nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒10‒25
twenty papers chosen by

  1. Looking for efficient qml estimation of conditional value-at-risk at multiple risk levels By Francq, Christian; Zakoian, Jean-Michel
  2. Global standards for liquidity regulation By Liebmann, Eva; Peek, Joe
  3. Systemic risk of UCITS investment funds and financial market stability tested using MRS model By Jakša Krišto; Alen Stojanović; Hrvoje Filipović
  4. Credit risk characteristics of US small business portfolios By Bams, Dennis; Pisa, Magdalena; Wolff, Christian C
  5. Portfolio Optimization under Expected Shortfall: Contour Maps of Estimation Error By Fabio Caccioli; Imre Kondor; G\'abor Papp
  6. Portfolio choice and investor preferences : A semi-parametric approach based on risk horizon By Georges Hübner; Thomas Lejeune
  7. CAPITAL REGULATION IN A MACROECONOMIC MODEL WITH THREE LAYERS OF DEFAULT By Laurent Clerc; Alexis Derviz; Caterina Mendicino; Stéphane Moyen; Kalin Nikolov; Livio Stracca; Javier Suarez; Alexandros P. Vardoulakis
  8. Downside Variance Risk Premium By Bruno Feunou; Mohammad R. Jahan-Parvar; Cédric Okou
  9. ADBI WP543: Mortgage Lending and Financial Stability in Asia By Morgan, Peter; Zhang, Yan
  10. Ripple effects from industry defaults By Bams, Dennis; Pisa, Magdalena; Wolff, Christian C
  11. Optimal Investment in a Dual Risk Model By Arash Fahim; Lingjiong Zhu
  12. Living in a Stochastic World and Managing Complex Risks By Dacorogna, Michel M; Kratz, Marie
  13. A Supermartingale Relation for Multivariate Risk Measures By Zachary Feinstein; Birgit Rudloff
  14. Bank Insolvencies, Priority Claims and Systemic Risk By Spiros Bougheas; Alan Kirman
  15. Bankers' pay and excessive risk By Thanassoulis, John; Tanaka, Misa
  16. Leverage and risk in US commercial banking in the light of the current financial crisis By Papanikolaou, Nikolaos I.; Wolff, Christian C
  17. Credit Risk and Interdealer Networks By Or Shachar; Jennifer La'O; Anna Costello; Nina Boyarchenko
  18. Shock Transmission Through International Banks: Canada By James Chapman; H. Evren Damar
  19. Does variance risk have two prices? Evidence from the equity and option markets By Laurent Barras; Aytek Malkhozov
  20. On the Welfare Cost of Rare Housing Disasters By Shaofeng Xu

  1. By: Francq, Christian; Zakoian, Jean-Michel
    Abstract: We consider joint estimation of conditional Value-at-Risk (VaR) at several levels, in the framework of general GARCH-type models. The conditional VaR at level $\alpha$ is expressed as the product of the volatility and the opposite of the $\alpha$-quantile of the innovation. A standard method is to estimate the volatility parameter by Gaussian Quasi-Maximum Likelihood (QML) in a first step, and to use the residuals for estimating the innovations quantiles in a second step. We argue that the Gaussian QML may be inefficient with respect to more general QML and can even be in failure for heavy tailed conditional distributions. We therefore study, for a vector of risk levels, a two-step procedure based on a generalized QML. For a portfolio of VaR's at different levels, confidence intervals accounting for both market and estimation risks are deduced. An empirical study based on stock indices illustrates the theoretical results.
    Keywords: Asymmetric Power GARCH; Distortion Risk Measures; Estimation risk; Non-Gaussian Quasi-Maximum Likelihood; Value-at-Risk
    JEL: C13 C22 C58
    Date: 2015–10
  2. By: Liebmann, Eva (Austrian Federal Ministry of Finance); Peek, Joe (Federal Reserve Bank of Boston)
    Abstract: Liquidity risk has received increased attention recently, especially in light of the 2007 - 2009 financial crisis, when banks' extensive reliance on short-term funding, maturity mismatches between assets and liabilities, and insufficient liquidity buffers made them quite susceptible to liquidity risk. To mitigate such risk, the Basel Committee on Banking Supervision (BCBS) introduced an improved global capital framework and new global liquidity standards for banks in December 2010 in the form of the new Basel Accord (Basel III). This brief offers insights from the crisis experience, identifies the problems that the new liquidity regulation aims to address, and summarizes underlying differences between the United States and Europe that may affect the ability to design and implement consistent global standards.
    JEL: F33 G01 G28
    Date: 2015–07–01
  3. By: Jakša Krišto (Faculty of Economics and Business, University of Zagreb); Alen Stojanović (Faculty of Economics and Business, University of Zagreb); Hrvoje Filipović (European Actuarial Services, Erst & Young Financial-Business Advisors SpA)
    Abstract: Systemic risk came into attention in the period of recent financial crisis. Importance of financial intermediation of investment funds is posing to a systemic influence of this sector to a stability of a financial market and therefore whole financial sector. This was proven through investment behavior, fire sales and net outflows from investment funds during the financial crisis. The article is testing systemic risk of whole range of different UCITS investment funds and behavior of these institutions as well as influence on financial market stability. Methodology is based on Markov regime switching model. A conclusion in this article proves existence of systemic risk in returns of analyzed UCITS investment funds and their strong systemic interconnections with returns and volatility on a financial market. Different investment strategy and type of UCITS investment fund shows no resistance to systemic risk according to this research.
    Keywords: systemic risk, UCITS investment funds, financial stability, interconnectedness, Markov regime switching model
    JEL: G23 G15 G01 C58
    Date: 2015–10–20
  4. By: Bams, Dennis; Pisa, Magdalena; Wolff, Christian C
    Abstract: This paper addresses issues related to industry heterogeneity, default clustering and parameter uncertainty of capital requirements in US retail loan portfolios. Using a multi-factor model of credit risk, we show that the Basel II capital requirements overstate the riskiness of small businesses. Retail exposures are a much safer investment than the regulator would suggest. We find that sensitivity to the common risk factors is low and that small business risk is predominantly a reflection of idiosyncratic risk. Our results show that only 0.00-3.39% of the asset variability is explained by economy-wide risk factors. The remaining 96.61%-100.00% of small business risk is due to changes in the firm-specific characteristics. Moreover, both expected and unexpected losses are time dependent. Their shifts over the course of financial crisis cause uncertainty in the provisions level and capital requirements. Importantly, our estimates of asset correlations are significantly lower than any available estimates for corporate firms. Our results are based on a new, representative dataset of US retail businesses from 2005 to 2011 and give fundamental insights into the US economy.
    Keywords: capital requirements
    JEL: G17 L14 L25
    Date: 2015–10
  5. By: Fabio Caccioli; Imre Kondor; G\'abor Papp
    Abstract: The contour maps of the error of historical resp. parametric estimates for large random portfolios optimized under the risk measure Expected Shortfall (ES) are constructed. Similar maps for the sensitivity of the portfolio weights to small changes in the returns as well as the VaR of the ES-optimized portfolio are also presented, along with results for the distribution of portfolio weights over the random samples and for the out-of-sample and in-the-sample estimates for ES. The contour maps allow one to quantitatively determine the sample size (the length of the time series) required by the optimization for a given number of different assets in the portfolio, at a given confidence level and a given level of relative estimation error. The necessary sample sizes invariably turn out to be unrealistically large for any reasonable choice of the number of assets and the confidence level. These results are obtained via analytical calculations based on methods borrowed from the statistical physics of random systems, supported by numerical simulations.
    Date: 2015–10
  6. By: Georges Hübner (Deloitte Chaired Professor of Portfolio Management and Performance, HEC Management School - University of Liège, Rue Louvrex 14 - N1, B-4000 Liège, Belgium); Thomas Lejeune (Research Department, NBB)
    Abstract: The paper proposes an innovative framework for characterizing investors' behavior in portfolio selection. The approach is based on the realistic perspective of unknown investors' utility and incomplete information on returns distribution. Using a four-moment generalization of the Chebyshev inequality, an intuitive risk measure, risk horizon, is introduced with reference to the speed of convergence of a portfolio's mean return to its expectation. Empirical implementation provides evidence on the consistency of the approach with standard portfolio criteria such as, among others, the Sharpe ratio, a shortfall probability decay-rate optimization and a general class of flexible three-parameter utility functions.
    Keywords: Portfolio choice, risk-return trade-off, horizon
    JEL: G11 G12 C14
    Date: 2015–10
  7. By: Laurent Clerc (Banque de France); Alexis Derviz (Czech National Bank); Caterina Mendicino (Banco de Portugal); Stéphane Moyen (Deutsch Bundesbank); Kalin Nikolov (European Central Bank); Livio Stracca (European Central Bank); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros); Alexandros P. Vardoulakis (Board of Governors of the Federal Reserve System)
    Abstract: We develop a dynamic general equilibrium model for the positive and normative analysis of macroprudential policies. Optimizing financial intermediaries allocate their scarce net worth together with funds raised from saving households across two lending activities, mortgage and corporate lending. For all borrowers (households, firms, and banks) 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 that cause financial amplification and the distortions due to deposit insurance. We apply it to the analysis of capital regulation.
    Keywords: Default risk, financial frictions, macroprudential policy.
    JEL: E3 E44 G01 G21
    Date: 2014–12
  8. By: Bruno Feunou; Mohammad R. Jahan-Parvar; Cédric Okou
    Abstract: We decompose the variance risk premium into upside and downside variance risk premia. These components reflect market compensation for changes in good and bad uncertainties. Their difference is a measure of the skewness risk premium (SRP), which captures asymmetric views on favorable versus undesirable risks. Empirically, we establish that the downside variance risk premium (DVRP) is the main component of the variance risk premium. We find a positive and significant link between the DVRP and the equity premium, and a negative and significant relation between the SRP and the equity premium. A simple equilibrium consumption-based asset pricing model supports our decomposition.
    Keywords: Asset pricing
    JEL: G G1 G12
    Date: 2015
  9. By: Morgan, Peter (Asian Development Bank Institute); Zhang, Yan (Asian Development Bank Institute)
    Abstract: This paper presents estimates of the effect of the share of mortgage lending by individual banks on two measures of financial stability—the bank Z-score and the nonperforming loan ratio. The sample covers 212 banks in 19 emerging Asian economies for 2007–2013 from the Bankscope database. The findings suggest that mortgage lending is positive for financial stability, specifically by lowering the probability of default by financial institutions and reducing the nonperforming loan ratio, at least in noncrisis periods, for levels of mortgage shares up to 30%–40%. For higher levels of mortgage lending shares, the impact on financial stability turns negative. Mortgage lending can also be a useful measure of both financial development and financial inclusion.
    Keywords: financial stability; mortgage loan ratio; mortgage lending
    JEL: G21 O16 R30
    Date: 2015–10–21
  10. By: Bams, Dennis; Pisa, Magdalena; Wolff, Christian C
    Abstract: This paper studies early default risk spillovers to small businesses. This study shows that default rates among small businesses are significantly higher following default on S&P rated debt in their or their customers' industries. Using a new data set on S&P rated debt default, small business default, production process linkages and industry characteristics, we find evidence of negative wealth effects transmitted to small businesses along the production process. Also, such ripple effects are mitigated in loan portfolios that are concentrated into large and highly interconnected industries. We observe that a large number of firms in an industry serves to cushion default risk transmission. This is much like how the broad economic connections other the benefits of diversification.
    Keywords: default clustering; default risk transmission; market structure; supply chain
    JEL: G17 L14 L25
    Date: 2015–10
  11. By: Arash Fahim; Lingjiong Zhu
    Abstract: Dual risk models are popular for modeling a venture capital or high tech company, for which the running cost is deterministic and the profits arrive stochastically over time. Most of the existing literature on dual risk models concentrated on the optimal dividend strategies. In this paper, we propose to study the optimal investment strategy on research and development for the dual risk models to minimize the ruin probability of the underlying company. We will also study the optimization problem when in addition the investment in a risky asset is allowed.
    Date: 2015–10
  12. By: Dacorogna, Michel M; Kratz, Marie
    Abstract: In this paper, we review the concept of risk, its evolution in history and the big changes we experienced in the last 50 years. We conclude that peak risks are growing and the need for risk management is becoming a societal demand. Two phenomena are identified to render risks more complex, increasing interconnectedness of the world and faster time scale whereby actors have little time to adapt. We conclude in showing the complementary between qualitative and quantitative risk management.
    Keywords: complexity, crisis, extreme risk, fertility, life expectancy, resilience, risk management, (industrial, financial) risk, scientific approach, societal demand, uncertainty, urbanization
    JEL: A10 Y2
    Date: 2015–07–25
  13. By: Zachary Feinstein; Birgit Rudloff
    Abstract: The equivalence between multiportfolio time consistency of a dynamic multivariate risk measure and a supermartingale property is proven. Furthermore, the dual variables under which this set-valued supermartingale is a martingale are characterized as the worst-case dual variables in the dual representation of the risk measure. Examples of multivariate risk measures satisfying the supermartingale property are given.
    Date: 2015–10
  14. By: Spiros Bougheas; Alan Kirman
    Abstract: We review an extensive literature debating the merits of alternative priority structures for banking liabilities put forward by financial economists, legal scholars and policymakers. This work has focused exclusively on the relative advantages of each group of creditors to monitor the activities of bankers. We argue that systemic risk is another dimension that this discussion must include.
    Date: 2015
  15. By: Thanassoulis, John (Bank of England); Tanaka, Misa (Bank of England)
    Abstract: This paper studies the agency problem between bank management, shareholders, and the taxpayer. Executive bonuses increase in the probability the bank is too big to fail. Bank management recognise it is very likely optimal to select risky projects which exploit the taxpayer, implying project selection effort (eg due diligence) is more expensive to incentivise. This agency problem leads to too much risk for society, not for shareholders. Compensation rules aimed at solving management-shareholder agency problems — equity pay, deferred, including debt — do not correct the excessive risk taking. By contrast, malus and clawbacks can incentivise the bank management to make better risk choices.
    Keywords: Executive compensation; bankers bonuses; risk-taking; financial regulation; return on equity; clawback; deferral
    JEL: G21 G28 G32 G38
    Date: 2015–10–14
  16. By: Papanikolaou, Nikolaos I.; Wolff, Christian C
    Abstract: In this paper we study the relationship between leverage and risk in commercial banking market. We employ a panel data set that consists of the biggest US commercial banks and which extends from 2002 to 2010 thus covering both the years before the outbreak of the current financial crisis as well as those followed. We make clear distinctions among different leverage types like on- and off-balance sheet leverage as well as short- and long-term leverage, which have never been made in the relevant literature. Our findings provide evidence that excessive leverage, both explicit and hidden off-the-balance sheet, rendered large banks vulnerable to financial shocks thus contributing to the fragility of the whole banking industry. In a similar vein, a direct link between short- and long-term leverage with risk is reported before the crisis, showing that leverage has been one of the key factors responsible for the serious liquidity shortages that were revealed after 2007 when the crisis erupted. We also demonstrate that banks which concentrate on traditional banking activities typically carry less risk exposure than those that are involved with modern financial instruments. Overall, our results provide a better understanding of the role of leverage in destabilizing the whole system whereas at the same time contribute to the current discussion on the resilience of the banking sector through the strengthening of the existing regulatory framework.
    Keywords: commercial banking; financial crisis; leverage; risk
    JEL: C23 D02 G21 G28
    Date: 2015–10
  17. By: Or Shachar (Federal Reserve Bank of New York); Jennifer La'O (Columbia University); Anna Costello (Massachusetts Institute of Technology); Nina Boyarchenko (Federal Reserve Bank of New York)
    Abstract: We study how bank holding companies interact in the corporate bond, syndicated loan, and credit default swap (CDS) markets. These three markets represent different ways to trade credit risk. The corporate bond market allows market participants to trade corporate credit risk directly. Similarly, the syndicated loan market allows direct exposure to corporate credit risk but is limited to only the largest borrowers and has lower secondary market liquidity. Finally, participants in the CDS market take an indirect exposure to the ultimate borrower. CDS markets are the most liquid of the three markets, allowing dealers to more easily assume long and short positions. Moreover, by entering into a CDS contract with another dealer, the firm also exposes itself to counterparty risk. This paper links data from these three different markets to create a more complete picture of how dealers assume and distribute credit risk. We identify key determinants of dealers' net and gross exposures to credit risk. We furthermore map out the interdealer network structures in these markets, allowing us to study how these network structures distribute risk among the dealers and how they shape the total risk borne by the system.
    Date: 2015
  18. By: James Chapman; H. Evren Damar
    Abstract: In this paper, we investigate how liquidity conditions in Canada may affect domestic and/or foreign lending of globally active banks and whether this transmission is influenced by individual bank characteristics. We find that Canadian banks expanded their foreign lending during the recent financial crisis, often through acquisitions of foreign banks. We also find evidence that internal capital markets play a role in the lending activities of globally active Canadian banks during times of heightened liquidity risk.
    Keywords: Financial institutions; Financial stability
    JEL: E44 F36 G21 G32
    Date: 2015
  19. By: Laurent Barras; Aytek Malkhozov
    Abstract: We formally compare two versions of the market Variance Risk Premium (VRP) measured in the equity and option markets. Both VRPs follow common patterns and respond similarly to changes in volatility and economic conditions. However, we reject the null hypothesis that they are identical and find that their difference is strongly related to measures of the financial standing of intermediaries. These results shed new light on the information content of the VRP, suggest the presence of market frictions between the two markets, and are consistent with the key role played by intermediaries in setting option prices.
    Keywords: variance risk premium, option, equity, financial intermediaries
    Date: 2015–10
  20. By: Shaofeng Xu
    Abstract: This paper examines the welfare cost of rare housing disasters characterized by large drops in house prices. I construct an overlapping generations general equilibrium model with recursive preferences and housing disaster shocks. The likelihood and magnitude of housing disasters are inferred from historic housing market experiences in the OECD. The model shows that despite the rarity of housing disasters, Canadian households would willingly give up 5 percent of their non-housing consumption each year to eliminate the housing disaster risk. The evaluation of this risk, however, varies considerably across age groups, with a welfare cost as high as 10 percent of annual non-housing consumption for the old, but near zero for the young. This asymmetry stems from the fact that, compared to the old, younger households suffer less from house price declines in disaster periods, due to smaller holdings of housing assets, and benefit from lower house prices in normal periods, due to the negative price effect of disaster risk.
    Keywords: Asset Pricing, Economic models, Housing
    JEL: E21 E44 G11 R21
    Date: 2015

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