
on Risk Management 
Issue of 2016‒10‒23
seventeen papers chosen by 
By:  Gambacorta, Leonardo; Karmakar, Sudipto 
Abstract:  The global financial crisis has highlighted the limitations of risksensitive bank capital ratios. To tackle this problem, the Basel III regulatory framework has introduced a minimum leverage ratio, defined as a bankâ€™s Tier 1 capital over an exposure measure, which is independent of risk assessment. Using a medium sized DSGE model that features a banking sector, financial frictions and various economic agents with differing degrees of creditworthiness, we seek to answer three questions: 1) How does the leverage ratio behave over the cycle compared with the riskweighted asset ratio? 2) What are the costs and the benefits of introducing a leverage ratio, in terms of the levels and volatilities of some key macro variables of interest? 3) What can we learn about the interaction of the two regulatory ratios in the long run? The main answers are the following: 1) The leverage ratio acts as a backstop to the risksensitive capital requirement: it is a tight constraint during a boom and a soft constraint in a bust; 2) the net benefits of introducing the leverage ratio could be substantial; 3) the steady state value of the regulatory minima for the two ratios strongly depends on the riskiness and the composition of bank lending portfolios. 
Keywords:  Bank Capital Buffers; leverage; regulation; RiskWeighted Assets 
JEL:  G21 G28 G32 
Date:  2016–10 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:11567&r=rmg 
By:  Dominique Guegan (Centre d'Economie de la Sorbonne); Bertrand K. Hassani (Grupo Santander et Centre d'Economie de la Sorbonne); Kehan Li (Centre d'Economie de la Sorbonne) 
Abstract:  Though risk measurement is the core of most regulatory document, in both financial and insurance industries, risk managers and regulators pay little attention to the random behaviour of risk measures. To address this uncertainty, we provide a novel way to build a robust parametric confidence interval (CI) of ValueatRisk (VaR) for different lengths of samples. We compute this CI from a saddlepoint approximation of the distribution of an estimator of VaR. Based on the CI, we create a spectrum representation that represents an area that we use to define a risk measure. We apply this methodology to risk management and stress testing providing an indicator of threats caused by events uncaptured in the traditional VaR methodology which can lead to dramatic failures 
Keywords:  Financial regulation; ValueatRisk; Order statistic; Uncertainty; Saddlepoint approximation; Stress testing 
JEL:  C14 D81 G28 G32 
Date:  2016–04 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:16034r&r=rmg 
By:  Ion Lapteacru (Larefi  Laboratoire d'analyse et de recherche en économie et finance internationales  Université Montesquieu  Bordeaux 4) 
Abstract:  This paper raises questions about the consistency of the Zscore, which is the most applied accountingbased measure of bank risk. In spite of its advantage, namely the concept of risk on which it relies, the traditional formula is precisely inconsistent with its own concept. The Zscore is deduced from the probability that bank’s losses exceed its capital, but under the very unrealistic assumption of normally distributed returns on assets. Consequently, we show that the traditional Zscore fails to consider correctly the distribution of banks’ returns. To make the Zscore consistent and preserve its original concept of risk, we propose more flexible distribution functions. Between skew normal and stable distributions, we prove that the latter fits the best the distribution of banks’ returns and therefore provides more reliable results for the Zscore. An application on the experience of the Central and Eastern European banks confirms this theoretical prove. 
Keywords:  Zscore, Bank risk, Central and Eastern European economies 
Date:  2016–04–13 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01301846&r=rmg 
By:  Pierluigi Bologna (Bank of Italy); Anatoli Segura (Bank of Italy) 
Abstract:  In the postcrisis era banks’ capital adequacy is established by the Basel III capital standards and, in many jurisdictions, also by supervisory stress tests. In this paper we first describe the ways in which supervisory stress tests can supplement the riskbased capital framework of Basel III and how this could be codified with a stress test buffer. We then argue that in order to ensure coherence with the macroprudential objectives of Basel III, the severity of supervisory stress tests should be procyclical. In addition, to increase the transparency and predictability of the overall capital framework, severity choices should follow a constrained discretion approach based on a simple rule. Finally, we analyze supervisory stress testing practices across some jurisdictions and find that while the United States and the UK frameworks are in line with some of the elements of our proposal, including most notably the need for procyclical severity, this is not the case in the euro area. 
Keywords:  stress test, capital regulation, macroprudential policy 
JEL:  G21 G28 
Date:  2016–10 
URL:  http://d.repec.org/n?u=RePEc:bdi:opques:qef_360_16&r=rmg 
By:  Janda, Karel; Kravtsov, Oleg 
Abstract:  In this paper we discuss the implications of the Basel III requirements on the leverage ratio for the banking sector in the Central and Eastern Europe (CEE) and particularly in the Czech Republic. In the empirical study, we applied a data sample of 198 major banks operating in seven countries across the CEE region over the period 20072014. The data of the Czech banking sector confirms stronger capital ratios and an overall solid leverage level with only few historical observations being lower than the regulatory guidelines. By analyzing the components of ratios, we conclude that the Czech banks during the last seven years are focusing more on the optimization of risk weighted assets and structuring portfolios with lower risks. We propose an empirical model that allows to test how the leverage ratios and its variables respond to the changes in the cycle. Our analysis across financial institutions in the CEE region shows that the leverage in normal times is strongly related to capital ratio. The statistic evidences on the risk profile and strategy as measured by risk proxy in the model are pointing out on incentives of the banks to manage actively their balance sheet and reduce the riskiness of their portfolios in adverse economic conditions. 
Keywords:  Leverage ratio, capital ratio, Basel III, Czech Republic, CEE 
JEL:  G21 G32 
Date:  2016–10–13 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:74560&r=rmg 
By:  Hanene Ben Salah (IMAG  Institut Montpelliérain Alexander Grothendieck  UM  Université de Montpellier  CNRS  Centre National de la Recherche Scientifique); Ali Gannoun (IMAG  Institut Montpelliérain Alexander Grothendieck  UM  Université de Montpellier  CNRS  Centre National de la Recherche Scientifique); Christian De Peretti (ISFA  Institut des Science Financière et d'Assurances  PRES Université de Lyon); Mathieu Ribatet (IMAG  Institut Montpelliérain Alexander Grothendieck  UM  Université de Montpellier  CNRS  Centre National de la Recherche Scientifique); Abdelwahed Trabelsi (Laboratoire BESTMOD ISG Tunis  ISG Tunis) 
Abstract:  The DownSide Risk (DSR) model for portfolio optimization allows to overcome the drawbacks of the classical MeanVariance model concerning the asymmetry of returns and the risk perception of investors. This optimization model deals with a positive definite matrix that is endogenous with respect to the portfolio weights and hence yields to a non standard optimization problem. To bypass this hurdle, Athayde (2001) developed a new recursive minimization procedure that ensures the convergence to the solution. However, when a finite number of observations is available, the portfolio frontier usually exhibits some inflexion points which make this curve not very smooth. In order to overcome these points, Athayde (2003) proposed a mean kernel estimation of returns to get a smoother portfolio frontier. This technique provides an effect similar to the case in which an infinite number of observations is available. In spite of the originality of this approach, the proposed algorithm was not neatly written. Moreover, no application was presented in his paper. Ben Salah et al (2015), taking advantage on the the robustness of the median, replaced the mean estimator in Athayde's model by a nonparametric median estimator of the returns, and gave a tidily and comprehensive version of the former algorithm (of Athayde (2001, 2003)). In all the previous cases, the problem is computationally complex since at each iteration, the returns (for each asset and for the portfolio) need to be reestimated. Due to the changes in the kernel weights for every time, the portfolio is altered. In this paper, a new method to reduce the number of iterations is proposed. Its principle is to start by estimating non parametrically all the returns for each asset; then, the returns of a given portfolio will be derived from the previous estimated assets returns. Using the DSR criterion and Athayde's algorithm, a smoother portfolio frontier is obtained when short selling is or is not allowed. The proposed approach is applied on the French and Brazilian stock markets. 
Keywords:  DownSide Risk,Kernel Method,Nonparametric Mean Estimation,Nonparametric Median Estimation,Semivariance 
Date:  2016–04–07 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01299561&r=rmg 
By:  I. Argimon; M. Dietsch; A. Estrada 
Abstract:  European banks hold 10% of their total assets in portfolios that give rise to unrealised gains and losses which under Basel III will no longer be allowed to be excluded from banks’ regulatory capital. Using a sample of European banks, and taking advantage of the different regulatory treatments that are allowed, under Basel II, to account for such gains and losses among jurisdictions and instruments and over time, we find evidence that: a) the inclusion of unrealised gains and losses in capital ratios increases their volatility; b) the partial inclusion of unrealised gains and total inclusion of losses on fixedincome securities in regulatory capital, compared with the complete exclusion of both (or “neutralization”), reduces the volume of securities categorised as Available For Sale (AFS), thus potentially affecting liquidity management and demand for bonds (most of which are currently government bonds); and c) the higher the partial inclusion of gains from debt instruments, the lower the holdings of such instruments in the AFS category and the higher the regulatory Tier 1 capital ratio, thus affecting banks’ capital buffer strategy. We do not find evidence that the absence of neutralisation would impact capital ratios. 
Keywords:  Bank capital ratios, Bank regulation, Fair Value Accounting, Prudential Filters. 
JEL:  G21 M41 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:bfr:decfin:22&r=rmg 
By:  Hanene Ben Salah (IMAG  Institut Montpelliérain Alexander Grothendieck  UM  Université de Montpellier  CNRS  Centre National de la Recherche Scientifique, ISFA  Institut des Science Financière et d'Assurances  PRES Université de Lyon, BESTMOD  Business and Economic Statistics MODeling  ISG  Institut Supérieur de Gestion de Tunis [Tunis]  Université de Tunis [Tunis]); Mohamed Chaouch (United Arab Emirates University); Ali Gannoun (IMAG  Institut Montpelliérain Alexander Grothendieck  UM  Université de Montpellier  CNRS  Centre National de la Recherche Scientifique); Christian De Peretti (ISFA  Institut des Science Financière et d'Assurances  PRES Université de Lyon); Abdelwahed Trabelsi (BESTMOD  Business and Economic Statistics MODeling  ISG  Institut Supérieur de Gestion de Tunis [Tunis]  Université de Tunis [Tunis]) 
Abstract:  The DownSide Risk (DSR) model for portfolio optimisation allows to overcome the drawbacks of the classical MeanVariance model concerning the asymmetry of returns and the risk perception of investors. This model optimization deals with a positive definite matrix that is endogenous with respect to portfolio weights. This aspect makes the problem far more difficult to handle. For this purpose, Athayde (2001) developed a new recursive minimization procedure that ensures the convergence to the solution. However, when a finite number of observations is available, the portfolio frontier presents some discontinuity and is not very smooth. In order to overcome that, Athayde (2003) proposed a Mean Kernel estimation of the returns, so as to create a smoother portfolio frontier. This technique provides an effect similar to the case in which continuous observations are available. In this paper, Athayde model is reformulated and clarified. Then, taking advantage on the robustness of the median, another nonparametric approach based on Median Kernel returns estimation is proposed in order to construct a portfolio frontier. A new version of Athayde's algorithm will be exhibited. Finally, the properties of this improved portfolio frontier are studied and analysed on the French Stock Market. Keywords DownSide Risk · Kernel Method · Mean Nonparametric Estimation · Median Nonparametric Estimation · Portefolio Efficient Frontier · SemiVariance. 
Date:  2016–04–12 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01300673&r=rmg 
By:  PierreEmmanuel Darpeix (PSE  ParisJourdan Sciences Economiques  CNRS  Centre National de la Recherche Scientifique  INRA  Institut National de la Recherche Agronomique  EHESS  École des hautes études en sciences sociales  ENS Paris  École normale supérieure  Paris  École des Ponts ParisTech (ENPC), PSE  Paris School of Economics) 
Abstract:  The literature generally agrees that the traditional insurance sector is not a source of systemic risk, and insurers are often considered to be shock absorbers rather than shock amplifiers. Yet, the evolution of the industry both in terms of structure (concentration of the reinsurers, increased linkages with banks, especially through bancassurance conglomerates) and in terms of techniques (securitization, monolines, derivatives) increased the systemic relevance of the insurers. 
Keywords:  Insurance,Systemic risk,International regulation 
Date:  2015–11 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:halshs01227969&r=rmg 
By:  Alexandre Mornet (SAF  Laboratoire de Sciences Actuarielle et Financière  UCBL  Université Claude Bernard Lyon 1); Thomas Opitz (BIOSP  Biostatistique et Processus Spatiaux  Institut national de la recherche agronomique (INRA)); Michel Luzi (Allianz); Stéphane Loisel (SAF  Laboratoire de Sciences Actuarielle et Financière  UCBL  Université Claude Bernard Lyon 1) 
Abstract:  Models and forecasts of damage from wind storms are a major issue for insurance companies. In this article, we focus on the calculation sensitivity of return periods for extreme events. Numerous elements come into play, such as data quality (location of insured buildings, weather report homogeneity), missing updates (history of insurance portfolios, change of ground roughness, climate change), the evolution of the model after an unprecedented event such as Lothar in Europe and temporal aggregation (events defined through blocks of 2 or 3 days or blocks of one week). Another important aspect concerns storm trajectories, which could change due to global warming or sweep larger areas. We here partition the French territory into 6 storm zones depending on extreme wind correlation to test several scenarios. We use a storm index defined in \cite{Ma} to show the difficulties met to obtain reliable results on extreme events. 
Date:  2016–04–12 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01299692&r=rmg 
By:  Michalski, Tomasz; Örs, Evren; Pakel, Banu Demir 
Abstract:  We find that changes in banks' riskbased capital requirements can affect firmlevel exports. We exploit the mandatory Basel II adoption in its Standardized Approach by all banks in Turkey on July 1, 2012. This change affects riskweights for letters of credit and generates two identification schemes with opposite predicted signs. Using data that cover 16,662 exporters shipping 2,888 different products to 158 countries, we find that the share of letter of creditbased exports decreases (increases) at the firm countryproduct level when the associated counterparty riskweights increase (decrease) after Basel II adoption. However, growth of firmproductcountry level exports remains unaffected. 
Keywords:  Basel II; international trade finance; letters of credit 
JEL:  F14 G21 G28 
Date:  2016–10 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:11565&r=rmg 
By:  Janda, Karel; Kravtsov, Oleg 
Abstract:  In this paper we discuss the implications of the Basel III requirements on the leverage ratio for the banking sector in the Czech Republic. We identify the potential binding constraints from regulatory limits and analyze the interactions among leverage and capital ratios over the country’s economic cycle (during the period 20072014). The historical data confirm stronger capital ratios of the banks and an overall solid leverage level with only 5% of the total historical observations being lower than the regulatory recommendations. By analyzing the components of ratios, we conclude that the banks are focusing more on the optimization of risk weighted assets. Strong comovement patterns between leverage and assets point to the active management of leverage as a means of expanding and contracting the size of balance sheets and maximizing the utility of the capital. The analysis of correlation patterns among the variables indicates that the total assets (and exposure) in contrast to Tier 1 capital are the main contributors to the cyclical movements in the leverage. The leverage and the total assets also demonstrate a weak correlation with GDP, but a strong comovement with loans to the private sector. 
Keywords:  Leverage ratio, capital ratio, Basel III, Czech Republic 
JEL:  G30 
Date:  2016–10–11 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:74457&r=rmg 
By:  Caporin, Massimiliano; Kolokolov, Alexey; Renò, Roberto 
Abstract:  The simultaneous occurrence of jumps in several stocks can be associated with major financial news, triggers shortterm predictability in stock returns, is correlated with sudden spikes of the variance risk premium, and determines a persistent increase (decrease) of stock variances and correlations when they come along with bad (good) news. These systemic events and their implications can be easily overlooked by traditional univariate jump statistics applied to stock indices. They are instead revealed in a clearly cut way by using a novel test procedure applied to individual assets, which is particularly effective on highvolume stocks. 
Keywords:  Jumps,Return predictability,Systemic events,Variance Risk Premium 
JEL:  C58 G11 C14 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:zbw:safewp:149&r=rmg 
By:  Daniella Acker 
Abstract:  Data on individual trades in prediction markets relating to the 2008 and 2012 US Presidential elections reveal that traders vary enormously in their behavior. This contrasts with the standard predictionmarket models, which assume relatively homogeneous participants who differ only in their beliefs and wealth. We show that risklovers have particularly strong distortionary effects on market outcomes even when beliefs are symmetrically distributed around the truth. Simulations of a model which allows traders to have different motives and tastes for risk indicate that including such traders produce the market outcomes we observe, such as herding, persistent contrariness, a skewed profits' distribution and favoritelongshot bias. The attraction of such markets to risklovers means that caution must be exercised when using predictionmarket prices for forecasting 
Keywords:  Prediction markets, risklovers, herding and contrariness, favoritelong shot bias. 
JEL:  G10 G12 G14 G17 
Date:  2016–10–18 
URL:  http://d.repec.org/n?u=RePEc:bri:accfin:16/5&r=rmg 
By:  Damien Ackerer; Thibault Vatter 
Abstract:  We introduce a class of flexible and tractable static factor models for the joint term structure of default probabilities, the factor copula models. These high dimensional models remain parsimonious with pair copula constructions, and nest numerous standard models as special cases. With finitely supported random losses, the loss distributions of credit portfolios and derivatives can be exactly and efficiently computed. Numerical examples on collateral debt obligation (CDO), CDO squared, and credit index swaption illustrate the versatility of our framework. An empirical exercise shows that a simple model specification can fit credit index tranche prices. 
Date:  2016–10 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1610.03050&r=rmg 
By:  Urtzi Ayesta (LAASSARA  Équipe Services et Architectures pour Réseaux Avancés  LAAS  Laboratoire d'analyse et d'architecture des systèmes [Toulouse]  INP  Institut National Polytechnique [Toulouse]  INSA Toulouse  Institut National des Sciences Appliquées  Toulouse  INSA  Institut National des Sciences Appliquées  UPS  Université Paul Sabatier  Toulouse 3  CNRS  Centre National de la Recherche Scientifique, Universidad del País Vasco  Euskal Herriko Unibertsitatea (SPAIN)); M Erausquin (Universidad del País Vasco  Euskal Herriko Unibertsitatea (SPAIN)); E Ferreira (Universidad del País Vasco  Euskal Herriko Unibertsitatea (SPAIN)); P Jacko (Lancaster University) 
Abstract:  We consider a resource allocation problem, where a rational agent has to decide how to share a limited amount of resources among different companies that might be facing financial difficulties. The objective is to minimize the total long term cost incurred by the economy due to default events. Using the framework of multiarmed restless bandits and, assuming a twostate evolution of the default risk, the optimal dynamic resource sharing policy is determined. This policy assigns an index value to each company, which orders its priority to be funded. We obtain an analytical expression for this index, which generalizes the returnoninvestment (ROI) index under the static setting, and we analyse the influence of the future events on the optimal dynamic policy. A discussion about the structure of the optimal dynamic policy is provided, as well as some extensions of the model. 
Keywords:  MultiArmed Bandit Problem,Default Risk Management,Dynamic Resource Allocation Policies,Markov Decision Processes 
Date:  2016–04–11 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01300681&r=rmg 
By:  Philippe Briand (LAMA  Laboratoire de Mathématiques  CNRS  Centre National de la Recherche Scientifique  USMB [Université de Savoie] [Université de Chambéry]  Université Savoie Mont Blanc); Romuald Elie (LAMA  Laboratoire d'Analyse et de Mathématiques Appliquées  Fédération de Recherche Bézout  UPEM  Université ParisEst MarnelaVallée  UPEC UP12  Université ParisEst Créteil ValdeMarne  Paris 12  CNRS  Centre National de la Recherche Scientifique); Ying Hu (IRMAR  Institut de Recherche Mathématique de Rennes  Université Rennes 2  UR1  Université de Rennes 1  INSA  Institut National des Sciences Appliquées  ENS Cachan  École normale supérieure  Cachan  AGROCAMPUS OUEST  CNRS  Centre National de la Recherche Scientifique  Inria  Institut National de Recherche en Informatique et en Automatique) 
Abstract:  In this paper, we study a new type of BSDE, where the distribution of the Ycomponent of the solution is required to satisfy an additional constraint, written in terms of the expectation of a loss function. This constraint is imposed at any deterministic time t and is typically weaker than the classical pointwise one associated to reflected BSDEs. Focusing on solutions (Y, Z, K) with deterministic K, we obtain the wellposedness of such equation, in the presence of a natural Skorokhod type condition. Such condition indeed ensures the minimality of the enhanced solution, under an additional structural condition on the driver. Our results extend to the more general framework where the constraint is written in terms of a static risk measure on Y. In particular, we provide an application to the super hedging of claims under running risk management constraint. 
Date:  2016–05–19 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01318649&r=rmg 