nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒01‒03
seven papers chosen by

  1. Choosing Expected Shortfall over VaR in Basel III Using Stochastic Dominance By Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Esfandiar Maasoumi; Michel McAleer; Teodosio Pérez-Amaral
  2. Longevity Risk Transfer activities by European insurers and pension funds By Patty Duijm
  3. Insurance activities and systemic risk By Berdin, Elia; Sottocornolay, Matteo
  4. On the Fractal Geometry of the Balance Sheet and the Fractal Index of Insolvency Risk By A. K. M. Azhar; Vincent B. Y. Gan; W. A. T. Wan Abdullah; H. Zainuddin
  5. MERCURE : A Macroprudential Stress Testing Model developed at the ACPR By B. Camara; F.-D. Castellani; H. Fraisse; L. Frey; C. Héam; L. Labonne; V. Martin
  6. The Ethics of Intergenerational Risk By Piacquadio, Paolo G.
  7. Assessing Internal Controls among Insurance companies in Ghana By Amponsah, Stephen; Adu, Kofi Osei; Amissah, Anthony

  1. By: Chia-Lin Chang (National Chung Hsing University, Taichung, Taiwan); Juan-Ángel Jiménez-Martín (Complutense University of Madrid, Spain); Esfandiar Maasoumi (Emory University, USA); Michel McAleer (National TsingHua University, Taiwan; Erasmus School of Economics, Erasmus University Rotterdam, and Tinbergen Institute, the Netherlands; Complutense University of Madrid, Spain); Teodosio Pérez-Amaral (Complutense University of Madrid, Spain)
    Abstract: Bank risk managers follow the Basel Committee on Banking Supervision (BCBS) recommendations that recently proposed shifting the quantitative risk metrics system from Value-at-Risk (VaR) to Expected Shortfall (ES). The Basel Committee on Banking Supervision (2013, p. 3) noted that: “a number of weaknesses have been identified with using VaR for determining regulatory capital requirements, including its inability to capture tail risk”. The proposed reform costs and impact on bank balances may be substantial, such that the size and distribution of daily capital charges under the new rules could be affected significantly. Regulators and bank risk managers agree that all else being equal, a “better” distribution of daily capital charges is to be preferred. The distribution of daily capital charges depends generally on two sets of factors: (1) the risk function that is adopted (ES versus VaR); and (2) their estimated counterparts. The latter is dependent on what models are used by bank risk managers to provide for forecasts of daily capital charges. That is to say, while ES is known to be a preferable “risk function” based on its fundamental properties and greater accounting for the tails of alternative distributions, that same sensitivity to tails can lead to greater daily capital charges, which is the relevant (that is, controlling) practical reference for risk management decisions and observations. In view of the generally agreed focus in this field on the tails of non-standard distributions and low probability outcomes, an assessment of relative merits of estimated ES and estimated VaR is ideally not limited to mean variance considerations. For this reason, robust comparisons between ES and VaR will be achieved in the paper by using a Stochastic Dominance (SD) approach to rank ES and VaR.
    Keywords: Stochastic dominance; Value-at-Risk; Expected Shortfall; Optimizing strategy; Basel III Accord
    JEL: G32 G11 G17 C53 C22
    Date: 2015–12–15
  2. By: Patty Duijm
    Abstract: Longevity risk, the risk that people live longer than expected, can have 7 a significant financial effect on pension funds and insurance companies. To manage this risk, these parties can transfer such risks to other parties, such as (re)insurers, investment banks and capital markets. In this study, Longevity Risk Transfer (LRT) activities are defined as those activities where financial instruments are used to transfer longevity risk to third parties. This study presents the initial results of a survey on LRT activities by European insurance companies and pension funds and aims to better understand the developments in this market and the related risks. In total, 26 countries participated in this questionnaire. The outcomes show that the market for LRT products has grown rapidly, but is still concentrated in just a few countries. LRT activities are most developed in countries with private Defined Benefit (DB) pension schemes. Countries that mainly have state pensions have less LRT activities as governments do not tend to transfer longevity risk in this manner. From a policy perspective, attention should be given to where the longevity risk is transferred to. Especially in a growing market monitoring of the holders of longevity risk is important as (i) LRT deals between banks, (re)insurers etc. could lead to increased interconnectedness and hence to more contagion during times of stress and; (ii) further growth in the market for LRT instruments could lead to a build-up of large tail risk exposure (e.g. in case of a cure for cancer).
    Date: 2015–10
  3. By: Berdin, Elia; Sottocornolay, Matteo
    Abstract: This paper investigates systemic risk in the insurance industry. We first analyze the systemic contribution of the insurance industry vis-a-vis other industries by applying 3 measures, namely the linear Granger causality test, conditional value at risk and marginal expected shortfall, on 3 groups, namely banks, insurers and non-financial companies listed in Europe over the last 14 years. We then analyze the determinants of the systemic risk contribution within the insurance industry by using balance sheet level data in a broader sample. Our evidence suggests that i) the insurance industry shows a persistent systemic relevance over time and plays a subordinate role in causing systemic risk compared to banks, and that ii) within the industry, those insurers which engage more in non-insurance-related activities tend to pose more systemic risk. In addition, we are among the first to provide empirical evidence on the role of diversification as potential determinant of systemic risk in the insurance industry. Finally, we confirm that size is also a significant driver of systemic risk, whereas price-to-book ratio and leverage display counterintuitive results.
    Keywords: Systemic Risk,Insurance Activities,Systemically Important Financial Institutions
    JEL: G01 G22 G28 G32
    Date: 2015
  4. By: A. K. M. Azhar; Vincent B. Y. Gan; W. A. T. Wan Abdullah; H. Zainuddin
    Abstract: This paper reviews the economic and theoretical foundations of insolvency risk measurement and capital adequacy rules. The proposed new measure of insolvency risk is constructed by disentangling assets, debt and equity at the micro-prudential firm level. This new risk index is the Firm Insolvency Risk Index (FIRI) which is symmetrical, proportional and scale invariant. We demonstrate that the balance sheet can be shown to evolve with a fractal pattern. As such we construct a fractal index that can measure the risk of assets. This index can differentiate between the similarity and dissimilarity in asset risk, and it will also possess the properties of being self-similar and invariant to firm characteristics that make up its asset composition hence invariant to all types of risk derived from assets. Self-similarity and scale invariance across the cross section allows direct comparison of degrees of risk in assets. This is by comparing the risk dissimilarity of assets. Being naturally bounded to its highest upper bound, (0,2], the fractal index is able to serve like a risk thermometer. We assign geometric probabilities of insolvency P (equity is equal or less than 0 conditional on debt being greater than 0).
    Date: 2015–12
  5. By: B. Camara; F.-D. Castellani; H. Fraisse; L. Frey; C. Héam; L. Labonne; V. Martin
    Abstract: The French Supervisory Authority got involved into macro stress testing exercises stress since the first Financial Stability Assessment Program (“FSAP”) led by the IMF in France in 2004. Along “bottom up” exercises led at the national or international level, the ACPR has developed a “top down” stress testing model. This model was primarily focused on credit risks. Over the years, its risk coverage has substantially been extended and this article provides an update. Some risks make explicitly part of a dedicated analysis –for example the risks related to banks’ retail activities. More attention is now given to contagion effects, sectorial shocks and concentration risks. Financial institutions other than banks are considered. More granular data allow for a more refined analysis.
    Keywords: Stress Testing, Systemic Risk, Macroprudential Policy.
    JEL: G21 G28
    Date: 2015
  6. By: Piacquadio, Paolo G. (Dept. of Economics, University of Oslo)
    Abstract: The paper reexamines the ethics of intergenerational risk. When risk resolves gradually, earlier decisions cannot depend on the realization of later shocks and, consequently, some inequalities across generations are inevitable. To account for these inequalities, risky intergenerational situations are assessed in relation to an endogenous reference. The reference is specific to each intergenerational resource distribution problem and captures information about the technology, the intensity of risk, and the way risk resolves over time. The characterized class of reference-dependent utilitarian criteria avoids serious drawbacks of existing alternatives, such as discounted expected utilitarianism. Specifically, the welfare criteria: (i) disentangle aversion to intergenerational inequality from aversion to risk; (ii) value an early resolution of risk; and (iii) discount the future based on the intensity and the time-resolution of risk.
    Keywords: Intergenerational justice; risk; social ordering; discounting
    JEL: D63 D81 H43 Q54 Q56
    Date: 2015–08–07
  7. By: Amponsah, Stephen; Adu, Kofi Osei; Amissah, Anthony
    Abstract: This study assessed the internal controls system in the insurance companies in Ghana. Data were collected from internal auditors in the insurance industry in Ghana and in total, 91 questionnaires were successfully administered. The study employed multivariate analysis of variance (MANOVA) as the analytical tool.There was a statistically significant difference among categories of insurance companies on the combined dependent variables (internal control variables-Control Activities, Monitoring, Information and Communication, Control Environment, and Risk Analysis). When the results for the dependent variables were considered separately, the variables that contributed to the statistical significance are the Control Activities, Monitoring, Control Environment and Risk Analysis.The study recommended that National Insurance Commission should organise seminar on effective implementation of internal controls for the insurance companies in Ghana with much focus on brokerage reinsurance, reinsurance and lost adjusters companies.
    Keywords: Internal Control Variables, Categories of insurance companies and MANOVA
    JEL: M1 M2
    Date: 2015–12–25

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NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.