nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒08‒02
sixteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Modern Portfolio optimiser techniques enabling more effective property 'market risk' management By Ostroumoff, Charles
  2. Asymmetric Realized Volatility Risk By David E. Allen; Michael McAleer; Marcel Scharth
  3. The Case for Risk Parity as an Alternative Strategy for Asset Allocation in Real Estate Portfolios By Katyoka, Mutale; Stevenson, Simon
  4. Diversification Gains and Systematic Risk Exposure in International Public Real Estate Markets By Lizieri, Colin; Chuangdumrongsomsuk, Marielle Apisara
  5. Determinants of corporate hedging policies and derivatives usage in risk management practices of non-financial firms By Chaudhry, Dr. Naveed Iqbal; Mehmood, Mian Saqib; Mehmood, Asif
  6. On modeling banking risk By Efthymios G. Tsionas
  7. Real Estate Risk and Exposure of Banking Institutions to Real Estate By Ong, Seow-Eng; Khairul, Mohd; Ibrahim, Muhammad Faishal; Thao, Le Thi Thanh
  8. Risk assessment of real estate investment with the use of subjective probability By Dittmann, Iwona
  9. Lessons from the European Financial Crisis By Marco Pagano
  10. Hedging house price risk with futures contracts after the bubble burst By Swidler, Steve; Schorno, Patrick; Wittry, Michael
  11. Individual Homebuyer's Loan Selection under the Differential Risk of Mortgage Products By Lin, Che-Chun
  12. Change of the Tools Used for Real Estate Risk Analysis By Wolski, Rafal; Zaleczna, Magdalena
  13. Identifying Real Sources of Risk and Diversification By Ryan, Stephen; Richardson, Matt
  14. Real Estate and Consumption Growth as Risk Factors: An Empirical Asset Pricing Approach By Coen, Alain; Carmichael, Benoit
  15. The Asset Owner Real Estate Investment Process: Risk Management Insights from the MSCI/IPD survey By Hobbs, Peter; Teuben, Bert
  16. Sustainability Assessment of Buildings and Corporate Real Estate Management: The Risk Management Perspective By Geissler, Susanne

  1. By: Ostroumoff, Charles
    Abstract: In this paper I will analyse the efficacy of current property portfolio risk management techniques employed by multi asset portfolio managers and property portfolio fund managers in the UK. I will differentiate between techniques employed at the asset specific level (bottom up approach) and techniques employed at the portfolio level (top down approach). Specifically, I will be analysing property “market risk� (beta) using time series data of IPD Capital Value Annual Returns since 1971. I will be assessing how possible it is to predict bubbles and troughs in the property cycle and then show how effective modern portfolio risk management optimiser techniques, currently employed in other asset classes (equities and bonds), but now available to real estate practitioners with the launch of annual IPD Property Futures could be used to eliminate future expected volatility and downside property market risk. Property Portfolio Risk Management, market risk, beta, diversification, IPD Property Futures, UK
    Date: 2014
  2. By: David E. Allen; Michael McAleer (University of Canterbury); Marcel Scharth
    Abstract: In this paper we document that realized variation measures constructed from highfrequency 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: 2014–07–17
  3. By: Katyoka, Mutale; Stevenson, Simon
    Abstract: Following the recent financial crisis, the need for diversification cannot be over emphasized. This notwithstanding, some concerns have been raised regarding the efficacy of the conventional asset allocation methods. These traditional strategies encompass equal weighting, minimum variance, and mean- variance optimization based on modern portfolio theory (MPT). MPT remains the most widely used method despite its inherent estimation error in the determination of expected returns and correlations. Portfolio construction using MPT in real estate presents similar challenges where naive diversification is predominantly used to diversify portfolios. Thus, these conventional strategies have been questioned especially in the wake of the financial crisis due to poor performance of portfolios.This paper introduces an alternative strategy of asset allocation called 'risk parity' to real estate portfolios by using the framework from mainstream finance. In contrast with the traditional strategies, the aim of risk parity is equal risk allocation across asset classes in a portfolio. To achieve the broad aim, the paper relies heavily on a systematic analysis of listed as well as direct real estate to ascertain whether risk parity provides a better alternative to the traditional allocation strategies employed in the real estate market. The paper argues that compared to the traditional allocation strategies, a risk parity based portfolio is likely to produce superior risk-reward tradeoff. Utilizing risk parity strategy in constructing a portfolio does not require the creation of expected return assumptions as only the asset class covariances are needed. These covariances can be more accurately estimated from historical data than expected returns. In lower risk portfolios, leverage can be employed in order to increase return expectation while derivatives can be used as a way to attain desired market exposures more safely and inexpensively.
    Date: 2013
  4. By: Lizieri, Colin; Chuangdumrongsomsuk, Marielle Apisara
    Abstract: In this paper, we re-examine the benefits of holding a portfolio of international real estate securities in the light of evidence of growing co-movement of securitised asset returns across markets. Do diversification benefits depend on how integrated or independent the firms and countries are at global or regional level? Specifically, can more risk reduction be achieved through holding international diversified investments in segmented markets rather than co-integrated markets? If so, is it possible to identify the extent of this effect, hence informing global investor strategy, particularly in the light of a growing integration within global securities markets? The paper develops studies such as Wilson and Zurbruegg (2003), Gerlach et al. (2006) and Gallo and Zhang (2010) in focussing on the cointegration between markets, but extends that work in seeking to identify the sources of difference and in investigating the impact of cointegration on the sensitivity of asset returns to factor risks. Cointegration is captured using a variety of techniques: ADF, PP, KPSS and Zivot and Andrews. From these tests, we produce two portfolios of “cointegratedâ€? and “independentâ€? indices and assess whether they differ in terms of risk-adjusted return. We examine Sharpe ratios and sensitivity to systematic risk, using a range of multi-factor models, decompose portfolio risk using a Fama-Macbeth approach and apply a canonical approach to test sensitivity to macro-economic and financial risk factors. The paper utilises data from GPR’s international real estate company database. Monthly returns 1997 to 2011 from individual firms are aggregated to produce value-weighted indices for 19 countries) and five regions. We also examine company returns by sector and, separately, examine firms that are based or predominantly invested in international financial centres. In the analysis presented here, we focus on results for US$ returns, although local currency returns are reported.The results indicate substantial differences in factor sensitivity and risk between the cointegrated and independent portfolios although benefits from risk sensitivity may be offset by lower aggregate performance. We re-examine the results for different time periods and for sector-specific company indices and, finally, examine the results for companies focussed in global financial centres. Differences in the results shed light on the sources of integration and systematic risk.
    Date: 2013
  5. By: Chaudhry, Dr. Naveed Iqbal; Mehmood, Mian Saqib; Mehmood, Asif
    Abstract: Derivatives are the major icon among risk management practices. Firms usually use derivatives to hedge their foreign exchange and interest rate risk. This study aims to examine the determinants’ of corporate hedging policies and derivative usage in risk management particularly with respect to Pakistan, as the political and economic conditions in Pakistan are highly volatile which intends the corporations to handle and mitigate their risk through channelizing the derivatives. Secondary data of 75 non financial firms listed in Karachi Stock Exchange was collected over the period 2007-2011 – to regress empirically – for achieving the aim of this study. Mann-Whitney U test was used to distinguish the derivative user and non user. Findings of this test characterize users as large size, higher growth opportunities, cash flow volatility, foreign exchange and interest rate exposure. Moreover this study finds that there is a significant relationship between the use of derivatives and foreign purchase, liquidity, firm growth and size. Our findings suggest that derivative users have competitive edge over the non user, as they get economies of scale and proper risk management through using these kinds of derivative instruments.
    Keywords: Corporate Hedging, Derivatives, Risk Management, Foreign Exchange Derivatives, Interest Rate Derivatives, Pakistan.
    JEL: F23 F30 G32
    Date: 2014–07–22
  6. By: Efthymios G. Tsionas (Athens University of Economics and Business)
    Abstract: The paper develops new indices of financial stability based on an explicit model of expected utility maximization by financial institutions subject to the classical technology restrictions of neoclassical production theory. The model can be estimated using standard econometric techniques, like GMM for dynamic panel data and latent factor analysis for the estimation of covariance matrices. An explicit functional form for the utility function is not needed and we show how measures of risk aversion and prudence (downside risk aversion) can be derived and estimated from the model. The model is estimated using data for Eurozone countries and we focus particularly on (i) the use of the modeling approach as an “early warning mechanism”, (ii) the bank- and country-specific estimates of risk aversion and prudence (downside risk aversion), and (iii) the derivation of a generalized measure of risk that relies on loan-price uncertainty.
    Keywords: Financial Stability; Banking; Expected Utility Maximization; Sub-prime crisis; Financial Crisis; Eurozone; PIIGS.
    JEL: G20 G21 C51 C54 D21 D22
    Date: 2014–05
  7. By: Ong, Seow-Eng; Khairul, Mohd; Ibrahim, Muhammad Faishal; Thao, Le Thi Thanh
    Abstract: Analyzing the real estate risk sensitivity of GCC banking institutions, we found that both real estate loan and equity exposure of conventional and Islamic banks positively increases its real estate beta risk. The results persist across different subsamples. As expected, the effect is more persistent during time periods when bank's real estate exposure is elevated. Generally, due to the greater real estate exposure of Islamic banks, they possess greater real estate beta risk than conventional banks. However there is no evidence that Islamic banks real estate exposure has a differential effect on real estate risk vis-à-vis conventional banks. With limited Shariah compliant real estate hedging capabilities, improving the management of real estate risk in Islamic banks could be a potential foray for regulators and product structurers.
    Date: 2013
  8. By: Dittmann, Iwona
    Abstract: Investing in real estate, as in any other market, involves risk. To assess investment risk, different measures are used, including measures based on probability distribution (like volatility measures and safety level) as well as measures based on distribution function (the probability of not achieving the aspiration level).The purpose of this paper is to propose the use of subjective probability in the risk assessment of investment in real estate. This paper: 1) will identify the determinants of subjective probability estimation in the assessment of investment risk in the real estate market, 2) will present heuristics and related possible errors committed by risk analysts and forecasters (like anchoring and adjustment heuristics, availability heuristic, representativeness heuristic, confirmation bias, hindsight bias, conjunction fallacy and unrealistic optimism), 3) will present the possibility of applying the Easyfit software to estimate subjective probability distribution based on the percentiles specified by experts.The theoretical considerations presented in the paper are based on the achievements of finance and behavioral economics. The practical part provides an example of estimating subjective probability distribution based on percentiles with the use of the Easyfit software.
    Date: 2014
  9. By: Marco Pagano (Università di Napoli Federico II CSEF, EEIF, CEPR and ECGI)
    Abstract: This paper distils three lessons for bank regulation from the experience of the 2009-12 euro-area financial crisis. First, it highlights the key role that sovereign debt exposures of banks have played in the feedback loop between bank and fiscal distress, and inquires how the regulation of banks’ sovereign exposures in the euro area should be changed to mitigate this feedback loop in the future. Second, it explores the relationship between the forbearance of non-performing loans by European banks and the tendency of EU regulators to rescue rather than resolving distressed banks, and asks to what extent the new regulatory framework of the euro-area “banking union” can be expected to mitigate excessive forbearance and facilitate resolution of insolvent banks. Finally, the paper highlights that capital requirements based on the ratio of Tier-1 capital to banks’ risk-weighted assets were massively gamed by large banks, which engaged in various forms of regulatory arbitrage to minimize their capital charges while expanding leverage. This argues in favor of relying on a set of simpler and more robust indicators to determine banks’ capital shortfall, such as book and market leverage ratios. JEL Classification: G01, G21, G28, G33.
    Keywords: bank regulation, euro, financial crisis, sovereign exposures, forbearance, bank resolution, bank capital requirements.
    Date: 2014–07–24
  10. By: Swidler, Steve; Schorno, Patrick; Wittry, Michael
    Abstract: This paper extends the existing literature on managing house price risk. While previous work finds that a hedger would have reduced a large amount of variance in housing returns in Las Vegas, Nevada using a static in-sample strategy in Chicago Mercantile Exchange (CME) futures contracts, we show that neither static nor dynamic strategies would have maintained an effective hedge during the significant decline in housing prices. The inability to hedge house price risk using CME contracts ultimately calls into question the long-term viability of housing futures.
    Date: 2014
  11. By: Lin, Che-Chun
    Abstract: Because homeownership represents the largest investment many individuals make, and the risks of competing mortgage products are not well understood, we develop a framework to quantify credit risks of mortgage products. We use simulations to examine the default rates of five types of mortgage products under both a normal and stressed economy to examine risk differences among the competing mortgage products. Results suggest that significant default risk differences exist between mortgage products. As a result, in addition to considering characteristics such as differential interest rates, points and fees, and the term of a mortgage, homebuyers should consider the risk differential of competing mortgage products before selecting a mortgage.
    Date: 2013
  12. By: Wolski, Rafal; Zaleczna, Magdalena
    Abstract: Market situation fluctuates under the pressure of macroeconomic factors between periods of strong growth and deep fall passing through shorter or longer periods of stabilization. The real estate market was traditionally considered as a competitive in relation to the stock market, experiencing declines and economic growth at a different time. From this point of view the real property added to the portfolio of an investor can give the risk reduction through diversification. This approach suggested the use of specific risk measures. However, the authors pose the hypothesis that the observed changes in the nature of the contemporary instruments of real estate market require a change of the tools used for risk analysis. The authors test the nature of real estate investment by analyzing results of direct and indirect real estate instruments used on the Polish real estate market and confront them with instruments used on the capital market.
    Date: 2013
  13. By: Ryan, Stephen; Richardson, Matt
    Abstract: Purpose - To examine whether current decision-making approaches and tools are effective for investors seeking risk-adjusted returns in private equity real estate. Two problems in particular are examined: first, over-reliance on geographic, sector and style labels; second, excessive emphasis on volatility of total returns (which is problematic because total return data mask the marked difference between the volatility of income returns and capital returns). Long term and short term improvements are suggested. Design/methodology/approach - Analysis of historic sources of risk and return at multiple levels and over different time periods, with focus on difference between income and capital returns. Findings - For investors whose priority is maximising risk-adjusted returns, better results are obtainable by looking through sector, geographic and style labels at the underlying cash flows. Long term diversification is more likely to be achieved through a combination of complementary income sources and lease structures than through naive geographical or sector diversification. The difference in volatility of income returns and capital returns merits greater attention. Research limitations/implications - Historic data is scarce outside the most mature markets. Practical implications - May help develop clearer understanding of real estate risk and improved decision-making for sell-side and buy-side market participants.
    Date: 2013
  14. By: Coen, Alain; Carmichael, Benoit
    Abstract: In this article our main objective is to study simultaneously the influence of three important risk factors on asset returns, namely the return on financial market (proxy for financial wealth), the consumption growth and the return on real estate wealth. The third factor has been surprisingly neglected by the financial literature: the global financial crisis has highlighted this drawback. More specifically, we develop a linear multifactor pricing model using monthly data of stock returns. For a long period from January 1972 to December 2013, our results shed new light on the relative importance of real estate risk on the 25 portfolios formed on size and book-to-market as computed from the CRSP database. Dividing our full sample in two sub-periods, we compute for each asset an estimate of the beta coefficient of each factor and then the mean risk premia associated. Using our full sample and dividing it in two sub-periods related to the contrasted evolution of the systemic risk (from January 1972 to December 1990 and from January 1991 to December 2013), we present results based on two alternative GMM procedures, the iterated GMM with optimal weighting matrix and the one-step GMM (introduced by Cochrane (1996)). The second GMM specification exhibits clearly, as suggested by Cochrane (1996), estimates with much lower average pricing errors. More interestingly, we report that the return on real estate wealth is a priced risk factor. Thanks to our sub-periods analysis, we are able to show that this neglected factor is useful to explain the cross-sectional variation of returns, especially for the last two decades associated to the so called «real estate bubble».
    Date: 2014
  15. By: Hobbs, Peter; Teuben, Bert
    Abstract: During the final quarter of 2013, IPD conducted a survey into the asset allocation processes of institutional asset owners, with a particularly close examination of their real estate exposures. This paper provides a detailed analysis of the real estate element of the survey, with a particular focus on risk management through the investment process.The results are based on a desk-based analysis of 138 asset owners, in-person interviews with 40 investors and a literature review. The focus is on Pension Funds and Sovereign Wealth Funds, providing in-depth coverage of these institutions across 28 countries. The research provides a comprehensive review of the role of the $700bn of real estate equity in asset owner portfolios, including their allocations to different investment styles, their geographic exposures and their approaches to execution. The more innovative aspects of the research relate to the approach of asset owners to real estate risk management, explaining the potential for misalignment at various stages of the investment process. This includes alignment between strategic asset allocation and actual real estate exposures, the use of appropriate benchmarks, and the link between portfolio and asset-specific monitoring and the strategic asset allocation process. The final section of the paper draws out some of the implications of the research including a categorization of different types of asset owner and the steps beginning to be taken by a series of ’global leaders‘ seeking to strengthen risk management through the investment process.
    Date: 2014
  16. By: Geissler, Susanne
    Abstract: Sustainability assessments of buildings are well known to result in certificates, which are mainly used for marketing purposes. This conference contribution does not tackle the marketing perspective but focuses on the sustainability assessment of buildings as a risk management tool for corporate real estate management. Buildings have a long life span, and it is important to ensure a stable performance of the property during several decades. Regarding market demand, the building location is undoubtedly a very high ranked criterion when it comes to making the decision to buy or rent a building or building unit or not. Nevertheless, building specific quality characteristics such as energy efficiency characteristics related with the building envelope and the HVAC system, characteristics related with the indoor air quality, and quality characteristics from the facility management perspective to reduce running cost have been gaining in importance, due to the following exemplary reasons: (1) Energy: Even if clients seldom demand for energy efficiency, this topic is definitely on the rise due the legal framework conditions such as the EPBD (Energy Performance of Buildings Directive) and the EED (Energy Efficiency Directive); if a building is not fit to be able to comply with the requirements to come, upgrading might be more expensive than taking energy efficiency into account from the beginning. (2) Indoor climate: Productivity depends on social aspects, but also on building related aspects such as air quality, summer and winter comfort, quality of light, and noise level; this area is more a subject of competition on the market than energy, because of the impact on people's health and productivity. (3) Materials: The type of façade and choice of materials in general has a strong influence on running costs; a wise choice results in a reduction of cleaning costs. All these aspects are finally cost-related factors, which might affect the saleability of a property. Building assessment schemes provide a full range of decision-making criteria to consider all building related aspects, which are already on the rise or might become important in the near future. However, it is the responsibility of the informed expert to decide between options. This conference contribution uses the Austrian sustainable building assessment scheme (ÖGNB – ASBC) to demonstrate the relation between building assessment criteria and risk factors.
    Date: 2013

This nep-rmg issue is ©2014 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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.