nep-rmg New Economics Papers
on Risk Management
Issue of 2019‒05‒27
nineteen papers chosen by

  1. The Rise of Shadow Banking: Evidence from Capital Regulation By Rustom M. Irani; Rajkamal Iyer; Ralf R. Meisenzahl; José-Luis Peydró
  2. Residual shape risk on natural gas market with mixed jump diffusion By Karel Janda; Jakub Kourilek
  3. Hedging crop yields against weather uncertainties -- a weather derivative perspective By Samuel Asante Gyamerah; Philip Ngare; Dennis Ikpe
  4. Hedging Climate Change News By Engle III, Robert F; Giglio, Stefano W; Kelly, Bryan; Lee, Heebum; Ströbel, Johannes
  5. Capital Flows: The Role of Bank and Nonbank Balance Sheets By Yuko Hashimoto; Signe Krogstrup
  6. Liquidation, bailout, and bail-in: Insolvency resolution mechanisms and bank lending. By Lambrecht, Bart; Tse, Alex
  7. Real-time Prediction of Bitcoin bubble Crashes By Min Shu; Wei Zhu
  8. The impact of hedge fund indices on portfolio performance By Maria Teresa Medeiros Garcia; Gonçalo Liberal
  9. Detection of Chinese Stock Market Bubbles with LPPLS Confidence Indicator By Min Shu; Wei Zhu
  10. Unhedgeable Inflation Risk within Pension Schemes By Beetsma, Roel; Chen, Damiaan; van Wijnbergen, Sweder
  11. Strengthening insurance partnerships in the face of climate change: insights from an agent-based model of flood insurance in the UK By Crick, Florence; Jenkins, Katie; Surminski, Swenja
  12. Spectral risk measures and uncertainty By Mohammed Berkhouch; Ghizlane Lakhnati; Marcelo Brutti Righi
  13. Variable annuities in a L\'evy-based hybrid model with surrender risk By Laura Ballotta; Ernst Eberlein; Thorsten Schmidt; Raghid Zeineddine
  14. Testing Sharpe ratio: luck or skill? By Eric Benhamou; David Saltiel; Beatrice Guez; Nicolas Paris
  15. From aggregate betting data to individual risk preferences By Pierre-Andre Chiappori; Bernard Salanie; Francois Salanie; Amit Gandhi
  16. The Resolution of Long-Run Risk By Myroslav Pidkuyko; Raffaele Rossi; Klaus Reiner Schenk-Hoppé
  17. Influence of US Presidential Terms on S&P500 Index Using a Time Series Analysis Approach By Gil-Alana, Luis A.; Mudida, Robert; Yaya, OlaOluwa S; Osuolale, Kazeem; Ogbonna, Ephraim A
  18. Republic of Poland; Financial Sector Assessment Program-Technical Note-Stress Testing and Systemic Risk Analysis By International Monetary Fund
  19. Republic of Poland; Financial Sector Assessment Program-Technical Note-Insurance Sector Regulation and Supervision By International Monetary Fund

  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: 2019–04
  2. By: Karel Janda; Jakub Kourilek
    Abstract: This paper introduces residual shape risk as a new subclass of energy commodity risk. Residual shape risk is caused by insufficient liquidity of energy forward market when retail energy supplier has to hedge his short sales by a non-flexible standard baseload product available on wholesale market. Because of this inflexibility energy supplier is left with residual unhedged position which has to be closed at spot market. The residual shape risk is defined as a difference between spot and forward prices weighted by residual unhedged position which size depends on the shape of customers’ portfolio of a given retail energy supplier. We evaluated residual shape risk over the years 2014 - 2018 with a real portfolio of a leading natural gas retail supplier in the Czech Republic. The size of residual shape risk in our example corresponds approximately to 1 percent of profit margin of natural gas retail supplier.
    Keywords: natural gas markets, spot prices, forward prices, residual shape risk
    JEL: C51 C58 Q41 Q47
    Date: 2019–05
  3. By: Samuel Asante Gyamerah; Philip Ngare; Dennis Ikpe
    Abstract: The effects of weather on agriculture in recent years have become a major concern across the globe. Hence, the need for an effective weather risk management tool (weather derivatives) for agricultural stakeholders. However, most of these stakeholders are unwilling to pay for the price of weather derivatives (WD) because of product-design and geographical basis risks in the pricing models of WD. Using machine learning ensemble technique for crop yield forecasting and feature importance, the major major weather variable (average temperature) that affects crop yields are empirically determined. This variable (average temperature) is used as the underlying index for WD to eliminate product-design basis risks. A model with time-varying speed of mean reversion, seasonal mean, local volatility that depends on the average temperature and time for the contract period is proposed. Based on this model, pricing models for futures, options on futures, and basket futures for cumulative average temperature and growing degree-days are presented. Pricing futures on baskets reduces geographical basis risk as buyer's have the opportunity to select the most appropriate weather stations with their desired weight preference. With these pricing models, agricultural stakeholders can hedge their crops against the perils of weather.
    Date: 2019–05
  4. By: Engle III, Robert F; Giglio, Stefano W; Kelly, Bryan; Lee, Heebum; Ströbel, Johannes
    Abstract: We propose and implement a procedure to dynamically hedge climate change risk. We extract innovations from climate news series that we construct through textual analysis of newspapers. We then use a mimicking portfolio approach to build climate change hedge portfolios. We discipline the exercise by using third-party ESG scores of firms to model their climate risk exposures. We show that this approach yields parsimonious and industry-balanced portfolios that perform well in hedging innovations in climate news both in sample and out of sample. We discuss multiple directions for future research on financial approaches to managing climate risk.
    JEL: G11 G18 Q54
    Date: 2019–05
  5. By: Yuko Hashimoto; Signe Krogstrup
    Abstract: This paper assesses the role of bank and nonbank financial institutions’ balance sheet foreign exposures and risk management practices in driving capital flow responses to global risk. Using a unique and previously unexplored dataset on domestic and cross border balance sheet positions of financial institutions collected by the IMF, we show that the response of overall capital flows to global risk shocks is associated with the on-balance sheet foreign exposures of nonbanks, but not with that of banks. A possible interpretation is that risk-averse and dynamically optimizing nonbanks reduce their foreign risk exposure when global risk perceptions increase, leading to capital flows, while banks tend to be hedged against these risks off balance sheet. In advanced countries, the findings suggest that nonbank portfolio adjustment to changing risk conditions may take place through derivatives transactions with banks, the hedging practices of which trigger bank related capital flows rather than portfolio flows.
    Date: 2019–04–29
  6. By: Lambrecht, Bart; Tse, Alex
    Abstract: We present a dynamic, continuous-time model in which risk averse inside equityholders set a bank's lending, payout, and financing policies, and the exposure of bank assets to crashes. We study how the prevailing insolvency resolution mechanism affects these policies, the insolvency rate, loss in default, value at risk (VaR), and the net value created by the bank. VaR depends non-trivially on jump (crash) risk, diffusion risk and the horizon. We examine the commonplace assertion that bailouts encourage excessive lending and risk-taking compared to the liquidation and bail-in regimes, and explore whether bailouts could be financed by banks without taxpayers' money.
    Keywords: agency; asset sale; bail-in; bailout; Liquidation
    JEL: G32 G33 G34 H81
    Date: 2019–05
  7. By: Min Shu; Wei Zhu
    Abstract: In the past decade, Bitcoin has become an emerging asset class well known to most people because of their extraordinary return potential in phases of extreme price growth and their unpredictable massive crashes. We apply the LPPLS confidence indicator as a diagnostic tool for identifying bubbles using the daily data of Bitcoin price in the past two years. We find that the LPPLS confidence indicator based on the daily data of Bitcoin price fails to provide effective warnings for detecting the bubbles when the Bitcoin price suffers from a large fluctuation in a short time, especially for positive bubbles. In order to diagnose the existence of bubbles and accurately predict the bubble crashes in the cryptocurrency market, this study proposes an adaptive multilevel time series detection methodology based on the LPPLS model. We adopt two levels of time series, 1 hour and 30 minutes, to demonstrate the adaptive multilevel time series detection methodology. The results show that the LPPLS confidence indicator based on the adaptive multilevel time series detection methodology have not only an outstanding performance to effectively detect the bubbles and accurately forecast the bubble crashes, but can also monitor the development and the crash of bubbles even if a bubble exists in a short time. In addition, we discover that the short-term LPPLS confidence indicator greatly affected by the extreme fluctuations of Bitcoin price can provide some useful insights into the bubble status on a shorter time scale, and the long-term LPPLS confidence indicator has a stable performance in terms of effectively monitoring the bubble status on a longer time scale. The adaptive multilevel time series detection methodology can provide real-time detection of bubbles and advanced forecast to warn of an imminent crash risk in not only the cryptocurrency market but also the other financial markets.
    Date: 2019–05
  8. By: Maria Teresa Medeiros Garcia; Gonçalo Liberal
    Abstract: The purpose of this paper is to assessthecombination of investable hedge funds indices with a traditional portfolio of 60% stocks and40% bonds.The S&P 500 Index,the Barclays US Aggregate Bond Index, and threeinvestable hedge fund indices,the MEBI Maximum Sharpe Ratio L1Index, the MEBI Zero Beta Strategy L1Index, and the Eurekahedge ILS Advisers Index, were considered to conduct performance comparison, using time windows of two, five and ten years, from the 1st of January,2006,to the 1st 2of February, 2016. Significant reduction of the beta of the overall portfolio is reached. The findings showed that the investable hedge fund indices under analysis can be used as an easy way to protect a portfolio during different market conditions, diversifying the risks of the traditional investment portfolios.The paper provides evidence of how investable hedge fund indices lead to an improvement in the performance results,when compared with the traditional global equity-bond portfolio alone.
    Keywords: Markowitz portfolio theory;optimal portfolios;investable hedge fund index;performance evaluation
    JEL: G11 G12
    Date: 2019–05
  9. By: Min Shu; Wei Zhu
    Abstract: This paper aims to present an advance bubble detection methodology based on LPPLS confidence indicator for the early causal identification of positive and negative bubbles in the Chinese stock market using the daily data on the Shanghai Shenzhen CSI 300 stock market index from January 2002 through April 2018. We account for the damping condition of LPPLS model in the search space and implement the stricter filter conditions for the qualification of the valid LPPLS fits by taking account of the maximum relative error, Lomb log-periodic test of the detrended residual, and unit-root tests of the logarithmic residual based on both the Phillips-Perron test and Dickey-Fuller test to improve the performance of LPPLS confidence indicator. Our analysis shows that the LPPLS detection strategy diagnoses the positive bubbles and negative bubbles corresponding to well-known historical events, implying the detection strategy based on the LPPLS confidence indicator has an outstanding performance to identify the bubbles in advance. We find that the probability density distribution of the estimated beginning time of bubbles appears to be skewed and the mass of the distribution is concentrated on the area where the bubbles start to have a super-exponentially growth. This study presents that it is possible to detect the potential positive and negative bubbles and crashes ahead of time, which provides a prerequisite for limiting the bubble sizes and eventually minimizing the damage from the bubble crash.
    Date: 2019–05
  10. By: Beetsma, Roel; Chen, Damiaan; van Wijnbergen, Sweder
    Abstract: Pension schemes generally aim to protect the purchasing power of their participants, but cannot completely do this when due to market incompleteness inflation risk cannot be fully hedged. Without a market price for inflation risk the value of a pension contract depends on the investor's risk appetite and inflation risk exposure. We develop a valuation framework to deal with two sources of unhedgeable inflation risk: the absence of instruments to hedge general consumer price inflation risk and differences in group-specific consumption bundles from the economy-wide bundle. We find that the absence of financial instruments to hedge inflation risks may reduce lifetime welfare by up to 6% of certainty-equivalent consumption for commonly assumed degrees of risk aversion. Regulators face a dilemma as young (workers) and old participants (retirees) have different capacities to absorb losses from unhedgeable inflation risks and as a consequence have a different risk appetite.
    Keywords: incomplete markets; pension contract; Unhedgeable inflation risk; Valuation; welfare loss
    JEL: C61 E21 G11 G23
    Date: 2019–05
  11. By: Crick, Florence; Jenkins, Katie; Surminski, Swenja
    Abstract: Multisectoral partnerships are increasingly cited as a mechanism to deliver and improve disaster risk management. Yet, partnerships are not a panacea and more research is required to understand the role that they can play in disaster risk management and particularly disaster risk reduction. This paper investigates how partnerships can incentivise flood risk reduction by focusing on the UK public-private partnership on flood insurance. Developing the right flood insurance arrangements to incentivise flood risk reduction and adaptation to climate change is a key challenge. In the face of rising flood risks due to climate change and socio-economic development insurance partnerships can no longer afford to focus only on the risk transfer function. However, while expectations of the insurance industry have traditionally been high when it comes to flood risk management, the insurance industry alone will not provide the solution to the challenge of rising risks. The case of flood insurance in the UK illustrates this: even national government and industry together cannot fully address these risks and other actors need to be involved to create strong incentives for risk reduction. Using an agent-based model focused on surface water flood risk in London we analyse how other partners could strengthen the insurance partnership by reducing flood risk and thus helping to maintain affordable insurance premiums. Our findings are relevant for wider discussions on the potential of insurance schemes to incentivise flood risk management and climate adaptation in the UK and also internationally.
    Keywords: partnerships; insurance; climate change; surface water flood risk; ES/K006576/1
    JEL: E6
    Date: 2018–09–15
  12. By: Mohammed Berkhouch; Ghizlane Lakhnati; Marcelo Brutti Righi
    Abstract: Risk assessment under different possible scenarios is a source of uncertainty that may lead to concerning financial losses. We address this issue, first, by adapting a robust framework to the class of spectral risk measures. Second, we propose a Deviation-based approach to quantify uncertainty. Furthermore, the theory is illustrated with a practical case study from NASDAQ index.
    Date: 2019–05
  13. By: Laura Ballotta; Ernst Eberlein; Thorsten Schmidt; Raghid Zeineddine
    Abstract: This paper proposes a market consistent valuation framework for variable annuities with guaranteed minimum accumulation benefit, death benefit and surrender benefit features. The setup is based on a hybrid model for the financial market and uses time-inhomogeneous L\'evy processes as risk drivers. Further, we allow for dependence between financial and surrender risks. Our model leads to explicit analytical formulas for the quantities of interest, and practical and efficient numerical procedures for the evaluation of these formulas. We illustrate the tractability of this approach by means of a detailed sensitivity analysis of the price of the variable annuity and its components with respect to the model parameters. The results highlight the role played by the surrender behaviour and the importance of its appropriate modelling.
    Date: 2019–05
  14. By: Eric Benhamou; David Saltiel; Beatrice Guez; Nicolas Paris
    Abstract: Sharpe ratio (sometimes also referred to as information ratio) is widely used in asset management to compare and benchmark funds and asset managers. It computes the ratio of the (excess) net return over the strategy standard deviation. However, the elements to compute the Sharpe ratio, namely, the expected returns and the volatilities are unknown numbers and need to be estimated statistically. This means that the Sharpe ratio used by funds is likely to be error prone because of statistical estimation errors. In this paper, we provide various tests to measure the quality of the Sharpe ratios. By quality, we are aiming at measuring whether a manager was indeed lucky of skillful. The test assesses this through the statistical significance of the Sharpe ratio. We not only look at the traditional Sharpe ratio but also compute a modified Sharpe insensitive to used Capital. We provide various statistical tests that can be used to precisely quantify the fact that the Sharpe is statistically significant. We illustrate in particular the number of trades for a given Sharpe level that provides statistical significance as well as the impact of auto-correlation by providing reference tables that provides the minimum required Sharpe ratio for a given time period and correlation. We also provide for a Sharpe ratio of 0.5, 1.0, 1.5 and 2.0 the skill percentage given the auto-correlation level.
    Date: 2019–05
  15. By: Pierre-Andre Chiappori (Department of Economics - Universität Mannheim [Mannheim]); Bernard Salanie (Department of Economics - Universität Mannheim [Mannheim]); Francois Salanie (TSE - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - CNRS - Centre National de la Recherche Scientifique - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales); Amit Gandhi (Department of Economics - Universität Mannheim [Mannheim])
    Abstract: We show that even in the absence of data on individual decisions, the distribution of individual attitudes towards risk can be identified from the aggregate conditions that characterize equilibrium on markets for risky assets. Taking parimutuel horse races as a textbook model of contingent markets, we allow for heterogeneous bettors with very general risk preferences, including non-expected utility. Under a standard single-crossing condition on preferences, we identify the distribution of preferences among the population of bettors and we derive testable implications. We estimate the model on data from U.S. races. Specifications based on expected utility fit the data very poorly. Our results stress the crucial importance of nonlinear probability weighting. They also suggest that several dimensions of heterogeneity may be at work.
    Keywords: Identification,revealed preferences,attitudes towards risk
    Date: 2019
  16. By: Myroslav Pidkuyko; Raffaele Rossi; Klaus Reiner Schenk-Hoppé
    Date: 2019
  17. By: Gil-Alana, Luis A.; Mudida, Robert; Yaya, OlaOluwa S; Osuolale, Kazeem; Ogbonna, Ephraim A
    Abstract: This paper examines the influence of US presidential terms on the stock market by focusing on the S&P500 index. Fractional integration techniques, which are more general than other standard methods, are used and the results obtained produce interesting findings. It was found that during the second presidential terms, stock markets are less efficient and present higher degrees of persistence in their volatilities. This is observed independently of the political affiliations of the president in power. The volatility, in general, reflects the spillover of economic excesses at the end of the first presidential term when seeking re-election into the second term in office. Expansionary monetary and fiscal policies at the end of the first term may create disequilibria in the economy which are amplified in the second term through a transmission mechanism resulting in contractionary interventionist policies in a situation where no incentive for re-election exists by the incumbent
    Keywords: emocratic party; Fractional integration; Republican party; Stocks; US Presidential terms
    JEL: C22 H54
    Date: 2019–03
  18. By: International Monetary Fund
    Abstract: Poland’s financial system is dominated by the banking sector, with significant state participation and foreign ownership. Commercial and cooperative banks play a leading role in financial intermediation, channeling deposits to credit to households and corporates. State-controlled and foreign-owned commercial banks account for about 60 percent of the financial sector (or 83 percent of the banking sector). While interbank and cross-sectoral exposures are relatively limited, the cooperative banks are highly interconnected with their affiliating commercial banks through the affiliating “Apex” network structure.
    Date: 2019–05–09
  19. By: International Monetary Fund
    Abstract: This technical note provides an update and an assessment of the development of regulation and supervision of the Polish insurance sector since an assessment concluded in 2012. The note is part of the Poland 2018 Financial Sector Assessment Program (FSAP) and draws on discussions in Poland from January 8 to 20 and May 8 to 21, 2018. Most recommendations of the 2012 FSAP insurance assessment have been implemented. The current FSAP did not carry out a detailed assessment of compliance with the IAIS Insurance Core Principles (ICPs). Nonetheless, it is clear that implementation of the EU Solvency II Directive in 2016 has significantly strengthened regulation and supervision, introducing risk-based capital standards, comprehensive insurance group supervision, and new requirements on the suitability of key persons, risk management, and controls. The supervision of intermediaries has also been strengthened in line with a 2012 FSAP recommendation, and further improvements were to take effect in late 2018. Unlike in many EU countries, Solvency II was implemented without significant increases in staff numbers.
    Date: 2019–05–09

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