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on Risk Management |
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Issue of 2019‒10‒28
thirteen papers chosen by |
| By: | Kouadio, Jean Joel; Mwamba, Muteba; Bonga-Bonga, Lumengo |
| Abstract: | This paper assesses the impact of systematic tail risk of stocks, defined as a stock’s exposure to market tail events, on the cross section returns of an emerging stock exchange, especially the Johannesburg Stock Exchange (JSE) from January 2002 through June 2018. If stock market investors are crash-averse, then holding stocks that experience high exposure to market tail events should be rewarded with a premium. The paper therefore sets out to determine whether high exposure to market tail events translates into higher returns of stocks traded on the JSE. To achieve this objective, the study extends on the work of Chabi-Yo, Ruenzi and Weigert (2015) based on extreme value theory (EVT) and copula models as well as the traditional asset pricing tools of portfolio formation and cross-sectional regressions. The results of the empirical analysis support the existence of a systematic tail risk premium in the JSE. Interestingly, the effect of systematic tail risk on the cross section of JSE returns is time-varying and independent from that of risk measures such as beta and downside beta and firm characteristics such as book-to-market (BTM) ratio, size and past returns. In addition, the study provides evidence on the impact of financial crises on crash aversion. |
| Keywords: | systematic tail risk, stock exchange, extreme value theory, copula |
| JEL: | C46 G01 G12 |
| Date: | 2019–10–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:96570&r=all |
| By: | Degiannakis, Stavros; Filis, George; Siourounis, Grigorios; Trapani, Lorenzo |
| Abstract: | Risk metrics users assume that the moments of asset returns exist, irrespectively of the trading frequency, hence the observed values of these moments are used to capture the potential losses from asset trading (e.g. with Value-at-Risk (VaR) or Expected Shortfall (ES) calculations). Despite the fact that the behavior of traditional risk metrics is well-examined for high frequency data (e.g. at daily intervals), very little is known on how these metrics behave under Ultra-High Frequency Trading (UHFT). We fill this void by firstly examining the existence of the daily and intraday returns moments, and subsequently by assessing the impact of their (non)existence in a risk management framework. We find that the third and fourth moments of the distribution of asset returns do not exist. We next use both real and simulated data to show that, when daily trading is implemented, VaR or ES deliver estimates in line with what the theory predicts. We show, however, that when UHFT is considered, assuming finite higher order moments, potential losses are much bigger than what the theory predicts, and they increase exponentially as the trading frequency increases. We argue that two possible explanations affect potential loses; first, the exponential increase in the sample data points at UHFT; second, the fact that the data, which are sampled from a heavy-tailed distribution, tend to have higher sample moments than the theory suggests - we call this phenomenon superkurtosis. Our findings entail that traditional risk metrics are unable to properly judge capital adequacy. Hence, the use of risk management techniques such as VaR or ES, by market participants who engage with UHFT, impose serious threats to the stability of financial markets, given that capital ratios may be severely underestimated. |
| Keywords: | Ultra high frequency trading, risk management, finite moments, superkurtosis. |
| JEL: | C12 C54 F30 F31 G10 G15 G17 |
| Date: | 2019–10–16 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:96563&r=all |
| By: | Romain Gauchon (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Jean-Louis Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Julien Trufin (Département de mathématiques Université Libre de Bruxelles - ULB - Université Libre de Bruxelles [Bruxelles]) |
| Abstract: | In this paper, we propose and study a risk model with two types of claims in which the insurer may invest into a prevention plan which decreases the large claims intensity without impacting the small claims. In this setting, we prove that prevention is advantageous when claim severities for small and large claims are ordered in the sense of the Harmonic-Mean-Residual-Lifetime (HMRL) order. In addition, we show that the optimal prevention amount is the lowest when there is no initial surplus. Finally, we characterize the asymptotic optimal prevention strategy when the initial surplus tends to infinity in the two main cases where both claim types are light-tailed and where one of them is light-tailed and the other one is heavy-tailed. |
| Keywords: | Ruin theory,Prevention,Optimal prevention strategy,Insurance |
| Date: | 2019–10–14 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-02314914&r=all |
| By: | Frank Bosserhoff; Mitja Stadje |
| Abstract: | Suppose an investor aims at Delta hedging a European contingent claim $h(S(T))$ in a jump-diffusion model, but incorrectly specifies the stock price's volatility and jump sensitivity, so that any hedging strategy is calculated under a misspecified model. When does the erroneously computed strategy super-replicate the true claim in an appropriate sense? If the misspecified volatility and jump sensitivity dominate the true ones, we show that following the misspecified Delta strategy does super-replicate $h(S(T))$ in expectation among a wide collection of models. We also show that if a robust pricing operator with a whole class of models is used, the corresponding hedge is dominating the contingent claim under each model in expectation. Our results rely on proving stochastic flow properties of the jump-diffusion and the convexity of the value function. In the pure Poisson case, we establish that an overestimation of the jump sensitivity results in an almost sure one-sided hedge. Moreover, in general the misspecified price of the option dominates the true one if the volatility and the jump sensitivity are overestimated. |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1910.08946&r=all |
| By: | Wenyuan Wang; Xueyuan Wu; Cheng Chi |
| Abstract: | In this paper we consider two problems on optimal implementation delay of taxation with trade-off for spectrally negative L\'{e}vy insurance risk processes. In the first case, we assume that an insurance company starts to pay tax when its surplus reaches a certain level $b$ and at the termination time of the business there is a terminal value incurred to the company. The total expected discounted value of tax payments plus the terminal value is maximized to obtain the optimal implementation level $b^*$. In the second case, the company still pays tax subject to an implementation level $a$ but with capital injections to prevent bankruptcy. The total expected discounted value of tax payments minus the capital injection costs is maximized to obtain the optimal implementation level $a^*$. Numerical examples are also given to illustrate the main results in this paper. |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1910.08158&r=all |
| By: | Gautier Marti |
| Abstract: | We propose a novel approach for sampling realistic financial correlation matrices. This approach is based on generative adversarial networks. Experiments demonstrate that generative adversarial networks are able to recover most of the known stylized facts about empirical correlation matrices estimated on asset returns. This is the first time such results are documented in the literature. Practical financial applications range from trading strategies enhancement to risk and portfolio stress testing. Such generative models can also help ground empirical finance deeper into science by allowing for falsifiability of statements and more objective comparison of empirical methods. |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1910.09504&r=all |
| By: | Romain Gauchon (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Jean-Louis Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Julien Trufin (Département de mathématiques Université Libre de Bruxelles - ULB - Université Libre de Bruxelles [Bruxelles]) |
| Abstract: | In this paper, we propose and study a first risk model in which the insurer may invest into a prevention plan which decreases claim intensity. We determine the optimal prevention investment for different risk indicators. In particular, we show that the prevention amount minimizing the ruin probability maximizes the adjustment coefficient in the classical ruin model with prevention, as well as the expected dividends until ruin in the model with dividends. We also show that the optimal prevention strategy is different if one aims at maximizing the average surplus at a fixed time horizon. A sensitivity analysis is carried out. We also prove that our results can be extended to the case where prevention starts to work only after a minimum prevention level threshold. |
| Keywords: | Prevention,Optimal prevention strategy,Ruin theory,Insurance |
| Date: | 2019–10–14 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-02314899&r=all |
| By: | Juan Dong; Lyudmila Korobenko; Deniz Sezer |
| Abstract: | We introduce a new model for pricing corporate bonds, which is a modification of the classical model of Merton. In this new model, we drop the liquidity assumption of the firm's asset value process, and assume that there is a liquidly traded asset in the market whose value is correlated with the firm's asset value, and all portfolios can be constructed using solely this asset and the money market account. We formulate the market price of the corporate bond as the product of the price of an optimal replicating portfolio and exp(- kappa x replication error), where kappa is a positive constant. The interpretation is that the representative investor accepts the price of the optimal replicating portfolio as a benchmark, however, requests compensation for the non-hedgeable risk. We show that if the replication error is measured relative to the firm's value, the resulting formula is arbitrage free with mild restrictions on the parameters. |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1910.08641&r=all |
| By: | Nguyen, Linh D. (RWTH Aachen University); Steininger, Bertram (Department of Real Estate and Construction Management, Royal Institute of Technology) |
| Abstract: | This study examines the impact of underpriced default risk on investment in the real estate investment trust (REIT) sector, where firms’ investment is highly sensitive to changes in credit market conditions. The findings reveal that REITs exploiting underpriced default risk have a higher level of investment than their peers because the former can access low-cost capital. Moreover, exploiting the underpriced default risk is specific to not only REITs but also to the whole real estate investment sector. In contrast, underpriced default risk has an insignificant impact on investment of non-real estate firms because non-recourse loans are unpopular in these firms. |
| Keywords: | default risk; investment; real estate investment trusts (REITs); underpricing of the default risk |
| JEL: | G21 G32 |
| Date: | 2019–10–21 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:kthrec:2019_005&r=all |
| By: | Dungey, Mardi (Tasmanian School of Business & Economics, University of Tasmania); Islam, Raisul (Tasmanian School of Business & Economics, University of Tasmania); Volkov, Vladimir (Tasmanian School of Business & Economics, University of Tasmania) |
| Abstract: | This paper develops a means of visualizing the vulnerability of complex systems of financial interactions around the globe using Neural Network clustering techniques. We show how time-varying spillover indices can be translated into two dimensional crisis maps. The crisis maps have the advantage of showing the changing paths of vulnerability, including the direction and extent of the effect between source and affected markets. Using equity market data for 31 global markets over 1998-2017 we provide these crisis maps. These tools help portfolio managers and policy makers to distinguish which of the available tools for crisis management will be most appropriate for the form of vulnerability in play. |
| Keywords: | systemic risk, networks |
| JEL: | C3 C32 C45 C53 D85 G10 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:tas:wpaper:31661&r=all |
| By: | Mathias Kruttli (Board of Governors of the Federal Reserve System, Oxford-Man Institute of Quantitative Finance); Phillip Monin (Office of Financial Research); Sumudu Watugala (Cornell University, Office of Financial Research) |
| Abstract: | The collapse of Lehman Brothers illustrated the importance of managing prime broker counterparty risks for hedge funds. Liquidity shocks to prime brokers can lead to cycles of deleveraging that produce losses at funds and potentially have harmful effects on financial market function and credit provision. While the hedge fund-prime broker credit network is highly concentrated, the average hedge fund in our sample borrows from three prime brokers and has a total credit exposure of $2.15 billion. We show that hedge fund borrowing tends to be overcollateralized and most of the collateral is allowed to be rehypothecated. Using a within fund-quarter empirical strategy, we identify the effects of an idiosyncratic liquidity shock to a major creditor. Such a shock results in significantly reduced borrowing due to the prime broker reducing credit supply instead of a precautionary reduction in credit demand from connected hedge funds. Borrowing by funds with more rehypothecable collateral is less affected because such collateral improves the constrained creditor's liquidity situation. Even large hedge funds simultaneously borrowing from multiple creditors see a significant reduction in their aggregate borrowing following the shock. Larger, more connected and better-performing hedge funds and those that do less OTC trading are better able to compensate for this loss. |
| Keywords: | hedge funds, prime brokers, credit networks, rehypothecation, collateral |
| Date: | 2019–10–01 |
| URL: | http://d.repec.org/n?u=RePEc:ofr:wpaper:19-03&r=all |
| By: | Zura Kakushadze |
| Abstract: | We discuss a simple, exactly solvable model of stochastic stock dynamics that incorporates regime switching between healthy and distressed regimes. Using this model, which is analytically tractable, we discuss a way of extracting expected returns for stocks from realized CDS spreads, essentially, the CDS market sentiment about future stock returns. This alpha/signal could be useful in a cross-sectional (statistical arbitrage) context for equities trading. |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1910.08531&r=all |
| By: | Maake, Tebogo; Bonga-Bonga, Lumengo |
| Abstract: | This study investigates the link between the currency carry trade operations and asset markets in South Africa, namely the equity and bond markets. The carry trade operation examined in this paper involves two strategies, both of which use the South African rand as the investment currency, with the dollar and the Yen as the funding currencies in each strategy. This study uses the vector autoregressive BEKK- Generalised Autoregressive Conditional Heteroscedastic model in assessing volatility spillover between carry trade profit from each strategy and the South African equity and bond markets. The results of the empirical analysis show evidence of volatility spillover relationships between the carry trade returns and the two capital market returns. These relationships are dependent on the choice of the funding currency, with the dollar funded strategy more related with the bond market whilst the yen funded strategy is related with the equity market. This study’s findings emphasise the importance of volatility spillovers between the currency carry trade market and other asset markets in South Africa when assessing financial markets’ risks and formulating risk management policies. |
| Keywords: | carry trade, yen, dollar, VAR-BEKK-GARCH |
| JEL: | C10 C58 G15 |
| Date: | 2019–10–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:96667&r=all |