nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒04‒30
thirteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Hedge Effectiveness of Texas Live Cattle By Regmund, Wesley S.; Martinez, Charles C.; Benavides, Justin R.; Anderson, David P.
  2. Measuring Systemic Risk Across Financial Market Infrastructures By Fuchun Li; Héctor Pérez Saiz
  3. Does the Geographic Expansion of Banks Reduce Risk? By Goetz, Martin; Laeven, Luc; Levine, Ross
  5. Reallocation of Price Risk among Cooperative Members By Pedersen, Michael
  6. Early Warning of Financial Stress Events: A Credit-Regime-Switching Approach By Fuchun Li; Hongyu Xiao
  7. Only Winners in Tough Times Repeat: Hedge Fund Performance Persistence over Different Market Conditions By Sun, Zheng; Wang, Ashley W.; Zheng, Lu
  8. Optimal investment and consumption with downside risk constraint in jump-diffusion models By Thai Nguyen
  9. What determines how banks respond to changes in capital requirements? By Bahaj, Saleem; Bridges, Jonathan; Malherbe, Frederic; O’Neill, Cian
  10. Median Response to Shocks: A Model for VaR Spillovers in East Asia By Fabrizio Cipollini; Giampiero Gallo; Andrea Ugolini
  11. Does weather matter? How rainfall shocks affect credit risk in agricultural micro-finance By Pelka, Niels; Weber, Ron; Musshoff, Oliver
  12. Stochastic Analysis of Margin Protection (MP) Crop Insurance in Arkansas Rice Production By Mane, Ranjitsinh; Watkins, Bradley
  13. Investing in disaster risk management in an uncertain climate By McDermott,Thomas K.J.

  1. By: Regmund, Wesley S.; Martinez, Charles C.; Benavides, Justin R.; Anderson, David P.
    Abstract: Cattle feeders face a multitude of challenges when raising their product. There is constant morbidity and mortality biological risk inherent in livestock feeding, coupled with the risk of negative weather conditions, and highly variable input prices. However, the greatest risk typically facing the fed cattle industry is price risk. In order to mitigate output price risk, producers look to hedging in the futures market. Hedges can effectively reduce price and revenue risk, although basis risk remains. Hedging is normally thought of as a risk management strategy rather than an effort to garner huge futures market returns. The main aim of hedging is assumed to be the minimization of the variance of the return on the portfolio. Hedging becomes particularly important in the fed cattle industry because fed cattle are ‘non-storable’ both in a definition’s sense, and a literal sense. An optimal hedge is a variance minimization tool. This paper uses an optimal hedge and a common 1:1 fed cattle price hedge using Texas cattle prices, over the 2010-2014 period to determine which hedge provides the most price protection. Additionally, the effects of different hedge lengths with regard to net price were estimated.
    Keywords: risk, cattle, live cattle, hedging, Agribusiness, Livestock Production/Industries, Risk and Uncertainty,
    Date: 2016–02–07
  2. By: Fuchun Li; Héctor Pérez Saiz
    Abstract: We measure systemic risk in the network of financial market infrastructures (FMIs) as the probability that two or more FMIs have a large credit risk exposure to the same FMI participant. We construct indicators of credit risk exposures in three main Canadian FMIs during the period 2007–11 and use extreme value methods to estimate this probability. We find large differences in the contribution to systemic risk across participants. We also find that when participants are in financial distress, they tend to create large credit exposures in two or more FMIs. Our results suggest that an appropriate oversight of FMIs may benefit from an in-depth system-wide analysis, which may have useful implications for the macroprudential regulation of the financial system.
    Keywords: Econometric and statistical methods, Financial stability, Payment clearing and settlement systems
    JEL: G21 G23 C58
    Date: 2016
  3. By: Goetz, Martin; Laeven, Luc; Levine, Ross
    Abstract: We develop a new identification strategy to evaluate the impact of the geographic expansion of a bank holding company (BHC) across U.S. metropolitan statistical areas (MSAs) on BHC risk. For the average BHC, the instrumental variable results suggest that geographic expansion materially reduces risk. Geographic diversification does not affect loan quality. The results are consistent with arguments that geographic expansion lowers risk by reducing exposure to idiosyncratic local risks and inconsistent with arguments that expansion, on net, increases risk by reducing the ability of BHCs to monitor loans and manage risks.
    Keywords: Bank Regulation; Banking; financial stability; Hedging; risk
    JEL: G11 G21 G28
    Date: 2016–04
  4. By: Péter Bauer (Magyar Nemzeti Bank (Central Bank of Hungary)); Marianna Endrész (Magyar Nemzeti Bank (Central Bank of Hungary))
    Abstract: The ultimate aim of this paper is to generate micro-level risk measures, which can provide a useful input for further research. To this end, this paper estimates bankruptcy probabilities for Hungarian firms using probit estimation. The estimated models show reasonable performance in distinguishing surviving and failing firms. We combine macro and micro information, as the addition of macro variables is needed to capture the aggregate dynamics and level of risk, especially during the crisis period. Controlling for the non-linear impact of firm characteristics and allowing heterogeneity by firm size improves the model’s performance significantly. The distributional characteristics of the micro-level risk indicators provide some interesting insights regarding the development of risk dispersion and the risktaking of the banking sector.
    Keywords: bankruptcy risk modelling, probit, micro data
    JEL: C23 G33
    Date: 2016
  5. By: Pedersen, Michael
    Abstract: The purpose of this paper is to explore the theoretical possibility of reallocation of price risk among members of processing cooperatives in the Danish hog and dairy sectors. Based on the observation that no effective price risk management institutions exist for Danish hog and dairy farmers, possible explanations for this are discussed and the possibility of cooperatives to reallocate risk among members is analyzed. Use of futures to hedge individual farmer price risk is absent, which may be due to prohibitively high basis risk. Farmers are exposed to the cooperative price. Endowing members with proportional forward contracts and organizing the exchange of these contracts via a double auction mechanism will reallocate risk, realizing gains depending on member heterogeneity and transaction costs. Most research on risk transfer focuses on vertical reallocations of risk in the value chain, whereas this paper explores the possibility of horizontal risk transfer.
    Keywords: Agricultural and Food Policy, Risk and Uncertainty,
    Date: 2015
  6. By: Fuchun Li; Hongyu Xiao
    Abstract: We propose an early warning model for predicting the likelihood of a financial stress event for a given future time, and examine whether credit plays an important role in the model as a non-linear propagator of shocks. This propagation takes the form of a threshold regression in which a regime change occurs if credit conditions cross a critical threshold. The in-sample and out-of-sample forecasting performances are encouraging. In particular, the out-of-sample forecasting results suggest that the model based on the credit-regime-switching approach outperforms the benchmark models based on a linear regression and signal extraction approach across all forecasting horizons and all criteria considered.
    Keywords: Econometric and statistical methods, Financial stability
    JEL: C12 C14 G01 G17
    Date: 2016
  7. By: Sun, Zheng; Wang, Ashley W.; Zheng, Lu
    Abstract: We provide novel evidence that hedge fund performance is persistent following weak hedge fund markets, but is not persistent following strong markets. Specifically, we construct two performance measures, DownsideReturns and UpsideReturns, conditioned on the level of overall hedge fund sector returns. After adjusting for risks, funds in the highest DownsideReturns quintile outperform funds in the lowest quintile by about 7% in the subsequent year, whereas funds with better UpsideReturns do not outperform subsequently. The DownsideReturns can predict future fund performance over a horizon as long as 3 years, for both winners and losers, and for funds with few share restrictions.
    Keywords: Conditional performance ; Hedge funds ; Performance Persistence
    JEL: G10 G23
    Date: 2016–03
  8. By: Thai Nguyen
    Abstract: This paper extends the results of the article [C. Kl\"{u}ppelberg and S. M. Pergamenchtchikov. Optimal consumption and investment with bounded downside risk for power utility functions. In Optimality and Risk: {\it Modern Trends in Mathematical Finance. The Kabanov Festschrift}, pages 133-169, 2009] to a jump-diffusion setting. We show that under the assumption that only positive jumps in the asset prices are allowed, the explicit optimal strategy can be found in the subset of admissible strategies satisfying the same risk constraint as in the pure diffusion setting. When negative jumps probably happen, the regulator should be more conservative. In that case, we suggest to impose on the investor's portfolio a stricter constraint which depends on the probability of having negative jumps in the assets during the whole considered horizon.
    Date: 2016–03
  9. By: Bahaj, Saleem (Bank of England); Bridges, Jonathan (Bank of England); Malherbe, Frederic (London Business School and CEPR); O’Neill, Cian (Bank of England)
    Abstract: Legacy asset overhang and incentive to shift risk due to government guarantees can both affect bank capital issuance and lending decisions. We show that such frictions lead to ambiguous predictions on how one should expect a bank to react to a change in capital requirements. One sustained prediction is that lending is less sensitive to a change in capital requirements when lending prospects are good and legacy assets are healthy. Using UK bank regulatory data from 1989 to 2007, we find strong empirical support for this prediction.
    Keywords: Debt overhang; risk-shifting; bank capital; local projections
    JEL: G21 G32
    Date: 2016–04–15
  10. By: Fabrizio Cipollini (Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti", Università di Firenze); Giampiero Gallo (Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti", Università di Firenze); Andrea Ugolini (Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti", Università di Firenze)
    Abstract: We propose a procedure for analyzing financial interdependencies within an area of interest, interpreting a negative daily return in an Originator market as a VaR (i.e. the product of a volatility level and the corresponding α-quantile of a time independent probability distribution), and measuring the Median Response in the Destination market through its volatility associated with the one in the Originator and the reconstruction of the correlation structure between the two (through copula functions). We apply our methodology to nine Asian markets, varying the choice of the Originator and deriving a number of indicators which represent the importance of each market as a provider or a receiver of turbulence. Over a 1996-2015 period we confirm the role of traditionally important markets (e.g. Hong Kong or Singapore), while over a rolling three--year estimation period, we can detect rises and declines, the explosion of turbulence in the occasion of the Great Recession and the magnified role of China in the recent years.
    Keywords: Value at Risk, Volatility, copula functions, Spillover, turbulence, financial crisis
    JEL: C58 G01 C22
    Date: 2016–04
  11. By: Pelka, Niels; Weber, Ron; Musshoff, Oliver
    Abstract: Small-scale farmers in developing countries are undersupplied with capital. Although microfinance institutions have become well established in developing countries, they have not significantly ex-tended their services to farmers. It is generally believed that this is partly due to the riskiness of lending to farmers. This paper combines original data from a Madagascan microfinance institution with weather data to estimate the effect of rainfall on the repayment performance of loans granted to farmers. Results estimated by linear probability models and a sequential logit model show that excessive rain in the harvest period increases the credit risk of loans granted to farmers
    Keywords: Agricultural Finance, Environmental Economics and Policy,
    Date: 2015
  12. By: Mane, Ranjitsinh; Watkins, Bradley
    Abstract: Rice is an irrigated crop, and irrigated crops are more insulated against yield risk than non-irrigated crops. However, rice is largely dependent on energy related inputs like fuel and fertilizer and suffers from systemic risks caused by increasing energy related input costs. The USDA Risk Management Agency (RMA) is making available a new insurance product to rice producers in 2016 called Margin Protection (MP). Margin Protection provides coverage against an unexpected decrease in operating margin resulting from increased input costs. Thls study used simulation to evaluate stochastic indemnities generated by MP at various coverage levels ranging from 70 to 90 percent for three major rice counties in Arkansas. Multivariate empirical distributions of county yields, margin rice prices and prices for allowed margin inputs were simulated. The likelihood of receiving indemnities under MP was small for 70 and 75 percent coverage levels based on our simulated results. Indemnity probabilities were 0.8, 5.2, and 18 percent for Arkansas County at MP coverage levels of 80, 85, and 95 percent, respectively. Indemnity probabilities for Poinsett and Desha Counties were higher at the 80, 85, and 90 percent MP coverage levels (6, 18.8, and 31.9 percent respectively for Poinsette; 6.6, 16.8, and 34.6 percent respectively for Desha). The higher probabilities of indemnities in Poinsett and Desha counties may be due to higher variability in yields for those counties.
    Keywords: Margin Protection, Indemnity, Price Risk, Risk Management, Price Volatility, Crop Production/Industries, Risk and Uncertainty, Q11, Q13, Q14, Q16,
    Date: 2016
  13. By: McDermott,Thomas K.J.
    Abstract: Climate change will exacerbate the challenges associated with environmental conditions, especially weather variability and extremes, in developing countries. These challenges play important, if as yet poorly understood roles in the development prospects of affected regions. As such, climate change reinforces the development case for investment in disaster risk management. Uncertainty about how climate change will affect particular locations makes optimal investment planning more difficult. In particular, the inability to derive meaningful probabilities from climate models limits the usefulness of standard project evaluation techniques, such as cost-benefit analysis. Although the deep uncertainty associated with climate change complicates disaster risk management investment decisions, the analysis presented here shows that these considerations are only relevant for a relatively limited set of investment circumstances. The paper offers a simple decision framework that enables policy makers to identify the particular circumstances under which uncertainty about future climate change becomes critical for disaster risk management investment decisions. Accounting for climate uncertainty is likely to shift the optimal balance of disaster risk management strategies toward more flexible, low-regret type interventions, especially those that seek to promote"development first"or"risk-coping"objectives. Such investments are likely to confer additional development dividends, regardless of the climate future that materializes in a given location. Importantly, the analysis here also demonstrates that climate uncertainty does not necessarily motivate a"wait and see"approach. Instead, where opportunities exist to avail of adaptation co-benefits, climate uncertainty provides additional motivation for early investment in disaster risk management initiatives.
    Keywords: Adaptation to Climate Change,Climate Change Economics,Science of Climate Change,Economic Theory&Research,Climate Change Mitigation and Green House Gases
    Date: 2016–04–12

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