nep-rmg New Economics Papers
on Risk Management
Issue of 2017‒06‒04
ten papers chosen by
Stan Miles
Thompson Rivers University

  1. Bail-in as an instrument protecting the banking sector from system risk vs. capital adequacy of banks in the EU By Zbigniew Kurylek
  2. Growth-Optimal Portfolio Selection under CVaR Constraints By Guy Uziel; Ran El-Yaniv
  3. Dynamic Index Tracking and Risk Exposure Control Using Derivatives By Tim Leung; Brian Ward
  4. Discerning lead-lag between fear index and realized volatility By Wahab, Fatin Farhana; Masih, Mansur
  5. Firms’ Default – from Prediction Accuracy to Informational Capacity of Predictors By Tomasz Berent; Boguslaw Blawat; Marek Dietl; Radoslaw Rejman
  6. The Time-Varying Risk of Macroeconomic Disasters By Roberto Marfè; Julien Penasse
  7. Country Risk Analysis Based on Demographic and Socio-Economic Data By Korotaev, Andrey; Shulgin, Sergey; Zinkina, Yulia
  8. Default Cycles By Wei Cui; Leo Kaas
  9. Volatility Risk and Economic Welfare By Shaofeng Xu
  10. The Risk Involved in Implementation of Innovations in the Real Estate Market By Marcin Sitek

  1. By: Zbigniew Kurylek (WSB School of Banking in Wroclaw)
    Abstract: Research background: The article refers to the introduced bank regulations aiming at maintaining capital adequacy of banks and a stable situation in the banking sector, allowing to keep the financial system stable at a time of a possible financial or systemic crisis. Purpose of the article: This article aims at presenting methods of protecting banks. It mostly focuses on the capital structure and the use of capital assets to repay liabilities in a situation that poses a risk to the continued functioning of a banking sector or a financial system. Methodology/methods: Our research was conducted by ways of analysing literature on using bail-in in the banking sector during an ordered bank restructuring or a winding up process. Data analysis was conducted with the use of statistical methods, including correlation analysis, followed by a comparative analysis of obtained results. The level of interdependence was determined on the basis of Pearson’s correlation analysis, and the results were verified with the use of J. Guildford’s classification of interdependence. Findings & Value added: The article presents bail-in — an instrument aiming at performing ordered restructuring or winding up of a bank in the context of capital adequacy of banks in the European Union. The text shows how quickly and strongly capital adequacy rate of banks was changing in specific EU member states between 2006 and 2016, including the variation value evaluated with regard to the division into developed and developing countries. What is more, the article also points at current directions of changes in capital structure of banks in EU member states.
    Keywords: bail–in, financial crisis, capital adequacy
    JEL: G21 G33
    Date: 2017–05
  2. By: Guy Uziel; Ran El-Yaniv
    Abstract: Online portfolio selection research has so far focused mainly on minimizing regret defined in terms of wealth growth. Practical financial decision making, however, is deeply concerned with both wealth and risk. We consider online learning of portfolios of stocks whose prices are governed by arbitrary (unknown) stationary and ergodic processes, where the goal is to maximize wealth while keeping the conditional value at risk (CVaR) below a desired threshold. We characterize the asymptomatically optimal risk-adjusted performance and present an investment strategy whose portfolios are guaranteed to achieve the asymptotic optimal solution while fulfilling the desired risk constraint. We also numerically demonstrate and validate the viability of our method on standard datasets.
    Date: 2017–05
  3. By: Tim Leung; Brian Ward
    Abstract: We develop a methodology for index tracking and risk exposure control using financial derivatives. Under a continuous-time diffusion framework for price evolution, we present a pathwise approach to construct dynamic portfolios of derivatives in order to gain exposure to an index and/or market factors that may be not directly tradable. Among our results, we establish a general tracking condition that relates the portfolio drift to the desired exposure coefficients under any given model. We also derive a slippage process that reveals how the portfolio return deviates from the targeted return. In our multi-factor setting, the portfolio's realized slippage depends not only on the realized variance of the index, but also the realized covariance among the index and factors. We implement our trading strategies under a number of models, and compare the tracking strategies and performances when using different derivatives, such as futures and options.
    Date: 2017–05
  4. By: Wahab, Fatin Farhana; Masih, Mansur
    Abstract: In theory, historical volatility gauges the fluctuations of underlying assets or securities by monitoring changes in price over predetermined time period, while implied volatility looks into the future in its attempts to forecast the movement of the asset’s price based on current ones. Option trader tends to combine both volatilities with realized volatility serving as the baseline and implied volatility redefining the relative values of the options. Henceforth, the purpose of this study is twofold; first is to investigate the nature of lead-lag between the ‘fear index’ (VIX) and its corresponding realized volatility (RVI) of S&P 500 indices. Second, we examine the dynamic analysis of implied volatility transmission across inter-market correlation with newly adapted volatility indices from CBOE, VIX, OVX and GVZ to indicate which market is leading. Contrary to the popular perception, the paper finds that S&P 500 implied volatility is lagging its historical variance markedly, and surprisingly even its price index is leading the implied volatility as well. The study also concludes that Gold spearheads the market with stocks being the most sensitive to shocks. Our findings have clear policy implications for trading strategies and using volatilities in risk management.
    Keywords: implied volatility, realized volatility, inter-market correlation, VIX, OVX, GVZ
    JEL: C58 E44 G15
    Date: 2017–05–11
  5. By: Tomasz Berent (Warsaw School of Economics); Boguslaw Blawat (Kozminski University); Marek Dietl (Warsaw School of Economics); Radoslaw Rejman (Warsaw School of Economics)
    Abstract: Research background: Bankruptcy literature is populated with scores of (econometric) models ranging from Altman’s Z-score, Ohlson’s O-score, Zmijewski’s probit model to k-nearest neighbors, classification trees, support vector machines, mathematical programming, evolutionary algorithms or neural networks, all designed to predict financial distress with highest precision. Purpose of the article: We believe corporate default is too an important research topic to be identified with the prediction accuracy only. Despite the wealth of modelling effort, a unified theory of default is yet to be proposed. Due to the disagreement, both on the definition and hence the timing of default as well as on the measurement of prediction accuracy, the comparison (of predictive power) of various models can be seriously misleading. The purpose of the article is to argue for the shift in research focus from maximizing accuracy to the analysis of the information capacity of predictors. By doing this, we may yet come closer to understand default itself. Methodology/methods: We have critically appraised the bankruptcy research literature for its methodological variety and empirical findings. Default definitions, sampling procedures, in and out-of-sample testing and accuracy measurement have all been scrutinized. We believe the bankruptcy models currently used are, using the language of Feyerabend, incommensurable. Findings: Instead of what we call the population of models paradigm (the comparison of predictive power of different models) prevailing today, we propose the model of population paradigm, consisting in the estimation a single unified default forecasting platform for both listed and non-listed firms, and analyze the marginal contribution of the different information sources. In addition to classical corporate financial data, information on both firm's strategic position and its macroeconomic environment should be studied.
    Keywords: default, bankruptcy, default probability; prediction accuracy, informational capacity
    JEL: C53 E47 G33
    Date: 2017–05
  6. By: Roberto Marfè; Julien Penasse
    Abstract: While time-varying disasters can explain many characteristics of financial markets, their quantitative assessment is still missing. We propose a latent variable approach to estimate the time-varying probability of a macroeconomic disaster, using a dataset of 42 countries over more than 100 years. We find that disaster risk is volatile and persistent, strongly correlates with the dividend yield, and forecasts stock returns. A state-of-the-art model calibrated with our disaster risk estimates generates a large and volatile equity premium and a low risk free rate under standard assumptions. This evidence supports the idea that investors' fear of disasters drives equity premium dynamics.
    Keywords: rare disasters, equity premium, return predictability, state-space model
    JEL: E44 G12 G17
    Date: 2016
  7. By: Korotaev, Andrey (Russian Presidential Academy of National Economy and Public Administration (RANEPA)); Shulgin, Sergey (Russian Presidential Academy of National Economy and Public Administration (RANEPA)); Zinkina, Yulia (Russian Presidential Academy of National Economy and Public Administration (RANEPA))
    Abstract: The paper analyzes six existing methodologies for assessing socio-political risks (the Index of Political Instability, the model Koplin's country political risks - O'Leary; Index of Lager's peace and conflict instability; Global Peace Index; The George Mason University Instability Index; Index of failed and unstable states). A theoretical model of social instability is analyzed, a methodology of Network analysis is introduced, and a forecast of country risks for the most unstable Countries is provided.
    Date: 2017–03
  8. By: Wei Cui (Centre for Macroeconomics (CFM); University College London (UCL)); Leo Kaas (University of Konstanz)
    Abstract: Recessions are often accompanied by spikes of corporate default and prolonged declines of business credit. This paper argues that credit and default cycles are the outcomes of variations in self-fulfilling beliefs about credit market conditions. We develop a tractable macroeconomic model in which leverage ratios and interest spreads are determined in optimal credit contracts that reflect the expected default risk of borrowing firms. We calibrate the model to evaluate the impact of sunspots and fundamental shocks on the credit market and on output dynamics. Self-fulfilling changes in credit market expectations trigger sizable reactions in default rates and generate endogenously persistent credit and output cycles. All credit market shocks together account for about 50% of the variation of U.S. output growth during 1982-2015.
    Keywords: Firm default, Financing constraints, Credit spreads, Sunspots
    JEL: E22 E32 E44 G12
    Date: 2017–05
  9. By: Shaofeng Xu
    Abstract: This paper examines the effects of time-varying volatility on welfare. I construct a tractable endogenous growth model with recursive preferences, stochastic volatility, and capital adjustment costs. The model shows that a rise in volatility can decelerate growth in the absence of any level shocks. In contrast to level risk, which is always welfare reducing for a risk-averse household, volatility risk can increase or decrease welfare, depending on model parameters. When calibrated to U.S. data, the model finds that the welfare cost of volatility risk is largely negligible under plausible model parameterizations.
    Keywords: Business fluctuations and cycles, Economic models
    JEL: E2 E3
    Date: 2017
  10. By: Marcin Sitek (Czestochowa University of Technology)
    Abstract: Research background: In this paper a short overview of the types of innovations and their innovative forms of investing in the real estate market, such as reverse mortgage, flipping, building for rent, system condo and crowdfunding was presented. Purpose of the article: The aim of the paper is to present risk factors in innovative activities in the real estate market and evaluation of their activity in this market. The study proposed the hypothesis that a specific level of development in the real estate market corresponds to a certain level of investment risk reflected by the rate of return. Methodology/methods: The questionnaire survey in the local real estate market participants (investors, employees in enterprises that provide services for the real estate market, external appraisers, real estate brokers and counsellors) was conducted for the purposes of evaluation of risk factors in the investment innovative activities. Findings: Analysis of the results of questionnaire survey supported the following thesis: (1) as an effect of a strong inflow of capital and disturbed balance between demand and supply, return rates represent the reaction to the previous market behaviours, (2)decline in the rates of return points to the increase in the investment risk in the real estate market. It was found that the particularly high contribution to the risk level is from market risk, which is little transparent in Poland and is characterized by high variability of the conditions of operation.
    Keywords: risk; investment risk; innovations; risk management
    JEL: E32 E44 F63 O12 O31
    Date: 2017–05

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