nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒09‒18
eleven papers chosen by

  1. Stress Testing in the Nigerian Banking Sector By FARAYIBI, Adesoji
  2. Firm Age and Size and the Financial Management of Infrequent Shocks By Benjamin L. Collier; Andrew F. Haughwout; Howard C. Kunreuther; Erwann O. Michel-Kerjan; Michael A. Stewart
  3. Risk Management and the Money Multiplier By Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan
  4. Clustering in Dynamic Causal Networks as a Measure of Systemic Risk on the Euro Zone By Monica Billio; Lorenzo Frattarolo; Hayette Gatfaoui; Philippe De Peretti
  5. Closed-form solutions for worst-case law invariant risk measures with application to robust portfolio optimization By Jonathan Yu-Meng Li
  6. The Risk Parity Principle applied on a Corporate Bond Index using Duration Times Spread By Lauren Stagnol
  7. Bayesian Process Networks: An approach to systemic process risk analysis by mapping process models onto Bayesian networks By Oepping, Hardy
  8. Value at risk and the diversification dogma By Arturo Erdely
  9. Realized Matrix-Exponential Stochastic Volatility with Asymmetry, Long Memory and Spillovers By Manabu Asai; Chia-Lin Chang; Michael McAleer
  10. On the optimal design of a Financial Stability Fund By à rpád à brahám; Eva Carceles-Poveda; Yan Liu; Ramon Marimon
  11. The joint distributions of running maximum of a Slepian processes By Pingjin Deng

  1. By: FARAYIBI, Adesoji
    Abstract: This paper examined stress testing in the Nigerian banking sector from 2004-2014 using error correction mechanism (ECM) and Ordinary Least Square (OLS) methodologies. The study adopted the bottom-up approach to stress management. Evidence from the analysis showed that stress testing is important to building a strong and viable financial system in the country. Bank’s going concern depends on profitability, solvency and liquidity whereas banks performance index depends on the behaviours of macroeconomic variables. The study found that Nigerian banking system is susceptible to various risks both within and outside the country. They are also exposed to macroeconomic risks as their performance index is based on these variables. The study concluded that how banks respond to risks determines the going concern and the viability of the nation’s financial system. Thus, a thorough credit risk management framework championed by the major stakeholders involved in the credit disbursement was recommended.
    Keywords: Stress Testing, Banking Sector, Credit Risk, Bottom-up Approach, Performance Index
    JEL: G2 G21 G24
    Date: 2016–09–06
  2. By: Benjamin L. Collier; Andrew F. Haughwout; Howard C. Kunreuther; Erwann O. Michel-Kerjan; Michael A. Stewart
    Abstract: Age and size distinctly affect firms’ financial management of infrequent risks. We examine a rare, severe event using detailed firm-level data collected following Hurricane Sandy in the New York area. Our results follow recent contributions from dynamic risk management theory, namely that larger firms are more likely to insure and to use credit after a shock. We build on this theory, showing tradeoffs between managing frequent versus infrequent risks: young firms, exposed to many risks, do not insure against infrequent events and are ex post credit constrained. Consequently, younger firms and smaller firms disproportionately bore the costs of the shock.
    JEL: D22 G22 G28 G32 L25 Q54
    Date: 2016–09
  3. By: Tatiana Damjanovic (Durham Business School); Vladislav Damjanovic (Durham Business School); Charles Nolan (Adam Smith Business School, University of Glasgow)
    Abstract: The conventional model of bank liquidity risk management predicts a negative relation between the risk free rate and the money multiplier. We extend that model to reflect credit, or loan book, risk. We find that credit risk model predicts a positive correlation between the risk free rate and the money multiplier, other things constant. In the pre-financial crisis period the liquidity risk view fits the data better whilst in the post-crisis period, the credit risk management model is more appropriate in explaining the relationship between the money multiplier and the risk free rate. In addition, the model implies that the money multiplier should increase with stock market return and decline with its volatility. We provide evidence that this is indeed the case
    Keywords: Credit risk management, Excess reserves, Money multiplier.
    Date: 2016–06
  4. By: Monica Billio (Università Ca' Foscari of Venice - Department of Economics); Lorenzo Frattarolo (Università Ca' Foscari of Venice - Department of Economics); Hayette Gatfaoui (IESEG - School of Management (LEM), CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Philippe De Peretti (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: In this paper, we analyze the dynamic relationships between ten stock exchanges of the euro zone using Granger causal networks. Using returns for which we allow the variance to follow a Markov-Switching GARCH or a Changing-Point GARCH, we first show that over different periods, the topology of the network is highly unstable. In particular, over very recent years, dynamic relationships vanish. Then, expanding on this idea, we analyze patterns of information transmission. Using rolling windows to analyze the topologies of the network in terms of clustering, we show that the nodes' state changes continually, and that the system exhibits a high degree of flickering in information transmission. During periods of flickering, the system also exhibits desynchronization in the information transmission process. These periods do precede tipping points or phase transitions on the market, especially before the global financial crisis, and can thus be used as early warnings of phase transitions. To our knowledge, this is the first time that flickering clusters are identified on financial markets, and that flickering is related to phase transitions.
    Keywords: Causal Network,Topology,Clustering,Flickering,Desynchronisation,Phase transitions
    Date: 2016–05
  5. By: Jonathan Yu-Meng Li
    Abstract: Worst-case risk measures refer to the calculation of the largest value for risk measures when only partial information of the underlying distribution is available. For the popular risk measures such as Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR), it is now known that their worst-case counterparts can be evaluated in closed form when only the first two moments are known for the underlying distribution. These results are remarkable since they not only simplify the use of worst-case risk measures but also provide great insight into the connection between the worst-case risk measures and existing risk measures. We show in this paper that somewhat surprisingly similar closed-form solutions also exist for the general class of law invariant coherent risk measures, which consists of spectral risk measures as special cases that are arguably the most important extensions of CVaR. We shed light on the one-to-one correspondence between a worst-case law invariant risk measure and a worst-case CVaR (and a worst-case VaR), which enables one to carry over the development of worst-case VaR in the context of portfolio optimization to the worst-case law invariant risk measures immediately.
    Date: 2016–09
  6. By: Lauren Stagnol
    Abstract: In this paper, we apply the principle of Equal Risk Contribution (ERC) to a corporate bond index, an asset class so far left behind in this literature. Specifically, we rely on the Duration Time Spread (DTS) and demonstrate that it is an coherent metric for bond risk. We construct indexes based on sector - issuer - and bond level using structured block correlation matrices, weights being inversely proportional to DTS. Our results provide evidence that applying ERC using DTS in the index design significantly improves corporate bond index risk-adjusted returns. It appears that the higher the granularity is, the higher will be the risk adjusted performance enhancements. More generally, the ERC application we present appears to be a valuable trade-off between heuristic and more complex risk-modeling based weighting schemes.
    Keywords: Equal Risk Contribution, Risk Parity, Smart Beta, Risk Measure, Risk-Based Indexing, Alternative Corporate Bond Index.
    JEL: G10 G11 C60
    Date: 2016
  7. By: Oepping, Hardy
    Abstract: This paper presents an approach to mapping a process model onto a Bayesian network resulting in a Bayesian Process Network, which will be applied to process risk analysis. Exemplified by the model of Event-driven Process Chains, it is demonstrated how a process model can be mapped onto an isomorphic Bayesian network, thus creating a Bayesian Process Network. Process events, functions, objects, and operators are mapped onto random variables, and the causal mechanisms between these are represented by appropriate conditional probabilities. Since process risks can be regarded as deviations of the process from its reference state, all process risks can be mapped onto risk states of the random variables. By example, we show how process risks can be specified, evaluated, and analysed by means of a Bayesian Process Network. The results reveal that the approach presented herein is a simple technique for enabling systemic process risk analysis because the Bayesian Process Network can be designed solely on the basis of an existing process model.
    Keywords: process models; process modelling; process chains; risk management; risk analysis; risk assessment; risk models; Bayesian networks; isomorphic mapping
    JEL: C11 L23 M10 M11
    Date: 2016–09–07
  8. By: Arturo Erdely
    Abstract: The so-called risk diversification principle is analyzed, showing that its convenience depends on individual characteristics of the risks involved and the dependence relationship among them. ----- Se analiza el principio de diversificaci\'on de riesgos y se demuestra que no siempre resulta mejor que no diversificar, pues esto depende de caracter\'isticas individuales de los riesgos involucrados, as\'i como de la relaci\'on de dependencia entre los mismos.
    Date: 2016–09
  9. By: Manabu Asai (Soka University, Japan); Chia-Lin Chang (National Chung Hsing University, Taiwan); Michael McAleer (National Tsing Hua University, Taiwan; Erasmus School of Economics, Erasmus University Rotterdam; Complutense University of Madrid, Spain; Yokohama National University, Japan)
    Abstract: The paper develops a novel realized matrix-exponential stochastic volatility model of multivariate returns and realized covariances that incorporates asymmetry and long memory (hereafter the RMESV-ALM model). The matrix exponential transformation guarantees the positive-definiteness of the dynamic covariance matrix. The contribution of the paper ties in with Robert Basmann’s seminal work in terms of the estimation of highly non-linear model specifications (“Causality tests and observationally equivalent representations of econometric models”, Journal of Econometrics , 1988, 39(1-2), 69–104), especially for developing tests for leverage and spillover effects in the covariance dynamics. Efficient importance sampling is used to maximize the likelihood function of RMESV-ALM, and the finite sample properties of the quasi-maximum likelihood estimator of the parameters are analysed. Using high frequency data for three US financial assets, the new model is estimated and evaluated. The forecasting performance of the new model is compared with a novel dynamic realized matrix-exponential conditional covariance model. The volatility and co-volatility spillovers are examined via the news impact curves and the impulse response functions from returns to volatility and co-volatility.
    Keywords: Matrix-exponential transformation; Realized stochastic covariances; Realized conditional covariances; Asymmetry; Long memory; Spillovers; Dynamic covariance matrix; Finite sample properties; Forecasting performance
    JEL: C22 C32 C58 G32
    Date: 2016–09–12
  10. By: à rpád à brahám; Eva Carceles-Poveda; Yan Liu; Ramon Marimon
    Date: 2016
  11. By: Pingjin Deng
    Abstract: Consider the Slepian process $S$ defined by $ S(t)=B(t+1)-B(t),t\in [0,1]$ with $B(t),t\in \R$ a standard Brownian motion.In this contribution we analyze the joint distribution between the maximum $m_{s}=\max_{0\leq u\leq s}S(u)$ certain and the maximum $M_t=\max_{0\leq u\leq t}S(u)$ for $0
    Date: 2016–09

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