nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒08‒20
ten papers chosen by

  1. Efficient estimation of extreme value-at-risks for standalone structural exchange rate risk By He, Zhongfang
  2. Advances in Financial Risk Management and Economic Policy Uncertainty: An Overview By Shawkat Hammoudeh; Michael McAleer
  3. A Composite Indicator of Systemic Stress (CISS) for Colombia By Wilmar Cabrera; Jorge Hurtado; Miguel Morales; Juan Sebastián Rojas
  4. Hedging inflation risk in a developing economy: The case of Brazil By Marie Briere; Ombretta Signori
  5. 'Sudden Floods, Macroprudential Regulation and Stability in an Open Economy' By Pierre-Richard Agénor; K. Alper; L. Pereira da Silva
  6. International portfolio allocation with European fixed-income funds: What scope for Italian funds? By Paolo Zagaglia
  7. The Risk-Return binomial after rating changes By Pilar Abad; M. Dolores Robles
  8. Speculative Bubbles and the Cross-Sectional Variation in Stock Returns By Chris Brooks; Keith Anderson
  9. Does oil price uncertainty transmit to the Thai stock market? By Jiranyakul, Komain
  10. Network Risk and Key Players: A Structural Analysis of Interbank Liquidity By Edward Denbee; Christian Julliard; Ye Li; Kathy Yuan

  1. By: He, Zhongfang
    Abstract: The standalone structural exchange rate risk depends on the product of the future foreign currency earning and the change in the exchange rate. Its Value-at-Risk (VaR) implying an extremely high survival probability, usually exceeding 99.9%, is used in practice to determine its economic capital. This paper proposes a new conditional method to calculate such extreme VaRs that is shown to be more efficient than the conventional method of directly simulating from the joint distribution of the future foreign currency earning and the change in the exchange rate. The intuition of the proposed method is that, conditional on either the future foreign currency earning or the change in the exchange rate, the distribution of the structural exchange rate risk is usually analytically tractable. The proposed method can be implemented by solving a nonlinear equation via a simple one-dimensional numerical integration and is generally applicable under the distributional assumptions commonly employed in practice.
    Keywords: value-at-risk, structural exchange rate risk, extreme value
    JEL: C02 G32
    Date: 2014–08–06
  2. By: Shawkat Hammoudeh (Drexel University, Philadelphia, United States); Michael McAleer (National Tsing Hua University, Taiwan; Erasmus University Rotterdam, the Netherlands; Complutense University of Madrid, Italy)
    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: 2014–06–23
  3. By: Wilmar Cabrera; Jorge Hurtado; Miguel Morales; Juan Sebastián Rojas
    Abstract: The most recent global financial crisis (2008-2009) highlighted the importance of systemic risk and promoted academic interest to develop a wide set of warning indicators, which are mechanisms to identify systemically important institutions and global systemic risk indexes. Using the methodology proposed by Holló et al. (2012), along with some considerations from Hakkio & Keeton (2009), this document comprises a Composite Indicator of Systemic Stress (CISS) for Colombia. The index takes into account several dimensions related to financial markets (credit institutions, housing market, external sector, money market and local bond market) and is constructed using portfolio theory, considering the contagion among dimensions. Results suggest the peak of the global financial crisis (September 2008) as the most important episode of systemic risk in Colombia between 2000-2014. Additionally, real activity seems to be adversely affected by an unexpected increase of the systemic risk index. Classification JEL: G12, G29, C51
    Date: 2014–06
  4. By: Marie Briere; Ombretta Signori
    Abstract: Inflation shocks are one of the pitfalls of developing economies and are usually difficult to hedge. This paper examines the optimal strategic asset allocation for a Brazilian investor seeking to hedge inflation risk at different horizons, ranging from one to 30 years. Using a vector-autoregressive specification to model inter-temporal dependency across variables, we measure the inflation hedging properties of domestic and foreign investments and carry out a portfolio optimisation. Our results show that foreign currencies complement traditional assets very efficiently when hedging a portfolio against inflation: around 70% of the portfolio should be dedicated to domestic assets (equities, inflation-linked (IL) bonds and nominal bonds), whereas 30% should be invested in foreign currencies, especially the US dollar and the euro. © 2012 Elsevier B.V.
    Keywords: Inflation hedge; Pension finance; Portfolio optimisation; Shortfall risk
    Date: 2013–01
  5. By: Pierre-Richard Agénor; K. Alper; L. Pereira da Silva
    Abstract: A dynamic stochastic model of a small open economy with a two-level banking intermediation structure, a risk-sensitive regulatory capital regime, and imperfect capital mobility is developed. Firms borrow from a domestic bank and the bank borrows on world capital markets, in both cases subject to a premium. A sudden flood in capital flows generates an expansion in credit and activity, as well as asset price pressures. Countercyclical capital regulation, in the form of a Basel III-type rule based on credit gaps, is effective at promoting macro stability (defined in terms of the volatility of a weighted average of inflation and the output gap) and financial stability (defined in terms of three measures based on asset prices, the credit-to-GDP ratio, and the ratio of bank foreign borrowing to GDP). However, because the gain in terms of reduced economic volatility exhibit diminishing returns, in practice a countercyclical regulatory capital rule may need to be supplemented by other, more targeted macroprudential instruments when shocks are large and persistent.
    Date: 2014
  6. By: Paolo Zagaglia (The Rimini Centre for Economic Analysis; Department of Economics (Bologna campus) and School of Political Science (Ravenna campus), Università degli Studi di Bologna)
    Abstract: We study optimal asset allocation for a portfolio of European fixed-income mutual funds during the recent financial turmoil. We use a sample of daily returns for country indices of French, German and Italian funds to investigate the quest for international diversification. Our analysis focuses on the specific role of Italian funds. We compute optimal portfolio allocations from a modified mean-variance framework that takes as input the out-of-sample forecasts for the conditional mean, volatility and correlation of the funds returns. VaR forecast comparisons between alternative models provide support for a fractionally-integrated GARCH for the conditional variance. The interaction between the funds is modelled as the Dynamic Conditional Correlation of Engle (2002). Our results are twofold. First, the optimal portfolio allocates more than 50% of assets to German funds, while assigning equal shares of approximately 20% to both French and Italian funds. This strategy generates portfolio returns that are more stable than those of our competing models. It is also characterized by a worsening of the risk-return tradeoff throughout the evaluation period. The second result is that overweighing Italian funds with respect to the optimal strategy causes the portfolio to hold additional volatility of returns without generating compensation for risk.
    Date: 2014–07
  7. By: Pilar Abad (Universidad Rey Juan Carlos, Paseo Artilleros s/n, 28032 Madrid, Spain and RFA-IREA.); M. Dolores Robles (Universidad Complutense de Madrid and ICAE, Campus de Somosaguas, 28223 Madrid, Spain.)
    Abstract: Risk-averse investors take into consideration risk-return tradeoff for decide their new position after the release of relevant information. This paper analyzes the informational content of rating change announcements focusing on the joint reaction they cause on the risk-return binomial. Our purpose is to identify the main factors that signal which announcements are informative. To do that we estimate a binomial logit model for the probability of informative content of credit rating announcements. We analyze a sample of rating events affecting Spanish listed firms from 2000 to 2010. Empirical results show significant differences in the informative content between positive and negative rating events. For both kinds of announcements, we find higher informative content when agencies agree about the new level of solvency, whereas those affecting high covered firm that operate in highly regulated sectors are the less informative. Other factors as the presence of a previous rating refinements or trends in the credit quality reveals different information depending on the direction of the rating event. Finally, we find the announcements after de crisis disclose less information, suggesting a loss of reputation of CRAs.
    Keywords: Abnormal return, Abnormal systematic risk, Abnormal volatility, Logit model.
    JEL: G12 G14 G24 C22
    Date: 2014–07
  8. By: Chris Brooks (ICMA Centre, Henley Business School, University of Reading); Keith Anderson (The York Management School)
    Abstract: Evidence suggests that rational, periodically collapsing speculative bubbles may be pervasive in stock markets globally, but there is no research that considers them at the individual stock level. In this study we develop and test an empirical asset pricing model that allows for speculative bubbles to affect stock returns. We show that stocks incorporating larger bubbles yield higher returns. The bubble deviation, at the stock level as opposed to the industry or market level, is a priced source of risk that is separate from the standard market risk, size and value factors. We demonstrate that much of the common variation in stock returns that can be attributable to market risk is due to the co-movement of bubbles rather than being driven fundamentals.
    Keywords: speculative bubbles, asset pricing, stock returns, CAPM, cross-sectional variation
    JEL: G11 G14 C21 C22
    Date: 2012–11
  9. 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 is 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. It is also found that oil price movement and its uncertainty adversely affect two main sub-index returns. These important findings give some 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
  10. By: Edward Denbee; Christian Julliard; Ye Li; Kathy Yuan
    Abstract: We model banks’ liquidity holding decision as a simultaneous game on an interbank borrowing network. We show that at the Nash equilibrium, the contributions of each bank to the network liquidity level and liquidity risk are distinct functions of its indegree and outdegree Katz-Bonacich centrality measures. A wedge between the planner and the market equilibria arises because individual banks do not internalize the effect of their liquidity choice on other banks’ liquidity benefit and risk exposure. The network can act as an absorbent or a multiplier of individual banks’ shocks. Using a sterling interbank network database from January 2006 to September 2010, we estimate the model in a spatial error framework, and find evidence for a substantial, and time varying, network risk: in the period before the Lehman crisis, the network is cohesive and liquidity holding decisions are complementary and there is a large network liquidity multiplier; during the 2007-08 crisis, the network becomes less clustered and liquidity holding less dependent on the network; after the crisis, during Quantitative Easing, the network liquidity multiplier becomes negative, implying a lower network potential for generating liquidity. The network impulse-response functions indicate that the risk key players during these periods vary, and are not necessarily the largest borrowers.
    Date: 2014

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