nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒01‒19
eight papers chosen by

  1. Banks' incentives and the quality of internal risk models By Plosser, Matthew; Santos, Joao A. C.
  2. Напрями узгодження стандартів фінансової звітності банків із сучасними концепціями управління кредитним ризиком By Voloshyn, Ihor
  3. Hedge Fund Portfolio Diversification Strategies Across the GFC By David E. Allen; Michael McAleer; Shelton Peiris; Abhay K. Singh
  4. Enhancing prudential standards in financial regulations By Allen, Franklin; Goldstein, Itay; Jagtiani, Julapa; Lang, William W.
  5. Does the Geographic Expansion of Bank Assets Reduce Risk? By Martin Goetz; Luc Laeven; Ross Levine
  6. Denmark: Report on Observance of Standards and Codes (ROSC) By International Monetary Fund. Monetary and Capital Markets Department
  7. Range-based Volatility Estimation and Forecasting By Daniel Bencik
  8. Determinants of Bank Profitability and Basel Capital Regulation: Empirical Evidence from Nigeria By Ozili, Peterson

  1. By: Plosser, Matthew (Federal Reserve Bank of New York); Santos, Joao A. C. (Federal Reserve Bank of New York)
    Abstract: This paper investigates the incentives for banks to bias their internally generated risk estimates. We are able to estimate bank biases at the credit level by comparing bank-generated risk estimates within loan syndicates. The biases are positively correlated with measures of regulatory capital, even in the presence of bank fixed effects, consistent with an effort by low-capital banks to improve regulatory ratios. At the portfolio level, the difference in borrower probability of default is as large as 100 basis points, which can improve the typical loan portfolio’s Tier 1 capital ratio by as much as 33 percent. Congruent with a regulatory motive, the sensitivity to capital is greater for larger, riskier, and more opaque credits. In addition, we find that low-capital banks’ risk estimates have less explanatory power than those of high-capital banks with regard to the prices set on loans, indicating that low-capital banks not only have downward-biased risk estimates but that they also incorporate less information.
    Keywords: banks; incentives; default models; capital regulation; Basel II
    JEL: G21 G28
    Date: 2014–12–01
  2. By: Voloshyn, Ihor
    Abstract: This paper examines ways of overcoming inconsistencies between IFRS and modern concepts of credit risk management, namely, expected loss model and risk-adjusted loan pricing. Also, it is considered an issue of acceptable levels of concentration risk in bank credit portfolio.
    Keywords: risk management, credit risk, incurred loss model, expected loss model, impairment, loan loss provision, allowance, loan, Basel, unexpected losses, capital, credit spread, interest income, financial standard, accounting standard
    JEL: G21
    Date: 2014–12–29
  3. By: David E. Allen (School of Accounting, Finance and Economics Edith Cowan University, Australia.); Michael McAleer (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute, The Netherlands, Department of Quantitative Economics, Complutense University of Madrid, and Institute of Economic Research, Kyoto University.); Shelton Peiris (School of Mathematics and Statistics, University of Sydney); Abhay K. Singh (School of Accounting, Finance and Economics, Edith Cowan University, Australia)
    Abstract: This paper features an analysis of the e_ectiveness of a range of portfolio diversification strategies as applied to a set of 17 years of monthly hedge fund index returns on a set of ten market indices representing 13 major hedge fund categories, as compiled by the EDHEC Risk Institute. The 17-year period runs from the beginning of 1997 to the end of August 2014. The sample period, which incorporates both the Global Financial Crisis (GFC) and subsequent European Debt Crisis (EDC), is a challenging one for the application of diversi_cation and portfolio investment strategies. The analysis features an examination of the diversification bene_ts of hedge fund investments through successive crisis periods. The connectedness of the Hedge Fund Indices is explored via application of the Diebold and Yilmaz (2009, 2014) spillover index. We conduct a series of portfolio optimisation analyses: comparing Markowitz with naive diversi_cation, and evaluate the relative e_ectiveness of Markowitz portfolio optimisation with various draw-down strategies, using a series of backtests. Our results suggest that Markowitz optimisation matches the characteristics of these hedge fund indices quite well.
    Keywords: Hedge Fund Diversi_cation, Spillover Index, Markowitz Analaysis, Downside Risk, CVaR, Draw-Down.
    JEL: G11 C61
    Date: 2014
  4. By: Allen, Franklin (The Wharton School of the University of Pennsylvania and Imperial College London); Goldstein, Itay (The Wharton School of the University of Pennsylvania); Jagtiani, Julapa (Federal Reserve Bank of Philadelphia); Lang, William W. (Federal Reserve Bank of Philadelphia)
    Abstract: The financial crisis has generated fundamental reforms in the financial regulatory system in the U.S. and internationally. Much of this reform was in direct response to the weaknesses revealed in the precrisis system. The new “macroprudential” approach to financial regulations focuses on risks arising in financial markets broadly, as well as the potential impact on the financial system that may arise from financial distress at systemically important financial institutions. Systemic risk is the key factor in financial stability, but our current understanding of systemic risk is rather limited. While the goal of using regulation to maintain financial stability is clear, it is not obvious how to design an effective regulatory framework that achieves the financial stability objective while also promoting financial innovations. This paper discusses academic research and expert opinions on this vital subject of financial stability and regulatory reforms. Specifically, among other issues, it discusses the impact of increasing public disclosure of supervisory information, the effectiveness of bank stress testing as a tool to enhance financial stability, whether the financial crisis was caused by too big to fail (TBTF), and whether the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) resolution regime would be effective in achieving financial stability and ending TBTF.
    Keywords: Financial stability; Financial regulations; Systemic risk; Too Big To Fail; Stress testing; Resolution plan; Mortgage finance
    JEL: G01 G18 G21 G23 G28
    Date: 2014–12–03
  5. By: Martin Goetz; Luc Laeven; Ross Levine
    Abstract: We develop a new identification strategy to evaluate the impact of the geographic expansion of bank holding company (BHC) assets across U.S. metropolitan statistical areas (MSAs) on BHC risk. We find that the geographic expansion of bank assets reduces risk. Moreover, geographic expansion reduces risk more when BHCs expand into economically dissimilar MSAs, i.e., MSAs with different industrial structures and business cycles. We do not find that geographic diversification improves loan quality. Our results are consistent with arguments that geographic expansion lowers risk by reducing exposure to idiosyncratic local risks and inconsistent with arguments that geographic expansion, on net, increases risk by reducing the ability of BHCs to monitor loans and manage risks.
    JEL: G11 G21 G28
    Date: 2014–12
  6. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: Denmark has a high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). The Danish Financial Supervisory Authority (DFSA) has the appropriate legal authority to carry out supervision effectively and in its risk based approach has focused well on the key elements of risk within its banking system. Its powers and supervisory approach have evolved significantly since the recent global crisis and the DFSA emerged as a hands- on and proactive supervisor. Its overall supervisory approach is sound and the compliance with the credit-risk and capital adequacy related principles is uniformly high. The length of the examination cycle should be reduced through the use of additional resources. A more thorough and comprehensive approach to operational risk and market risk is warranted. Finally, the operational independence of the DFSA should be protected by retaining certain supervisory imperatives within the authority of the Director General, while strengthening the governance of the DFSA Board.
    Keywords: Banking sector;Basel Core Principles;Bank supervision;Insurance supervision;Reports on the Observance of Standards and Codes;Denmark;
    Date: 2014–12–09
  7. By: Daniel Bencik (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic)
    Abstract: In this paper, we analyze new possibilities in predicting daily ranges, i.e. differences between daily high and low prices. We empirically assess efficiency gains in volatility estimation when using range-based estimators as opposed to simple daily ranges and explore the use of these more efficient volatility measures as predictors of daily ranges. The array of models used in this paper include the heterogeneous autoregressive model, conditional autoregressive ranges model and a vector error-correction model of daily highs and lows. Contrary to intuition, models based on co-integration of daily highs and lows fail to produce good quality out of sample forecasts of daily ranges. The best one-day-ahead daily ranges forecasts are produced by a realized range based HAR model with a GARCH volatility-of-volatility component.
    Keywords: volatility, returns, futures contracts, cointegration, prediction
    JEL: C52 C53 C58
    Date: 2014–12
  8. By: Ozili, Peterson
    Abstract: This study, empirically, investigates the determinants of bank profitability. After including the regulatory variable into the model, I find no significant difference in bank profitability during pre-and post-capital regulation regime. Second, after employing NIM and ROA profitability metrics, I find that the determinants of bank profitability, and its significance, depends on the profitability metric employed. Third, I find that asset quality is a strong determinant of bank interest margin, relative to return on asset. Also, I observe that economies of scale and scope enables larger banks to be profitable (ROA) relative to smaller banks. Overall, the insignificant effect of Basel capital regime on bank profitability seems to suggest that such regulation might not be aimed at decreasing bank profits.
    Keywords: Bank Profitabilty, Basel Capital Regulation
    JEL: E5 E58 G2 G21 N2 N20 N27
    Date: 2015–01

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