nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒03‒06
fifteen papers chosen by

  1. Uncertainty in historical Value-at-Risk: an alternative quantile-based risk measure By Dominique Guegan; Bertrand K. Hassani; Kehan Li
  2. Explicit diversification benefit for dependent risks By Michel Dacorogna; Laila Elbahtouri; Marie Kratz
  3. Econometric Analysis of Financial Derivatives By Chang, C-L.; McAleer, M.J.
  4. Portfolio optimization under expected shortfall: contour maps of estimation error By Fabio Caccioli; Imre Kondor; Gábor Papp
  5. Financial Stability Paper No 29: An investigation into the procyclicality of risk-based initial margin models By Murphy, David; Vasios, Michalis; Vause, Nick
  6. Higher Bank Capital Requirements and Mortgage Pricing: Evidence from the Countercyclical Capital Buffer (CCB) By Basten, Christhoph; Koch, Cathérine
  7. Basel III capital surcharges for G-SIBs fail to control systemic risk and can cause pro-cyclical side effects By Sebastian Poledna; Olaf Bochmann; Stefan Thurner
  8. More Accurate Measurement for Enhanced Controls: VaR vs ES? By Dominique Guegan; Bertrand K. Hassani
  9. Information Disclosures, Default Risk, and Bank Value By Zer, Ilknur
  10. Use of maximum entropy in estimating production risks in crop farms By Kevorchian, Cristian; Gavrilescu, Camelia
  11. Forecasting with VAR Models: Fat Tails and Stochastic Volatility By Ching-Wai (Jeremy) Chiu; Haroon Mumtaz; Gabor Pinter
  12. The Lehman Brothers Bankruptcy A: Overview By Rosalind Z. Wiggins; Thomas Piontek; Andrew Metrick
  13. Foreign vs Domestic Acquisitions on Financial Risk Reduction By Vassiliki Bamiatzi; Georgios Efthyvoulo; Liza Jabbour
  14. Covenant as an instrument of financial risk management By Kondratjev, Alexey
  15. Risk of Monetary Gambles: An Axiomatic Approach By Tomer Siedner

  1. By: Dominique Guegan (Centre d'Economie de la Sorbonne); Bertrand K. Hassani (Grupo Santander et Centre d'Economie de la Sorbonne); Kehan Li (Centre d'Economie de la Sorbonne)
    Abstract: The financial industry has extensively used quantile-based risk measures relying on the Value-at-Risk (VaR). They need to be estimated from relevant historical data set. Consequently, they contain uncertainty. We propose an alternative quantile-based risk measure (the Spectral Stress VaR) to capture the uncertainty in the historical VaR approach. This one provides flexibility to the risk manager to implement prudential regulatory framework. It can be a VaR based stressed risk measure. In the end we propose a stress testing application for it
    Keywords: Historical method; Uncertainty; Value-at-Risk; Stress risk measure; Tail risk measure; Prudential financial regulation; Stress testing
    JEL: G28 G32 C14
    Date: 2016–01
  2. By: Michel Dacorogna (SCOR SE - SCOR SE); Laila Elbahtouri (SCOR SE - SCOR SE); Marie Kratz (SID - Information Systems, Decision Sciences and Statistics Department - Essec Business School)
    Abstract: We propose a new approach to analyse the effect of diversification on a portfolio of risks. By means of mixing techniques, we provide an explicit formula for the probability density function of the portfolio. These techniques allow to compute analytically risk measures as VaR or TVaR, and consequently the associated diversification benefit. The explicit formulas constitute ideal tools to analyse the properties of risk measures and diversification benefit. We use standard models, which are popular in the reinsurance industry, Archimedean survival copulas and heavy tailed marginals. We explore numerically their behavior and compare them to the aggregation of independent random variables, as well as of linearly dependent ones. Moreover, the numerical convergence of Monte Carlo simulations of various quantities is tested against the analytical result. The speed of convergence appears to depend on the fatness of the tail; the higher the tail index, the faster the convergence.
    Keywords: Weibull,Aggregation of risks, Archimedean copula, Clayton, Diversification (benefit), Gaussian, Gumbel, Heavy tail, Mixing technique, Pareto, Risk measure, TVaR, VaR
    Date: 2015–12
  3. By: Chang, C-L.; McAleer, M.J.
    Abstract: __Abstract__ One of the fastest growing areas in empirical finance, and also one of the least rigorously analyzed, especially from a financial econometrics perspective, is the econometric analysis of financial derivatives, which are typically complicated and difficult to analyze. The purpose of this special issue of the journal on “Econometric Analysis of Financial Derivatives” is to highlight several areas of research by leading academics in which novel econometric, financial econometric, mathematical finance and empirical finance methods have contributed significantly to the econometric analysis of financial derivatives, including market-based estimation of stochastic volatility models, the fine structure of equity-index option dynamics, leverage and feedback effects in multifactor Wishart stochastic volatility for option pricing, option pricing with non-Gaussian scaling and infinite-state switching volatility, stock return and cash flow predictability: the role of volatility risk, the long and the short of the risk-return trade-off, What’s beneath the surface? option pricing with multifrequency latent states, bootstrap score tests for fractional integration in heteroskedastic ARFIMA models, with an application to price dynamics in commodity spot and futures markets, a stochastic dominance approach to financial risk management strategies, empirical evidence on the importance of aggregation, asymmetry, and jumps for volatility prediction, non-linear dynamic model of the variance risk premium, pricing with finite dimensional dependence, quanto option pricing in the presence of fat tails and asymmetric dependence, smile from the past: a general option pricing framework with multiple volatility and leverage components, COMFORT: A common market factor non-Gaussian returns model, divided governments and futures prices, and model-based pricing for financial derivatives
    Keywords: Stochastic volatility, switching volatility, volatility risk, option pricing, dynamics, futures prices, fractional integration, stochastic dominance, variance risk, premium, fat tails, leverage and asymmetry, divided governments.
    JEL: C50 C58 G23 G32
    Date: 2014–12–01
  4. By: Fabio Caccioli; Imre Kondor; Gábor 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 confi dence level. These results are obtained via analytical calculations based on methods borrowed from the statistical physics of random systems, supported by numerical simulations.
    JEL: G32 F3 G3
    Date: 2015–11
  5. By: Murphy, David (Bank of England); Vasios, Michalis (Bank of England); Vause, Nick (Bank of England)
    Abstract: The initial margin requirements for a portfolio of derivatives are typically calculated using a risk model. Common risk models are procyclical: margin requirements for the same portfolio are higher in times of market stress and lower in calm markets. This procyclicality can cause liquidity stress whereby parties posting margin have to find additional liquid assets, often at just the times when it is most difficult for them to do so. Hence regulation has recognised that, subject to being adequately risk sensitive, margin models should not be ‘overly’ procyclical. There is, however, no standard definition of procyclicality. This paper proposes two types of quantitative measure of procyclicality: one that examines margin variation across the cycle and one that focuses on short-term margin increases. It then studies, using historical and simulated data, various margin models with regard to both their risk sensitivity and the proposed procyclicality measures. It finds that models which pass common risk sensitivity tests can have very different levels of procyclicality. The paper recommends that CCPs and major dealers should disclose the procyclicality properties of their margin models, perhaps by reporting the proposed procyclicality measures. This would help derivatives users to anticipate potential margin calls and ensure they have adequate holdings of or access to liquid assets.
    Keywords: derivatives; financial regulation
    JEL: G15 G28
    Date: 2014–05–16
  6. By: Basten, Christhoph; Koch, Cathérine
    Abstract: We examine how the CCB affects mortgage pricing after Switzerland was first to activate this macroprudential tool of Basel III. Observing multiple offers per request, we obtain three core findings. First, the CCB changes the composition of mortgage supply, as capital-constrained and mortgage-specialized banks raise prices relatively more. Second, risk-weighting schemes do not amplify the CCB effect. Third, CCB-subjected banks and CCB-exempt insurers both raise mortgage rates. To conclude, changes in the supply composition hint at the CCB’s success in shifting mortgages from less to more resilient banks, but stricter capital requirements do not discourage banks from risky mortgage lending.
    Keywords: macroprudential policy, capital requirement, mortgage pricing
    JEL: G21 E51
    Date: 2015–06
  7. By: Sebastian Poledna; Olaf Bochmann; Stefan Thurner
    Abstract: In addition to constraining bilateral exposures of financial institutions, there are essentially two options for future financial regulation of systemic risk (SR): First, financial regulation could attempt to reduce the financial fragility of global or domestic systemically important financial institutions (G-SIBs or D-SIBs), as for instance proposed in Basel III. Second, future financial regulation could attempt strengthening the financial system as a whole. This can be achieved by re-shaping the topology of financial networks. We use an agent-based model (ABM) of a financial system and the real economy to study and compare the consequences of these two options. By conducting three "computer experiments" with the ABM we find that re-shaping financial networks is more effective and efficient than reducing leverage. Capital surcharges for G-SIBs can reduce SR, but must be larger than those specified in Basel III in order to have a measurable impact. This can cause a loss of efficiency. Basel III capital surcharges for G-SIBs can have pro-cyclical side effects.
    Date: 2016–02
  8. By: Dominique Guegan (Centre d'Economie de la Sorbonne); Bertrand K. Hassani (Grupo Santander et Centre d'Economie de la Sorbonne)
    Abstract: This paper analyses how risks are measured in financial institutions, for instance Market, Credit, Operational, etc with respect to the choice of the risk measures, the choice of the distributions used to model them and the level of confidence selected. We discuss and illustrate the characteristics, the paradoxes and the issues observed comparing the Value-at-Risk and the Expected Shortfall in practice. This paper is built as a differential diagnosis and aims at discussing the reliability of the risk measures as long as making some recommendations
    Keywords: Risk measures; Marginal distributions; Level of confidence; Capital requirement
    JEL: G28 G32 C14
    Date: 2016–02
  9. By: Zer, Ilknur (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper investigates the causal effects of voluntary information disclosures on a bank's expected default probability, enterprise risk, and value. I measure disclosure via a self-constructed index for the largest 80 U.S. bank holding companies for the period 1998-2011. I provide evidence that a bank's management responds to a plausibly exogenous deterioration in the supply of public information by increasing its voluntary disclosure, which in turn improves investors' assessment of the bank risk and value. This evidence suggests that disclosure may alleviate informational frictions and lead to a more efficient allocation of risk and return.
    Keywords: Disclosure; default probability; firm value; risk management; asymmetric information; corporate governance
    Date: 2015–11–17
  10. By: Kevorchian, Cristian; Gavrilescu, Camelia
    Abstract: The entropic value of the production risk is closely linked to the farmer’s aversion to this type of risk. Since risk aversion is difficult to quantify, it is preferable to use the MaxEnt model as a quantitative benchmark in assessing and covering the production risk through adequate financial resources. The classification of the Selyaninov index value as measure of the production risk based on the MaxEnt model utilization makes it possible to evaluate the production risk and the transfer decision to an adequate market implicitly. The authors’ previous research investigated the risk coverage through derivative financial instruments that diminish the farmer’s exposure to the production risk; the present paper adds to previous research by investigating an equally important issue: sizing the risk that is the object of coverage. Through the utilization of the stochastic methods in estimating the risk measure, a less rigid method is obtained that can be adapted and applied to the risk management processes in agriculture.
    Keywords: Production risk, crop farms, Markov models, MaxEnt
    JEL: C12 C63 D81 Q12
    Date: 2015–11–20
  11. By: Ching-Wai (Jeremy) Chiu (Bank of England); Haroon Mumtaz (Queen Mary University of London); Gabor Pinter (Bank of England)
    Abstract: In this paper, we provide evidence that fat tails and stochastic volatility can be important in improving in-sample fit and out-of-sample forecasting performance. Specifically, we construct a VAR model where the orthogonalised shocks feature Student’s t distribution and time-varying variance. We estimate this model using US data on output growth, inflation, interest rates and stock returns. In terms of in-sample fit, the VAR model that features both stochastic volatility and Student’s t-distributed disturbances outperforms restricted alternatives that feature either attributes. The VAR model with Student’s t disturbances results in density forecasts for industrial production and stock returns that are superior to alternatives that assume Gaussianity, and this difference appears to be especially stark over the recent Great Recession. Further international evidence confirms that accounting for both stochastic volatility and Student’s t-distributed disturbances may lead to improved forecast accuracy.
    Keywords: Financial Frictions, Predictive Densities, Great Recession, Threshold VAR
    JEL: C11 C32 C52
    Date: 2015–02
  12. By: Rosalind Z. Wiggins; Thomas Piontek; Andrew Metrick
    Abstract: On September 15, 2008, Lehman Brothers Holdings, Inc., the fourth-largest U.S. investment bank, sought Chapter 11 protection, initiating the largest bankruptcy proceeding in U.S. history. The demise of the 164-year old firm was a seminal event in the global financial crisis. Under the direction of its long-time Chief Executive Officer Richard Fuld, Lehman had been very successful pursuing a high-leverage, high-risk business model that required it to daily raise billions of dollars to fund its operations. Beginning in 2006, Lehman began to invest aggressively in real-estate-related assets and soon had significant exposures to housing and subprime mortgages, just as these markets began to sour. Lehman employed a cadre of accountants and risk professionals to continually monitor its balance sheet, key ratios, and risks. It undertook desperate and some questionable actions to stay alive. Nevertheless, Lehman ultimately failed because of an inability to finance itself. This overview case provides background information about Lehman’s business and key personnel and also the economic environment during 2006-2008. It may be utilized individually or in connection with any of the other seven YPFS Lehman case studies.
    Keywords: Systemic Risk, Financial Crises, Financial Regulation
    JEL: G01 G28
    Date: 2014–10
  13. By: Vassiliki Bamiatzi (Leeds University Business School, University of Leeds); Georgios Efthyvoulo (Department of Economics, University of Sheffield); Liza Jabbour (Birmingham Business School, University of Birmingham)
    Abstract: This paper examines the role of foreign versus domestic ownership in improving the financial health of acquired firms. In particular, it explores the impact of foreign and domestic acquisitions on financial risk reduction of acquired firms in Italy and Spain over the period 2002-2010. To estimate causal relationships, we control for selection bias by applying propensity score matching techniques. Our results indicate that foreign acquisition leads to a significant and steady reduction in financial risk. In contrast, the relationship between domestic acquisition and financial risk appears to be smaller and statistically less robust.
    Keywords: financial risk; capital structure; acquisitions; foreign investment
    JEL: F23 O33 D24
    Date: 2016–11
  14. By: Kondratjev, Alexey (Russian Presidential Academy of National Economy and Public Administration)
    Abstract: The problems of application of covenants in Russia, showing the direction of improving their use: to recognize covenants legitimate financial tool in the federal legislation, supplemented by regulations order of their legal regulation, delegate the conduct of all of its financial covenants audit companies, enter into the business turnover of the position of the owner of the bonds authorized to demand early the repayment or redemption of any breach of the covenant, to recommend the commercial banks to monitor the financial covenants under the credit risk assessment, and develop regulations for their application.
    Keywords: covenant, risk-management, debt, credit risk
    Date: 2015
  15. By: Tomer Siedner
    Abstract: In this work we present five axioms for a risk-order relation defined over (monetary) gambles. We then characterize an index that satisfies all these axioms – the probability of losing money in a gamble multiplied by the expected value of such an outcome – and prove its uniqueness. We propose to use this function as the risk of a gamble. This index is continuous, homogeneous, monotonic with respect to first- and second-order stochastic dominance, and simple to calculate. We also compare our index with some other risk indices mentioned in the literature.
    Keywords: NTU game, Convex game, Bargaining set
    Date: 2015–04

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