nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒08‒21
eleven papers chosen by

  1. Accurate Evaluation of Expected Shortfall for Linear Portfolios with Elliptically Distributed Risk Factors By Dobrev, Dobrislav; Nesmith, Travis D.; Oh, Dong Hwan
  2. "Cholesky Realized Stochastic Volatility Model" By Shinichiro Shirota; Yasuhiro Omori; Hedibert. F. Lopes; Haixiang Piao
  3. How to hedge if the payment date is uncertain? By Korn, Olaf; Merz, Alexander
  4. Realized Wishart-GARCH: A Score-driven Multi-Asset Volatility Model By Peter Reinhard Hansen; Pawel Janus; Siem Jan Koopman
  5. Risk reduction and Diversification within Markowitz's Mean-Variance Model: Theoretical Revisit By Gilles Boevi Koumou
  6. The modern tontine: An innovative instrument for longevity risk management in an aging society By Weinert, Jan-Hendrik; Gründl, Helmut
  7. Lending Conditions and Loan Default: What Can We Learn From UK Buy-to-Let Loans? By Kelly, Robert; O'Toole, Conor
  8. Global price of risk and stabilization policies By Adrian, Tobias; Stackman, Daniel; Vogt, Erik
  9. Ausgewählte Anforderungen an die Gesamtbanksteuerung deutscher Kreditinstitute im Zuge der Einführung von Basel III: Unter besonderer Betrachtung der Anrechenbarkeit stiller Einlagen und stiller Reserven als Eigenmittel By Fieker, Michael
  10. The supply of 'safe' assets and fiscal policy By Schuknecht, Ludger
  11. Why does idiosyncratic risk increase with market risk? By Bartram, Söhnke M.; Brown, Gregory W.; Stulz, René M.

  1. By: Dobrev, Dobrislav; Nesmith, Travis D.; Oh, Dong Hwan
    Abstract: We provide an accurate closed-form expression for the expected shortfall of linear portfolios with elliptically distributed risk factors. Our results aim to correct inaccuracies that originate in Kamdem (2005) and are present also in the recent comprehensive survey by Nadarajah, Zhang, and Chan (2014) on estimation methods for expected shortfall. In particular, we show that the correction we provide in the popular multivariate Student t setting eliminates understatement of expected shortfall by a factor varying from at least 4 to more than 100 across different tail quantiles and degrees of freedom. As such, the resulting economic impact in financial risk management applications could be significant. More generally, our findings point to the extra scrutiny required when deploying new methods for expected shortfall estimation in practice.
    Keywords: Expected shortfall ; Elliptical distributions ; Multivariate Student t distribution ; Accurate closed-form expression
    JEL: C46 G11
    Date: 2016
  2. By: Shinichiro Shirota (Department of Statistical Science, Duke University); Yasuhiro Omori (Faculty of Economics, The University of Tokyo); Hedibert. F. Lopes (Insper Institute of Education and Research); Haixiang Piao (Nippon Life Insurance Company)
    Abstract: Multivariate stochastic volatility models with leverage are expected to play important roles in financial applications such as asset allocation and risk management. However, these models suffer from two major difficulties: (1) there are too many parameters to estimate by using only daily asset returns and (2) estimated covariance matrices are not guaranteed to be positive definite. Our approach takes advantage of realized covariances to achieve the efficient estimation of parameters by incorporating additional information for the co-volatilities, and considers Cholesky decomposition to guarantee the positive definiteness of the covariance matrices. In this framework, a exible model is proposed for stylized facts of financial markets, such as dynamic correlations and leverage effects among volatilities. By using the Bayesian approach, Markov Chain Monte Carlo implementation is described with a simple but efficient sampling scheme. Our model is applied to the data of nine U.S. stock returns, and it is compared with other models on the basis of portfolio performances.
    Date: 2016–08
  3. By: Korn, Olaf; Merz, Alexander
    Abstract: This paper is the first to study the hedging of price risk with uncertain payment dates, a frequent problem in practice. It derives a variance-minimizing hedging strategy for two settings, the first employing linear contracts with different times to maturity and the second allowing for non-linear exotic derivatives. Using commodity prices and exchange rates, we empirically show the optimal strategy clearly outperforms heuristic alternatives in both settings. Non-linear instruments offer advantages with increasing hedge horizons and strongly dependent time and price risk, while linear instruments can suffice for short horizons and weak dependency.
    Keywords: risk management,hedging,forwards,exotic derivatives,time uncertainty
    JEL: G30 D81
    Date: 2016
  4. By: Peter Reinhard Hansen (University of North Carolina at Chapel Hill, United States); Pawel Janus (UBS Global Asset Management, Zürich, Switzerland); Siem Jan Koopman (VU University Amsterdam, the Netherlands)
    Abstract: We propose a novel multivariate GARCH model that incorporates realized measures for the variance matrix of returns. The key novelty is the joint formulation of a multivariate dynamic model for outer-products of returns, realized variances and realized covariances. The updating of the variance matrix relies on the score function of the joint likelihood function based on Gaussian and Wishart densities. The dynamic model is parsimonious while each innovation still impacts all elements of the variance matrix. Monte Carlo evidence for parameter estimation based on different small sample sizes is provided. We illustrate the model with an empirical application to a portfolio of 15 U.S. financial assets.
    Keywords: high-frequency data; multivariate GARCH; multivariate volatility; realised covariance; score; Wishart density
    JEL: C32 C52 C58
    Date: 2016–08–11
  5. By: Gilles Boevi Koumou
    Abstract: The conventional wisdom of mean-variance (MV) portfolio theory asserts that the nature of the relationship between risk and diversification is a decreasing asymptotic function, with the asymptote approximating the level of portfolio systematic risk or undiversifiable risk. This literature assumes that investors hold an equally-weighted or a MV portfolio and quantify portfolio diversification using portfolio size. However, the equally-weighted portfolio and portfolio size are MV optimal if and only if asset returns distribution is exchangeable or investors have no useful information about asset expected return and risk. Moreover, the whole of literature, absolutely all of it, focuses only on risky assets, ignoring the role of the risk free asset in the efficient diversification. Therefore, it becomes interesting and important to answer this question: how valid is this conventional wisdom when investors have full information about asset expected return and risk and asset returns distribution is not exchangeable in both the case where the risk free rate is available or not? Unfortunately, this question have never been addressed in the current literature. This paper fills the gap.
    Date: 2016–08
  6. By: Weinert, Jan-Hendrik; Gründl, Helmut
    Abstract: The changing social, financial and regulatory frameworks, such as an increasingly aging society, the current low interest rate environment, as well as the implementation of Solvency II, lead to the search for new product forms for private pension provision. In order to address the various issues, these product forms should reduce or avoid investment guarantees and risks stemming from longevity, still provide reliable insurance benefits and simultaneously take account of the increasing financial resources required for very high ages. In this context, we examine whether a historical concept of insurance, the tontine, entails enough innovative potential to extend and improve the prevailing privately funded pension solutions in a modern way. The tontine basically generates an age-increasing cash flow, which can help to match the increasing financing needs at old ages. However, the tontine generates volatile cash flows, so that - especially in the context of an aging society - the insurance character of the tontine cannot be guaranteed in every situation. We show that partial tontinization of retirement wealth can serve as a reliable supplement to existing pension products.
    Keywords: Life Insurance,Tontines,Annuities,Asset Allocation,Retirement Welfare,Aging Society
    JEL: D14 D91 G11 G22 H75 J11 J14
    Date: 2016
  7. By: Kelly, Robert (Central Bank of Ireland); O'Toole, Conor (Central Bank of Ireland)
    Abstract: This research considers one approach as to how originating lending conditions on debtservice ratios and loan-to-value ratios affect future default risk in the “Buy-to-Let” market. Using a sample of mortgage loans for the UK, we estimate a “double trigger” default model, with originating equity and affordability terms. We find default increasing with originating loan-to-value (OLTV) and falling in original rent coverage (ORC). A non-linear cubic spline model is used to identify threshold effects in the relationship between OLTV, ORC and default, with loans of OLTV greater than 75 and ORC below 1.5 showing a large increase in default risk. These results provide empirical evidence for the non-linear nature of default in these origination terms and provides useful insights into for understanding OLTV and ORC limits in a macro prudential context. In addition, we investigate how multiple loan portfolios interact with these thresholds. While there is no impact on the main findings of 75 and 1.5, there is strong evidence to support tighter restrictions on loans for second and subsequent properties.
    Keywords: Macroprudential, Credit Risk, Mortgages, UK.
    JEL: E32 E51 F30 G21 G28
    Date: 2016–06
  8. By: Adrian, Tobias (Federal Reserve Bank of New York); Stackman, Daniel (Federal Reserve Bank of New York); Vogt, Erik (Federal Reserve Bank of New York)
    Abstract: We estimate a highly significant price of risk that forecasts global stock and bond returns as a nonlinear function of the CBOE Volatility Index (VIX). We show that countries’ exposure to the global price of risk is related to macroeconomic risks as measured by output, credit, and inflation volatility, the magnitude of financial crises, and stock and bond market downside risk. Higher exposure to the global price of risk corresponds to both higher output volatility and higher output growth. We document that the transmission of the global price of risk to macroeconomic outcomes is mitigated by the magnitude of stabilization in the Taylor rule, the degree of countercyclicality of fiscal policy, and countries’ tendencies to employ prudential regulations. The estimated magnitudes are quantitatively important and significant, with large cross-sectional explanatory power. Our findings suggest that macroeconomic and financial stability policies should be considered jointly.
    Keywords: financial stability; monetary policy; fiscal policy; regulatory policy
    JEL: G01 G12 G17
    Date: 2016–08–01
  9. By: Fieker, Michael
    Abstract: Als Reaktion auf die Finanzkrise wurde vom Baseler Ausschuss für Bankenaufsicht das Regelwerk Basel III erstellt. Die neuen regulatorischen Anforderungen zielen auf eine bessere Balance zwischen den eingegangenen Risiken und den vorhandenen Eigenmitteln der Kreditinstitute. Insbesondere werden in der vorliegenden Arbeit die Auswirkungen der neuen Eigenkapital- und Liquiditätsvorschriften sowie der eingeführten Leverage Ratio betrachtet, um anschließend Steuerungsmöglichkeiten der Gesamtbanksteuerung aufzuzeigen. Die Eigenkapitalanforderungen wurden qualitativ und quantitativ erhöht. Durch Basel III wird die Anrechenbarkeit von stillen Einlagen und stillen Reserven als Eigenmittel eingeschränkt. Mit Basel III wird dem Liquiditätsrisiko der gleiche Stellenwert beigemessen wie anderen Risikoarten. Die Liquidity Coverage Ratio und Net Stable Funding Ratio sollen sicherstellen, dass Kreditinstitute in Stresssituationen über ausreichende Liquidität verfügen. Die Leverage Ratio begrenzt die Bilanzaktiva und die außerbilanziellen Positionen unabhängig jeder Risikobetrachtung. Die neuen regulatorischen Anforderungen wirken sich auf sämtliche Geschäftsfelder der Kreditinstitute aus und reduzieren die Profitabilität des Bankgeschäfts.
    Keywords: Basel III,Gesamtbanksteuerung,Kreditinstitute,Stille Reserven,Stille Einlagen,Eigenmittel,Kapitalpuffer,Net Stable Funding Ratio,Liquidity Coverage Ratio,Leverage Ratio
    Date: 2016
  10. By: Schuknecht, Ludger
    Abstract: This study looks at the interrelationship between fiscal policy and safe assets as there is surprisingly little analysis about this beyond fleeting references. The study argues that from a certain point more public debt will not "buy" more safety: countries face a kind of "safe-assets Laffer curve" with a maximum amount of safe assets at some level of indebtedness. The position and "stability" of this curve depend on a number of national and international factors, including the international risk appetite and, as a more recent factor, QE policies by central banks. The study also finds evidence of declining safe assets as reflected in government debt ratings.
    Keywords: fiscal policy,public debt,safe assets,financial markets
    JEL: E62 G10
    Date: 2016
  11. By: Bartram, Söhnke M.; Brown, Gregory W.; Stulz, René M.
    Abstract: From 1963 through 2015, idiosyncratic risk (IR) is high when market risk (MR) is high. We show that the positive relation between IR and MR is highly stable through time and is robust across exchanges, firm size, liquidity, and market-to-book groupings. Though stock liquidity affects the strength of the relation, the relation is strong for the most liquid stocks. The relation has roots in fundamentals as higher market risk predicts greater idiosyncratic earnings volatility and as firm characteristics related to the ability of firms to adjust to higher uncertainty help explain the strength of the relation. Consistent with the view that growth options provide a hedge against macroeconomic uncertainty, we find evidence that the relation is weaker for firms with more growth options.
    Keywords: uncertainty,idiosyncratic risk,market risk,growth options,liquidity,limits to arbitrage
    JEL: G10 G11 G12
    Date: 2016

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