nep-rmg New Economics Papers
on Risk Management
Issue of 2018‒12‒24
nineteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Risk sensitivity and risk shifting in banking regulation By Hinterschweiger, Marc; Neumann, Tobias; Saporta, Victoria
  2. Securitization and crash risk : Evidence from large European banks By Battaglia, Francesca; Buchanan, Bonnie G.; Fiordelisi, Franco; Ricci, Ornella
  3. Re-use of collateral: leverage, volatility, and welfare By Brumm, Johannes; Grill, Michael; Kubler, Felix; Schmedders, Karl
  4. The economics of sharing macro-longevity risk By Dirk Broeders; Roel Mehlkopf; Annick van Ool
  5. Infinitesimal perturbation analysis for risk measures based on the Smith max-stable random field By Erwan Koch; Christian Y. Robert
  6. Putting the pension back in 401(k) retirement plans: Optimal versus default longevity income annuities By Horneff, Vanya; Maurer, Raimond; Mitchell, Olivia S.
  7. What are the consequences of global banking for the international transmission of shocks?: a quantitative analysis By Fillat, Jose; Garetto, Stefania; Smith, Arthur V.
  8. Low Inflation: High Default Risk AND High Equity Valuations By Harjoat S. Bhamra; Christian Dorion; Alexandre Jeanneret; Michael Weber
  9. Volatility Risk Pass-Through By Colacito, Riccardo; Croce, Mariano Massimiliano; Liu, Yang; Shaliastovich, Ivan
  10. Estimating Value-at-Risk for the g-and-h distribution: an indirect inference approach. By Marco Bee; Julien Hambuckers; Luca Trapin
  11. Some Principles for Regulating Cyber Risk By Kashyap, Anil K; Wetherilt, Anne
  12. Measuring and mitigating cyclical systemic risk in Ireland: The application of the countercyclical capital buffer By O'Brien, Eoin; O'Brien, Martin; Velasco, Sofia
  13. The Benchmark Inclusion Subsidy By Kashyap, Anil K; Kovrijnykh, Natalia; Li, Jian; Pavlova, Anna
  14. The Factors Influence Credit Risk in Japan Banking Sector Specific for Kyoto Bank By Mohammad Azmi, Nur Syafikah Atirah
  15. Special Repo Rates and the Cross-Section of Bond Prices: the Role of the Special Collateral Risk Premium By D'Amico, Stefania; Pancost, N. Aaron
  16. The Alpha-Heston Stochastic Volatility Model By Ying Jiao; Chunhua Ma; Simone Scotti; Chao Zhou
  17. Selection of a dynamic supply portfolio under delay and disruption risks By Tadeusz Sawik
  18. The Empirical Merit of Structural Explanations of Commodity Price Volatility: Review and Perspectives By Nicolas Legrand
  19. Real Time Monitoring of Asset Markets: Bubbles and Crises By Peter C.B. Phillips; Shuping Shi

  1. By: Hinterschweiger, Marc (Bank of England); Neumann, Tobias (Bank of England); Saporta, Victoria (Bank of England)
    Abstract: The financial crisis exposed enormous failures of risk management by financial institutions and of the authorities’ regulation and supervision of these institutions. Reforms introduced as part of Basel III have tackled some of the most important fault‐lines. As the focus now shifts toward the implementation and evaluation of these reforms, it will be essential to assess where the balance has been struck between the robustness and the risk sensitivity of the capital framework. This paper contributes to this assessment by stepping back from the details of the recent reforms and instead taking a bird’s eye view on the fundamental tradeoffs that may exist between robustness, complexity, and risk sensitivity. We review the history of risk sensitivity in capital standards and assess whether a higher degree of risk sensitivity necessarily leads to a better measurement of risk. We also provide evidence that the more risk‐sensitive Basel II framework may have reduced banks’ incentives to engage in higher‐risk mortgage lending in the UK. Our analysis suggests the need for a robust regulatory framework with several complementary standards interacting and reinforcing each other, even if, prima facie, subjecting banks to a number of regulatory constraints adds to complexity.
    Keywords: Basel 2; capital regulation; risk sensitivity; risk shifting
    JEL: G01 G18 G21 G28
    Date: 2018–07–04
  2. By: Battaglia, Francesca; Buchanan, Bonnie G.; Fiordelisi, Franco; Ricci, Ornella
    Abstract: The 2008 global financial crisis highlights the importance of securitization and crash risk. Yet there is a dearth of papers exploring the link between securitization and crash risk. We analyze 7,096 securitization deals made by large European listed banks between 2000 and 2017. Our paper provides evidence that bank risk declines in the year of the securitization and increases in the following year. We also show that this effect is driven by low-risk securitization deals. We use a dynamic panel data approach to establish a causal relationship and control the robustness of our results by using different tail risk measures (such as crash risk, value at risk, and expected shortfall). We also show that the risk reduction effect is weaker in crisis periods relative to normal times. Our findings have policy implications as regulators attempt to revive European securitization markets.
    JEL: F30 G01 G14 G21 G32
    Date: 2018–12–11
  3. By: Brumm, Johannes; Grill, Michael; Kubler, Felix; Schmedders, Karl
    Abstract: We assess the quantitative implications of collateral re-use on leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to reuse frees up collateral that can be used to back more transactions. Re-use thus contributes to the buildup of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing re-use beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets. JEL Classification: D53, G01, G12, G18
    Keywords: heterogeneous agents, leverage, re-use of collateral, volatility, welfare
    Date: 2018–12
  4. By: Dirk Broeders; Roel Mehlkopf; Annick van Ool
    Abstract: Pension funds face macro-longevity risk or uncertainty about future mortality rates. We analyze macro-longevity risk sharing between cohorts in a pension fund as a risk management tool. We show that both the optimal risk-sharing rule and the welfare gains from risk sharing depend on the retirement age policy. Welfare gains from sharing macro-longevity risk measured on a 10-year horizon in case of a fixed retirement age are between 0.2 and 0.3 percent of certainty equivalent consumption after retirement. Cohorts experience a similar impact of macro-longevity risk on post retirement consumption and it is not optimal for young cohorts to absorb risk of older cohorts. However, in case the retirement age is fully linked to changes in life expectancy, the welfare gains are substantially higher. The risk bearing capacity of workers is larger when they use their labor supply as a hedge against macro-longevity risk. As a result, workers absorb risk from retirees in the optimal risk-sharing rule, thereby increasing the welfare gain up to 2.7 percent.
    Keywords: Macro-longevity risk; risk sharing; welfare analysis; retirement age
    JEL: D61 G22 J26 J32
    Date: 2018–12
  5. By: Erwan Koch; Christian Y. Robert
    Abstract: When using risk or dependence measures based on a given underlying model, it is essential to be able to quantify the sensitivity or robustness of these measures with respect to the model parameters. In this paper, we consider an underlying model which is very popular in spatial extremes, the Smith max-stable random field. We study the sensitivity properties of risk or dependence measures based on the values of this field at a finite number of locations. Max-stable fields play a key role, e.g., in the modelling of natural disasters. As their multivariate density is generally not available for more than three locations, the Likelihood Ratio Method cannot be used to estimate the derivatives of the risk measures with respect to the model parameters. Thus, we focus on a pathwise method, the Infinitesimal Perturbation Analysis (IPA). We provide a convenient and tractable sufficient condition for performing IPA, which is intricate to obtain because of the very structure of max-stable fields involving pointwise maxima over an infinite number of random functions. IPA enables the consistent estimation of the considered measures' derivatives with respect to the parameters characterizing the spatial dependence. We carry out a simulation study which shows that the approach performs well in various configurations.
    Date: 2018–12
  6. By: Horneff, Vanya; Maurer, Raimond; Mitchell, Olivia S.
    Abstract: A recent US Treasury regulation allowed deferred longevity income annuities to be included in pension plan menus as a default payout solution, yet little research has investigated whether more people should convert some of the $15 trillion they hold in employer-based defined contribution plans into lifelong income streams. We investigate this innovation using a calibrated lifecycle consumption and portfolio choice model embodying realistic institutional considerations. Our welfare analysis shows that defaulting a small portion of retirees' 401(k) assets (over a threshold) is an attractive way to enhance retirement security, enhancing welfare by up to 20% of retiree plan accruals.
    Keywords: life cycle saving,household finance,annuity,longevity risk,401(k) plan,retirement
    JEL: G11 G22 D14 D91
    Date: 2018
  7. By: Fillat, Jose (Federal Reserve Bank of Boston); Garetto, Stefania (Boston University); Smith, Arthur V. (Boston University)
    Abstract: The global financial crisis of 2008 was followed by a wave of regulatory reforms that affected large banks, especially those with a global presence. These reforms were reactive to the crisis. In this paper we propose a structural model of global banking that can be used proactively to perform counterfactual analysis on the effects of alternative regulatory policies. The structure of the model mimics the US regulatory framework and highlights the organizational choices that banks face when entering a foreign market: branching versus subsidiarization. When calibrated to match moments from a sample of European banks, the model is able to replicate the response of the US banking sector to the European sovereign debt crisis. Our counterfactual analysis suggests that pervasive subsidiarization, higher capital requirements, or ad hoc policy interventions would have mitigated the effects of the crisis on US lending.
    Keywords: global banks; banking regulation; shock transmission
    JEL: F12 F23 F36 G21
    Date: 2018–10–01
  8. By: Harjoat S. Bhamra; Christian Dorion; Alexandre Jeanneret; Michael Weber
    Abstract: We develop an asset-pricing model with endogenous corporate policies that explains how inflation jointly impacts real asset prices and corporate default risk. Our model includes two empirically grounded nominal frictions: fixed nominal coupons and sticky profitability. Taken together, these two frictions result in higher real equity prices and credit spreads when inflation falls. An increase in inflation has opposite effects, but with smaller magnitudes. In the cross section, the model predicts the negative impact of inflation on real equity values is stronger for low leverage firms. We find empirical support for the model predictions.
    JEL: E44 G12 G32 G33
    Date: 2018–11
  9. By: Colacito, Riccardo; Croce, Mariano Massimiliano; Liu, Yang; Shaliastovich, Ivan
    Abstract: We develop a novel measure of volatility pass-through to assess international propagation of output volatility shocks to macroeconomic aggregates, equity prices, and currencies. An increase in country's output volatility is associated with a decrease in its output, consumption, and net exports. The average consumption pass-through is 50% (a 1% increase in output volatility increases consumption volatility by 0.5%) and it increases to 70% for shocks originating in smaller countries. The equity volatility pass-through is 90%, whereas the link between volatility of currency and fundamentals is weak. A novel channel of risk sharing of volatility risks can explain our empirical findings.
    Keywords: foreign exchange disconnect; Risk Sharing; Volatility pass-through
    JEL: C62 F31 G12
    Date: 2018–11
  10. By: Marco Bee; Julien Hambuckers; Luca Trapin
    Abstract: TThe g-and-h distribution is a flexible model with desirable theoretical properties. Especially, it is able to handle well the complex behavior of loss data and it is suitable for VaR estimation when large skewness and kurtosis are at stake. However, parameter estimation is di cult, because the density cannot be written in closed form. In this paper we develop an indirect inference method using the skewed- t distribution as instrumental model. We show that the skewed-t is a well suited auxiliary model and study the numerical issues related to its implementation. A Monte Carlo analysis and an application to operational losses suggest that the indirect inference estimators of the parameters and of the VaR outperform the quantile-based estimators.
    Keywords: Value-at-Risk; g-and-h distribution; loss model; indirect infer- ence; simulation; intractable likelihood
    JEL: C15 C46 C51 G22
    Date: 2018
  11. By: Kashyap, Anil K; Wetherilt, Anne
    Abstract: We explain why cyber risk differs from other operational risks in the financial sector. The form of cyber shocks differs because of their intent, probability of success, possibility of a hidden phase and evolving form of the risks. The impact differs because problems can spread quickly and because uncertainty over the possibility of a hidden phase can impact responses. We explain why private incentives to attend to these risks may differ from societies' preferences and develop six (micro- and macroprudential) regulatory principles to deal with cyber risk.
    Keywords: cyber risk; macroprudential regulation; stress test
    JEL: G18 G28 L51 O33
    Date: 2018–11
  12. By: O'Brien, Eoin (Central Bank of Ireland); O'Brien, Martin (Central Bank of Ireland); Velasco, Sofia (Central Bank of Ireland)
    Abstract: Following a number of years where the activation of the countercyclical capital buffer was limited, it is now becoming an increasingly relevant and actively used macroprudential policy tool across Europe. Against this background, this Note describes the high-level approach taken by the Central Bank of Ireland in setting the countercyclical capital buffer rate applicable to Irish exposures. In addition, the Note discusses issues around the identification of cyclical systemic risk in Ireland, and in particular the role of the credit-to-GDP gap as an appropriate reference indicator for countercyclical capital buffer rate decisions. The Note introduces work within the Central Bank of Ireland to develop a potential alternative reference indicator for informing countercyclical capital buffer decisions. In particular, an alternative measure of the national credit gap which looks to account for structural shifts in the economy and informs the estimation of the cycle through additional variables. This semi-structural measure of cyclical systemic risk addresses some of the main drawbacks of purely statistical methods such as excessively persistent trends, a feature that is particularly desirable in post-crisis circumstances.
    Date: 2018–07
  13. By: Kashyap, Anil K; Kovrijnykh, Natalia; Li, Jian; Pavlova, Anna
    Abstract: We study the impact of evaluating the performance of asset managers relative to a benchmark portfolio on firms' investment, merger and IPO decisions. We introduce asset managers into an otherwise standard asset pricing model and show that firms that are part of the benchmark are effectively subsidized by the asset managers. This "benchmark inclusion subsidy" arises because asset managers have incentives to hold some of the equity of firms in the benchmark regardless of the risk characteristics of these firms. Contrary to what is usually taught in corporate finance, we show that the value of an investment project is not governed solely by its own cash-flow risk. Instead, because of the benchmark inclusion subsidy, a firm inside the benchmark would accept some projects that an identical one outside the benchmark would decline. The two types of firms' incentives to undertake mergers or spinoffs also differ and the presence of the subsidy can alter a decision to take a firm public. We show that the higher the cash-flow risk of an investment, the larger the benchmark inclusion subsidy; the subsidy is zero for safe projects. Benchmarking also leads fundamental firm-level cash-flow correlations to rise. We review a host of empirical evidence that is consistent with the implications of the model.
    Keywords: asset management; Benchmark; Index; investment; mergers; Project Valuation
    JEL: G11 G12 G23 G32 G34
    Date: 2018–12
  14. By: Mohammad Azmi, Nur Syafikah Atirah
    Abstract: This research paper is to the performance of credit risk in japan bank specific for Bank of Kyoto. The measurement is based on bank specific factor and macroeconomics factor. However, the finding result would determine whether both factors is correlated significant or uninfluenced.
    Keywords: bank specific factor, macroeconomic factor, credit risk
    JEL: G1 G2
    Date: 2018–12–16
  15. By: D'Amico, Stefania (Federal Reserve Bank of Chicago); Pancost, N. Aaron (University of Texas at Austin)
    Abstract: We estimate the joint term-structure of U.S. Treasury cash and repo rates using daily prices of all outstanding Treasury securities and corresponding special collateral (SC) repo rates. This allows us to derive a risk premium associated to the SC value of Treasuries and quantitatively link this premium to various price anomalies, such as the on-the-run premium. We show that a time-varying SC risk premium can explain between 74%–90% of the on-the-run premium, and is highly correlated with a number of other Treasury market anomalies. This suggests a commonality across these price anomalies, explicitly linked to the SC value of the highest-quality securities—recently-issued U.S. nominal Treasuries.
    Keywords: Bond prices; collateral; interest rates; risk premia
    JEL: E42 G12 G14 G32
    Date: 2018–12–03
  16. By: Ying Jiao; Chunhua Ma; Simone Scotti; Chao Zhou
    Abstract: We introduce an affine extension of the Heston model where the instantaneous variance process contains a jump part driven by $\alpha$-stable processes with $\alpha\in(1,2]$. In this framework, we examine the implied volatility and its asymptotic behaviors for both asset and variance options. Furthermore, we examine the jump clustering phenomenon observed on the variance market and provide a jump cluster decomposition which allows to analyse the cluster processes.
    Date: 2018–12
  17. By: Tadeusz Sawik
    Abstract: The problem of a multi-period supplier selection and order quantity allocation in the presence of supply chain disruption and delay risks is considered. Given a set of customer orders for finished products, the decision-maker needs to decide from which supplier and when to deliver product-specific parts required for each customer order to meet customer requested due date at a low cost or a high service level and to mitigate the impact of supply chain risks. For the selection of risk-neutral or risk-averse dynamic supply portfolio, a scenario-based stochastic mixed integer programming approach is developed. In the scenario analysis, the low probability and high impact supply disruptions are combined with the high probability and low impact supply delays. The risk-neutral portfolio is optimised by minimising expected cost or maximising expected service level. The risk-averse portfolio is optimised by calculating cost- or service-at-risk and minimising conditional cost-at risk or maximising conditional service at risk. The proposed dynamic portfolio approach leads to a time-indexed stochastic MIP formulation with a strong LP relaxation, which has proven to be computationally very efficient. The findings indicate that neglecting potential delay risks in supplier selection may lead to greater supply fluctuations and manufacturing delays.
    JEL: C6 M3 O2
    Date: 2018–12–14
  18. By: Nicolas Legrand (SMART - Structures et Marché Agricoles, Ressources et Territoires - INRA - Institut National de la Recherche Agronomique - AGROCAMPUS OUEST)
    Abstract: This paper presents both the history of and state‐of‐the‐art in empirical modeling approaches to the world commodity price volatility. The analysis builds on the storage model and key milestones in its development. Specifically, it is intended to offer a reader unfamiliar with the relevant literature an insight into the modeling issues at stake from both a historical and speculative viewpoint. The review considers primarily the empirical techniques designed to assess the merits of the storage theory; it does not address purely statistical approaches that do not rely on storage theory and that have been studied in depth in other streams of the commodity price literature. The paper concludes with some suggestions for future research to try to resolve some of the existing empirical flaws, and hopefully to increase the explanatory power of the storage model.
    Keywords: empirical validation,storage model,structural econometrics,commodity price dynamics
    Date: 2018
  19. By: Peter C.B. Phillips (Cowles Foundation, Yale University); Shuping Shi (Macquarie University)
    Abstract: While each financial crisis has its own characteristics, there is now widespread recognition that crises arising from sources such as financial speculation and excessive credit creation do inflict harm on the real economy. Detecting speculative market conditions and ballooning credit risk in real time is therefore of prime importance in the complex exercises of market surveillance, risk management, and policy action. This chapter provides an R implementation of the popular real-time monitoring strategy proposed by Phillips, Shi and Yu in the International Economic Review (2015), along with a new bootstrap procedure designed to mitigate the potential impact of heteroskedasticity and to effect family-wise size control in recursive testing algorithms. This methodology has been shown effective for bubble and crisis detection and is now widely used by academic researchers, central bank economists, and fiscal regulators. We illustrate the effectiveness of this procedure with applications to the S&P financial market and the European sovereign debt sector using the psymonitor R package developed in conjunction with this chapter.
    Keywords: Bubbles, Crises, Real-time detection, Recursive evolving test
    JEL: C12 C14
    Date: 2018–11

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