
on Risk Management 
Issue of 2018‒07‒23
nineteen papers chosen by 
By:  Chao Wang; Richard Gerlach; Qian Chen 
Abstract:  A new realized joint ValueatRisk (VaR) and expected shortfall (ES) regression framework is proposed, through incorporating a measurement equation into the original joint VaR and ES regression model. The measurement equation models the contemporaneous dependence between the realized measures (e.g. Realized Variance and Realized Range) and the latent conditional quantile. Further, subsampling and scaling methods are applied to both the realized range and realized variance, to help deal with the inherent microstructure noise and inefficiency. An adaptive Bayesian Markov Chain Monte Carlo method is employed for estimation and forecasting, whose properties are assessed and compared with maximum likelihood estimator through simulation study. In a forecasting study, the proposed models are applied to 7 market indices and 2 individual assets, compared to a range of parametric, nonparametric and semiparametric models, including GARCH, RealizedGARCH, CARE and Taylor (2017) joint VaR and ES quantile regression models, onedayahead ValueatRisk and Expected Shortfall forecasting results favor the proposed models, especially when incorporating the subsampled Realized Variance and the subsampled Realized Range in the model. 
Date:  2018–07 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1807.02422&r=rmg 
By:  Kaouther Toumi (LGCO  Laboratoire Gouvernance et Contrôle Organisationnel  UPS  Université Paul Sabatier  Toulouse 3); JeanLaurent Viviani (CREM  Centre de recherche en économie et management  UNICAEN  Université de Caen Normandie  NU  Normandie Université  UR1  Université de Rennes 1  UNIVRENNES  Université de Rennes  CNRS  Centre National de la Recherche Scientifique); Zeinab Chayeh (U. Paris 6  Université Pierre & Marie Curie  Paris 6) 
Abstract:  Highlights We identify the displaced commercial risk DCR exposure of Islamic banks. We identify the scenarios of displaced commercial risk exposure to compute the DCR Profits and Losses to Islamic banks shareholders. Scenarios of risk depend on the actual rate of return on investment accounts, the benchmark rate of return and level of existing reserves to mitigate the DCR. We assess the capital charge needed to cover the displaced commercial risk using the Valueatrisk measure of risk, DCRVaR. We assess the coefficient alpha α CARVaR for the capital adequacy ratio for Islamic banks. We consider three methods, the Historical nonparametric VaR, the parametricVaR and the Extreme Value TheoryVaR. Abstract The objective of the research is to quantify the displaced commercial risk (DCR) based on quantitative finance techniques. We develop an internal model based on the Valueatrisk (VaR) measure of risk to assess the DCRVaR and the alpha coefficient in the capital adequacy ratio of Islamic banks. We identify first the scenarios of exposure of Islamic banks to DCR that depend on the actual return on unrestricted profit sharing investment accounts (PSIA U), the benchmark return as well as the level of the existing profit equalization reserve (PER) and investment risk reserve (IRR). Second, we quantify the DCRVaR and the alpha coefficient for a given holding period and for given confidence level. We illustrate the DCRVaR model on selected Islamic banks from Bahrain. Our model helps to better assess the needed equity to cover the DCR and an accurate capital adequacy ratio for Islamic banks. The model has also policy implications for regulators and the IFSB to develop better guidance on good practices in managing this risk. 
Keywords:  Displaced commercial risk, Valueatrisk, Extreme value theory, Profit equalization reserve, Investment risk reserve, Capital adequacy ratio 
Date:  2018–03 
URL:  http://d.repec.org/n?u=RePEc:hal:journl:halshs01806496&r=rmg 
By:  Rustom M. Irani; Rajkamal Iyer; Ralf R. Meisenzahl; Jose Luis Peydro 
Abstract:  We investigate the connections between bank capital regulation and the prevalence of lightly regulated nonbanks (shadow banks) in the U.S. corporate loan market. For identification, we exploit a supervisory credit register of syndicated loans, loantime fixedeffects, and shocks to capital requirements arising from surprise features of the U.S. implementation of Basel III. We find that lesscapitalized banks reduce loan retention and nonbanks step in, particularly among loans with higher capital requirements and at times when capital is scarce. This reallocation has important spillovers: loans funded by nonbanks with fragile liabilities experience greater sales and price volatility during the 2008 crisis. 
Keywords:  Shadow banks ; Riskbased capital regulation ; Basel III ; Interactions between banks and nonbanks ; Trading by banks ; Distressed debt 
JEL:  G01 G21 G23 G28 
Date:  2018–06–20 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgfe:201839&r=rmg 
By:  Choi, Dong Boem (Federal Reserve Bank of New York); Holcomb, Michael R. (Federal Reserve Bank of New York); Morgan, Donald P. (Federal Reserve Bank of New York) 
Abstract:  The supplementary leverage ratio (SLR) rule recently imposed on the very largest U.S. banks has revived the question of whether banks sidestep such rules by shifting toward riskier, higheryielding assets. Using differenceindifference analysis, we find that, after the SLR was finalized in 2014, covered banks shifted their portfolio toward riskier (riskweighted) assets and higheryielding securities compared to other large banks not subject to the rule. The shifts are sizable and tend to be larger at banks more constrained ex ante by the leverage limit. Despite increased asset risk, overall bank risk (book and market measures) did not increase, suggesting the higher capital required under the new rule offset the riskshifting. Taken together, our findings reinforce regulators’ longstanding concerns about riskshifting around leverage limits and suggest that the recent recalibration will curb those incentives without necessarily increasing bank risk. 
Keywords:  Basel III regulation; bank risk; leverage limit; regulatory arbitrage; reaching for yield 
JEL:  G20 G21 G28 
Date:  2018–06–01 
URL:  http://d.repec.org/n?u=RePEc:fip:fednsr:856&r=rmg 
By:  Imbierowicz, Björn; Kragh, Jonas; Rangvid, Jesper 
Abstract:  We investigate how banks' capital and lending decisions respond to changes in bankspecific capital and disclosure requirements. We find that an increase in the bankspecific regulatory capital requirement results in a higher bank capital ratio, brought about via less asset risk. A decrease in the requirement implies more lending to firms but also less Tier 1 capital and higher bank leverage. We do not observe differences between confidential and public disclosure of capital requirements. Our results empirically illustrate a tradeoff between bank resilience and a fostering of the economy through more bank lending using banks' capital requirement as policy instrument. 
Keywords:  capital requirement,bank lending,bank capital structure,capital disclosure rules 
JEL:  G21 G28 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:zbw:bubdps:182018&r=rmg 
By:  Yacine AitSahalia (Princeton University and National Bureau of Economic Research (NBER)); Mustafa Karaman (University of Zurich); Loriano Mancini (University of Lugano and Swiss Finance Institute) 
Abstract:  We study the term structure of variance swaps, equity and variance risk premia. A modelfree analysis reveals a significant price jump component in variance swap rates. A modelbased analysis shows that investors' willingness to ensure against volatility risk increases after a market drop. This effect is stronger for short horizons and more persistent for long horizons. During the financial crisis investors demanded large risk premia to hold equities but the risk premia largely depended and strongly decreased with the holding horizon. The term structure of equity and variance risk premia responds differently to various economic indicators. 
Keywords:  Variance Swap, Stochastic Volatility, Likelihood Approximation, Term Structure, Equity Risk Premium, Variance Risk Premium 
JEL:  C51 G12 G13 
Date:  2018–05 
URL:  http://d.repec.org/n?u=RePEc:chf:rpseri:rp1837&r=rmg 
By:  Tim Xiao 
Abstract:  This paper presents a new model for pricing financial derivatives subject to collateralization. It allows for collateral arrangements adhering to bankruptcy laws. As such, the model can back out the market price of a collateralized contract. This framework is very useful for valuing outstanding derivatives. Using a unique dataset, we find empirical evidence that credit risk alone is not overly important in determining creditrelated spreads. Only accounting for both collateral posting and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of derivatives. We also empirically gauge the impact of collateral agreements on risk measurements. Our findings indicate that there are important interactions between market and credit risk. 
Date:  2018–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1805.11981&r=rmg 
By:  Ariah KlagesMundt; Andreea Minca 
Abstract:  We develop a model for contagion in reinsurance networks by which primary insurers' losses are spread through the network. Our model handles general reinsurance contracts, such as typical excess of loss contracts. We show that simpler models existing in the literaturenamely proportional reinsurancegreatly underestimate contagion risk. We characterize the fixed points of our model and develop efficient algorithms to compute contagion with guarantees on convergence and speed under conditions on network structure. We characterize exotic cases of problematic graph structure and nonlinearities, which cause network effects to dominate the overall payments in the system. We lastly apply our model to data on real world reinsurance networks. Our simulations demonstrate the following: (1) Reinsurance networks face extreme sensitivity to parameters. A firm can be wildly uncertain about its losses even under small network uncertainty. (2) Our sensitivity results reveal a new incentive for firms to cooperate to prevent fraud, as even small cases of fraud can have outsized effect on the losses across the network. (3) Nonlinearities from excess of loss contracts obfuscate risks and can cause excess costs in a real world system. 
Date:  2018–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1805.12222&r=rmg 
By:  Leo de Haan; Jan Kakes 
Abstract:  This paper takes stock of European banks' accumulated losses since 2007 and relates these to bank characteristics. In line with previous studies, we find that large, marketoriented banks were particularly hit by the 20072009 global financial crisis whereas smaller, retailoriented banks weathered these years relatively well. In subsequent years, however, the picture reversed and retailoriented banks were most affected. Over the entire period, mediumsized banks suffered most losses and often needed state aid. This suggests that measures to contain systemic risk, such as capital surcharges and bailin requirements, are as relevant for these institutions as they are for the largest banks. 
Keywords:  Bank profitability; Business model; Financial crisis 
JEL:  G01 G21 
Date:  2018–07 
URL:  http://d.repec.org/n?u=RePEc:dnb:dnbwpp:600&r=rmg 
By:  Výrost, Tomas; Lyócsa, Štefan; Baumöhl, Eduard 
Abstract:  In this study, we construct financial networks in which nodes are represented by assets and where edges are based on longrun correlations. We construct four networks (complete graph, a minimum spanning tree, a planar maximally filtered graph, and a threshold significance graph) and use three centrality measures (betweenness, eigenvalue centrality, and the expected force). To improve riskreturn characteristics of wellknown return maximization and risk minimization benchmark portfolios, we propose simple adjustments to portfolio selection strategies that utilize centralization measures from financial networks. From a sample of 45 assets (stock market indices, bond and money market instruments, commodities, and foreign exchange rates) and from data for 1999 to 2015, we show that irrespective of the network and centrality employed, the proposed networkbased asset allocation strategies improve key portfolio return characteristics in an outofsample framework, most notably, risk and lefttail riskadjusted returns. Resolving portfolio model selection uncertainties further improves riskreturn characteristics. Improvements made to portfolio strategies based on risk minimization are also robust to transaction costs. 
Keywords:  networks,portfolio,centrality,riskreturn profile 
JEL:  G10 G11 G15 C61 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:zbw:esprep:180063&r=rmg 
By:  Urairat Maneerattanasak (Thammasat University); Nitaya Wongpinunwatana (Thammasat University) 
Abstract:  The purpose of studying the success factors of principle and practice in Information Technology Risk Management (ITRM) is initiated from the proposition that appropriate ITRM principle and practice can mitigate IT risks and losses which is a result of security threats. The literature showed that various general principles and frameworks are widely published but the established principle cannot be put into the practice. Additionally, there is a research study regarding the difficulty to maintain independent in identifying, reviewing and reporting tasks of IT risk and internal audit functions. The methodology consisted of the review of general principles and frameworks? documents and the interview from case studies. The general principles and frameworks in this research collected from the question ?Which principles and frameworks are applied to ITRM in your organization??. The question was asked to people in IT risk and IT internal audit functions from banking organizations and other industries which advanced information technologies are critical to the organizations. The content from first five applied principles and frameworks from the survey are Basel, COBIT 5 framework, COSO Enterprise Risk Management, ISO 31000 and ISO/IEC 27005 were reviewed. In addition, the interviews were conducted to the people in both functions from banking organizations regarding the success factors of principle and practice in ITRM in their opinions without guiding from the interviewer. The findings from the review of documents are eleven success factors that are general principle and framework selection, principle establishment, process design, structure of risk team, team?s expertise, complex level of task, interdependent level, risk culture, communication in organization, training and risk management?s tools and techniques. Meanwhile, the indepth interviews? results showed that nine success factors that are adoption of ITRM principle, appropriate Process from ITRM Principle, task, interaction, adaptability, outsourcing, management support, conflict management and culture transformation. In conclusion, the success factors from both resources were compared and discussed as triangulation.The practical contribution of the research is that the success factors can be used as a primary check for the appropriation of current principle and practice, the exploration an intrinsic problem in both principle and practice on ITRM or the development stage. For the theoretical contribution, the researcher recommends studying various success case studies applying the principle and practices from various industries and classified the patterns by organization types which the information technologies are significant to their operation. 
Keywords:  Information Technology Risk Management; Principle and Practice; Success Factors 
JEL:  M15 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:sek:iacpro:5407887&r=rmg 
By:  Gabriela Kovacova; Birgit Rudloff 
Abstract:  Choosing a portfolio of risky assets over time that maximizes the expected return at the same time as it minimizes portfolio risk is a classical problem in Mathematical Finance and is referred to as the dynamic Markowitz problem (when the risk is measured by variance) or more generally, the dynamic meanrisk problem. In most of the literature, the meanrisk problem is scalarized and it is well known that this scalarized problem does not satisfy the (scalar) Bellman's principle. Thus, the classical dynamic programming methods are not applicable. For the purpose of this paper we focus on the discrete time setup, and we will use a time consistent dynamic convex risk measure to evaluate the risk of a portfolio. We will show that when we do not scalarize the problem, but leave it in its original form as a vector optimization problem, the upper images, whose boundary contains the efficient frontier, recurse backwards in time under very mild assumptions. Thus, the dynamic meanrisk problem does satisfy a Bellman's principle, but a more general one, that seems more appropriate for a vector optimization problem: a setvalued Bellman's principle. We will present conditions under which this recursion can be exploited directly to compute a solution in the spirit of dynamic programming. Numerical examples illustrate the proposed method. The obtained results open the door for a new branch in mathematics: dynamic multivariate programming. 
Date:  2018–06 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1806.10981&r=rmg 
By:  Javier Ojea Ferreiro (Department of Quantitative Economics, Complutense University of Madrid (UCM), Somosaguas, 28223,Spain.) 
Abstract:  I examine the evolution of contagion indexes between the European financial sector and the sovereign sector (Austria, Belgium, France, Germany, Italy, Netherlands and Spain) during the European sovereign credit crisis. Contagion indexes, Delta CoVaR and Delta CoES, reflect events associated with extreme left tail returns and interdependencies between defaults different than those observed in tranquil times. These measures reveal very useful information concerning risk management. I use a copula approach with timevarying parameters to capture changes in the tail dependence between returns in the financial and the sovereign sectors. I employ a Switching Markov model to identify the most stressful moments of the contagion indicators. The results point out the emergence of Greek debt crisis on March 2010 and the vulnerable situation of Spain and Italy in summer 2011 as the main periods where the contagion from the sovereign to the financial sector was stronger. The decrease in contagion was gradual since the speech made by the ECB on July 26th,2012. The statistical significance of the change in the contagion indicators is checked using boostrap tests. 
Keywords:  CoVaR; Copula; European sovereign credit crisis; systemic risk. 
JEL:  G18 G21 G32 G38 
Date:  2018–05 
URL:  http://d.repec.org/n?u=RePEc:ucm:doicae:1812&r=rmg 
By:  Luigi Infante (Bank of Italy); Stefano Piermattei (Bank of Italy); Raffaele Santioni (Bank of Italy); Bianca Sorvillo (Bank of Italy) 
Abstract:  The derivatives market has experienced quick growth all over the world in the last two decades. Banks decide to participate in the derivatives market either to hedge against unexpected movements in economic variables or for trading and brokerdealer activities. This paper analyses, by means of multivariate descriptive statistical tools, the determinants of Italian banks’ use of derivatives over a long time horizon (20032017) by using quarterly Bank of Italy supervisory data. We find that size and being part of a banking group positively affect banks’ use of derivatives. Moreover, banks mainly employ derivatives for hedging purposes, especially to hedge against interest rate and credit risks. Finally, derivatives represent a hedging alternative to capital and liquidity. Our results are robust to different specifications that take into account the classification of derivatives by purpose (hedging versus trading) and the distinction between dealer versus enduser banks. 
Keywords:  banking, derivatives, financial risks, hedging 
JEL:  G21 G32 
Date:  2018–06 
URL:  http://d.repec.org/n?u=RePEc:bdi:opques:qef_441_18&r=rmg 
By:  Boyarchenko, Nina (Federal Reserve Bank of New York); Eisenbach, Thomas M. (Federal Reserve Bank of New York); Gupta, Pooja (Federal Reserve Bank of New York); Shachar, Or (Federal Reserve Bank of New York); Van Tassel, Peter (Federal Reserve Bank of New York) 
Abstract:  We argue that postcrisis bank regulation can explain large, persistent deviations from parity on basis trades requiring leverage. Documenting the financing cost and balance sheet impact on a broad array of basis trades for regulated institutions, we show that the implied return on equity on such trades is considerably lower under postcrisis regulation. In addition, although hedge funds would serve as natural alternative arbitrageurs, we document that funds reliant on leverage from a global systemically important bank suffer significant declines in assets and returns relative to unlevered funds. Thus, postcrisis regulation not only affects the targeted banks directly but also spills over to unregulated firms that rely on bank intermediation for their arbitrage strategies. 
Keywords:  bank regulation; arbitrage; hedge funds 
JEL:  G01 G21 G23 G28 
Date:  2018–06–01 
URL:  http://d.repec.org/n?u=RePEc:fip:fednsr:858&r=rmg 
By:  Vilislav Boutchaktchiev 
Abstract:  A Markovchain model is developed for the purpose estimation of the cure rate of nonperforming loans. The technique is performed collectively, on portfolios and it can be applicable in the process of calculation of credit impairment. It is efficient in terms of data manipulation costs which makes it accessible even to smaller financial institutions. In addition, several other applications to portfolio optimization are suggested. 
Date:  2018–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1805.11804&r=rmg 
By:  Arpad Abraham; Eva CarcelesPoveda; Yan Liu; Ramon Marimon 
Abstract:  A Financial Stability Fund set by a union of sovereign countries can improve countries' ability to share risks, borrow and lend, with respect to the standard instrument used to smooth fluctuations: sovereign debt financing. Efficiency gains arise from the ability of the fund to over longterm contingent financial contracts, subject to limited enforcement (LE) and moral hazard (MH) constraints. In contrast, standard sovereign debt contracts are uncontingent and subject to untimely debt rollovers and default risk. We develop a model of the Financial Stability Fund (Fund) as a longterm partnership with LE and MH constraints. We quantitatively compare the constrainedefficient Fund economy with the incomplete markets economy with default. In particular, we characterize how (implicit) interest rates and asset holdings differ, as well as how both economies react differently to the same productivity and government expenditure shocks. In our economies, "calibrated" to the euro area "stressed countries", substantial efficiency gains are achieved by establishing a welldesigned Financial Stability Fund; this is particularly true in times of crisis. Our theory provides a basis for the design of a Fund  for example, beyond the current scope of the Euroepan Stability Mechanism (ESM)  and a theoretical and quantitative framework to assess alternative risksharing (shockabsorbing) facilities, as well as proposals to deal with the euro area "debt overhang problem." 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:nys:sunysb:1806&r=rmg 
By:  Taras Bodnar; Dmytro Ivasiuk; Nestor Parolya; Wofgang Schmid 
Abstract:  We derive new results related to the portfolio choice problem for a power and logarithmic utilities. Assuming that the portfolio returns follow a lognormal distribution, the closedform expressions of the optimal portfolio weights are obtained for both utility functions. Moreover, we prove that both optimal portfolios belong to the set of meanvariance feasible portfolios and establish necessary and sufficient conditions such that they are meanvariance efficient. Furthermore, an application to the stock market is presented and the behavior of the optimal portfolio is discussed for different values of the relative risk aversion coefficient. It turns out that the assumption of lognormality does not seem to be a strong restriction. 
Date:  2018–06 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1806.08005&r=rmg 
By:  Masako Ikefuji (University of Tsukuba); Roger J. A. Laeven (University of Amsterdam, CentER, EURANDOM); Jan R. Magnus (Vrije Universiteit Amsterdam); Yuan Yue (University of Amsterdam) 
Abstract:  We analyze the impact of shortrun and longrun earthquake risk on Japanese property prices. We exploit a rich panel data set of property characteristics, ward attractiveness information, macroeconomic variables, seismic hazard data, and historical earthquake occurrences, supplemented with shortrun earthquake probabilities that we generate from a seismic excitation model. We design a hedonic property price model that allows for probability weighting, employ a multivariate error components structure, and develop associated maximum likelihood estimation and variance computation procedures. We find that distorted shortrun and longrun earthquake probabilities have a significantly negative impact on property prices. Our approach enables us to identify the total compensation for earthquake risk embedded in property prices and to decompose this into pieces stemming from shortrun and longrun risk, and to further decompose this into objective and distorted risk components. 
Keywords:  Earthquake risk; House price; Seismic excitation; Probability weighting; Hedonic pricing; Multivariate error components. 
JEL:  R20 C33 D81 Q51 
Date:  2018–07–11 
URL:  http://d.repec.org/n?u=RePEc:tin:wpaper:20180061&r=rmg 