nep-rmg New Economics Papers
on Risk Management
Issue of 2019‒04‒22
twenty-one papers chosen by
Stan Miles
Thompson Rivers University

  1. The rise of shadow banking: evidence from capital regulation By Rustom M. Irani; Rajkamal Iyer; Ralf R. Meisenzahl; José-Luis Peydró
  2. Bayesian Risk Forecasting for Long Horizons By Agnieszka Borowska; Lennart Hoogerheide; Siem Jan Koopman
  3. Risk measures with markets volatility By Fei Sun; Yijun Hu
  4. Quasiconvex risk measures with markets volatility By Fei Sun; Yijun Hu
  5. Capital Regulation, Efficiency, and Risk Taking: A Spatial Panel Analysis of U.S. Banks By Ding, Dong; Sickles, Robin C.
  6. Improving Forecast Accuracy of Financial Vulnerability: PLS Factor Model Approach By Hyeongwoo Kim; Kyunghwan Ko
  7. Loss-based risk statistics with set-valued analysis By Fei Sun
  8. Complex Network Construction of Internet Financial risk By Runjie Xu; Chuanmin Mi; Camelia Delcea
  9. Frontier Efficiency, Capital Structure, and Portfolio Risk: An Empirical Analysis of U.S. Banks By Ding, Dong; Sickles, Robin C.
  10. Till death (or divorce) do us part: Early-life family disruption and fund manager behavior By Betzer, André; Limbach, Peter; Rau, P. Raghavendra; Schürmann, Henrik
  11. How Financial Management Affects Institutional Investors’ Portfolio Choices: Evidence from Insurers By Ge, Shan; Weisbach, Michael S.
  12. Assessing Macroeconomic Tail Risk By Loria, Francesca; Matthes, Christian; Zhang, Donghai
  13. Persistent Government Debt and Risk Distribution By Croce, Mariano; Nguyen, Thien; Raymond, Steve
  14. Tail probabilities of random linear functions of regularly varying random vectors By Bikramjit Das; Vicky Fasen-Hartmann; Claudia Kl\"uppelberg
  15. A general theory of risk apportionment By Gollier, Christian
  16. New Results for Additive and Multiplicative Risk Apportionment By Henri Loubergé; Yannick Malevergne; Béatrice Rey
  17. Risky assets in Europe and the US: risk vulnerability, risk aversion and economic environment By Bekhtiar, Karim; Fessler, Pirmin; Lindner, Peter
  18. Optimal loss-carry-forward taxation for L\'{e}vy risk processes stopped at general draw-down time By Wenyuan Wang; Zhimin Zhang
  19. Choosing between Hail Insurance and Anti-Hail Nets: A Simple Model and a Simulation among Apples Producers in South Tyrol By Marco Rogna; Günter Schamel; Alex Weissensteiner
  20. Asset Integration, Risk Taking and Loss Aversion in the Laboratory By Morrison, William G.; Oxoby, Robert J.
  21. From (Martingale) Schrodinger bridges to a new class of Stochastic Volatility Models By Pierre Henry-Labordere

  1. By: Rustom M. Irani; Rajkamal Iyer; Ralf R. Meisenzahl; José-Luis Peydró
    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, loan-time fixed-effects, and shocks to capital requirements arising from surprise features of the U.S. implementation of Basel III. We find that less-capitalized 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; risk-based capital regulation; Basel III; interactions between banks and nonbanks; trading by banks; distressed debt
    JEL: G01 G21 G23 G28
    Date: 2018–04
  2. By: Agnieszka Borowska (VU Amsterdam); Lennart Hoogerheide (VU Amsterdam); Siem Jan Koopman (VU Amsterdam)
    Abstract: We present an accurate and efficient method for Bayesian forecasting of two financial risk measures, Value-at-Risk and Expected Shortfall, for a given volatility model. We obtain precise forecasts of the tail of the distribution of returns not only for the 10-days-ahead horizon required by the Basel Committee but even for long horizons, like one-month or one-year-ahead. The latter has recently attracted considerable attention due to the different properties of short term risk and long run risk. The key insight behind our importance sampling based approach is the sequential construction of marginal and conditional importance densities for consecutive periods. We report substantial accuracy gains for all the considered horizons in empirical studies on two datasets of daily financial returns, including a highly volatile period of the recent financial crisis. To illustrate the flexibility of the proposed construction method, we present how it can be adjusted to the frequentist case, for which we provide counterparts of both Bayesian applications.
    Keywords: Bayesian inference, forecasting, importance sampling, numerical accuracy, long run risk, Value-at-Risk, Expected Shortfall
    JEL: C32
    Date: 2019–02–22
  3. By: Fei Sun; Yijun Hu
    Abstract: Since the risk in financial markets has become much more uncertain and volatile than before, the usual risk measures may be limited when dealing with the risk management. In this paper, we will study several classes of risk measures on a special space $L^{p(\cdot)}$ where the variable exponent $p(\cdot)$ is no longer a given real number like the space $L^{p}$, but a random variable, which reflects the possible volatility of the financial markets. The dual representations for them are also provided.
    Date: 2018–06
  4. By: Fei Sun; Yijun Hu
    Abstract: Since the quasiconvex risk measures is a bigger class than the well known convex risk measures, the study of quasiconvex risk measures makes sense especially in the financial markets with volatility. In this paper, we will study the quasiconvex risk measures defined on a special space $L^{p(\cdot)}$ where the variable exponent $p(\cdot)$ is no longer a given real number like the space $L^{p}$, but a random variable, which reflects the possible volatility of the financial markets. The dual representation for this quasiconvex risk measures will also provided.
    Date: 2018–06
  5. By: Ding, Dong (Rice U); Sickles, Robin C. (Rice U)
    Abstract: In this study, we empirically assess the impact of capital regulations on capital adequacy ratios, portfolio risk levels and cost efficiency for U.S. banks. Using a large panel data of U.S. banks between 2001-2016, we first estimate the model using two-step generalized method of moments (GMM) estimators. After obtaining residuals from the regressions, we propose a method to construct the network based on clustering of these residuals. The residuals capture the unobserved heterogeneity that goes beyond systematic factors and banks' business decisions that impact its level of capital, risk and cost efficiency and thus represent unobserved network heterogeneity across banks. We then re-estimate the model in a spatial error framework. The comparisons of Fixed Effects, GMM Fixed Effect models with spatial fixed effects models provide clear evidence of the existence of unobserved spatial effects in the interbank network. We find a stricter capital requirement causes banks to reduce investments in risk-weighted assets, but at the same time, increase holdings of non-performing loans, suggesting the unintended effects of higher capital requirements on credit risks. We also find the amount of capital buffers has an important impact on banks' management practices even when regulatory capital requirements are not binding.
    Date: 2018–07
  6. By: Hyeongwoo Kim; Kyunghwan Ko
    Abstract: We present a factor augmented forecasting model for assessing the financial vulnerability in Korea. Dynamic factor models often extract latent common factors from a large panel of time series data via the method of the principal components (PC). Instead, we employ the partial least squares (PLS) method that estimates target specific common factors, utilizing covariances between predictors and the target variable. Applying PLS to 198 monthly frequency macroeconomic time series variables and the Bank of Korea's Financial Stress Index (KFSTI), our PLS factor augmented forecasting models consistently outperformed the random walk benchmark model in out-of-sample prediction exercises in all forecast horizons we considered. Our models also outperformed the autoregressive benchmark model in short-term forecast horizons. We expect our models would provide useful early warning signs of the emergence of systemic risks in Korea's financial markets.
    Keywords: Partial Least Squares; Principal Component Analysis; Financial Stress Index; Out-of-Sample Forecast; RRMSPE
    JEL: C38 C53 E44 E47 G01 G17
    Date: 2019–04
  7. By: Fei Sun
    Abstract: Since the portfolio has become a hot topic, we wii introduce a special risk statistics from the perspective of loss. This new risk statistic can be uesd for the quantification of portfolio risk. Representation results are provided. Finally, examples are also given to demonstrate the application prospect of this risk statistic.
    Date: 2019–04
  8. By: Runjie Xu; Chuanmin Mi; Camelia Delcea
    Abstract: Internet finance is a new financial model that applies Internet technology to payment, capital borrowing and lending and transaction processing. In order to study the internal risks, this paper uses the Internet financial risk elements as the network node to construct the complex network of Internet financial risk system. Different from the study of macroeconomic shocks and financial institution data, this paper mainly adopts the perspective of complex system to analyze the systematic risk of Internet finance. By dividing the entire financial system into Internet financial subnet, regulatory subnet and traditional financial subnet, the paper discusses the relationship between contagion and contagion among different risk factors, and concludes that risks are transmitted externally through the internal circulation of Internet finance, thus discovering potential hidden dangers of systemic risks. The results show that the nodes around the center of the whole system are the main objects of financial risk contagion in the Internet financial network. In addition, macro-prudential regulation plays a decisive role in the control of the Internet financial system, and points out the reasons why the current regulatory measures are still limited. This paper summarizes a research model which is still in its infancy, hoping to open up new prospects and directions for us to understand the cascading behaviors of Internet financial risks.
    Date: 2019–04
  9. By: Ding, Dong (Rice U); Sickles, Robin C. (Rice U)
    Abstract: The measurement of firm performance is central to management research. Firms' ability to effectively allocate capital and manage risks are the essence of their production and performance. This study investigated the relationship between capital structure, portfolio risk levels and firm performance using a large sample of U.S. banks from 2001-2016. Stochastic frontier analysis (SFA) was used to construct a frontier to measure firm's cost efficiency as a proxy for firm performance. We further look at their relationship by dividing the sample into different size and ownership classes, as well as the most and least efficient banks. The empirical evidence suggests that more efficient banks increase capital holdings and take on greater credit risk while reducing risk weighted assets. Moreover, it appears that increasing the capital buffer impacts risk-taking by banks depending on their level of cost efficiency, which is a placeholder for how productive their intermediation services are performed. More cost efficient banks that are well-capitalized tend to maintain relatively large capital buffers versus banks that are not. An additional finding, which is quite important, is that the direction of the relationship between risk-taking and capital buffers differs depending on what measure of risk is used.
    Date: 2018–06
  10. By: Betzer, André; Limbach, Peter; Rau, P. Raghavendra; Schürmann, Henrik
    Abstract: We show that early-life family disruption (death or divorce of a parent) causes fund managers to be more risk averse when they manage their own funds. Treated managers take lower systematic, idiosyncratic, and downside risk than non-treated managers. This effect is most pronounced for managers who experienced family disruption during their formative years or who had little social support. Treated managers invest less in lottery-like stocks, make smaller tracking errors, and bet less on factors during recessions, but do not perform worse than their untreated cohorts. Our evidence indicates that familial background affects economic decisions later in life even for finance professionals.
    Keywords: Family disruption,Formative experiences,Portfolio activities,Risk-taking
    JEL: G11 G23
    Date: 2019
  11. By: Ge, Shan (New York University, Stern School of Business); Weisbach, Michael S. (Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI))
    Abstract: Many institutional investors depend on the returns they generate to fund their operations and liabilities. How does these investors’ demand for capital affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather-related events. We find that insurers with more financial flexibility have larger portfolio weights on riskier and more illiquid assets, and have higher realized returns. Among corporate bonds, for which we can control for regulatory treatment, we find that more financially flexible insurers have larger portfolio weights on riskier and more illiquid corporate bonds. Following losses, P&C insurers decrease allocations to riskier corporate bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for P&C losses with weather shocks. The change in allocations following losses is larger for more financially constrained insurers and during the financial crisis, suggesting that the shift toward less risky securities is driven by concerns about financial flexibility. The results highlight the importance of financial flexibility to fund operations in institutional investors’ portfolio decisions.
    JEL: G11 G22 G23 G31 G32
    Date: 2019–03
  12. By: Loria, Francesca (Federal Reserve Board); Matthes, Christian (Federal Reserve Bank of Richmond); Zhang, Donghai (University of Bonn)
    Abstract: What drives macroeconomic tail risk? To answer this question, we borrow a definition of macroeconomic risk from Adrian et al. (2019) by studying (left-tail) percentiles of the forecast distribution of GDP growth. We use local projections (Jordà, 2005) to assess how this measure of risk moves in response to economic shocks to the level of technology, monetary policy, and financial conditions. Furthermore, by studying various percentiles jointly, we study how the overall economic outlook—as characterized by the entire forecast distribution of GDP growth—shifts in response to shocks. We find that contractionary shocks disproportionately increase downside risk, independently of what shock we look at.
    Keywords: macroeconomic risk; shocks; local projections
    JEL: C21 C53 E17 E37
    Date: 2019–04–19
  13. By: Croce, Mariano (Finance Department, Bocconi University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); University of North Carolina Kenan-Flagler Business School); Nguyen, Thien (Ohio State University (OSU) - Department of Finance); Raymond, Steve (University of North Carolina (UNC) at Chapel Hill - Department of Economics)
    Abstract: Does it matter whether a government is prompt or slow in consolidating outstanding debt? We address this question by studying the connection between the time variation of the persistence of government-debt-to-output ratio, macroeconomic activity, and asset prices. In the US, when government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which (i) fiscal policy is distortionary, (ii) the value of innovation depends on fiscal risk, and (iii) the representative agent is sensitive to the resulting distribution of consumption risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and hence welfare.
    JEL: E62 G1 H2 H3
    Date: 2018–11
  14. By: Bikramjit Das; Vicky Fasen-Hartmann; Claudia Kl\"uppelberg
    Abstract: We provide a new extension of Breiman's Theorem on computing tail probabilities of a product of random variables to a multivariate setting. In particular, we give a complete characterization of regular variation on cones in $[0,\infty)^d$ under random linear transformations. This allows us to compute probabilities of a variety of tail events, which classical multivariate regularly varying models would report to be asymptotically negligible. We illustrate our findings with applications to risk assessment in financial systems and reinsurance markets under a bipartite network structure.
    Date: 2019–04
  15. By: Gollier, Christian
    Abstract: Suppose that the conditional distributions of ˜x (resp. ˜y) can be ranked according to the m-th (resp. n-th) risk order. Increasing their statistical concordance increases the (m, n) degree riskiness of (˜x, ˜y), i.e., it reduces expected utility for all bivariate utility functions whose sign of the (m, n) cross-derivative is (−1)m+n+1. This means in particular that this increase in concordance of risks induces a m + n degree risk increase in ˜x + ˜y. On the basis of these general results, I provide different recursive methods to generate high degrees of univariate and bivariate risk increases. In the reverse-or-translate (resp.reverse-or-spread) univariate procedure, a m degree risk increase is either reversed or translated downward (resp. spread) with equal probabilities to generate a m + 1 (resp.m + 2) degree risk increase. These results are useful for example in asset pricing theory when the trend and the volatility of consumption growth are stochastic or statistically linked.
    Keywords: Stochastic dominance; risk orders; prudence; temperance; concordance.
    JEL: D81
    Date: 2019–04–08
  16. By: Henri Loubergé (Geneva School of Economics and Management, University of Geneva, Uni Mail, Pont d'Arve 40, 1211 Geneva 4); Yannick Malevergne (Université Paris 1 Panthéon Sorbonne, PRISM Sorbonne EA 4101 and LabEx ReFi, F-75005 Paris, France); Béatrice Rey (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France)
    Abstract: We start by pointing out a simple property of risk apportionment with additive risks in the general stochastic dominance context defined by Eeckhoudt et al. (2009b). Quite generally, an observed preference for risk apportionment with additive risks in a specific risk environment is preserved when the decision-maker is confronted to other risk situations, so long as the total order of stochastic dominance relationships among pairs of risks remains the same. Our objective is to check whether this simple property also holds for multiplicative risk environments. We show that this is not the case, in general, but that the property holds and more strongly for the case of CRRA utility functions. This is due to a particular feature of CRRA functions that we unveil.
    Keywords: Additive risks, Constant relative risk aversion, Multiplicative risks, Preserved preference ranking, Risk apportionment
    JEL: D81
    Date: 2019
  17. By: Bekhtiar, Karim; Fessler, Pirmin; Lindner, Peter
    Abstract: We use cross-country microdata to analyse the risk taking of households in Europe and the US. Concerning the extensive as well as the intensive margin of risky assets, European households differ substantially from US households; but also inside Europe we document substantial differences. Furthermore, average risk aversion is strongly correlated with the share of households holding risky assets across countries. We decompose the observed differences into two parts. A part explainable by household characteristics as well as differences in risk aversion and a remainder. We employ the unexplained part resulting from our microeconometric decomposition analysis together with country-level variables on the economic environment to relate observed differences in risky asset holdings to institutional ones. We find that institutional differences such as shareholder protection are strongly correlated with the unexplainable differences with regard to holdings of risky assets. JEL Classification: D12, D14, D31, G11
    Keywords: background risk, HFCS, household finance, portfolio choice, SCF
    Date: 2019–04
  18. By: Wenyuan Wang; Zhimin Zhang
    Abstract: Motivated by Kyprianou and Zhou (2009), Wang and Hu (2012), Avram et al. (2017), Li et al. (2017) and Wang and Zhou (2018), we consider in this paper the problem of maximizing the expected accumulated discounted tax payments of an insurance company, whose reserve process (before taxes are deducted) evolves as a spectrally negative L\'{e}vy process with the usual exclusion of negative subordinator or deterministic drift. Tax payments are collected according to the very general loss-carry-forward tax system introduced in Kyprianou and Zhou (2009). To achieve a balance between taxation optimization and solvency, we consider an interesting modified objective function by considering the expected accumulated discounted tax payments of the company until the general draw-down time, instead of until the classical ruin time. The optimal tax return function together with the optimal tax strategy is derived, and some numerical examples are also provided.
    Date: 2019–04
  19. By: Marco Rogna (Free University of Bolzano‐Bozen, Faculty of Economics and Management, Italy); Günter Schamel (Free University of Bolzano‐Bozen, Faculty of Economics and Management, Italy); Alex Weissensteiner (Free University of Bolzano‐Bozen, Faculty of Economics and Management, Italy)
    Abstract: There is a growing interest in analysing the diffusion of agricultural insurance, seen as an effective tool for managing farm risks. Much atten- tion has been dedicated to understanding the scarce adoption rate despite high levels of subsidization and policy support. In this paper, we analyse an aspect that seems to have been partially overlooked: the potential competing nature between insurance and other risk management tools. We consider hail as a single source weather shock and analyse the potential competing effect of anti-hail nets over insurance as instruments to cope with this shock by presenting a simple theoretical model that is rooted into expected utility theory. After describing the basic model, we perform some comparative static analysis to identify the role of individual elements that are shaping farmers' decisions. From this exercise it results that the worth of anti-hail nets compared to insurance is an increasing function of the overall risk of hail damages, of the farmers' level of risk aversion and of the worth of the agricultural output. Finally, we develop a simulation model using data related to apple production in South Tyrol, a Northern-Italian province with a relatively high risk of hail. The model generally confirms the results of the comparative static analysis and it shows that, in this region, anti-hail nets are often superior than insurance in expected utility terms.
    Keywords: Actuarial soundness, Agricultural insurance markets, Antihail nets, Hail, Expected utility
    JEL: Q12 Q18
    Date: 2019–04
  20. By: Morrison, William G. (Wilfrid Laurier University); Oxoby, Robert J. (University of Calgary)
    Abstract: We report on a laboratory experiment testing for the presence of loss aversion, as separate from risk aversion, utilizing an asset integration protocol designed to ensure that a loss of cash provided by the experimenter is viewed as a real loss by experimental participants. Our experimental design augments the Holt-Laury risk preference elicitation methodology to assess how individuals choose between a safe option and a riskier lottery. When the money at stake is viewed as the individual's own money, one of the lottery outcomes is in the domain of losses. Our results confirm that individuals display an additional reluctance to participate in a mixed domain lottery beyond that predicted by risk aversion. We show that only preference functions incorporating loss aversion are able to generate predicted behaviour that matches our results.
    Keywords: risk taking, experiments
    JEL: C91 D81
    Date: 2019–03
  21. By: Pierre Henry-Labordere (SOCIETE GENERALE - Equity Derivatives Research Societe Generale - Société Générale)
    Abstract: Following closely the construction of the Schrodinger bridge, we build a new class of Stochastic Volatility Models exactly calibrated to market instruments such as for example Vanillas, options on realized variance or VIX options. These models differ strongly from the well-known local stochastic volatility models, in particular the instantaneous volatility-of-volatility of the associated naked SVMs is not modified, once calibrated to market instruments. They can be interpreted as a martingale version of the Schrodinger bridge. The numerical calibration is performed using a dynamic-like version of the Sinkhorn algorithm. We finally highlight a striking relation with Dyson non-colliding Brownian motions.
    Keywords: stochastic volatility model,conditioned SDEs,stochastic control,Sinkhorn algorithm,Schrodinger bridge
    Date: 2019–04–05

This nep-rmg issue is ©2019 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.