nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒04‒19
twelve papers chosen by

  1. Switching-GAS Copula Models for Systemic Risk Assessment By Mauro Bernardi; Leopoldo Catania
  2. Extreme Value Theory: An Application to the Peruvian Stock Market Returns By Alfredo Calderon Vela; Gabriel Rodríguez
  3. Discussion of “Systemic Risk and the Solvency-Liquidity Nexus of Banks” By Adrian, Tobias
  4. Pricing and Risk Management with High-Dimensional Quasi Monte Carlo and Global Sensitivity Analysis By Marco Bianchetti; Sergei Kucherenko; Stefano Scoleri
  5. The failure of supervisory stress testing: Fannie Mae, Freddie Mac, and OFHEO By Frame, W. Scott; Gerardi, Kristopher S.; Willen, Paul S.
  6. The value of insolvency safe harbours By Philipp Paech
  7. Risk Analysis of Energy Performance Contracting Projects in Russia: An Analytic Hierarchy Process Approach By Garbuzova-Schlifter, Maria; Madlener, Reinhard
  8. The Impact of State Foreclosure and Bankruptcy Laws on Higher-Risk Lending: Evidence from FHA and Subprime Mortgage Originations By Qianqian Cao and Shimeng Liu
  9. Random Time Forward Starting Options By Fabio Antonelli; Alessandro Ramponi; Sergio Scarlatti
  10. Implementation of Risk-Based State-Government Regulation in the Russian Conditions By Ivleva, Galina; Borovikova, Elena; Melnikov, Roman
  11. How Bank Managers Anticipate Non-Performing Loans. Evidence from Europe, US, Asia and Africa By Ozili, PK
  12. Personal Pensions with Risk sharing: Affordable, Adequate and Stable Private Pensions in Europe By Bovenberg, A Lans; Nijman, Theo E

  1. By: Mauro Bernardi; Leopoldo Catania
    Abstract: Recent financial disasters have emphasised the need to accurately predict extreme financial losses and their consequences for the institutions belonging to a given financial market. The ability of econometric models to predict extreme events strongly relies on their flexibility to account for the highly nonlinear and asymmetric dependence observed in financial returns. We develop a new class of flexible Copula models where the evolution of the dependence parameters follow a Markov-Switching Generalised Autoregressive Score (SGASC) dynamics. Maximum Likelihood estimation is consistently performed using the Inference Functions for Margins (IFM) approach and a version of the Expectation-Maximisation (EM) algorithm specifically tailored to this class of models. The SGASC models are then used to estimate the Conditional Value-at-Risk (CoVaR), which is defined as the VaR of a given asset conditional on another asset (or portfolio) being in financial distress, and the Conditional Expected Shortfall (CoES). Our empirical investigation shows that the proposed SGASC models are able to explain and predict the systemic risk contribution of several European countries. Moreover, we also find that the SGASC models outperform competitors using several CoVaR backtesting procedures.
    Date: 2015–04
  2. By: Alfredo Calderon Vela (Departamento de Economía - Pontificia Universidad Católica del Perú); Gabriel Rodríguez (Departamento de Economía - Pontificia Universidad Católica del Perú)
    Abstract: Using daily observations of the index and stock market returns for the Peruvian case from January 3, 1990 to May 31, 2013, this paper models the distribution of daily loss probability, estimates maximum quantiles and tail probabilities of this distribution, and models the extremes through a maximum threshold. This is used to obtain the better measurements of the Value at Risk (VaR) and the Expected Short-Fall (ES) at 95% and 99%. One of the results on calculating the maximum annual block of the negative stock market returns is the observation that the largest negative stock market return (daily) is 12.44% in 2011. The shape parameter is equal to -0.020 and 0.268 for the annual and quarterly block, respectively. Then, in the Örst case we have that the non-degenerate distribution function is Gumbel-type. In the other case, we have a thick-tailed distribution (FrÈchet). Estimated values of the VaR and the ES are higher using the Generalized Pareto Distribution (GPD) in comparison with the Normal distribution and the di§erences at 99.0% are notable. Finally, the non-parametric estimation of the Hill tail-index and the quantile for negative stock market returns shows quite instability. JEL Classification-JEL: C22, C58, G32.
    Keywords: Extreme Value Theory, Value-at-Risk (VaR), Expected Short-Fall (ES), Generalized Pareto Distribution (GPD), Distributions Gumbel, Exponential, FrÈchet, Extreme Loss, Peruvian Stock Market.
    Date: 2014
  3. By: Adrian, Tobias (Federal Reserve Bank of New York)
    Abstract: Pierret (2015) presents empirical analysis of the solvency-liquidity nexus for the banking system, documenting that a shock to the level of banks’ solvency risk is followed by lower short-term debt. Conversely, higher short-term debt Granger-causes higher solvency risk. These results point toward a tight interaction between solvency and liquidity risk over time. My comments are threefold. First, I suggest improving the identification of shocks in Pierret’s vector autoregressive setup. Second, I caution against using the quantitative results as the basis for setting policy. Third, I recommend using theoretical restrictions from macro-finance theories to improve identification and interpretation.
    Keywords: systemic risk; banking liquidity; capital regulation; liquidity regulation
    JEL: G01 G21 G28
    Date: 2015–04–01
  4. By: Marco Bianchetti; Sergei Kucherenko; Stefano Scoleri
    Abstract: We review and apply Quasi Monte Carlo (QMC) and Global Sensitivity Analysis (GSA) techniques to pricing and risk management (greeks) of representative financial instruments of increasing complexity. We compare QMC vs standard Monte Carlo (MC) results in great detail, using high-dimensional Sobol' low discrepancy sequences, different discretization methods, and specific analyses of convergence, performance, speed up, stability, and error optimization for finite differences greeks. We find that our QMC outperforms MC in most cases, including the highest-dimensional simulations and greeks calculations, showing faster and more stable convergence to exact or almost exact results. Using GSA, we are able to fully explain our findings in terms of reduced effective dimension of our QMC simulation, allowed in most cases, but not always, by Brownian bridge discretization. We conclude that, beyond pricing, QMC is a very promising technique also for computing risk figures, greeks in particular, as it allows to reduce the computational effort of high-dimensional Monte Carlo simulations typical of modern risk management.
    Date: 2015–04
  5. By: Frame, W. Scott (Federal Reserve Bank of Atlanta); Gerardi, Kristopher S. (Federal Reserve Bank of Atlanta); Willen, Paul S. (Federal Reserve Bank of Boston)
    Abstract: Stress testing has recently become a critical risk management and capital planning tool for large financial institutions and their supervisors around the world. However, the one prior U.S. experience tying stress test results to capital requirements was a spectacular failure: the Office of Federal Housing Enterprise Oversight's (OFHEO) risk-based capital stress test for Fannie Mae and Freddie Mac. We study a key component of OFHEO's model—30-year fixed-rate mortgage performance—and find two key problems. First, OFHEO had left the model specification and associated parameters static for the entire time the rule was in force. Second, the house price stress scenario was insufficiently dire. We show how each problem resulted in a significant underprediction of mortgage credit losses and associated capital needs at Fannie Mae and Freddie Mac during the housing bust.
    Keywords: Bank supervision; stress test; model risk; residential mortgages; government-sponsored enterprises
    JEL: G21 G23 G28
    Date: 2015–03–01
  6. By: Philipp Paech
    Abstract: ‘Safe harbour’ is shorthand for a bundle of privileges in insolvency which are typically afforded to financial institutions. They are remotely comparable to security interests as they provide a financial institution with a considerably better position as compared to other creditors should one of its counterparties fail or become insolvent. Safe harbours have been introduced widely and continue to be introduced in financial markets. The common rationale for such safe harbours is that the protection against the fallout of the counterparty’s insolvency contributes to systemic stability, as the feared ‘domino effect’ of insolvencies is not triggered from the outset. However, safe harbours are also criticised for accelerating contagion in the financial market in times of crisis and making the market more risky. This paper submits that the more important argument for the existence of safe harbours is liquidity in the financial market. Safe harbour rules do away with a number of legal concepts, notably those attached to traditional security, and thereby allow for an exponentiation of liquidity. Normative decisions of the legislator sanction safe harbours as modern markets could not exist without these high levels of liquidity. To the extent that safe harbours accelerate contagion in terms of crisis, which in principle is a valid argument, specific regulation is well suited to correct this situation, whereas a repeal or significant restriction of the safe harbours would be counterproductive.
    Keywords: financial institutions; financial market; banks; insolvency; safe harbours; safe harbors; collateral; netting; set-off; close-out netting; Unidroit; FCD; Financial Collateral Directive; insolvency; bank resolution; moral hazard; systemic risk; risk management; liquidity
    JEL: G32 F3 G3
    Date: 2015
  7. By: Garbuzova-Schlifter, Maria (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN)); Madlener, Reinhard (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN))
    Abstract: Systematic and effective risk management in energy performance contracting (EPC) projects requires a sound understanding of the main risks faced by energy service companies (ESCOs) and other energy service providing companies (ESPCs), which accomplish such projects under vulnerable market conditions in Russia. This study explores the EPC project risks (risk factors and their causes) and develops a risk analysis framework that is applied to three Russian sectors: (1) industrial; (2) housing and communal services; and (3) public. The identified general risks were validated by Russian EPC practitioners in expert interviews. An analytic hierarchy process (AHP) approach was then used to rank the identified risks in terms of their contribution to the riskiness of EPC projects. The data were obtained from a web-based questionnaire survey conducted among Russian ESCOs and ESPCs. For improving consistency of the obtained AHP results, the maximum deviation approach (MDA) for 8×8 matrices and the induced bias matrix model (IBBM) for 3×3 and 4×4 matrices were applied. This study indicates that there is a need for a widely usable formal approach for risk analysis and management in EPC projects in Russia. Causes of risk related to the financial and regulatory aspects were found to contribute most to the riskiness of EPC projects performed in all three focus sectors in that country.
    Keywords: Risk analysis; energy performance contracting; EPC; energy service company; ESCO; Russia; analytic hierarchy process; AHP
    Date: 2014–10
  8. By: Qianqian Cao and Shimeng Liu
    Abstract: State foreclosure and bankruptcy laws govern the rights of mortgage lenders and borrowers during foreclosure and bankruptcy proceedings and therefore impact on lenders’ exposure to credit risk. This paper seeks to understand the effects of these state laws on the type of mortgages originated. The empirical identification is based on state-level variations in foreclosure and bankruptcy provisions and a border estimation strategy. We find that higher-risk loans (FHA and subprime loans) are more likely to be originated in a state with lender-friendly foreclosure laws. Also, higher-risk loans are less likely to be originated in a state with a more generous bankruptcy homestead exemption. In addition, our results are consistent with the idea that FHA and subprime loans share a very similar clientele and are close substitutes. These results are robust without the ordering assumption among conventional prime, FHA and subprime loans.
    Keywords: State foreclosure laws, homestead exemption, mortgage originations, ordered probit
    Date: 2015
  9. By: Fabio Antonelli; Alessandro Ramponi; Sergio Scarlatti
    Abstract: We introduce a natural generalization of the forward-starting options, first discussed by M. Rubinstein. The main feature of the contract presented here is that the strike-determination time is not fixed ex-ante, but allowed to be random, usually related to the occurrence of some event, either of financial nature or not. We will call these options {\bf Random Time Forward Starting (RTFS)}. We show that, under an appropriate "martingale preserving" hypothesis, we can exhibit arbitrage free prices, which can be explicitly computed in many classical market models, at least under independence between the random time and the assets' prices. Practical implementations of the pricing methodologies are also provided. Finally a credit value adjustment formula for these OTC options is computed for the unilateral counterparty credit risk.
    Date: 2015–04
  10. By: Ivleva, Galina (Russian Presidential Academy of National Economy and Public Administration (RANEPA)); Borovikova, Elena (Russian Presidential Academy of National Economy and Public Administration (RANEPA)); Melnikov, Roman (Russian Presidential Academy of National Economy and Public Administration (RANEPA))
    Abstract: Risk-based methods of taking decisions in the system of public administration have found applying in foreign countries with development economics and in Russia. Economic crisis, factors, which result to financial instability, problems in financial and real sector of the economy create situation of rising risks and complicate the processes of regulation of economics by the methods of government impact. In such situation there is a need to study the accumulated experience of risk-based regulation in Russia. High interest is connected with the internal mechanisms of evaluating of risks and managing of risks by controlled entities. Presented work includes analysis of Russian practice of risk-based regulation, proposals for development tools.
    Keywords: risk-based methods of taking decisions, public administration, risk-based regulation, evaluating the risks, managing the risks,
    Date: 2015–04
  11. By: Ozili, PK
    Abstract: This study extends the literature on the determinants of NPL. I investigate whether banks anticipate non-performing loans by making balance sheet adjustments. This study draws insights into the actions taken by credit risk management teams and bank managers to minimize the size of non-performing loans. After examining 82 banks from US, Europe, Asia and Africa, the result indicate that banks adjust the level of loan loss reserves and loan growth to minimize the size of NPLs. Our results do not show evidence that loan diversification minimizes NPLs. Further, I find that banks in developing countries reduce loan growth when they expect high NPL while banks in developed countries do not anticipate the level of NPL by adjusting loan growth. Further, I find that post-crisis Basel regulation did not lead to a decrease in the size of NPLs among banks in developed countries but appear to minimize NPLs in some developing countries. Overall, the significance and predictive power of each bank-specific factor (excluding loan diversification), regulatory variable and macroeconomic indicator in explaining NPLs depends on regional factors (less significantly) and country-specific factors (more significantly).
    Keywords: Non-performing Loans, Credit risk, Macroeconomic determinants, bank specific determinants, banking
    JEL: G20 G21 G32 G38
    Date: 2015
  12. By: Bovenberg, A Lans; Nijman, Theo E
    Abstract: Private pension provision faces the challenging task of providing stable income streams during retirement. The challenge has increased markedly in the last decades due to volatile financial markets, falling interest rates and the withdrawal of employers and external insurers as risk bearers of systematic financial and longevity risks. Partly because of these developments, policyholders desire pensions tailored to their individual needs. This paper proposes a new type of pension: the Personal Pension with Risk sharing (PPR). By unbundling and valuing the investment, (dis)saving, insurance and risk-sharing functions of pensions, PPRs allow risk management and (dis)saving to be customized to the specific features of heterogeneous individuals. Moreover, unlike variable annuities, PPRs allow investment risks to be combined with longevity insurance without giving rise to high year-on-year volatility in consumption streams or opaque and rigid valuation and smoothing rules. The unbundling of functions in the PPR also deepens the internal markets for financial and insurance products while at the same time accommodating the diverse traditions of countries in terms of occupational pension provision. Finally, the PPR reconciles financial, fiscal and macroeconomic stability with growth by increasing the supply of long-term risk-bearing and illiquid capital, complementing public retirement provision, reducing the interest-rate sensitivity of pensions and smoothing shocks.
    Keywords: decumulation phase; defined benefit; defined contribution; longevity insurance; private pensions; risk management; risk sharing; variable annuities
    JEL: D14 D91 E21 E62 G11 G22 G23 G28 H31 H55 J14 J18 J26 J62 P43
    Date: 2015–04

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