsing Hua University, Taiwan; Erasmus University Rotterdam, Tinbergen Institute, the Netherlands; Complutense University Madrid, Spain); and Marcel Scharth (University of New South Wales, Australia)
    Abstract: In this paper we document that realized variation measures constructed from high-frequency returns reveal a large degree of volatility risk in stock and index returns, where we characterize volatility risk by the extent to which forecasting errors in realized volatility are substantive. Even though returns standardized by ex post quadratic variation measures are nearly gaussian, this unpredictability brings considerably more uncertainty to the empirically relevant ex ante distribution of returns. Explicitly modeling this volatility risk is fundamental. We propose a dually asymmetric realized volatility model, which incorporates the fact that realized volatility series are systematically more volatile in high volatility periods. Returns in this framework display time varying volatility, skewness and kurtosis. We provide a detailed account of the empirical advantages of the model using data on the S&P 500 index and eight other indexes and stocks.
    Keywords: Realized volatility, volatility of volatility, volatility risk, value-at-risk, forecasting, conditional heteroskedasticity
    JEL: C58 G12
    Date: 2014–06–23
  7. By: International Monetary Fund. Monetary and Capital Markets Department
    Keywords: Financial Sector Assessment Program;Banking sector;International banks;Spillovers;Risk management;Malaysia;
    Date: 2014–04–17
  8. By: Alex Ferrer (Department of Quantitative Economics, Universidad Complutense de Madrid, Spain); José Casals (Department of Quantitative Economics, Universidad Complutense de Madrid, Spain); Sonia Sotoca (Department of Quantitative Economics, Universidad Complutense de Madrid, Spain)
    Abstract: This paper analyzes the unconditional measurement of default risk and proposes an alternative modeling approach. We begin the analysis by showing that when conducted under non-stationarity, the objective of the unconditional measurement changes and that some relevant problems appear as a consequence of the sample dependence. Based on this result, we introduce our approach and discuss its consistency, practical advantages, and the main dierences from the conventional static framework. An empirical analysis is also conducted. Under non-stationarity, the regulatory model for the unconditional probability of default distribution performs badly when compared to our approach. Results also show that the capital gure presents a determinant and non-trivial dependence on the homogeneity and severity of the economic scenario represented in the sample.
    Keywords: Default risk, Probability of default, Unconditional measurement, Conditional measurement
    JEL: C46 C58 G21 G32
    Date: 2014–06
  9. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
    Keywords: Financial Sector Assessment Program;Stress testing;Banking sector;Liquidity;External shocks;Financial risk;Austria;banking system, interbank market, sovereign risk, banking institutions, capital adequacy, banking system assets, bank assets, banks ’ solvency, recapitalization, banking systems, banking sector assets, tier 1 capital, national bank, capital adequacy ratio, bank asset quality, retained earnings, return on assets, capital base, bank stability, banking relationships, financial transaction, bank stocks, capital requirement, banking authority, bank securities, off balance sheet, bank bonds, probability of default, bank run, banking sector liquidity, subordinated debt, banks ’ balance sheet, banks ’ balance sheets, var model, bank exposures
    Date: 2014–01–21
  10. By: Adlane HAFFAR; Lubica HIKKEROVA
    Abstract: This article deals with the issue of natural disaster risk coverage. We introduce a solution to cover this natural disaster risk through securitizations, first, by subscribing « options on total loss experience ratio» that are derivative products, the
    Keywords: Total loss ratio, risk transfer, alternative risk, insurance, securitization, natural disaster option, reinsurance.
    Date: 2014–06–23
  11. By: Natasha Xingyuan Che; Yoko Shinagawa
    Abstract: Better “financial soundness†of banks could help mitigate the volatility of financial cycles by reducing banks’ risk exposure. But trying to improve financial soundness in the midst of a downturn can do the opposite—further aggravating the contraction of credit. Consistent with this notion, the paper found that better initial scores in certain financial soundness indicators (FSIs) are associated with milder and shorter downturns; and improving FSIs during a downturn worsens the shrinkage of credit and amplifies the cycle. In this context, our results suggest that policy makers should be mindful about the timing of regulating changes in banks’ FSIs.
    Keywords: Financial soundness indicators;Banks;Risk management;Business cycles;Economic models;financial cycle, bank supervision, capital ratio, banking, banking system, capital adequacy, subsidiaries, inflation rate, foreign exchange exposure, capital base, liquid – asset, banking crises, var model, bank capital, capital requirement, capital position, banking systems, credit expansion, capital – asset, bank balance sheets, return on equity, foreign asset, domestic credit, capital flow, credit market, capital – asset ratio, return on assets, bank credit, banking supervisors, bank of canada, bank provisioning, government securities
    Date: 2014–01–27
  12. By: René M. Stulz
    Abstract: This paper examines how governance and risk management affect risk-taking in banks. It distinguishes between good risks, which are risks that have an ex ante private reward for the bank on a stand-alone basis, and bad risks, which do not have such a reward. A well-governed bank takes the amount of risk that maximizes shareholder wealth subject to constraints imposed by laws and regulators. In general, this involves eliminating or mitigating all bad risks to the extent that it is cost effective to do so. The role of risk management in such a bank is not to reduce the bank’s total risk per se. It is to identify and measure the risks the bank is taking, aggregate these risks in a measure of the bank’s total risk, enable the bank to eliminate, mitigate and avoid bad risks, and ensure that its risk level is consistent with its risk appetite. Organizing the risk management function so that it plays that role is challenging because there are limitations in measuring risk and because, while more detailed rules can prevent destructive risk-taking, they also limit the flexibility of an institution in taking advantage of opportunities that increase firm value. Limitations of risk measurement and the decentralized nature of risk-taking imply that setting appropriate incentives for risk-takers and promoting an appropriate risk culture are essential to the success of risk management in performing its function.
    JEL: G21 G32
    Date: 2014–06
  13. By: Luc Laeven; Lev Ratnovski; Hui Tong
    Abstract: The proposed SDN documents the evolution of bank size and activities over the past 20 years. It discusses whether this evolution can be explained by economies of scale or “too big to fail†subsidies. The paper then presents evidence on the extent to which bank size and market-based activities contribute to systemic risk. The paper concludes with policy messages in the area of capital regulation and activity restrictions to reduce the systemic risk posed by large banks. The analysis of the paper complements earlier Fund work, including SDN 13/04 and the recent GFSR chapter on “too big to fail†subsidies, and its policy message is in line with this earlier work.
    Keywords: Systemic risk;Systemic risk assessment;Too-big-too-fail;Bank capital;Bank regulations;Corporate governance;Financial crisis;Bank financing;Bank deposits;Financial Structure; Financial Regulation
    Date: 2014–05–08
  14. By: International Monetary Fund. Fiscal Affairs Dept.
    Keywords: Fiscal transparency;Fiscal risk;Budgeting;Fiscal policy;Risk management;Bolivia;
    Date: 2014–03–12
  15. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: EXECUTIVE SUMMARY Hong Kong SAR’s (HKSAR) financial sector is one of the largest and most developed in the world, ranking number one in the World Economic Forum Financial Development Index. The banking system, with assets of US$2 trillion and equivalent to 705 percent of GDP, is highly capitalized, profitable, and liquid. The securities markets are deep, liquid, and efficient, with total stock market capitalization of 1,000 percent of GDP. The insurance sector has high penetration (now ranked the second in Asia after Japan), and is well capitalized. The sector is very well regulated, with the capacity to withstand a diversity of shocks. While the financial sector faced significant stress during the early stages of the 2008 global financial crisis, market confidence recovered quickly, aided by the decisive measures adopted by the Hong Kong authorities to mitigate its impact. The sector, however, faces major risks, which puts a significant premium on effective liquidity management, macroprudential oversight and microprudential supervision. The anticipated exit from unconventional monetary policy in the United States could increase capital market volatility and reduce system-wide liquidity. A correction of property prices, which now stand at historical highs, poses risks for both borrowers and banks. The increasing economic and financial integration between HKSAR and Mainland China offers considerable expansion opportunities, but, at the same time, generates significant spillover risks, especially if a significant financial disruption or economic slowdown were experienced. Stress tests suggest that banks are well positioned to absorb a significant realization of risks. Banks’ aggregate capitalization would remain well above the Basel III’s minimum capital requirement, and the banking sector (including foreign branches) has sufficient liquidity to withstand large deposit and wholesale funding withdrawals. At the same time, the tests highlight that a few smaller banks might be slightly more vulnerable under a severe economic scenario, and, reflecting the nature of their businesses, foreign branches are relatively more sensitive to withdrawals of wholesale funding. This underscores the need for continued vigilance in these areas. The authorities have actively deployed macroprudential policies to mitigate systemic risks. In particular, in the face of a doubling of house prices, the Hong Kong Monetary Authority (HKMA) introduced tighter limits on loan-to-value (LTV) and debt-servicing (DSR) ratios. Going forward, it will be important that the authorities strengthen their capacity for systemic risk analysis at both the Securities and Futures Commission (SFC) and Insurance Authority (IA) to complement the analysis undertaken by the HKMA. This would help ensure that cross-sectoral interconnections are adequately captured when considering systemic risks.
    Keywords: Financial system stability assessment;Financial sector;Financial risk;Banks;Spillovers;Bank resolution;Bank supervision;Stress testing;Macroprudential Policy;Hong Kong SAR;
    Date: 2014–05–22
  16. By: Jeanne Gobat; Mamoru Yanase; Joseph Maloney
    Abstract: As part of Basel III reforms, the NSFR is a new prudential liquidity rule aimed at limiting excess maturity transformation risk in the banking sector and promoting funding stability. The revised package has been issued for public consultation with a plan of making the rule binding in 2018. This paper complements earlier quantitative impact studies by discussing the potential impact of introducing the NSFR based on empirical analysis of end-2012 financial data for over 2000 banks covering 128 countries. The calculations show that a sizeable percentage of the banks in most countries would meet the minimum NSFR prudential requirement at end-2012, and, further, that larger banks tend to be more vulnerable to the introduction of the NSFR. Additionally, by comparing the NSFR to other structural funding mismatch indicators, we find that the NSFR is a relatively consistent regulatory measure for capturing banks’ funding risk. Finally, the paper discusses key policy issues for consideration in implementing the NSFR.
    Keywords: Banking sector;Liquidity;Financial risk;Risk management;Banking, Bank Regulation, Financing, Firm Size, Policy
    Date: 2014–06–12
  17. By: Zsofia Arvai; Ananthakrishnan Prasad; Kentaro Katayama
    Abstract: As undiversified commodity exporters, GCC economies are prone to pro-cyclical systemic risk in the financial system. During periods of high hydrocarbon prices, favorable economic prospects make the financial sector keen to lend, leading to higher domestic credit growth and easier access to external financing. Fiscal policy is a very important tool for macroeconomic management, but due to the significant time lags and expenditure rigidities, it has not been a flexible enough tool to prevent credit booms and the build-up of systemic risk in the GCC. This, together with limited monetary policy independence because of the pegged exchange rate, means that macro-prudential policy has a particularly important role in limiting systemic risk in the financial system. This importance is reinforced by the underdeveloped financial markets in the region that provide limited risk management tools and shortcomings in crisis resolution frameworks. This paper will discuss the importance of macro-prudential policy in the GCC countries, look at the experience with macro-prudential policies in the boom/bust cycle in the second half of the 2000s, and use the broad frameworks being developed in the Fund and elsewhere to discuss ways existing frameworks and policy toolkits in the region can be strengthened given the characteristics of the GCC economies.
    Keywords: Macroprudential Policy;Cooperation Council for the Arab States of the Gulf;Financial sector;Financial risk;Risk management;Fiscal policy;
    Date: 2014–03–19
  18. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: EXECUTIVE SUMMARY Switzerland’s financial sector is one of the largest in the world, especially relative to GDP. It is home to two of the largest banks, which are designated as globally systemically important financial institutions (G-SIFIs), and one of the largest reinsurance companies. The two global banks, account for 43 percent of Swiss banking sector deposits and 18 percent of capital; in addition, there are 24 cantonal banks, one of which has been designated a domestically systemically important financial institution (D-SIFI), as well as the newly licensed Postfinance, a cooperative Raiffeisenbank, and small private and regional banks. The two global banks––particularly UBS––were hard hit by the recent global financial crisis (GFC); the rest of the banking sector emerged relatively unscathed. In response to the GFC the Swiss authorities took forceful action. The single supervisor, the Swiss Financial Market Supervisory Authority (FINMA), became operational in 2009. Capital standards were raised above Basel minima and ahead of the Basel implementation timetable. Additional capital buffers were imposed on the two large banks, and contingent capital instruments (CoCos) introduced. Macroprudential instruments were analyzed, and at end-September 2013 a countercyclical capital buffer (CCB) targeting residential property mortgages took effect; an increase in the CCB was announced in January 2014, to take effect from June 2014. The insurance industry became subject to the Swiss Solvency Test (SST). Stress tests indicate that the banks are robust against even severe shocks. Banks have increased their capital, and the two global banks have achieved substantial deleveraging. FINMA has focused on significantly improving the quality of its supervision. That said, identification of individual bank risk was hindered as legal constraints prevented the Swiss authorities from providing regulatory data at the individual bank level. Hence the stress tests will not have served to indentify outliers in performance. Nonetheless, there remain important vulnerabilities and challenges to financial stability: • The Swiss economy is among the most interconnected in the world and is deeply exposed to volatility in the European Union (EU). Stresses in the euro area periphery led to “safe haven†flows to the Swiss franc, putting sustained upward pressure on the rate, which the authorities seek to counter through maintaining an exchange rate floor. • Real estate bubbles appear to be emerging; with monetary instruments not available, macroprudential instruments are being introduced, but so far are limited and untested. • While important progress has been made in addressing too-big-to-fail (TBTF) and too-big-to- save (TBTS) issues, this is still a work in progress. • Interest rates are negative at some maturities, threatening the business models of life insurance and pension companies. Temporary alleviation from the SST is in effect through 2015.
    Keywords: Financial system stability assessment;Financial sector;Banks;Stress testing;Bank supervision;Bank resolution;Insurance;Securities regulations;Financial risk;Risk management;Switzerland;
    Date: 2014–05–28
  19. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: EXECUTIVE SUMMARY Barbados has a relatively well-developed financial system, including a large offshore sector.1 The onshore system is dominated by large, regionally active banks. Banking services to the population are also provided by the credit union sector. The system also includes a mature but concentrated insurance sector with extensive international affiliates, and other non-bank financial institutions provide credit and other instruments for savers. The offshore sector is financially segregated from the domestic economy and is dominated by international banks mainly conducting treasury and wealth management operations. The financial system has increasingly been funding the government and residential mortgages, reflecting fiscal pressures and the limits imposed by capital controls on investments abroad. Systemic risks With a deteriorating fiscal situation and weak growth prospects, Barbados faces considerable macroeconomic vulnerabilities. Sovereign risk is a concern, given a large public debt, high fiscal deficits, and slow growth, and policy options are limited by a fixed exchange rate regime. While long-standing capital controls provide some protection against disorderly scenarios, they are likely to become less effective over time unless fiscal vulnerabilities are addressed. The authorities are committed to the announced fiscal consolidation plan, but full efforts should be deployed to secure timely and successful implementation. While the financial system does not appear to be a source of immediate risk, its position appears to be deteriorating, with implications for systemic stability. Credit quality of domestic banks and credit unions has weakened considerably since the global crisis and, with growth expected to remain slow in the years ahead, is projected to deteriorate further. Weaker bank balance sheets could dampen credit supply, amplify the economic decline, and exacerbate broader macroeconomic vulnerabilities. Moreover, stress-tests illustrate that the financial system would be vulnerable in the face of severe shocks. Relatively large capital and liquidity buffers mean that onshore banks can generally withstand moderate shocks without breaching regulatory requirements. However, vulnerabilities emerge in the case of severe shocks, particularly in a branch of a strong foreign bank and in the credit union sector. The latter is also vulnerable to medium-sized liquidity shocks. The offshore financial sector does not appear to be a major source of risk given that it is prevented from carrying out financial transactions with domestic residents, but common ownership links and reputational risks should be monitored closely.
    Keywords: Financial system stability assessment;Financial sector;Banks;Bank supervision;Basel Core Principles;Insurance supervision;Reports on the Observance of Standards and Codes;Barbados;
    Date: 2014–02–12
  20. By: Alex Ferrer (Department of Quantitative Economics, Universidad Complutense de Madrid, Spain); José Casals (Department of Quantitative Economics, Universidad Complutense de Madrid, Spain); Sonia Sotoca (Department of Quantitative Economics, Universidad Complutense de Madrid, Spain)
    Abstract: We define the vector of conditional coverage values generated over the business cycle by a constant capital figure. Using a convenient analytical framework, we explore its properties and propose two applications based on it. For the former, we state a result that links the concepts of conditional and unconditional solvency and offers an alternative interpretation of the unconditional capital. For the latter, we propose using the minimum of the conditional coverage vector in the determination of long-term capital requirements, as well as using its minimum and its standard deviation in the long-term assessment of a given capital figure. Both applications are illustrated empirically. The entire analysis can be understood as an attempt to recognize and incorporate capital cyclicality into the measurement and analysis of default risk.
    Keywords: Default risk, Long-term capital, Unconditional capital, Conditional coverage, Unconditional coverage, Capital cyclicality.
    JEL: C58 G21 G32
    Date: 2014–06
  21. By: Shawkat Hammoudeh (Lebow College of Business Drexel University.); Michael McAleer (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute, The Netherlands, Department of Quantitative Economics, Complutense University of Madrid, and Institute of Economic Research, Kyoto University.)
    Abstract: Financial risk management is difficult at the best of times, but especially so in the presence of economic uncertainty and financial crises. The purpose of this special issue on “Advances in Financial Risk Management and Economic Policy Uncertainty” is to highlight some areas of research in which novel econometric, financial econometric and empirical finance methods have contributed significantly to the analysis of financial risk management when there is economic uncertainty, especiallythe power of print: uncertainty shocks, markets, and the economy, determinants of the banking spread in the Brazilian economy: the role of micro and macroeconomic factors, forecasting value-at-risk using block structure multivariate stochastic volatility models, the time-varying causality between spot and futures crude oil prices: a regime switching approach, a regime-dependent assessment of the information transmission dynamics between oil prices, precious metal prices and exchange rates, a practical approach to constructing price-based funding liquidity factors, realized range volatility forecasting: dynamic features and predictive variables, modelling a latent daily tourism financial conditions index, bank ownership, financial segments and the measurement of systemic risk: an application of CoVaR, model-free volatility indexes in the financial literature: a review, robust hedging performance and volatility risk in option markets: application to Standard and Poor’s 500 and Taiwan index options, price cointegration between sovereign CDS and currency option markets in the global financial crisis, whether zombie lending should always be prevented, preferences of risk-averse and risk-seeking investors for oil spot and futures before, during and after the global financial crisis, managing financial risk in Chinese stock markets: option pricing and modeling under a multivariate threshold autoregression, managing systemic risk in The Netherlands, mean-variance portfolio methods for energy policy risk management, on robust properties of the SIML estimation of volatility under micro-market noise and random sampling, asymmetric large-scale (I)GARCH with hetero-tails, the economic fundamentals and economic policy uncertainty of Mainland China and their impacts on Taiwan and Hong Kong, prediction and simulation using simple models characterized by nonstationarity and seasonality, and volatility forecast of stock indexes by model averaging using high frequency data.
    Keywords: Financial risk management, Economic policy uncertainty, Financial econometrics, Empirical finance.
    JEL: C58 D81 E60 G32
    Date: 2014–06
  22. By: Stijn Claessens; Laura E. Kodres
    Abstract: We identify current challenges for creating stable, yet efficient financial systems using lessons from recent and past crises. Reforms need to start from three tenets: adopting a system-wide perspective explicitly aimed at addressing market failures; understanding and incorporating into regulations agents’ incentives so as to align them better with societies’ goals; and acknowledging that risks of crises will always remain, in part due to (unknown) unknowns – be they tipping points, fault lines, or spillovers. Corresponding to these three tenets, specific areas for further reforms are identified. Policy makers need to resist, however, fine-tuning regulations: a “do not harm†approach is often preferable. And as risks will remain, crisis management needs to be made an integral part of system design, not relegated to improvisation after the fact.
    Keywords: Financial systems;Fiscal risk;Financial crisis;Fiscal policy;Fiscal reforms;Macroprudential Policy;Monetary policy;Risk management;Financial crises, regulation, systemic risks, macroprudential policies
    Date: 2014–03–14
  23. By: Walid Chkili; Shawkat Hammoudeh; Duc Khuong Nguyen
    Abstract: This paper explores the relevance of asymmetry and long memory in modeling and forecasting the conditional volatility and market risk of four widely traded commodities (crude oil, natural gas, gold, and silver). A broad set of the most popular linear and
    Keywords: commodity markets, GARCH models, asymmetries, long memory, volatility forecasts.
    JEL: C22 G17 Q47
    Date: 2014–06–23
  24. By: Brenda González-Hermosillo; Christian A Johnson
    Abstract: This paper proposes a stochastic volatility model to measure sovereign financial distress. It examines how key European sovereign credit default swap (CDS) spreads affect each other; specifically, the paper analyses the volatility structure of Germany, Greece, Ireland, Italy, Spain and Portugal. The stability of Germany is a close proxy for the resilience of the euro area as markets use Germany’s sovereign CDS as a hedge for systemic risk. Although most of the CDS changes for Germany during 2009–12 were due to idiosyncratic factors, market developments in Italy and Spain contributed significantly, likely due to their relative importance in the region. Changes in Greece’s sovereign CDS had no significant effect on Germany’s sovereign CDS despite initial widespread concerns about such linkages. Spain and Italy show a notable co-dependence in explaining each other’s volatility while Germany also plays an important role. It is found that extreme bad news led to persistent and nearly permanent effects on the stochastic volatility of European sovereign CDS spreads.
    Keywords: Financial risk;Italy;Spain;Greece;Euro Area;Financial crisis;Spillovers;Global Financial Crisis 2008-2009;Economic models;Systemic Risk, Financial Crises, Volatility, Contagion, Credit Default Swaps
    Date: 2014–05–02
  25. By: Juliusz Jabłecki (Faculty of Economic Sciences, University of Warsaw); Ryszard Kokoszczyński (Faculty of Economic Sciences, University of Warsaw); Paweł Sakowski (Faculty of Economic Sciences, University of Warsaw); Robert Ślepaczuk (Faculty of Economic Sciences, University of Warsaw); Piotr Wójcik (Faculty of Economic Sciences, University of Warsaw)
    Abstract: We suggest that the term structure of volatility futures (e.g. VIX futures) shows a clear pattern of dependence on the current level of VIX index. At the low level of VIX (below 20) the term structure is highly upward sloping; at the high VIX level (over 30) it is strongly downward sloping. We use those features to better predict future volatility and index futures. We begin by introducing some quantitative measures of volatility term structure (VTS) and volatility risk premium (VRP). We use them further to estimate the distance between the actual value and the fair (model) value of the VTS. We find that this distance has significant predictive power for volatility futures and index futures and we use this feature to design a simple strategy to invest in VIX index futures and S&P500.
    Keywords: volatility term structure, volatility risk premium, volatility and index futures, realized volatility, implied volatility, investment strategies, returns forecasting, efficient risk and return measures
    JEL: G11 G14 G15 G23 C61 C22
    Date: 2014
  26. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: EXECUTIVE SUMMARY The global crisis has had virtually no impact on Algeria’s financial system, which remains stable overall but thoroughly underdeveloped. Pervasive exchange controls, widespread public ownership, and an abundance of domestic funding have protected banks from external shocks. Financial sector reforms have been pushed to the backburner by the emergence of global financial and regional political turmoil, with privatization of banks halted and consumer lending suspended. The authorities have made progress in a number of areas implementing the recommendations of the 2007 FSAP update. Banking supervision was improved by introducing a risk-based bank rating system, and by tightening and adopting internationally accepted prudential standards. In addition, the central bank has taken on additional responsibilities in the area of financial stability, and has published its first financial stability report. Moreover, the team’s stability analysis suggests only moderate vulnerability of the financial system to shocks. Stress tests indicate that credit and specifically loan concentration are the main banking sector risks, and that public banks are most vulnerable. In particular, the public banks are highly exposed to large state-owned enterprises involved in the manufacturing, construction, and commerce sectors, which leaves them exposed to firm- and sector-specific shocks. However, Algeria’s external and fiscal buffers are substantial, owing to high oil prices, and past experience has illustrated that the state is able and prepared to provide a backstop to the banks. However, a number of important recommendations from the 2007 FSAP remain valid. Governance of public banks still needs to be enhanced, and the operations of the judicial system, including for extra-judicial procedures for debt workouts, requires further strengthening. Public banks have not been privatized, and a well-defined yield-curve based on an interest rate-centered monetary policy is still lacking. Even closer coordination between the BA and the MoF is needed to enable better liquidity management. And besides these measures, a broader reform strategy is needed to better enable the financial system to support economic growth: • Modernizing the financial sector: Measures are needed to facilitate financial deepening, including further improving corporate governance in state banks, implementing the public credit registry modernization plan, improving the collateral regime and strengthening insolvency rights, boosting the financial sector safety net and introducing a dedicated bank resolution regime, enhancing risk-based banking supervision and other financial sector supervision and oversight, strengthening the AML/CFT regime by addressing the strategic deficiencies identified by the FATF, and promoting access to finance.
    Keywords: Financial system stability assessment;Financial sector;Banks;Nonbank financial sector;Basel Core Principles;Bank supervision;Stress testing;Financial stability;Financial safety nets;Algeria;
    Date: 2014–06–10
  27. By: Langenmayr, Dominika; Lester, Rebecca
    Abstract: We study whether the corporate tax system provides incentives for risky firm investment. We first model the effects of corporate tax rates and tax loss offset rules on firm risk-taking. Testing the theoretical predictions, we find that firm risk-taking is positively related to the length of tax loss periods. This result occurs because the loss rules shift a portion of investment risk to the government, inducing firms to increase their overall level of risk-taking. Moreover, the corporate tax rate has a positive effect on risk-taking for firms that can expect to use their tax losses, and a negative effect for those that cannot. Thus, the effect of taxes on risky investment decisions varies among firms, and its sign hinges on firm-specific expectations of future tax loss recovery.
    Keywords: Corporate taxation; firm risk-taking; net operating losses
    JEL: H25 H32 G32
    Date: 2014–06–20
  28. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
    Keywords: Financial Sector Assessment Program;Bank resolution;Bank legislation;Deposit insurance;Liquidity management;Bank supervision;Financial safety nets;Risk management;Reports on the Observance of Standards and Codes;El Salvador;
    Date: 2014–02–11

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.