nep-rmg New Economics Papers
on Risk Management
Issue of 2019‒12‒16
twenty-two papers chosen by

  2. Information-theoretic Portfolio Decision Model for Optimal Flood Management By Convertino, Matteo; Annis, Antonio; Nardi, Fernando
  3. Pricing Financial Derivatives Subject to Multilateral Credit Risk and Collateralization By Xiao, Tim
  4. Risk of Bitcoin Market: Volatility, Jumps, and Forecasts By Junjie Hu; Wolfgang Karl H\"ardle; Weiyu Kuo
  5. Speed-up credit exposure calculations for pricing and risk management By Kathrin Glau; Ricardo Pachon; Christian P\"otz
  6. Pricing and hedging short-maturity Asian options in local volatility models By Hyungbin Park; Jonghwa Park
  7. Profit Taxation and Bank Risk Taking By Kogler, Michael
  8. Omega and Sharpe ratio By Eric Benhamou; Beatrice Guez; Nicolas Paris1
  9. Risk allocation through securitization - Evidence from non-performing loans By Sascha Tobias Wengerek; Benjamin Hippert; André Uhde
  10. An assessment of factors determining choice of risk management strategies among smallholder dairy farmers in Murang’a county, Kenya By Waweru, Caroline; Nyikal, Rose; Busienei, John
  11. Opacity: Insurance and Fragility By Ryuichiro Izumi
  12. Market Risk and Operational Risk Towards Company’s Profitability By Kam Yan Hui, Jane Sarah
  13. Graph-based Era segmentation of financial integration By Patrice ABRY; Cécile Bastidon; Pierre BORGNAT; Pablo Jensen; Antoine Parent
  14. Reduction of Qubits in Quantum Algorithm for Monte Carlo Simulation by Pseudo-random Number Generator By Koichi Miyamoto; Kenji Shiohara
  15. Tornado damage ratings estimated with cumulative logistic regression By Elsner, James B.; Schroder, Zoe
  16. How Best to Annuitize Defined Contribution Assets? By Alicia H. Munnell; Gal Wettstein; Wenliang Hou
  17. The equivalent CEV volatility of the SABR model By Jaehyuk Choi; Lixin Wu
  18. Determinants of banks' profitability: Do Basel III liquidity and capital ratios matter? By Pierre Durand
  19. From point through density valuation to individual risk assessment in the discounted cash flows method By Marcin Dec
  20. Proceedings: 3rd International Conference on Food and Agricultural Economics: EXPLORING THE DYNAMIC CORRELATION BETWEEN THE FUTURE WHEAT MARKETS AND EGYPTIAN SPOT PRICES By Ahmed, Osama; Sallan, Walid
  21. Production risk and risk preference among small-scale pig enterprises in Southwestern Cameroon By Tembei, Mbah Leslie; Molua, Ernest L.; Akamin, Ajapnwa
  22. Proceedings: 3rd International Conference on Food and Agricultural Economics: RISK MANAGEMENT PROBLEMS AND SOLUTIONS IN RURAL TOURISM IN LATVIA By Kaufmane, Dace; Eglite, Aija

  1. By: Phoon, Chin Pei
    Abstract: Corporate Governance management is a very important aspect in the any types of organization. This study is aimed to test the McDonald’s overall performance with specific risk to avoid or reduce any kind of risk that organization need to play important role to efficiently manage the corporate governance element. The data is integrated from McDonald’s annual report which from year 2014 until 2018. The analysis shows that company’s risk affected by corporate governance towards company’s performance. From this research suggest that McDonald’s should control their risk in the smart way to prove the McDonald’s more reputation and stable.
    Keywords: corporate governance, risk, performance, Return on Assets (ROA)
    JEL: G3 G32
    Date: 2019–10–31
  2. By: Convertino, Matteo; Annis, Antonio; Nardi, Fernando
    Abstract: The increasing impact of flooding urges more effective flood management strategies to guarantee sustainable ecosystem development. Recent catastrophes underline the importance of avoiding local flood management, but characterizing large scale basin wide approaches for systemic flood risk management. Here we introduce an information-theoretic Portfolio Decision Model (iPDM) for the optimization of a systemic ecosystem value at the basin scale by evaluating all potential flood risk mitigation plans. iPDM calculates the ecosystem value predicted by all feasible combinations of flood control structures (FCS) considering environmental, social and economical asset criteria. A multi-criteria decision analytical model evaluates the benefits of all FCS portfolios at the basin scale weighted by stakeholder preferences for assets' criteria as ecosystem services. The risk model is based on a maximum entropy model (MaxEnt) that predicts the flood susceptibility, the risk of floods based on the exceedance probability distribution, and its most important drivers. Information theoretic global sensitivity and uncertainty analysis is used to select the simplest and most accurate model based on a flood return period. A stochastic optimization algorithm optimizes the ecosystem value constrained to the budget available and provides Pareto frontiers of optimal FCS plans for any budget level. Pareto optimal solutions maximize FCS diversity and minimize the criticality of floods manifested by the scaling exponent of the Pareto distribution of flood size that links management and hydrogeomorphological patterns. The proposed model is tested on the 17,000 $km^2$ Tiber river basin in Italy. iPDM allows stakeholders to identify optimal FCS plans in river basins for a comprehensive evaluation of flood effects under future ecosystem trajectories.
    Date: 2019–06–27
  3. By: Xiao, Tim
    Abstract: This article presents a new model for valuing financial contracts subject to credit risk and collateralization. Examples include the valuation of a credit default swap (CDS) contract that is affected by the trilateral credit risk of the buyer, seller and reference entity. We show that default dependency has a significant impact on asset pricing. In fact, correlated default risk is one of the most pervasive threats in financial markets. We also show that a fully collateralized CDS is not equivalent to a risk-free one. In other words, full collateralization cannot eliminate counterparty risk completely in the CDS market.
    Date: 2019–11–01
  4. By: Junjie Hu; Wolfgang Karl H\"ardle; Weiyu Kuo
    Abstract: Among all the emerging markets, the cryptocurrency market is considered the most controversial and simultaneously the most interesting one. The visibly significant market capitalization of cryptos motivates modern financial instruments such as futures and options. Those will depend on the dynamics, volatility, or even the jumps of cryptos. In this paper, the risk characteristics for Bitcoin are analyzed from a realized volatility dynamics view. The realized variance is estimated with the corrected threshold jump components, realized semi-variance, and signed jumps. Our empirical results show that the BTC is far riskier than any of the other developed financial markets. Up to 68% of the days are identified to be entangled with jumps. However, the discontinuities do not contribute to the variance significantly. The full-sample fitting suggests that future realized variance has a positive relationship with downside risk and a negative relationship with the positive jump. The rolling-window out-of-sample forecasting results reveal that the forecasting horizon plays an important role in choosing forecasting models. For the long horizon risk forecast, explicitly modeling jumps and signed estimators improve forecasting accuracy and give extra utility up to 19 bps annually, while the HAR model without accounting jumps or signed estimators suits the short horizon case best. Lastly, a simple equal-weighted portfolio of BTC not only significantly reduces the size and quantity of jumps but also gives investors higher utility in short horizon case.
    Date: 2019–12
  5. By: Kathrin Glau; Ricardo Pachon; Christian P\"otz
    Abstract: We introduce a new method to calculate the credit exposure of European and path-dependent options. The proposed method is able to calculate accurate expected exposure and potential future exposure profiles under the risk-neutral and the real-world measure. Key advantage of is that it delivers an accuracy comparable to a full re-evaluation and at the same time it is faster than a regression-based method. Core of the approach is solving a dynamic programming problem by function approximation. This yields a closed form approximation along the paths together with the option's delta and gamma. The simple structure allows for highly efficient evaluation of the exposures, even for a large number of simulated paths. The approach is flexible in the model choice, payoff profiles and asset classes. We validate the accuracy of the method numerically for three different equity products and a Bermudan interest rate swaption. Benchmarking against the popular least-squares Monte Carlo approach shows that our method is able to deliver a higher accuracy in a faster runtime.
    Date: 2019–12
  6. By: Hyungbin Park; Jonghwa Park
    Abstract: This paper discusses the short-maturity behavior of Asian option prices and hedging portfolios. We consider the risk-neutral valuation and the delta value of the Asian option having a H\"older continuous payoff function in a local volatility model. The main idea of this analysis is that the local volatility model can be approximated by a Gaussian process at short maturity $T.$ By combining this approximation argument with Malliavin calculus, we conclude that the short-maturity behaviors of Asian option prices and the delta values are approximately expressed as those of their European counterparts with volatility $$\sigma_{A}(T):=\sqrt{\frac{1}{T^3}\int_0^T\sigma^2(t,S_0)(T-t)^2\,dt}\,,$$ where $\sigma(\cdot,\cdot)$ is the local volatility function and $S_0$ is the initial value of the stock. In addition, we show that the convergence rate of the approximation is determined by the H\"older exponent of the payoff function. Finally, the short-maturity asymptotics of Asian call and put options are discussed from the viewpoint of the large deviation principle.
    Date: 2019–11
  7. By: Kogler, Michael
    Abstract: How can tax policy improve financial stability? Recent studies point to large potential stability gains from a reform that eliminates the debt bias in corporate taxation. It is well known that such a reform reduces bank leverage. This paper analyzes a novel, complementary channel: bank risk taking. We model the portfolio choice of banks under moral hazard and thereby emphasize the “incentive function” of equity. We find that (i) an allowance for corporate equity (ACE) and a lower corporate tax rate discourage risk taking and offer stability and welfare gains, (ii) a revenue-neutral introduction of the ACE unambiguously improves financial stability, and (iii) capital regulation and deposit insurance importantly influence the tax sensitivities of bank risk taking.
    Keywords: Corporate taxation, tax reform, banking, risk taking, financial stability
    JEL: G21 G28 H25
    Date: 2019–12
  8. By: Eric Benhamou; Beatrice Guez; Nicolas Paris1
    Abstract: Omega ratio, defined as the probability-weighted ratio of gains over losses at a given level of expected return, has been advocated as a better performance indicator compared to Sharpe and Sortino ratio as it depends on the full return distribution and hence encapsulates all information about risk and return. We compute Omega ratio for the normal distribution and show that under some distribution symmetry assumptions, the Omega ratio is oversold as it does not provide any additional information compared to Sharpe ratio. Indeed, for returns that have elliptic distributions, we prove that the optimal portfolio according to Omega ratio is the same as the optimal portfolio according to Sharpe ratio. As elliptic distributions are a weak form of symmetric distributions that generalized Gaussian distributions and encompass many fat tail distributions, this reduces tremendously the potential interest for the Omega ratio.
    Date: 2019–10
  9. By: Sascha Tobias Wengerek (University of Paderborn); Benjamin Hippert (University of Paderborn); André Uhde (University of Paderborn)
    Abstract: Employing a unique and hand-collected dataset of securitization transactions by European banks, this paper analyzes the relationship between true sale loan securitization and the issuing banks’ non-performing loans to total assets ratios (NPLRs). We provide evidence for an NPLR-reducing effect during the boom phase of securitizations suggesting that banks (partly) securitized NPLs as the most risky junior tranche. In contrast, we find the reverse effect during the crises period indicating that issuing banks demonstrated `skin in the game'. A variety of sensitivity analyses provides further important implications for the vital debate on reducing NPL exposures and regulating securitization markets.
    Keywords: European Banking, Non-performing Loans, Risk Allocation, Securitization
    JEL: G21 G28 G32
    Date: 2019–09
  10. By: Waweru, Caroline; Nyikal, Rose; Busienei, John
    Keywords: Risk and Uncertainty, Livestock Production/Industries
    Date: 2019–09
  11. By: Ryuichiro Izumi (Department of Economics, Wesleyan University)
    Abstract: What are the effects of banks holding opaque, complex assets? Should regulators require bank assets to be more transparent? I study these questions in a model of fnancial intermediation where opacity determines how long the realized value of an asset remains unknown. By allowing a bank to sell assets before the realization is known, opacity provides insurance to the bank's depositors. However, higher opacity also increases depositors' incentives to join a bank run. In choosing the level of opacity, therefore, a bank faces a trade-off between providing insurance and increasing fragility. If depositors can accurately observe the level of opacity, banks will choose the socially-effcient level. If depositors are unable to observe this choice, however, banks will have an incentive to become overly opaque and regulation to limit opacity can improve welfare.
    Keywords: Opacity, Bank runs, Insurance, Banking regulation
    JEL: G01 G21 G28
    Date: 2019–12
  12. By: Kam Yan Hui, Jane Sarah
    Abstract: The objective of a business is to earn profit and it should be acclaimed that profitability alone is not very helpful in determining the efficiency and performance of the business firm unless it is related to other factors such as risk. In the context of business proliferation, we are witnessing an unprecedented variegation of risk situations and uncertainty in the business world where the entire existence of an organization are being akin to risk. Each profit earns are associated to numerous of risk and every company consist different types of risks. Nevertheless, market risk and operational risk are very impactful to every business, as it directly influence business profitability and if it doesn’t manage well, the business will come into a drastic problem. This study was presented to examine the outcomes of market risk and operational risk on profitability of Skechers from year 20014-2018. This study in the end halt that effective risk management is very fundamental for business insight and growth.
    Keywords: Market Risk, Operational Risk, Profitability
    JEL: G3 G32 O16
    Date: 2019–11–18
  13. By: Patrice ABRY (Université de Lyon (UdL)); Cécile Bastidon (Université de Toulon et du Var (UTLN)); Pierre BORGNAT (Université de Lyon (UdL)); Pablo Jensen (Institut des Systèmes Complexes Rhône-alpes); Antoine Parent (Observatoire français des conjonctures économiques)
    Abstract: Assessing world-wide financial integration constitutes a recurrent challenge in macroeconometrics, often addressed by visual inspections searching for data patterns. Econophysics literature enables us to build complementary, data-driven measures of financial integration using graphs. The present contribution investigates the potential and interests of a novel 3-step approach that combines several state-of-the-art procedures to i) compute graph-based representations of the multivariate dependence structure of asset prices time series representing the financial states of 32 countries world-wide (1955-2015); ii) compute time series of 5 graph-based indices that characterize the time evolution of the topologies of the graph; iii) segment these time evolutions in piece-wise constant eras, using an optimization framework constructed on a multivariate multi-norm total variation penalized functional. The method shows first that it is possible to find endogenous stable eras of world-wide financial integration. Then, our results suggest that the most relevant globalization eras would be based on the historical patterns of global capital flows, while the major regulatory events of the 1970s would only appear as a cause of sub-segmentation.
    Keywords: Graph topology; Time segmentation; Multivariate time series; Econophysics
    Date: 2019–10
  14. By: Koichi Miyamoto; Kenji Shiohara
    Abstract: It is known that quantum computers can speed up Monte Carlo simulation compared to classical counterparts. There are already some proposals of application of the quantum algorithm to practical problems, including quantitative finance. In many problems in finance to which Monte Carlo simulation is applied, many random numbers are required to obtain one sample value of the integrand, since those problems are extremely high-dimensional integrations, for example, risk measurement of credit portfolio. This leads to the situation that the required qubit number is too large in the naive implementation where a quantum register is allocated per random number. In this paper, we point out that we can reduce qubits keeping quantum speed up if we perform calculation similar to classical one, that is, estimate the average of integrand values sampled by a pseudo-random number generator (PRNG) implemented on a quantum circuit. We present not only the overview of the idea but also concrete implementation of PRNG and application to credit risk measurement. Actually, reduction of qubits is a trade-off against increase of circuit depth. Therefore full reduction might be impractical, but such a trade-off between speed and memory space will be important in adjustment of calculation setting considering machine specs, if large-scale Monte Carlo simulation by quantum computer is in operation in the future.
    Date: 2019–11
  15. By: Elsner, James B.; Schroder, Zoe
    Abstract: Empirical studies have led to improvements in evaluating and quantifying the tornado threat. However more work is needed to put the research onto a solid statistical foundation. Here the authors begin to build this foundation by introducing and then demonstrating a statistical model to estimate damage rating probabilities. A goal is to alert researchers to available statistical technology for improving severe weather warnings. The model is cumulative logistic regression and the parameters are determined using Bayesian inference. The model is demonstrated by estimating damage rating probabilities from values of known environmental factors on days with many tornadoes in the United States. Controlling for distance-to-nearest town/city, which serves as a proxy variable for damage target density, the model quantifies the chance that a particular tornado will be assigned any damage rating given specific environmental conditions. Under otherwise average conditions the model estimates a 65% chance that a tornado occurring in a city or town will be rated EF0 when bulk shear is weak (10 m/s). This probability drops to 38% when the bulk shear is strong (40 m/s). The model quantifies the corresponding increases in the chance of the same tornado receiving higher damage ratings. Quantifying changes to the probability distribution on the ordered damage rating categories is a natural application of cumulative logistic regression.
    Date: 2019–07–18
  16. By: Alicia H. Munnell; Gal Wettstein; Wenliang Hou
    Abstract: Unlike defined benefit pensions that provide participants with steady benefits for as long as they live, 401(k) plans and Individual Retirement Accounts (IRAs) provide little guidance on how to turn accumulated assets into income. As a result, retirees have to decide how much to withdraw each year and face the risk of either spending too quickly and outliving their resources or spending too conservatively and consuming too little. Surveys of individuals’ plans and several recent studies suggest that people will not draw down their accumulations for fear that they will exhaust their money and be unable to cover end-of-life health care costs. They also must consider how to invest their savings after retirement. These are difficult decisions. Better strategies are possible that will ensure a higher level of lifetime income, reduce the likelihood that people will outlive their resources, and alleviate some of the anxiety associated with post-retirement investing. Workers could use a portion of their 401(k) and IRA assets to purchase an immediate annuity that pays a fixed amount throughout their lives, typically starting at age 65. Or they could purchase an advanced life deferred annuity (ALDA) that requires a smaller share of accumulated assets and begins payments at a later age like 85. Alternatively, they could use their assets to delay claiming Social Security – essentially purchasing an inflation-indexed annuity. Right now, none of these three options is commonly used. Very few workers choose to purchase immediate or deferred annuities (the first two options). And few retirees appear to be deferring claiming in order to receive the maximum annuity income from Social Security – most people simply retire earlier and claim immediately. Increasing annuitization in a meaningful way would require embedding annuities in 401(k) plans, with annuitization as the default. Recent proposed federal legislation, such as the SECURE Act (Setting Every Community Up for Retirement Enhancement), encourages plan sponsors to offer annuities in their plans by establishing a fiduciary safe harbor when specific statutory conditions are followed in selecting an insurance company. This legislation does not address, however, the question of defaults or the possibility of using 401(k) assets to purchase additional Social Security benefits. Moving forward on these fronts would require some consensus about the appropriate share of 401(k) assets to be annuitized and the best method for annuitizing them. To address these issues, this paper compares the level of lifetime utility generated by alternative annuitization approaches – immediate annuities, deferred annuities, and additional Social Security through delayed claiming. The analysis also tests different assumptions for the share of initial wealth that participants use to purchase these products.
    Date: 2019–10
  17. By: Jaehyuk Choi; Lixin Wu
    Abstract: This study presents new analytic approximations of the stochastic-alpha-beta-rho (SABR) model. Unlike existing studies that focus on the equivalent Black-Scholes (BS) volatility, we instead derive the equivalent volatility under the constant-elasticity-of-variance (CEV) model, which is the limit of the SABR model when the volatility of volatility approaches 0. Numerical examples demonstrate the accuracy of the CEV volatility approximation for a wide range of parameters. Moreover, in our approach, arbitrage occurs at a lower strike price than in existing BS-based approximations.
    Date: 2019–11
  18. By: Pierre Durand
    Abstract: In this paper, we investigate the role played by the TCR and LCR among determinants of banks' profitability. To this end, using Random Forest regressions and a large dataset of banks' balance sheet variables, we assess the impact and predicting power of Basel III capital and liquidity ratios. Our results confirm the trade-off theory of the capital structure: banks have an optimal capital ratio below which the relation between capital and profitability is positive. On average, this optimum falls between 15% and 20%. Furthermore, we show that LCR has a positive, but weak, effect on profitability. Overall, our findings illustrate the fact that regulatory ratios do not constitute binding conditions for banks' performance.
    Keywords: Basel III, Capital ratio, Liquidity ratio, Banks' profitability, Random Forest regressions.
    JEL: C44 G21 G28
    Date: 2019
  19. By: Marcin Dec (Group for Research in Applied Economics (GRAPE))
    Abstract: We review the developments and practice of the discounted cash-flow method in finance with an intermediate goal of presenting parsimonious methods of generating density valuation rather than point forecasts. Our ultimate aim is to select, propose and discuss some density-based risk measures that may be used by appraisers and investment analysts when conducting DCF valuation for broad group of heterogeneous (by risk appetite) final users or investors. Such a toolbox may be applied directly by the latter group without necessity to rely on aggregated point valuations and recommendations.
    Keywords: discounted cash-flows, density forecasts, downside risk measures, Monte Carlo simulation
    JEL: G17 G12 G11
    Date: 2019
  20. By: Ahmed, Osama; Sallan, Walid
    Abstract: Egypt is considered a higher wheat importer in the world, and given the reality that futures prices lead spot prices that makes the Egyptian prices vulnerable to future wheat markets. This study assesses the relationship between Egyptian flour prices and future wheat prices associated with Paris (MATIF) and USA (CBOT). Markov switching-vector error correction methods are used to estimate two regimes by splitting the sample by high and low volatility regimes. This study also examines the dynamic conditional correlation using Asymmetric-Dynamic Conditional Correlation with Multivariate Generalized Autoregressive Conditional Heteroscedasticity (DCC-GARCH). Results suggest a high volatility regime observes especially during the extreme market events; in the time of the food crisis 2007/2008 and 2010 as well as after two revaluations in Egypt in 2011 and 2013 and during the economic reforms in 2016, mainly in the range from 0 to 0.4 before crisis, while the fluctuations are higher in the time of food crisis, revolutions and economic reform that in the range from -0.2 to 0.8. This implies that the negative impact of the economic and political crisis on the consumer prices. The results provide evidence of symmetric volatility spillovers from future markets to Egyptian wheat market. Results from impulse response functions indicate that shock by 1% in the future markets will lead to positive shock in the flour spot market in Egypt.
    Keywords: Demand and Price Analysis, International Relations/Trade
    Date: 2019–04
  21. By: Tembei, Mbah Leslie; Molua, Ernest L.; Akamin, Ajapnwa
    Keywords: Livestock Production/Industries, Risk and Uncertainty
    Date: 2019–09
  22. By: Kaufmane, Dace; Eglite, Aija
    Abstract: As project management practiceexpandedin national and nongovernmental organizations in Latvia, the role of various project-related activities increased. Latvia is a Member State of the EU that obtains EU funding and implements a lot of EU co-funded projects in various industries of the national economy, including rural tourism. In Latvia, rural tourism is defined as a kind of tourism aimed at offering tourists opportunities to rest or use tourist accommodation facilities in countryside based on local social, cultural and natural resources. Implementing a project involves potential problems or risks that can affect the pace of the project implementation. Rural tourism projects are exposed to both industry-specific risks and classical financial, technological, administrative, human resource, fraud and legal risks. National institutions, associations and countless private entrepreneurs that have received EU funding for their project proposals under support programsdeal with project implementation. The association PierigasPartneriba, the administrations of Kurzeme planning region and Vidzemeplanning region, the association Rural Traveler etc. could be referred to as one of the largest project implementers in terms of amount of funding involved. Risk management is a component of project management that deals with a successful and effective project implementation pace; therefore, it is important to identify how to minimize every potential risk. The aim of the paper is to identify risk management problems and solutions in rural tourism in Latvia based onananalysis of relevant research investigations. A content analysis revealed main risk management problems and solutions to the problems. A solution could be found to most of the problems with rural tourism projects even if a risk occurs unexpectedly, and a solution is easier to find to a timely identified risk, as well as more time is available for finding the solution.
    Keywords: Risk and Uncertainty
    Date: 2019–04

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