nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒04‒11
thirteen papers chosen by

  1. Do Long Memory and Asymmetries Matter When Assessing Downside Return Risk? By Nico Katzke; Chris Garbers
  2. Systemic risk and the solvency-liquidity nexus of banks By PIERRET, Diane
  3. Equally-weighted Risk Contribution Portfolios: an empirical study using expected shortfall By Elisabetta Cagna; Giulio Casuccio
  4. Construction of value-at-risk forecasts under different distributional assumptions within a BEKK framework By Braione, Manuela; Scholtes, Nicolas K.
  5. Remark on the Paper "Entropic Value-at-Risk: A New Coherent Risk Measure" by Amir Ahmadi-Javid, J. Opt. Theory and Appl., 155 (2001),1105--1123 By Freddy Delbaen
  6. Capital Regulation in a Macroeconomic Model with Three Layers of Default By Laurent Clerc; Alexis Derviz; Caterina Mendicino; Stephane Moyen; Kalin Nikolov; Livio Stracca; Javier Suarez; Alexandro Vardulakis
  7. Introduction of an Income Contingent Repayment Scheme for Non-Performing Mortgage Loans - Lessons from Hungary’s Case By Edina Berlinger; György Walter
  8. A New Liquidity Risk Measure for the Chilean Banking Sector By Sebastián Becerra; Gregory Claeys; Juan Francisco Martínez
  9. Protecting the organization against risk and the role of financial audit By Sylwia Bozek; Izabela Emerling
  10. Are benefits from oil-stocks diversification gone? New evidence from a dynamic copula and high frequency data By Avdulaj, Krenar; Barunik, Jozef
  11. DebtRank: A microscopic foundation for shock propagation By Marco Bardoscia; Stefano Battiston; Fabio Caccioli; Guido Caldarelli
  12. Financial stress indices and financial crises By Robert Vermeulen; Marco Hoeberichtsa; Borek Vašícekb; Diana Žigraiová; Katerina Šmídková; Jakob de Haan
  13. Forecasting Financial Market Vulnerability in the U.S.: A Factor Model Approach By Hyeongwoo Kim; Wen Shi

  1. By: Nico Katzke (Department of Economics, University of Stellenbosch); Chris Garbers (Department of Economics, University of Stellenbosch)
    Abstract: In this paper we set out to test whether, on sector level, returns series in South Africa exhibit long memory and asymmetries and, more specifically, whether these effects should be accounted for when assessing downside risk. The purpose of this analysis is not to identify the most optimal downside risk assessment model or to reaffirm the often regarded stylized fact of long memory and asymmetry in asset returns series. Rather we set out to establish whether accounting for these effects and allowing for more flexibility in second order persistence models lead to improved risk assessments. We use several variants of the widely used GARCH family of second order persistence models that control for these effects, and compare the downside risk estimates using Value-at-Risk measures of these different models and compare their out-of-sample performances. Our findings confirm that controlling for asymmetries and long memory in volatility models improve risk management calculations.
    Keywords: Value-at-Risk, Expected Shortfall, GARCH, Fractional Integration, Kupiec back-testing procedure
    JEL: C22 G13 G17
    Date: 2015
  2. By: PIERRET, Diane (Université catholique de Louvain, CORE& ISBA, Belgium; NYU Stern School of Business)
    Abstract: This paper highlights the empirical interaction between solvency and liquidity risks of banks that make them particularly vulnerable to an aggregate crisis. I find that banks lose their access to short-term funding when markets expect they will be insolvent in a crisis. Conversely, the expected amount of capital a bank should raise to remain solvent in a crisis (its capital shortfall) increases when the bank holds more short-term debt (has a larger exposure to funding liquidity risk). This solvency-liquidity nexus is found to be strong under many robustness checks and to contain useful information for forecasting the short-term balance sheet of banks. The results suggest that the solvency-liquidity interaction should be accounted for when designing liquidity and capital requirements, in contrast to Basel III regulation where solvency and liquidity risks are treated separately.
    Keywords: capital shortfall, funding liquidity risk, short-term funding
    JEL: G01 G21 G28
    Date: 2014–11–05
  3. By: Elisabetta Cagna (Symphonia Sgr); Giulio Casuccio (Fondaco sgr)
    Abstract: The high volatility observed in financial markets during the last crisis prompted renewed interest in designing truly diversified portfolios. One of the most interesting approach proposed by recent literature is the Equally-weighted Risk Contribution strategy (Maillard et al., 2009), usually implemented with standard deviation as risk measure: our paper extends this approach introducing expected shortfall. The expected shortfall risk contributions are computed through a non-parametric approach which aims to reduce the estimation error generated by the historical sample applying a bootstrap resampling procedure. The ex-post performance analysis also accounts for realistic transaction costs. We find superiority of the ERC portfolios, with better Sharpe ratio along with asymmetric performance metrics.
    Date: 2014–10
  4. By: Braione, Manuela (Université catholique de Louvain, CORE, Belgium); Scholtes, Nicolas K. (Université catholique de Louvain, CORE, Belgium)
    Abstract: Financial asset returns are known to be conditionally heteroskedastic and generally non-normally distributed, fat-tailed and often skewed. In order to account for both the skewness and the excess kurtosis in returns, we combine the BEKK model from the multivariate GARCH literature with different multivariate densities for the returns. The set of distributions we consider comprises the normal, Student, Multivariate Exponential Power and their skewed counterparts. Applying this framework to a sample of ten assets from the Dow Jones Industrial Average Index, we compare the performance of equally- weighted portfolios derived from the symmetric and skewed distributions in forecasting out-of-sample Value-at-Risk. The accuracy of the VaR forecasts is assessed by implementing standard statistical backtesting procedures. The results unanimously show that the inclusion of fat-tailed densities into the model specification yields more accurate VaR forecasts, while the further addition of skewness does not lead to significant improvements.
    Keywords: Dow Jones industrial average, BEKK model, maximum likelihood, value-at-risk
    JEL: C01 C22 C52 C58
    Date: 2014–11–18
  5. By: Freddy Delbaen
    Abstract: The paper mentioned in the title introduces the entropic value at risk. I give some extra comments and using the general theory make a relation with some commonotone risk measures.
    Date: 2015–04
  6. By: Laurent Clerc; Alexis Derviz; Caterina Mendicino; Stephane Moyen; Kalin Nikolov; Livio Stracca; Javier Suarez; Alexandro Vardulakis
    Abstract: We develop a dynamic general equilibrium model for the positive and normativeanalysis of macroprudential policies. Optimizing financial intermediaries allocate theirscarce net worth together with funds raised from saving households across two lendingactivities, mortgage and corporate lending. For all borrowers (households, firms, andbanks) external financing takes the form of debt which is subject to default risk. This“3D model” shows the interplay between three interconnected net worth channels thatcause financial amplification and the distortions due to deposit insurance. We apply itto the analysis of capital regulation.
    JEL: E3 E44 G01 G21
    Date: 2015
  7. By: Edina Berlinger (Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Department of Finance, Corvinus University of Budapest); György Walter (Department of Finance, Corvinus University of Budapest)
    Abstract: In Hungary, more than 22% of the FX mortgage portfolio is non-performing and the tendency is worsening. In this paper we propose a solution to effectively reduce the credit and systemic risk inherent to this portfolio, but the proposed model can be applied to other mortgage portfolios in trouble, as well. The main element of our proposal is the income contingent repayment complemented with effective incentives to motivate debtors to repay their debt in a highly flexible way. We show that the proposed scheme is attractive both for the debtors and the lenders; therefore, contrary to some recent policy measures, in this case there is no need for direct state intervention to force modifications to the existing legal contracts. In order to evaluate the possible effects, we simulated a realistic population of borrowers with different age, debt, LTV and income. Then we calculated the expected income paths and the repayments of the borrowers, and also the profit of the lenders on the basis of the non-perforing FX mortgage portfolio. The results underpin that the proposed scheme creates significant value added, and most importantly it can effectively reduce the vulnerability of the whole economy to future shocks.
    Keywords: FX mortgage loans, emerging markets, management of credit and systemic risk, PTI, income contingent repayment, micro-simulation
    JEL: E42 G17 G21 G28
    Date: 2015–01
  8. By: Sebastián Becerra; Gregory Claeys; Juan Francisco Martínez
    Abstract: The objective of this work is to construct an appropriate measure of liquidity risk for Chilean banks. There are already several measures of liquidity risk in the literature. Most of these metrics are based on specific assumptions and expert opinion. In order to overcome the potential problems associated with discretionary assumptions, and to exploit the information available, similar to the work of Drehman and Nikolaou (2012), we propose a metric based on the behavior of banks in the procurement operations Chilean open market (OMO). Due to the particularities of the implementation of monetary policy of the Chilean economy, we introduce an adaptation of the original metric. We calculate the liquidity indicator at an aggregate level and for a sample of groups of banks in a period that includes the recent crisis in the sub-prime. After that, we compare this indicator with a variety of standard metrics proposed in the literature. We find that our metric reasonably captures episodes of liquidity crises and therefore can be used as a complementary tool in the assessment of systemic risks.
    Date: 2015–02
  9. By: Sylwia Bozek (University of Economics in Katowice); Izabela Emerling (University of Economics in Katowice)
    Abstract: In the contemporary economic reality and organization’s activities aiming at effectiveness and efficiency of functioning, a lot of significance is attached to a financial audit as an important instrument for protecting the organization against the risk factors. The aim of this article is to present theoretical and practical (on the basis of the examined example) aspects concerning the (internal) financial audit in the organization within the context of its assessment of the exposure to risk. The applied research methods are based on the method of conceptual analysis of the literature on the examined field, as well as on the case study of the auditing task. The results of the performed analyses and examinations allow to state that the financial audit constitutes an effective tool for protecting the organization against internal, as well as external risks. Each of the co-authors will contribute 50% of work to this article.
    Keywords: risk, risk identification, risk management, financial audit, internal audit
    JEL: D81 M42
    Date: 2015–04
  10. By: Avdulaj, Krenar; Barunik, Jozef
    Abstract: Oil is perceived as a good diversification tool for stock markets. To fully understand this potential, we propose a new empirical methodology that combines generalized autoregressive score copula functions with high frequency data and allows us to capture and forecast the conditional time-varying joint distribution of the oil-stocks pair accurately. Our realized GARCH with time-varying copula yields statistically better forecasts of the dependence and quantiles of the distribution relative to competing models. Employing a recently proposed conditional diversification benefits measure that considers higher-order moments and nonlinear dependence from tail events, we document decreasing benefits from diversification over the past ten years. The diversification benefits implied by our empirical model are, moreover, strongly varied over time. These findings have important implications for asset allocation, as the benefits of including oil in stock portfolios may not be as large as perceived.
    Keywords: portfolio diversification,dynamic correlations,high frequency data time-varying copulas,commodities
    JEL: C14 C32 C51 F37 G11
    Date: 2015
  11. By: Marco Bardoscia; Stefano Battiston; Fabio Caccioli; Guido Caldarelli
    Abstract: The DebtRank algorithm has been increasingly investigated as a method to estimate the impact of shocks in financial networks, as it overcomes the limitations of the traditional default-cascade approaches. Here we formulate a dynamical "microscopic" theory of instability for financial networks by iterating balance sheet identities of individual banks and by assuming a simple rule for the transfer of shocks from borrowers to lenders. By doing so, we generalise the DebtRank formulation, both providing an interpretation of the effective dynamics in terms of basic accounting principles and preventing the underestimation of losses on certain network topologies. Depending on the structure of leverages the dynamics is either stable, in which case the asymptotic state can be computed analytically, or unstable, meaning that at least a bank will default. We apply this results to a network of roughly 200 among the largest European banks in the period 2008 - 2013. We show that network effects generate an amplification of exogenous shocks of a factor ranging between three (in normal periods) and six (during the crisis), when we stress the system with a 0.5% shock on external (i.e. non-interbank) assets for all banks.
    Date: 2015–04
  12. By: Robert Vermeulen; Marco Hoeberichtsa; Borek Vašícekb; Diana Žigraiová; Katerina Šmídková; Jakob de Haan
    Abstract: This paper develops a Financial Stress Index (FSI) for 28 OECD countries and examines its relationship to crises using a novel database for financial crises. A stress index measures the current state of stress in the financial system and summarizes it in a single statistic. Our results suggest that even though our FSI is clearly related to the occurrence of crises, there is only a weak relationship between the FSI and the onset of a crisis, notably the onset of a banking crisis. Policymakers should therefore be aware of the limited usefulness of FSIs as an early warning indicator.
    Keywords: financial stress index; financial crises; developed countries; early warning indicators
    JEL: E5 G10
    Date: 2015–03
  13. By: Hyeongwoo Kim; Wen Shi
    Abstract: This paper presents a factor-based forecasting model for the financial market vulnerability in the U.S. We estimate latent common factors via the method of the principal components from 170 monthly frequency macroeconomic data to out-of-sample forecast the Cleveland Financial Stress Index. Our factor models outperform both the random walk and the autoregressive benchmark models in out-of-sample predictability for short-term forecast horizons, which is a desirable feature since financial crises often come to a surprise realization. Interestingly, the first common factor, which plays a key role in predicting the financial vulnerability index, seems to be more closely related with real activity variables rather than nominal variables. The recursive and the rolling window approaches with a 50% split point perform similarly well.
    Keywords: Financial Stress Index; Method of the Principal Component; Out-of-Sample Forecast; Ratio of Root Mean Square Prediction Error; Diebold-Mariano-West Statistic
    JEL: E44 E47 G01 G17
    Date: 2015–04

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