nep-rmg New Economics Papers
on Risk Management
Issue of 2017‒10‒15
nine papers chosen by
Stan Miles
Thompson Rivers University

  1. Modelling Systemic Risk in the South African Banking Sector Using CoVar By Mathias Manguzvane; John W. Muteba Mwamba
  2. Sparse Portfolio Selection via the sorted $\ell_{1}$-Norm By Philipp J. Kremer; Sangkyun Lee; Malgorzata Bogdan; Sandra Paterlini
  3. Deflation, Sticky Leverage and Asset Prices By Michael Weber; Christian Dorion; Alexandre Jeanneret; Harjoat Bhamra
  4. Capital budgeting and risk taking under credit constraints By Iachan, Felipe Saraiva
  5. The Role of Time-Varying Rare Disaster Risks in Predicting Bond Returns and Volatility By Rangan Gupta; Tahir Suleman; Mark E. Wohar
  6. Liquidity risk in markets with trading frictions: What can swing pricing achieve? By Ulf Lewrick; Jochen Schanz
  7. Market Discipline, Deposit Insurance, and Competitive Advantages: Evidence from the Financial Crisis By Kaposty, Florian; Pfingsten, Andreas; Domikowsky, Christian
  8. A Justification of Conditional Confidence Intervals By Beutner, Eric; Heinemann, Alexander; Smeekes, Stephan
  9. Macroeconomic Impact of Basel III: Evidence from a Meta-Analysis By Jarko Fidrmuc; Ronja Lind

  1. By: Mathias Manguzvane; John W. Muteba Mwamba
    Abstract: In this paper we model systemic risk by making use of the conditional quantile regression to identify the most systemically important and vulnerable banks in the South Africa (SA) banking sector. We measure the marginal contributions of each bank to systemic risk by computing the delta Conditional Value at Risk which measures the difference between system risk of individual banks when they are in a normal state and when they are in distress state. Using daily stock market closing prices of six South African banking banks from 19 June 2007 to 11 April 2016; our back tested systemic risk measures suggest that the contribution of South African banks to systemic risk tends to significantly increase during periods of financial crises. The two largest banks namely First Rand Bank and Standard Bank are found to be the highest contributors to systemic risk while the smallest bank namely African Bank is found to be the least contributor to the overall systemic risk in South African banking sector. Based on the delta Conditional Value at Risk; we show that there is a need to go beyond micro prudential regulation in order to sustain stability in the South African banking sector.
    Keywords: conditional quantile, systemic risk, conditional value at risk and banking sector
    JEL: C13 C22 C58 G01 G21
    Date: 2017–09
  2. By: Philipp J. Kremer; Sangkyun Lee; Malgorzata Bogdan; Sandra Paterlini
    Abstract: We introduce a financial portfolio optimization framework that allows us to automatically select the relevant assets and estimate their weights by relying on a sorted $\ell_1$-Norm penalization, henceforth SLOPE. Our approach is able to group constituents with similar correlation properties, and with the same underlying risk factor exposures. We show that by varying the intensity of the penalty, SLOPE can span the entire set of optimal portfolios on the risk-diversification frontier, from minimum variance to the equally weighted. To solve the optimization problem, we develop a new efficient algorithm, based on the Alternating Direction Method of Multipliers. Our empirical analysis shows that SLOPE yields optimal portfolios with good out-of-sample risk and return performance properties, by reducing the overall turnover through more stable asset weight estimates. Moreover, using the automatic grouping property of SLOPE, new portfolio strategies, such as SLOPE-MV, can be developed to exploit the data-driven detected similarities across assets.
    Date: 2017–10
  3. By: Michael Weber (University of Chicago); Christian Dorion (HEC Montreal); Alexandre Jeanneret (HEC Montreal); Harjoat Bhamra (Imperial College London)
    Abstract: We develop an asset pricing model with endogenous corporate policies to understand how deflation risk impacts real asset prices. Our key assumption is that nominal coupons paid to long-term corporate debt are fixed, i.e. leverage is sticky creating a nominal rigidity. Our model shows that deflation risk reduces real equity prices and increases equity return volatility. For the US economy, our model shows that deflationary episodes have a strong negative impact on real equity values, whereas inflationary episodes have a relatively mild positive impact. The overall impact of nominal risk on real equity values is therefore negative. In the cross-section, the model predicts that the negative impact of deflation risk on real equity values is stronger for high leverage firms. We find empirical support for our theoretical predictions.
    Date: 2017
  4. By: Iachan, Felipe Saraiva
    Abstract: Credit constraints generate a hedging motive that extends beyond purely financial decisions by also distorting the selection and operation of real investment projects. We study these distortions through a dynamic model in which collateral constraints emerge endogenously. The hedging motive can be broken down into three components: expected future productivity, leverage capacity, and current net worth. While constrained firms behave as if averse to transitory fluctuations in net worth, additional exposure to factors related to persistent productivity innovations or credit capacity fluctuations increases their value. The most constrained firms abstain from financial hedging while still distorting real decisions to reflect the hedging motive. Firm-level volatility is influenced by capital budgeting distortions, which contribute as a potential explanation for the higher volatility of lower net-worth firms.
    Date: 2017–10
  5. By: Rangan Gupta (University of Pretoria, Pretoria, South Africa and IPAG Business School, Paris, France); Tahir Suleman (School of Economics and Finance, Victoria University of Wellington, New Zealand and School of Business, Wellington Institute of Technology, New Zealand); 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: This paper aims to provide empirical evidence to the theoretical claim that rare disaster risks affect government bond market movements. Using a nonparametric quantiles-based methodology, we show that rare disaster-risks affect only volatility, but not returns, of tenyear government bond of the US over the monthly period of 1918:01 to 2013:12. In addition, the predictability of volatility holds for the majority of the conditional distribution of the volatility, with the exception of the extreme ends. Moreover, in general, similar results are also obtained for long-term government bonds of an alternative developed country (UK) and an emerging market (South Africa).
    Keywords: Bond Returns and Volatility, Rare Disasters, Nonparametric Quantile Causality
    JEL: C22 C58 G12
    Date: 2017–10
  6. By: Ulf Lewrick; Jochen Schanz
    Abstract: Open-end mutual funds expose themselves to liquidity risk by granting their investors the right to daily redemptions at the fund's net asset value. We assess how swing pricing can dampen such risks by allowing the fund to settle investor orders at a price below the fund's net asset value. This reduces investors' incentive to redeem shares and mitigates the risk of large destabilising outflows.Optimal swing pricing balances this risk with the benefit of providing liquidity to cash-constrained investors. We derive bounds, depending on trading costs and the share of liquidity-constrained investors, within which a fund chooses to swing the settlement price. We also show how the optimal settlement price responds to unanticipated shocks. Finally, we discuss whether swing pricing can help mitigate the risk of self-fulfilling runs on funds.
    Keywords: Financial stability, mutual funds, regulation, liquidity insurance, trading frictions
    JEL: G01 G23 G28 C72
    Date: 2017–10
  7. By: Kaposty, Florian; Pfingsten, Andreas; Domikowsky, Christian
    Abstract: First, this study empirically explores whether it is possible to offer full insurance for non-financial depositors whilst maintaining market discipline. Second, we analyze whether a more credible deposit insurance scheme can be a competitive advantage for banks in a systemic crisis. We find (1) evidence for market discipline, and (2) banks ceteris paribus achieving higher growth rates of customer deposits in the financial crisis if they are part of a credible deposit insurance scheme.
    JEL: G01 G21 G28
    Date: 2017
  8. By: Beutner, Eric (QE / Mathematical economics and game the); Heinemann, Alexander (QE / Econometrics); Smeekes, Stephan (QE / Econometrics)
    Abstract: To quantify uncertainty around point estimates of conditional objects such as conditional means or variances, parameter uncertainty has to be taken into account. Attempts to incorporate parameter uncertainty are typically based on the unrealistic assumption of observing two independent processes, where one is used for parameter estimation, and the other for conditioning upon. Such unrealistic foundation raises the question whether these intervals are theoretically justified in a realistic setting. This paper presents an asymptotic justification for this type of intervals that does not require such an unrealistic assumption, but relies on a sample-split approach instead. By showing that our sample-split intervals coincide asymptotically with the standard intervals, we provide a novel, and realistic, justification for confidence intervals of conditional objects. The analysis is carried out for a general class of Markov chains nesting various time series models.
    Keywords: Conditional confidence intervals, Parameter Uncertainty, Markov chain, Sample-splitting, Prediction, Merging
    JEL: C53 C22 C32 G17
    Date: 2017–10–10
  9. By: Jarko Fidrmuc (Zeppelin University Friedrichshafen); Ronja Lind (Zeppelin University Friedrichshafen)
    Abstract: We present a meta-analysis of the impact of higher capital requirements imposed by regulatory reforms on the macroeconomic activity (Basel III). The empirical evidence derived from a unique dataset of 48 primary studies indicates that there is a negative, albeit moderate GDP level effect in response to a change in the capital ratio. The effects are likely to be slightly stronger but still low for the CEECs. Meta-regression results suggest that the estimates reported in the literature tend to be systematically influenced by a selected set of study characteristics, such as econometric specifications, the authors’affiliations, and the underlying financial system. Finally, we document a significant positive publication bias.
    Keywords: Meta-analysis, Bayesian model averaging, publication bias, banking, capital requirements, Basel III
    JEL: E51 E44 G28
    Date: 2017–09

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