nep-rmg New Economics Papers
on Risk Management
Issue of 2017‒04‒02
sixteen papers chosen by

  1. A novel multivariate risk measure: the Kendall VaR By Matthieu Garcin; Dominique Guegan; Bertrand Hassani
  2. Systemic risk and individual risk: A trade-off? By Tatiana Gaelle Yongoua Tchikanda
  3. Did the Basel Process of Capital Regulation Enhance the Resiliency of European Banks? By Gehrig, Thomas; Iannino, Maria Chiara
  4. Impact of multimodality of distributions on VaR and ES calculations By Dominique Guegan; Bertrand Hassani; Kehan Li
  5. L’ALBERO DEL RISCHIO: RELAZIONI STOCASTICHE (ELEMENTARI) TRA GLI INDICATORI DI BILANCIO [The tree of risk: (elementary) stochastic relations between financial ratios] By Varetto Franco
  6. Risk hedging and competition : the case of electricity markets By Raphaël Homayoun Boroumand; Georg Zachmann
  7. LARGE DEVIATIONS OF THE REALIZED (CO-)VOLATILITY VECTOR By Hacène Djellout; Arnaud Guillin; Yacouba Samoura
  8. How does risk flow in the credit default swap market? By Marco D'Errico; Stefano Battiston; Tuomas Peltonen; Martin Scheicher
  9. Strategic complementarity in banks’ funding liquidity choices and financial stability By André Silva
  10. Arbitraging the Basel securitization framework: Evidence from German ABS investment By Matthias Efing
  11. On the Returns of Trend-Following Trading Strategies By Lundström, Christian
  12. Global Banking: Risk Taking and Competition By Ester Faia; Gianmarco Ottaviano
  13. Predicting vulnerabilities in the EU banking sector: the role of global and domestic factors By Markus Behn; Carsten Detken; Tuomas Peltonen; Willem Schudel
  14. Banking Crises and the Japanese Legal Framework By Ignacio Tirado
  15. Natural Disasters: Financial preparedness of corporate Japan By SAWADA Yasuyuki; MASAKI Tatsujiro; NAKATA Hiroyuki; SEKIGUCHI Kunio
  16. Measuring the Systemic Risk in Interfirm Transaction Networks By Hazama, Makoto; Uesugi, Iichiro

  1. By: Matthieu Garcin (Natixis Asset Management, Labex ReFi - Université Paris1 - Panthéon-Sorbonne); Dominique Guegan (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, Labex ReFi - Université Paris1 - Panthéon-Sorbonne); Bertrand Hassani (Grupo Santander, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, Labex ReFi - Université Paris1 - Panthéon-Sorbonne)
    Abstract: The definition of multivariate Value at Risk is a challenging problem, whose most common solutions are given by the lower- and upper-orthant VaRs, which are based on copulas: the lower-orthant VaR is indeed the quantile of the multivariate distribution function, whereas the upper-orthant VaR is the quantile of the multivariate survival function. In this paper we introduce a new approach introducing a total-order multivariate Value at Risk, referred to as the Kendall Value at Risk, which links the copula approach to an alternative definition of multivariate quantiles, known as the quantile surface, which is not used in finance, to our knowledge. We more precisely transform the notion of orthant VaR thanks to the Kendall function so as to get a multivariate VaR with some advantageous properties compared to the standard orthant VaR: it is based on a total order and, for a non-atomic and Rd-supported density function, there is no distinction anymore between the d-dimensional VaRs based on the distribution function or on the survival function. We quantify the differences between this new kendall VaR and orthant VaRs. In particular, we show that the Kendall VaR is less (respectively more) conservative than the lower-orthant (resp. upper-orthant) VaR. The definition and the properties of the Kendall VaR are illustrated using Gumbel and Clayton copulas with lognormal marginal distributions and several levels of risk.
    Keywords: Kendall function,risk measure,Value at Risk,multivariate quantile,copula,total order
    Date: 2017–01
  2. By: Tatiana Gaelle Yongoua Tchikanda
    Abstract: The global financial crisis raised concerns about the European financial system structure. The systemic nature of financial institutions, especially banking institutions, was highlighted, questioning the bottom-up approach used so far to ensure the financial stability as a whole. In this study, we legitimize the calibration of micro-prudential instruments for macro-prudential purposes in order to measure and manage systemic risk. The debate on the best way to eliminate the negative externalities of systemic risk is politically controversial and economically complicated. Using bank balance sheet and daily stock market data from listed banks classified as Monetary Financial Institutions (MFIs) across EU-17 over the period 1999-2013, we investigate whether more individual bank soundness is conducive for financial stability. Through a 2SLS model to correct the observed endogeneity between the individual risk, measured by Z-score (Roy, 1952) and the systemic risk, measured by SRISK (Acharya, Engle and Richardson, 2012), our strong empirical results suggest that riskier banks contribute more to systemic risk. Thus, individual bank soundness increases the banking system resilience to potential shocks. On the one hand, this finding seems to challenge the traditional bottom-up approach. Indeed, our outcome emphasizes the fallacy of composition prior the crisis. Nevertheless, it shows that even if the sum of the risks borne by financial institutions does not reflect the global risks borne by the entire system, it is an important addition. On the other hand, this result justifies the calibration of micro-prudential tools for macro-prudential purposes; taking into account individual factors that are sources of systemic fragilities and a part of individual risk-taking. This study has important policy implications for designing and implementing new regulations to improve the financial system stability, in particular for MFIs because systemic risk remains misunderstood and its measuring tools are still ongoing (Hansen, 2012).
    Keywords: Financial stability, Bank risk-taking, systemic risk, financial structure.
    JEL: G21 G28
    Date: 2017
  3. By: Gehrig, Thomas; Iannino, Maria Chiara
    Abstract: This paper analyses the evolution of the safety and soundness of the European banking sector during the various stages of the Basel process of capital regulation. In the first part we document the evolution of various measures of systemic risk as the Basel process unfolds. Most strikingly, we find that the exposure to systemic risk as measured by SRISK has been steeply rising for the highest quintile, moderately rising for the second quintile and remaining roughly stationary for the remaining three quintiles of listed European banks. This observation suggests that the Basel process has succeeded in containing systemic risk for the majority of European banks but not for the largest institutions. In the second part we analyse the drivers of systemic risk. We find compelling evidence that the increase in exposure to systemic risk (SRISK) is intimately tied to the implementation of internal models for determining credit risk as well as market risk. Based on this evidence, the sub-prime crisis found especially the largest and more systemic banks ill-prepared and lacking resiliency. This condition has even aggravated during the European sovereign crisis. Banking Union has not (yet) brought about a significant increase in the safety and soundness of the European banking system. Finally, low interest rates affect considerably to the contribution to systemic risk across the whole spectrum of banks.
    Keywords: capital shortfall; internal risk models; quantile regressions; resilience; systemic risk
    JEL: B26 E58 G21 G28 H12 N24
    Date: 2017–03
  4. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, Labex ReFi - Université Paris1 - Panthéon-Sorbonne); Bertrand Hassani (Grupo Santander, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, Labex ReFi - Université Paris1 - Panthéon-Sorbonne); Kehan Li (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, Labex ReFi - Université Paris1 - Panthéon-Sorbonne)
    Abstract: Unimodal probability distribution has been widely used for Value-at-Risk (VaR) computation by investors, risk managers and regulators. However, financial data may be characterized by distributions having more than one modes. Using a unimodal distribution may lead to bias for risk measure computation. In this paper, we discuss the influence of using multimodal distributions on VaR and Expected Shortfall (ES) calculation. Two multimodal distribution families are considered: Cobb's family and distortion family. We provide two ways to compute the VaR and the ES for them: an adapted rejection sampling technique for Cobb's family and an inversion approach for distortion family. For empirical study, two data sets are considered: a daily data set concerning operational risk and a three month scenario of market portfolio return built five minutes intraday data. With a complete spectrum of confidence levels from 0001 to 0.999, we analyze the VaR and the ES to see the interest of using multimodal distribution instead of unimodal distribution.
    Keywords: Risks,Multimodal distributions,Value-at-Risk,Expected Shortfall,Moments method,Adapted rejection sampling,Regulation
    Date: 2017–03
  5. By: Varetto Franco (National Research Council of Italy, Research Institute on Sustainable Economic Growth CNR-IRCrES Torino, Italy)
    Abstract: Starting from a map of financial ratios organized to analyse the corporate profitability, here is proposed a closed formula approach to compute the averages of ratios and their variabilities over the whole map. An application is provided using the 2016 edition of Mediobanca’s Dati Cumulativi. The proposed approach is easily generalizable and could be use in the domain of risk analysis of non-financial companies.
    Keywords: financial ratios, financial statements analysis, statistical methods, risk analysis
    JEL: M41 C18 G32
    Date: 2016–10
  6. By: Raphaël Homayoun Boroumand; Georg Zachmann
    Abstract: The advent of retail competition in the energy industry was concomitant with the explicit emergence of energy suppliers.The latter buys electricity on the wholesale market or contractually from producers and resells it to its customers. The “textbook model” of competitive decentralized energy markets required the vertical separation of generation, retail, as well as network activities (transmission and distribution). Introducing competition at the retail level was thought to imply the emergence and development of “asset-light suppliers” who neither own generating nor distribution assets. By offering innovative retail contracts with attractive prices to electricity consumers, those suppliers were expected to generate a fierce price-competition (Hunt 2002; Hunt and Schuttleworth, 1997). However, in stark contrast to this theoretical vision, asset-light retail entry has never eventuated as expected. Asset-light suppliers bankrupted, left the market, were taken over, or evolved towards an integration into production in all retail markets. Departing from this unexpected market outcome, the paper compares hourly risk hedging portfolios for three European markets relying on hourly electricity volumes and price data. The paper is organized as follows: in section 2 we put forward the market risks faced by energy suppliers. Section 3 demonstrates the limits of financial hedging in liberalized electricity markets. Section 4 is devoted to comparing from numerical simulations the risk profiles of different hourly hedging portfolios’ made exclusively (or conjointly) of forwards, financial options, and/ or physical assets. The last section concludes and provides regulatory and policy recommendations. We demonstrate through a Monte Carlo simulation based on 6000 hourly electricity volume and price data, how portfolios can be optimized to reduce suppliers net revenue exposure. We use the Value at Risk (95%) and the CVAR to compare the risk profiles of the portfolios. Through the presented numerical simulations we provide evidence, that energy suppliers can hedge the market risks originating from their retail contracts by either a combination of forwards and options on the spot price or by a combination of forwards and physical assets. In all observed electricity markets, however, liquid derivatives on the spot market are absent (Geman, 2005; Hull, 2005). Thus, the only real choice for suppliers is to hedge their retail obligations through physical hedging (investing in electricity plants). These, however, might help to significantly reduce a supplier’s risk exposure. Consequently, as long as derivatives markets are not sufficiently liquid, suppliers will strive to vertically integrate to hedge their risk exposure. We also propose portfolio optimization based on intraday hedging of electricity intermediaries. Indeed, our results clearly demonstrate that the optimal hedging portfolio varies in relation with the hours of the day. First, our model demonstrates that the average of the cumulated hourly losses [as measured by the average VaR(95%)]of the seven homogeneous group of hours is lower than the VaR (95%) of a single daily optimal portfolio. Therefore, we propose several optimal hedging portfolios per day. Secondly, for any group of hours, we demonstrate that the optimal portfolio is specific. Conclusions and policy recommendations Our paper demonstrates that physical hedging, supported to some degree by forward contracting and spot transactions is an efficient and sustainable approach to risk management in decentralized electricity markets. In contrast to the theoretical premises, financial contracts are imperfect substitutes to vertical integration in the current market environment. The failure of asset-light electricity suppliers is indicative of the intrinsic incapacity of this organizational model to manage efficiently the combination of sourcing and selling risks. Vertically integrated, suppliers will maximize profits by relying on tacit price collusion in an oligopoly setting, which radically constrasts with the expected price competition envisioned in the reference market model of electricity liberalization. The role of competition auhthorities will therefore consist in stimulating competition between vertically integrated suppliers.
    Keywords: France, UK, Energy and environmental policy, Finance
    Date: 2015–07–01
  7. By: Hacène Djellout (LMBP - Laboratoire de Mathématiques Blaise Pascal - UBP - Université Blaise Pascal - Clermont-Ferrand 2 - CNRS - Centre National de la Recherche Scientifique); Arnaud Guillin (IUF - Institut Universitaire de France - M.E.N.E.S.R. - Ministère de l'Éducation nationale, de l’Enseignement supérieur et de la Recherche, LMBP - Laboratoire de Mathématiques Blaise Pascal - UBP - Université Blaise Pascal - Clermont-Ferrand 2 - CNRS - Centre National de la Recherche Scientifique); Yacouba Samoura (LMBP - Laboratoire de Mathématiques Blaise Pascal - UBP - Université Blaise Pascal - Clermont-Ferrand 2 - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Realized statistics based on high frequency returns have become very popular in financial economics. In recent years, different non-parametric estimators of the variation of a log-price process have appeared. These were developed by many authors and were motivated by the existence of complete records of price data. Among them are the realized quadratic (co-)variation which is perhaps the most well known example, providing a consistent estimator of the integrated (co-)volatility when the logarithmic price process is continuous. Limit results such as the weak law of large numbers or the central limit theorem have been proved in different contexts. In this paper, we propose to study the large deviation properties of realized (co-)volatility (i.e., when the number of high frequency observations in a fixed time interval increases to infinity. More specifically, we consider a bivariate model with synchronous observation schemes and correlated Brownian motions of the following form: $dX_{\ell,t} = \sigma_{\ell,t}dB_{\ell,t}+b_{\ell}(t,\omega)dt$ for $\ell=1,2$, where $X_{\ell}$ denotes the log-price, we are concerned with the large deviation estimation of the vector $V_t^n(X)=\left(Q_{1,t}^n(X), Q_{2,t}^n(X), C_{t}^n(X)\right)$ where $Q_{\ell,t}^n(X)$ and $C_{t}^n(X)$ represente the estimator of the quadratic variational processes $Q_{\ell,t}=\int_0^t\sigma_{\ell,s}^2ds$ and the integrated covariance $C_t=\int_0^t\sigma_{1,s}\sigma_{2,s}\rho_sds$ respectively, with $\rho_t=cov(B_{1,t}, B_{2,t})$. Our main motivation is to improve upon the existing limit theorems. Our large deviations results can be used to evaluate and approximate tail probabilities of realized (co-)volatility. As an application we provide the large deviation for the standard dependence measures between the two assets returns such as the realized regression coefficients up to time $t$, or the realized correlation. Our study should contribute to the recent trend of research on the (co-)variance estimation problems, which are quite often discussed in high-frequency financial data analysis.
    Keywords: large deviations,diffusion,discrete-time observation,Realised Volatility and covolatility
    Date: 2017–01–30
  8. By: Marco D'Errico; Stefano Battiston; Tuomas Peltonen; Martin Scheicher
    Abstract: We develop a framework to analyse the Credit Default Swaps (CDS) market as a network of risk transfers among counterparties. From a theoretical perspective, we introduce the notion of flow-of-risk and provide sufficient conditions for a bow-tie network architecture to endogenously emerge as a result of intermediation. This architecture shows three distinct sets of counterparties: i) Ultimate Risk Sellers (URS), ii) Dealers (indirectly connected to each other), iii) Ultimate Risk Buyers (URB). We show that the probability of widespread distress due to counterparty risk is higher in a bow-tie architecture than in more fragmented network structures. Empirically, we analyse a unique global dataset of bilateral CDS exposures on major sovereign and financial reference entities in 2011 −2014. We find the presence of a bow-tie network architecture consistently across both reference entities and time, and thatt the flow-of-risk originates from a large number of URSs (e.g. hedge funds) and ends up in a few leading URBs, most of which are non-banks (in particular asset managers). Finally, the analysis of the CDS portfolio composition of the URBs shows a high level of concentration: in particular, the top URBs often show large exposures to potentially correlated reference entities. JEL Classification: G10, G15
    Keywords: flow-of-risk, systemic risk, credit default swap, financial networks, network architecture
    Date: 2016–12
  9. By: André Silva
    Abstract: This paper examines whether banks’ liquidity and maturity mismatch decisions are affected by the choices of competitors and the impact of these coordinated funding liquidity policies on financial stability. Using a novel identification strategy where interactions are structured through decision networks, I show that banks do consider their peers’ liquidity choices when determining their own. This effect is asymmetric and not present in bank capital choices. Importantly, I find that these strategic funding liquidity decisions increase both individual banks’ default risk and overall systemic risk. From a macroprudential perspective, the results highlight the importance of explicitly regulating systemic liquidity risk. JEL Classification: G20, G21, G28
    Keywords: funding liquidity risk, financial stability, macroprudential policy
    Date: 2016–07
  10. By: Matthias Efing
    Abstract: This paper provides evidence for regulatory arbitrage within the class of asset-backed securities (ABS) based on individual asset holding data of German banks. I find that banks operating with tight regulatory constraints exploit the low risk-sensitivity of rating-contingent capital requirements for ABS. Unlike unconstrained banks they systematically pick the securities with the highest yield and the lowest collateral performance among ABS with the same regulatory risk weight. This reaching for yield allows constrained banks to increase the return on the capital required for an ABS investment by a factor of four. JEL Classification: G01, G21, G24, G28
    Keywords: regulatory arbitrage, asset-backed securities, reaching for yield, credit ratings
    Date: 2016–09
  11. By: Lundström, Christian (Department of Economics, Umeå University)
    Abstract: Paper [I] tests the success rate of trades and the returns of the Opening Range Breakout (ORB) strategy. A trader that trades on the ORB strategy seeks to identify large intraday price movements and trades only when the price moves beyond some predetermined threshold. We present an ORB strategy based on normally distributed returns to identify such days and find that our ORB trading strategy result in significantly higher returns than zero as well as an increased success rate in relation to a fair game. The characteristics of such an approach over conventional statistical tests is that it involves the joint distribution of low; high; open and close over a given time horizon. Paper [II] measures the returns of a popular day trading strategy; the Opening Range Breakout strategy (ORB); across volatility states. We calculate the average daily returns of the ORB strategy for each volatility state of the underlying asset when applied on long time series of crude oil and S&P 500 futures contracts. We find an average difference in returns between the highest and the lowest volatility state of around 200 basis points per day for crude oil; and of around 150 basis points per day for the S&P 500. This finding suggests that the success in day trading can depend to a large extent on the volatility of the underlying asset. Paper [III] performs empirical analysis on short-term and long-term Commodity Trading Advisor (CTA) strategies regarding their exposures to unanticipated risk shocks. Previous research documents that CTA strategies offer diversification opportunities during equity market crisis situations when evaluated as a group; but do not separate between short-term and long-term CTA strategies. When separating between short-term and long-term CTA strategies; this paper finds that only short-term CTA strategies provide a significant; and consistent; exposure to unanticipated risk shocks while long-term CTA strategies do not. For the purpose of diversifying a portfolio during equity market crisis situations; this result suggests that an investor should allocate to short-term CTA strategies rather than to long-term CTA strategies.
    Keywords: Bootstrap; Commodity Trading Advisor funds; Contraction-Expansion principle; Crude oil futures; Futures trading; Opening Range Breakout strategies; S&P 500 futures; Technical analysis; Time series momentum; Time-varying market inefficiency
    JEL: C21 C49 G11 G14 G17
    Date: 2017–03–23
  12. By: Ester Faia; Gianmarco Ottaviano
    Abstract: Direct involvement of global banks in local retail activities can reduce risk-taking by promoting local competition. We develop this argument through a model in which multinational banks operate simultaneously in different countries with direct involvement in imperfectly competitive local deposit and loan markets. The model generates predictions that are consistent with the foregoing argument as long as the expansionary impact of competition on multinational banks' aggregate profits through larger scale is strong enough to offset its parallel contractionary impact through lower loan-deposit return margin (a result valid with both perfectly and imperfectly correlated loans' risk). When this is the case, banking globalization also moderates the credit crunch following a deterioration in the investment climate. Compared with multinational banking, the beneficial effect of cross-border lending on risk-taking is weaker.
    Keywords: global bank, oligopoly, oligopsony, endogenous risk taking,expectation of rents extraction, appetitefor leverage
    JEL: G21 G32 L13
    Date: 2017–03
  13. By: Markus Behn; Carsten Detken; Tuomas Peltonen; Willem Schudel
    Abstract: We estimate a multivariate early-warning model to assess the usefulness of private credit and other macro-financial variables in predicting banking sector vulnerabilities. Using data for 23 European countries, we find that global variables and in particular global credit growth are strong predictors of domestic vulnerabilities. Moreover, domestic credit variables also have high predictive power, but should be complemented by other macro-financial indicators like house price growth and banking sector capitalization that play a salient role in predicting vulnerabilities. Our findings can inform decisions on the activation of macroprudential policy measures and suggest that policy makers should take a broad approach in the analytical models that support risk identification and calibration of tools. JEL Classification: G01, G21, G28
    Keywords: early-warning model, banking crises, signalling approach, systemic risk
    Date: 2016–11
  14. By: Ignacio Tirado (Professor, Universidad Autónoma de Madrid, Spain (E-mail:
    Abstract: This paper presents an overview of the Japanese system to deal with the distress of banks, providing a classification of the regulation and remedies based on the level of systemic risk of the troubled entity. The paper differentiates between the types of actions available and analyses in detail the instruments and their application. While the regulation is disperse and its apprehension is complicated for a foreign reader, Japan counts on a modern, thorough and adequate group of institutions and instruments to tackle bank distress. Its most notable feature is the proportionality of measures and the flexibility enjoyed by a resolution authority that may accommodate its intervention to the characteristics of the case and the degree of contagion risk. Although mainly inspired by the American model, the system is compared with the new European framework and FSB recommendations are considered. Although a few elements could be reconsidered, its high institutional level and flexibility make the Japanese system one capable of dealing with financial crises at both national and international levels.
    Keywords: Bank Resolution, Financial Crisis, Preventive Corrective Action, General Bankruptcy Proceedings, Systemic Risk
    JEL: G21 G33 K23
    Date: 2017–03
  15. By: SAWADA Yasuyuki; MASAKI Tatsujiro; NAKATA Hiroyuki; SEKIGUCHI Kunio
    Abstract: In this paper, we investigate the factors behind the low disaster insurance subscription rate in the Japanese corporate sector using unique firm-level data sets. According to our data, disaster insurance participation rates are 59.5% and 47.0% for large enterprises and small and medium enterprises, respectively. Corporate awareness of disasters, resulting adoption of business continuity planning/business continuity management (BCP/BCM), and insurance participation are systematically related to the commitment of corporate executives, reliance on self-finance against disaster losses, and potential exposure to and past experience of natural disasters. Particularly, firms tend to be aware of disasters, set BCP/BCM, and subscribe to disaster insurance after being exposed to disasters, suggesting that disaster preparedness is not necessarily sufficient in the Japanese corporate sector. Since high exposure to a variety of natural disasters is likely to undermine economic prospects, expansion of formal insurance mechanisms will be indispensable. Our empirical results imply that effective interventions are needed to stimulate awareness and the commitment of corporate management.
    Date: 2017–03
  16. By: Hazama, Makoto; Uesugi, Iichiro
    Abstract: Using a unique and massive data set that contains information on interfirm transaction relationships, this study examines default propagation in trade credit networks and provides direct and systematic evidence of the existence and relevance of such default propagation. Not only do we implement simulations in order to detect prospective defaulters, we also estimate the probabilities of actual firm bankruptcies and compare the predicted defaults and actual defaults. We find, first, that an economically sizable number of firms are predicted to fail when their customers default on their trade debt. Second, these prospective defaulters are indeed more likely to go bankrupt than other firms. Third, firms that have abundant external sources of financing or whose transaction partners have such abundant sources are less likely to go bankrupt even when they are predicted to default. This provides evidence for the existence and relevance of firms – called “deep pockets” by Kiyotaki and Moore (1997) – that can act as shock absorbers.
    Keywords: interfirm networks, trade credit, default propagation
    JEL: E32 G21 G32 G33
    Date: 2017–02

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