nep-rmg New Economics Papers
on Risk Management
Issue of 2016‒12‒04
23 papers chosen by

  1. The Lila distribution and its applications in risk modelling By Bertrand K. Hassani; Wei Yang
  2. Support for the SME supporting factor: Multi-country empirical evidence on systematic risk factor for SME loans By Dietsch, Michel; Düllmann, Klaus; Fraisse, Henri; Koziol, Philipp; Ott, Christine
  3. New modalities for managing drought risk in rainfed agriculture: Evidence from a discrete choice experiment in Odisha, India: By Ward, Patrick S.; Makhija, Simrin
  4. Business complexity and risk management: evidence from operational risk events in U. S. bank holding companies By Chernobai, Anna; Ozdagli, Ali K.; Wang, Jianlin
  5. The economic and fiscal burdens of disasters in the Pacific By Noy, Ilan; Edmonds, Christopher
  6. Macro-economic factors in credit risk calculations: including time-varying covariates in mixture cure models By Lore Dirick; Tony Bellotti; Gerda Claeskens; Bart Baesens
  7. The Failure of a Clearinghouse: Empirical Evidence By Bignon, Vincent; Vuillemey, Guillaume
  8. Ambiguity and the Tradeoff Theory of Capital Structure By Yehuda Izhakian; David Yermack; Jaime F. Zender
  9. Risk neutral versus real-world distribution on puclicly listed bank corporations By Michel Dacorogna; Juan-José Francisco Miguelez; Marie Kratz
  10. Sovereign Ratings and National Culture By Huong Dang; Graham Partington
  11. An Early Warning System for Macro-prudential Policy in France. By V. Coudert; J. Idier
  12. A coupled component GARCH model for intraday and overnight volatility By Linton, O.; Wu, J.
  13. Centralized netting in financial networks By Garratt, Rodney
  14. Beta-boosted ensemble for big credit scoring data By Maciej Zieba; Wolfgang K. Härdle
  15. Asset Pricing with Endogenously Uninsurable Tail Risks By anmol bhandari; Hengjie Ai
  16. Network Quantile Autoregression By Xuening Zhu; Wolfgang K. Härdle; Weining Wang; Hangsheng Wang
  17. Evaluation of Exchange Rate Point and Density Forecasts: an application to Brazil By Wagner Piazza Gaglianone; Gabriel Jaqueline Terra Moura Marins
  18. Related Party Transactions and Stock Price Crash Risk: Evidence from India By Ekta Selarka; Subhra Choudhury
  19. Ireland: Financial Sector Assessment Program; Technical Note-Stress Testing the Banking System By International Monetary Fund. Monetary and Capital Markets Department
  20. Ireland: Financial Sector Assessment Program; Technical Note-Financial Safety Net, Bank Resolution, and Crisis Management By International Monetary Fund. Monetary and Capital Markets Department
  21. Tunisia; Fiscal Transparency Evaluation By International Monetary Fund. Fiscal Affairs Dept.
  22. Ireland: Financial Sector Assessment Program; Technical Note-Macroprudential Policy Framework By International Monetary Fund. Monetary and Capital Markets Department
  23. Morocco: Financial Sector Assessment Program; Technical Note-Banking Supervision By International Monetary Fund. Independent Evaluation Office

  1. By: Bertrand K. Hassani (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Wei Yang (Risk methodology - Grupo Santander)
    Abstract: Risk date sets tend to have heavy-tailed, sometimes bi-modal, empirical distributions, especially in operational risk, market risk and customers behaviour data sets. To capture these observed “unusual” features, we construct a new probability distribution and call it the lowered-inside-leveraged-aside (Lila) distribution as it transfers the embedded weight of data from the body to the tail. This newly constructed distribution can be viewed as a parametric distribution with two peaks. It is constructed through the composition of a Sigmoid-shaped continuous increasing differentiable function with cumulative distribution functions of random variables. Examples and some basic properties of the Lila distribution are illustrated. As an application, we fit a Lila distribution to a set of generated data by using the quantile distance minimisation method (alternative methodologies have been tested too, such as maximum likelihood estimation).
    Keywords: probability distribution,parametric distribution,multimodal distribution,operational risk,market risk,pseudo bi-modal distribution
    Date: 2016–10
  2. By: Dietsch, Michel; Düllmann, Klaus; Fraisse, Henri; Koziol, Philipp; Ott, Christine
    Abstract: Using a unique and comprehensive data set on the two largest economies of the Eurozone - France and Germany - this paper first proceeds to a computation of the Gordy formula relaxing the ad hoc sizedependent constraints of the Basel formulas. Our study contributes to Article 501 of the Capital Requirements Regulation (CRR) requesting analysis of the consistency of own funds requirements with the riskiness of SME. In both the French and the German sample, results suggest that the relative differences between the capital requirements for large corporates and those for SME (in other words the capital relief for SME) are lower in the Basel III framework than implied by empirically estimated asset correlations. Results show that the SME Supporting Factor in the CRR/CRD IV is able to compensate the difference between estimated and CRR/CRD IV capital requirements for loans in the corporate portfolio. However, no empirical evidence is found supporting the € 1.5 mln SME threshold currently included in Article 501 (CRR).
    Keywords: SME finance,Asset correlation,Basel III,CRR/CRD IV,Asymptotic Single Risk factor Model,SME Supporting Factor
    JEL: C13 G21 G33
    Date: 2016
  3. By: Ward, Patrick S.; Makhija, Simrin
    Abstract: In this paper we explore the potential for a new approach to managing drought risk among rainfed rice producers in Odisha, India. Droughts have historically been a serious constraint to agricultural production in rainfed agricultural systems, with droughts resulting in significant reductions in both yields and cultivated area, in turn leading to significant impacts on rural livelihoods and food security. Scientists and policy makers have proposed various strategies for managing risks, with limited success. In this study we consider two such strategies, specifically drought-tolerant rice and weather index insurance. While neither drought-tolerant cultivars nor weather index insurance products are perfect solutions for adequately managing drought risk in and of themselves, there is scope to exploit the benefits of each and bundle them into a complementary risk management product, specifically through proper index calibration and an optimized insurance design. In this study, we explore preferences for such a complementary risk management product using discrete choice experiments in Odisha, India. We are able to estimate the added value that farmers perceive in the bundled product above and beyond the value associated with each of the independent products. We also show that valuations are sensitive to the basis risk implied by the insurance product, with farmers less enthusiastic about risk management products that leave significant risks uninsured.
    Keywords: droughts, risk, drought tolerance, rice, insurance, rainfed farming, agricultural policies,
    Date: 2016
  4. By: Chernobai, Anna (Syracuse University); Ozdagli, Ali K. (Federal Reserve Bank of Boston); Wang, Jianlin (Federal Reserve Bank of Boston)
    Abstract: How does business complexity affect risk management in financial institutions? The commonly used risk measures rely on either balance-sheet or market-based information, both of which may suffer from identification problems when it comes to answering this question. Balance-sheet measures, such as return on assets, capture the risk when it is realized, while empirical identification requires knowledge of the risk when it is actually taken. Market-based measures, such as bond yields, not only ignore the problem that investors are not fully aware of all the risks taken by management due to asymmetric information, but are also contaminated by other confounding factors such as implicit government guarantees associated with the systemic importance of complex financial institutions. To circumvent these problems, we use operational risk events as a risk management measure because (i) the timing of the origin of each event is well identified, and (ii) the risk events can serve as a direct measure of materialized failures in risk management without being influenced by the confounding factors that drive asset prices. Using the gradual deregulation of banks’ nonbank activities during 1996–1999 as a natural experiment, we show that the frequency and magnitude of operational risk events in U. S. bank holding companies have increased significantly with their business complexity. This trend is particularly strong for banks that were bound by regulations beforehand, especially for those with an existing Section 20 subsidiary, and weaker for other banks that were not bound and for nonbank financial institutions that were not subject to the same regulations to begin with. These results reveal the darker side of post-deregulation diversification, which in earlier studies has been shown to lead to improved stock and earnings performance. Our findings have important implications for the regulation of financial institutions deemed systemically important, a designation tied closely to their complexity by the Bank for International Settlements and the Federal Reserve.
    Keywords: operational risk; bank holding companies; financial deregulation; Glass-Steagall Act; business complexity
    JEL: G18 G20 G21 G32 L25
    Date: 2016–10–01
  5. By: Noy, Ilan; Edmonds, Christopher
    Abstract: The Pacific Islands face the highest disaster risk, in per capita terms, globally. Examples of catastrophic events in the region include the 2009 tsunami in Samoa, the 2014 floods in the Solomon Islands, and the 2015 cyclone Pam in Vanuatu. Even without these catastrophic events, countries in the Pacific are affected by frequent natural hazards of smaller magnitude. We first evaluate the three main sources quantifying risk in the region: EMDAT, Desinventar, and PCRAFI. We describe these sources and conclude they all underestimate the risk, especially for atoll nations, and because of four important trends with respect to changes in natural hazards as a consequence of climate change. These are: (1) increasing frequency of extremely hot days; (2) changing frequency and intensity of extreme rainfall events causing flash flooding or droughts; (3) increasing intensities and changing trajectories of cyclones; and (4) sea-level rise and other oceanic ecological changes. Financial protection is the one policy area where the Pacific is the most exposed—given the very large role of the public sector in the region. It is also the area where there is probably the most room for easy-to-implement improvement. We end by analysing the applicability of various financial instruments to facilitate both ex-ante and ex-post disaster risk management in the region.
    Keywords: Disaster risk, Pacific Islands, Small Island Developing States, SIDS,
    Date: 2016
  6. By: Lore Dirick; Tony Bellotti; Gerda Claeskens; Bart Baesens
    Abstract: The prediction of the time of default in a credit risk setting via survival analysis needs to take a high censoring rate into account. This rate is due to the fact that default does not occur for the majority of debtors. Mixture cure models allow the part of the loan population that is unsusceptible to default to be modelled, distinct from time of default for the susceptible population. In this paper, we extend the mixture cure model to include time-varying covariates. We illustrate the method via simulations and by incorporating macro-economic factors as predictors for an actual bank data set.
    Keywords: Credit risk modeling, Mixture cure model, Time-varying covariates, Macroeconomic factors, Survival analysis
    Date: 2016–11
  7. By: Bignon, Vincent; Vuillemey, Guillaume
    Abstract: We provide the first empirical description of the failure of a derivatives clearinghouse. We use novel, hand-collected, archive data to study risk management incentives by the Paris commodity futures clearinghouse around its failure in 1974. We do not find evidence of lenient risk management during the commodity price boom of 1973-1974. However, we show strong distortions of risk management incentives, akin to risk-shifting, as soon as prices collapsed and a large clearing member approached distress. Distortions persist during the recovery/resolution phase. Theoretically, these distortions suggest that capitalization and governance were weak, but do not imply that moral hazard was significant before the failure. Our findings have implications for the design of clearing institutions, including their default management schemes.
    Keywords: CCP; Central clearing; Collateral; Derivatives; Failure; Resolution
    JEL: G23
    Date: 2016–11
  8. By: Yehuda Izhakian; David Yermack; Jaime F. Zender
    Abstract: We examine the importance of ambiguity, or Knightian uncertainty, in the capital structure decision. We develop a static tradeoff theory model in which agents are both risk averse and ambiguity averse. The model con firms the usual idea that increased risk - the uncertainty over known possible outcomes - leads firms to use less leverage. Conversely, greater ambiguity - the uncertainty over the probabilities associated with the outcomes - leads firms to increase leverage. Our empirical analysis provides results consistent with these predictions.
    JEL: C65 D81 D83 G32
    Date: 2016–11
  9. By: Michel Dacorogna (SCOR SE - SCOR SE); Juan-José Francisco Miguelez (ESSEC Business School - Essec Business School); Marie Kratz (ESSEC Business School - Essec Business School, MAP5 - MAP5 - Mathématiques Appliquées à Paris 5 - UPD5 - Université Paris Descartes - Paris 5 - Institut National des Sciences Mathématiques et de leurs Interactions - CNRS - Centre National de la Recherche Scientifique)
    Abstract: In this study, we examine different quantitative methods to recover the risk neutral distribution function associated to the prices of option on bank shares. This is useful for a wide range of applications, such as determining the implicit State guarantee that systemic financial institutions benefit from the State, or looking if the market prices correctly the fat tails of financial returns. We assess the performance of these techniques in various ways, including comparing market option prices and historical Values-at-Risk to option prices and Value-at-Risk implied by the estimated risk neutral distribution. We find that, contrary to what is expected for a market composed of risk averse investors, the latter is much smaller than the one obtained from real data. We discuss our results with respect to the theory of risk neutral valuation and investor risk preference.
    Keywords: extremes, fat tail, option pricing, real world probability, risk neutral probability, SIFI, value-­at-­risk
    Date: 2016–07
  10. By: Huong Dang (University of Canterbury); Graham Partington
    Abstract: Whether sovereign governments default in part depends upon their willingness to pay and this in turn may depend on national culture. National culture may also affect capacity to pay and the assessment by rating analysts of sovereign risk. We therefore argue that culture affects ratings and empirically test the effects of culture on levels and changes in sovereign ratings. Levels and changes in sovereign ratings have traditionally been modelled in terms of macro-economic variables, rating outlook and rating history. The addition of culture variables to such models significantly improves the models' fit to the data.
    Keywords: Sovereign debt; sovereign rating; national culture; rating history; rating outlook
    JEL: G24
    Date: 2016–10–24
  11. By: V. Coudert; J. Idier
    Abstract: We construct an early warning system for detecting banking crises that could be used for the macroprudential policy conduct in France. First, we select macro-financial risk indicators among a large number of candidates by considering their performances both over a panel of ten euro area countries and at the French level, for the 1985:Q1 to 2009:Q4. Second, we run all the logit models including four of these indicators, one being necessarily a measure of credit gap to fit the Basel Committee recommendations. We then retain two sets of models: one including those with all coefficients significant and expected signs, another one, obtained by relaxing these criteria. Third, we aggregate the probabilities estimated by the models, by giving each a weight proportional to its usefulness at predicting crises either at the panel or the country-level. The simulations performed both over and out of the sample show that aggregating more models yields better results than relying on one single model or only a few. Performance is also enhanced by aggregating models’ results with country-specific weights relatively to common panel-weightings.
    Keywords: Macroprudential policy, Banking Crises, Early Warning Indicators
    JEL: E52 G12 C58
    Date: 2016
  12. By: Linton, O.; Wu, J.
    Abstract: We propose a semi-parametric coupled component GARCH model for intraday and overnight volatility that allows the two periods to have different properties. To capture the very heavy tails of overnight returns, we adopt a dynamic conditional score model with t innovations. We propose a several step estimation procedure that captures the nonparametric slowly moving components by kernel estimation and the dynamic parameters by t maximum likelihood. We establish the consistency and asymptotic normality of our estimation procedures. We extend the modelling to the multivariate case. We apply our model to the study of the component stocks of the Dow Jones industrial average over the period 1991-2016. We show that actually overnight volatility has increased in importance during this period. In addition, our model provides better intraday volatility forecast since it takes account of the full dynamic consequences of the overnight shock and previous ones.
    Date: 2016–12–01
  13. By: Garratt, Rodney
    Abstract: We consider how the introduction of centralized netting in financial networks affects total netted exposures between counterparties. In some cases there is a trade-off: centralized netting increases the expectation of net exposures, but reduces the variance. We show that the set of networks for which expected net exposures decreases is a strict subset of those for which the variance decreases, so the trade-off can only be in one direction. For some network structures, introducing centralized netting is never beneficial to dealers unless sufficient weight is placed on reductions in variance. This may explain why, in the absence of regulation, traders in a derivatives network do not develop central clearing. Our results can be used to estimate margin requirements and counterparty risk in financial networks.
    Keywords: Social and Behavioral Sciences, centralized netting, central clearing, exposures, networks
    Date: 2016–10–23
  14. By: Maciej Zieba; Wolfgang K. Härdle
    Abstract: In this work we present a novel ensemble model for a credit scoring problem. The main idea of the approach is to incorporate separate beta binomial distributions for each of the classes to generate balanced datasets that are further used to construct base learners that constitute the final ensemble model. The sampling procedure is performed on two separate ranking lists, each for one class, where the ranking is based on prepotency of observing positive class. Two strategies are considered: one assumes mining easy examples and the second one forces good classification of hard cases. The proposed solutions are tested on two big datasets on credit scoring.
    JEL: C53
    Date: 2016–11
  15. By: anmol bhandari (university of minnesota); Hengjie Ai (University of Minnesota)
    Abstract: This paper studies asset pricing implications of idiosyncratic risk in labor productivities in a model where markets are endogenously incomplete. Well-diversified owners of firms provide insurance to workers using long-term wage contracts but cannot commit to ventures that yield a net present value of dividends. We show that under the optimal contract subject to limited commitment, workers are uninsured against tail risks in idiosyncratic productivities. Risk compensations are higher when we calibrate the model to replicate the feature that tail risk in labor income is more pervasive in recessions relative to expansions. Besides salient features of equity and bond markets, the model is consistent with other empirical facts such as the cyclicality of factor shares and limited stock market participation.
    Date: 2016
  16. By: Xuening Zhu; Wolfgang K. Härdle; Weining Wang; Hangsheng Wang
    Abstract: It is a challenging task to understand the complex dependency structures in an ultra-high dimensional network, especially when one concentrates on the tail dependency. To tackle this problem, we consider a network quantile autoregres- sion model (NQAR) to characterize the dynamic quantile behavior in a complex system. In particular, we relate responses to its connected nodes and node spe- ci c characteristics in a quantile autoregression process. A minimum contrast estimation approach for the NQAR model is introduced, and the asymptotic properties are studied. Finally, we demonstrate the usage of our model by in- vestigating the nancial contagions in the Chinese stock market accounting for shared ownership of companies.
    JEL: C12
    Date: 2016–11
  17. By: Wagner Piazza Gaglianone; Gabriel Jaqueline Terra Moura Marins
    Abstract: In this paper, we construct multi-step-ahead point and density forecasts of the exchange rate, from statistical or economic-driven approaches, using financial or macroeconomic data and using parametric or nonparametric distributions. We employ a set of statistical tools, from di¤erent strands of the literature, to identify which models work in practice, in terms of forecast accuracy across di¤erent data frequencies and forecasting horizons. We propose a novel full-density/local analysis approach to collect the many test results, and deploy a simple risk based decision rule to rank models. An empirical exercise with Brazilian daily and monthly data reveals that macro fundamentals matter when modeling the risk of exchange rate appreciation, whereas models using survey information or ?nancial data are the best way to account for the depreciation risk. These findings have relevance for econometricians, risk managers or policymakers interested in evaluating the accuracy of competing exchange rate models.
    Date: 2016–11
  18. By: Ekta Selarka (Assistant Professor, Madras School of Economics); Subhra Choudhury (Madras School of Economics)
    Abstract: Related Party Transactions disclosures in Annual Reports have recently gained more attention of the Indian policymakers. This paper aims at finding out the effect of related party transactions disclosure on the stock price crash risk faced by the firms. Using a large sample of all the NSE listed firms for the period 2005-2012 this study provides evidence that related party disclosure decreases the stock price crash risk faced by the firms. This study is consistent with the view that information asymmetry increases crash risk. Related party transactions disclosure decreases information asymmetry in the market and thus reduces stock price crash risk. Moreover the study shows that the effect of disclosure about related party transactions is significantly more for higher risk firms.
    Keywords: Related party transactions, Stock price crash risk, Ownership structure, IndiaClassification-JEL: G12; G14; G32
    Date: 2015–10
  19. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This Technical Note discusses the results of the stress testing carried out to examine the banking system in Ireland. These tests examined the resilience of the Irish banking system to solvency, liquidity, and contagion risks. The results revealed several sources of vulnerability, although these remain manageable at the macro level. The global liquidity stress tests reveal that some banks in the system would be exposed to liquidity risks in the event of large deposit withdrawals, under a more severe scenario than the Basel III Liquidity Coverage Ratio metrics. By contrast, additional counterbalancing capacity would allow banks to cope with net outflows in every maturity bucket.
    Keywords: Financial Sector Assessment Program;Banking sector;Credit risk;Liquidity;Stress testing;Ireland;
    Date: 2016–09–29
  20. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This Technical Note discusses the findings and recommendations in the Financial Sector Assessment Program for Ireland regarding the financial safety net, bank resolution, and crisis management. The introduction of the “single rulebook†for financial services regulation within the European Union and the establishment of the banking union have transformed the Irish framework for dealing with failing banks. The new regime reflects an EU-wide initiative to strengthen supervision, harmonize prudential rules, and establish a uniform bank resolution regime. The Bank Recovery and Resolution Directive has significantly strengthened the resolution regime in Ireland and the European Union. Significant progress has also been made on the banking union, although key aspects remain to be completed.
    Keywords: Financial Sector Assessment Program;Banking sector;Bank resolution;Bank supervision;Intervention;Financial safety nets;Deposit insurance;Crisis prevention;Risk management;Ireland;
    Date: 2016–09–29
  21. By: International Monetary Fund. Fiscal Affairs Dept.
    Abstract: Since 2011, Tunisia has experienced a profound transformation of its political institutions, including the new Constitution that came into force on January 27, 2014. In this context, the authorities have initiated several reforms to improve fiscal transparency and modernize public financial management. The establishment of a new government in early 2015 also presents an opportunity to revitalize the reform agenda in this area.
    Keywords: Fiscal transparency;Fiscal policy;Budgets;Budgeting;Fiscal risk;Risk management;Technical Assistance Reports;Tunisia;
    Date: 2016–11–07
  22. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This Technical Note discusses the findings and recommendations made in the Financial Sector Assessment Program for Ireland in the area of the macroprudential policy framework. The current institutional arrangement in Ireland is appropriate for effective macroprudential policy and in line with IMF guidance. The Central Bank of Ireland’s analysis of systemic vulnerabilities is sophisticated and timely. The central bank has been introducing a range of macroprudential instruments to contain a buildup of systemic risk in the financial system. Ireland’s boom-bust experience amply demonstrates the need for forward-looking action to head off incipient financial problems.
    Keywords: Financial Sector Assessment Program;Macroprudential Policy;Monetary policy;Banking sector;Nonbank financial sector;Risk management;Ireland;
    Date: 2016–09–29
  23. By: International Monetary Fund. Independent Evaluation Office
    Abstract: Morocco applies international best practices in the area of banking supervision. Nevertheless, it is important that its banking supervision system adapt to both the new international standard3 implemented following the global financial crisis and the structural changes in the Moroccan banking system. In response to these challenges, the Bank Al-Maghrib (BAM) has adopted a new banking law,4 which includes principles on the supervision of systemically important banks, the strengthening of governance mechanisms, a framework for the orderly resolution of credit institutions, and expansion of the cooperation between regulators.
    Keywords: Financial Sector Assessment Program;Banks;Bank supervision;Bank regulations;Credit risk;Liquidity;Risk management;Morocco;
    Date: 2016–11–07

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