nep-rmg New Economics Papers
on Risk Management
Issue of 2014‒12‒29
seventeen papers chosen by
Stan Miles
Thompson Rivers University

  1. The limits of model-based regulation By Behn, Markus; Haselmann, Rainer; Vig, Vikrant
  3. Estimation of Extreme Depth-Based Quantile Regions By He, Y.; Einmahl, J.H.J.
  4. Drivers of Bank Risk, Solvency, and Profitability in the Armenian Banking System By Suren Pakhchanyan; Gor Sahakyan
  5. On robust representation of conditional risk measures on a $L^\infty$-type module By Jos\'e Miguel Zapata
  6. An Evolutionary Optimization Approach to Risk Parity Portfolio Selection By Ronald Hochreiter
  7. Switching Risk Off: FX Correlations and Risk Premia By Beber, Alessandro; Brandt, Michael; Cen, Jason
  8. Corporate Governance and Bank Insolvency Risk: International Evidence By Anginer, Deniz; Demirguc-Kunt, Asli; Huizinga, Harry; Ma, Kebin
  9. Bank Systemic Risk-Taking and Loan Pricing : Evidence from Syndicated Loans By Gong, D.
  10. Russian-Doll Risk Models By Zura Kakushadze
  11. Assessing the Basel II Internal Ratings-Based Approach: Empirical Evidence from Australia By Marek Rutkowski; Silvio Tarca
  12. A transitions-based framework for estimating expected credit losses By Gaffney, Edward; Kelly, Robert; McCann, Fergal
  13. Statistics of Heteroscedastic Extremes By Einmahl, J.H.J.; de Haan, L.F.M.; Zhou, C.
  14. Evaluation of Credit Risk Under Correlated Defaults: The Cross-Entropy Simulation Approach By Loretta Mastroeni; Giuseppe D'Acquisto; Maurizio Naldi
  15. FRIM : A New Tool for Financial Risk Monitoring and MENA By Pietro Calice
  16. On the Bank Stocks Return and Volatility: Tale of a South Asian Economy By Shahzad, Syed Jawad Hussain; Zakaria, Muhammad; Raza, Naveed; Ali, Sajid
  17. Variance reduced multilevel path simulation: going beyond the complexity $\varepsilon^{-2}$ By Denis Belomestny; Tigran Nagapetyan

  1. By: Behn, Markus; Haselmann, Rainer; Vig, Vikrant
    Abstract: In this paper, we investigate how the introduction of complex, model-based capital regulation affected credit risk of financial institutions. Model-based regulation was meant to enhance the stability of the financial sector by making capital charges more sensitive to risk. Exploiting the staggered introduction of the model-based approach in Germany and the richness of our loan-level data set, we show that (1) internal risk estimates employed for regulatory purposes systematically underpredict actual default rates by 0.5 to 1 percentage points; (2) both default rates and loss rates are higher for loans that were originated under the model-based approach, while corresponding risk-weights are significantly lower; and (3) interest rates are higher for loans originated under the model-based approach, suggesting that banks were aware of the higher risk associated with these loans and priced them accordingly. Further, we document that large banks benefited from the reform as they experienced a reduction in capital charges and consequently expanded their lending at the expense of smaller banks that did not introduce the model-based approach. Counter to the stated objectives, the introduction of complex regulation adversely affected the credit risk of financial institutions. Overall, our results highlight the pitfalls of complex regulation and suggest that simpler rules may increase the efficacy of financial regulation.
    Keywords: capital regulation,internal ratings,Basel regulation
    JEL: G01 G21 G28
    Date: 2014
  2. By: Kryvych, Yana; Makarenko, Inna
    Abstract: The article deals with the nature,basic principles and objectives of the bank risk management system under modern conditions and the requirements of regulators to the transparency of its activities are considered. The authors developed a scheme of risk management and justified basic disclosure of banking risks in the context of introduction of the International Financial Reporting Standards.
    Keywords: risk, risk management, information disclosure, transparency and corporate governance.
    JEL: G21 M21
    Date: 2014
  3. By: He, Y. (Tilburg University, Center For Economic Research); Einmahl, J.H.J. (Tilburg University, Center For Economic Research)
    Abstract: Consider the extreme quantile region, induced by the halfspace depth function HD, of the form Q = fx 2 Rd : HD(x; P) g, such that PQ = p for a given, very small p > 0. This region can hardly be estimated through a fully nonparametric procedure since the sample halfspace depth is 0 outside the convex hull of the data. Using Extreme Value Theory, we construct a natural, semiparametric estimator of this quantile region and prove a refined consistency result. A simulation study clearly demonstrates the good performance of our estimator. We use the procedure for risk management by applying it to stock market returns.
    Keywords: Extreme value statistics; halfspace depth; multivariate quantile; outlier detection; rare event; tail dependence
    JEL: C13 C14
    Date: 2014
  4. By: Suren Pakhchanyan (University of Oldenburg, Faculty II, Department of Business Administration, Economics, and Law, Area Finance and Banking); Gor Sahakyan (Financial System Stability and Development Department, Central Bank of the Republic of Armenia)
    Abstract: The aim of this study is to examine the effects of bank-specific, regulatory and macroeconomic determinants on bank risk, profitability and solvency in the Armenian banking sector. To account for these, we apply a GMM technique to a panel of 22 Armenian banks covering the 2003–2014 period. The estimation results show that abnormal loan growth leads to a decrease in the regulatory capital ratio, to an increase in loan loss provision and to a reduction of relative interest income. Regarding GDP we observe a negative influence on banks´ solvency, profitability and risk. When focusing on regulatory variables we identify a negative relation between the implementation of the Basel II Accord and the regulatory capital ratio. Moreover, we find that banks belonging to international financial groups have better credit risk management than domestic banks. All in all, our results suggest, that excessive loan growth, economic environment and ownership structure affect core aspects of banks’ operations.
    Keywords: risk management, Basel II, profitability, solvency, credit risk, Armenian banks, loan growth
    JEL: G32 G21 G28
    Date: 2014–11
  5. By: Jos\'e Miguel Zapata
    Abstract: The purpose of this paper is to establish a robust representation theorem for conditional risk measures by using a module-based convex analysis, where risk measures are defined on a $L^\infty$-type module. We define and study a Fatou property for this kind of risk measures, which is a generalization of the already known Fatou property for static risk measures. In order to prove this robust representation theorem we provide a modular version of Krein-Smulian theorem.
    Date: 2014–11
  6. By: Ronald Hochreiter
    Abstract: In this paper we present an evolutionary optimization approach to solve the risk parity portfolio selection problem. While there exist convex optimization approaches to solve this problem when long-only portfolios are considered, the optimization problem becomes non-trivial in the long-short case. To solve this problem, we propose a genetic algorithm as well as a local search heuristic. This algorithmic framework is able to compute solutions successfully. Numerical results using real-world data substantiate the practicability of the approach presented in this paper.
    Date: 2014–11
  7. By: Beber, Alessandro; Brandt, Michael; Cen, Jason
    Abstract: Risk-off refers to a change in risk preferences and the associated portfolio rebalancing. We identify these episodes using the switch to a polarized correlation regime of foreign-exchange returns. These risk-off transitions are relatively infrequent but noticeably increasing over time, are persistent and associated with geopolitical events, and seem unrelated to changes in macroeconomic fundamentals and to volatility or average correlation shocks. Risk-off switches have very significant effects on the returns of a large number of asset classes and trading strategies, with risky and safe asset returns being penalized and favored, respectively. This evidence is consistent with a price pressure story induced by portfolio rebalancing, as we document that risk-off transitions are associated with significant changes in the positions of professional investors across different futures markets.
    Keywords: currency risk premia; FX correlation; risk-off
    JEL: G12
    Date: 2014–10
  8. By: Anginer, Deniz; Demirguc-Kunt, Asli; Huizinga, Harry; Ma, Kebin
    Abstract: This paper finds that shareholder-friendly corporate governance is positively associated with bank insolvency risk, as proxied by the Z-score and the Merton’s distance to default measure, for an international sample of banks over the 2004-2008 period. Banks are special in that ‘good’ corporate governance increases bank insolvency risk relatively more for banks that are large and located in countries with sound public finances, as banks aim to exploit the financial safety net. ‘Good’ corporate governance is specifically associated with higher asset volatility, more non-performing loans, and a lower tangible capital ratio. Furthermore, ‘good’ corporate governance is associated with more bank risk taking at times of rapid economic expansion. Consistent with increased risk-taking, ‘good’ corporate governance is associated with a higher valuation of the implicit insurance provided by the financial safety net, especially in the case of large banks. These results underline the importance of the financial safety net and too-big-to-fail policies in encouraging excessive risk-taking by banks.
    Keywords: Bank insolvency; Capitalization; Corporate governance; Non-performing loans
    JEL: G21 M21
    Date: 2014–10
  9. By: Gong, D. (Tilburg University, Center For Economic Research)
    Abstract: In this paper we document evidence of systemic risk taking from syndicated loan pricing. Using U.S. syndicated loan data, we find that the borrower's idiosyncratic risk is positively priced whereas systematic risk is negatively related to loan spreads, controlling for firm, loan and bank specific variables. We argue that the underpricing of systematic risk relative to idiosyncratic risk suggests banks' preference for investing in systematic risk which increases interbank correlation and systemic risk of banks. We relate the incentive for systemic risk-taking to the \too-many-to-fail" guarantee. We further show that small and lowly correlated banks underprice systematic risk relative to big and more correlated banks.
    Keywords: Systemic risk-taking;; Loan pricing;; Public guarantees;; Too-many-to-fail; Syndicated
    JEL: G21 G23
    Date: 2014
  10. By: Zura Kakushadze
    Abstract: We give a simple explicit algorithm for building multi-factor risk models. It dramatically reduces the number of or altogether eliminates the risk factors for which the factor covariance matrix needs to be computed. This is achieved via a nested "Russian-doll" embedding: the factor covariance matrix itself is modeled via a factor model, whose factor covariance matrix in turn is modeled via a factor model, and so on. We discuss in detail how to implement this algorithm in the case of (binary) industry classification based risk factors (e.g., "sector -> industry -> sub-industry"), and also in the presence of (non-binary) style factors. Our algorithm is particularly useful when long historical lookbacks are unavailable or undesirable, e.g., in short-horizon quant trading.
    Date: 2014–12
  11. By: Marek Rutkowski; Silvio Tarca
    Abstract: The Basel II internal ratings-based (IRB) approach to capital adequacy for credit risk implements an asymptotic single risk factor (ASRF) model. Measurements from the ASRF model of the prevailing state of Australia's economy and the level of capitalisation of its banking sector find general agreement with macroeconomic indicators, financial statistics and external credit ratings. However, given the range of economic conditions, from mild contraction to moderate expansion, experienced in Australia since the implementation of Basel II, we cannot attest to the validity of the model specification of the IRB approach for its intended purpose of solvency assessment. With the implementation of Basel II preceding the time when the effect of the financial crisis of 2007-09 was most acutely felt, our empirical findings offer a fundamental assessment of the impact of the crisis on the Australian banking sector. Access to internal bank data collected by the prudential regulator distinguishes our research from other empirical studies on the recent crisis.
    Date: 2014–11
  12. By: Gaffney, Edward (Central Bank of Ireland); Kelly, Robert (Central Bank of Ireland); McCann, Fergal (Central Bank of Ireland)
    Abstract: This paper presents a framework for estimating losses for residential mortgage loans.At the core is a transitions-based probability of default model which yields directly observ- able cash-fl ows at the loan level. The estimated model includes coefficients on unemployment, Loan to Value ratio and interest rates, all of which allow a macroeconomic scenario to be fed through the model and impact loans' probability of default and cure. Other loan-level covariates such as bank, Buy-to-Let status, and vintage also impact loans' transition probabilities. Loss Given Default is also modelled over a three-year horizon combining loan-level collateral information with macroeconomic house price forecasts. The breakout of ows from the stock of defaults allows the impact of loan modications on recovery rates to be modelled. Unlike other models of mortgage credit risk, this framework allows a hysteresis eect of the time spent in default on the probability of loan cure to be modelled explicitly. In Ireland, an increase in the time spent in default from three months to one year leads to a decrease in the probability of loan cure from 30 to 12 per cent.
    Keywords: Mortgages, default, credit risk, Markov multi-state model.
    Date: 2014–11
  13. By: Einmahl, J.H.J. (Tilburg University, Center For Economic Research); de Haan, L.F.M. (Tilburg University, Center For Economic Research); Zhou, C.
    Abstract: Abstract: We extend classical extreme value theory to non-identically distributed observations. When the distribution tails are proportional much of extreme value statistics remains valid. The proportionality function for the tails can be estimated nonparametrically along with the (common) extreme value index. Joint asymptotic normality of both estimators is shown; they are asymptotically independent. We develop tests for the proportionality function and for the validity of the model. We show through simulations the good performance of tests for tail homoscedasticity. The results are applied to stock market returns. A main tool is the weak convergence of a weighted sequential tail empirical process.
    Date: 2014
  14. By: Loretta Mastroeni; Giuseppe D'Acquisto; Maurizio Naldi
    Abstract: Credit risk, associated to borrowers defaulting on their debts, is an ever growing source of concern for lenders. The presence of correlation among defaults may be described by the t-copula model. However, the typically large number of variables involved calls for a simulation approach. A simulation method, based on the use of the Cross-Entropy (CE) technique, is here proposed as an alternative to non-adaptive Importance Sampling (IS) techniques so far presented in the literature, the main advantage of CE being that it allows to deal easily with a wider range of probability models than ad hoc IS. The method is validated through a comparison of its results with the crude MonteCarlo and the Exponential Twist approaches. The proposed Cross-Entropy technique is shown to provide accurate results even when the sample size is several orders of magnitude smaller than the inverse of the probability to be estimated.
    Keywords: Credit risk, Cross-Entropy, Copula models
    JEL: C15 G32
    Date: 2014–09
  15. By: Pietro Calice
    Keywords: Banks and Banking Reform Financial Crisis Management and Restructuring Law and Development - Corporate Law Finance and Financial Sector Development - Bankruptcy and Resolution of Financial Distress Urban Development - Hazard Risk Management
    Date: 2014–08
  16. By: Shahzad, Syed Jawad Hussain; Zakaria, Muhammad; Raza, Naveed; Ali, Sajid
    Abstract: This paper examines Pakistani Banks stock return and volatility relationship with market, interest rate and foreign exchange rate. The study extensively applies different statistical approaches to model return and volatility relation. First, Ordinary Least Square (OLS) multiple regression model is applied for estimation of return relation. Further, Generalize Method of Movement (GMM) is applied to cater the endogeniety issue. Secondly, Due to presence of Conditional Heteroskedasticity, Weighted Least Square (WLS) and Generalize Auto Regression Conditional Heteroskedasticity - GARCH (1,1) estimation model is applied to estimate conditional return and volatility. Interest rate and foreign exchange rate have significant impact on unconditional and conditional bank stock returns under different model specifications. Market return is a determining factor in bank stock pricing. The results infer that bank volatility is significantly related with interest rate and foreign exchange rate risk. The volatility of bank stock returns is persistent with slower decay over time.
    Keywords: Bank stock returns, Market rate, Interest rate, Foreign exchange rate, GARCH, Pakistan
    JEL: G17 G21 G28
    Date: 2014–11–01
  17. By: Denis Belomestny; Tigran Nagapetyan
    Abstract: In this paper a novel modification of the multilevel Monte Carlo approach, allowing for further significant complexity reduction, is proposed. The idea of the modification is to use the method of control variates to reduce variance at level zero. We show that, under a proper choice of control variates, one can reduce the complexity order of the modified MLMC algorithm down to $\varepsilon^{-2+\delta}$ for any $\delta\in [0,1)$ with $\varepsilon$ being the precision to be achieved. These theoretical results are illustrated by several numerical examples.
    Date: 2014–12

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