nep-rmg New Economics Papers
on Risk Management
Issue of 2017‒06‒18
fifteen papers chosen by

  1. Approaches and Techniques to Validate Internal Model Results By Dacorogna, Michel M
  2. The Optimal Response of Bank Capital Requirements to Credit and Risk in a Model with Financial Spillovers By Occhino, Filippo
  3. Realized Stochastic Volatility with General Asymmetry and Long Memory By Asai, M.; Chang, C-L.; McAleer, M.J.
  4. Impacts of Deregulation on Property and Casualty Insurers' Pricing and Risk Taking: Empirical Evidence in Japan By YASUDA, Yukihiro
  5. Does Inflation Cause Gold Prices? Evidence from G7 Countries By Mehmet Balcilar; Zeynel Abidin Ozdemir; Muhammad Shahbaz; Serkan Gunes
  6. A multi-layered risk estimation routine for strategic planning and operations for the maritime industry By Knapp, S.; Vander Hoorn, S.
  7. Does Partisan Conflict Predict a Reduction in US Stock Market (Realized) Volatility? Evidence from a Quantile-on-Quantile Regression Model By Rangan Gupta; Christian Pierdzioch; Refk Selmi; Mark E. Wohar
  8. Shocks and Shock Absorbers in Japanese Bonds and Banks During the Global Financial Crisis By KIM, Hyonok; WILCOX, James A.; YASUDA, Yukihiro
  9. Mandatory adoption of business risk disclosure: evidence from Japanese firms By KIM, Hyonok; YASUDA, Yukihiro
  10. Bank Diversification into the Insurance Business: The Effects of the Deregulation of the Bank-Sales Channel at Japanese Banks By KONISHI, Masaru; OKUYAMA, Eiji; YASUDA, Yukihiro
  11. Realized volatility and parametric estimation of Heston SDEs By Robert Azencott; Peng Ren; Ilya Timofeyev
  12. Rollover and Capital Adequacy Requirements By YASUDA, Yukihiro
  13. Benefits and Costs of Bank Capital By Jihad Dagher; Giovanni Dell'Ariccia; Luc Laeven; Lev Ratnovski; Hui Tong
  14. The nexus between the oil price and its volatility in a stochastic volatility in mean model with time-varying parameters By Mehmet Balcilar; Zeynel Abidin Ozdemir
  15. The Withdrawal of Correspondent Banking Relationships; A Case for Policy Action By Michaela Erbenova; Yan Liu; Nadim Kyriakos-Saad; Aledjandro Lopez Mejia; Jose Giancarlo Gasha; Emmanuel Mathias; Mohamed Norat; Francisca Fernando; Yasmin Almeida

  1. By: Dacorogna, Michel M
    Abstract: The development of risk model for managing portfolio of financial institutions and insurance companies require both from the regulatory and management points of view a strong validation of the quality of the results provided by internal risk models. In Solvency II for instance, regulators ask for independent validation reports from companies who apply for the approval of their internal models. Unfortunately, the usual statistical techniques do not work for the validation of risk models as we lack enough data to significantly test the results of the models. We will certainly never have enough data to statistically estimate the significance of the VaR at a probability of 1 over 200 years, which is the risk measure required by Solvency II. Instead, we need to develop various strategies to test the reasonableness of the model. In this paper, we review various ways, management and regulators can gain confidence in the quality of models. It all starts by ensuring a good calibration of the risk models and the dependencies between the various risk drivers. Then applying stress tests to the model and various empirical analysis, in particular the probability integral transform, we build a full and credible framework to validate risk models.
    Keywords: Risk Models, validation, stress tests, statistical tests, solvency
    JEL: C30 C49 C59 C65
    Date: 2017–04–23
  2. By: Occhino, Filippo (Federal Reserve Bank of Cleveland)
    Abstract: This paper studies optimal bank capital requirements in an economy where bank losses have financial spillovers. The spillovers amplify the effects of shocks, making the banking system and the economy less stable. The spillovers increase with banks’ financial distortions, which in turn increase with banks’ credit risk. Higher capital requirements dampen the current supply of banks’ credit, but mitigate banks’ future financial distortions. Capital requirements should be raised in response to both an expansion of banks’ credit supply and an increase in the expected future credit risk of banks. They should be lowered close to one-to-one in response to bank losses.
    Keywords: Debt overhang; financial vulnerabilities; financial stability; macro prudential regulation;
    JEL: G20 G28
    Date: 2017–06–06
  3. By: Asai, M.; Chang, C-L.; McAleer, M.J.
    Abstract: The paper develops a novel realized stochastic volatility model of asset returns and realized volatility that incorporates general asymmetry and long memory (hereafter the RSV-GALM model). The contribution of the paper ties in with Robert Basmann’s seminal work in terms of the estimation of highly non-linear model specifications (“Causality tests and observationally equivalent representations of econometric models”, Journal of Econometrics, 1988), especially for specifying causal effects from returns to future volatility. This paper discusses asymptotic results of a Whittle likelihood estimator for the RSV-GALM model and a test for general asymmetry, and analyses the finite sample properties. The paper also develops an approach to obtain volatility estimates and out-of-sample forecasts. Using high frequency data for three US financial assets, the new model is estimated and evaluated. The paper compares the forecasting performance of the new model with a realized conditional volatility model.
    Keywords: Stochastic Volatility, Realized Measure, Long Memory, Asymmetry, Whittle likelihood, Asymptotic Distribution
    JEL: C13 C22
    Date: 2017–04–01
  4. By: YASUDA, Yukihiro
    Abstract: The purpose of this paper is to examine empirically the effects of rate-deregulation on Japanese Property and Casualty (P/C) insurers' pricing and risk-taking behaviors. As long as we know, there is little empirical evidence of the determinants of risk-taking at P/C insurance companies in Japan. Applying the basic ideas from the field of banking, we investigate the factors affecting risk-taking at P/C insurance companies. We find that the price setting at Japanese P/C insurers are decreased after the deregulation. In contrast, we find the risk levels of Japanese P/C insurers are generally increased after the rate-deregulation. However, franchise value that is measured by simple Q contributes adversely to P/C insurer risk-taking only before the deregulation. Lastly, we find that P/C insurers that belong to keiretsu groups have reduced the insurer rates but increased risk taking after the deregulation. In this sense, the impacts of deregulation are higher for P/C insurance companies that belong to the Keiretsu groups.
    Keywords: Japanese P/C insurers, Rate-deregulation, Risk Taking, Franchise Value, Keiretsu affliation.
    JEL: G21 G22 G28
    Date: 2016–03
  5. By: Mehmet Balcilar (Department of Economics, Eastern Mediterranean University); Zeynel Abidin Ozdemir (Gazi University, Ankara, Turkey); Muhammad Shahbaz (Montpellier Business School, Montpelier, France); Serkan Gunes (Gazi University, Ankara, Turkey)
    Abstract: This paper utilises the newly proposed nonparametric causality-in-quantiles test to examine the predictability of returns and the volatility of gold based on inflation for G7 countries. The causality-in-quantiles approach permits us to test for not only causality in mean but also causality in variance. We start our investigation by utilising tests for nonlinearity. These tests identify nonlinearity, as the linear Granger causality tests are subject to misspecification error. Unlike tests of misspecified linear models, our nonparametric causality-in-quantiles tests find causality in mean and variance from inflation to gold returns via quantiles 0.20 to 0.70, implying that very low- and high-return movements in gold markets are not related to inflation. These changes in low- and high-level gold returns should be related to other sources, such as financial shocks and exchange market shocks. We find support that gold serves as a hedge against inflation, but only in the mid-quantile ranges, i.e., quantiles 0.20 to 0.70. Our results show that gold does not serve as a hedge against inflation during periods when gold returns are very low or very high, which are respectively quiet and highly volatile periods.
    Keywords: Gold, Inflation, Spot and futures markets; Quantile causality
    JEL: C22 Q02 E31
    Date: 2017
  6. By: Knapp, S.; Vander Hoorn, S.
    Abstract: Maritime regulators and port authorities require the ability to predict risk exposure for strategic planning aspects to optimize asset allocation, mitigate and prevent incidents. This article builds on previous work to develop the strategic planning component and introduces the concept of a multilayered risk estimation framework (MLREF) for strategic planning and operations. The framework accounts for most of the risk factors such as ship specific risk, vessel traffic densities and met ocean conditions and allows the integration of the effect of risk control option and a location specific spatial rate ratio to allow for micro level risk assessments. Both, the macro (eg. covering larger geographic areas or EEZ) and micro level application (eg. passage way, particular route of interest) of MLREF was tested via a pilot study for the Australian region using a comprehensive and unique combination of dataset. The underlying routine towards the development of a strategic planning tool was developed and tested in R. Applications of the layers for the operational part such as an automated alert system and sources of uncertainties for risk assessments in general are described and discussed along with future developments and improvements.
    Keywords: Total risk exposure, binary logistic regression, spatial statistics, incident models, uncertainties, strategic planning, operational alerts, drift groundings, collisions, powered groundings, prediction routines
    Date: 2017–02–01
  7. By: Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa); Christian Pierdzioch (Department of Economics, Helmut Schmidt University, Hamburg, Germany); Refk Selmi (University of Tunis, Campus Universitaire, Tunis, Tunisia and University of Pau, France); Mark E. Wohar (College of Business Administration, University of Nebraska at Omaha, Omaha, USA and School of Business and Economics, Loughborough University, Leicestershire, UK)
    Abstract: Theory suggests that partisan conflict negatively affects the possibility of economic policy change, implying that financial markets tend to operate under lower policy risk. Given that stock-return volatility measures risk, if the gridlock argument holds, stock–market volatility should be lower under divided than under a unified government. Using a partisan conflict index (PCI), we empirically confirm this theoretical argument for the U.S. stock market based on quantiles-based regressions. In particular, quantile-on-quantile regressions show that PCI tends to predict reduced volatility, with the effect being stronger at levels of volatility that are moderately high (i.e., beyond the median, but not at its extreme) for an increase in the predictor, especially with lower initial values (i.e., when PCI is at its lower quantiles).
    Keywords: Partisan Conflict, Realized Volatility, Quantile Regressions
    JEL: C22 E60 G15
    Date: 2017–06
  8. By: KIM, Hyonok; WILCOX, James A.; YASUDA, Yukihiro
    Abstract: During the global financial crisis (GFC), Japan and the U.S. differed in at least two important ways: (1) while markets were stable in Japan then, the bubbles in the U.S. housing and financial markets burst and (2) while Japanese banks suffered few losses, huge losses badly weakened U.S. banks. In addition, and unlike the U.S., Japan requires firms' balance sheets to show, not only their total debt, but also the components of their debt: bonds, loans, and other debt. We used data for listed, non-financial, Japanese firms' bonds, bank loans, and other debt to investigate whether the 2008 "Lehman shock" in the U.S. disrupted Japanese bond markets. The Japanese data al-lowed us to estimate how much the Lehman shock affected Japanese firms' bonds outstanding and issued and to estimate how much, in turn, the Lehman shock resulted in firms' getting more loans from Japanese banks. The estimates revealed important cross-currents during the crisis. Our estimates implied that, while the crisis reduced bond issuance, it was accompanied by enough more bank loans to raise total debt. During the crisis, both bonds outstanding and bond issuance responded less to prior bond shortfalls and responded less to their maturing bonds. Second, while it greatly reduced bonds issued and outstanding at smaller, listed firms, the crisis boosted them at the very largest firms. In contrast, bank loans then rose more at smaller firms. Third, bank loans rose more, and bonds outstanding fell more, at firms with greater exposure to foreign sales. Fourth, the crisis led firms, and especially larger firms, to hold more cash and fewer securities and to reduce costs. Fifth, capital expenditures generally declined during the crisis, but declined significantly less at larger firms.
    Keywords: crisis, bonds, Lehman, bond issuance, Japan, loans, cash, banks
    JEL: G21 G28
    Date: 2016–03–15
  9. By: KIM, Hyonok; YASUDA, Yukihiro
    Abstract: We take advantage of institutional changes and its characteristics in Japan to empirically examine mandatory business risk disclosure. We find that there is a negative impact on total risk from the introduction of mandatory business risk disclosure. This suggests that an increase in business risk disclosure reduces a firm's cost of capital, which is contrary to the results of previous research. However, we also find that there is a positive relationship across firms and years after inception between the amount of business risk disclosure and total risk, indicating that mandatory business risk disclosure has a negative impact on investors' assessment of firms' risk. Although these two effects offset each other, the positive effects of enhanced disclosure of business risks on the cost of capital overcome the negative effects.
    Keywords: Mandatory business risk disclosure, Total risk, Cost of capital
    JEL: G14 M41
    Date: 2016–05
  10. By: KONISHI, Masaru; OKUYAMA, Eiji; YASUDA, Yukihiro
    Abstract: In this paper we empirically examine the diversification effects of the deregulation of bank-sales channel into the insurance business by Japanese banks. Using the Japanese unique data set on fee-based revenues, we identify separate fee-based revenues, such as insurance and/or mutual fund sales. We find that banks with a higher BIS ratio, more branches, more monopolistic power in loan market, and higher loan-to-deposit ratios tend to have shifted towards an insurance fee-based business. This indicates that bank health and branch expansion can affect the fee business strategy at each bank. We also find that banks with lower mutual fund fee revenues tend to earn more insurance fee revenues, implying that a substitute relationship has developed between them after the Global Financial Crisis of 2007. We find that banks with higher insurance revenues are positively associated with return volatilities (such as ROA and/or ROE) but are not related with total risk or Z score. The results indicate that although increased fee-based activities can increase the volatility of bank earnings, they have only had a small impact on equity and/or insolvency risks at Japanese banks.
    JEL: G21 G22 G28
    Date: 2016–05–26
  11. By: Robert Azencott; Peng Ren; Ilya Timofeyev
    Abstract: We present a detailed analysis of the Heston model with particular emphasis on the indirect observability framework for parameter estimation in the volatility equation. Since the volatility process is not directly observable, values of parameters have to be inferred from an approximating realized volatility process. In this paper we analytically establish criteria for the optimal sub-sampling of the realized volatility process depending on the size of the averaging window. Our analytical results are supplemented by extensive numerical investigation of the Heston model. Thus, our analytical and numerical results in this paper provide practical guidelines for selecting the frequency of estimation, size of the observational samples, etc. to achieve near-optimal parameter estimation accuracy.
    Date: 2017–06
  12. By: YASUDA, Yukihiro
    Abstract: This paper shows theoretically that if bank supervision is weak, capital adequacy requirements provide an incentive for troubled banks with their non-performing loans to refinance their client distressed firms, even those with poor prospects. We also argue that in some cases rollover is desirable because the bank can resolve the debt overhang problem of its clients. Therefore, results such as these indicate that loan rollovers need to be assessed more carefully.
    Keywords: Rollover, Capital adequacy requirements, Debt overhang
    JEL: G21 G28
    Date: 2016–05
  13. By: Jihad Dagher; Giovanni Dell'Ariccia; Luc Laeven; Lev Ratnovski; Hui Tong
    Abstract: The appropriate level of bank capital and, more generally, a bank’s capacity to absorb losses, has been at the core of the post-crisis policy debate. This paper contributes to the debate by focusing on how much capital would have been needed to avoid imposing losses on bank creditors or resorting to public recapitalizations of banks in past banking crises. The paper also looks at the welfare costs of tighter capital regulation by reviewing the evidence on its potential impact on bank credit and lending rates. Its findings broadly support the range of loss absorbency suggested by the Financial Stability Board (FSB) and the Basel Committee for systemically important banks.
    Keywords: Bank capital;Cost of capital;United States;Banking crisis;Capital requirements;Risk management;General equilibrium models;Bank Capital, TLAC, Financial Regulation, bank, capital, banks, capital requirements, General, All Countries,
    Date: 2016–03–03
  14. By: Mehmet Balcilar (Department of Economics, Eastern Mediterranean University); Zeynel Abidin Ozdemir (Gazi University, Ankara, Turkey)
    Abstract: This study investigates the dynamic nexus between oil price and its volatility for oil spot and futures markets by means of stochastic volatility in mean model with time-varying parameters in the conditional mean. The study finds substantial time-variation about the impact of oil price volatility on oil price return in both spot and 1-month to 10-month futures markets. The oil price return volatility has positive impact on oil price return series over the sample period form the mid-1980s to 2017s except for four very short time periods, which correspond to collapse of OPEC in 1986, invasion of Kuwait in 1990/91, Asian crisis in 1997/2000 and the Global Financial Crisis in 2008. While the oil price return volatility has positive impact on oil prices, it has limited negative impact on oil prices during periods corresponding to these historical events. Moreover, the findings from this study point out to the existence of a negative and small effect of the lagged oil return series on its volatility for both the spot and futures markets.
    Keywords: Oil price; Oil price uncertainty; Spot and futures markets; Nonlinearity; Stochastic volatility; State–space.
    JEL: C22 E32
    Date: 2017
  15. By: Michaela Erbenova; Yan Liu; Nadim Kyriakos-Saad; Aledjandro Lopez Mejia; Jose Giancarlo Gasha; Emmanuel Mathias; Mohamed Norat; Francisca Fernando; Yasmin Almeida
    Abstract: This paper focuses on the withdrawal of correspondent banking relationships (CBRs) in some jurisdictions post-global financial crisis. It describes existing evidence and consequences of the withdrawal of CBRs and explores drivers of this phenomenon drawing on recent surveys and select country information. While the withdrawal of CBRs has reached a critical level in some affected countries, which can have a systemic impact if unaddressed, macroeconomic consequences have not been identified so far at a global level. The paper presents responses from the international community to address this phenomenon, and explains the role that the IMF has been playing in this global effort, especially with regards to supporting member countries in the context of surveillance and technical assistance, facilitating dialogue among stakeholders, and encouraging data gathering efforts. The paper concludes by suggesting policy responses by public and private sector stakeholders needed to further mitigate potential negative impacts that could undermine financial stability, inclusion, growth and development goals.
    Keywords: Cross-border banking;Payment systems;International banks;Anti-money laundering;Combating the financing of terrorism;Bank supervision;Bank regulations;Risk management;Fund role;Correspondent Banking, De-risking, correspondent and respondent banks, remittances, AML/CFT, banking supervision and regulation, Money Transfer Operators, Money or Value Transfer Services, Technical Assistance, Payment systems, Trade Finance
    Date: 2016–06–30

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