nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒03‒10
ten papers chosen by

  1. Currency Diversification of Banks: A Spontaneous Buffer Against Financial Losses By Justine Pedrono
  3. Strengthening Financial Surveillance: A Practical Approach to Systemic Risk Monitoring By Nicolas R. Blancher; Srobona Mitra
  4. Characteristics-based Portfolio Choice with Leverage Constraints By Ammann, Manuel; Coqueret, Guillaume; Schade, Jan-Philip
  5. Forecasting Daily Stock Volatility Using GARCH-CJ Type Models with Continuous and Jump Variation By BOUSALAM, Issam; HAMZAOUI, Moustapha; ZOUHAYR, Otman
  6. Solar energy production: Short-term forecasting and risk management By Cédric Join; Michel Fliess; Cyril Voyant; Frédéric Chaxel
  7. Banks' Capital Structure and US dollar Diversification of Assets: Does Reduction in Systemic Risk Offset Agency Costs? By Justine Pedrono; Aurélien Violon
  8. Where the Wild Things Are: Measuring Systemic Risk through Investor Sentiment By Ergungor, O. Emre
  9. Fluctuation-bias trade-off in portfolio optimization under Expected Shortfall with $\ell_2$ regularization By G\'abor Papp; Fabio Caccioli; Imre Kondor
  10. Polynomial Preserving Diffusion Models for Life Insurance Liabilities By Francesca Biagini; Yinglin Zhang

  1. By: Justine Pedrono (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université)
    Abstract: The Basel Committee on Banking Supervision has introduced in December 2010 a Basel III framework for more resilient banks and banking system. We posit in this paper that, in addition to the current regulatory instruments currently under the review of authorities, the currency diversification of banks’ balance sheets can be a source of banking stability considering both assets and liabilities simultaneously. Our conclusions are based on a simplified definition of a globalized bank’s balance sheet. As banks’ balance sheets are expressed in domestic currency, our model implies an exchange rate conversion of each foreign component. Risks are introduced with stochastic processes in assets, liabilities and exchange rate. In accordance with the Basel III framework and the Basel III Leverage ratio, the bank’s leverage ratio is limited. Our model provides detailed information in each risk faced by global banks including foreign exchange risk. Although our conclusions depend on the variance covariance matrix of assets, liabilities and foreign exchange rate, our main results confirm the positive impact of currency diversification on banking stability considering the current banking system.
    Keywords: Basel III,bank,financial integration,financial stability,currency diversification,financial volatility
    Date: 2016–01
  2. By: Chia-Chien Chang (Department of finance); Yung -Jen Chung (Department of finance)
    Abstract: In December 2010, the BCBS (2010a) strengthened its liquidity framework by proposing two quantitative indicators for liquidity risk in Basel III: the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR). Whether the new liquidity risk indicators are effective to measure the liquidity risk of bank thereby reducing bank failures is an issue of concern. Thus, this study uses a quarterly data of Taiwan banks from 2006 to 2013 and uses the panel multiple regression model to investigate the effectiveness of LCR and NSFR in Taiwan banks. We also study the effectiveness of spread and several liquidity risk indictors used in Taiwan based on Principles for Sound Liquidity Risk Management and Supervision (PSLRMS). Moreover, we test the liquidity risk majored from systematic or non-systematic risk, and consider the size effect and time effect to compare the result. The result shows that all liquidity risk indicators can explain empirical default point (EDD) significantly, for big banks, LCR is more important than NSFR, but for small banks, NSFR is more important. In crisis period, spread and LCR are significant in big banks, but no indicators are significant in small banks. After crisis, both big and small banks are affected by spread, and NSFR and LCR is significant in small bank and in big bank, respectively.
    Keywords: Subprime mortgage crisis, Basel III, The Liquidity Coverage Ratio, The Net Stable Funding Ratio, Size effect
  3. By: Nicolas R. Blancher; Srobona Mitra
    Abstract: The world was taken by surprise by the global financial crisis that started in 2007. In response, there has been a proliferation of international initiatives to improve the quantitative toolkit for systemic risk monitoring. The IMF has played a key role in supporting these efforts, given its surveillance mandate and increasing role as a global risk advisor. Indeed, well before this crisis, the Fund started to strengthen the analytical underpinnings of its risk assessments and has strived to remain at the frontier of macro-financial analysis, including in areas such as macroprudential policy, stress testing, and interconnectedness and spillovers. The Fund's Systemic Risk Monitoring (SysMo) project aims to take stock of these efforts and to make this knowledge widely available. It responds in particular to demand from policymakers and practitioners for practical guidance on using tools for systemic risk monitoring. For this purpose, it proposes an innovative approach to monitor systemic risk, based on combinations of existing individual tools. In providing direction on using a wide array of tools, SysMo also reflects the full range of country circumstances across the Fund’s membership, and helps policymakers to customize systemic risk monitoring accordingly.
    Keywords: Financial sector surveillance;Financial sector;Systemic Risk; Macroprudential Policy; Early Warning; Stress Testing; Financial Crisis
  4. By: Ammann, Manuel; Coqueret, Guillaume; Schade, Jan-Philip
    Abstract: We show that the introduction of a leverage constraint improves the practical implementation of characteristics-based portfolios. The addition of the constraint leads to significantly lower transaction costs, to a reduction of negative portfolio weights, and to a decrease in volatility and misspecification risk. Furthermore, it allows investors to implement any desired level of leverage. In this study, we include 12 characteristics, thereby extending the classical size, book-to-market and momentum paradigm. We report several key indicators such as the proportion of negative weights, Sharpe ratio, volatility, transaction costs, the transaction cost-adjusted certainty equivalent returns, and the Herfindahl-Hirschman index. Analyzing the sensitivity of these key indicators to the choice of multiple combinations of the 12 characteristics, to risk aversion, and to estimation sample size, we show that constrained policies are much less sensitive to these parameters than their unconstrained counterparts. Finally, for quadratic utility, we derive a semi-closed analytical form for the portfolio weights. Overall, we provide a comprehensive extension of characteristics-based portfolio choice and contribute to a better understanding and implementation of the allocation process.
    Keywords: Portfolio choice, leverage constraint, characteristics-based investing
    Date: 2016–02
  5. By: BOUSALAM, Issam; HAMZAOUI, Moustapha; ZOUHAYR, Otman
    Abstract: In this paper we decompose the realized volatility of the GARCH-RV model into continuous sample path variation and discontinuous jump variation to provide a practical and robust framework for non-parametrically measuring the jump component in asset return volatility. By using 5-minute high-frequency data of MASI Index in Morocco for the period (January 15, 2010 - January 29, 2016), we estimate parameters of the constructed GARCH and EGARCH-type models (namely, GARCH, GARCH-RV, GARCH-CJ, EGARCH, EGARCH-RV, and EGARCH-CJ) and evaluate their predictive power to forecast future volatility. The results show that the realized volatility and the continuous sample path variation have certain predictive power for future volatility while the discontinuous jump variation contains relatively less information for forecasting volatility. More interestingly, the findings show that the GARCH-CJ-type models have stronger predictive power for future volatility than the other two types of models. These results have a major contribution in financial practices such as financial derivatives pricing, capital asset pricing, and risk measures.
    Keywords: GARCH-CJ; Jumps variation; Realized volatility; MASI Index; Morocco.
    JEL: C22 F37 F47 G17
    Date: 2016–01–20
  6. By: Cédric Join (CRAN - Centre de Recherche en Automatique de Nancy - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique, INRIA Lille - Nord Europe - INRIA, AL.I.E.N. - ALgèbre pour Identification & Estimation Numériques - ALIEN); Michel Fliess (LIX - Laboratoire d'informatique de l'École polytechnique [Palaiseau] - Polytechnique - X - CNRS - Centre National de la Recherche Scientifique, AL.I.E.N. - ALgèbre pour Identification & Estimation Numériques - ALIEN); Cyril Voyant (SPE - Sciences pour l'environnement - Université Pascal Paoli - CNRS - Centre National de la Recherche Scientifique, Hôpital d'Ajaccio); Frédéric Chaxel (CRAN - Centre de Recherche en Automatique de Nancy - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Electricity production via solar energy is tackled via short-term forecasts and risk management. Our main tool is a new setting on time series. It allows the definition of "confidence bands" where the Gaussian assumption, which is not satisfied by our concrete data, may be abandoned. Those bands are quite convenient and easily implementable. Numerous computer simulations are presented.
    Keywords: confidence bands,normality tests,risk,volatility,Solar energy,intelligent knowledge-based systems,time series,forecasts,persistence
    Date: 2016–06–28
  7. By: Justine Pedrono (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université); Aurélien Violon (Banque de France - ACPR)
    Abstract: Multinational Corporation (MNCs) should gain advantage from international diversification by lowering their systemic risk and reducing their bankruptcy cost. Hence, internationalization should induce larger leverage. However, it may imply additional agency costs due to wider informal gaps and higher cost of investigation induced by the multiplication of markets. To examine how currency diversification of asset may change the bank’s systemic risk, we provide a theoretical framework based on relative CAPM by introducing explicitly the exchange rate risk. Due to exchange rate dynamics asset diversification may reduce systemic risk even through the two assets are perfectly correlated. Using innovative micro data on credit institutions located in France between 1999 and 2014 we expand our analysis to the net effect of US dollar diversification of assets. Contrary to past studies, this measure of financial internationalization take into consideration the exchange rate risk. Although our results highlight the two opposite effects of diversification, they posit the importance of international agency costs in the capital structure decision.
    Keywords: bank,capital structure,leverage,currency,diversification,internationalization
    Date: 2016–01
  8. By: Ergungor, O. Emre (Federal Reserve Bank of Cleveland)
    Abstract: In this paper, I develop a systemic risk measure derived from investor sentiment that has predictive power over future economic activity and market returns. Unlike existing measures, it is not focused on flagging investors’ heightened awareness of risk at the end of a boom episode but rather on capturing shifts in their trading behavior at the beginning of the episode. The method allows investors and regulators to observe industries in which risks could be building and provides regulators some lead time in deploying their macroprudential tools.
    Keywords: Financial stability; Systemic risk; Investor sentiment; Risk management;
    JEL: G01 G11 G12 G18 G28
    Date: 2016–02–19
  9. By: G\'abor Papp; Fabio Caccioli; Imre Kondor
    Abstract: The optimization of a large random portfolio under the Expected Shortfall risk measure with an $\ell_2$ regularizer is carried out by analytical calculation. The regularizer reins in the large sample fluctuations and the concomitant divergent estimation error, and eliminates the phase transition where this error would otherwise blow up. In the data-dominated region, where the number of different assets in the portfolio is much less than the length of the available time series, the regularizer plays a negligible role, while in the (much more frequently occurring in practice) opposite limit, where the samples are comparable or even small compared to the number of different assets, the optimum is almost entirely determined by the regularizer. Our results clearly show that the transition region between these two extremes is relatively narrow, and it is only here that one can meaningfully speak of a trade-off between fluctuations and bias.
    Date: 2016–02
  10. By: Francesca Biagini; Yinglin Zhang
    Abstract: In this paper we study the pricing and hedging problem of a portfolio of life insurance products under the benchmark approach, where the reference market is modelled as driven by a state variable following a polynomial preserving diffusion on a compact state space. Such a model guarantees not only the positivity of the OIS short rate and the mortality intensity, but also the possibility of approximating both pricing formula and hedging strategy of a large class of life insurance products by explicit formulas.
    Date: 2016–02

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.