nep-rmg New Economics Papers
on Risk Management
Issue of 2019‒11‒11
fourteen papers chosen by
Stan Miles
Thompson Rivers University

  1. Micro-prudential regulation and banks' systemic risk By Jakob de Haan; Zhenghao Jin; Chen Zhou
  2. Investment funds under stress By Maqui, Eduardo; Sydow, Matthias; Gourdel, Régis
  3. Oil Prices and Stock Markets: A Review of the Theory and Empirical Evidence By Degiannakis, Stavros; Filis, George; Arora, Vipin
  4. Thrive in Any Environment: Strengthening Resilience Through Risk Management By Rosenberg, Joshua V.
  5. A Regulated Market Under Sanctions: On Tail Dependence Between Oil, Gold, and Tehran Stock Exchange Index By Abootaleb Shirvani; Dimitri Volchenkov
  6. Liquidity Risk and Corporate Bond Yield Spread: Evidence from China By Yinghui Chen; Lunan Jiang
  7. Partial Default By Arellano, Cristina; Mateos-Planas, Xavier; Rios-Rull, Jose-Victor
  8. Does macroeconomics help in predicting stock markets volatility comovements? A nonlinear approach By Andrea Bucci; Giulio Palomba; Eduardo Rossi
  9. Insurance against Downside Risk for the U.S. Economy By Bullard, James B.
  10. Bitcoin Coin Selection with Leverage By Daniel J. Diroff
  11. Endogenous Leverage and Default in the Laboratory By Cipriani, Marco; Fostel, Ana; Houser, Daniel
  12. Robo-advising: Learning Investor's Risk Preferences via Portfolio Choices By Humoud Alsabah; Agostino Capponi; Octavio Ruiz Lacedelli; Matt Stern
  13. Emerging Issues for Risk Managers By Stiroh, Kevin J.
  14. Risk Management for Sovereign Debt Financing with Sustainability Conditions By Zenios, Stavros A.; Consiglio, Andrea; Athanasopoulou, Marialena; Moshammer, Edmund; Gavilan, Angel; Erce, Aitor

  1. By: Jakob de Haan; Zhenghao Jin; Chen Zhou
    Abstract: This paper investigates how countries' micro-prudential regulatory regimes are related to banks' systemic risk. We use a bank-level systemic risk indicator that can be decomposed into a bank's individual risk and its systemic linkage. To proxy the strictness of a country's regulatory regime, we employ World Bank survey data. Our results suggest that entry regulations increased systemic risk before and after the crisis. Liquidity and entry regulations seem to reduce individual risk in the post-crisis era, with little impact on systemic linkage. Other regulation categories, including capital regulation, do not have a robust relationship with systemic risk or its subcomponents.
    Keywords: systemic risk; regulatory regime; micro-prudential regulation
    JEL: G21 G28
    Date: 2019–09
  2. By: Maqui, Eduardo; Sydow, Matthias; Gourdel, Régis
    Abstract: This paper presents a model for stress testing investment funds, based on a broad worldwide sample of primary open-end equity and bond funds. First, we employ a Bayesian technique to project the impact of macro-financial scenarios on country-level portfolio flows worldwide that are constructed from fund-level asset holdings. Second, from these projected country-level flows, we model the scenarios’ repercussions on individual funds along a three year horizon. Importantly, we further decompose portfolio flows, disentangling the specific contributions of transactions, valuation and foreign exchange effects. Overall, our results indicate that the impact of a global adverse macro-financial scenario leads to a median depletion in assets under management (AUM) of 24% and 5%, for euro area-domiciled equity and bond funds respectively, largely driven by valuation effects. Scenario and results both present similarities to the global financial crisis. We use historical information on fund liquidations to estimate a threshold for a drop in AUM that signals a high likelihood of a forthcoming liquidation. Based on this, we estimate that 5.8% and 0.5% of euro area-domiciled equity and bond funds respectively could go into liquidation. Such empirical thresholds can be useful for the implementation of prudential policy tools, such as redemption gates. JEL Classification: F21, G15, G17, G23, G28
    Keywords: Bayesian model averaging, international capital flows, investment funds, portfolio valuation, prudential policy
    Date: 2019–10
  3. By: Degiannakis, Stavros; Filis, George; Arora, Vipin
    Abstract: Do oil prices and stock markets move in tandem or in opposite directions? The complex and time varying relationship between oil prices and stock markets has caught the attention of the financial press, investors, policymakers, researchers, and the general public in recent years. In light of such attention, this paper reviews research on the oil price and stock market relationship. The majority of papers we survey study the impacts of oil markets on stock markets, whereas, little research in the reverse direction exists. Our review finds that the causal effects between oil and stock markets depend heavily on whether research is performed using aggregate stock market indices, sectorial indices, or firm-level data and whether stock markets operate in net oil-importing or net oil-exporting countries. Additionally, conclusions vary depending on whether studies use symmetric or asymmetric changes in the price of oil, or whether they focus on unexpected changes in oil prices. Finally, we find that most studies show oil price volatility transmits to stock market volatility, and that including measures of stock market performance improves forecasts of oil prices and oil price volatility. Several important avenues for further research are identified.
    Keywords: Oil prices, oil price volatility, stock markets, interconnectedness, forecasting, oil-importers, oil-exporters.
    JEL: G15 Q40 Q47
    Date: 2018
  4. By: Rosenberg, Joshua V. (Federal Reserve Bank of New York)
    Abstract: Remarks at the Risk USA Conference, New York City.
    Keywords: resilience; organizational silos; risk silos; continuity plan; complexity of control; threats; uncertainty; automated controls; incident response
    Date: 2019–11–06
  5. By: Abootaleb Shirvani; Dimitri Volchenkov
    Abstract: We demonstrate that the tail dependence should always be taken into account as a proxy for systematic risk of loss for investments. We provide the clear statistical evidence of that the structure of investment portfolios on a regulated market should be adjusted to the price of gold. Our finding suggests that the active bartering of oil for goods would prevent collapsing the national market facing international sanctions.
    Date: 2019–11
  6. By: Yinghui Chen (School of Accounting, Zhongnan University of Economics and Law); Lunan Jiang (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan)
    Abstract: This paper investigates the contribution of liquidity risk to Chinese corporate bond spreads. We calculate corporate bond spreads based on the full treasury yield curve and establish a set of liquidity measures of the Chinese corporate bonds. Our empirical study shows that liquidity premium accounts for a relatively smaller portion of corporate bond spread in China, although the market liquidity is low and corporate bond issuers are strictly pre-screened. These findings are interesting, as the developed markets have better liquidity and less pre-issuance restriction, and liquidity premium still explains a relatively larger portion of corporate bond spread. Besides, we also explore the determinants of Chinese corporate bond liquidity and default premiums.
    Keywords: Yield spread, Liquidity risk, Default risk
    JEL: C23 G12
    Date: 2019–11
  7. By: Arellano, Cristina (Federal Reserve Bank of Minneapolis); Mateos-Planas, Xavier (Queen Mary University London); Rios-Rull, Jose-Victor (University of Pennsylvania)
    Abstract: In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with spreads, debt levels, and output, and the dynamics of debt during default episodes. In our theory, as in the data, debt grows during default episodes, and large defaults are longer, and associated with higher interest rate spreads, higher debt levels, and deeper recessions.
    Keywords: Sovereign risk; Debt crises; Default episodes; Emerging markets; Debt restructuring
    JEL: F34 G01 H63
    Date: 2019–07–09
  8. By: Andrea Bucci (Dipartimento di Scienze Economiche e Sociali, Universita' Politecnica delle Marche); Giulio Palomba (Dipartimento di Scienze Economiche e Sociali, Universita' Politecnica delle Marche); Eduardo Rossi (Dipartimento di Scienze Economiche ed Aziendali, University of Pavia)
    Abstract: This paper addresses the question of the relevance of macroeconomic determinants in forecasting the evolution of stock markets volatilities and co-volatilities. Our approach combines the Cholesky decomposition of the covariance matrix with the use of the Vector Logistic Smooth Transition Autoregressive Model. The model includes predetermined variables and takes into account the asymmetries in volatility process. Structural breaks and nonlinearity tests are also implemented to determine the number of regimes and to identify the transition variables. The model is applied to realized volatility of stock indices of several countries in order to evaluate the role of economic variables in predicting the future evolution of conditional covariances. Our results show that the forecast accuracy of our model is significantly de m the accuracy of the forecasts obtained via other standard approaches.
    Keywords: Multivariate realized volatility, Non-linear models, Smooth transition, Forecast evaluation, Portfolio optimization
    JEL: C32 C58 G11 G17
    Date: 2019–10
  9. By: Bullard, James B. (Federal Reserve Bank of St. Louis)
    Abstract: During a presentation in London, St. Louis Fed President James Bullard noted that the U.S. economy is slowing down relative to 2017 and 2018. The economy faces downside risk that may cause a sharper-than-expected slowdown, which “may make it more difficult for the Federal Open Market Committee (FOMC) to achieve its 2% inflation target,” he said.
    Date: 2019–10–15
  10. By: Daniel J. Diroff (Akvelon, Inc.)
    Abstract: We present a new Bitcoin coin selection algorithm, "coin selection with leverage", which aims to improve upon cost savings than that of standard knapsack like approaches. Parameters to the new algorithm are available to be tuned at the users discretion to address other goals of coin selection. Our approach naturally fits as a replacement for the standard knapsack ingredient of full coin selection procedures.
    Date: 2019–11
  11. By: Cipriani, Marco (Federal Reserve Bank of New York); Fostel, Ana (University of Virginia); Houser, Daniel (George Mason University)
    Abstract: We study default and endogenous leverage in the laboratory. To this purpose, we develop a general equilibrium model of collateralized borrowing amenable to laboratory implementation and gather experimental data. In the model, leverage is endogenous: agents choose how much to borrow using a risky asset as collateral, and there are no ad hoc collateral constraints. When the risky asset is financial—namely, its payoff does not depend on ownership (such as a bond)— collateral requirements are high and there is no default. In contrast, when the risky asset is nonfinancial—namely, its payoff depends on ownership (such as a firm)—collateral requirements are lower and default occurs. The experimental outcomes are in line with the theory's main predictions. The type of collateral, whether financial or not, matters. Default rates and loss from default are higher when the risky asset is nonfinancial, stemming from laxer collateral requirements. Default rates and collateral requirements move closer to the theoretical predictions as the experiment progresses.
    Keywords: collateral; default; double auction; experimental economics; leverage
    JEL: A10 C90 G12
    Date: 2019–11–01
  12. By: Humoud Alsabah; Agostino Capponi; Octavio Ruiz Lacedelli; Matt Stern
    Abstract: We introduce a reinforcement learning framework for retail robo-advising. The robo-advisor does not know the investor's risk preference, but learns it over time by observing her portfolio choices in different market environments. We develop an exploration-exploitation algorithm which trades off costly solicitations of portfolio choices by the investor with autonomous trading decisions based on stale estimates of investor's risk aversion. We show that the algorithm's value function converges to the optimal value function of an omniscient robo-advisor over a number of periods that is polynomial in the state and action space. By correcting for the investor's mistakes, the robo-advisor may outperform a stand-alone investor, regardless of the investor's opportunity cost for making portfolio decisions.
    Date: 2019–11
  13. By: Stiroh, Kevin J. (Federal Reserve Bank of New York)
    Abstract: Introductory Remarks at the GARP Global Risk Forum, Federal Reserve Bank of New York, New York City.
    Keywords: climate change; physical risk; data gaps; GARP; corporate culture; digital transformation; cultural capital; technological innovation; fintech
    Date: 2019–11–07
  14. By: Zenios, Stavros A. (University of Cyprus); Consiglio, Andrea (University of Palermo); Athanasopoulou, Marialena (European Stability Mechanism); Moshammer, Edmund (European Stability Mechanism); Gavilan, Angel (Banco de España); Erce, Aitor (Banco de España)
    Abstract: We develop a model of debt sustainability analysis with optimal financing decisions in the presence of macroeconomic, financial and fiscal uncertainty. We define a coherent measure of refinancing risk, and trade off the risks of debt stock and flow dynamics, subject to debt sustainability constraints and endogenous risk and term premia. We optimize both static and dynamic financing strategies, compare them with several simple rules and consol financing to demonstrate economically significant effects of optimal financing, and show that the stock-flow tradeoff can be critical for sustainability. We quantify the minimum refinancing risk and the maximum rate of debt reduction that a sovereign can achieve given its economic fundamentals, and extend the model to identify optimal timing for debt flow adjustments that allow the sovereign to go beyond these limits. We put the model to the data on three real-world cases: a representative euro zone crisis country, a low-debt country (Netherlands) and a high-debt country (Italy). These applications illustrate the use of the model in informing diverse policy decisions on sustainable public finance. The model is part of the European Stability Mechanism toolkit to assess debt sustainability and repayment capacity of member states in the context of financial assistance.
    Keywords: sovereign debt; sustainability; debt financing; optimization; stochastic programming; scenario analysis; conditional Value-at-Risk; risk measures
    JEL: C61 C63 D61 E3 E47 E62 F34 G38 H63
    Date: 2019–06–01

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