nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒09‒11
twenty-one papers chosen by

  1. Measuring Concentration Risk - A Partial Portfolio Approach By Pierpaolo Grippa; Lucyna Gornicka
  2. Value-at-Risk with Application of DCC-GARCH Model By Tomas Meluzin; Marek Zinecker; Michal Bernard Pietrzak; Marcin Faldzinski; Adam P. Balcerzak
  3. Foreign Bank Subsidiaries’ Default Risk during the Global Crisis; What Factors Help Insulate Affiliates from their Parents? By Deniz Anginer; Eugenio M Cerutti; Maria Soledad Martinez Peria
  4. Intertemporal stability of survey-based measures of risk and time preferences over a three-year course By Drichoutis, Andreas C.; Vassilopoulos, Achilleas
  5. Network, Market, and Book-Based Systemic Risk Rankings By Michiel C.W. van de Leur; Andre Lucas
  6. Peer-to-Peer Lending – A (Financial Stability) Risk Perspective By Benjamin Käfer
  7. Short Selling in the Tails By Marco Valerio Geraci; Tomas Garbaravicius; David Veredas
  8. Contractionary Volatility or Volatile Contractions? By Stefano Giglio; Ian Dew-Becker; David Berger
  9. The importance of governance and risk management in corporate finance: An empirical analysis of financing and interest rate risks By Happ, Christian
  10. Germany; Financial Sector Assessment Program-Stress Testing the Banking and Insurance Sectors-Technical Notes By International Monetary Fund. Monetary and Capital Markets Department
  11. United Kingdom; Financial Sector Assessment Program-Review of the Bank of England’s Liquidity Provision Framework-Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  12. United Kingdom; Financial Sector Assessment Program-Supervision and Systemic Risk Management of Financial Market Infrastructures-Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  13. Germany; Financial Sector Assessment Program-Crisis Preparedness, Bank Resolution and Crisis Management Frameworks-Technical Notes By International Monetary Fund. Monetary and Capital Markets Department
  14. United Kingdom; Financial Sector Assessment Program-Systemic Risk and Interconnectedness Analysis-Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  15. United Kingdom; Financial Sector Assessment Program-Stress Testing the Banking Sector-Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  16. Romania; Technical Assistance Report- Improving Compliance Risk Management of Large Taxpayers By International Monetary Fund. Fiscal Affairs Dept.
  17. Germany; Financial Sector Assessment Program-Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  18. United Kingdom; Financial Sector Assessment Program-Basel Core Principles for Effective Banking Supervision-Detailed Assessment Report By International Monetary Fund. Monetary and Capital Markets Department
  19. Russian Federation; Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department
  20. United Kingdom; Financial Sector Assessment Program-The Bank of England’s Stress Testing Framework-Technical Note By International Monetary Fund. Monetary and Capital Markets Department
  21. Ireland; Financial System Stability Assessment By International Monetary Fund. Monetary and Capital Markets Department

  1. By: Pierpaolo Grippa; Lucyna Gornicka
    Abstract: Concentration risk is an important feature of many banking sectors, especially in emerging and small economies. Under the Basel Framework, Pillar 1 capital requirements for credit risk do not cover concentration risk, and those calculated under the Internal Ratings Based (IRB) approach explicitly exclude it. Banks are expected to compensate for this by autonomously estimating and setting aside appropriate capital buffers, which supervisors are required to assess and possibly challenge within the Pillar 2 process. Inadequate reflection of this risk can lead to insufficient capital levels even when the capital ratios seem high. We propose a flexible technique, based on a combination of “full†credit portfolio modeling and asymptotic results, to calculate capital requirements for name and sector concentration risk in banks’ portfolios. The proposed approach lends itself to be used in bilateral surveillance, as a potential area for technical assistance on banking supervision, and as a policy tool to gauge the degree of concentration risk in different banking systems.
    Keywords: Banking sector;Loan concentration;Credit risk;Capital requirements;Bank regulations;Bank supervision;concentration risk, Basel capital requirements, Pillar 2, Credit VaR.
    Date: 2016–08–02
  2. By: Tomas Meluzin (Brno University of Technology, Czech Republic); Marek Zinecker (Brno University of Technology, Czech Republic); Michal Bernard Pietrzak (Nicolaus Copernicus University, Poland); Marcin Faldzinski (Nicolaus Copernicus University, Poland); Adam P. Balcerzak (Nicolaus Copernicus University, Poland)
    Abstract: The article concentrates on modelling of volatility of capital markets and estimation of Value-at-Risk. The aim of the article is the description of volatility and interdependencies among three indices: WIG (Poland), DAX (Germany) and DJIA (United States). In order to measure the volatility and strength of interdependencies DCC-GARCH-In model was used, where an impact of the volatility of other markets is additionally taken into consideration during construction of the model. The conducted research for the years 2000-2012 confirmed the presence of interactions among selected capital markets. Next, the model DCC-GARCH-In was applied for evaluation of Value-at-Risk and the obtained measure was assessed with application of backtesting procedure. The results confirm that including volatility in the variance in DCC-GARCH-In model enables better assessment of VaR measure.
    Keywords: capital market, value-at-risk, backtesting, DCC-GARCH model, conditional variance
    JEL: G15 C58
    Date: 2016–09
  3. By: Deniz Anginer; Eugenio M Cerutti; Maria Soledad Martinez Peria
    Abstract: This paper examines the association between the default risk of foreign bank subsidiaries in developing countries and their parents during the global financial crisis, with the purpose of determining the size and sign of this correlation and, more importantly, understanding what factors can help insulate affiliates from their parents. We find evidence of a significant and robust positive correlation between parent banks’ and foreign subsidiaries’ default risk. This correlation is lower for subsidiaries that have a higher share of retail deposit funding and that are more independently managed from their parents. Host country bank regulations also influence the extent to which shocks to the parents affect the subsidiaries’ default risk. In particular, the correlation between the default risk of subsidiaries and their parents is lower for subsidiaries operating in countries that impose higher capital, reserve, provisioning, and disclosure requirements, and tougher restrictions on bank activities.
    Keywords: Foreign banks;Default;Financial risk;Cross-border banking;Bank regulations;Developing countries;Global Financial Crisis 2008-2009;Banking crises, default risk, ring-fencing, bank subsidiaries, distance to default, Merton model.
    Date: 2016–06–08
  4. By: Drichoutis, Andreas C.; Vassilopoulos, Achilleas
    Abstract: Given the importance of risk and time preferences for economics and other disciplines, we seek to examine the intertemporal stability of six related survey-based measures. Using a panel of subjects over a three-year course, between 2013 and 2015, we find aggregate stability of all six measures over the time span of our data. With few exceptions, the measures also show remarkably high individual stability over the examined period. Our results contribute to the wider adoption of survey-based measures, especially considering the ease with which such measures can be incorporated in large-scale surveys.
    Keywords: Delay Discounting; Risk Taking; Risk perception
    JEL: D80 D90
    Date: 2016–08–29
  5. By: Michiel C.W. van de Leur (VU University Amsterdam, the Netherlands); Andre Lucas (VU University Amsterdam, the Netherlands)
    Abstract: We investigate the information content of stock correlation based network measures for systemic risk rankings, such as SIFIRank (based on Google's PageRank). Using European banking data, we first show that SIFIRank is empirically equivalent to a ranking based on average pairwise stock correlations. Next, we find that correlation based network measures still appear to complement currently available systemic risk ranking methods based on book or market values. A further analytical investigation, however, shows that the value-added appears to be mainly attributable to pairwise cross-sectional heterogeneity rather than to more subtle network relations and feedback loops.
    Keywords: Systemically Important Financial Institutions (SIFI); European banking sector; systemic risk rankings; network based risk measures
    JEL: G01 G21
    Date: 2016–09–08
  6. By: Benjamin Käfer (University of Kassel)
    Abstract: The aim of this paper is to discuss P2P lending, a subcategory of crowdfunding, from a (financial stability) risk perspective. The discussion focuses on a number of dimensions such as the role of soft information, herding, platform default risk, liquidity risk, and the institutionalization of P2P markets. Overall, we conclude that P2P lending is more risky than traditional banking. However, it is important to recognize that a constant conclusion would be misleading. P2P platforms have evolved and changed their appearance markedly over time, which implies that although our final conclusion of increased riskiness through P2P markets remains valid over time, it is based on different arguments at different points in time. In addition, we discuss that acting on P2P online platforms satisfies most possible definitions of shadow banking and shows significant similarities with many observed aspects of shadow banking. We thus infer that P2P lending can be considered part of the shadow banking sector.
    Keywords: Peer-to-peer lending, crowdfunding, financial development, financial stability risk, shadow banking
    JEL: F34 G21 G23
    Date: 2016
  7. By: Marco Valerio Geraci; Tomas Garbaravicius; David Veredas
    Abstract: Short selling plays a crucial role for price discovery and liquidity purposes yetnational governing authorities decided to ban short selling in periods of extreme pricemovements, on the grounds that short selling can exacerbate price downturns. Whereasmost of the literature analyses the average relation between short selling and pricechanges, our study focuses on the relation that occurs during extreme events, usinga new paradigm that stems from the literature on tail correlations. For the largestEuropean and US banks, as well as European insurers, we uncover a very strong relationwhen both variables are in their tails. In normal times, no negative association is found,which favours the view that short sellers act as price stabilizers. But during turmoil,short selling relates with excessive price drops that can put the market under seriousstress.
    JEL: G15 G18 G28
    Date: 2016–09
  8. By: Stefano Giglio (University of Chicago); Ian Dew-Becker (Northwestern University); David Berger (Northwestern University)
    Abstract: Innovations in realized volatility are associated with recessions, while shocks to volatility expectations are not.
    Date: 2016
  9. By: Happ, Christian
    Abstract: The dissertation deals with corporate governance and risk management from an empirical corporate finance perspective. Three specific aspects are scrutinized in detail: (1) the governance role of capital structure and ownership structure as well as their respective contribution to firm value, (2) the importance of corporate governance in the process of equity capital increases, and (3) the management of interest rate risk by means of forecasting target rate changes by monetary policy authorities. First, the literature review reveals that capital structure and ownership structure constitute important components of the overall corporate governance framework of the firm. Based on the prevailing separation of ownership and control in (listed) corporations, the chapter focuses on the resulting agency problems and provides an overview of how capital and ownership structure can alleviate these problems. Mitigating agency problems can be accomplished for example through increasing leverage in order to put pressure on the management to generate the required minimum cash flows or by incentivizing managers through managerial share ownership. The main contribution of this chapter is the finding that managers cannot generate firm value simply by setting an optimal capital and ownership structure. Instead, corporate financial policies are jointly optimized in equilibrium and additionally depend on the prevailing level of alternative internal and external corporate governance mechanisms and provisions. In this context, the chapter emphasizes the importance of endogeneity and the relevance of accurately accounting for it in empirical investigations in this research field. Finally, open issues in the literature and avenues for future research are addressed. Second, the role of governance in the context of seasoned equity offerings of real estate companies is scrutinized. Using a 4-factor model event study, average decreases in shareholder value of one percent are documented upon announcement of seasoned equity offerings. Further analyses illustrate that companies with a rather concentrated ownership structure, lower leverage, and less disposable cash experience less negative announcement effects. Therefore, the results suggest that firms with good corporate governance, as indicated by concentrated ownership which facilitates effective monitoring, and a lower probability of overinvestment problems, as indicated by lower cash amounts on firms’ balance sheets, are less likely suspected of squandering the offering proceeds. The chapter therefore concludes that investors evaluate the potential for active monitoring by shareholders on the one hand and the risk of empire building by the management on the other hand when they assess the impact of capital increases. Thus, companies with sound corporate governance and investment policy suffer lower losses in shareholder value. Moreover, the analysis reveals that firms were consistently able to issue equity, even during periods of financial turmoil such as the financial crisis. This is a positive signal for both managers and regulators. Third, the final chapter highlights the risk management perspective of the dissertation by focusing on interest rate changes. The rapid deterioration of credit market conditions during the global financial crisis has emphasized that interest rate risk management is essential. A suitable instrument for this purpose is presented in this chapter which studies target interest rate decisions by the Federal Reserve. These monetary policy decisions significantly affect interest rates on debt markets and thus the financing opportunities of companies (e.g. Kuttner 2001; Swanson/Williams 2014). In order to predict changes of the federal funds target rate, market expectations of future monetary policy are recovered using the prices of federal funds derivatives. Subsequently, changes of these expectations upon the release of macroeconomic news, such as employment or inflation data, are studied using event study methodology. The analysis reveals the following important findings. Prior to 2007, changes in monetary policy expectations are generally consistent with a Taylor rule in which employment-related news dominate whereas inflation-related announcements only have a minor impact. However, the findings change significantly with the beginning of the financial crisis and the approach of the zero lower bound in 2007 and 2008. Monetary policy expectations hardly react to macroeconomic announcements anymore. This suggests that market participants expected a considerable period of monetary policy without any target rate changes irrespective of the macroeconomic development. This seems reasonable due to the overall negative economic outlook by that time and a target rate virtually at zero percent. The results provide new evidence for the existence of different US monetary policy regimes depending on the state of the economy. The onset of the financial crisis seems to have triggered a regime switch. Thus, the chapter also illustrates the importance of adapting interest rate forecasting tools to account for possible policy regime switches, asymmetric distribution of future interest rates, and unconventional monetary policy measures. Only in this way, reasonable expectations of future interest rates can be formed and firms are enabled to manage interest rate risk accordingly.
    Date: 2016–04–14
  10. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper assesses Germany’s financial system and, in particular, its potential for spillover risk. The analysis comprises structural and financial statement analyses, detailed stress tests for banks and insurance companies, and spillover risk analysis. Solvency and liquidity stress tests cover all 1,776 banks operating in Germany, and insurance-sector analysis covers 93 percent of the life insurance sector in terms of the assets. Germany is highly interconnected through trade and financial channels. The total consolidated claims of German banks on foreign banks, nonbank private sector, and public sector stood at about $1.7 trillion in the second quarter of 2015, with the majority of cross-border exposures vis-Ã -vis France, Italy, the United Kingdom, and the United States.
    Keywords: Financial Sector Assessment Program;Banking sector;Liquidity;Credit risk;Insurance;Stress testing;Risk management;Germany;
    Date: 2016–06–29
  11. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper provides a review of the liquidity provision framework and recent developments in the United Kingdom. The Bank of England’s (BoE’s) Sterling Monetary Framework is the mechanism used in the United Kingdom to direct liquidity provision. The BoE’s relatively wide-ranging and accessible liquidity insurance framework raises three key questions and four other issues relevant to financial stability. The quantification of implications of the liquidity framework for the BoE balance sheet is still a work in progress. Safeguards are generally sufficient, although the BoE should ensure that lower level of supervisory scrutiny directed at small- and medium-sized enterprises does not adversely impact its horizon-scanning for firms at risk of requiring liquidity support.
    Keywords: Financial Sector Assessment Program;Central banks;Liquidity;Insurance;Monetary policy;Financial stability;Risk management;United Kingdom;liquidity, insurance, market, monetary fund, future
    Date: 2016–06–17
  12. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: The main objective of this technical note is to analyze the supervision and systemic risk management of financial market infrastructures (FMIs) in the United Kingdom. It focuses on the supervision of FMIs, including the regulatory framework, supervisory practices, available resources, transparency, adoption of international standards and coordination and cooperation mechanisms among authorities, both domestically and cross-border; identification and management of interdependencies among FMIs, clearing members and markets, as well as other mechanisms for monitoring of system-wide risks that may exacerbate a crisis and impact financial stability in the United Kingdom and worldwide; and recovery and resolution of FMIs as relatively new instruments to sustain critical operations and services.
    Keywords: United Kingdom;market, settlement, financial market, market infrastructures, monetary fund
    Date: 2016–06–17
  13. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper analyzes the crisis preparedness and crisis management frameworks for German banks. Banks dominate German financial system and represent one of the largest small- and medium-sized banking segments in the EU. The banking sector is a three-pillar system with a total of nearly 1,800 institutions. Both at the EU level and at domestic German level a range of legal instruments have been adopted that collectively establish a complex framework for bank resolution and crisis preparedness and management in financial sector. The Single Supervisory Mechanism Regulation has conferred specific tasks on the European Central Bank concerning prudential supervision of banks including the adoption of early intervention measures and a requirement that banks prepare recovery plans.
    Keywords: Financial Sector Assessment Program;Banks;Bank resolution;Financial safety nets;Deposit insurance;Crisis prevention;Risk management;Germany;
    Date: 2016–06–29
  14. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper summarizes the assessment of interconnectedness and systemic risk undertaken for the U.K. financial system as part of the Financial Sector Assessment Program. It consists of three parts, focusing on the following: (1) motivation for monitoring cross-sector interconnectedness as part of the financial system’s resilience assessment, (2) description of selected empirical methods that may be employed to analyze interconnectedness, and (3) an illustrative analysis conducted, based on a definition of the financial system that incorporates U.K. banking and life insurance sectors. The assessment of financial system resilience should account for the evolution of interconnectedness between firms and sectors.
    Keywords: United Kingdom;Europe;banks, risk, banking, insurance, systemic risk
    Date: 2016–06–17
  15. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper discusses how Financial Sector Assessment Program (FSAP) stress test assesses the resilience of the banking sector as a whole rather than the capital adequacy of individual institutions. The FSAP approach to stress testing is essentially macroprudential: it focuses on resilience of the broader financial system to adverse macro-financial conditions rather than on resilience of individual banks to specific shocks. This test ensures consistency in macroeconomic scenarios and metrics across firms to facilitate the assessment of the banking system as a whole. The stress test analysis is intended to help country authorities to identify key sources of systemic risk in the banking sector and inform macroprudential policies to enhance its resilience to absorb shocks.
    Keywords: Europe;United Kingdom;banks, risk, bank, banking, credit
    Date: 2016–06–17
  16. By: International Monetary Fund. Fiscal Affairs Dept.
    Abstract: Further technical assistance is needed. Implementing modern risk-based methods in the LTO will require follow up FAD technical assistance to progress the advice provided in this report. This technical assistance should include translation of key risk-based compliance management documents to help the broader dissemination and acceptance of the approach. Translation of key documents provided during this TA mission (see Appendix IX) would greatly assist the dissemination of modern risk-based concepts and understanding to a larger group of LTO and NAFA officials
  17. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper evaluates the risks and vulnerabilities of the German financial system and reviews both the German regulatory and supervisory framework and implementation of the common European framework insofar as it is relevant for Germany. The country is home to two global systemically important financial institutions, Deutsche Bank AG and Allianz SE. The system is also very heterogeneous, with a range of business models and a large number of smaller banks and insurers. The regulatory landscape has changed profoundly with strengthened solvency and liquidity regulations for banks (the EU Capital Requirements Regulation and Directive IV), and the introduction of macroprudential tools.
    Keywords: Financial system stability assessment;Economic growth;Financial sector;Banks;Insurance;Financial risk;Spillovers;Stress testing;Bank supervision;Financial safety nets;Economic indicators;Financial soundness indicators;Reports on the Observance of Standards and Codes;Germany;
    Date: 2016–06–29
  18. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper provides detailed assessment of observance on the Basel Core Principles for Effective Banking Supervision. The current assessment took place during a period of continuing development and transition. It is based on the assessors’ understanding of the current state of the supervisory approach, but also incorporates, where relevant, the available information about changes expected in the near future. Stress testing has become a critical supervisory tool that encourages firms and supervisors to adopt a more forward-looking view on the strength of their balance sheets and resilience to shocks. The emphasis on stress testing has encouraged firms to strengthen their internal analytical and risk-management capabilities.
    Keywords: Financial Sector Assessment Program;Anti-money laundering;Combating the financing of terrorism;Transparency;Banking sector;Bank supervision;Corporate sector;United Kingdom;risk, banking, capital, banks, services
    Date: 2016–06–17
  19. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper discusses key findings of the Financial System Stability Assessment of Russian Federation. The Russian banking system is weak and likely to need additional capital. Even in the baseline scenario, certain banks will need new capital owing to low profitability and increasing credit losses. The required resources increase in the stress scenarios, but remain manageable. Bank regulation and supervision have greatly improved in recent years, but there is more to be done. Key areas for improvement include related party lending, country and transfer risks, operational risks, and supervisory interactions with external auditors. In addition, the implementation of risk-based supervision is also in progress.
    Keywords: Financial system stability assessment;Economic recession;Banking sector;Liquidity management;Stress testing;Bank supervision;Bank regulations;Anti-money laundering;Combating the financing of terrorism;Macroprudential Policy;Capital markets;Insurance;Economic indicators;Russian Federation;
    Date: 2016–07–13
  20. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper discusses the Bank of England’s (BoE’s) stress testing program, including both the concurrent stress test and the stress testing done by the banks through the Internal Capital Adequacy Assessment Process, though with a clear focus on the former. The stress test is meant to generate information on potential vulnerabilities of the system to emerging and growing risks, both financial and in the real economy. The main purpose of the stress testing framework is to provide a forward-looking, quantitative assessment of capital adequacy of the U.K. banking system as a whole, and individual institutions within it. The stress-testing program is evaluated along five dimensions: scope of coverage, scenario design, analytical infrastructure, disclosure, and governance.
    Keywords: United Kingdom;Europe;banks, bank, capital, risk, banking
    Date: 2016–06–17
  21. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper discusses key findings of the Financial System Stability Assessment for Ireland. The Irish financial system has strengthened significantly since the crisis and undergone major structural changes. Important vulnerabilities in the banking system relate to the real-estate sector, some parts of the corporate sector, the sovereign, and funding in pound sterling. Pockets of weakness remain, notably among highly leveraged households and smaller domestic firms. Over the medium term, technological innovations and shifts in competitive pressures will throw up challenges to the profitability of both banks and nonbank financial institutions. The U.K. vote to leave the EU is also very likely to have negative effects on the Irish financial system.
    Keywords: Financial system stability assessment;Financial sector;Banks;Bank resolution;Stress testing;Securities markets;Insurance;Pensions;Financial safety nets;Macroprudential Policy;Economic indicators;Financial soundness indicators;Financial stability;Ireland;
    Date: 2016–07–28

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