
on Risk Management 
Issue of 2016‒04‒16
ten papers chosen by 
By:  Xi Yang 
Abstract:  This paper investigates the efficiency of leverage ratios and riskweighted capital ratios as bank failure predictors during the global financial crisis. Analyzing 417 bank failures between 2008 and 2012, we find that the predictive power of different capital ratios is not homogeneous across banks. The simple leverage ratio outperforms the riskweighted ratio in predicting failures of large banks, while both capital ratios are important in predicting the failure of smaller banks. The better performance of the leverage ratio in the case of large banks is especially important during the crisis period of 20082010. The findings support the regulatory reforms proposed by Basel Committee on Banking Supervision on the adoption of a supplementary minimum leverage ratio in order to strengthen the resilience of the bank sector. 
Keywords:  leverage ratio, riskweighted capital ratio, bank failure, CAMELS, Logit model 
JEL:  G21 G28 G33 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:drm:wpaper:201615&r=rmg 
By:  Olivier Bruno (GREDEG  Groupe de Recherche en Droit, Economie et Gestion  UNS  Université Nice Sophia Antipolis  CNRS  Centre National de la Recherche Scientifique); Alexandra Girod (GREDEG  Groupe de Recherche en Droit, Economie et Gestion  UNS  Université Nice Sophia Antipolis  CNRS  Centre National de la Recherche Scientifique) 
Abstract:  We investigate the impact the risk sensitive regulatory ratio may have on banks' risk taking behaviours during the business cycle. We show that the risk sensitivity of capital requirements introduce by Basel II adds either an "equity surplus" or an "equity deficit" on a bank that owns a fixed capital endowment and a constant leverage ratio. Depending on the magnitude of cyclical variations into requirements, the "surplus" may be exploited by the bank to increase its value toward the selection of a riskier asset or the "deficit" may restrict the bank to opt for a less risky asset. Whether the optimal asset risk level swings among classes of risk through the cycle, the risk level of bank's portfolio may increase during economic upturns, or decrease in downturns, leading to a rise in financial fragility or a "fly to quality" phenomenon. 
Keywords:  Bank capital,Basel capital accord,risk incentive 
Date:  2016–03–31 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:halshs01295573&r=rmg 
By:  Bikramjit Das; Vicky Fasen 
Abstract:  Risk contagion concerns any entity dealing with large scale risks. Suppose (X,Y) denotes a risk vector pertaining to two components in some system. A relevant measurement of risk contagion would be to quantify the amount of influence of high values of Y on X. This can be measured in a variety of ways. In this paper, we study two such measures: the quantity E[max(Xt,0)Y > t] called Marginal Mean Excess (MME) as well as the related quantity E[XY > t] called Marginal Expected Shortfall (MES). Both quantities are indicators of risk contagion and useful in various applications ranging from finance, insurance and systemic risk to environmental and climate risk. We work under the assumptions of multivariate regular variation, hidden regular variation and asymptotic tail independence for the risk vector (X,Y). Many broad and useful model classes satisfy these assumptions. We present several examples and derive the asymptotic behavior of both MME and MES as the threshold t tends to infinity. We observe that although we assume asymptotic tail independence in the models, MME and MES converge to 1 under very general conditions; this reflects that the underlying weak dependence in the model still remains significant. Besides the consistency of the empirical estimators, we introduce an extrapolation method based on extreme value theory to estimate both MME and MES for high thresholds t where little data are available. We show that these estimators are consistent and illustrate our methodology in both simulated and real data sets. 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1603.09406&r=rmg 
By:  Denise Scheld (University of Giessen); Johannes Paha (University of Giessen); Nicolas Fandrey (Protiviti GmbH) 
Abstract:  Competition law compliance has become increasingly important in the banking industry as the number of infringements and the associated fines imposed by the European Commission are rising. This article shows that not only governments and regulators, but also shareholders and managers, should be interested in managing antitrust risks in banks in order to avoid competition law infringements. Therefore, this article sets out an approach to assessing the residual risk of antitrust noncompliance as well as the costs associated with such conduct, in order to be able to identify the required intensity of risk management activities. It also shows how antitrust risk management can be implemented in banks’ governance structures using the Three Lines of Defence model and the COSO ERM framework. As a result, it demonstrates how to integrate antitrust risk management activities into existing structures and processes, thus improving the efficiency and effectiveness of overall risk management, in particular antitrust risk management. 
Keywords:  risk management, antitrust, compliance, banks, competition 
JEL:  G20 G30 G32 L21 K21 
Date:  2015 
URL:  http://d.repec.org/n?u=RePEc:mar:magkse:201535&r=rmg 
By:  Kara, Gazi; Ozsoy, S. Mehmet 
Abstract:  This paper examines the optimal design of and interaction between capital and liquidity regulations in a model characterized by fire sale externalities. In the model, banks can insure against potential liquidity shocks by hoarding sufficient precautionary liquid assets. However, it is never optimal to fully insure, so realized liquidity shocks trigger an asset fire sale. Banks, not internalizing the fire sale externality, overinvest in the risky asset and underinvest in the liquid asset in the unregulated competitive equilibrium. Capital requirements can lead to less severe fire sales by addressing the inefficiency and reducing risky assets  however, we show that banks respond to stricter capital requirements by decreasing their liquidity ratios. Anticipating this response, the regulator preemptively sets capital ratios at high levels. Ultimately, this interplay between banks and the regulator leads to inefficiently low levels of risky assets and liquidity. Macroprudential liquidity requirements that complement capital regulations, as in Basel III, restore constrained efficiency, improve financial stability and allow for a higher level of investment in risky assets. 
Keywords:  Bank capital regulation ; liquidity regulation ; fire sale externality ; Basel III 
JEL:  G20 G21 G28 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgfe:201626&r=rmg 
By:  Suarez, Ronny 
Abstract:  In this paper we estimated for the period 1990  2015, Sortino Ratio and Return Level using a Generalized Pareto Distribution to evaluate downside risk of largecap companies, approach through S&P 500 Index, and smallcap companies, approach through Russell 2000 Index. Smallcap depicted higher downside risk than largecap. 
Keywords:  largecap, S&P 500, smallcap, Russell 2000, return level, sortino ratio, downsiderisk 
JEL:  C0 G0 
Date:  2016–04–06 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:70547&r=rmg 
By:  Jason Donaldson; Eva Micheler 
Abstract:  Many debt claims, such as bonds, are resaleable, whereas others, such as repos, are not. There was a fivefold increase in repo borrowing before the 2008 crisis. Why? Did banks’ dependence on nonresaleable debt precipitate the crisis? In this paper, we develop a model of bank lending with credit frictions. The key feature of the model is that debt claims are heterogeneous in their resaleability. We find that decreasing credit market frictions leads to an increase in borrowing via nonresaleable debt. Borrowing via nonresaleable debt has a dark side: it causes credit chains to form, since if a bank makes a loan via nonresaleable debt and needs liquidity, it cannot sell the loan but must borrow via a new contract. These credit chains are a source of systemic risk, since one bank’s default harms not only its creditors but also its creditors’ creditors. Overall, our model suggests that reducing credit market frictions may have an adverse effect on the financial system and may even lead to the failures of financial institutions. 
JEL:  J1 
Date:  2016–01 
URL:  http://d.repec.org/n?u=RePEc:ehl:lserod:66042&r=rmg 
By:  Malcolm Baker; Mathias F. Hoeyer; Jeffrey Wurgler 
Abstract:  Higherbeta and highervolatility equities do not earn commensurately higher returns, a pattern known as the risk anomaly. In this paper, we consider the possibility that the risk anomaly represents mispricing and develop its implications for corporate leverage. The risk anomaly generates a simple tradeoff theory: At zero leverage, the overall cost of capital falls as leverage increases equity risk, but as debt becomes riskier the marginal benefit of increasing equity risk declines. We show that there is an interior optimum and that it is reached at lower leverage for firms with high asset risk. Empirically, the risk anomaly tradeoff theory and the traditional tradeoff theory are both consistent with the finding that firms with lowrisk assets choose higher leverage. More uniquely, the risk anomaly theory helps to explain why leverage is inversely related to systematic risk, holding constant total risk; why leverage is inversely related to upside risk, not just downside risk; why numerous firms maintain low or zero leverage despite high marginal tax rates; and, why other firms maintain high leverage despite little tax benefit. 
JEL:  G32 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:22116&r=rmg 
By:  Enzo Busseti; Ernest K. Ryu; Stephen Boyd 
Abstract:  We consider the classic Kelly gambling problem with general distribution of outcomes, and an additional risk constraint that limits the probability of a drawdown of wealth to a given undesirable level. We develop a bound on the drawdown probability; using this bound instead of the original risk constraint yields a convex optimization problem that guarantees the drawdown risk constraint holds. Numerical experiments show that our bound on drawdown probability is reasonably close to the actual drawdown risk, as computed by Monte Carlo simulation. Our method is parametrized by a single parameter that has a natural interpretation as a riskaversion parameter, allowing us to systematically trade off asymptotic growth rate and drawdown risk. Simulations show that this method yields bets that out perform fractionalKelly bets for the same drawdown risk level or growth rate. Finally, we show that a natural quadratic approximation of our convex problem is closely connected to the classical meanvariance Markowitz portfolio selection problem. 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1603.06183&r=rmg 
By:  Lux, Thomas 
Abstract:  This paper provides a review of recent research on the structure of interbank relations and theoretical models developed to assess the contagious potential of shocks (default of single units) via the interbank network. The empirical literature has established a set of stylized facts that includes a fattailed distribution of the number of banks, disassortativity of credit links and a pronounced persistence of existing links over time. These topological features correspond to the existence of money center banks, the importance of relationship banking and the selforganization of the interbank market into a coreperiphery structure. Models designed to replicate these topological features exhibit on average more contagious potential than baseline models for the generation of random networks (such as the ErdösRenyi or preferential attachment mechanisms) that do not share the stylized facts. Combining different channels of contagion such as interbank exposures, portfolio overlaps and common exposure to nonfinancial borrowers, one typically finds that different contagion channels interact in a distinctly nonlinear way. 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:zbw:fmpwps:62&r=rmg 