nep-rmg New Economics Papers
on Risk Management
Issue of 2017‒03‒19
sixteen papers chosen by
Stan Miles
Thompson Rivers University

  1. On representing and hedging claims for coherent risk measures By Saul Jacka; Seb Armstrong; Abdelkarem Berkaoui
  2. Systemic Risk, Maximum Entropy and Interbank Contagion By M. Andrecut
  3. Financial Stability and Macro Prudential Regulation: Policy Implication of Systemic Expected Shortfall Measure By Hatem Salah; Marwa Souissi
  4. Model Spaces for Risk Measures By Felix-Benedikt Liebrich; Gregor Svindland
  5. Topological Data Analysis of Financial Time Series: Landscapes of Crashes By Marian Gidea; Yuri Katz
  6. Curbing Corporate Debt Bias By Ruud A. de Mooij; Shafik Hebous
  7. Risk Taking and Interest Rates; Evidence from Decades in the Global Syndicated Loan Market By Seung Jung Lee; Lucy Qian Liu; Viktors Stebunovs
  8. Perfect hedging in rough Heston models By Omar El Euch; Mathieu Rosenbaum
  9. Disentangling Price, Risk and Model Risk By Marco Frittelli; Marco Maggis
  10. Data driven partition-of-unity copulas with applications to risk management By Dietmar Pfeifer; Andreas M\"andle; Olena Ragulina
  11. Re-Use of Collateral: Leverage, Volatility, and Welfare By Johannes Brumm; Michael Grill; Felix Kubler; Karl Schmedders
  12. The Two-Moment Decision Model with Additive Risks By Guo, Xu; Wagener, Andreas; Wong, Wing-Keung; Zhu, Lixing
  13. Optimality of Excess-Loss Reinsurance under a Mean-Variance Criterion By Danping Li; Dongchen Li; Virginia R. Young
  14. Market Discipline in the Secondary Bond Market: The Case of Systemically Important Banks By Elyasiani, Elyas; Keegan, Jason
  15. Banks’ Adjustment to Basel III Reform; A Bank-Level Perspective for Emerging Europe By Michal Andrle; Vladimír Tomšík; Jan Vlcek
  16. What Are Reference Rates For? By Divya Kirti

  1. By: Saul Jacka; Seb Armstrong; Abdelkarem Berkaoui
    Abstract: We provide a dual characterisation of the weak$^*$-closure of a finite sum of cones in $L^\infty$ adapted to a discrete time filtration $\mathcal{F}_t$: the $t^{th}$ cone in the sum contains bounded random variables that are $\mathcal{F}_t$-measurable. Hence we obtain a generalisation of Delbaen's m-stability condition for the problem of reserving in a collection of num\'eraires $\mathbf{V}$, called $\mathbf{V}$-m-stability, provided these cones arise from acceptance sets of a dynamic coherent measure of risk. We also prove that $\mathbf{V}$-m-stability is equivalent to time-consistency when reserving in portfolios of $\mathbf{V}$, which is of particular interest to insurers.
    Date: 2017–03
  2. By: M. Andrecut
    Abstract: We discuss the systemic risk implied by the interbank exposures reconstructed with the maximum entropy method. The maximum entropy method severely underestimates the risk of interbank contagion by assuming a fully connected network, while in reality the structure of the interbank network is sparsely connected. Here, we formulate an algorithm for sparse network reconstruction, and we show numerically that it provides a more reliable estimation of the systemic risk.
    Date: 2017–03
  3. By: Hatem Salah (University of Manouba); Marwa Souissi
    Abstract: In this paper we highlighted the importance of systemic risk in the new framework of financial regulation. We employed several macro-economic variables and balance sheets indicators, to underline the degree of vulnerability of Tunisian banking sector .We also applied the Systemic Expected Shortfall measurement for the case of Tunisian financial institutions. Empirically, we showed which variable had a powerful alternative in explaining potential riskiness of Tunisian banking sector during the financial crisis of 2011. Our analytical framework presents a recent essay to evaluate systemic importance of Tunisian banks.
    Date: 2016–04
  4. By: Felix-Benedikt Liebrich; Gregor Svindland
    Abstract: We show how risk measures originally defined in a model free framework in terms of acceptance sets and reference assets imply a meaningful underlying probability structure. Hereafter we construct a maximal domain of definition of the risk measure respecting the underlying ambiguity profile. We particularly emphasise liquidity effects and discuss the correspondence between properties of the risk measure and the structure of this domain as well as subdifferentiability properties. Keywords: Model free risk assessment, extension of risk measures, continuity properties of risk measures, subgradients.
    Date: 2017–03
  5. By: Marian Gidea; Yuri Katz
    Abstract: We explore the evolution of daily returns of four major US stock market indices during the technology crash of 2000, and the financial crisis of 2007-2009. Our methodology is based on topological data analysis (TDA). We use persistence homology to detect and quantify topological patterns that appear in multidimensional time series. Using a sliding window, we extract time-dependent point cloud data sets, to which we associate a topological space. We detect transient loops that appear in this space, and we measure their persistence. This is encoded in real-valued functions referred to as a 'persistence landscapes'. We quantify the temporal changes in persistence landscapes via their $L^p$-norms. We test this procedure on multidimensional time series generated by various non-linear and non-equilibrium models. We find that, in the vicinity of financial meltdowns, the $L^p$-norms exhibit strong growth prior to the primary peak, which ascends during a crash. Remarkably, the average spectral density at low frequencies of the time series of $L^p$-norms of the persistence landscapes demonstrates a strong rising trend for 250 trading days prior to either dotcom crash on 03/10/2000, or to the Lehman bankruptcy on 09/15/2008. Our study suggests that TDA provides a new type of econometric analysis, which goes beyond the standard statistical measures. The method can be used to detect early warning signals of imminent market crashes. We believe that this approach can be used beyond the analysis of financial time series presented here.
    Date: 2017–03
  6. By: Ruud A. de Mooij; Shafik Hebous
    Abstract: Tax provisions favoring corporate debt over equity finance (“debt bias†) are widely recognized as a risk to financial stability. This paper explores whether and how thin-capitalization rules, which restrict interest deductibility beyond a certain amount, affect corporate debt ratios and mitigate financial stability risk. We find that rules targeted at related party borrowing (the majority of today’s rules) have no significant impact on debt bias—which relates to third-party borrowing. Also, these rules have no effect on broader indicators of firm financial distress. Rules applying to all debt, in contrast, turn out to be effective: the presence of such a rule reduces the debt-asset ratio in an average company by 5 percentage points; and they reduce the probability for a firm to be in financial distress by 5 percent. Debt ratios are found to be more responsive to thin capitalization rules in industries characterized by a high share of tangible assets.
    Keywords: Corporate debt;Debt service ratios;Financial risk;Corporate taxes;Thin capitalization;Risk management;Econometric models;Corporate tax, capital structure, debt bias, thin capitalization rule
    Date: 2017–01–30
  7. By: Seung Jung Lee; Lucy Qian Liu; Viktors Stebunovs
    Abstract: We study how low interest rates in the United States affect risk taking in the market of crossborder leveraged corporate loans. To the extent that actions of the Federal Reserve affect U.S. interest rates, our analysis provides evidence of a cross-border spillover effect of monetary policy. We find that before the crisis, lenders made ex-ante riskier loans to non- U.S. borrowers in response to a decline in short-term U.S. interest rates, and, after it, in response to a decline in longer-term U.S. interest rates. Economic uncertainty and risk appetite appear to play a limited role in explaining ex-ante credit risk. Our results highlight the potential policy challenges faced by central banks in affecting credit risk cycles in their own jurisdictions.
    Keywords: Interest rates on loans;Loans;Credit risk;United States;Monetary policy;Spillovers;Regression analysis;Syndicated loans, risk taking, monetary policy, international spillovers
    Date: 2017–01–27
  8. By: Omar El Euch; Mathieu Rosenbaum
    Abstract: Rough volatility models are known to reproduce the behavior of historical volatility data while at the same time fitting the volatility surface remarkably well, with very few parameters. However, managing the risks of derivatives under rough volatility can be intricate since the dynamics involve fractional Brownian motion. We show in this paper that surprisingly enough, explicit hedging strategies can be obtained in the case of rough Heston models. The replicating portfolios contain the underlying asset and the forward variance curve, and lead to perfect hedging (at least theoretically). From a probabilistic point of view, our study enables us to disentangle the infinite-dimensional Markovian structure associated to rough volatility models.
    Date: 2017–03
  9. By: Marco Frittelli; Marco Maggis
    Abstract: We propose a method to assess the intrinsic risk carried by a financial position when the agent faces uncertainty about the pricing rule providing its present value. Our construction is inspired by a new interpretation of the quasiconvex duality and naturally leads to the introduction of the general class of Value\&Risk measures.
    Date: 2017–03
  10. By: Dietmar Pfeifer; Andreas M\"andle; Olena Ragulina
    Abstract: We present a constructive and self-contained approach to data driven general partition-of-unity copulas that were recently introduced in the literature. In particular, we consider Bernstein-, negative binomial and Poisson copulas and present a solution to the problem of fitting such copulas to highly asymmetric data.
    Date: 2017–03
  11. By: Johannes Brumm (Karlsruhe Institute of Technology); Michael Grill (European Central Bank (ECB)); Felix Kubler (University of Zurich and Swiss Finance Institute); Karl Schmedders (University of Zurich and Swiss Finance Institute)
    Abstract: We assess the quantitative implications of the re-use of collateral on financial market leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to re-use frees up collateral that can be used to back more transactions. Re-use thus contributes to the build-up of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing reuse beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets.
    Keywords: heterogeneous agents, leverage, re-use of collateral, volatility, welfare
    JEL: D53 G01 G12 G18
    Date: 2017–02
  12. By: Guo, Xu; Wagener, Andreas; Wong, Wing-Keung; Zhu, Lixing
    Abstract: With multiple additive risks, the mean-variance approach and the expected-utility approach of risk preferences are compatible if all attainable distributions belong to the same location-scale family. Under this proviso, we survey existing results on the parallels of the two approaches with respect to risk attitudes, the changes thereof, and the comparative statics for simple, linear choice problems under risks. In mean-variance approach all effects can be couched in terms of the marginal rate of substitution between mean and variance. We provide some simple proofs of some previous results. We apply the theory we stated or developed in our paper to study the behavior of banking firm and study risk taking behavior with background risk in the mean-variance model.
    Keywords: Mean-variance model; location-scale family; background risk; multiple additive risks; expected-utility approach
    JEL: C0 D81 G11
    Date: 2017–03–17
  13. By: Danping Li; Dongchen Li; Virginia R. Young
    Abstract: In this paper, we study an insurer's reinsurance-investment problem under a mean-variance criterion. We show that excess-loss is the unique equilibrium reinsurance strategy under a spectrally negative L\'{e}vy insurance model when the reinsurance premium is computed according to the expected value premium principle. Furthermore, we obtain the explicit equilibrium reinsurance-investment strategy by solving the extended Hamilton-Jacobi-Bellman equation.
    Date: 2017–03
  14. By: Elyasiani, Elyas (Temple University); Keegan, Jason (Federal Reserve Bank of Philadelphia)
    Abstract: We investigate the association between the yields on debt issued by U.S. systemically important banks (SIBs) and their idiosyncratic risk factors, macroeconomic factors, and bond features, in the secondary market. Although greater SIB risk levels are expected to increase debt yields (Evanoff and Wall, 2000), prevalence of government safety nets complicates the market discipline mechanism, rendering the issue an empirical exercise. Our main objectives are twofold. First, we study how bond buyers reacted to elevation of SIB-specific and macroeconomic risk factors over the recent business cycle. Second, we investigate the degree to which the proportion of variance in yields explained by SIB and macroeconomic risk factors changed across the phases of the cycle. Our data include over 8 million bond trades across 26 SIBs. We divide our sample period into the pre-crisis (2003:Q1 to 2007:Q3), crisis (2007:Q4 to 2009:Q2), and post-crisis (2009:Q3 to 2014:Q3) sub-periods to contrast the findings. We obtain several results. First, bond buyers do react to changes in the SIB-specific risk factors (leverage, credit risk, inefficiency, lack of profitability, illiquidity, and interest rate risk) by demanding higher yields. Second, bond buyers’ responses to risk factors are sensitive to the phase of the business cycle. Third, the proportion of variance in yields driven by SIB-specific and bond-specific risk factors increased from 23 percent in the pre-crisis period to 47 percent and 73 percent, respectively, during the crisis and post-crisis periods. These findings indicate that the force of market discipline improved greatly during the crisis and post-crisis periods, at the expense of macroeconomic factors. The strengthening of market discipline in the crisis and post-crisis periods, despite the unprecedented regulatory intervention in the form of quantitative easing programs, the Troubled Asset Relief Program, large bail outs, and generally accommodative fiscal and monetary policies adopted during these periods, demonstrates that regulatory intervention and market discipline can work in tandem.
    Keywords: Bank Risk; Financial Crisis; U.S. Bank Holding Companies; Risk Management; Market Discipline
    JEL: G01 G2 G21 G28
    Date: 2017–03–10
  15. By: Michal Andrle; Vladimír Tomšík; Jan Vlcek
    Abstract: The paper seeks to identify strategies of commercial banks in response to higher capital requirements of Basel III reform and its phase-in. It focuses on a sample of nine EU emerging market countries and picks up 5 largest banks in each country assessing their response. The paper finds that all banking sectors raised CAR ratios mainly through retained earnings. In countries where the banking sector struggled with profitability, banks have resorted to issuance of new equity or shrunk the size of their balance sheets to meet the higher capital-adequacy requirements. Worries echoed at the early stage of Basel III compilation, namely that commercial banks would shrink their balance sheet by reducing their lending to meet stricter capital requirements, did materialize only in banks struggling with profitability.
    Keywords: Banking sector;Europe;Commercial banks;Emerging markets;Bank supervision;Basel Core Principles;Bank reforms;capital adequacy, Basel III, balance sheet
    Date: 2017–02–10
  16. By: Divya Kirti
    Abstract: What is the precise role of reference rates? Why does it matter if LIBOR was manipulated? To address these questions, I analyze the use of reference rates in floating-rate loans and interestrate derivatives in the context of lending relationships. I develop a simple framework combining maturity transformation with three key frictions which generate meaningful funding risk and a rationale for risk management. Reference rates like LIBOR mitigate contractual incompleteness, facilitating management of funding risk. As bank funding costs move with bank credit risk, it makes sense for the reference rate to have a bank credit risk component. Manipulation can add noise, reducing the usefulness of reference rates for this purpose.
    Keywords: London interbank offer rate;Interest rates;Loans;Financial derivatives;Risk management;Reference rates, interest rate risk
    Date: 2017–01–27

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