nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒04‒04
twenty papers chosen by
Stan Miles
Thompson Rivers University

  1. The Measurement of the Long-Term and Short-Term Risks of Chinese Listed Banks By Song, Wenjuan; Sun, Lixin
  2. Risk and Return Spillovers among the G10 Currencies By Matthew Greenwood-Nimmo; Viet Hoang Nguyen; Barry Rafferty
  3. Institutionalizing Countercyclical Investment; A Framework for Long-term Asset Owners By Bradley Jones
  4. Rare events and risk perception: evidence from Fukushima accident By Renaud Coulomb; Yanos Zylberberg
  5. Accelerated Depreciation, Default Risk and Investment Decisions By Paolo M. Panteghini; Sergio Vergalli
  6. Benefits and Costs of Higher Capital Requirements for Banks By William R. Cline
  7. Statistically similar portfolios and systemic risk By Stanislao Gualdi; Giulio Cimini; Kevin Primicerio; Riccardo Di Clemente; Damien Challet
  8. Bank distress in the news: Describing events through deep learning By Samuel R\"onnqvist; Peter Sarlin
  9. The multivariate nature of systemic risk: direct and common exposures By Paolo Giudici; Peter Sarlin; Alessandro Spelta
  10. Regulatory competition in capital standards with selection effects among banks By Haufler, Andreas; Maier, Ulf
  11. Operational risk management at the Federal Reserve Bank of New York By Rosenberg, Joshua V.
  12. Hedging strategies in energy markets: The case of electricity retailers By Raphaël Homayoun Boroumand; Stéphane Goutte; Simon Porcher; Thomas Porcher
  13. Modeling and Estimation of the Risk When Choosing a Provider By Ekaterina Sorokina
  14. Global Risk and International Equity Portfolio Rebalancing By Dongwon Lee; Kyungkeun Kim
  15. Some mixing properties of conditionally independent processes By Manel Kacem; Stéphane Loisel; Véronique Maume-Deschamps
  16. Tukey's Transformational Ladder for Portfolio Management By Philip Ernst; James Thompson; Yinsen Miao
  17. Can banks default overnight? Modeling endogenous contagion on O/N interbank market By Pawe{\l} Smaga; Mateusz Wili\'nski; Piotr Ochnicki; Piotr Arendarski; Tomasz Gubiec
  18. A coefficient of risk vulnerability By Philomena M. Bacon; Anna Conte; Peter G. Moffatt
  19. Contagion Risk and Network Design By Diego Cerdeiro; Marcin Dziubinski; Sanjeev Goyal;
  20. How Management Risk Affects Corporate Debt By Yihui Pan; Tracy Yue Wang; Michael S. Weisbach

  1. By: Song, Wenjuan; Sun, Lixin
    Abstract: In this paper, we employ Semi-APARCH model to measure and analyze the long-term and the short-term risk of Chinese 16 listed commercial banks between January 2007 and December 2013, and provide an early warning method for financial regulation by developing a scale function. We find that, first, during the financial crisis of 2008-2009, the long-term risk levels of Chinese banking industry as a whole and the individual commercial banks are very higher, they gradually declined to the normal level only after 2010. Secondly, the current risk of Chinese banks and banking industry is at lower level. Thirdly, the surging of overnight rate in 2013 increased the risk level of commercial banks, which could increase more, of which the regulator should be more cautious. Fourthly, the leverage-effects in the short-term risk of Chinese commercial banks are lower; t-distribution shows a fat-tail. Fifthly, the scale functions of commercial banks are highly correlated, the correlation coefficients are close to 1, which indicates a significantly systematically correlations between the long-term risk of Chinese commercial banks.
    Keywords: Commercial Banks; Long-term Risk; Short-term Risk; Semi-APPARCH Model; Chinese Financial Market
    JEL: G21
    Date: 2014–03
  2. 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
  3. By: Bradley Jones
    Abstract: Do portfolio shifts by the world’s largest asset owners respond procyclically to past returns, or countercyclically to valuations? And if countercyclical investment (with both market-stabilizing and return-generating properties) is a public and private good, how might asset owners be empowered to do more of it? These two questions motivate this study. Based on analysis of representative portfolios (totaling $24 trillion) for a range of asset owners (central banks, pension funds, insurers and endowments), portfolio changes typically appear procyclical. In response, I suggest a framework aimed at jointly bolstering long-term returns and financial stability should: (i) embed governance practices to mitigate ‘multi-year return chasing;’ (ii) rebalance to benchmarks with factor exposures best suited to long-term investors; (iii) minimize principal-agent frictions; (iv) calibrate risk management to minimize long-term shortfall risk (not short-term price volatility); and (v) ensure regulatory conventions do not amplify procyclicality at the worst possible times.
    Keywords: Financial stability;Asset Allocation, Asset Owners, Momentum, Risk Management, asset, investment, risk, returns, Asset Pricing, Government Policy and Regulation, All Countries, Risk Management.,
    Date: 2016–02–29
  4. By: Renaud Coulomb; Yanos Zylberberg
    Abstract: We study changes in nuclear-risk perception following the Fukushima nuclear accident of March 2011. Using an exhaustive registry of individual housing transactions in England and Wales between 2007 and 2014, we implement a difference-in-difference strategy and compare housing prices in at-risk areas to areas further away from nuclear sites before and after Fukushima incident. We find a persistent price malus of about 3.5% in response to the Fukushima accident for properties close to nuclear plants. We show evidence that this price malus can be interpreted as a change in nuclear-risk perception. In addition, the price decrease is much larger for high-value properties within neighborhoods, and deprived zones in at-risk areas are more responsive to the accident. We discuss various theoretical channels that could explain these results.
    Date: 2016–03
  5. By: Paolo M. Panteghini (Università degli Studi di Brescia, CESifo and AccounTax Lab); Sergio Vergalli (Università degli Studi di Brescia and Fondazione Eni Enrico Mattei (FEEM))
    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
    JEL: H2
    Date: 2016–03
  6. By: William R. Cline (Peterson Institute for International Economics)
    Abstract: This study provides new estimates of the likely economic losses from banking crises. It also provides new estimates of the economic cost of increasing bank capital requirements, based on the author’s earlier estimate (Cline 2015) of the empirical magnitude of the Modigliani-Miller effect in which higher capital reduces unit cost of equity capital. The study applies previous official estimates (BCBS 2010a) of the impact of higher capital on the probability of banking crises to derive a benefits curve for additional capital, which is highly nonlinear. The benefit and cost curves are examined to identify the socially optimal level of bank capital. This optimum is estimated at about 7 percent of total assets, with a more cautious alternative (75th percentile) at about 8 percent, corresponding to about 12 and 14 percent of riskweighted assets, respectively. These levels are, respectively, about one-fourth to one-half higher than the Basel III capital requirements for the large global systemically important banks (G-SIBs).
    Keywords: Financial Regulation, Bank Capital Requirements, Capital Structure
    JEL: E44 G21 G28 G32
    Date: 2016–03
  7. By: Stanislao Gualdi; Giulio Cimini; Kevin Primicerio; Riccardo Di Clemente; Damien Challet
    Abstract: We propose a similarity measure between portfolios with possibly very different numbers of assets and apply it to a historical database of institutional holdings ranging from 1999 to the end of 2013. The resulting portfolio similarity measure increased steadily before the global financial crisis, and reached a maximum when the crisis occurred. We argue that the nature of this measure implies that liquidation risk from fire sales was maximal at that time. After a sharp drop in 2008, portfolio similarity resumed its growth in 2009, with a notable acceleration in 2013, reaching levels not seen since 2007.
    Date: 2016–03
  8. By: Samuel R\"onnqvist; Peter Sarlin
    Abstract: While many models are purposed for detecting the occurrence of events in complex systems, the task of providing qualitative detail on the developments is not usually as well automated. We present a deep learning approach for detecting relevant discussion in text and extracting natural language descriptions of events. Supervised by only a small set of event information, the model is leveraged by unsupervised learning of semantic vector representations on extensive text data. We demonstrate applicability to the study of financial risk based on news (6.6M articles), particularly bank distress and government interventions (243 events), where indices can signal the level of bank-stress-related reporting at the entity level, or aggregated at country or European level, while being coupled with explanations. Thus, we exemplify how text, as timely and widely available data, can serve as a useful complementary source of information for financial risk analytics.
    Date: 2016–03
  9. By: Paolo Giudici (Department of Economics and Management, University of Pavia); Peter Sarlin (Hanken School of Economics); Alessandro Spelta (Department of Economics and Finance, Catholic University Milan)
    Abstract: To capture systemic risk related to network structures, this paper introduces a measure that complements direct exposures with common exposures, as well as compares these to each other. Trying to address the interconnected nature of financial systems, researchers have recently proposed a range of approaches for assessing network structures. Much of the focus is on direct exposures or market-based estimated networks, yet little attention has been given to the multivariate nature of systemic risk, indirect exposures and overlapping portfolios. In this regard, we rely on correlation network models that tap into the multivariate network structure, as a viable means to assess common exposures and complement direct linkages. Using BIS data, we compare correlation networks with direct exposure networks based upon conventional network measures, as well as we provide an approach to aggregate these two components for a more encompassing measure of interconnectedness.
    Keywords: Bank of International Settlements data, Correlation networks, Exposure networks
    JEL: G01 C58 C63
    Date: 2016–03
  10. By: Haufler, Andreas; Maier, Ulf
    Abstract: Several countries have recently introduced national capital standards exceeding the internationally coordinated Basel III rules, thus suggesting a `race to the top' in capital standards. We study regulatory competition when banks are heterogeneous and give loans to firms that produce output in an integrated market. In this setting capital requirements change the pool quality of banks in each country and inflict negative externalities on neighboring jurisdictions by shifting risks to foreign taxpayers and by reducing total credit supply and output. Non-cooperatively set capital standards are higher than coordinated ones when governments care equally about bank profits, taxpayers, and consumers.
    Keywords: regulatory competition; capital requirements; bank heterogeneity
    JEL: G28 F36 H73
    Date: 2016–03
  11. By: Rosenberg, Joshua V. (Federal Reserve Bank of New York)
    Abstract: Remarks at the 18th Annual OpRisk North America 2016 conference, New York City.
    Keywords: risk ownership; three lines model; risk control; risk analysis; audit; causation
    Date: 2016–03–15
  12. By: Raphaël Homayoun Boroumand (ESG Research Lab - ESG Management School, City University London - City University London); Stéphane Goutte (Banque-Finance - LED - Laboratoire d'Economie Dionysien - UP8 - Université Paris 8, Vincennes-Saint-Denis); Simon Porcher (LSE - Department Mathematics [London] - LSE - London School of Economics); Thomas Porcher (ESG Research Lab - ESG Management School)
    Abstract: As market intermediaries, electricity retailers buy electricity from the wholesale market or self generate for re(sale) on the retail market. Electricity retailers are uncertain about how much electricity their residential customers will use at any time of the day until they actually turn switches on. While demand uncertainty is a common feature of all commodity markets, retailers generally rely on storage to manage demand uncertainty. On electricity markets, retailers are exposed to joint quantity and price risk on an hourly basis given the physical singularity of electricity as a commodity. In the literature on electricity markets, few articles deals on intra-day hedging portfolios to manage joint price and quantity risk whereas electricity markets are hourly markets. The contributions of the article are twofold. First, we define through a VaR and CVaR model optimal portfolios for specific hours (3am, 6am,. .. ,12pm) based on electricity market data from 2001 to 2011 for the French market. We prove that the optimal hedging strategy differs depending on the cluster hour. Secondly, we demonstrate the significantly superior efficiency of intra-day hedging portfolios over daily (therefore weekly and yearly) portfolios. Over a decade (2001-2011), our results
    Keywords: VaR,Intra-day,Retailer,Electricity,Risk,Hedging,Portfolio,CVaR
    Date: 2015
  13. By: Ekaterina Sorokina
    Abstract: The paper provides an algorithm for the risk estimation when a company selects an outsourcing service provider for innovation product. Calculations are based on expert surveys conducted among customers and among providers of outsourcing. The surveys assessed the degree of materiality of species at risk.
    Date: 2016–03
  14. By: Dongwon Lee (Department of Economics, University of California Riverside); Kyungkeun Kim (University of Washington)
    Date: 2016–03
  15. By: Manel Kacem (IHEC Sousse - IHEC); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1); Véronique Maume-Deschamps (ICJ - Institut Camille Jordan (Villeurbanne, Rhône))
    Abstract: In this paper we consider conditionally independent processes with respect to some dynamic factor. We derive some mixing properties for random processes when conditioning is given with respect to unbounded memory of the factor. Our work is motivated by some real examples related to risk theory.
    Keywords: mixing properties,risk processes,Conditional independence
    Date: 2016
  16. By: Philip Ernst; James Thompson; Yinsen Miao
    Abstract: Recently, the authors of (\cite{Ernst}) empirically showed that over the 1958-2014 horizon, the returns of the MaxMedian S\&P 500 portfolio (see \cite{thomp2}) substantially exceed both those of the market capitalization weighted S\&P 500 portfolio as well as those of the equally weighted S\&P 500 portfolio. In this work, we find superior S\&P 500 portfolio weighting strategies to that of the MaxMedian rule, calculated over an updated 1958-2015 time horizon. The portfolio weighting strategies we consider are the seven transformations of Tukey's transformational ladder (\cite{Tukey2}): $1/x^2$, $1/x$, $1/\sqrt{x}$, $\log(x)$, $\sqrt{x}$, $x$, $x^2$ (in our setting, $x$ is the market capitalization weighted portfolio). We find that the $1/x^2$ weighting strategy produces cumulative returns which significantly dominate all other portfolios, posting an annual geometric mean return of 20.889 \%. In addition, we show that the $1/x^2$ weighting strategy is superior to a $1/x$ weighting strategy, which is in turn superior to a 1/$\sqrt{x}$ weighted portfolio, and so forth, culminating with the $x^2$ transformation, whose cumulative returns are the lowest of the seven transformations of Tukey's transformational ladder. It is astonishing that the ranking of portfolio performance (from best to worst) precisely follows that of the late John Tukey's transformational ladder.
    Date: 2016–03
  17. By: Pawe{\l} Smaga; Mateusz Wili\'nski; Piotr Ochnicki; Piotr Arendarski; Tomasz Gubiec
    Abstract: We propose a new model of the liquidity driven banking system focusing on overnight interbank loans. This significant branch of the interbank market is commonly neglected in the banking system modeling and systemic risk analysis. We construct a model where banks are allowed to use both the interbank and the securities markets to manage their liquidity demand and supply as driven by prudential requirements in a volatile environment. The network of interbank loans is dynamic and simulated every day. We show how only the intrasystem cash fluctuations, without any external shocks, may lead to systemic defaults, what may be a symptom of the self-organized criticality of the system. We also analyze the impact of different prudential regulations and market conditions on the interbank market resilience. We confirm that central bank's asset purchase programs, limiting the declines in government bond prices, can successfully stabilize bank's liquidity demand. The model can be used to analyze the interbank market impact of macroprudential tools.
    Date: 2016–03
  18. By: Philomena M. Bacon (Aviva UK & Ireland); Anna Conte (University of Westminster); Peter G. Moffatt (University of East Anglia)
    Abstract: Panel data from the German SOEP is used to test for risk vulnerability (RV) in the wider population. Two different survey responses are analysed: the response to the question about willingness-to-take risk in general; and the chosen investment in a hypothetical lottery. A con- venient indicator of background risk is the VDAX index, an established measure of volatility in the German stock market. This is used as an explanatory variable in conjunction with HDAX, the stock market index, which proxies wealth. The impacts of these measures on risk attitude are identifiable by exploiting the time dimension of the panel, and matching survey months with corresponding observations from these time-varying factors. Both of the survey responses allow us to test for decreasing absolute risk aversion (DARA); in one case we find strong evidence of DARA, while in the other, we do not. Both survey responses also allow us to test for RV, and in both cases we find strong evidence. In the case of the hypothetical lottery response we are also able to estimate a "coefficient of risk vulnerability" (CRV). This is defined as the absolute amount by which absolute risk aversion rises in response to a doubling of background risk. We estimate CRV to be between 1.03 and 1.27.
    Keywords: risk vulnerability, background risk, panel data, survey data
    JEL: D81 D91 C23
    Date: 2016–01–26
  19. By: Diego Cerdeiro; Marcin Dziubinski; Sanjeev Goyal;
    Abstract: Individuals derive bene ts from their connections, but these may, at the same time, transmit external threats. Individuals therefore invest in security to protect themselves. However, the incentives to invest in security depend on their network exposures. We study the problem of designing a network that provides the right individual incentives. Motivated by cybersecurity, we rst study the situation where the threat to the network comes from an intelligent adversary. We show that, by choosing the right topology, the designer can bound the welfare costs of decentralized protection. Both over-investment as well as under-investment can occur depending on the costs of security. At low costs, over-protection is important: this is addressed by discon- necting the network into two unequal components and sacri cing some nodes. At high costs, under-protection becomes salient: it is addressed by disconnecting the network into equal components. Motivated by epidemiology, we then turn to the study of random attacks. The over-protection problem is no longer present, whereas under-protection problems is mitigated in a diametrically opposite way: namely, by creating dense networks that expose the individuals to the risk of contagion.
    Keywords: cybersecurity, epidemics, security choice, externalities.
    Date: 2015–02–24
  20. By: Yihui Pan; Tracy Yue Wang; Michael S. Weisbach
    Abstract: Management risk occurs when uncertainty about future managerial decisions increases a firm’s overall risk. This paper argues that management risk is an important yet unexplored determinant of a firm’s default risk and the pricing of its debt. CDS spreads, loan spreads and bond yield spreads all increase at the time of CEO turnover, when management risk is highest, and decline over the first three years of CEO tenure, regardless of the reason for the turnover. A similar pattern but of smaller magnitude occurs around CFO turnovers. The increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of prior uncertainty about the new management.
    JEL: G32 G34 M12 M51
    Date: 2016–03

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