
on Risk Management 
Issue of 2017‒08‒27
fourteen papers chosen by 
By:  Amir AhmadiJavid; Malihe FallahTafti 
Abstract:  The entropic valueatrisk (EVaR) is a new coherent risk measure, which is an upper bound for both the valueatrisk (VaR) and conditional valueatrisk (CVaR). As important properties, the EVaR is strongly monotone over its domain and strictly monotone over a broad subdomain including all continuous distributions, while wellknown monotone risk measures, such as VaR and CVaR lack these properties. A key feature for a risk measure, besides its financial properties, is its applicability in largescale samplebased portfolio optimization. If the negative return of an investment portfolio is a differentiable convex function, the portfolio optimization with the EVaR results in a differentiable convex program whose number of variables and constraints is independent of the sample size, which is not the case for the VaR and CVaR. This enables us to design an efficient algorithm using differentiable convex optimization. Our extensive numerical study shows the high efficiency of the algorithm in large scales, compared to the existing convex optimization software packages. The computational efficiency of the EVaR portfolio optimization approach is also compared with that of CVaRbased portfolio optimization. This comparison shows that the EVaR approach generally performs similarly, and it outperforms as the sample size increases. Moreover, the comparison of the portfolios obtained for a real case by the EVaR and CVaR approaches shows that the EVaR approach can find portfolios with better expectations and VaR values at high confidence levels. 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1708.05713&r=rmg 
By:  Guo, ZiYi 
Abstract:  We adopt Schwartz and Smith’s model (2000) to calculate risk measures of Brent oil futures contracts and light sweet crude oil (WTI) futures contracts and Mirantes, Poblacion and Serna’s model (2012) to calculate risk measures of natural gas futures contracts, gasoil futures contracts, heating oil futures contracts, RBOB gasoline futures contracts, PJM western hub peak and offpeak electricity futures contracts. We show that the models present well goodness of fit and explain two stylized facts of the data: the Samuelson effect and the seasonality effect. Our backtesting results demonstrate that the models provide satisfactory risk measures for listed energy commodity futures contracts. A simple estimation method possessing quick convergence is developed. 
Keywords:  Samuelson effect,seasonal effect,valueatrisk,leastsquareestimation 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:esprep:167619&r=rmg 
By:  Michael A. Kouritzin; Anne MacKay 
Abstract:  In a market with stochastic volatility and jumps, we consider a VIXlinked fee structure for variable annuity contracts with guaranteed minimum withdrawal benefits (GMWB). Our goal is to assess the effectiveness of the VIXlinked fee structure in decreasing the sensitivity of the insurer's liability to volatility risk. Since the GMWB payoff is highly pathdependent, it is particularly sensitive to volatility risk, and can also be challenging to price, especially in the presence of the VIXlinked fee. In this paper, we present an explicit weak solution for the value of the VA account and use it in Monte Carlo simulations to value the GMWB guarantee. Numerical examples are provided to analyze the impact of the VIXlinked fee on the sensitivity of the liability to changes in market volatility. 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1708.06886&r=rmg 
By:  Ferrari, Stijn; Pirovano, Mara; Rovira Kaltwasser, Pablo 
Abstract:  In December 2013 the National Bank of Belgium introduced a sectoral capital requirement aimed at strengthening the resilience of Belgian banks against adverse developments in the real estate market. This paper assesses the impact of this macroprudential measure on mortgage lending. Our results indicate that the sectoral capital requirement on average did not affect IRB banks’ mortgage rates and mortgage loan growth. However, the findings do indicate that IRB banks may have reacted heterogeneously to the introduction of the measure: capitalconstrained banks with more exposures to the segment targeted by the additional requirement tended to respond stronger in terms of mortgage lending. 
Keywords:  Systemic risk, macroprudential policy, bank capital requirements, real estate. 
JEL:  E44 E58 G21 G28 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:80821&r=rmg 
By:  Christoph Frei; Agostino Capponi; Celso Brunetti 
Abstract:  We study how banks manage their default risk before bilaterally negotiating the quantities and prices of overthecounter (OTC) contracts resembling credit default swaps (CDSs). We show that the costly actions exerted by banks to reduce their default probabilities are not socially optimal. Depending on the imposed trade size limits, riskmanagement costs and sellers' bargaining power, banks may switch from choosing default risk levels above the social optimum to reducing them even below the social optimum. We use a unique and comprehensive data set of bilateral exposures from the CDS market to test the main model implications on the OTC market structure: (i) intermediation is done by lowrisk banks with medium credit exposure; (ii) all banks with high credit exposures are net buyers of CDSs, and lowrisk banks with low credit exposures are the main net sellers; and (iii) heterogeneity in posttrade credit exposures is higher for riskier banks and smaller for safer banks. 
Keywords:  Overthecounter markets ; Counterparty risk ; Credit default swaps ; Search 
JEL:  G11 G12 G21 
Date:  2017–08–15 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgfe:201783&r=rmg 
By:  Vsevolod I Gorlach 
Abstract:  This paper highlights the shortfalls of Modern Portfolio Theory (MPT). Amongst other flaws, MPT assumes that returns are normally distributed; that correlations are linear; and that risks are symmetrical. We propose a dynamic and flexible scenariobased approach to portfolio selection that incorporates an investorâ€™s economic forecast. Extreme Value Theory (EVT) is used to capture the skewness and kurtosis inherent in assetclass returns; and it also accounts for the volatility clustering and the extreme comovements across asset classes. The estimation consists of using an asymmetric GJRGARCH model to extract the filtered residuals for each assetclass return. Subsequently, a marginal cumulative distribution function (CDF) of each asset class is constructed by using a Gaussiankernel estimation for the interior, together with a generalised Pareto distribution (GPD) for the upper and lower tails. The distribution of exceedance method is applied to find residuals in the tails. A Studentâ€™s t copula is then fitted to the data; and then used to induce correlation between the simulated residuals of each asset class. A Monte Carlo technique is applied to simulate standardised residuals, which represent a univariate stochastic process when viewed in isolation; but it maintains the correlation induced by the copula. The results are meanCVaR optimised portfolios, which are derived based on an investorâ€™s forwardlooking expectation. 
Keywords:  Portfolio optimisation, Scenariobased, Nonnormal distribution, Fattails, Nonlinear correlation, Extreme Value Theory, Marginal Distribution Modelling, Copula, simulation, Conditional ValueatRisk 
JEL:  C14 C58 C61 G11 G17 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:rza:wpaper:695&r=rmg 
By:  Edimilson Costa Lucas; Wesley Mendes Da Silva; Gustavo Silva Araujo 
Abstract:  Natural extreme events have been occurring more frequently with growing impacts in wellbeing, mainly in emerging economies. Therefore, the need for more accurate information for managing such impacts has grown. In response to this issue, financial literature has been focusing on the assessment of economic impacts that arise from extreme weather changes. However, these efforts have imparted little attention to the economic impact analysis at the corporate level. To reduce this gap, this article analyzes the impact of extreme rainfall events on the food industry in an emerging economy that is a prominent player in this sector, Brazil. For this purpose, we use the ARGARCHGPD hybrid methodology to identify whether extreme rainfalls affect stock prices of food companies. The results indicate that these events have a strong impact on the stock returns: In more than half of the days immediately after extreme rain events that occurred between 2.28.2005 and 12.30.2014, returns were significantly low, causing average daily losses of 1.97%. These results point to the need for more accurate financial management to hedge against weather risk 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:bcb:wpaper:462&r=rmg 
By:  Gollier, Christian 
Abstract:  Suppose that the decisionmaker is uncertain about the variance of the payoff of a gamble, and that this uncertainty comes from not knowing the number of zeromean i.i.d. risks attached to the gamble. In this context, we show that any nth degree increase in this variance risk reduces expected utility if and only if the sign of the 2nth derivative of the utility function u is (1)n+1. Moreover, increasing the statistical concordance between the mean payoff of the gamble and the nth degree riskiness of its variance reduces expected utility if and only if the sign of the 2n + 1 derivative of u is (1)n+1. These results generalize the theory of risk apportionment developed by Eeckhoudt and Schlesinger (2006), and is useful to better understand the impact of stochastic volatility on welfare and asset prices. 
Keywords:  Longrun risk; stochastic dominance; prudence; temperance; stochastic volatility; risk apportionment. 
JEL:  D81 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:tse:wpaper:31818&r=rmg 
By:  Qiang Ji (Center for Energy and Environmental Policy research, Institutes of Science and Development, Chinese Academy of Sciences and School of Public Policy and Management, University of Chinese Academy of Sciences, Beijing, China); BingYue Liu (Center for Energy and Environmental Policy research, Institutes of Science and Development, Chinese Academy of Sciences and Department of Statistics and Finance, University of Science and Technology of China, Hefei, China); Juncal Cunado (University of Navarra, School of Economics, Edificio Amigos, E31080 Pamplona, Spain); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa) 
Abstract:  This paper analyses the risk spillover effect between the US stock market and the remaining G7 stock markets by measuring the conditional ValueatRisk (CoVaR) using timevarying copula models with Markov switching and data that covers more than 100 years. The main results suggest that the dependence structure varies with time and has distinct high and low dependence regimes. Our findings verify the existence of risk spillover between the US stock market and the remaining G7 stock markets. Furthermore, the results imply the following: 1) abnormal spikes of dynamic CoVaR were induced by wellknown historical economic shocks; 2) The value of upside risk spillover is significantly larger than the downside risk spillover and 3) The magnitudes of risk spillover from the remaining G7 countries to the US are significantly larger than that from the US to these countries. 
Keywords:  Timevarying copula, Markov switching, CoVaR, risk spillover, G7 stock markets 
JEL:  C21 G32 G38 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:pre:wpaper:201759&r=rmg 
By:  Guo, ZiYi 
Abstract:  We introduce a new type of heavytailed distribution, the normal reciprocal inverse Gaussian distribution (NRIG), to the GARCH and GlostenJagannathanRunkle (1993) GARCH models, and compare its empirical performance with two other popular types of heavytailed distribution, the Student’s t distribution and the normal inverse Gaussian distribution (NIG), using a variety of asset return series. Our results illustrate that there is no overwhelmingly dominant distribution in fitting the data under the GARCH framework, although the NRIG distribution performs slightly better than the other two types of distribution. For market indexes series, it is important to introduce both GJRterms and the NRIG distribution to improve the models’ performance, but it is ambiguous for individual stock prices series. Our results also show the GJRGARCH NRIG model has practical advantages in quantitative risk management. Finally, the convergence of numerical solutions in maximumlikelihood estimation of GARCH and GJRGARCH models with the three types of heavytailed distribution is investigated. 
Keywords:  Heavytailed distribution,GARCH model,Model comparison,Numerical solution 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:esprep:167626&r=rmg 
By:  Tracey, Belinda (Bank of England); Schnittker, Christian (Bank of England); Sowerbutts, Rhiannon (Bank of England) 
Abstract:  We use provisions for misconduct issues as an instrumental variable to identify the causal effect of bank capital on risktaking. Misconduct provisions can adversely affect bank capital via their negative impact on retained earnings, and we find evidence of this for UK banks. We also find strong support for our assumption that misconduct provisions are otherwise unrelated to risktaking. We facilitate our analysis with a new UK panel dataset of banklevel information including misconduct provisions, merged with loanlevel data on all regulated UK mortgages. Our main finding is that a negative bank capital shock leads to an increase in risktaking. 
Keywords:  Banking; risktaking; capital shocks; 2SLS 
JEL:  G21 G28 
Date:  2017–08–18 
URL:  http://d.repec.org/n?u=RePEc:boe:boeewp:0671&r=rmg 
By:  Xiong, Wanting; Wang, Yougui 
Abstract:  Recent evidences provoke broad rethinking of the role of banks in money creation. The authors argue that apart from the reserve requirement, prudential regulations also play important roles in constraining the money supply. Specifically, they study three Basel III regulations and theoretically analyze their standalone and collective impacts. The authors find that 1) the money multiplier under Basel III is not constant but a decreasing function of the monetary base; 2) the determinants of the bank's money creation capacity are regulationspecific; 3) the effective binding regulation and the corresponding money multiplier vary across different economic states and bank balance sheet conditions. 
Keywords:  money creation,Basel III,liquidity coverage ratio,capital adequacy ratio,leverage ratio,money multiplier 
JEL:  E51 G28 G18 E60 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:ifwedp:201753&r=rmg 
By:  Roxana Dumitrescu; Romuald Elie; Wissal Sabbagh; Chao Zhou 
Abstract:  We introduce a new class of \textit{Backward Stochastic Differential Equations with weak reflections} whose solution $(Y,Z)$ satisfies the weak constraint $\textbf{E}[\Psi(\theta,Y_\theta)] \geq m,$ for all stopping time $\theta$ taking values between $0$ and a terminal time $T$, where $\Psi$ is a random nondecreasing map and $m$ a given threshold. We study the wellposedness of such equations and show that the family of minimal time $t$values $Y_t$ can be aggregated by a rightcontinuous process. We give a nonlinear Mertens type decomposition for lower reflected $g$submartingales, which to the best of our knowledge, represents a new result in the literature. Using this decomposition, we obtain a representation of the minimal time $t$values process. We also show that the minimal supersolution of a such equation can be written as a \textit{stochastic control/optimal stopping game}, which is shown to admit, under appropriate assumptions, a value and saddle points. From a financial point of view, this problem is related to the approximative hedging for American options. 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1708.05957&r=rmg 
By:  Mohammed Ali, Khalifa (The Islamic Research and Teaching Institute (IRTI)) 
Abstract:  Recently the issue of the real exchange rate management has received renewed attention from prominent development economist in leading universities and development intuitions. Example of some of the recent work include Gala (2007), Eichengreen (2007), Prasad et al. (2006) and Rodrik (2009). The main theme of this recent research is the importance of managing the real exchange rate as growth facilitating factor. Research on this area has shown that both the level and the volatility of the real exchange rate have important impact on exports, investment and growth in developing countries. This study uses a new large data set for the real effective exchange rate for estimating real exchange rate over/under valuation for member countries. The study also discusses the implication of the results on member countries of the Islamic Development Bank Group 
Keywords:  Risk Management Practices; Islamic banking; Nigeria; Malaysia 
JEL:  G20 G21 G28 
Date:  2017–02–20 
URL:  http://d.repec.org/n?u=RePEc:ris:irtiwp:2017_001&r=rmg 