
on Risk Management 
Issue of 2017‒01‒15
eleven papers chosen by 
By:  Peter Sands; Gordon Liao; Yueran Ma 
Abstract:  Operational risk capital requirements represent a relative backwater of the Basel capital framework for banks. We examine both the existing Basel II framework and the latest Basel Committee proposals for reform and conclude that neither are effective in creating the incentives and loss absorbency to minimize negative externalities from operational risk events. We suggest an alternative approach that we believe would be much more effective in achieving the regulatory objectives. We do not offer a view on the amount of capital required, focusing instead on the methodology and structure of the capital requirement. 
Date:  2017–01 
URL:  http://d.repec.org/n?u=RePEc:qsh:wpaper:482781&r=rmg 
By:  Ghent, Andra C. (University of WisconsinMadison); Kudlyak, Marianna (Federal Reserve Bank of San Francisco) 
Abstract:  We document novel, economically important correlations between children’s future credit risk scores, default, and homeownership status and their parents’ credit characteristics measured when the children are in their late teens. A one standard deviation higher parental credit risk score when the child is 19 is associated with a 24 percent reduction in the likelihood that the child goes bankrupt by age 29, a 36 percent lower likelihood of other serious default, a 35 point higher child credit score, and a 23 percent higher chance of the child becoming a homeowner. The linkages persist after controlling for parental income. The linkages are stronger in cities with lower intergenerational income mobility, implying that common factors might drive both. Existing measures of statelevel educational policy have limited effects on the strength of the linkages. Evidence from a sample of siblings suggests that the linkages might be largely due to family fixed effects. 
JEL:  D14 E21 G10 
Date:  2017–01–05 
URL:  http://d.repec.org/n?u=RePEc:fip:fedfwp:201631&r=rmg 
By:  Naohisa Hirakata (Bank of Japan); Yosuke Kido (Bank of Japan); Jie Liang Thum (Monetary Authority of Singapore) 
Abstract:  We examine a sample of Japanese regional banks and explore whether exposure to market risk factors affects systemic risk through a banks' portfolio composition or revenue source, using Adrian and Brunnermeier's (2016) CoVaR to proxy for systemic risk. We find evidence of "systemic as a herd" behavior among Japanese regional banks, as portfolio and revenue components associated with market activities exert positive and significant impacts on systemic risk by generating higher comovement among banks, even though they reduce standalone bank risk through portfolio diversification. Further, the marginal effect of an increase in a given banks' marketrelated components on systemic risk is larger when the share of the corresponding components is already high among other banks. Our results have important implications from the macroprudential perspective. 
Keywords:  Systemic risk; Herd behavior; Market risk factors; CoVaR 
JEL:  D21 G28 G32 G38 
Date:  2017–01–12 
URL:  http://d.repec.org/n?u=RePEc:boj:bojwps:wp17e01&r=rmg 
By:  Christoph Wunderer 
Abstract:  Asset correlations play an important role in credit portfolio modelling. One possible data source for their estimation are default time series. This study investigates the systematic error that is made if the exposure pool underlying a default time series is assumed to be homogeneous when in reality it is not. We find that the asset correlation will always be underestimated if homogeneity with respect to the probability of default (PD) is wrongly assumed, and the error is the larger the more spread out the PD is within the exposure pool. If the exposure pool is inhomogeneous with respect to the asset correlation itself then the error may be going in both directions, but for most PD and asset correlation ranges relevant in practice the asset correlation is systematically underestimated. Both effects stack up and the error tends to become even larger if in addition we assume a negative correlation between asset correlation and PD within the exposure pool, an assumption that is plausible in many circumstances and consistent with the Basel RWA formula. It is argued that the generic inhomogeneity effect described in this paper is one of the reasons why asset correlations measured from default data tend to be lower than asset correlations derived from asset value data. 
Date:  2017–01 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1701.02028&r=rmg 
By:  Vadim Kaushansky; Alexander Lipton; Christoph Reisinger 
Abstract:  We consider a structural default model in an interconnected banking network as in Lipton [International Journal of Theoretical and Applied Finance, 19(6), 2016], with mutual obligations between each pair of banks. We analyse the model numerically for two banks with jumps in their asset value processes. Specifically, we develop a finite difference method for the resulting twodimensional partial integrodifferential equation, and study its stability and consistency. We then compute joint and marginal survival probabilities, as well as prices of credit default swaps (CDS), firsttodefault swaps (FTD), credit and debt value adjustments (CVA and DVA). Finally, we calibrate the model to market data and assess the impact of jump risk. 
Date:  2016–12 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1701.00030&r=rmg 
By:  Gabor Fukker (Magyar Nemzeti Bank) 
Abstract:  This paper investigates the effects of contagion in interbank lending networks. I introduce a new measure based on the harmonic distance of Acemoglu et al. (2015) and, motivated by their theoretical results, compare it to wellknown centrality measures already applied in the systemic risk literature which do not take into account the structure of a contagion mechanism. I derive an explicit formula of sizeadjusted harmonic distances and extend it with the usage of liquid assets for a heterogeneous banking system. The simulation results on scalefree and complete networks do not confirm that this new distance would perform better than "offtheshelf" measures but its performance becomes similar to the best known measures in case of averaged networks which are applied in central banking analysis. This new measure is capable of identifying systemically important institutions and its time variation is also presented in an interbank network. I also test for the scalefree property of the Hungarian interbank lending network and besides, network measures as systemic risk indicators are analyzed on Hungarian data. 
Keywords:  systemic risk, financial networks, interbank contagion, macroprudential regulation. 
JEL:  D85 E44 G01 G21 G28 L14 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:mnb:wpaper:2017/1&r=rmg 
By:  Csoka, Péter (corvinus university of budapest); Herings, P. JeanJacques (General Economics 1 (Micro)) 
Abstract:  The most important rule to determine payments in reallife bankruptcy problems is the proportional rule. Many bankruptcy problems are characterized by network aspects and default may occur as a result of contagion. Indeed, in financial networks with defaulting agents, the values of the agents' assets are endogenous as they depend on the extent to which claims on other agents can be collected. These network aspects make an axiomatic analysis challenging. This paper is the first to provide an axiomatization of the proportional rule in financial networks. Our two central axioms are impartiality and nonmanipulability by identical agents. The other axioms are claims boundedness, limited liability, priority of creditors, and continuity. 
Keywords:  financial networks, systemic risk, bankruptcy rules, proportional rule 
JEL:  C71 G10 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:unm:umagsb:2017001&r=rmg 
By:  Kazutoshi Yamazaki 
Abstract:  The GerberShiu function provides a way of measuring the risk of an insurance company. It is given by the expected value of a function that depends on the ruin time, the deficit at ruin, and the surplus prior to ruin. Its computation requires the evaluation of the overshoot/undershoot distributions of the surplus process at ruin. In this paper, we use the recent developments of the fluctuation theory and approximate it in a closed form by fitting the underlying process by phasetype Levy processes. A sequence of numerical results are given. 
Date:  2017–01 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1701.02798&r=rmg 
By:  Niu, Cuizhen; Wong, WingKeung; Xu, Qunfang 
Abstract:  This paper extends the theory between Kappa ratio and stochastic dominance (SD) and riskseeking SD (RSD) by establishing several relationships between first and higherorder risk measures and (higherorder) SD and RSD. We first show the sufficient relationship between the (n+1)order SD and the norder Kappa ratio. We then find that, in general, the necessary relationship between SD/RSD and the Kappa ratio cannot be established. Thereafter, we find that when the variables being compared belong to the same locationscale family or the same linear combination of locationscale families, we can get the necessary relationships between the (n+1)order SD with the norder Kappa ratio when we impose some conditions on the means. Our findings enable academics and practitioners to draw better decision in their analysis. 
Keywords:  Stochastic Dominance, Kappa ratio, Omega Ratio, Sortino ratio, meanrisk analysis, risk aversion, risk seeking 
JEL:  C02 D81 G10 
Date:  2017–01–03 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:75948&r=rmg 
By:  Sabiou Inoua 
Abstract:  Financial price changes obey two universal properties: they follow a power law and they tend to be clustered in time. The second regularity, known as volatility clustering, entails some predictability in the price changes: while their sign is uncorrelated in time, their amplitude (or volatility) is longrange correlated. Many models have been proposed to account for these regularities, notably agentbased models; but these models often invoke relatively complicated mechanisms. This paper identifies a basic reason behind volatility clustering: the impact of exogenous news on expectations. Indeed the expectations of financial agents clearly vary with the advent of news; the simplest way of modeling this idea is to assume the expectations follow a random walk. We show that this random walk implies volatility clustering in a generic way. 
Date:  2016–12 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1612.09344&r=rmg 
By:  Roxana Dumitrescu; MarieClaire Quenez; Agn\`es Sulem 
Abstract:  In this paper, we study the properties of nonlinear BSDEs driven by a Brownian motion and a martingale measure associated with a default jump with intensity process $(\lambda_t)$. We give a priori estimates for these equations and prove comparison and strict comparison theorems. These results are generalized to drivers involving a singular process. The special case of a $\lambda$linear driver is studied, leading to a representation of the solution of the associated BSDE in terms of a conditional expectation of an adjoint exponential semimartingale. We then apply these results to nonlinear pricing of European contingent claims in an imperfect financial market with a defaultable risky asset. The case of claims paying dividends is also included via the singular process. 
Date:  2016–12 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1612.05681&r=rmg 