nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒02‒28
nineteen papers chosen by

  1. Estimación del riesgo mediante el ajuste de cópulas By Catalina Bolancé ; Montserrat Guillén ; Alemar Padilla
  2. The use of fexible quantile-based measures in risk assessment By Jaume Belles-Sampera ; Montserrat Guillén ; Miguel Santolino
  4. Systemic Risk and the Macroeconomy: An Empirical Evaluation By Stefano Giglio ; Bryan T. Kelly ; Seth Pruitt
  5. Application of internal ratings-based methods on credit risk measurement By Alejandro Vargas Sanchez ; Saulo Mostajo Castelú
  6. Macro credit scoring as a proposal for quantifying credit risk By Sergio Edwin Torrico Salamanca
  7. Model risk on credit risk By J. Molins ; E. Vives
  8. The Bank Capital Regulation (BCR) Model. By Hyejin Cho
  9. Mark-to-market accounting and systemic risk: evidence from the insurance industry By Andrew Ellul ; Chotibhak Jotikasthira ; Christian T. Lundblad ; Yihui Wang
  10. Procyclical leverage and value-at-risk By Tobias Adrian ; Hyun Song Shin
  11. Insider bank runs: community bank fragility and the financial crisis of 2007 By Henderson, Christopher ; Lang, William W. ; Jackson, William E.
  12. Comonotonic Monte Carlo and its applications in option pricing and quantification of risk. By Alain Chateauneuf ; Mina Mostoufi ; David Vyncke
  13. Contour map of estimation error for Expected Shortfall By Imre Kondor ; Fabio Caccioli ; G\'abor Papp ; Matteo Marsili
  14. Pricing sovereign credit risk of an emerging market By Gonzalo Camba-Méndez ; Konrad Kostrzewa ; Anna Mospan ; Dobromił Serwa
  15. Risk-Return Trade-Off for European Stock Markets By Aslanidis, Nektarios ; Christiansen, Charlotte ; Savva, Christos S.
  16. Cyclical adjustment of capital requirements: a simple framework By Rafael Repullo
  17. Should Icelandic pension funds hedge currency risk in their foreign investments? By Ásgeir Daníelsson
  18. Stock market and crude oil relationship: A wavelet analysis By shafaai, Shafizal ; Masih, Mansur
  19. Impact of Weather Insurance on Small Scale Farmers: A Natural Experiment By Stephan Dietrich ; Marcela Ibanez

  1. By: Catalina Bolancé (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona ); Montserrat Guillén (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona ); Alemar Padilla (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona )
    Abstract: Here is an example on how to calculate the risk of a portfolio using bivariate parametric copulas and Monte Carlo simulation. First, the parameter of the copula are estimated, then marginal distributions are fitted and value at risk (VaR) and tail value at risk (TVaR) are calculated.
    Keywords: Dependence, copula, financial risk, Value-at-Risk, Tail Value-at-Risk
    Date: 2015–02
  2. By: Jaume Belles-Sampera (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona ); Montserrat Guillén (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona ); Miguel Santolino (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona )
    Abstract: A new family of distortion risk measures -GlueVaR- is proposed in Belles- Sampera et al. (2014) to procure a risk assessment lying between those provided by common quantile-based risk measures. GlueVaR risk measures may be expressed as a combination of these standard risk measures. We show here that this relationship may be used to obtain approximations of GlueVaR measures for general skewed distribution functions using the Cornish-Fisher expansion. A subfamily of GlueVaR measures satises the tail-subadditivity property. An example of risk measurement based on real insurance claim data is presented, where implications of tail-subadditivity in the aggregation of risks are illustrated.
    Keywords: quantiles, subadditivity, tails, risk management, Value-at-Risk
    Date: 2015–02
  3. By: Renata Karkowska (University of Warsaw, Faculty of Management )
    Abstract: We measure a systemic risk faced by European banking sectors using the CoVaR measure. We propose the conditional value-at-risk (CoVaR) for measuring a spillover risk which demonstrates the bilateral relation between the tail risks of two financial institutions. The aim of the study is to estimate the contribution systemic risk of the bank i in the analyzed banking sector of a country in conditions of its insolvency. The study included commercial banks from 8 emerging markets from Europe, which gave a total of 40 banks, traded on the public market, which provided a market valuation of the bank's capital. The conclusions are that the CoVaR seems to be a better measure for systemic risk in the banking sector than the VaR, which is more individual. And banks in developing countries in Europe do not provide significant risk for the banking sector as a whole. But it must be taken into account that some individuals that may find objectionable. Our results hence tend to a practical use of the CoVaR for supervisory purposes.
    Keywords: Systemic Risk, Value at Risk, Risk Spillovers, Banking Sector
    JEL: G01 G10 G20 G28 G38
    Date: 2015–02
  4. By: Stefano Giglio ; Bryan T. Kelly ; Seth Pruitt
    Abstract: This article evaluates a large collection of systemic risk measures based on their ability to predict macroeconomic downturns. We evaluate 19 measures of systemic risk in the US and Europe spanning several decades. We propose dimension reduction estimators for constructing systemic risk indexes from the cross section of measures and prove their consistency in a factor model setting. Empirically, systemic risk indexes provide significant predictive information out- of-sample for the lower tail of future macroeconomic shocks.
    JEL: C31 C32 C38 C58 E44 G01 G2
    Date: 2015–02
  5. By: Alejandro Vargas Sanchez ; Saulo Mostajo Castelú
    Abstract: This paper presents the concepts and methods used for credit risk measurement. The main objective was to explain Internal Ratings-Based Methods. The applicatin and analysis was performed on financial information for supposed business case loan, as well as a simulated banking transaction database used to develop a credit scoring model. The reults obtained form a Structural Model and Reduced Form Model showed significant differences in credit risk measures with respect to requirements established by applicable law for regulated financial entities in Bolivia. The study revealed that the application of advanced models for measuring credit risk requires adequate estimates of business volatility and credit scoring models that allow deeply analyse of a credit transaction.
    Keywords: Credit risk, Credit scoring, Structural models, Reduced form Models, Expected loss, Probability of default.
    JEL: C39
    Date: 2014–09
  6. By: Sergio Edwin Torrico Salamanca
    Abstract: Credit scoring is a methodology used in finance to quantify the credit risk of individuals/firms. This article proposes the application of this technique as a tool to measure the aggregated risk of banks and the banking system. An application in the Bolivian commercial banking system is presented, in order to expose the proposed methodology, called Macro Credit Scoring. By applying this methodology, it is identified that the risk measure applied is greater than that needed in the Bolivian commercial banking system in the current situation. Finally, empirical evidence of the relationship between credit risk and economic variables (macro / micro) is presented.
    Keywords: Credit scoring, Risk Management, Credit Risk, Banking.
    JEL: C39
    Date: 2014–09
  7. By: J. Molins ; E. Vives
    Abstract: This paper develops the Jungle model in a credit portfolio framework. The Jungle model is able to model credit contagion, produce doubly-peaked probability distributions for the total default loss and endogenously generate quasi phase transitions, potentially leading to systemic credit events which happen unexpectedly and without an underlying single cause. We show the Jungle model provides the optimal probability distribution for credit losses, under some reasonable empirical constraints. The Dandelion model, a particular case of the Jungle model, is presented, motivated and exactly solved. The Dandelion model suggests contagion and macroeconomic risk factors may be understood under a common framework. We analyse the Diamond model, the Supply Chain model and the Noria model, which are particular cases of the Jungle model as well. We show the Diamond model experiences a quasi phase transition for a not unreasonable set of empirical parameters. We suggest how the Jungle model is able to explain a series of empirical stylized facts in credit portfolios, hard to reconcile by some standard credit portfolio models. We show the Jungle model can handle inhomogeneous portfolios with state-dependent recovery rates. We look at model risk in a credit risk framework under the Jungle model, especially in relation to systemic risks posed by doubly-peaked distributions and quasi phase transitions.
    Date: 2015–02
  8. By: Hyejin Cho (Centre d'Economie de la Sorbonne )
    Abstract: The motivation of this article is to induce the bank capital management solution for banks and regulation bodies on commercial banks. The goal of the paper is intended to mitigate the risk of a banking area and also provide the right incentive for banks to support the real economy.
    Keywords: Demand deposit, On-balance-sheet risks and off-balance-sheet risks, Portfolio composition, Minimum equity capital regulation.
    JEL: C62 C63 D01 G10 G21
    Date: 2015–02
  9. By: Andrew Ellul ; Chotibhak Jotikasthira ; Christian T. Lundblad ; Yihui Wang
    Abstract: One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark-to-market accounting. Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk. We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark-to-market accounting may indeed generate fire sales during a crisis, forward-looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position- and transaction-level data from the U.S. insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark-to-market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across U.S. states. Rather than promoting a shift away from market-based information, our results indicate that regulatory simplicity may be preferred to the complexity of risk-weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk-taking incentives and potential build-up of systemic risk.
    Keywords: Regulation; Systemic risk; Mark to market; Historical cost accounting; Fire sales; Capital ratios; Insurance companies
    JEL: G11 G12 G14 G18 G22
    Date: 2013–10–22
  10. By: Tobias Adrian ; Hyun Song Shin
    Abstract: The availability of credit varies over the business cycle through shifts in the leverage of financial intermediaries. Empirically, we find that intermediary leverage is negatively aligned with the banks’ value-at-risk (VaR). Motivated by the evidence, we explore a contracting model that captures the observed features. Under general conditions on the outcome distribution given by Extreme Value Theory (EVT), intermediaries maintain a constant probability of default to shifts in the outcome distribution, implying substantial deleveraging during downturns. For some parameter values, we can solve the model explicitly, thereby endogenizing the VaR threshold probability from the contracting problem.
    Keywords: financial intermediary leverage; procyclicality; collateralized borrowing
    JEL: G21 G32
    Date: 2013–09–05
  11. By: Henderson, Christopher (Federal Reserve Bank of Philadelphia ); Lang, William W. (Federal Reserve Bank of Philadelphia ); Jackson, William E. (University of Alabama )
    Abstract: From 2007 to 2010, more than 200 community banks in the United States failed. Many of these failed community banking organizations (CBOs) held less than $1 billion in total assets. As economic conditions worsen, banking organizations are expected to preserve capital to withstand unexpected losses. This study examines CBOs prior to failure or becoming problem institutions to understand if, on average, a run on capital by insiders via dividend payouts led to greater financial fragility at the onset of the crisis. We use a control group of similar-sized banks that did not fail or become problem institutions to compare our results and to draw statistical conclusions. We use standard control variables highlighting corporate governance and managerial ownership, such as S-corporation designation and bank complexity that might create incentives more conducive to insider enrichment than to the welfare of depositors or debtholders. Although the new Dodd-Frank legislation exempted smaller banks from many proposed requirements, our results show that capital distributions to insiders contributed to community bank weakness during the financial crisis.
    Keywords: Dividend policy; Financial crisis; Bank lending; Bank risk; Bank regulation; Risk management
    JEL: E44 G01 G21 G32 G35
    Date: 2015–01–01
  12. By: Alain Chateauneuf (IPAG Business School et Centre d'Economie de la Sorbonne - Paris School of Economics ); Mina Mostoufi (Centre d'Economie de la Sorbonne - Paris School of Economics ); David Vyncke (Universiteit Gent )
    Abstract: Monte Carlo (MC) simulation is a technique that provides approximate solutions to a broad range of mathematical problems. A drawback of the method is its high computational cost, especially in a high-dimensional setting. Estimating the Tail Value-at-Risk for large portfolios or pricing basket options and Asian options for instance can be quite time-consuming. For these types of problems, one can construct an upper bound in the convex order by replacing the copula by the comonotonic copula. This comonotonic upper bound can be computed very quickly, but it gives only a rough approximation. In this paper we introduce the Comonotonic Monte Carlo (CoMC) simulation, which uses the best features of both approaches. By using the comonotonic approximation as a control variate we get more accurate estimates and hence the simulation is less time-consuming. The CoMC is of broad applicability and numerical results show a remarkable speed improvement. We illustrate the method for estimating Tail Value-at-Risk and pricing basket options and Asian options.
    Keywords: Control Variate Monte Carlo, Comonotonicity, Option pricing.
    JEL: G17 C02 C13 C15 C63
    Date: 2015–02
  13. By: Imre Kondor ; Fabio Caccioli ; G\'abor Papp ; Matteo Marsili
    Abstract: The contour map of estimation error of Expected Shortfall (ES) is constructed. It allows one to quantitatively determine the sample size (the length of the time series) required by the optimization under ES of large institutional portfolios for a given size of the portfolio, at a given confidence level and a given estimation error.
    Date: 2015–02
  14. By: Gonzalo Camba-Méndez ; Konrad Kostrzewa ; Anna Mospan ; Dobromił Serwa
    Abstract: We analyze the market assessment of sovereign credit risk in an emerging market using a reduced-form model to price the credit default swap (CDS) spreads thus enabling us to derive values for the probability of default (PD) and loss given default (LGD) from the quotes of sovereign CDS contracts. We compare different specifications of the models allowing for both fixed and time varying LGD, and we use these values to analyze the sovereign credit risk of Polish debt throughout the period of a global financial crisis. Our results suggest the presence of a low LGD and a relatively high PD for Poland during a recent financial crisis. The highest PD is in the months following collapse of Lehman Brothers. The derived measures of sovereign risk are strongly linked with the level of public debt and with another measure of PD from a structural model. Correlations between our PD values and the CDS spreads heavily depend on the maturity of the sovereign CDS.
    Keywords: sovereign credit risk, CDS spreads, probability of default, loss given default, Poland
    JEL: C11 C32 G01 G12 G15
    Date: 2014
  15. By: Aslanidis, Nektarios ; Christiansen, Charlotte ; Savva, Christos S.
    Abstract: This paper adopts dynamic factor models with macro-finance predictors to test the intertemporal risk-return relation for 13 European stock markets. We identify country specific, euro area, and global macro-finance factors to determine the conditional risk and return. Empirically, the risk- return trade-off is generally negative. However, a Markov switching model documents that there is time-variation in this trade-off that is linked to the state of the economy. Keywords: Risk-return trade-off; Dynamic factor model; Macro-finance predictors; European stock markets; Markov switching model JEL Classifications: C22; G11; G12; G17
    Keywords: Mercats financers -- Europa, Finances -- Models economètrics, Gestió de cartera, 336 - Finances. Banca. Moneda. Borsa,
    Date: 2015
  16. By: Rafael Repullo
    Abstract: We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.
    Keywords: Banking regulation; Basel II; Capital requirements; Procyclicality
    JEL: E44 G21 G28
    Date: 2013–09–27
  17. By: Ásgeir Daníelsson
    Abstract: This paper discusses efficient hedging of currency risk in foreign investments through short term forward contracts. It is shown that for long term investors the efficient level of currency hedging depends on the behaviour of the exchange rate. If the exchange rate follows random walk the efficient hedging of the currency risk may be as large as it is for the short term investor, or possibly larger, but if the exchange rate follows a stationary stochastic process efficient hedging of the long term currency risk through short term forward contracts is zero in most cases. It is also shown that pass through of changes in the exchange rate into inflation forms a partial hedge for an investor that considers the real return and its volatility rather than the nominal return, diminishing the efficient level of forward currency contracts. It is shown that it is possible to use forward currency contracts for speculative investments. These contracts are profitable investment opportunities if the interest rate differential exceeds the expected change in the exchange rate. This same condition motivated the carry trade.
    Date: 2014–08
  18. By: shafaai, Shafizal ; Masih, Mansur
    Abstract: Financialisation of crude oil and its frequent inclusion into investment portfolios raise the demand for analysis of crude oil and stock market indices relationship at various time scales. In this paper, the relationships between crude oil and stock markets in three Islamic stock market indices and three non-Islamic indices are examined by using a time-scale decomposition based on the theory of wavelets. This study employs daily closing price data of Brent crude oil index and the six stock market indices. The oil and stock return series are first decomposed into different time components and then their relationships are investigated over different time scales through wavelet’s estimated correlations. We also characterized the crude oil and stock market relationship for different timescales in an attempt to disentangle the possible existence of comovement during the global financial crisis. The results mainly show evidence of significant time scale effects on the behavior of the oil-stock market links, and that investors should consider these effects when diversifying their portfolios of stocks into the oil asset. The paper specifies the investment horizons that should be considered to maximize diversification properties of crude oil. These findings also have important implications for risk management, monetary policies to control oil inflationary pressures and fiscal policy in oil-exporting countries.
    Keywords: wavelet analysis, stock markets, crude oil
    JEL: C22 C58 G15
    Date: 2013–08–15
  19. By: Stephan Dietrich (Georg-August-University Göttingen ); Marcela Ibanez (Georg-August-University Göttingen )
    Abstract: This paper explores the impacts of traditional agricultural insurance that offers protection against climatic shocks on small-scale tobacco farmers in Colombia. We analyze the impacts of access to the insurance on household financial outcomes after a period of severe climatic events that caused substantial crop failures. Our identification strategy benefits from a natural experimental setup of the form in which the insurance was launched. We find that tobacco producers with access to the insurance program were less likely to acquire informal loans, were less likely to use loans to repay debts, and had access to loans with lower interest rates and longer maturation periods. Moreover, access to this program was positively associated with increased savings and accumulation of liquid assets.
    Keywords: Insurance; Credit; Natural Disasters; Risk Management; Colombia
    JEL: G22 G23 O13 O16 Q14
    Date: 2015–02–23

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