nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒03‒23
fifteen papers chosen by

  1. Risk Management—the Revealing Hand By Robert S. Kaplan; Anette Mikes
  2. EWS-GARCH: New Regime Switching Approach to Forecast Value-at-Risk By Marcin Chlebus
  3. Risk and Return Spillovers among the G10 Currencies By Matthew Greenwood-Nimmo; Viet Hoang Nguyen; Barry Rafferty
  4. Bank Charter Value, Systemic Risk and Credit Reporting Systems: Evidence from the Asia-Pacific Region By Wahyoe Soedarmono; Romora Edward Sitorus; Amine Tarazi
  5. More Accurate Measurement for Enhanced Controls: VaR vs ES? By Dominique Guegan; Bertrand Hassani
  6. A Credibility Approach of the Makeham Mortality Law By Yahia Salhi; Pierre-Emmanuel Thérond; Julien Tomas
  7. Impact of dependence on some multivariate risk indicators By Véronique Maume-Deschamps; Didier Rullière; Khalil Said
  8. Networks in risk spillovers: a multivariate GARCH perspective By Monica Billio; Massimiliano Caporin; Lorenzo Frattarolo; Loriana Pelizzon
  9. Network externalities across financial institutions By Carlos Castro; Juan S. Ordoñez; Sergio Preciado
  10. Expected returns and idiosyncratic risk: Industry-level evidence from Russia By Kinnunen, Jyri; Martikainen, Minna
  11. Options-Pricing Formula with Disaster Risk By Robert J. Barro; Gordon Y. Liao
  12. Accelerated Depreciation, Default Risk and Investment Decisions By Panteghini, Paolo M.; Vergalli, Sergio
  13. Anatomy of Risk Premium in UK Natural Gas Futures By Beatriz Martínez; Hipòlit Torró
  14. Predicting US banks bankruptcy: logit versus Canonical Discriminant analysis By Zeineb Affes; Rania Hentati-Kaffel
  15. Financial Soundness Indicators for Financial Sector Stability in Viet Nam By Asian Development Bank (ADB); Asian Development Bank (ADB); Asian Development Bank (ADB); Asian Development Bank (ADB)

  1. By: Robert S. Kaplan (Harvard Business School, Accounting and Management Unit); Anette Mikes (HEC Lausanne)
    Abstract: Many believe that the recent emphasis on enterprise risk management function is misguided, especially after the failure of sophisticated quantitative risk models during the global financial crisis. The concern is that top-down risk management will inhibit innovation and entrepreneurial activities. We disagree and argue that risk management should function as a Revealing Hand to identify, assess, and mitigate risks in a cost-efficient manner. Done well, the Revealing Hand of risk management adds value to firms by allowing them to take on riskier projects and strategies. But risk management must overcome severe individual and organizational biases that prevent managers and employees from thinking deeply and analytically about their risk exposure. In this paper, we draw lessons from seven case studies about the multiple and contingent ways that a corporate risk function can foster highly interactive and intrusive dialogues to surface and prioritize risks, help to allocate resources to mitigate them, and bring clarity to the value trade-offs and moral dilemmas that lurk in those decisions.
    Date: 2016–03
  2. By: Marcin Chlebus (Faculty of Economic Sciences, University of Warsaw)
    Abstract: In the study a proposal of two-step EWS-GARCH models to forecast Value-at-Risk is presented. The EWS-GARCH allows different distributions of returns to be used in Value-at-Risk forecasting depending on a forecasted state of the financial time series. In the study EWS-GARCH with GARCH(1,1) and GARCH(1,1) with the amendment to the empirical distribution of returns as a Value-at-Risk model in a state of tranquillity and empirical tail, exponential or Pareto distributions used to forecast Value-at-Risk in a state of turbulence were considered. The evaluation of the quality of the Value-at-Risk forecasts was based on the Value-at-Risk forecasts adequacy (the excess ratio, the Kupiec test, the Christoffersen test, the asymptotic test of unconditional coverage and the back-testing criteria defined by the Basel committee) and the analysis of loss functions (the Lopez quadratic loss function, the Abad & Benito absolute loss function, the 3rd version of Caporin loss function and proposed in the study the function of excessive costs). Obtained results indicate that the EWS-GARCH models may improve the quality of the Value-at-Risk forecasts generated using benchmark models. However, the choice of best assumptions for an EWS-GARCH model should depend on the goals of the Value-at-Risk forecasting model. The final selection may depend on an expected level of adequacy, conservatism and costs of a model.
    Keywords: Value-at-Risk, GARCH, forecasting, state of turbulence, regime switching, risk management, risk measure, market risk.
    JEL: G17 C51 C52 C53
    Date: 2016
  3. By: Matthew Greenwood-Nimmo (Department of Economics, The University of Melbourne); Viet Hoang Nguyen (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne); Barry Rafferty (Department of Economics, The University of Melbourne)
    Abstract: We study spillovers among daily returns and innovations in option-implied risk-neutral volatility and skewness of the G10 currencies. An empirical network model uncovers substantial time variation in the interaction of risk measures and returns, both within and between currencies. We find that aggregate spillover intensity is countercyclical with respect to the federal funds rate and increases in periods of financial stress. During these times, volatility spillovers and especially skewness spillovers between currencies increase, reflecting greater systematic risk. Likewise, linkages between returns and risk measures strengthen in times of stress, with returns becoming more sensitive to risk measures and vice versa. Classification-C58, F31, G01, G15
    Keywords: Foreign exchange markets, risk-neutral volatility, risk-neutral skewness, spillovers, coordinated crash risk
    Date: 2016–02
  4. By: Wahyoe Soedarmono (Universitas Siswa Bangsa Internasional, Faculty of Business / Sampoerna School of Business); Romora Edward Sitorus (Universitas Siswa Bangsa Internasional, Faculty of Business / Sampoerna School of Business); Amine Tarazi (LAPE - Laboratoire d'Analyse et de Prospective Economique - UNILIM - Université de Limoges - IR SHS UNILIM - Institut Sciences de l'Homme et de la Société)
    Abstract: From a sample of publicly-traded banks in the Asia-Pacific region over the 1998-2012 period, we document that banks with higher charter value are able to insulate themselves from systemic risk by acquiring more capital. Nevertheless, we find that the self-disciplining role of bank charter value is more pronounced for countries with lower depth of credit information sharing. Our results also show that in countries with lower quality of private credit bureaus, higher charter value enhances capitalization, and alleviates systemic risk in banking. Overall, these findings suggest that higher bank charter value might be detrimental to systemic stability for countries where the credit reporting system is of better quality.
    Keywords: Asian banks ,credit information sharing,systemic risk,Bank charter value
    Date: 2016–03–08
  5. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Bertrand Hassani (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    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
    Date: 2016–02
  6. By: Yahia Salhi (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1); Pierre-Emmanuel Thérond (Galea & Associés, SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1); Julien Tomas (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1)
    Abstract: The present article illustrates a credibility approach to mortality. Interest from life insurers to assess their portfolios' mortality risk has considerably increased. The new regulation and norms, Solvency II, shed light on the need of life tables that best reect the experience of insured portfolios in order to quantify reliably the underlying mortality risk. In this context and following the work of Bühlmann and Gisler (2005) and Hardy and Panjer (1998), we propose a credibility approach which consists on reviewing, as new observations arrive, the assumption on the mortality curve. Unlike the methodology considered in Hardy and Panjer (1998) that consists on updating the aggregate deaths we have chosen to add an age structure on these deaths. Formally, we use a Makeham graduation model. Such an adjustment allows to add a structure in the mortality pattern which is useful when portfolios are of limited size so as to ensure a good representation over the entire age bands considered. We investigate the divergences in the mortality forecasts generated by the classical credibility approaches of mortality including Hardy and Panjer (1998) and the Poisson-Gamma model on portfolios originating from various French insurance companies.
    Keywords: Graduation,Life insurance,Mortality,Credibility,Makeham law,Extrapolation
    Date: 2016
  7. By: Véronique Maume-Deschamps (ICJ - Institut Camille Jordan [Villeurbanne] - ECL - École Centrale de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - INSA - Institut National des Sciences Appliquées - CNRS - Centre National de la Recherche Scientifique); Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1); Khalil Said (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1, COACTIS - UL2 - Université Lumière - Lyon 2 - Université Jean Monnet - Saint-Etienne)
    Abstract: The minimization of some multivariate risk indicators may be used as an allocation method, as proposed in Cénac et al. [6]. The aim of capital allocation is to choose a point in a simplex, according to a given criterion. In a previous paper [17] we proved that the proposed allocation technique satisfies a set of coherence axioms. In the present one, we study the properties and asymptotic behavior of the allocation for some distribution models. We analyze also the impact of the dependence structure on the allocation using some copulas.
    Keywords: copulas.,Multivariate risk indicators,dependence modeling,risk theory,sub-exponential distributions,optimal capital allocation
    Date: 2016–02–29
  8. By: Monica Billio (Department of Economics, University Of Venice Cà Foscari); Massimiliano Caporin (Department of Economics, University Of Padova); Lorenzo Frattarolo (SAFE-Goethe University Frankfurt); Loriana Pelizzon (SAFE-Goethe University Frankfurt)
    Abstract: We propose a spatial approach for modeling risk spillovers using financial time-varying proximity matrices based on observable networks. We show how these methods could be useful in (i) isolating risk channels, risk spreaders and risk receivers, (ii) investigating the role of portfolio composition in risk transfer, and (iii) computing target exposure structures able to reduce the forecasted system variance and thus the risk of the system. Our empirical analysis builds on banks’ foreign exposures provided by the Bank of International Settlements (BIS) as a proxy for Euro area cross-country holdings. We find, in the European sovereign bond markets, that Germany, Italy and, to a lesser extent, Greece are playing a central role in spreading risk, and Ireland and Spain are the most susceptible receivers of spillover effects that can be traced back to a physical claim channel: banks’ foreign exposures. We additionally show that acting on these physical channels before the sovereign crisis, it would have been possible to have a clear risk mitigation outcome
    Keywords: spatial GARCH, network, risk spillover, financial spillover
    JEL: C58 G10
    Date: 2016
  9. By: Carlos Castro; Juan S. Ordoñez; Sergio Preciado
    Abstract: We propose and estimate a financial distress model that explicitly accounts for the interactions or spill-over effects between financial institutions, through the use of a spatial continuity matrix that is build from financial network data of interbank transactions. Such setup of the financial distress model allows for the empirical validation of the importance of network externalities in determining financial distress, in addition to institution specific and macroeconomic covariates. The relevance of such specification is that it incorporates simultaneously micro-prudential factors (Basel 2) as well as macro-prudential and systemic factors (Basel 3) as determinants of financial distress. Results indicate network externalities are an important determinant of financial health of a financial institutions. The parameter that measures the effect of network externalities is both economically and statistical significant and its inclusion as a risk factor reduces the importance of the firm specific variables such as the size or degree of leverage of the financial institution. In addition we analyse the policy implications of the network factor model for capital requirements and deposit insurance pricing.
    Keywords: systemic risk, network models, spatial econometrics
    JEL: C21 C58 G32
    Date: 2016–02–28
  10. By: Kinnunen, Jyri; Martikainen, Minna
    Abstract: ​In this paper, we explore a relation between expected returns and idiosyncratic risk. As in many emerging markets, investors in the Russian stock market cannot fully diversify their portfolios due to transaction costs, information gathering and processing costs, and short-comings in investor protection. This implies that investors demand a premium for idiosyncratic risk – unique asset-specific risk plays a role in investment decisions. We estimate the price of idiosyncratic risk using MIDAS regressions and a cross-section of Russian industry portfolios. We find that idiosyncratic risk commands an economically and statistically significant risk premium. The results remain unaffected after controlling for global pricing factors and short-term return reversal.
    Keywords: idiosyncratic risk, industry risk, cross-sectional returns, MIDAS, Russia
    JEL: G12
    Date: 2015–10–30
  11. By: Robert J. Barro; Gordon Y. Liao
    Abstract: A new options-pricing formula applies to far-out-of-the money put options on the overall stock market when disaster risk is the dominant force, the size distribution of disasters follows a power law, and the economy has a representative agent with Epstein-Zin utility. In the applicable region, the elasticity of the put-options price with respect to maturity is close to one. The elasticity with respect to exercise price is greater than one, roughly constant, and depends on the difference between the power-law tail parameter and the coefficient of relative risk aversion, γ. The options-pricing formula conforms with data from 1983 to 2015 on far-out-of-the-money put options on the U.S. S&P 500 and analogous indices for other countries. The analysis uses two types of data—indicative prices on OTC contracts offered by a large financial firm and market data provided by OptionMetrics, Bloomberg, and Berkeley Options Data Base. The options-pricing formula involves a multiplicative term that is proportional to the disaster probability, p. If γ and the size distribution of disasters are fixed, time variations in p can be inferred from time fixed effects. The estimated disaster probability peaks particularly during the recent financial crisis of 2008-09 and the stock-market crash of October 1987.
    JEL: E44 G12 G13
    Date: 2016–01
  12. By: Panteghini, Paolo M.; Vergalli, Sergio
    Abstract: In this article we focus on a representative firm that can decide when to invest under default risk. On the one hand, this firm can benefit from generous tax depreciation allowances, on the other hand it faces a default risk. Our aim is to study the effects of tax depreciation allowances in a risky environment. As will be shown in our numerical analysis, generous tax depreciation allowances lead to a decrease in a firm’s leverage and, in most cases, cause a reduction in default risk. This result has a strong policy implication, in that it shows that an investment stimulus pack is expected neither to increase the default risk nor to cause financial instability.
    Keywords: Capital Structure, Contingent Claims, Corporate Taxation and Hybrid Securities, Risk and Uncertainty, H2,
    Date: 2016–03–01
  13. By: Beatriz Martínez (Department of Business Finance, University of Valencia); Hipòlit Torró (Financial and Actuarial Economics, University of Valencia)
    Abstract: In many futures markets, trading is concentrated in the front contract and positions are rolled-over until the strategy horizon is attained. In this paper, a pair-wise comparison between the conventional risk premium and the accrued risk premium in rolled-over positions in the front contract is carried out for UK natural gas futures. Several novel results are obtained. Firstly, and most importantly, the accrued risk premium in rollover strategies is significatively larger than conventional risk premiums and increases with the time to delivery. Specifically, for strategy horizons between three and six months, this difference increases from 1% to 10%. Secondly, it is the first time that risk premium in day-ahead futures has been measured in this market. The average value of the day-ahead risk premium is 0.5% per day and it is statistically significant. Thirdly, all risk premiums are significantly larger and more volatile in winter. Finally, risk premium time-variation is analyzed using a regression model. It is shown that reservoirs, weather, liquidity, volatility, skewness, and seasons are able in all cases to explain between 21% and 59% of the risk premium time-variation (depending on the futures maturity and sub-period).
    Keywords: Natural Gas Market, Futures Premium, Rollover, Seasonal Risk Premiums
    JEL: G13 L95
    Date: 2016–01
  14. By: Zeineb Affes (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Rania Hentati-Kaffel (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Using a large panel of US banks over the period 2008-2013, this paper proposes an early-warning framework to identify bank leading to bankruptcy. We conduct a comparative analysis based on both Canonical Discriminant Analysis and Logit models to examine and to determine the most accurate of these models. Moreover, we analyze and improve suitability of models by comparing different optimal cut-off score (ROC curve vs theoretical value). The main conclusions are: i) Results vary with cut-off value of score, ii) the logistic regression using 0.5 as critical cut-off value outperforms DA model with an average of correct classification equal to 96.22%. However, it produces the highest error type 1 rate 42.67%, iii) ROC curve validation improves the quality of the model by minimizing the error of misclassification of bankrupt banks: only 4.42% in average and exhibiting 0% in both 2012 and 2013. Also, it emphasizes better prediction of failure of banks because it delivers in mean the highest error type II 8.43%.
    Keywords: Bankruptcy prediction,Canonical Discriminant Analysis,Logistic regression,CAMELS,ROC curve,Early-warning system
    Date: 2016–02
  15. By: Asian Development Bank (ADB); Asian Development Bank (ADB) (East Asia Department, ADB); Asian Development Bank (ADB) (East Asia Department, ADB); Asian Development Bank (ADB)
    Abstract: Financial soundness indicators (FSIs) are methodological tools that help quantify and qualify the soundness and vulnerabilities of financial systems according to five areas of interests: capital adequacy, asset quality, earnings, liquidity, and sensitivity to market risk. With support from the Investment Climate Facilitation Fund under the Regional Cooperation and Integration Financing Facility, this report describes the development of FSIs for Viet Nam and analyzes the stability and soundness of the Vietnamese banking system by using these indicators. The key challenges to comprehensively implementing reforms and convincingly addressing the root causes of the banking sector problems include (i) assessing banks’ recapitalization needs, (ii) revising classification criteria to guide resolution options, (iii) recapitalization and restructuring that may include foreign partnerships, (iv) strengthening the VAMC, (v) developing additional options to deal with NPLs, (vi) tightening supervision to ensure a sound lending practice; (vii) revamping the architecture and procedures for crisis management, and (viii) strengthening financial safety nets during the reform process.
    Keywords: financial sector, financial soundness indicators, asia, pacific, adb, investment climate, core indicators, encouraged indicators, deposit takers, financial corporations, nonfinancial sectors, viet nam finance, financial institutions, financial markets, viet nam banks, banking, nguyen duc thanh, vu minh long, ngo quoc thai
    Date: 2015–09

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