nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒10‒02
twenty-one papers chosen by

  1. Uncertainty in historical Value-at-Risk: an alternative quantile-based risk measure By Dominique Guegan; Bertrand K. Hassani; Kehan Li
  2. Risk-Consistent Conditional Systemic Risk Measures By Hannes Hoffmann; Thilo Meyer-Brandis; Gregor Svindland
  3. Multi-layered interbank model for assessing systemic risk By Montagna, Mattia; Kok, Christoffer
  4. Modeling censored losses using splicing: A global fit strategy with mixed Erlang and extreme value distributions By Tom Reynkens; Roel Verbelen; Jan Beirlant; Katrien Antonio
  5. Bargaining Power, Business Cycle and Levered Equity Risk By Chen, Zhiyao; Strebulaev, Ilya A.
  6. Does Geopolitical Risks Predict Stock Returns and Volatility of Leading Defense Companies? Evidence from a Nonparametric Approach By Nicholas Apergis; Matteo Bonato; Rangan Gupta; Clement Kyei
  7. Strongly Consistent Multivariate Conditional Risk Measures By Hannes Hoffmann; Thilo Meyer-Brandis; Gregor Svindland
  8. Taxation and Corporate Risk-Taking By Langenmayr, Dominika; Lester, Rebecca
  9. Time-Adaptive Probabilistic Forecasts of Electricity Spot Prices with Application to Risk Management. By Brenda López Cabrera; Franziska Schulz; ;
  10. Discrete Sums of Geometric Brownian Motions, Annuities and Asian Options By Dan Pirjol; Lingjiong Zhu
  11. Using Speed and Credit Limits to Address the Procyclicality of Initial Margin at Central Counterparties By Nikil Chande; Nicholas Labelle
  12. Improving Patient’s Satisfaction at Urgent Care Clinics by Using Simulation-based Risk Analysis and Quality Improvement By Sajadnia, Sahar; Heidarzadeh, Elham
  13. "Minsky at Basel: A Global Cap to Build an Effective Postcrisis Banking Supervision Framework" By Giuseppe Mastromatteo; Giuseppe Mastromatteo
  14. Bank capital and dividend externalities By Viral Acharya; Hanh Le; Hyun Song Shin
  15. Endogenous Debt Maturity and Rollover Risk By Emanuele Brancati; Marco Macchiavelli
  16. Russian Federation: Financial Sector Assessment Program; Technical Note-Bank Resolution and Crisis Management Framework By International Monetary Fund.
  17. It Takes a Village to Maintain a Dangerous Financial System By Admati, Anat R.
  18. Dread and Risk Elimination Premium for the Value of a Statistical Life By Olofsson , Sara; Gerdtham, Ulf-G.; Hultkrantz, Lars; Persson, Ulf
  19. An empirical contribution to Minsky’s financial fragility:Evidence from non-financial sectors in Japan By Hiroshi Nishi
  20. The Booms and Busts of Beta Arbitrage By Huang, Shiyang; Lou, Dong; Polk, Christopher
  21. Recollection Bias and Its Underpinnings: Lessons from Terrorism-Risk Assessments By Viscusi, W. Kip; Zeckhauser, Richard J.

  1. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Bertrand K. Hassani (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Kehan Li (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: The financial industry has extensively used quantile-based risk measures relying on the Value-at-Risk (VaR). They need to be estimated from relevant historical data set. Consequently, they contain uncertainty. We propose an alternative quantile-based risk measure (the Spectral Stress VaR) to capture the uncertainty in the historical VaR approach. This one provides flexibility to the risk manager to implement prudential regulatory framework. It can be a VaR based stressed risk measure. In the end we propose a stress testing application for it.
    Keywords: Prudential financial regulation,Stress risk measure,Tail risk measure,Historical method,Uncertainty,Value-at-Risk,Stress testing
    Date: 2016–01
  2. By: Hannes Hoffmann; Thilo Meyer-Brandis; Gregor Svindland
    Abstract: We axiomatically introduce risk-consistent conditional systemic risk measures defined on multidimensional risks. This class consists of those conditional systemic risk measures which can be decomposed into a state-wise conditional aggregation and a univariate conditional risk measure. Our studies extend known results for unconditional risk measures on finite state spaces. We argue in favor of a conditional framework on general probability spaces for assessing systemic risk. Mathematically, the problem reduces to selecting a realization of a random field with suitable properties. Moreover, our approach covers many prominent examples of systemic risk measures from the literature and used in practice.
    Date: 2016–09
  3. By: Montagna, Mattia; Kok, Christoffer
    Abstract: In this paper, we develop an agent-based multi-layered interbank network model based on a sample of large EU banks. The model allows for taking a more holistic approach to interbank contagion than is standard in the literature. A key finding of the paper is that there are material non-linearities in the propagation of shocks to individual banks when taking into account that banks are related to each other in various market segments. The contagion effects when considering the shock propagation simultaneously across multiple layers of interbank networks can be substantially larger than the sum of the contagion-induced losses when considering the network layers individually. In addition, a bank “systemic importance” measure based on the multi-layered network model is developed and is shown to outperform standard network centrality indicators. The finding of non-linear contagion effects when accounting for the interaction between the different layers of banks’ interlinkages have important policy implications. For example, it provides an argument for separating banks’ trading activities from their other intermediation activities. JEL Classification: C45, C63, D85, G21
    Keywords: Financial contagion, interbank market, network theory
    Date: 2016–08
  4. By: Tom Reynkens; Roel Verbelen; Jan Beirlant; Katrien Antonio
    Abstract: In risk analysis, a global fit that appropriately captures the body and the tail of the distribution of losses is essential. Modeling the whole range of the losses using a standard distribution is usually very hard and often impossible due to the specific characteristics of the body and the tail of the loss distribution. A possible solution is to combine two distributions in a splicing model: a light-tailed distribution for the body which covers light and moderate losses, and a heavy-tailed distribution for the tail to capture large losses. We propose a splicing model with a mixed Erlang (ME) distribution for the body and a Pareto distribution for the tail. This combines the flexibility of the ME distribution with the ability of the Pareto distribution to model extreme values. We extend our splicing approach for censored and/or truncated data. Relevant examples of such data can be found in financial risk analysis. We illustrate the flexibility of this splicing model using practical examples from risk measurement.
    Keywords: censoring, composite model, expectation-maximization algorithm, risk measurement, tail modeling
    Date: 2016
  5. By: Chen, Zhiyao (Chinese University of Hong Kong); Strebulaev, Ilya A. (Stanford University)
    Abstract: Bargaining power allows equity holders to recover a fraction of residual assets in bankruptcy, therefore reducing their exposure to default risk. We develop an agency-based model and provide the first evidence via structural estimation that equity holders could extract about 50% of the liquidation surplus from the residual assets. Using a counterfactual experiment, we further demonstrate that bargaining power significantly reduces equity risk, as proxied by stock-cash flow sensitivity. The percentage reduction is 15% during expansions and 36% during recessions for highly leveraged firms, and is 10% during expansions and 26% during recessions for firms with a high book-to-market ratio.
    JEL: G12 G13 G33
    Date: 2016–06
  6. By: Nicholas Apergis (Department of Banking and Financial Management, University of Piraeus, Greece); Matteo Bonato (Department of Economics and Econometrics, University of Johannesburg, South Africa); Rangan Gupta (Department of Economics, University of Pretoria, South Africa); Clement Kyei (Department of Economics, University of Pretoria, South Africa)
    Abstract: We use the k-th order nonparametric causality test at monthly frequency over the period of 1985:1 to 2016:06 to analyze whether geopolitical risks can predict movements in stock returns and volatility of twenty-four global defense firms. The nonparametric approach controls for the existing misspecification of a linear framework of causality, and hence, the mild evidence of causality obtained under the standard Granger tests cannot be relied upon. When we apply the nonparametric test, we find that there is no evidence of predictability of stock returns of these defense companies emanating from the geopolitical risk measure. However, the geopolitical risk index does predict realized volatility in 50 percent of the companies. Our results indicate that while global geopolitical events over a period of time is less likely to predict returns, such global risks are more inclined in affecting future risk profile of defense firms.
    Keywords: Geopolitical risks, returns, volatility, defense firms
    JEL: C22 G10
    Date: 2016–09
  7. By: Hannes Hoffmann; Thilo Meyer-Brandis; Gregor Svindland
    Abstract: We consider families of strongly consistent multivariate conditional risk measures. We show that under strong consistency these families admit a decomposition into a conditional aggregation function and a univariate conditional risk measure as introduced Hoffmann et al. (2016). Further, in analogy to the univariate case in F\"ollmer (2014), we prove that under law-invariance strong consistency implies that multivariate conditional risk measures are necessarily multivariate conditional certainty equivalents.
    Date: 2016–09
  8. By: Langenmayr, Dominika (Catholic University of Eichstatt-Ingolstadt and CESifo, Munich); Lester, Rebecca (Stanford University)
    Abstract: We study whether the corporate tax system provides incentives for risky firm investment. We analytically and empirically show two main findings: first, risktaking is positively related to the length of tax loss periods because the loss rules shift some risk to the government; and second, the tax rate has a positive effect on risk-taking for firms that expect to use losses, and a negative effect for those that cannot. Thus, the sign of the tax effect on risky investment hinges on firm-specific expectations of future loss recovery.
    JEL: G32 H25 H32
    Date: 2016–08
  9. By: Brenda López Cabrera; Franziska Schulz; ;
    Abstract: The increasing exposure to renewable energy has amplied the need for risk management in electricity markets. Electricity price risk poses a major challenge to market participants. We propose an approach to model and fore- cast electricity prices taking into account information on renewable energy production. While most literature focuses on point forecasting, our method- ology forecasts the whole distribution of electricity prices and incorporates spike risk, which is of great value for risk management. It is based on func- tional principal component analysis and time-adaptive nonparametric density estimation techniques. The methodology is applied to electricity market data from Germany. We nd that renewable infeed eects both, the location and the shape of spot price densities. A comparison with benchmark methods and an application to risk management are provided.
    JEL: C1 Q41 Q47
    Date: 2016–08
  10. By: Dan Pirjol; Lingjiong Zhu
    Abstract: The discrete sum of geometric Brownian motions plays an important role in modeling stochastic annuities in insurance. It also plays a pivotal role in the pricing of Asian options in mathematical finance. In this paper, we study the probability distributions of the infinite sum of geometric Brownian motions, the sum of geometric Brownian motions with geometric stopping time, and the finite sum of the geometric Brownian motions. These results are extended to the discrete sum of the exponential L\'evy process. We derive tail asymptotics and compute numerically the asymptotic distribution function. We compare the results against the known results for the continuous time integral of the geometric Brownian motion up to an exponentially distributed time. The results are illustrated with numerical examples for life annuities with discrete payments, and Asian options.
    Date: 2016–09
  11. By: Nikil Chande; Nicholas Labelle
    Abstract: This paper proposes a practical approach to address the procyclicality of initial margin at central counterparties (CCPs) that can work even in periods of extreme stress. The approach allows CCPs to limit the speed of margin increases resulting from spikes in market volatility. To maintain the desired level of risk protection, the model covers, through loss-sharing arrangements, a chosen number of the largest shares of the margin increases that are deemed procyclical. To facilitate adoption of this approach, we allow loss sharing to be capped through the allocation of bilateral credit limits. We undertake an empirical exercise to demonstrate that, even with conservative assumptions, the proposed approach can generate significant margin relief without generating losses that cannot be absorbed by clearing members.
    Keywords: Financial markets, Financial stability, Financial system regulation and policies, Payment clearing and settlement systems
    JEL: G G1 G18
    Date: 2016
  12. By: Sajadnia, Sahar; Heidarzadeh, Elham
    Abstract: Several factors are expected to significantly increase stakeholders’ interest in healthcare simulation studies in the foreseeable future, e.g., the use of metrics for performance measurement, and increasing patients’ expectations. Total time spent by a patient as an important issue leads to patients’ dissatisfaction which should be improved in any healthcare facility. We reported on the use of discrete event simulation modeling, quality function deployment (QFD) and failure mode effects analysis (FMEA) to support process improvements at urgent care clinics. The modeling helped identify improvement alternatives such as optimized healthcare facility staff numbers. It also showed that lack of identified role for all team members and inconsistent process of ordering and receiving blood products and lab results are crucial failures that may occur. Moreover, using experienced staff and forcing staff to follow correct procedures are important technical aspects of improving the urgent care clinics in order to increase patient’s satisfaction. Quantitative results from the modeling provided motivation to implement the improvements. Statistical analysis of data taken before and after the implementation indicate that total time spent by a patient was significantly improved and the after result of waiting time is also decreased.
    Keywords: Urgent care, discrete event simulation, quality function deployment (QFD), failure mode effects analysis (FMEA), process improvement.
    JEL: I1 I11 I15
    Date: 2016–09–05
  13. By: Giuseppe Mastromatteo; Giuseppe Mastromatteo
    Abstract: The global financial crisis shattered the conventional wisdom about how financial markets work and how to regulate them. Authorities intervened to stop the panic -- short-term pragmatism that spoke volumes about the robustness of mainstream economics. However, their very success in taming the collapse reduced efforts to radically change the "big bank" business model and lessened the possibility of serious banking reform -- meaning that a strong and possibly even bigger financial crisis is inevitable in the future. We think an overall alternative is needed and at hand: Minsky's theories on investment, financial stability, the growing weight of the financial sector, and the role of the state. Building on this legacy, it is possible to analyze which aspects of the post-2008 reforms actually work. In this respect, we argue that the only effective solution is to impose a global cap on the absolute size of banks.
    Keywords: Banking Regulation; Financial Stability; Minsky; Basel 3
    JEL: E12 G01 G28
    Date: 2016–09
  14. By: Viral Acharya; Hanh Le; Hyun Song Shin
    Abstract: Dividend payouts affect the relative value of claims within a firm. When firms have contingent claims on each other, as in the banking sector, dividend payouts can shift the relative value of stakeholders' claims across firms. Through this channel, one bank's capital policy affects the equity value and risk of default of other banks. In a model where such externalities are strong, bank capital takes on the attribute of a public good, where the private equilibrium features excessive dividends and inefficient recapitalization relative to the efficient policy that maximizes banking sector equity. We compare the implications of the model with observed bank behavior during the crisis of 2007-09.
    Keywords: bank dividends, capital erosion, systemic risk
    Date: 2016–09
  15. By: Emanuele Brancati; Marco Macchiavelli
    Abstract: We challenge the common view that short-term debt, by having to be rolled over continuously, is a risk factor that exposes banks to higher default risk. First, we show that the average effect of expiring obligations on default risk is insignificant; it is only when a bank has limited access to new funds that maturing debt has a detrimental impact on default risk. Next, we show that both limited access to new funds and shorter maturities are causally determined by deteriorating market expectations about the bank's future profitability. In other words, short-term debt is not a cause of fragility but the result of creditors losing faith in the long-run prospects of the bank, hence forcing it to shorten its debt maturity. Finally, we build a model that endogenizes the debt maturity structure and predicts that worse market expectations lead to a maturity shortening.
    Keywords: Banks ; Debt issuance ; Financial crisis ; Maturity structure ; Rollover risk
    JEL: G01 G21 G32
    Date: 2016–09–09
  16. By: International Monetary Fund.
    Abstract: The experiences of past financial crises have strengthened the Russian bank resolution framework. In December 2014, the framework was updated by consolidating existing resolution regimes, including making permanent the temporary measures introduced in 2008 to deal with the failure of large banks. Key changes included enhancing powers to exchange information with foreign resolution authorities and sanctioning managers of failed banks.
    Date: 2016–09–22
  17. By: Admati, Anat R. (Stanford University)
    Abstract: I discuss the motivations and actions (or inaction) of individuals in the financial system, governments, central banks, academia and the media that collectively contribute to the persistence of a dangerous and distorted financial system and inadequate, poorly designed regulations. Reassurances that regulators are doing their best to protect the public are false. The underlying problem is a powerful mix of distorted incentives, ignorance, confusion, and lack of accountability. Willful blindness seems to play a role in flawed claims by the system's enablers that obscure reality and muddle the policy debate.
    Date: 2016–05
  18. By: Olofsson , Sara (The Swedish Institute for Health Economics (IHE)); Gerdtham, Ulf-G. (Department of Economics, Lund University); Hultkrantz, Lars (Örebro University, School of Business); Persson, Ulf (The Swedish Institute for Health Economics (IHE))
    Abstract: The Value of a Statistical Life (VSL) is a widely used measure of the value of mortality risk reduction. Since VSL should reflect preferences and attitudes to risk, there are reasons to believe that it varies depending on the type of risk involved. It has been argued that cancer should be considered a “dread disease”, which supports the use of a “cancer premium”. The objective of this study is to elicit the existence and size of a cancer premium (for pancreatic cancer and multiple myeloma) in relation to road traffic accidents, sudden cardiac arrest and Amyotrophic Lateral Sclerosis (ALS). Data was collected from 500 individuals in the Swedish general population 50 -74 years old using a web-based questionnaire. Preferences were elicited using the Contingent Valuation method, and a split-sample design was applied to test for scale sensitivity. VSL differs significantly between contexts, being highest for ALS and lowest for road traffic accident. A premium (26-76 %) for cancer was found in relation to road traffic accidents, but not in relation to ALS and sudden cardiac arrest. The premium was higher for cancer with a shorter time from diagnosis to death. Eliminating risk was associated with a premium of around 17 %. Evidence of scale sensitivity was found when comparing WTP for all risks simultaneously. This study shows that there exist a dread premium and risk elimination premium. These factors should be considered when searching for an appropriate value for economic evaluation and health technology assessment.
    Keywords: willingness to pay; value of a statistical life; cancer; contingent valuation; risk elimination
    JEL: D61 D80 I18 J17
    Date: 2016–09–23
  19. By: Hiroshi Nishi
    Abstract: This study presents an empirical analysis to detect Minsky’s financial fragility and its determinants in the non- financial sectors in Japan, with particular attention paid to differences between sectors and sizes. While Minsky developed theoretical analyses of financial fragility for use in economic growth models, its empirical application is limited. Based on the financial fragility indices derived from a cash flow accounting framework and Minsky’s margins of safety, I detect the overall configuration and evolution of financial fragility (hedge, speculative, and Ponzi) in Japan. Then, the factors that determine the probability of being Ponzi finance are detected by using panel logistic regression. In doing so, this study reveals that although speculative finance is dominant in many sectors, the evolution of financial fragility is diversified and its determinants differ according to sector and size in Japan.
    Keywords: Minsky, Financial fragility, Margin of safety, Japanese economy
    JEL: E12 C25 N15
    Date: 2016–09
  20. By: Huang, Shiyang; Lou, Dong; Polk, Christopher
    Abstract: Low-beta stocks deliver high average returns and low risk relative to high-beta stocks, an opportunity for professional investors to “arbitrage†away. We argue that beta-arbitrage activity instead generates booms and busts in the strategy’s abnormal trading profits. In times of low activity, the beta-arbitrage strategy exhibits delayed correction, taking up to three years for abnormal returns to be realized. In stark contrast, when activity is high, prices overshoot as short-run abnormal returns are much larger and then revert in the long run. These cyclical patterns also show up in hedge fund exposures to beta arbitrage, particularly exposures of smaller and thus more nimble funds, and can be linked to the past performance of the strategy. We document a novel positive-feedback channel operating through firm-level leverage that facilitates these boom and bust cycles.
    Keywords: betting against beta; crowded trades; positive-feedback trading
    JEL: G02 G12 G14 G23
    Date: 2016–09
  21. By: Viscusi, W. Kip (Vanderbilt University); Zeckhauser, Richard J. (Harvard University)
    Abstract: Recollection bias is the phenomenon whereby people, after observing a highly unexpected event, hold current risk beliefs about a similar event that are no higher than their recollection of their prior beliefs. This article explores recollection bias in relation to individuals' perceptions of the risks of terrorism attacks. Over 60% of respondents in a national U.S. sample of over 900 adults believe that the risks of a future terrorist attack by either an airplane or in a public setting are no higher than they believed respectively before the 9/11 attack and the Boston Marathon bombing. Only one-fifth of respondents are free of any type of recollection bias. Recollection bias is negatively correlated with absolute levels of risk belief. Recollection bias-basically the belief that perceived risks have not increased-dampens support for a variety of anti-terrorism measures, controlling for the level of risk beliefs and demographic factors. Public attitudes influence policy. Thus, educating the public about risk is critical.
    Date: 2016–01

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