nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒07‒11
thirteen papers chosen by

  1. The Spectral Stress VaR (SSVaR) By Dominique Guegan; Bertrand K. Hassani; Kehan Li
  2. Reinsurance and securitisation of life insurance risk: the impact of regulatory constraints By Pauline BARRIEU; Henri LOUBERGE
  3. Risk or Regulatory Capital? Bringing distributions back in the foreground By Dominique Guegan; Bertrand Hassani
  4. Using probabilistic models to appraise and decide on sovereign disaster risk financing and insurance By Ley-Borrás,Roberto; Fox,Benjamin Daniel
  5. The Effects of Leverage Requirements and Fire Sales on Financial Contagion via Asset Liquidation Strategies in Financial Networks By Zachary Feinstein; Fatena El-Masri
  6. Ambiguity and therapy in risk management By Tom Horlick-Jones; Jonathan Rosenhead
  7. Impact of dependence on some multivariate risk indicators By V\'eronique Maume-Deschamps; Didier Rulli\`ere; Khalil Said
  8. Modeling the Interactions between Volatility and Returns By Andrew Harvey and Rutger-Jan Lange
  9. Some Statistical Properties of the Mini Flash Crashes By Demos, Guilherme; Da Silva, Sergio; Matsushita, Raul
  10. Supervisory Stress Testing of Large Systemic Financial Institutions : A speech at the Riksbank Macroprudential Conference, Stockholm, Sweden, June 24, 2015 By Fischer, Stanley
  11. Intraday Stochastic Volatility in Discrete Price Changes: the Dynamic Skellam Model By Siem Jan Koopman; Rutger Lit; Andre Lucas
  12. Measuring the Speed of Convergence of Stock Prices: A Nonparametric and Nonlinear Approach By Hyeongwoo Kim; Deockhyun Ryu
  13. Price Level Targeting and Risk Management* By Billi, Roberto

  1. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS); Bertrand K. Hassani (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS); Kehan Li (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS)
    Abstract: One of the key lessons of the crisis which began in 2007 has been the need to strengthen the risk coverage of the capital framework. In response, the Basel Committee in July 2009 completed a number of critical reforms to the Basel II framework which will raise capital requirements for the trading book and complex securitisation exposures, a major source of losses for many international active banks. One of the reforms is to introduce a stressed value-at-risk (VaR) capital requirement based on a continuous 12-month period of significant financial stress (Basel III (2011) [1]. However the Basel framework does not specify a model to calculate the stressed VaR and leaves it up to the banks to develop an appropriate internal model to capture material risks they face. Consequently we propose a forward stress risk measure “spectral stress VaR” (SSVaR) as an implementation model of stressed VaR, by exploiting the asymptotic normality property of the distribution of estimator of VaR p. In particular to allow SSVaR incorporating the tail structure information we perform the spectral analysis to build it. Using a data set composed of operational risk factors we fit a panel of distributions to construct the SSVaR in order to stress it. Additionally we show how the SSVaR can be an indicator regarding the inner model robustness for the bank.
    Date: 2015–06
  2. By: Pauline BARRIEU (London School of Economics); Henri LOUBERGE (University of Geneva and Swiss Finance Institute)
    Abstract: Large systematic risks, such as those arising from natural catastrophes, climatic changes and uncertain trends in longevity increases, have risen in prominence at a societal level and, more particularly, have become a highly relevant issue for the insurance industry. Against this background, the combination of reinsurance and capital market solutions (insurance-linked securities) has received an accrued interest. In this paper, we develop a general model of optimal risk-sharing among three representative agents – an insurer, a reinsurer and a financial investor, making a distinction between systematic and idiosyncratic risks. We focus on the impact of regulation on risk transfer, by differentiating reinsurance and securitisation in terms of their impact on reserve requirements. Our results show that different regulatory prescriptions will lead to quite different results in terms of global risk-sharing.
    Keywords: Reinsurance, Risk sharing, Risk measures, Longevity risk, Insurance-Linked securities
    JEL: G22
  3. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS); Bertrand Hassani (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS)
    Abstract: This paper discusses the regulatory requirement (Basel Committee, ECB-SSM and EBA) to measure financial institutions' major risks, for instance Market, Credit and Operational, regarding the choice of the risk measures, the choice of the distributions used to model them and the level of confidence. We highlight and illustrate the paradoxes and the issues observed implementing an approach over another and the inconsistencies between the methodologies suggested and the goal to achieve. This paper make some recommendations to the supervisor and proposes alternative procedures to measure the risks.
    Date: 2015–05
  4. By: Ley-Borrás,Roberto; Fox,Benjamin Daniel
    Abstract: This paper presents an overview of the structure of probabilistic catastrophe risk models, discusses their importance for appraising sovereign disaster risk financing and insurance instruments and strategy, and puts forward a model and a process for improving decision making on the linked disaster risk management strategy and sovereign disaster risk financing and insurance strategy. The paper discusses governments'use of probabilistic catastrophe models to inform sovereign disaster risk financing decision making and describes the ex ante and expost financing instruments available for responding to extreme natural events. It also discusses the challenge of appraising sovereign disaster risk financing and insurance instruments, including a review of the multiple dimensions of disaster risks and the value that probabilistic catastrophe risk models provide. The decision making framework for sovereign disaster risk financing and insurance put forward by the paper includes the use of a decision model (an influence diagram) as a rigorous representation of the relationships between the decisions, uncertain events, and consequences relevant to sovereign disaster risk financing and insurance decision making. The framework also includes a process for generating high-quality customized components for the decision model, and a tool for designing coherent sovereign disaster risk financing and insurance strategies. The paper ends with suggestions for improving catastrophe risk models to facilitate sovereign disaster risk financing and insurance decision making.
    Keywords: Banks&Banking Reform,Labor Policies,Hazard Risk Management,Insurance&Risk Mitigation,Natural Disasters
    Date: 2015–07–02
  5. By: Zachary Feinstein; Fatena El-Masri
    Abstract: This paper provides a framework for modeling the financial system with multiple illiquid assets when liquidation of illiquid assets is caused by failure to meet a leverage requirement. This extends the network model of Cifuentes, Shin & Ferrucci (2005) which incorporates a single asset with fire sales and capital adequacy ratio. This also extends the network model of Feinstein (2015) which incorporates multiple illiquid assets with fire sales and no leverage ratios. We prove existence of equilibrium clearing payments and liquidation prices for a known liquidation strategy when leverage requirements are required. We also prove sufficient conditions for the existence of an equilibrium liquidation strategy with corresponding clearing payments and liquidation prices. Finally we calibrate network models to asset and liability data for 50 banks in the United States from 2007-2014 in order to draw conclusions on systemic risk as a function of leverage requirements.
    Date: 2015–07
  6. By: Tom Horlick-Jones; Jonathan Rosenhead
    Abstract: Ambiguity, the existence of multiple plausible (though possibly contested) ways of making sense of the characteristics of decision situations, can present significant difficulties for a wide range of risk management tasks. We will argue that ambiguity is present in risk management situations to a far greater extent that is commonly appreciated. The concept of ambiguity has arisen in different forms across disciplinary literatures and domains of practice. In this paper, we situate our experience of finding ways of supporting planning and decision-making processes concerned with ambiguous risks in the context of those wider perspectives. Our own efforts have employed a hybrid form of problem structuring methods (drawn from operational research and management science) and ethnography (drawn from sociology and anthropology). These engagements with organisational and inter-organisational risk management issues have led us to recognise that ‘untangling’ otherwise intractable risk management problems may be regarded, in some sense, as a therapeutic process. In this paper, we develop this therapeutic interpretation of the untangling of collective ambiguities using illustrations from a concrete problem situation. We set this therapeutic reading of decision processes in the context of wider perspectives, including those drawn from Habermas’ theorisation of communication, the sociology of science and the literature on citizen engagement and deliberation processes.
    Keywords: organizational risk management; ambiguity; uncertainty; plural rationalities; ethnomethodology; problem structuring methods; practical reasoning; the metaphor of psychotherapy; engagement; transdisciplinarity
    JEL: J50 G32
    Date: 2013–11
  7. By: V\'eronique Maume-Deschamps (ICJ); Didier Rulli\`ere (SAF); Khalil Said (SAF)
    Abstract: The minimization of some multivariate risk indicators may be used as an allocation method, as proposed in C\'enac et al. [6]. The aim of capital allocation is to choose a point in a simplex, according to a given criterion. In a previous paper [17] we proved that the proposed allocation technique satisfies a set of coherence axioms. In the present one, we study the properties and asymptotic behavior of the allocation for some distribution models. We analyze also the impact of the dependence structure on the allocation using some copulas.
    Date: 2015–07
  8. By: Andrew Harvey and Rutger-Jan Lange
    Abstract: Volatility of a stock may incur a risk premium, leading to a positive correlation between volatility and returns. On the other hand the leverage effect, whereby negative returns increase volatility, acts in the opposite direction. We propose a reformulation and extension of the ARCH in Mean model, in which the logarithm of scale is driven by the score of the conditional distribution. This EGARCH-M model is shown to be theoretically tractable as well as practically useful. By employing a two component extension we are able to distinguish between the long and short run effects of returns on volatility. The EGARCH formulation allows more flexibility in the asymmetry of the response (leverage) and this enables us to find that the short-term response is, in some cases, close to being anti-asymmetric. The long and short run volatility components are shown to have very different effects on returns, with the long-run component yielding the risk premium. A model in which the returns have a skewed t distribution is shown to fit well to daily and weekly data on some of the major stock market indices.Keywords: Asymmetric price transmission, cost pass-through, electricity markets, price theory, rockets and feathers
    Date: 2015–07–02
  9. By: Demos, Guilherme; Da Silva, Sergio; Matsushita, Raul
    Abstract: We present some properties of the data from the recent mini flash crashes occurring in individual stocks of the Dow Jones Industrial Average. The top five are: 1) Gaussianity is absent in data; 2) the tail decay of the return distributions follow power laws; 3) chaos and logperiodicity cannot be dismissed at first; 4) chaos and logperiodicity are not good models for the data on second thoughts; and 5) a threshold GARCH fit can also describe the data well, but fails to detect the power law tail decay of most distributions of returns.
    Keywords: flash crash, mini flash crashes
    JEL: C00 G10
    Date: 2015
  10. By: Fischer, Stanley (Board of Governors of the Federal Reserve System (U.S.))
    Date: 2015–06–24
  11. By: Siem Jan Koopman (VU University Amsterdam); Rutger Lit (VU University Amsterdam); Andre Lucas (VU University Amsterdam)
    Abstract: We introduce a dynamic Skellam model that measures stochastic volatility from high-frequency tick-by-tick discrete stock price changes. The likelihood function for our model is analytically intractable and requires Monte Carlo integration methods for its numerical evaluation. The proposed methodology is applied to tick-by-tick data of four stocks traded on the New York Stock Exchange. We require fast simulation methods for likelihood evaluation since the number of observations per series per day varies from 1000 to 10,000. Complexities in the intraday dynamics of volatility and in the frequency of trades without price impact require further non-trivial adjustments to the dynamic Skellam model. In-sample residual diagnostics and goodness-of-fit statistics show that the final model provides a good fit to the data. An extensive forecasting study of intraday volatility shows that the dynamic modified Skellam model provides accurate forecasts compared to alternative modeling approaches.
    Keywords: non-Gaussian time series models; volatility models; importance sampling; numerical integration; high-frequency data; discrete price changes.
    JEL: C22 C32 C58
    Date: 2015–07–01
  12. By: Hyeongwoo Kim; Deockhyun Ryu
    Abstract: This paper evaluates the speed of convergence across national stock markets employing a nonlinear, nonparametric stochastic model of relative stock prices. We use straightforward operational algorithms for estimating measures of persistence of the relative stock price that are based on two statistical notions: the short memory in mean (SMM) and the short memory in distribution (SMD). Using stock indices of G7 countries, we obtain strong empirical evidence of convergence of national stock prices in France, Germany, and the UK vis-à-vis the US index. Also, we obtain faster convergence rates from our nonlinear models in comparison with those from linear alternatives. On the contrary, our results imply very limited evidence of convergence for Canada, Italy, and Japan. We obtain similarly weak evidence of convergence from non-G7 developed countries. Our simulation exercise for portfolio switching strategies overall confirm the validity of empirical results in the preset paper.
    Keywords: Persistence; Contrarian Strategy; Momentum Strategy; Short Memory in Mean; Short-Memory in Distribution; Max Half-Life; Portfolio Switching Strategies
    JEL: C14 C22 F36 G11 G14
    Date: 2015–06
  13. By: Billi, Roberto (Research Department, Central Bank of Sweden)
    Abstract: Many argue that, in the presence of a lower bound on nominal interest rates, central banks should use a risk management approach for setting policy, which implies committing to a more expansionary policy to deal with uncertainty about the economic recovery. Using a standard model for monetary policy analysis, I study the effects of an uncertain future for both price level targeting and nominal GDP level targeting. The results clarify that, during lower bound episodes, the extent to which policy can overcome uncertainty depends crucially on the choice of policy framework.
    Keywords: nominal level targets; optimal discretionary policy; zero lower bound
    JEL: E31 E52 E58
    Date: 2015–06–01

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