nep-rmg New Economics Papers
on Risk Management
Issue of 2018‒08‒27
fifteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Real implications of corporate risk management: Evidence from U.S. oil producers By Dionne, Georges; Mnasri, Mohamed
  2. Basel III capital requirements and heterogeneous banks By Müller, Carola
  3. Optimal model points portfolio in Life Insurance By Enrico Ferri
  4. Risk-Reward Ratio Optimisation (Revisited) By Manfred Gilli; Enrico Schumann
  5. Banks’ Liquidity Management and Systemic Risk By Luca G. Deidda; Ettore Panetti
  6. Key Borrowers Detection by Long-Range Interactions By Fuad Aleskerov; Natalia Meshcheryakova; Alisa Nikitina; Sergey Shvydun
  7. A Theory of Credit Scoring and the Competitive Pricing of Default Risk By Satyajit Chatterjee; Dean Corbae; Jose-Victor Rios-Rull; Kyle Dempsey
  8. Willingness to Take Risk: The Role of Risk Conception and Optimism By Dohmen, Thomas; Quercia, Simone; Willrodt, Jana
  9. Convertible bonds and bank risk-taking By Martynova, Natalya; Perotti, Enrico C.
  10. We inspect the price volatility before, during, and after financial asset bubbles in order to uncover possible commonalities and check empirically whether volatility might be used as an indicator or an early warning signal of an unsustainable price increase and the associated crash. Some researchers and finance practitioners believe that historical and/or implied volatility increase before a crash, but we do not see this as a consistent behavior. We examine forty well-known bubbles and, using creative graphical representations to capture robustly the transient dynamics of the volatility, find that the dynamics of the volatility would not have been a useful predictor of the subsequent crashes. In approximately two-third of the studied bubbles, the crash follows a period of lower volatility, reminiscent of the idiom of a “lull before the storm”. This paradoxical behavior, from the lenses of traditional asset pricing models, further questions the general relationship between risk and return. By Didier Sornette; Peter Cauwels; Georgi Smilyanov
  11. Why do banks securitise their assets? Bank-level evidence from over one hundred countries in the pre-crisis period By Fabio Panetta; Alberto Franco Pozzolo
  12. Repo market functioning: the role of capital regulation By Van Horen, Neeljte; Kotidis, Antonis
  13. Valuing Life as an Asset, as a Statistic and at Gunpoint By Hugonnier, J.;; Pelgrin, F.;; St-Amour, P.;
  14. Law-invariant insurance pricing and its limitations By Fabio Bellini; Pablo Koch-Medina; Cosimo Munari; Gregor Svindland
  15. Risk Framework Analysis in the Management of Sovereign Debt: The Argentine case By Emiliano Delfau

  1. By: Dionne, Georges (HEC Montreal, Canada Research Chair in Risk Management); Mnasri, Mohamed (HEC Montreal, Canada Research Chair in Risk Management)
    Abstract: This study revisits the question of whether risk management has real implications on firm value, risk, and accounting performance using a new dataset on the hedging activities of U.S. oil producers. In light of the controversial results in the literature, this paper estimates the hedging premium question for firms using a more robust econometric methodology, namely essential heterogeneity models, that controls for bias related to selection on unobservables and self‒selection in the estimation of marginal treatment effects (MTE). We find that oil producers with higher propensity scores for the use of more extensive hedging activities tend to have higher marginal firm value and higher marginal risk reduction, and realize stronger marginal accounting performance. They also have significant average treatment effects (ATE) for firm financial value, idiosyncratic risk and systematic risk.
    Keywords: Corporate risk management; real implications; value creation; risk reduction; hedging benefits; oil producers; marginal treatment effect; average treatment effect; essential heterogeneity model
    JEL: D80 G32
    Date: 2018–06–20
  2. By: Müller, Carola
    Abstract: I develop a theoretical model to investigate the effect of simultaneous regulation with a leverage ratio and a risk-weighted ratio on banks' risk taking and banking market structure. I extend a portfolio choice model by adding heterogeneity in productivity among banks. Regulators face a trade-off between the efficient allocation of resources and financial stability. In an oligopolistic market, risk-weighted requirements incentivise banks with high productivity to lend to low-risk firms. When a leverage ratio is introduced, these banks lose market shares to less productive competitors and react with risk-shifting into high-risk loans. While average productivity in the low-risk market falls, market shares in the high-risk market are dispersed across new entrants with high as well as low productivity.
    Keywords: banking regulation,heterogeneous banks,banking competition,capital requirements,leverage ratio,Basel III
    JEL: G11 G21 G28
    Date: 2018
  3. By: Enrico Ferri
    Abstract: We consider the problem of seeking an optimal set of model points associated to a fixed portfolio of life insurance policies. Such an optimal set is characterized by minimizing a certain risk functional, which gauges the average discrepancy with the fixed portfolio in terms of the fluctuation of the interest rate term structure within a given time horizon. We prove a representation theorem which provides two alternative formulations of the risk functional and which may be understood in connection with the standard approaches for the portfolio immunization based on sensitivity analysis. For this purpose, a general framework concerning some techniques of stochastic integration in Banach space and Malliavin calculus is introduced. A numerical example is discussed when considering a portfolio of whole life policies.
    Date: 2018–08
  4. By: Manfred Gilli (University of Geneva and Swiss Finance Institute); Enrico Schumann (Independent researcher)
    Abstract: We study the empirical performance of alternative risk and reward specifications in portfolio selection. In particular, we look at models that take into account asymmetry of returns, and treat losses and gains differently. In tests on a dataset of German equities we find that portfolios constructed with the help of such models generally outperform the market index and in many cases also the risk-based benchmark (minimum variance). In part, higher returns can be explained by exposure to factors such as momentum and value. Nevertheless, a substantial part of the performance cannot be explained by standard asset-pricing models.
    Keywords: Numerical optimisation; Heuristics; Risk-based investing; Downside risk; Factor Investing; UCITS
    Date: 2017–05
  5. By: Luca G. Deidda; Ettore Panetti
    Abstract: We study a novel mechanism to explain the interaction between banks’ liquidity management and the emergence of systemic financial crises, in the form of self-fulfilling runs. To this end, we develop an environment where banks offer insurance to their depositors against both idiosyncratic and aggregate real shocks, by holding a portfolio of liquidity and productive but illiquid assets. Moreover, banks’ asset portfolios and the probability of a depositors’ self-fulfilling run are jointly determined via a “global game†. We characterize the sufficient conditions under which there exists a unique threshold recovery rate, associated with the early liquidation of the productive assets, below which the banks first employ liquidity and then liquidate, in order to finance depositors’ early withdrawals. Ex ante, the banks hold more liquidity than in a full-information economy, where there are no self-fulfilling runs and risk is only due to idiosyncratic and aggregate real shocks.
    JEL: G01 G21
    Date: 2017
  6. By: Fuad Aleskerov; Natalia Meshcheryakova; Alisa Nikitina; Sergey Shvydun
    Abstract: We propose a new method for assessing agents' influence in financial network structures, which takes into consideration the intensity of interactions. A distinctive feature of this approach is that it considers not only direct interactions of agents of the first level and indirect interactions of the second level, but also long-range indirect interactions. At the same time we take into account the attributes of agents as well as the possibility of impact to a single agent from a group of other agents. This approach helps us to identify systemically important elements which cannot be detected by classical centrality measures or other indices. The proposed method was used to analyze the banking foreign claims for the end of 1Q 2015. Under the approach, two types of key borrowers were detected: a) major players with high ratings and positive credit history; b) intermediary players, which have a great scale of financial activities through the organization of favorable investment conditions and positive business climate.
    Date: 2018–06
  7. By: Satyajit Chatterjee (Federal Reserve Bank of Philadelphia); Dean Corbae (University of Wisconsin); Jose-Victor Rios-Rull (University of Pennsylvania); Kyle Dempsey (The Ohio State University)
    Abstract: We propose a theory of unsecured consumer credit where: (i) borrowers have the legal option to default; (ii) defaulters are not exogenously excluded from future borrowing; and (iii) there is free entry of lenders; and (iv) lenders cannot collude to punish defaulters. In our framework, limited credit or credit at higher interest rates following default arises from the lender's optimal response to limited information about the agent's type. The lender learns from an individual's borrowing and repayment behavior about his type and encapsulates his reputation for not defaulting in a credit score. We take the theory to data choosing the parameters of the model to match key data moments such as the overall delinquency rate. We use the model to quantify the value to having a good reputation in the credit market in a variety of ways, and also analyze the differential effects of static versus dynamic costs on credit market equilibria.
    Date: 2018
  8. By: Dohmen, Thomas (University of Bonn and IZA); Quercia, Simone (University of Bonn); Willrodt, Jana (Düsseldorf Institute for Competition Economics (DICE))
    Abstract: We show that the disposition to focus on favorable or unfavorable outcomes of risky situations affects willingness to take risk as measured by the general risk question. We demonstrate that this disposition, which we call risk conception, is strongly associated with optimism, a stable facet of personality and that it predicts real-life risk taking. The general risk question captures this disposition alongside pure risk preference. This enlightens why the general risk question is a better predictor of behavior under risk across different domains than measures of pure risk preference. Our results also rationalize why risk taking is related to optimism.
    Keywords: risk taking behavior, optimism, preference measures, risk conception
    JEL: D91 C91 D81 D01
    Date: 2018–06
  9. By: Martynova, Natalya; Perotti, Enrico C.
    Abstract: We study how contingent capital affects banks' risk choices. When triggered in highly levered states, going-concern conversion reduces risk-taking incentives, unlike conversion at default by traditional bail-inable debt. Interestingly, contingent capital (CoCo) may be less risky than bail-inable debt as its lower priority is compensated by a lower induced risk. The main beneficial effect on risk incentives comes from reduced leverage upon conversion, while any equity dilution has the opposite effect. This is in contrast to traditional convertible debt, since CoCo bondholders have a short option position. As a result, principal write-down CoCo debt is most desirable for risk preventive pur- poses, although the effect may be tempered by a higher yield. The risk reduction effect of CoCo debt depends critically on the informativeness of the trigger. As it should ensure deleveraging in all states with high risk incentives, it is always inferior to pure equity.
    Keywords: Banks,Contingent Capital,Risk-shifting,Financial Leverage
    JEL: G13 G21 G28
    Date: 2018
  10. By: Didier Sornette (ETH Zurich and Swiss Finance Institute); Peter Cauwels (ETH Zurich); Georgi Smilyanov (ETH Zurich)
    Keywords: gradual portfolio adjustment, international portfolio allocation, predictable excess returns.
    JEL: F30 F41 G11 G12
    Date: 2017–04
  11. By: Fabio Panetta (Bank of Italy); Alberto Franco Pozzolo (University of Molise)
    Abstract: We investigate the causes and consequences of securitisations using a large data set of banks from over 100 world countries between 1991 and 2007, when the financial crisis caused the market to collapse. Our results show that banks were more likely to securitise their assets when they faced binding capital requirements and when the direct and indirect costs of these operations were lower (e.g., administrative expenses or the loss implied in the sale of opaque assets in an imperfect information environment). We also find evidence that banks securitised their assets to contain credit risk and reduce the exposure to liquidity shocks. The ex-post effects of securitisations are consistent with these ex-ante determinants. After the securitisation, banks improved their capital ratios and did not increase their riskiness. More important, they increased their credit supply. These results suggest that if properly used, these techniques can provide additional flexibility in managing banks’ activities and risk, and can foster credit supply. But, as the crisis has made well clear, provisions must be taken to avoid that some banks may use these new techniques in a way that increases individual and especially systemic risk.
    Keywords: credit risk transfer, securitisation, financial derivatives
    JEL: G21 G32
    Date: 2018–07
  12. By: Van Horen, Neeljte (Bank of England); Kotidis, Antonis (University of Bonn)
    Abstract: This paper shows that the leverage ratio affects repo intermediation for banks and non-bank financial institutions. We exploit a novel regulatory change in the UK to identify an exogenous intensification of the leverage ratio and combine this with supervisory transaction-level data capturing the near-universe of gilt repo trading. Studying adjustments at the dealer-client level and controlling for demand and confounding factors, we find that dealers subject to a more binding leverage ratio reduced liquidity in the repo market. This affected their small but not their large clients. We further document a reduction in frequency of transactions and a worsening of repo pricing, but no adjustment in haircuts or maturities. Finally, we find evidence of market resilience, based on existing, rather than new repo relationships, with foreign, non-constrained dealers stepping in. Overall, our findings help shed light on the impact of Basel III capital regulation on repo markets.
    Keywords: Capital regulation; leverage ratio; repo market; non-bank financial institutions
    JEL: G10 G21 G23
    Date: 2018–08–03
  13. By: Hugonnier, J.;; Pelgrin, F.;; St-Amour, P.;
    Abstract: The Human Capital (HK) and Statistical Life Values (VSL) differ sharply in their empirical pricing of a human life and lack a common theoretical background to justify these differences. We first contribute to the theory and measurement of life value by providing a unified framework to formally define and relate the Hicksian willingness to pay (WTP) to avoid changes in death risks, the HK and the VSL. Second, we use this setting to introduce an alternative life value calculated at Gunpoint (GPV), i.e. the WTP to avoid certain, instantaneous death. Third, we associate a flexible human capital model to the common framework to characterize the WTP and the three life valuations in closed-form. Fourth, our structural estimates of these solutions yield mean life values of 8.35 M$ (VSL), 421 K$ (HK) and 447 K$ (GPV). We confirm that the strong curvature of the WTP and the linear projection hypothesis of the VSL explain why the latter is much larger than other values.
    Keywords: value of human life; human capital; value of statistical life; Hicksian willingness to pay; equivalent variation; mortality; structural estimation;
    JEL: J17 G11
    Date: 2018–08
  14. By: Fabio Bellini; Pablo Koch-Medina; Cosimo Munari; Gregor Svindland
    Abstract: We show that a law-invariant pricing functional defined on a general Orlicz space is typically incompatible with frictionless risky assets in the sense that one and only one of the following alternatives can hold: Either every risky payoff has a strictly-positive bid-ask spread or the pricing functional is given by an expectation and, hence, every payoff has zero bid-ask spread. In doing so we extend and unify a variety of "collapse to the mean" results from the literature and highlight the key role played by law invariance in causing the collapse. As a byproduct, we derive a number of applications to law-invariant acceptance sets and risk measures as well as Schur-convex functionals.
    Date: 2018–08
  15. By: Emiliano Delfau
    Abstract: The main objective of this paper is to develop a practical approach to Argentina’s sovereign risk management. Through Contingent Claim Analysis (CCA), Gape, Gray, Lim and Xiao (2008)[1] developed a sovereign risk framework whereby we can construct a marked to market sovereign balance sheet and obtain a set of credit risk indicators that can help policy-makers: set thresholds for foreign reserves, design risk mitigation strategies and select best policy options. The main contribution is that instead of using a conventional index such as GBI-EM1 in order to estimate the volatility of domestic currency liabilities, we use 24 sovereign domestic currency bonds to construct an interest rate covariance matrix. That is, an interest rate sensitive sovereign portfolio, whose risk factor variations2 are represented by a vector of the portfolio PV01 (present value of a basis point change) with respect to each interest rate of the zero-coupon yield curve. Since zero-coupon rates are rarely directly observable, we must estimate them from market data. In this paper we implemented a widely-used parametric term structure estimation method called Nelson and Siegel. For Argentina we generated two yield curves, i.e., sets of fixed maturity interest rates determined by Badlar and CER.
    Keywords: Contingent Claim Analysis (CCA), Debt Sustainability Analysis (DSA),MertonModel, Sovereign Risk, Distance to Default, Risk Neutral Spread.
    Date: 2018–07

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