
on Risk Management 
By:  Stefan Weber 
Abstract:  Under Solvency II the computation of capital requirements is based on value at risk (V@R). V@R is a quantilebased risk measure and neglects extreme risks in the tail. V@R belongs to the family of distortion risk measures. A serious deficiency of V@R is that firms can hide their total downside risk in corporate groups. They can largely reduce their total capital requirements via appropriate transfer agreements within a group structure consisting of sufficiently many entities and thereby circumvent capital regulation. We prove several versions of such a result for general distortion risk measures of V@Rtype, explicitly construct suitable allocations of the group portfolio, and finally demonstrate how these findings can be extended beyond distortion risk measures. 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1702.08901&r=rmg 
By:  Gehrig, Thomas Paul; Iannino, Maria Chiara 
Abstract:  This paper analyses the evolution of the resiliency of the European banking sector after the implementation of the Basel Capital Accord. In particular, by analysing SRISK and CoVaR we trace systemic risk and measures of systematic risk as the Basel process unfolds. We observe that, though systematic risk for European banks have been decreasing over the last three decades, systemic risk has heightened especially for the largest systemic banks. While the Basel process has succeeded in containing systemic risk of small banks, it has been less successful for the larger institutions. The latter ones opportunistically exploited the option of selfregulation by employing internal models and effectively increasing SRISK. Hence, the subprime crisis found the largest and more systemic banks illprepared and lacking resiliency. This condition was even aggravated during the European sovereign crisis. 
JEL:  G21 G01 B26 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:zbw:vfsc16:145743&r=rmg 
By:  Greig Smith; Goncalo dos Reis 
Abstract:  Bond rating Transition Probability Matrices (TPMs) are built over a oneyear timeframe and for many practical purposes, like the assessment of risk in portfolios, one needs to compute the TPM for a smaller time interval. In the context of continuous time Markov chains (CTMC) several deterministic and statistical algorithms have been proposed to estimate the generator matrix. We focus on the ExpectationMaximization (EM) algorithm by \cite{BladtSorensen2005} for a CTMC with an absorbing state for such estimation. This work's contribution is fourfold. Firstly, we provide directly computable closed form expressions for quantities appearing in the EM algorithm. Previously, these quantities had to be estimated numerically and considerable computational speedups have been gained. Secondly, we prove convergence to a single set of parameters under reasonable conditions. Thirdly, we derive a closedform expression for the error estimate in the EM algorithm allowing to approximate confidence intervals for the estimation. Finally, we provide a numerical benchmark of our results against other known algorithms, in particular, on several problems related to credit risk. The EM algorithm we propose, padded with the new formulas (and error criteria), is very competitive and outperforms other known algorithms in several metrics. 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1702.08867&r=rmg 
By:  Daniel Grigat; Fabio Caccioli 
Abstract:  We reverse engineer dynamics of financial contagion to find the scenario of smallest exogenous shock that, should it occur, would lead to a given final systemic loss. This reverse stress test can be used to identify the potential triggers of systemic events, and it removes the arbitrariness in the selection of shock scenarios in stress testing. We consider in particular the case of distress propagation in an interbank market, and we study a network of 44 European banks, which we reconstruct using data collected from Bloomberg. By looking at the distribution across banks of the size of smallest exogenous shocks we rank banks in terms of their systemic importance, and we show the effectiveness of a policy with capital requirements based on this ranking. We also study the properties of smallest exogenous shocks as a function of the largest eigenvalue $\lambda_{\rm max}$ of the matrix of interbank leverages, which determines the endogenous amplification of shocks. We find that the size of smallest exogenous shocks reduces and that the distribution across banks becomes more localized as $\lambda_{\rm max}$ increases. 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1702.08744&r=rmg 
By:  Ahnert, Toni; Anand, Kartik; Gai, Prasanna; Chapman, James 
Abstract:  How does asset encumbrance affect the fragility of intermediaries subject to rollover risk? We offer a model of covered bonds that features the bankruptcy remoteness and replenishment of the asset pool that backs secured funding. Encumbering assets allows a bank to raise cheap secured debt and expand profitable investment, but it also concentrates risk on unsecured debt and thus exacerbates fragility. Deposit insurance or guarantees induce excessive encumbrance, shifting risks to the deposit insurance fund or the guarantor. Prudential regulation to correct this negative externality are limits on encumbrance, capital requirements, and surcharges on deposit insurance premia. 
JEL:  G01 G21 G28 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:zbw:vfsc16:145782&r=rmg 
By:  Tetsuya Ishikawa; Scott Robertson 
Abstract:  We consider the optimal investment problem when the traded asset may default, causing a jump in its price. For an investor with constant absolute risk aversion, we compute indifference prices for defaultable bonds, as well as a price for dynamic protection against default. For the latter problem, our work complements Sircar & Zariphopoulou (2007), where it is implicitly assumed the investor is protected against default. We consider a factor model where the asset's instantaneous return, variance, correlation and default intensity are driven by a timehomogenous diffusion X taking values in an arbitrary region E. We identify the certainty equivalent with a semilinear degenerate elliptic partial differential equation with quadratic growth in both function and gradient. Under a minimal integrability assumption on the market price of risk, we show the certainty equivalent is a classical solution. In particular, our results cover when X is a onedimensional affine diffusion and when returns, variances and default intensities are also affine. Numerical examples highlight the relationship between the factor process and both the indifference price and default insurance. Lastly, we show the insurance protection price is not the default intensity under the dual optimal measure. 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1703.00062&r=rmg 
By:  Jamal Bouoiyour (CATT); Refk Selmi (CATT) 
Abstract:  During times of extreme market turmoil, it is acknowledged that there is a tendency towards "flight to safety". A strong (weak) safe haven is defined as an asset that has a significant positive (negative) return in periods where another asset is in distress, while hedge has to be negatively correlated (uncorrelated) on average. The Bitcoin's surge alongside the aftermath of Trump's win in the 2016 U.S. presidential elections has strengthened its status as the modern safe haven. This paper uses a truly noiseassisted data analysis method, termed as Ensemble Empirical Mode Decompositionbased approach, to examine whether Bitcoin can act as a hedge and safe haven for U.S. stock price index. The results document that the Bitcoin's safehaven property is timevarying and that it has primarily been a weak safe haven in the short term and the longterm. We also demonstrate that precious metals lost their safe haven properties over time as the correlation between gold/silver and U.S. stock price declines from shortto longrun horizons. 
Date:  2017–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1703.00308&r=rmg 
By:  Natoli, Filippo; Sigalotti, Laura 
Abstract:  We analyze the degree of anchoring of inflation expectations in the euro area during the postcrisis period, with a focus on the time span from 2014 onwards when longterm beliefs have substantially drifted away from the policy target. Using a new estimation technique, we look at tail comovements between short and longterm distributions of inflation expectations, estimated from daily quotes of inflation derivatives. We find that, during 2014, average correlations between short and longterm inflation expectations rose sharply; moreover, negative tail events impacting shortterm beliefs have been increasingly channeled to longterm views, triggering both downward revisions in expectations and upward changes in uncertainty. Overall, our results signal a risk of downside deanchoring of longterm inflation expectations. JEL Classification: C14, C58, E31, E44, G13 
Keywords:  anchoring, inflation expectations, inflation swaps, inflations options, optionimplied density, tail comovement 
Date:  2017–01 
URL:  http://d.repec.org/n?u=RePEc:ecb:ecbwps:20171997&r=rmg 
By:  Takuji Arai; Yuto Imai 
Abstract:  We derive an explicit closedform representation of meanvariance hedging strategies for models whose asset price follows an exponential additive process. Our representation is given in terms of Malliavin calculus for L\'evy processes. In addition, we develop an approximation method to compute meanvariance hedging strategies for exponential L\'evy models, and illustrate numerical results. 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1702.07556&r=rmg 
By:  Schmitt, Noemi; Westerhoff, Frank 
Abstract:  After showing that the distribution of the S&P 500's distortion, i.e. the log difference between its real stock market index and its real fundamental value, is bimodal, we demonstrate that agentbased financial market models may explain this puzzling observation. Within these models, speculators apply technical and fundamental analysis to predict asset prices. Since destabilizing technical trading dominates the market near the fundamental value, asset prices tend to be either overvalued or undervalued. Interestingly, the bimodality of the distribution of the S&P 500's distortion confirms an implicit prediction of a number of seminal agentbased financial market models. 
Keywords:  stock market dynamics,bubbles and crashes,chartists and fundamentalists,nonlinear dynamics,bimodality tests,time series analysis 
JEL:  G12 G14 G17 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:bamber:119&r=rmg 
By:  David Landriault; Bin Li; Hongzhong Zhang 
Abstract:  Drawdown (resp. drawup) of a stochastic process, also referred as the reflected process at its supremum (resp. infimum), has wide applications in many areas including financial risk management, actuarial mathematics and statistics. In this paper, for general timehomogeneous Markov processes, we study the joint law of the first passage time of the drawdown (resp. drawup) process, its overshoot, and the maximum of the underlying process at this first passage time. By using shorttime pathwise analysis, under some mild regularity conditions, the joint law of the three drawdown quantities is shown to be the unique solution to an integral equation which is expressed in terms of fundamental twosided exit quantities of the underlying process. Explicit forms for this joint law are found when the Markov process has only onesided jumps or is a L\'{e}vy process (possibly with twosided jumps). The proposed methodology provides a unified approach to study various drawdown quantities for the general class of timehomogeneous Markov processes. 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1702.07786&r=rmg 
By:  Andreu, Laura; Pütz, Alexander 
Abstract:  We analyze what a second business degree reveals about the investment behavior of mutual fund managers. Specifically, we compare investment risk and style of managers with both a CFA designation and an MBA degree to managers with only one of these qualifications. We document that managers with both degrees take less risk, follow less extreme investment styles, and achieve less extreme performance outcomes. Our results are consistent with the explanation that managers with a certain personal attitude that makes them take less risk and invest more conventionally choose to gather both qualifications. We rule out several alternative explanations: our results are not driven by the respective contents of the MBA and the CFA program, by the manager's skill, or by the fund family's investment policy. 
Keywords:  Mutual funds,Investment behavior,Manager education,MBA,CFA 
JEL:  G23 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:zbw:cfrwps:1201r2&r=rmg 
By:  Wayne Passmore; Alexander H. von Hafften 
Abstract:  The Basel Committee promulgates bank regulatory standards that many major economies enact to a significant extent. One element of the Basel III capital standards is a system of capital surcharges for global systemically important banks (GSIBs). If the purpose of the surcharges is to ensure the survival of GSIBs through serious crises (like the 200709 financial crisis) without extraordinary public assistance, our analysis suggests that current surcharges are too low because of three shortcomings: (1) the Basel system underestimates the probability that a GSIB can fail, (2) the Basel system fails to account for shortterm funding, and (3) the Basel system excludes too many banks from current surcharges. Our best estimate suggests that the current surcharges should be between 225 and 525 basis points higher for GSIBs that are not reliant on shortterm funding; GSIBs that are reliant on shortterm funding should have even higher surcharges. Furthermore, we find that, even with significant confidence in the effectiveness of other Basel III reforms, modest increases in surcharges appear needed. 
Keywords:  Basel III ; GSIBs ; GSIFIs ; Bank capital ; Bank equity ; Bank regulation ; Banks 
JEL:  G01 G18 G21 
Date:  2017–02–21 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgfe:201721&r=rmg 
By:  Noth, Felix; Schüwer, Ulrich 
Abstract:  We document that natural disasters significantly weaken the stability of banks with business activities in affected regions, as reflected in lower zscores, higher probabilities of default, higher nonperforming assets ratios, higher foreclosure ratios, lower returns on assets and lower bank equity ratios. The effects are economically relevant and suggest that insurance payments and public aid programs do not sufficiently protect bank borrowers against financial difficulties. We also find that the adverse effects on bank stability dissolve after some years if no further disasters occur in the meantime. 
Keywords:  natural disasters,bank stability,nonperforming assets,bank performance 
JEL:  G21 Q54 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:safewp:167&r=rmg 
By:  Robin Greenwood; Andrei Shleifer; Yang You 
Abstract:  We evaluate Eugene Fama’s claim that stock prices do not exhibit price bubbles. Based on US industry returns 19262014 and international sector returns 19852014, we present four findings: (1) Fama is correct in that a sharp price increase of an industry portfolio does not, on average, predict unusually low returns going forward; (2) such sharp price increases predict a substantially heightened probability of a crash; (3) attributes of the price runup, including volatility, turnover, issuance, and the price path of the runup can all help forecast an eventual crash and future returns; and (4) some of these characteristics can help investors earn superior returns by timing the bubble. Results hold similarly in US and international samples. 
JEL:  G02 G1 G12 G14 
Date:  2017–02 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:23191&r=rmg 