nep-rmg New Economics Papers
on Risk Management
Issue of 2018‒11‒19
fourteen papers chosen by

  1. Diversifying portfolios of U.S. stocks with crude oil and natural gas: A regime-dependent optimization with several risk measures By Hayette Gatfaoui
  2. Value-at-Risk prediction using option-implied risk measures By Kai Schindelhauer; Chen Zhou
  3. Forecasting Financial Stress Indices in Korea: A Factor Model Approach By Kim, Hyeongwoo; Shi, Wen; Kim, Hyun Hak
  4. Forecasting Financial Vulnerability in the US: A Factor Model Approach By Kim, Hyeongwoo; Shi, Wen
  5. Long Run Returns Predictability and Volatility with Moving Averages By Chang, C-L.; Ilomäki, J.; Laurila, H.; McAleer, M.J.
  6. Financial Credit Risk Evaluation Based on Core Enterprise Supply Chains By Mou, W.M.; Wong, W.-K.; McAleer, M.J.
  7. Volatility Spillovers and Systemic Risk Across Economies: Evidence from a Global Semi-Structural Model By Javier G. Gómez-Pineda
  8. The Value Premium During Flights By Galvani, Valentina
  9. Calibrating the Magnitude of the Countercyclical Capital Buffer Using Market-Based Stress Tests By Maarten van Oordt
  10. An agent based early warning indicator for financial market instability By Vidal-Tomás, David; Alfarano, Simone
  11. Decision Under Normative uncertainty By Franz Dietrich; Brian Jabarian
  12. To Ask or Not To Ask? Collateral versus Screening in Lending Relationships By Artashes Karapetyan; Hans Degryse; Sudipto Karmakar
  13. The Mitigation of Risk in Resilient Supply Chains By Martin Christopher
  14. Supervisory implications of rising similarity in banking: remarks at the Financial Times U.S. Banking Forum: Charting a Course for Stability and Success, New York City By Stiroh, Kevin J.

  1. By: Hayette Gatfaoui
    Abstract: Energy markets are strategic to governments and economic development. Several commodities compete as substitutable energy sources and energy diversifiers. Such competition reduces the energy vulnerability of countries as well as portfolios' risk exposure. Vulnerability results mainly from price trends and fluctuations, following supply and demand shocks. Such energy price uncertainty attracts many market participants in the energy commodity markets. First, energy producers and consumers hedge adverse price changes with energy derivatives. Second, financial market participants use commodities and commodity derivatives to diversify their conventional portfolios. For that reason, we consider the joint dependence between the United States (U.S.) natural gas, crude oil and stock markets. We use Gatfaoui's (2015) time varying multivariate copula analysis and related variance regimes. Such approach handles structural changes in asset prices. In this light, we draw implications for portfolio optimization, when investors diversify their stock portfolios with natural gas and crude oil assets. We minimize the portfolio's variance, semi-variance and tail risk, in the presence and the absence of constraints on the portfolio's expected return and/or U.S. stock investment. The return constraint reduces the performance of the optimal portfolio. Moreover, the regime-specific portfolio optimization helps implement an enhanced active management strategy over the whole sample period. Under a return constraint, the semi-variance optimal portfolio offers the best risk-return tradeoff, whereas the tail-risk optimal portfolio offers the best tradeoff in the absence of a return constraint.
    Date: 2018–11
  2. By: Kai Schindelhauer; Chen Zhou
    Abstract: This paper investigates the prediction of Value-at-Risk (VaR) using option-implied information obtained by the maximum entropy method. The maximum entropy method provides an estimate of the risk-neutral distribution based on option prices. Besides commonly used implied volatility, we obtain implied skewness, kurtosis and quantile from the estimated risk-neutral distribution. We find that using the implied volatility and implied quantile as explanatory variables significantly outperforms considered benchmarks in predicting the VaR, including the commonly used GARCH(1,1)-model. This holds for all considered VaR prediction models and VaR probability levels. Overall, a simple quantile regression model performs best for all considered VaR probability levels and forecast horizons.
    Keywords: Implied Quantile; GARCH; Quantile Regression; Comparative Backtest
    JEL: C14 G17
    Date: 2018–10
  3. By: Kim, Hyeongwoo; Shi, Wen; Kim, Hyun Hak
    Abstract: We propose factor-based out-of-sample forecast models for Korea's financial stress index and its 4 sub-indices that are developed by the Bank of Korea. We extract latent common factors by employing the method of the principal components for a panel of 198 monthly frequency macroeconomic data after differencing them. We augment an autoregressive-type model of the financial stress index with estimated common factors to formulate out-of-sample forecasts of the index. Our models overall outperform both the stationary and the nonstationary benchmark models in forecasting the financial stress indices for up to 12-month forecast horizons. The first common factor that represents not only financial market but also real activity variables seems to play a dominantly important role in predicting the vulnerability in the financial markets in Korea.
    Keywords: Financial Stress Index; Principal Component Analysis; PANIC; In-Sample Fit; Out-of-Sample Forecast; Diebold-Mariano-West Statistic
    JEL: E44 E47 G01 G17
    Date: 2018–10
  4. By: Kim, Hyeongwoo; Shi, Wen
    Abstract: This paper presents a factor-based forecasting model for the financial market vulnerability, measured by changes in the Cleveland Financial Stress Index (CFSI). We estimate latent common factors via the method of the principal components from 170 monthly frequency macroeconomic data in order to out-of-sample forecast the CFSI. Our factor models outperform both the random walk and the autoregressive benchmark models in out-of-sample predictability at least for the short-term forecast horizons, which is a desirable feature since financial crises often come to a surprise realization. Interestingly, the first common factor, which plays a key role in predicting the financial vulnerability index, seems to be more closely related with real activity variables rather than nominal variables. We also present a binary choice version factor model that estimates the probability of the high stress regime successfully.
    Keywords: Financial Stress Index; Method of the Principal Component; Out-of-Sample Forecast; Ratio of Root Mean Square Prediction Error; Diebold-Mariano-West Statistic; Ordered Probit Model
    JEL: E44 E47 G01 G17
    Date: 2018–10
  5. By: Chang, C-L.; Ilomäki, J.; Laurila, H.; McAleer, M.J.
    Abstract: The paper examines how the size of the rolling window, and the frequency used in moving average (MA) trading strategies, affect financial performance when risk is measured. We use the MA rule for market timing, that is, for when to buy stocks and when to shift to the risk-free rate. The important issue regarding the predictability of returns is assessed. It is found that performance improves, on average, when the rolling window is expanded and the data frequency is low. However, when the size of the rolling window reaches three years, the frequency loses its significance and all frequencies considered produce similar financial performance. Therefore, the results support stock returns predictability in the long run. The procedure takes account of the issues of variable persistence as we use only returns in the analysis. Therefore, we use the performance of MA rules as an instrument for testing returns predictability in financial stock markets.
    Keywords: Trading strategies, Risk, Moving average, Market timing, Returns predictability, Volatility, Rolling window, Data frequency
    JEL: C22 C32 C58 G32
    Date: 2018–09–01
  6. By: Mou, W.M.; Wong, W.-K.; McAleer, M.J.
    Abstract: Supply chain finance has broken through traditional credit modes and advanced rapidly as a creative financial business discipline. Core enterprises have played a critical role in the credit enhancement of supply chain finance. Through the analysis of core enterprise credit risks in supply chain finance, by means of a “fuzzy analytical hierarchy process” (FAHP), the paper constructs a supply chain financial credit risk evaluation system, making quantitative measurements and evaluation of core enterprise credit risk. This enables enterprises to take measures to control credit risk, thereby promoting the healthy development of supply chain finance.
    Keywords: Supply chain finance, core enterprises, financial credit risk evaluation, Fuzzy Analytical Hierarchy Process (FAHP)
    JEL: D81 G32 P42
    Date: 2018–09–01
  7. By: Javier G. Gómez-Pineda (Banco de la República (the central bank of Colombia))
    Abstract: The paper presents some evidence on the overwhelming relevance of systemic risk and the lesser importance of US interest rates in the global transmission of shocks. This evidence suggests that the literature could benefit from incorporating global confidence variables into global frameworks in the study of the global transmission of shocks. As framework, we used a global semi-structural model (GSSM) augmented with common factors for country risk and country credit. We approximated country risk with historical stock volatility, a measure that is uniform and available across countries; in addition, we measured spillovers as the share of forecast error variance explained by different volatility factors. We found that systemic risk is the main volatility factor in all systemic economies, and also accounts for the bulk of spillovers into non systemic economies. Other volatility factors such as global credit, foreign interest rates and trade-related factors rarely accounted for shares of forecast error variance above one percent.
    Keywords: Spillovers, Systemic risk, Systemic Economies, Global semi structural model
    JEL: E58 E37 E43 Q43
    Date: 2018–11–01
  8. By: Galvani, Valentina (University of Alberta, Department of Economics)
    Abstract: This study examines the profitability on the value-minus-growth strategy in the U.S. stock market, during episodes of market instability. The value premium is very large for small and medium-sized equities during flight-to-safety episodes. There is evidence also of a remarkable value premium for large caps, during flight-from-safety events, where these scenarios are marked by declines in systematic risk and increasing yields. The empirical findings are consistent with a size-dependent explanation of the premium involving both leverage and the value of the growth option.
    Keywords: Value Premium; Flight-to-Safety; Flight-from-Safety; Book-to-market
    JEL: G01 G12
    Date: 2018–11–01
  9. By: Maarten van Oordt
    Abstract: This paper proposes a novel methodology to calibrate the magnitude of the cap on the countercyclical capital buffer (CCyB) using market-based stress tests. The macroprudential authority in our paper aims to contain the possibility of a breach of a minimum capital ratio in the event of a severe system-wide shock within a certain permissible failure probability. To meet its objective during periods of challenging macro-financial conditions, the macroprudential authority requires banks to build up the CCyB during credit booms. We show how market-based stress tests can be used to estimate the necessary magnitude of the CCyB. We apply the methodology to major banks in six advanced economies. Our estimates suggest a magnitude of the cap on the CCyB in a range from 1.4 to 1.7 per cent of total assets, depending on the ability of the macro-prudential authority to forecast macrofinancial conditions.
    Keywords: Financial Institutions, Financial stability, Financial system regulation and policies
    JEL: G10 G21 G28
    Date: 2018
  10. By: Vidal-Tomás, David; Alfarano, Simone
    Abstract: Inspired by the Bank of America Merrill Lynch Global Breath Rule, we propose an investor sentiment index based on the collective movement of stock prices in a given market. We show that the time evolution of the sentiment index can be reasonably described by the herding model proposed by Kirman on his seminal paper "Ants, rationality and recruitment" (Kirman, 1993). The correspondence between the index and the model allows us to easily estimate its parameters. Based on the model and the empirical evolution of the sentiment index, we propose an early warning indicator able to identify optimistic and pessimistic phases of the market. As a result, investors and policymakers can set different strategies anticipating financial market instability. The former, reducing the risk of their portfolio, and the latter, setting more efficient policies to avoid the effect of financial crashes on the real economy. The validity of our results is supported by means of a robustness analysis showing the application of the early warning indicator in eight different stock markets.
    Keywords: Herding behaviour, Kirman model, Financial market
    JEL: C61 D84 G10
    Date: 2018–10–24
  11. By: Franz Dietrich (Centre d'Economie de la Sorbonne Author-Workplace-Homepage:; Brian Jabarian (Centre d'Economie de la Sorbonne)
    Abstract: How should we evaluate options when we are uncertain about the correct standard of evaluation, for instance due to conflicting normative intuitions? Such 'normative' uncertainty differs from ordinary 'empirical' uncertainty about an unknown state, and raises new challenges for decision theory and ethics. The most widely discussed proposal is to form the expected value of options, relative to correctness probabilities of competing valuations. We show that the expected-value theory is just one of four natural expectation-based theories. These theories differ in the attitudes to normative risk and to empirical risk. The ordinary expected-value theory imposes neutrality to normative risk, whereas its attitude to empirical risk is impartial, i.e., determined by the risk attitudes of the competing valuations deemed possible. The three other theories are, respectively, neutral to both types of risk; impartial to both types of risk; or neutral to empirical but impartial to normative risk. We conditionally defend the theory which is impartial to all risk - the impartial value theory - on the grounds that it respects risk-attitudinal beliefs rather than imposing an ad-hoc risk attitude. Mean-while, our analysis shows how one can address empirical and normative uncertainty within a unified formal framework, and rigorously define risk attitudes of theories
    Keywords: empirical uncertainty; normative uncertainty; risk attitude; expected value; impartial value
    JEL: D81
    Date: 2018–09
  12. By: Artashes Karapetyan; Hans Degryse; Sudipto Karmakar
    Abstract: We study the impact of higher capital requirements on banks' decisions to grant collateralized rather than uncollateralized loans. We exploit the 2011 EBA capital exercise, a quasi-natural experiment that required a number of banks to increase their regulatory capital but not others. This experiment makes secured lending more attractive vis-à-vis unsecured lending for the affected banks as secured loans require less regulatory capital. Using a loan-level dataset covering all corporate loans in Portugal, we identify a novel channel of tighter capital requirements: relative to the control group and after the shock, treated banks require loans more often to be collateralized but less so for relationship borrowers. We further nd this impact is stronger for collateral that saves more on regulatory capital.
    JEL: G21 G28 G32
    Date: 2018
  13. By: Martin Christopher
    Abstract: This paper examines the sources of supply chain risk and suggests ways in which higher levels of resilience can be achieved. Recent years have seen a significant increase in the risk of supply chain disruption and the need for resilience across the supply/demand network has become imperative. The paper discusses the focus on agility and flexibility required to achieve higher resilience, which in turn will require new ways of working across organisational boundaries.
    Date: 2018–10–19
  14. By: Stiroh, Kevin J. (Federal Reserve Bank of New York)
    Abstract: Remarks at the Financial Times U.S. Banking Forum: Charting a Course for Stability and Success, New York City.
    Keywords: large banks; bank similarity; risk management framework; systemic as a herd; Comprehensive Capital Analysis and Review (CCAR); bank homogeneity
    Date: 2018–11–01

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