New Economics Papers
on Risk Management
Issue of 2014‒07‒21
eleven papers chosen by

  1. An Alternative Model to Basel Regulation By Aboura, Sofiane; Lépinette-Denis, Emmanuel
  2. Modeling Portfolio Risk by Risk Discriminatory Trees and Random Forests By Yang, Bill Huajian
  3. CVA under Partial Risk Warehousing and Tax Implications By Chris Kenyon; Andrew Green
  4. Portfolio optimization in the case of an asset with a given liquidation time distribution By Ljudmila A. Bordag; Ivan P. Yamshchikov; Dmitry Zhelezov
  5. Liquidity Risk and U.S. Bank Lending at Home and Abroad By Ricardo Correa; Linda S. Goldberg; Tara Rice
  6. Estimating Long-Run PD, Asset Correlation, and Portfolio Level PD by Vasicek Models By Yang, Bill Huajian
  7. Short-sale constraints and financial stability: Evidence from the Spanish market By Óscar Arce; Sergio Mayordomo
  8. Does Regulation Matter? Riskiness and Procyclicality of Pension Asset Allocation By Brière, Marie; Boon, Ling-Ni; Rigot, Sandra
  9. Correlations By Paul Ehling; Christian Heyerdahl-Larsen
  10. Systemic Risk in Commodity Markets: What Do Trees Tell Us About Crises? By Lautier, Delphine; Ling, Julien; Raynaud, Franck
  11. Does oil price uncertainty transmit to the Thai stock market? By Jiranyakul, Komain

  1. By: Aboura, Sofiane; Lépinette-Denis, Emmanuel
    Abstract: The post-crisis financial reforms address the need for systemic regulation, focused not only on individual banks but also on the whole financial system. The regulator principal objective is to set banks' capital requirements equal to international minimum standards in order to mimimise systemic risk. Indeed, Basel agreement is designed to guide a judgement about minimum universal levels of capital and remains mainly microprudential in its focus rather than being macroprudential. An alternative model to Basel framework is derived where systemic risk is taken into account in each bank's dynamic. This might be a new departure for prudential policy. It allows for the regulator to compute capital and risk requirements for controlling systemic risk. Moreover, bank regulation is considered in a two-scale level, either at the bank level or at the system-wide level. We test the adequacy of the model on a data set containing 19 banks of 5 major countries from 2005 to 2012. We compute the capital ratio threshold per year for each bank and each country and we rank them according to their level of fragility. Our results suggest to consider an alternative measure of systemic risk that requires minimal capital ratios that are bank-specic and time-varying.
    Keywords: Systemic risk; Bank Regulation; Basel Accords;
    JEL: E44 E58 G01 G21 G28
    Date: 2014–05
  2. By: Yang, Bill Huajian
    Abstract: Common tree splitting strategies involve minimizing a criterion function for minimum impurity (i.e. difference) within child nodes. In this paper, we propose an approach based on maximizing a discriminatory criterion for maximum risk difference between child nodes. Maximum discriminatory separation based on risk is expected in credit risk scoring and rating. The search algorithm for an optimal split, proposed in this paper, is efficient and simple, just a scan through the dataset. Choices of different trees, with options either more or less aggressive in variable splitting, are made possible. Two special cases are shown to relate to the Kolmogorov Smirnov (KS) and the intra-cluster correlation (ICC) statistics. As a validation of the proposed approaches, we estimate the exposure at default for a commercial portfolio. Results show, the risk discriminatory trees, constructed and selected using the bagging and random forest, are robust. It is expected that the tools presented in this paper will add value to general portfolio risk modelling.
    Keywords: Exposure at default, probability of default, loss given default, discriminatory tree, CART tree, random forest, bagging,, KS statistic, intra-cluster correlation, penalty function, risk concordance
    JEL: C1 C14 G32 G38
    Date: 2013–08–01
  3. By: Chris Kenyon; Andrew Green
    Abstract: Given the limited CDS market it is inevitable that CVA desks will partially warehouse credit risk. Thus realistic CVA pricing must include both warehoused and hedged risks. Furthermore, warehoused risks may produce profits and losses which will be taxable. Paying for capital use, will also generate potentially taxable profits with which to pay shareholder dividends. Here we extend the semi-replication approach in (Burgard and Kjaer 2013) to include partial risk warehousing and tax consequences. In doing so we introduce double-semi-replication, i.e. partial hedging of value jump on counterparty default, and TVA: Tax Valuation Adjustment. We take an expectation approach to hedging open risk and so introduce a market price of counterparty default value jump risk. We show that both risk warehousing and tax are material in a set of interest rate swap examples.
    Date: 2014–07
  4. By: Ljudmila A. Bordag; Ivan P. Yamshchikov; Dmitry Zhelezov
    Abstract: Management of the portfolios containing low liquidity assets is a tedious problem. The buyer proposes the price that can differ greatly from the paper value estimated by the seller, the seller, on the other hand, can not liquidate his portfolio instantly and waits for a more favorable offer. To minimize losses in this case we need to develop new methods. One of the steps moving the theory towards practical needs is to take into account the time lag of the liquidation of an illiquid asset. This task became especially significant for the practitioners in the time of the global financial crises. Working in the Merton's optimal consumption framework with continuous time we consider an optimization problem for a portfolio with an illiquid, a risky and a risk-free asset. While a standard Black-Scholes market describes the liquid part of the investment the illiquid asset is sold at a random moment with prescribed liquidation time distribution. In the moment of liquidation it generates additional liquid wealth dependent on illiquid assets paper value. The investor has the logarithmic utility function as a limit case of a HARA-type utility. Different distributions of the liquidation time of the illiquid asset are under consideration - a classical exponential distribution and Weibull distribution that is more practically relevant. Under certain conditions we show the existence of the viscosity solution in both cases. Applying numerical methods we compare classical Merton's strategies and the optimal consumption-allocation strategies for portfolios with different liquidation-time distributions of an illiquid asset.
    Date: 2014–07
  5. By: Ricardo Correa; Linda S. Goldberg; Tara Rice
    Abstract: While the balance sheet structure of U.S. banks influences how they respond to liquidity risks, the mechanisms for the effects on and consequences for lending vary widely across banks. We demonstrate fundamental differences across banks without foreign affiliates versus those with foreign affiliates. Among the nonglobal banks (those without a foreign affiliate), cross-sectional differences in response to liquidity risk depend on the banks’ shares of core deposit funding. By contrast, differences across global banks (those with foreign affiliates) are associated with ex ante liquidity management strategies as reflected in internal borrowing across the global organization. This intra-firm borrowing by banks serves as a shock absorber and affects lending patterns to domestic and foreign customers. The use of official-sector emergency liquidity facilities by global and nonglobal banks in response to market liquidity risks tends to reduce the importance of ex ante differences in balance sheets as drivers of cross-sectional differences in lending.
    JEL: F3 G21 G38
    Date: 2014–07
  6. By: Yang, Bill Huajian
    Abstract: In this paper, we propose a Vasicek-type of models for estimating portfolio level probability of default (PD). With these Vasicek models, asset correlation and long-run PD for a risk homogenous portfolio both have analytical solutions, longer external time series for market and macroeconomic variables can be included, and the traditional asymptotic maximum likelihood approach can be shown to be equivalent to least square regression, which greatly simplifies parameter estimation. The analytical formula for long-run PD, for example, explicitly quantifies the contribution of uncertainty to an increase of long-run PD. We recommend the bootstrap approach to addressing the serial correlation issue for a time series sample. To validate the proposed models, we estimate the asset correlations for 13 industry sectors using corporate annual default rates from S&P for years 1981-2011, and long-run PD and asset correlation for a US commercial portfolio, using US delinquent rate for commercial and industry loans from US Federal Reserve.
    Keywords: Portfolio level PD, long-run PD, asset correlation, time series, serial correlation, bootstrapping, binomial distribution, maximum likelihood, least square regression, Vasicek model
    JEL: C02 C13 C5 G32
    Date: 2013–07–10
  7. By: Óscar Arce (Banco de España); Sergio Mayordomo (University of Navarra)
    Abstract: We examine the effect of the short-selling ban in 2011 on Spanish stocks on the level of risk in the banking sector. Before the ban, short positions were found to be positive and significantly related to the creditworthiness of medium-sized banks, these being generally less internationally diversified and more reliant on official support. We show that the ban helped stabilise the credit risk of medium-sized banks, especially those more exposed to short-sellers’ activity, but not that of large banks and non-financial corporations. This stabilising effect came at the cost of a significantly sharp decline in liquidity, trading and price efficiency of medium-sized banks’ stocks relative to other stocks.
    Keywords: G01, G12, G14, G18
    Date: 2014–06
  8. By: Brière, Marie; Boon, Ling-Ni; Rigot, Sandra
    Abstract: In this paper, we investigate the relative importance of drivers to pension funds’ asset allocation choices. We specifically test if the contrast between regulatory approaches of public and private Defined Benefits (DB) pension funds in the US, Canada and the Netherlands have an impact on the riskiness and procyclicality of their asset allocation. Derived from panel data analysis of a unique database comprising of more than 800 pension funds’ detailed asset allocations, our results underscore the economic importance of regulation in the funds’ asset allocation choices, relative to institutional and individual funds’ characteristics. In particular, quantitative risk-based capital requirements, and to a lesser extent valuation and funding requirements (i.e., the choice of the liability discount rate) or the presence of quantitative investment restrictions, induce pension funds to significantly decrease their asset allocation to risky assets, especially to equities. Allocation to alternatives, which are comparatively treated quite favorably by solvency standards, is higher in the presence of risk-based capital requirements. Contrary to popular conviction that regulatory mechanisms encourage procyclical asset allocation, we find that funds subject to risk-based capital requirements were likely to be less procyclical during the last crisis – an outcome possibly tempered by temporary regulatory slackening in response to the crisis.
    Keywords: Solvency; Pension funds; Financial stability; Regulation;
    JEL: G11 G28 H55
    Date: 2014–05
  9. By: Paul Ehling (BI Norwegian business school); Christian Heyerdahl-Larsen (London business school)
    Abstract: Correlations of equity securities have varied substantially over time and remain a source of continuing policy debate. This paper studies stock market correlations in an equilibrium model with heterogeneous risk aversion. In the model, preference heterogeneity causes countercyclical variations in the volatility of aggregate risk aversion. At times of high volatility of aggregate risk aversion, which is a common factor in returns, we see high correlations. The calibrated model matches average industry return correlations and changes in correlations from business cycle peaks to troughs, and replicates the cyclical dynamics of expected excess returns and standard deviations. A proxy for model-implied aggregate risk aversion jointly explains average industry correlations, expected excess returns, standard deviations and turnover volatility in the data. We find supportive evidence for the model’s prediction that industries with low dividend-consumption correlation have low average return correlation but experience disproportionate increases in return correlations in recessions.
    Keywords: equity return correlations, heterogeneous risk aversion, volatility of turnover, cyclical dynamics of stock price moments
    JEL: G10 G11
    Date: 2014–06
  10. By: Lautier, Delphine; Ling, Julien; Raynaud, Franck
    Abstract: We examine the impact, on commodity derivative markets, of two financial crises: the Subprime crisis and the bankruptcy of Lehman Brothers. These crises are "external" for commodity markets: they appeared in the financial sphere. Still, because now commodity markets are highly integrated, between themselves and with other financial markets, such events could have had an impact. In order to fully comprehend this possible impact, we examine prices fluctuations in three dimensions: the observation time, the space dimension – the same underlying asset can be traded simultaneously in two different places – and the maturity of the transactions. We first focus on the efficiency of the shocks propagation: does it improve during crises? Then we concentrate on the paths of shocks propagation: are they modified? How? Finally we focus on the centrality of the prices system: does it change? Does it increase?
    Keywords: Commodity markets; Financial markets; Derivative markets; Market integration; Crises; Graph theory; Minimum spanning tree; Centrality;
    JEL: E44 F15 G01 Q02 Q40
    Date: 2014–05
  11. By: Jiranyakul, Komain
    Abstract: This study investigates the impact of oil price volatility (uncertainty) on the Stock Exchange of Thailand. Monthly data from May 1987 to December 2013 are applied to the two-stage procedure. In the first step, a bivariate generalized autoregressive conditional heteroskedastic (GARCH) model is estimated to obtain the volatility series of stock market index and oil price. In the second step, the pairwise Granger causality tests are performed to determine the direction of volatility transmission between oil to stock markets. It this found that movement in real oil price does not adversely affect real stock market return, but stock price volatility does affect real stock return. In addition, there exists a positive one-directional volatility transmission running from oil to stock market. These findings give important implications for risk management and policy measures.
    Keywords: Real stock price, real oil price, volatility transmission, emerging markets
    JEL: C22 G15 Q40
    Date: 2014–06

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