nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒10‒17
twelve papers chosen by

  1. Procyclicality of credit rating systems: how to manage it By Tatiana Cesaroni
  2. Asymmetric volatility of the Thai stock market: evidence from high-frequency data By Thakolsri, Supachok; Sethapramote, Yuthana; Jiranyakul, Komain
  3. Getting the Dog to Bark: Disclosing Fiscal Risks from the Financial Sector By Timothy Irwin
  4. The feasibility of index-based insurance as a risk management tool in Central Asia By Grigoreva, Diana; Bobojonov, Ihtiyor; Aw-Hassan, Aden; Biradar, Chandrashekar; Nurbekov, Aziz
  5. Volatility contagion: new evidence from market pricing of volatility risk By Raczko, Marek
  6. A State-Dependent Dual Risk Model By Lingjiong Zhu
  7. Optimal Bank Recovery By C. A. E. Goodhart; Miguel A. Segoviano Basurto
  8. Regime-switching Stochastic Volatility Model : Estimation and Calibration to VIX options By Stéphane Goutte; Amine Ismail; Huyên Pham
  9. Optimal Risk Sharing with Optimistic and Pessimistic Decision Makers By Aloisio Araujo; Laurence Jean-Marc Bonnisseau; Alain Chateauneuf; Rodrigo Novinski
  10. Bancarizing with Credit Cards: Experimental Evidence on Interest Rates and Minimum Payments Elasticities for New Clients By Seira Enrique; Castellanos Pascacio Sara Gabriela; Jiménez Hernández Diego J.
  11. Heterogeneity in the Value of Life By Aldy, Joseph Edgar; Smyth, Seamus J
  12. The Impact of Global Liquidity on Financial Landscapes and Risks in the ASEAN-5 Countries By Tao Sun

  1. By: Tatiana Cesaroni (Bank of Italy)
    Abstract: This paper evaluates the characteristics of a Point in Time (PiT) rating approach for the estimation of firms’ credit risk in terms of procyclicality. To this end I first estimate a logit model for the probability default (PD) of a set of Italian non-financial firms during the period 2006-2012, then, in order to address the issue of rating stability (hedging against rating changes) during the financial crisis, I study the effectiveness of ex post smoothing of PDs in terms of obligors’ migration among rating risk grades. As a by-product I further discuss and analyse the role played by the choice of rating scale in producing ratings stability. The results show that ex post PD smoothing is able to remove business cycle effects on the credit risk estimates and to produce a mitigation of obligors’ migration among risk grades over time. The rating scale choice also has a significant impact on rating stability. These findings have important policy implications in banking sector practices in terms of the stability of the financial system.
    Keywords: procyclicality, business cycle, financial stability, PiT rating system, long run probability default
    JEL: C32 E32 G24 G32
    Date: 2015–09
  2. By: Thakolsri, Supachok; Sethapramote, Yuthana; Jiranyakul, Komain
    Abstract: This study employs the daily data of the Stock Exchange of Thailand to test for the leverage and volatility feedback effects. The period of investigation is during January 4, 2005 to December 27, 2013, which includes the Subprime crisis period in the US that might affect the volatility of stock market return in emerging stock markets. The results from this study show that the US subprime crisis imposes a minimal positive impact on volatility. In addition, the estimations of the three parametric asymmetric volatility models give the results showing some evidence of the volatility feedback and leverage effects. The findings give implications for portfolio diversification and risk management.
    Keywords: Asymmetric volatility, feedback effect, leverage effect, emerging stock market
    JEL: C22 G10
    Date: 2015–10
  3. By: Timothy Irwin
    Abstract: Fiscal reporting is intended to warn of fiscal crises while there is still time to prevent them. The recent crisis thus seems to reveal a failure of fiscal reporting: before the crisis, even reports on fiscal risk typically did not mention banks as a possible source of fiscal problems. One reason for silence was that the risk arose partly from implicit guarantees, and governments may have feared that disclosure would increase moral hazard. The crisis cast doubt, however, on the effectiveness of silence in mitigating risks. This paper discusses how fiscal risks from the financial sector could be discussed in reports on fiscal risk, with a view to encouraging their mitigation.
    Keywords: Financial sector;Moral hazard;Fiscal risk;Contingent liabilities;Financial crises;Financial crises;Risk management;Implicit guarantees, fiscal risks, financial crisis, budget reports, guarantees, debt, liabilities, Forecasts of Budgets, Deficits, and Debt,
    Date: 2015–09–28
  4. By: Grigoreva, Diana; Bobojonov, Ihtiyor; Aw-Hassan, Aden; Biradar, Chandrashekar; Nurbekov, Aziz
    Abstract: This study investigates suitable several indexes, as well as risk coping potential of index-based insurance in Central Asia. This study discusses the challenges of index selection for irrigated systems and compares the results with rainfed systems. For this purpose, suitability and impact of area-yield, irrigation water intake at regional level, as well as remote sensing based indexes are analyzed. The results of the study show that selection of index for the irrigated systems is more complex than rainfed systems and more caution is required in order to minimize the basis risk.
    Keywords: Risk management, crop insurance, weather Index-based insurance, climate risk, irrigation water, NDVI, crop yield, Central Asia, Agribusiness,
    Date: 2015
  5. By: Raczko, Marek (Bank of England)
    Abstract: This paper proposes a novel approach to assessing volatility contagion across equity markets. I decompose the variance risk premia of three major stock indices into: crash and non-crash risk components and analyse their cross-market correlations. I find that crash-risk premia exhibit higher correlations than non-crash risk premia, implying the existence of volatility contagion. This suggests that investors believe that equity returns will be more highly correlated across countries during market crashes than during more normal times. The main result of the analysis holds when I apply other measures of co-movement as well as when I allow correlation to be time varying. Moreover I document that crash-premia constitute a large portion of the overall variance risk premia, highlighting the importance of crash-risks. Unlike the existing literature, my approach to testing the existence of volatility contagion does not rely on short periods of financial distress, but allows for crash-risk premia to be computed in tranquil times.
    Keywords: Financial contagion; variance risk premium; tail-risk; equity co-movement; volatility co-movement
    JEL: C58 F36 G12 G13 G15
    Date: 2015–09–29
  6. By: Lingjiong Zhu
    Abstract: In a dual risk model, the premiums are considered as the costs and the claims are regarded as the profits. The surplus can be interpreted as the wealth of a venture capital, whose profits depend on research and development. In most of the existing literature of dual risk models, the profits follow the compound Poisson model and the cost is constant. In this paper, we develop a state-dependent dual risk model, in which the arrival rate of the profits and the costs depend on the current state of the wealth process. Ruin probabilities are obtained in closed-forms. Further properties and results will also be discussed.
    Date: 2015–10
  7. By: C. A. E. Goodhart; Miguel A. Segoviano Basurto
    Abstract: Banks’ living wills involve both recovery and resolution. Since it may not always be clear when recovery plans or actions should be triggered, there is a role for an objective metric to trigger recovery. We outline how such a metric could be constructed meeting criteria of (i) adequate loss absorption; (ii) distinguishing between weak and sound banks; (iii) little susceptibility to manipulation; (iv) timeliness; (v) scalable from the individual bank to the system. We show how this would have worked in the U.K., during 2007–11. This approach has the added advantage that it could be extended to encompass a whole ladder of sanctions of increasing severity as capital erodes.
    Keywords: Bank resolution;Banks;Bank supervision;Bank Recovery, Bank Resolution, Metrics for Triggers, Loss Absorption, Probability of Distress, Loan Default.
    Date: 2015–09–30
  8. By: Stéphane Goutte (LED - Université Vincennes Saint-Denis (Paris 8)); Amine Ismail (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UP7 - Université Paris Diderot - Paris 7 - CNRS); Huyên Pham (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UP7 - Université Paris Diderot - Paris 7 - CNRS, ENSAE Paris-Tech & CREST, Laboratoire de Finance et d'Assurance - ENSAE Paris-Tech & CREST)
    Abstract: We develop and implement a method for maximum likelihood estimation of a regime-switching stochastic volatility model. Our model uses a continuous time stochastic process for the stock dynamics with the instantaneous variance driven by a Cox-Ingersoll-Ross (CIR) process and each parameter modulated by a hidden Markov chain. We propose an extension of the EM algorithm through the Baum-Welch implementation to estimate our model and filter the hidden state of the Markov chain while using the VIX index to invert the latent volatility state. Using Monte Carlo simulations, we test the convergence of our algorithm and compare it with an approximate likelihood procedure where the volatility state is replaced by the VIX index. We found that our method is more accurate than the approximate procedure. Then, we apply Fourier methods to derive a semi-analytical expression of S&P 500 and VIX option prices, which we calibrate to market data. We show that the model is sufficiently rich to encapsulate important features of the joint dynamics of the stock and the volatility and to consistently fit option market prices.
    Keywords: EM algorithm,Regime-switching model, Stochastic volatility, VIX index, Baum-Welch algorithm.
    Date: 2015–10–06
  9. By: Aloisio Araujo (IMPA and EPGE/FGV - Rio de Janeiro); Laurence Jean-Marc Bonnisseau (Centre d'Economie de la Sorbonne - Paris School of Economics); Alain Chateauneuf (IPAG - Centre d'Economie de la Sorbonne - Paris School of Economics); Rodrigo Novinski (Faculdades Ibmec - Rio de Janeiro)
    Abstract: We prove that under mild conditions individually rational Pareto optima will exist even in presence of non-convex preferences. We consider decision makers dealing with a countable flow of payoffs or choosing among financial assets whose outcomes depend on the realization of a countable set of states of the world. Our conditions for the existence of Pareto optima can be interpreted as a requirement of impatience in the first context and of some pessimism or not unrealistic optimism in the second context. A non-existence example is provided when, in the second context, some decision maker is too optimistic. We furthermore show that at an individually rational Pareto optimum at most one strictly optimistic decision maker will avoid ruin at each state or date. Considering a risky context this entails that even is risk averters will share risk in a comonotonic way as usual, at most one classical strong risk lover will avoid ruin at each state or date. Finally some examples illustrate circumstances when a risk averter could take advantage of sharing risk with a risk lover rather than with a risk averter
    Keywords: Risk sharing; Pareto optimum; impatience; optimistic
    JEL: D80 D81
    Date: 2015–09
  10. By: Seira Enrique; Castellanos Pascacio Sara Gabriela; Jiménez Hernández Diego J.
    Abstract: We study the bancarization of marginal borrowers using credit cards and document that this process is difficult: default risk is substantial, returns heterogeneous, and account closings common. We also take advantage of a randomized control trial that varied interest rates and minimum payments in a very wide range. Against our hypothesis, we find that default risk is very insensitive to (randomized) large changes in interest rates and minimum payments. This could imply that regulating these contract terms may not necessarily "protect" consumers against default and that moral hazard in this market is negligible on average.
    Keywords: Credit cards; Development finance; Consumer behavior; Mexico.
    JEL: D14 D18 D82 G21
    Date: 2015–06
  11. By: Aldy, Joseph Edgar; Smyth, Seamus J
    Abstract: We develop a numerical life-cycle model - with choice over consumption and leisure, stochastic mortality and labor income processes, and calibrated to U.S. data - to characterize willingness to pay (WTP) for mortality risk reduction. Our theoretical framework can explain many empirical findings in this literature, including an inverted-U life-cycle WTP and an order of magnitude difference in prime-aged adults WTP. By endogenizing leisure and employing multiple income measures, we reconcile the literature's large variation in estimated income elasticities. By accounting for gender-and race-specific stochastic mortality and income processes,we explain the literature's black-white and female-male differences.
    Date: 2014
  12. By: Tao Sun
    Abstract: This paper analyzes the transmission of global liquidity to the ASEAN-5 countries (ASEAN-5), including the impact on financial landscapes and risks to financial stability. It finds that global liquidity transmission and changing financial landscapes have contributed to increases in risks to financial stability in ASEAN-5. Therefore, policymakers in ASEAN-5 should prepare for possible liquidity tightening, strengthen regulation of nonbanks, and establish a comprehensive financial stability framework. A number of couontries are well-advanced in this process.
    Keywords: Brunei Darussalam;Cambodia;Capital inflows;Association of Southeast Asian Nations;Cross country analysis;Financial risk;Malaysia;Myanmar;Nonbank financial sector;Financial stability;Indonesia;International liquidity;Vietnam;Shadow banking;Central banks and their policies;Global liquidity;Philippines;Singapore;Thailand;financial landscape, liquidity, debt, security, international debt security, International Lending and Debt Problems, financial stability.,
    Date: 2015–09–29

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