nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒09‒05
eleven papers chosen by

  1. Assessing systemic risk due to fire sales spillover through maximum entropy network reconstruction By Domenico Di Gangi; Fabrizio Lillo; Davide Pirino
  2. Bosnia and Herzegovina: Financial Sector Assessment Program - Banking Sector Supervision Core Principles Implementation Update—Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  3. Asset Allocation Strategies Based On Penalized Quantile Regression By Giovanni Bonaccolto; Massimiliano Caporin; Sandra Paterlini
  4. Risk Management Optimization for Sovereign Debt Restructuring By Consiglio, Andrea; Zenios, Stavros A.
  5. Indicators used in setting the countercyclical capital buffer By Kalatie, Simo; Laakkonen, Helinä; Tölö, Eero
  6. Early warning of large volatilities based on recurrence interval analysis in Chinese stock markets By Zhi-Qiang Jiang; Askery A. Canabarro; Boris Podobnik; H. Eugene Stanley; Wei-Xing Zhou
  7. Stress Testing Convergence By Gallardo, German Gutierrez; Schuermann, Til; Duane, Michael
  8. Bank Capital Requirements: A Quantitative Analysis By Nguyen, Thien Tung
  9. The Pricing of Short-Term market Risk: Evidence from Weekly Options By Torben G. Andersen; Nicola Fusari; Viktor Todorov
  10. Depositor Discipline During Good and Bad Times: The Role of the Guarantor of Last Resort By Jackowicz, Krzysztof; Kowalewski, Oskar; Kozlowski, Lukasz
  11. Rethinking Financial Regulation: How Confusions Have Prevented Progress By Admati, Anat R.

  1. By: Domenico Di Gangi; Fabrizio Lillo; Davide Pirino
    Abstract: Assessing systemic risk in financial markets is of great importance but it often requires data that are unavailable or available at a very low frequency. For this reason, systemic risk assessment with partial information is potentially very useful for regulators and other stakeholders. In this paper we consider systemic risk due to fire sales spillover and portfolio rebalancing by using the risk metrics defined by Greenwood et al. (2015). By using the Maximum Entropy principle we propose a method to assess aggregated and single bank's systemicness and vulnerability and to statistically test for a change in these variables when only the information on the size of each bank and the capitalization of the investment assets are available. We prove the effectiveness of our method on 2001-2013 quarterly data of US banks for which portfolio composition is available.
    Date: 2015–09
  2. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: EXECUTIVE SUMMARY1 A review of supervisory practices was conducted to assess progress towards implementation of the Basel Committee Core Principles for Effective Banking Supervision (BCP). A detailed BCP assessment was conducted in 2006 based on the 1999 version of the principles. A factual assessment of compliance was performed this time to measure progress towards BCP implementation since 2006. Each entity, Republika Srpska (RS) and Federation of Bosnia and Herzegovina (FBiH), completed a full self-assessment that was reviewed by the assessors and fully discussed during the mission. The self-assessments and discussions with management and staff of the Banking Agency of Republika Srpska (BARS) and the Banking Agency of Federation Bosnia and Herzegovina (FBA) provided a detailed view of actions undertaken to continue enhancing compliance with the BCPs. The results of the assessment are reported in a technical note with attachments providing detailed principle-by-principle summaries for each entity. However, compliance ratings were not assigned as the focus was on measuring progress. The attachments are formatted as the standard detailed assessment reports (DAR) but do not cover all essential criteria. Although all essential criteria were discussed, and compliance verified, the report was structured to highlight remaining areas in need of improvement and provide a summary of the current state of development. Although regulations2 in both entities are largely harmonized, as are supervisory practices, individual attachments were prepared to reflect the preference of the authorities and the preparation of individual self-assessments. The system of banking supervision oversight has significantly improved since the last review in 2006, but shortcomings remain. Both supervisory authorities have made progress in enhancing the regulatory framework and supervisory processes since the 2006 FSAP.3 The banking agencies are in the process of preparing a new Law on Banks that should address deficiencies in the supervisory powers, resolution tools, and consolidated supervision. These reforms will impact the respective laws on the Banking Agencies by adding supervisory powers. The regulatory framework has been broadened by the issuance of regulations on corporate governance, credit risk management and capital. Comprehensive regulations on risk management have been drafted that will address remaining deficiencies that are highlighted in this assessment. Harmonization in regulation between the entities has been largely achieved and joint planning continues for the implementation of additional regulations and operational improvements.
    Keywords: Reports on the Observance of Standards and Codes;Financial Sector Assessment Program;Bosnia and Herzegovina;Bank supervision;Banking sector;Basel Core Principles;banks, banking, bank, risk, banking supervision
    Date: 2015–08–03
  3. By: Giovanni Bonaccolto (University of Padova); Massimiliano Caporin (University of Padova); Sandra Paterlini (European Business School)
    Abstract: It is well known that quantile regression model minimizes the portfolio extreme risk, whenever the attention is placed on the estimation of the response variable left quantiles. We show that, by considering the entire conditional distribution of the dependent variable, it is possible to optimize different risk and performance indicators. In particular, we introduce a risk-adjusted profitability measure, useful in evaluating financial portfolios under a pessimistic perspective, since the reward contribution is net of the most favorable outcomes. Moreover, as we consider large portfolios, we also cope with the dimensionality issue by introducing an l1-norm penalty on the assets weights.
    Keywords: Quantile regression, l1-norm penalty, pessimistic asset allocation.
    JEL: C58 G10
    Date: 2015–07
  4. By: Consiglio, Andrea (University of Palermo); Zenios, Stavros A. (University of Cyprus nd University of PA)
    Abstract: Debt restructuring is gaining acceptance as a policy tool for resolving sovereign debt crises. In this paper we propose a scenario analysis for debt sustainability and integrate it with scenario optimization for the risk management of re-profiling sovereign debt. The scenario dynamics of debt are used to define a risk metric--conditional Debt-at-Risk--for the tail of debt-to-GDP ratios, and a multi-period stochastic programming model optimizes the expected cost of financing a debt structure, subject to limits on the risk. The model handles important technical aspects of debt restructuring: it collects all debt issues in a common framework, and can include embedded options and contingent claims, multiple currencies and step-up or linked contractual features. Alternative debt profiles are then analyzed for their cost vs risk tradeoffs. With a suitable re-calculation of the efficient frontier, debt sustainability of a given debt profile can then be ascertained. The model is applied to two stylized examples drawn from an IMF publication and from the Cyprus debt crisis.
    Date: 2014–08
  5. By: Kalatie, Simo (Bank of Finland); Laakkonen, Helinä (Bank of Finland); Tölö, Eero (Bank of Finland, Financial Stability and Statistics Department)
    Abstract: According to EU legislation, the national authorities should use the principle of 'guided discretion' in setting the countercyclical capital buffer (CCB), which increases banks' resilience against systemic risk associated with periods of excessive credit growth. This means that the decision should be based on signals from a pre-determined set of early warning indicators, but that there should also be room for discretion, as there is always uncertainty associated with the use of early warning indicators. The European Systemic Risk Board (ESRB) recommends that the authorities use the deviation of the credit-to-GDP ratio from its long term trend value (credit-to-GDP gap) as the primary indicator in setting the CCB. In addition, designated authorities should use in their decision making indicators that measure private sector credit developments and debt burden, overvaluation of property prices, external imbalances, mispricing of risk, and strength of bank balance sheets. Based on an empirical analysis of data on EU countries and a large assortment of potential indicators, we propose a set of suitable early warning indicators for each of these categories.
    Keywords: countercyclical capital buffer; macroprudential policy; early warning indicators
    JEL: G01 G28
    Date: 2015–03–16
  6. By: Zhi-Qiang Jiang (ECUST, BU); Askery A. Canabarro (UFAL, BU); Boris Podobnik (UR); H. Eugene Stanley (BU); Wei-Xing Zhou (ECUST)
    Abstract: Being able to forcast extreme volatility is a central issue in financial risk management. We present a large volatility predicting method based on the distribution of recurrence intervals between volatilities exceeding a certain threshold $Q$ for a fixed expected recurrence time $\tau_Q$. We find that the recurrence intervals are well approximated by the $q$-exponential distribution for all stocks and all $\tau_Q$ values. Thus a analytical formula for determining the hazard probability $W(\Delta t |t)$ that a volatility above $Q$ will occur within a short interval $\Delta t$ if the last volatility exceeding $Q$ happened $t$ periods ago can be directly derived from the $q$-exponential distribution, which is found to be in good agreement with the empirical hazard probability from real stock data. Using these results, we adopt a decision-making algorithm for triggering the alarm of the occurrence of the next volatility above $Q$ based on the hazard probability. Using a "receiver operator characteristic" (ROC) analysis, we find that this predicting method efficiently forecasts the occurrance of large volatility events in real stock data. Our analysis may help us better understand reoccurring large volatilities and more accurately quantify financial risks in stock markets.
    Date: 2015–08
  7. By: Gallardo, German Gutierrez (Oliver Wyman); Schuermann, Til (Oliver Wyman); Duane, Michael (Oliver Wyman)
    Abstract: Increasingly aggressive capital management: Banks initially responded to CCAR by maintaining wide capital cushions vs. regulatory minimums. However, as CCAR processes stabilize and capital minimums increase, some institutions appear to be managing capital more and more tightly, especially investment banks, universals and custodians. Drivers of enhanced financial resource management: What allows institutions to manage capital more closely? First, stress test results are beginning to stabilize and, in some cases, converge. Second, although we have just a handful of examples, the market seems to reward aggressive capital requests, even if they are, at first, rejected by the Fed. Unintended consequences: As stress test results converge and institutions begin to manage capital to Fed-projected results, the Fed?s stress testing models become an increasingly important driver of the fate of the financial system.
    JEL: G20 G21 G28
    Date: 2015–07
  8. By: Nguyen, Thien Tung (OH State University)
    Abstract: This paper examines the welfare implications of bank capital requirements in a general equilibrium model in which a dynamic banking sector endogenously determines aggregate growth. Due to government bailouts, banks engage in risk-shifting, thereby depressing investment efficiency; furthermore, they over-lever, causing fragility in the financial sector. Capital regulation can address these distortions and has a first-order effect on both growth and welfare. In the model, the optimal level of minimum Tier 1 capital requirement is 8%, greater than that prescribed by both Basel II and III. Increasing bank capital requirements can produce welfare gains greater than 1% of lifetime consumption.
    JEL: G21 G28
    Date: 2014–01
  9. By: Torben G. Andersen; Nicola Fusari; Viktor Todorov
    Abstract: We study short-term market risks implied by weekly S&P 500 index options. The introduction of weekly options has dramatically shifted the maturity profile of traded options over the last five years, with a substantial proportion now having expiry within one week. Economically, this reflects a desire among investors for actively managing their exposure to very short-term risks. Such short-dated options provide an easy and direct way to study market volatility and jump risks. Unlike longer-dated options, they are largely insensitive to the risk of intertemporal shifts in the economic environment, i.e., changes in the investment opportunity set. Adopting a novel general semi-nonparametric approach, we uncover variation in the shape of the negative market jump tail risk which is not spanned by market volatility. Incidents of such tail shape shifts coincide with serious mispricing of standard parametric models for longer-dated options. As such, our approach allows for easy identification of periods of heightened concerns about negative tail events on the market that are not always "signaled" by the level of market volatility and elude standard asset pricing models.
    JEL: C01 C14 C52 C58 G12 G13 G17 G32
    Date: 2015–08
  10. By: Jackowicz, Krzysztof (Kozminski University); Kowalewski, Oskar (Institute of Economics, Polish Academy of Sciences); Kozlowski, Lukasz (Kozminski University)
    Abstract: In this paper, we investigate, for the first time in the literature, whether the ability of the public sector or government, for convenience purposes called the guarantor of last resort (GLR), to effectively help banks or guarantee bank liabilities affects the sensitivity of interest costs and deposit dynamics to banks' fundamentals. To test our hypothesis, we gathered a global bank sample covering the period from 1991 to 2012. We proxy for the GLR's risk using sovereign ratings, credit default swap spreads, bond yields and changes in macroeconomic indicators. Additionally, we observe the period subsequent to systemic financial crises. Regardless of the method we apply to describe the GLR's risk and the estimation procedure employed, we find that interest cost sensitivity to banks' fundamentals, especially equity capital, is generally an increasing function of the GLR's risk. Moreover, we provide evidence that the relationship between interest cost sensitivity to banks' fundamentals and the GLR's risk is non-linear and is even U-shaped in certain cases. Therefore, in economic terms, our results indicate that, paradoxically, moderate GLR risk levels may foster market monitoring by depositors.
    JEL: G21 G28
    Date: 2015–02
  11. By: Admati, Anat R. (Stanford University)
    Abstract: Flawed and ineffective financial regulation fails to counter, and may exacerbate, distorted incentives within the financial system. The forces that lead to excessive fragility through unnecessary and dangerous levels of leverage, opacity, complexity and interconnectedness also distort credit markets and create other inefficiencies. In this chapter I focus on the failure to correct key flaws, which were evident in 2007-2009, in the design and implementation of capital regulations. These flaws include low equity levels, the risk-weighting system, allowing debt-like hybrids (under various titles, such as Total Loss Absorbing Capacity or TLACs) as substitutes for equity, and measurement issues, including poor accounting of risk exposures in derivatives markets and in the so-called shadow banking system. Confusions about the sources of the problems and about the tradeoffs associated with specific tools have muddled the policy debate and have allowed narrow interests and political forces to derail progress towards a safer and healthier financial system.
    Date: 2015–06

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.