nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒11‒12
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Is the Central and Eastern European banking systems stable? Evidence from the recent financial crisis By Karkowska, Renata
  2. Systemic risk and bank business models By Maarten van Oordt; Chen Zhou
  3. “Forward Looking Banking Stress in EMU Countries” By Manish K. Singh; Marta Gómez-Puig; Simón Sosvilla-Rivero
  4. The 2011 European Short Sale Ban: An Option Market Perspective By Roman Kräussl; Luiz Félix; Philip Stork
  5. Properties of risk capital allocation methods: Core Compatibility, Equal Treatment Property and Strong Monotonicity By Dóra Balog; Tamás László Bátyi; Péter Csóka; Miklós Pintér
  6. Are news important to predict large losses? By Mauro Bernardi; Leopoldo Catania; Lea Petrella
  7. Systemic risk in a large claims insurance market with bipartite graph structure By Oliver Kley; Claudia Kluppelberg; Gesine Reinert
  8. Predicting Rare Events: Evaluating Systemic and Idiosyncratic Risk (editorial) By Gloria Gonzalez-Rivera
  9. The Perception of Lethal Risks - Evidence from a Laboratory Experiment By Tilman Brück; Manuel Schubert
  10. Management of Interest Rate Risk in Indian Banking By Swamy, Vighneswara
  11. Modelling the Impact of New Capital Regulations on Bank Profitability By Swamy, Vighneswara
  12. The Response of Stock Market Volatility to Futures-Based Measures of Monetary Policy Shocks By Gospodinov, Nikolay; Jamali, Ibrahim
  13. Integrating Agricultural Risks Management Strategies in selected EU Partner Countries: Syria, Tunisia, Turkey By Santeramo, Fabio Gaetano; Capitanio, Fabian; Adinolfi, Felice
  14. Are There Profit (Returns) in Shariah-Compliant Exchange Traded Funds? The Multiscale Propensity By Farouk, Faizal; Masih, Mansur

  1. By: Karkowska, Renata
    Abstract: Systemic risk is a very important but very complex notion in banking and how to measure it adequately is challenging. We introduce a new framework for measuring systemic risk by using a risk-adjusted balance sheet approach. The measure models credit risk of banks as a put option on bank assets, a tradition that originated with Merton. We conceive of an individual bank’s systemic risk as its contribution to the potential sector-wide net. In this regard, the analysis of public commercial banks operating in 7 countries from Central and Eastern Europe, shows potential risk which could threaten all the financial system. The paper shows how risk management tools can be applied in new ways to measure and analyze systemic risk in European banking system. The research results is a systemic risk map for the CEE banking systems. The study finds also instability of systemic risk determinants.
    Keywords: systemic risk, banking system, instability, emerging markets, Merton option model
    JEL: A10 C01 C32 C58 G13 G21 G32 G33
    Date: 2014–01
  2. By: Maarten van Oordt; Chen Zhou
    Abstract: In this study we disentangle two dimensions of banks' systemic risk: the level of bank tail risk and the linkage between a bank's tail risk and severe shocks in the financial system. We employ a measure of the systemic risk of financial institutions that can be decomposed into two subcomponents reflecting these dimensions. Empirically, we show quantitatively how bank characteristics are related to bank tail risk and systemic linkage. The interrelationship between bank characteristics and these dimensions determine the relation between bank characteristics and systemic risk. Certain characteristics that are irrelevant to the soundness of a financial institution taken in isolation turn out to be important for the level of systemic risk, and vice versa. Our analytical framework helps to evaluate differences in direction and scope of policy under the micro- and macro-prudential objectives of regulation.
    Keywords: Financial institutions; financial stability; tail risk; macroprudential regulation; non-interest income
    JEL: G10 G21 G28
    Date: 2014–10
  3. By: Manish K. Singh (Faculty of Economics, University of Barcelona); Marta Gómez-Puig (Faculty of Economics, University of Barcelona); Simón Sosvilla-Rivero (Faculty of Economics, Complutense University of Madrid)
    Abstract: Based on contingent claims analysis (CCA), this paper tries to estimate the systemic risk build-up in the European Economic and Monetary Union (EMU) countries using a market based measure \distance-to-default" (DtD). It analyzes the individual and aggregated series for a comprehensive set of banks in each eurozone country over the period 2004-Q4 to 2013-Q2. Given the structural di_erences in _nancial sector and banking regulations at national level, the indices provide a useful indicator for monitoring country speci_c banking vulnerability and stress. We _nd that average DtD indicators are intuitive, forward-looking and timely risk indicators. The underlying trend, uctuations and correlations among indices help us analyze the interdependence while cross-sectional di_erences in DtD prior to crisis suggest banking sector fragility in peripheral EMU countries.
    Keywords: contingent claim analysis, distance-to-default, systemic risk JEL classification: G01, G21, G28
    Date: 2014–10
  4. By: Roman Kräussl; Luiz Félix; Philip Stork (LSF)
    Abstract: We examine how the 2011 European short sale ban affected jump risk and contagion risk of both banned and unbanned stocks. Using Extreme Value Theory, we estimate the tails of stock options’ risk-neutral densities to calculate extreme downside risk. Using this measure and implied volatility skews, we find that on ban announcement day jump risk abruptly rose for all stocks and subsequently remained elevated, impacting especially banned stocks. We show that it is the imposition of the ban itself that led to the increase in jump risk rather than other causes such as information flow, options trading volumes, or stock specific factors. We document that contagion risk decreased for banned stocks after imposition of the ban, while it increased for unbanned stocks. Substitution effects were minimal, as both banned stocks’ put trading volumes and put-call ratios declined during the ban. We argue that the ban curbed further selling pressure and decreased contagion risk in financial stocks, by redirecting trading activity towards index options.
    Keywords: Short sale ban; jump risk; risk-neutral density; implied volatility skew; contagion risk
    JEL: G01 G14 G28
    Date: 2014
  5. By: Dóra Balog (Corvinus University of Budapest, Department of Finance); Tamás László Bátyi (University of California, Berkeley, Department of Economics); Péter Csóka (Momentum Game Theory Research Group, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Department of Finance, Corvinus University of Budapest); Miklós Pintér (Corvinus University of Budapest, Department of Mathematics and MTA-BCE Lendület Strategic Interactions Research Group)
    Abstract: In finance risk capital allocation raises important questions both from theoretical and practical points of view. How to share risk of a portfolio among its subportfolios? How to reserve capital in order to hedge existing risk and how to assign this to different business units? We use an axiomatic approach to examine risk capital allocation, that is we call for fundamental properties of the methods. Our starting point is Csóka and Pintér (2011) who show by generalizing Young (1985)'s axiomatization of the Shapley value that the requirements of Core Compatibility, Equal Treatment Property and Strong Monotonicity are irreconcilable given that risk is quantified by a coherent measure of risk. In this paper we look at these requirements using analytic and simulations tools. We examine allocation methods used in practice and also ones which are theoretically interesting. Our main result is that the problem raised by Csóka and Pintér (2011) is indeed relevant in practical applications, that is it is not only a theoretical problem. We also believe that through the characterizations of the examined methods our paper can serve as a useful guide for practitioners.
    Keywords: Coherent Measures of Risk, Risk Capital Allocation, Shapley value, Core, Simulation
    JEL: C71 G10
    Date: 2014–07
  6. By: Mauro Bernardi; Leopoldo Catania; Lea Petrella
    Abstract: In this paper we investigate the impact of news to predict extreme financial returns using high frequency data. We consider several model specifications differing for the dynamic property of the underlying stochastic process as well as for the innovation process. Since news are essentially qualitative measures, they are firstly transformed into quantitative measures which are subsequently introduced as exogenous regressors into the conditional volatility dynamics. Three basic sentiment indexes are constructed starting from three list of words defined by historical market news response and by a discriminant analysis. Models are evaluated in terms of their predictive accuracy to forecast out-of-sample Value-at-Risk of the STOXX Europe 600 sectors at different confidence levels using several statistic tests and the Model Confidence Set procedure of Hansen et al. (2011). Since the Hansen's procedure usually delivers a set of models having the same VaR predictive ability, we propose a new forecasting combination technique that dynamically weights the VaR predictions obtained by the models belonging to the optimal final set. Our results confirms that the inclusion of exogenous information as well as the right specification of the returns' conditional distribution significantly decrease the number of actual versus expected VaR violations towards one, as this is especially true for higher confidence levels.
    Date: 2014–10
  7. By: Oliver Kley; Claudia Kluppelberg; Gesine Reinert
    Abstract: We model business relationships exemplified for a (re)insurance market by a bipartite graph which determines the sharing of severe losses. Using Pareto-tailed claims and multivariate regular variation we obtain asymptotic results for the Value-at-Risk and the Conditional Tail Expectation. We show that the dependence on the network structure plays a fundamental role in their asymptotic behaviour. As is well-known, if the Pareto exponent is larger than 1, then for the individual agent (re-insurance company) diversification is beneficial, whereas when it is less than 1, concentration on a few objects is the better strategy. The situation changes, however, when systemic risk comes into play. The random network structure has a strong influence on diversification effects, which destroys this simple individual agent's diversification rule. It turns out that diversification is always beneficial from a macro-prudential point of view creating a conflicting situation between the incentives of individual agents and the interest of some superior entity to keep overall risk small. We explain the influence of the network structure on diversification effects in different network scenarios.
    Date: 2014–10
  8. By: Gloria Gonzalez-Rivera (Department of Economics, University of California Riverside)
    Date: 2014–01
  9. By: Tilman Brück (Stockholm International Peace Research Institute (SIPRI), Institute for the Study of Labor (IZA) and International Security and Development Center (ISDC)); Manuel Schubert (University of Passau)
    Abstract: We run a novel experiment to explore the relationship between the perception of real-life risks and the demand for risk reduction. Subjects play a series of loss lotteries in which the odds are matched to the likelihood of lethal events in real life. For each risk, subjects can pay premiums in order to reduce the likelihood of total bankruptcy. Our results show a complex interplay of mortality perception and demand for risk reduction. We observe that perceived annual mortality positively affects the demand for risk reduction. Moreover, we find certain risk characteristics to affect perceived mortality, others to drive the demand for risk reduction, and some to alter both. Our findings suggest that 30 percent of all insurance payments are due to biased perceptions of annual mortality while perfect precaution could lower payments by 45 percent. Implications for risk management policies are discussed.
    Keywords: risk perception, lethal risks, experiment, insurance
    JEL: C9 D81
    Date: 2014–10
  10. By: Swamy, Vighneswara
    Abstract: In a move towards effective management of interest rate risk in Indian banking, in addition to the existing return on Interest Rate Sensitivity under Traditional Gap Analysis, a new return is being introduced to monitor the interest rate risk using Duration Gap Analysis (DGA), called Interest Rate Sensitivity under Duration Gap Analysis (IRSD). The DGA involves bucketing of all Risk Sensitive Assets (RSA) and Risk Sensitive Liabilities (RSL) as per residual maturity/re-pricing dates in various time bands and computing the Modified Duration Gap (MDG). One of the important things to note is that the RSA and RSL include the rate-sensitive off-balance sheet assets and liabilities as well. MDG can be used to evaluate the impact on the Market Value of Equity (MVE) of the bank under different interest rate scenarios. The past few years have seen banks’ foray into financing long-term assets, such as home loans and infrastructure projects. Banks have been allowed to raise funds through long-term bonds with a minimum maturity of five years to the extent of their exposure of residual maturity of more than five years to the infrastructural sector. This article attempts to illustrate the significance of interest rate risk management and approaches towards its management in the Indian context.
    Keywords: Interest Rate Risk Management, Duration Gap Analysis, Maturity Gap Analysis, Risk Sensitivity, Modified Duration Gap, Banking Risk
    JEL: E40 E43 E44 G20
    Date: 2013
  11. By: Swamy, Vighneswara
    Abstract: This study models the impact of new capital regulations proposed under Basel III on bank profitability by constructing a stylized representative bank’s financial statements. We show that the higher cost associated with a one-percentage increase in the capital ratio can be recovered by increasing lending spreads. The results indicate that in the case of scheduled commercial banks, one-percentage point increase in capital ratio can be recovered by increasing the bank lending spread by 31 basis points and would go upto an extent of 100 basis points for six-percentage point increase assuming that the risk weighted assets are unchanged. We also provide the estimations for the scenarios of changes in risk weighted assets, changes in return on equity (ROE) and the cost of debt.
    Keywords: Banks, Regulation, Basel III, Capital, Interest Income
    JEL: E44 E51 E61 G2 G21 G28
    Date: 2014
  12. By: Gospodinov, Nikolay (Federal Reserve Bank of Atlanta); Jamali, Ibrahim (American University of Beirut)
    Abstract: In this paper, we investigate the dynamic response of stock market volatility to changes in monetary policy. Using a vector autoregressive model, our findings reveal a significant and asymmetric response of stock returns and volatility to monetary policy shocks. Although the increase in the volatility risk premium, futures-trading volume, and leverage appear to contribute to a short-term increase in volatility, the longer-term dynamics of volatility are dominated by monetary policy's effect on fundamentals. The estimation results from a bivariate VAR-GARCH model suggest that the Fed does not respond to the stock market at a high frequency, but they also suggest that market participants' uncertainty regarding the monetary stance affects stock market volatility.
    Keywords: stock market volatility; federal funds futures; monetary policy; variance risk premium; vector autoregression; bivariate GARCH; leverage effect; volatility feedback effect
    JEL: C32 C58 E52 E58 G10 G12
    Date: 2014–08–01
  13. By: Santeramo, Fabio Gaetano; Capitanio, Fabian; Adinolfi, Felice
    Abstract: Dynamics and transitions in the agricultural sector of emerging countries are not well understood yet. A decade of major political and economic changes is challenging the Mediterranean Economies, affecting the primary sectors of transition economies which are largely influenced by recent trends. The resulting exposure of agriculture to risks has called great attention on risk management strategies and public intervention. We explore their role in three different economies with a view to a unified policy framework. The analysis is conducted through a field activity in Syria, Tunisia and Turkey that has allowed to understand the key issues. The experts’ opinions draw a clear picture of retrospect and prospects and stimulate a comparative analysis that widens the current knowledge of risk management in the EU Partner Countries.
    Keywords: EU Integration, Agricultural Policy, Partner Countries, Risk Management
    JEL: F15 N54 Q18
    Date: 2014
  14. By: Farouk, Faizal; Masih, Mansur
    Abstract: This paper investigates the co-movement of nine Islamic Exchange Traded Fund (ETF) returns using wavelet coherence methods. The results tend to indicate consistent co-movement between most of the ETF returns especially in the long run. The study also uncovers evidence of wide variation of co-movement across the time-scales during the global financial crisis and the Euro debt crisis. Strong co-movement can be observed during the global financial crisis, both for the medium term investors and long term investors. The paper also studies the relationship between different ETF returns using wavelet multi-resolution analysis. The cross-correlation analysis also shows certain significant and positive correlations between the ETF returns, especially during the period of global financial crisis. The findings from these two recent dynamic time-scale decomposition methodologies have important policy implications for risk management and investors’ investment policy.
    Keywords: Islamic exchange traded fund returns, Wavelet coherence, MODWT
    JEL: C22 C58 G12 G15
    Date: 2014–08–27

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