nep-rmg New Economics Papers
on Risk Management
Issue of 2018‒04‒30
seventeen papers chosen by

  1. Multivariate Shortfall Risk Allocation and Systemic Risk By Yannick Armenti; Stéphane Crépey; Samuel Drapeau; Antonis Papapantoleon
  2. Default risk and equity value: forgotten factor or cultural revolution? By CLERE, Roland; MARANDE, Stephane
  3. A Comparative Study of GARCH and EVT Model in Modeling Value-at-Risk By Li, Longqing
  4. A fuzzy multi-criteria decision making approach for managing performance and risk in integrated procurement-production planning By Rihab Khemiri; Khaoula Elbedoui-Maktouf; Bernard Grabot; Belhassen Zouari
  5. Option valuation and hedging using asymmetric risk function: asymptotic optimality through fully nonlinear Partial Differential Equations By Emmanuel Gobet; Isaque Pimentel; Xavier Warin
  6. From the horse’s mouth: surveying responses to stress by banks and insurers By Brinkhoff, Jeroen; Langfield, Sam; Weeken, Olaf
  7. Insurers as Asset Managers and Systemic Risk By Chotibhak, Jotikasthira; Ellul, Andrew; Kartasheva, Anastasia; Lundblad, Christian; Wagner, Wolf
  8. Consumption volatility risk and the inversion of the yield curve By Grasso, Adriana; Natoli, Filippo
  9. Asset Pledgeability and Endogenously Leveraged Bubbles By Bengui, Julien; Phan, Toan
  10. Counterparty risk and funding: immersion and beyond By Stéphane Crépey; Shiqi Song
  11. Size-related premiums By Souza, Thiago de Oliveira
  12. Dissection of Bitcoin's Multiscale Bubble History from January 2012 to February 2018 By Jan-Christian Gerlach; Guilherme Demos; Didier Sornette
  13. When Japanese Banks Become Pure Creditors: The effects of declining shareholding by banks on bank lending and firms’risk-taking By Ono, Arito; Suzuki, Katsushi; Uesugi, Iichiro
  14. Accounting Noise and the Pricing of Cocos By Derksen, Mike; Spreij, Peter; van Wijnbergen, Sweder
  15. The Sustainable Black-Scholes Equations By Yannick Armenti; Stéphane Crépey; Chao Zhou
  16. The impact of margin trading on share price evolution: A cascading failure model investigation By Ya-Chun Gao; Huai-Lin Tang; Shi-Min Cai; Jing-Jing Gao; H. Eugene Stanley
  17. The Framework of Risk Management in A Real Estate Development Project With A Focus on Macroeconomics Aspects: A Case of Mixed-Use Real Estate Project in Ankara Province By Akin Ozturk; Harun Tanrivermis; Yunus Emre Kapusuz

  1. By: Yannick Armenti (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - ENSIIE - CNRS - Centre National de la Recherche Scientifique); Stéphane Crépey (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - ENSIIE - CNRS - Centre National de la Recherche Scientifique); Samuel Drapeau (Ausonius-Institut de recherche sur l'Antiquité et le Moyen âge - Université Bordeaux Montaigne - CNRS - Centre National de la Recherche Scientifique); Antonis Papapantoleon (TUB - Technische Universität Berlin)
    Abstract: The ongoing concern about systemic risk since the outburst of the global financial crisis has highlighted the need for risk measures at the level of sets of interconnected financial components, such as portfolios, institutions or members of clearing houses. The two main issues in systemic risk measurement are the computation of an overall reserve level and its allocation to the different components according to their systemic relevance. We develop here a pragmatic approach to systemic risk measurement and allocation based on multivariate shortfall risk measures, where acceptable allocations are first computed and then aggregated so as to minimize costs. We analyze the sensitivity of the risk allocations to various factors and highlight its relevance as an indicator of systemic risk. In particular, we study the interplay between the loss function and the dependence structure of the components. Moreover, we address the computational aspects of risk allocation. Finally, we apply this methodology to the allocation of the default fund of a CCP on real data.
    Keywords: Systemic risk, risk allocation, multivariate shortfall risk, sensitivities, numerical methods, CCP default fund
    Date: 2018–04–11
  2. By: CLERE, Roland; MARANDE, Stephane
    Abstract: Default risk is the forgotten factor when it comes to equity valuation. And yet, in this article, we show that default risk has a bigger impact on equity values than it does on bond values. Our work is based on a default intensity model that we extrapolate to equities. This model does not presuppose a particular method for estimating distance to default. As a result, unlike Merton structural models, which only apply to indebted companies, it can be used to assess default risk for any company. Highlighting a default risk premium in the cost of capital calculation makes it possible to reconcile the CAPM with evaluation methods based on forecasts in the event of survival. At the same time, the CAPM and default risk can explain the vast majority of bond spreads. The test consisting of estimating “physical” implied default probabilities and the share of systemic risk included in corporate euro bond spreads at end-2015 led us to detect the likely existence of excessive remuneration of investment grade bonds. This finding corroborates identical conclusions reached earlier by other researchers. This potential market anomaly could indicate a windfall for investors. Performing this test again at various points in the economic and financial cycle would help establish whether the bond market is serving a free lunch to investors not bound by regulatory reserve requirements.
    Keywords: Cost of equity, credit risk, default risk, credit spread, default spread, default premium, systematic risk, cost of leverage, cost of default, APV, adjusted present value, reduced form model, debt beta, CAPM, Spread AAA, implied cost of capital, ex-ante equity risk premium, forecast bias, optimistic bias premium, recovery rate, probability of default conditional and non-conditional.
    JEL: G12 G32 G33 M21
    Date: 2018–02–26
  3. By: Li, Longqing
    Abstract: The paper addresses an inefficiency of the traditional approach in modeling the tail risk, particularly the 1-day ahead forecast of Value-at-Risk (VaR), using Extreme Value Theory (EVT) and GARCH model. Specifically, I apply both models onto major countries stock markets daily loss, including U.S., U.K., China and Hong Kong between 2006 and 2015, and compare the relative forecasting performance. The paper differs from other studies in two important ways. First, it incorporates an asymmetric shock of volatility in the financial time series. Second, it applies a skewed fat-tailed return distribution using the Generalized Error Distribution (GED). The back-testing result shows that, on one hand, the conditional EVT performs equally well relative to GARCH model under the Generalized Error Distribution. On the other hand, the Exponential GARCH based model is the best performing one in Value-at-Risk forecasting, because it not only correctly identifies the future extreme loss, but more importantly, its occurrence is independent.
    Keywords: Value-at-Risk,Extreme Value Theory, Backtesting, Risk Forecasting
    JEL: C53 C58 G32
    Date: 2017–02–25
  4. By: Rihab Khemiri (University of Tunis - Faculty of Sciences of Tunis - UTM - Université Tunis El Manar); Khaoula Elbedoui-Maktouf (University of Tunis - Faculty of Sciences of Tunis - UTM - Université Tunis El Manar); Bernard Grabot (LGP - Laboratoire Génie de Production - Ecole Nationale d'Ingénieurs de Tarbes); Belhassen Zouari (Mediatron Laboratory - Higher communications school of Tunis)
    Abstract: Nowadays in Supply Chain (SC) networks, a high level of risk comes from SC partners. An effective risk management process becomes as a consequence mandatory, especially at the tactical planning level. The aim of this article is to present a risk-oriented integrated procurement–production approach for tactical planning in a multi-echelon SC network involving multiple suppliers, multiple parallel manufacturing plants, multiple subcontractors and several customers. An originality of the work is to combine an analytical model allowing to build feasible scenarios and a multi-criteria approach for assessing these scenarios. The literature has mainly addressed the problem through cost or profit-based optimisation and seldom considers more qualitative yet important criteria linked to risk, like trust in the supplier, flexibility or resilience. Unlike the traditional approaches, we present a method evaluating each possible supply scenario through performance-based and risk-based decision criteria, involving both qualitative and quantitative factors, in order to clearly separate the performance of a scenario and the risk taken if it is adopted. Since the decision-maker often cannot provide crisp values for some critical data, fuzzy sets theory is suggested in order to model vague information based on subjective expertise. Fuzzy Technique for Order of Preference by Similarity to Ideal Solution is used to determine both the performance and risk measures correlated to each possible tactical plan. The applicability and tractability of the proposed approach is shown on an illustrative example and a sensitivity analysis is performed to investigate the influence of criteria weights on the selection of the procurement–production plan.
    Keywords: Procurement,Supply chain management,Multi-criteria decision-making,Risk management,Fuzzy sets theory,Fuzzy logic
    Date: 2017–04–03
  5. By: Emmanuel Gobet (CMAP - Centre de Mathématiques Appliquées - Ecole Polytechnique - X - École polytechnique - CNRS - Centre National de la Recherche Scientifique); Isaque Pimentel (CMAP - Centre de Mathématiques Appliquées - Ecole Polytechnique - X - École polytechnique - CNRS - Centre National de la Recherche Scientifique, EDF - EDF); Xavier Warin (EDF - EDF)
    Abstract: Discrete time hedging produces a residual risk, namely, the tracking error. The major problem is to get valuation/hedging policies minimizing this error. We evaluate the risk between trading dates through a function penalizing asymmetrically profits and losses. After deriving the asymptotics within a discrete time risk measurement for a large number of trading dates, we derive the optimal strategies minimizing the asymptotic risk in the continuous time setting. We characterize the optimality through a class of fully nonlinear Partial Differential Equations (PDE). Numerical experiments show that the optimal strategies associated with discrete and asymptotic approach coincides asymptotically.
    Keywords: hedging,asymmetric risk,fully nonlinear parabolic PDE,regression Monte Carlo
    Date: 2018–04–08
  6. By: Brinkhoff, Jeroen; Langfield, Sam; Weeken, Olaf
    Abstract: Existing stress tests do not capture feedback loops between individual institutions and the financial system. To identify feedback loops, the European Systemic Risk Board has developed macroprudential surveys that ask banks and insurers how they would behave in a macroeconomic stress scenario. In a pilot application of these surveys, we find evidence of herding behaviour in the banking sector, notably concerning credit retrenchment. Results show that the consequences can be large, potentially undoing the initial effects of banks’ remedial actions by worsening their solvency position. In contrast, insurers’ responses to the survey provide little evidence of herding in response to macroeconomic stress. These results highlight the usefulness of macroprudential surveys in identifying feedback loops. JEL Classification: E30, E44, G10, G18, G21, G22, G28
    Keywords: financial instability, macroprudential, stress tests, surveys
    Date: 2018–04
  7. By: Chotibhak, Jotikasthira; Ellul, Andrew; Kartasheva, Anastasia; Lundblad, Christian; Wagner, Wolf
    Abstract: Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. Using the U.S. life insurance industry as a laboratory, we present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds ("reach-for-yield"). We then calibrate the model to insurer-level data, and show that the VA-writing insurers' collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20-70% of insurers' equity capital.
    Keywords: Insurance companies.; Inter-connectedness; Systemic risk; Financial stability
    JEL: G11 G12 G14 G18 G22
    Date: 2018–04
  8. By: Grasso, Adriana; Natoli, Filippo
    Abstract: We propose a consumption-based model that allows for an inverted term structure of real and nominal risk-free rates. In our framework the agent is subject to time-varying macroeconomic risk and interest rates at all maturities depend on her risk perception which shape saving propensities over time. In bad times, when risk is perceived to be higher in the short- than the long-term, the agent would prefer to hedge against low realizations of consumption in the near future by investing in long-term securities. This determines, in equilibrium, the inversion of the yield curve. Pricing time-varying consumption volatility risk is essential for obtaining the inversion of the real curve and allows to price the average level and slope of the nominal one. JEL Classification: G12
    Keywords: habits, inverted yield curve, real rates, uncertainty, volatility risk
    Date: 2018–04
  9. By: Bengui, Julien (Université de Montréal); Phan, Toan (Federal Reserve Bank of Richmond)
    Abstract: We develop a simple model of defaultable debt and rational bubbles in the price of an asset, which can be pledged as collateral in a competitive credit pool. When the asset pledgeability is low, the down payment is high, and bubble investment is unleveraged, as in a standard rational bubble model. When the pledgeability is high, the down payment is low, making it easier for leveraged borrowers to invest in the bubbly asset. As loans are packaged together into a competitive pool, the pricing of individual default risk may facilitate risk-taking. In equilibrium, credit-constrained borrowers may optimally choose a risky leveraged investment strategy – borrow to invest in the bubbly asset and default if the bubble bursts. The model predicts joint boom-bust cycles in asset prices and securitized credit.
    Keywords: rational bubbles; collateral; credit pool; household debt; equilibrium default
    JEL: E12 E24 E44 G01
    Date: 2018–04–19
  10. By: Stéphane Crépey (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - ENSIIE - CNRS - Centre National de la Recherche Scientifique); Shiqi Song (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - ENSIIE - CNRS - Centre National de la Recherche Scientifique)
    Abstract: In Crépey [9], a basic reduced-form counterparty risk modelling approach was introduced under a standard immersion hypothesis between a reference filtration and the filtration progressively enlarged by the default times of the two parties. This basic setup, with a related continuity assumption on some of the data at the first default time of the two parties, is too restrictive for wrong-way and gap risk applications, such as counterparty risk on credit derivatives. This paper introduces an extension of the basic approach, implements it through marked default times and applies it to counterparty risk on credit derivatives.
    Keywords: Credit derivatives, Collateral, Gap risk, Wrong-way risk, Immersion, Reduced-form credit modelling, BSDE, Funding,Counterparty risk
    Date: 2018–04–11
  11. By: Souza, Thiago de Oliveira (Department of Business and Economics)
    Abstract: This paper theoretically links the stock characteristics size and value to risks. The size premium arises – and spans the value premium – exclusively for portfolios formed in high market price of risk states. This is when the cross-sectional differences in risk premiums dominate the differences in expected cash flows connecting size and risk. Otherwise, value links better to the same risks, as it scales size by a proxy for expected cash flows. The hypothesis that value and size are (constant) risk proxies is formally rejected in the data, challenging the use of size-related portfolios as risk factors along with several strands of the literature based on this hypothesis.
    Keywords: Size premium; Value premium; Risk; Conditional; Portfolio sorts
    JEL: G11 G12 G14
    Date: 2018–04–19
  12. By: Jan-Christian Gerlach; Guilherme Demos; Didier Sornette
    Abstract: We present a detailed bubble analysis of the Bitcoin to US Dollar price dynamics from January 2012 to February 2018. We introduce a robust automatic peak detection method that classifies price time series into periods of uninterrupted market growth (drawups) and regimes of uninterrupted market decrease (drawdowns). In combination with the Lagrange Regularisation Method for detecting the beginning of a new market regime, we identify 3 major peaks and 10 additional smaller peaks, that have punctuated the dynamics of Bitcoin price during the analyzed time period. We explain this classification of long and short bubbles by a number of quantitative metrics and graphs to understand the main socio-economic drivers behind the ascent of Bitcoin over this period. Then, a detailed analysis of the growing risks associated with the three long bubbles using the Log-Periodic Power Law Singularity (LPPLS) model is based on the LPPLS Confidence Indicators, defined as the fraction of qualified fits of the LPPLS model over multiple time windows. Furthermore, for various fictitious present analysis times $t_2$, positioned in advance to bubble crashes, we employ a clustering method to group LPPLS fits over different time scales and the predicted critical times $t_c$ (the most probable time for the start of the crash ending the bubble). Each cluster is argued to provide a plausible scenario for the subsequent Bitcoin price evolution. We present these predictions for the three long bubbles and the four short bubbles that our time scale of analysis was able to resolve. Overall, our predictive scheme provides useful information to warn of an imminent crash risk.
    Date: 2018–04
  13. By: Ono, Arito; Suzuki, Katsushi; Uesugi, Iichiro
    Abstract: Utilizing the regulatory change relating to banks' shareholding in Japan as an instrument, this study examines the causal effects of declining shareholding by banks on bank lending and firms’ risk-taking. Banks may hold equity claims over client firms for either of the following two reasons: (i) gaining a competitive advantage by exploiting complementarity between shareholding and lending activities, and (ii) mitigating shareholder–creditor conflict. Exogenous reduction in a bank’s shareholding would then impair the competitiveness of the bank’s lending activities and aggravate the risk-taking behavior of client firms. Using a firm–bank matched dataset for Japan’s listed firms during the period 2001–2006, we empirically test these two hypotheses and obtain the following findings. First, after a bank’s removal from the list of major shareholders of a client firm, the bank’s share of the firm’s loans decreases. Second, volatility of a firm’s return on assets increases after the top shareholding bank is removed from the list of the firm’s major shareholders. Third, the negative impact of a bank’s removal from the list of major shareholders on bank lending mainly applies to non-main banks, while the positive impact of the top shareholding bank’s removal from the list of major shareholders on firms’ risk-taking mainly applies to main banks.
    Keywords: Bank shareholding, cross-selling, conflict of interest
    JEL: G21 G32 G34
    Date: 2018–03
  14. By: Derksen, Mike; Spreij, Peter; van Wijnbergen, Sweder
    Abstract: Contingent Convertible bonds (CoCos) are debt instruments that convert into equity or are written down in times of distress. Existing pricing models assume conversion triggers based on market prices and on the assumption that markets can always observe all relevant firm information. But all Cocos issued sofar have triggers based on accounting ratios and/or regulatory intervention. We incorporate that markets receive information through noisy accounting reports issued at discrete intervals, which allows us to distinguish between market and accounting values, and between automatic triggers and regulator-mandated conversions. Our second contribution is to incorporate that coupon payments are contingent too: their payment is conditional on the maxumum Distributable Amount not being exceeded. We examine the impact of CoCo design parameters, asset volatility and accounting noise on the price of a CoCo; and investigate the interaction between CoCo design features, the capital structure of the issuing bank and their implications for risk taking and investment incentives. Finally, we use our model to explain the crash in coco prices after Deutsche Bank's profit warning february 2016.
    Keywords: accounting noise; Coco design; Coco triggers; Contingent capital pricing; Investment incentives; risk taking incentives
    JEL: G12 G13 G18 G21 G28 G32
    Date: 2018–04
  15. By: Yannick Armenti (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - ENSIIE - CNRS - Centre National de la Recherche Scientifique); Stéphane Crépey (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - INRA - Institut National de la Recherche Agronomique - UEVE - Université d'Évry-Val-d'Essonne - ENSIIE - CNRS - Centre National de la Recherche Scientifique); Chao Zhou (Department of Mathematics [Singapore] - NUS - National University of Singapore)
    Abstract: In incomplete markets, a basic Black-Scholes perspective has to be complemented by the valuation of market imperfections. Otherwise this results in Black-Scholes Ponzi schemes, such as the ones at the core of the last global financial crisis, where always more derivatives need to be issued for remunerating the capital attracted by the already opened positions. In this paper we consider the sustainable Black-Scholes equations that arise for a portfolio of options if one adds to their trade additive Black-Scholes price, on top of a nonlinear funding cost, the cost of remunerating at a hurdle rate the residual risk left by imperfect hedging. We assess the impact of model uncertainty in this setup.
    Keywords: Market incompleteness,cost of capital (KVA),cost of funding (FVA),model risk,volatility uncertainty,optimal martingale transport
    Date: 2018–04–11
  16. By: Ya-Chun Gao; Huai-Lin Tang; Shi-Min Cai; Jing-Jing Gao; H. Eugene Stanley
    Abstract: Margin trading in which investors purchase shares with money borrowed from brokers is blamed to be a major cause of the 2015 Chinese stock market crash. We propose a cascading failure model and examine how an increase in margin trading increases share price vulnerability. The model is based on a bipartite graph of investors and shares that includes four margin trading factors, (i) initial margin $k$, (ii) minimum maintenance $r$, (iii) volatility $v$, and (iv) diversity $s$. We use our model to simulate margin trading and observe how the share prices are affected by these four factors. The experimental results indicate that a stock market can be either vulnerable or stable. A stock market is vulnerable when an external shock can cause a cascading failure of its share prices. It is stable when its share prices are resilient to external shocks. Furthermore, we investigate how the cascading failure of share price is affected by these four factors, and find that by increasing $v$ and $r$ or decreasing $k$ we increase the probability that the stock market will experience a phase transition from stable to vulnerable. It is also found that increasing $s$ decreases resilience and increases systematic risk. These findings could be useful to regulators supervising margin trading activities.
    Date: 2018–04
  17. By: Akin Ozturk; Harun Tanrivermis; Yunus Emre Kapusuz
    Abstract: Risk expresses the change in the expected values and is the key factor in making decision on large-scale investments with fixed capital. However, unlike uncertainties, risks can be foreseen and incorporated into project plans. The real estate development risks in academic studies vary according to classification types and approaches. Basically, risks are divided into four main groups, which are environmental risks, economic risks, sector-specific risks, and project-specific risks. Costs have recently been following a certain trend in Turkey and housing supply has been increasing based on the increasing demand. There is a requirement for risk management in the real estate development process to keep the risks under control and prevent undesired consequences. The steps to be taken in risk management can be listed as identification of risks, analyzing risks, development of response strategies, and monitoring procedures. In this study, a macroeconomic risk management framework for a mixed-use real estate project that had been started in 2010 was established and the identification, quantification, analyzes of the risks were made. The scenario-sensitivity method was used to analyze the risks. Retrospective response planning (avoid, mitigate, accept and transfer) scenarios were developed and their impact was evaluated for the selected project. In addition, if-then analyzes were used to investigate the actual and target values were and reasons thereof were investigated. According to the research results, macroeconomic variables such as real estate rent index, exchange rates, interest rates, and economic outlook were effective in the deviations from the expected values.
    Keywords: macroeconomic indicators; real estate development projects; Risk Analysis; Risk Management; risk management strategies
    JEL: R3
    Date: 2017–07–01

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