nep-rmg New Economics Papers
on Risk Management
Issue of 2019‒12‒23
twenty-two papers chosen by

  1. Does Predictive Ability of an Asset Price Rest in 'Memory'? Insights from a New Approach. By Mohamed CHIKHI; Claude DIEBOLT; Tapas MISHRA
  2. Optimal Value-at-Risk Disclosure By Seixas, Mário; Barbosa, António
  3. A Dynamic MST- deltaCovar Model Of Systemic Risk In The European Insurance Sector By Anna Denkowska; Stanis{\l}aw Wanat
  4. Loan Insurance, Market Liquidity, and Lending Standards By Toni Ahnert; Martin Kuncl
  5. Emergence of correlations between securities at short time scales By Sebastien Valeyre; Denis Grebenkov; Sofiane Aboura
  6. Sub-sampling and other considerations for efficient risk estimation in large portfolios By Michael B. Giles; Abdul-Lateef Haji-Ali
  7. Brexit Risk Implied by the SABR Martingale Defect in the EUR-GBP Smile By Petteri Piiroinen; Lassi Roininen; Martin Simon
  8. Optimal insurance with adverse selection and comonotonic background risk By David Alary; Franck Bien
  9. CENTER-OUTWARD QUANTILES AND THE MEASUREMENT OF MULTIVARIATE RISK By Jan Bierlant; Sven Buitendag; Eustasio Del Barrio; Marc Hallin
  10. Measuring “Dark Matter” in Asset Pricing Models By Hui Chen; Winston Wei Dou; Leonid Kogan
  11. Growth of Large Farms and Financial Risk in U.S. Agriculture By Burns, Christopher
  12. Malta; Financial Sector Assessment Program-Technical Note-Risk Analysis By International Monetary Fund
  13. Malta; Financial Sector Assessment Program-Technical Note-Insurance and Securities Sector Supervision By International Monetary Fund
  14. Pengaruh Kecukupan Modal dan Penyaluran Kredit Terhadap Profitabilitas Perbankan By Razak, Nurlaely; Sjahruddin, Herman; Astuti, Niken Probondani; Syakhrun, A. Muh.
  15. Predicting Insurance Demand from Risk Attitudes By Johannes G. Jaspersen; Marc A. Ragin; Justin R. Sydnor
  16. The Role of Crop Insurance in Agricultural Risk Mitigation By Barbe, Martin
  17. Ukraine; Technical Assistance Report-Fiscal Decentralization and Legal Framework for Fiscal Risk Management and Medium-term Budgeting By International Monetary Fund
  18. The Impacts of Interest Rate on Stock Market: Empirical Evidence from Dhaka Stock Exchange By Alam, Md. Mahmudul; Uddin, Gazi Salah
  19. Ukraine; Technical Assistance Report-Medium-Term Budget Framework and Fiscal Risk Statement By International Monetary Fund
  20. The industrial impact of economic uncertainty shocks in Australia By Burrell, Hamish; Vespignani, Joaquin

  1. By: Mohamed CHIKHI; Claude DIEBOLT; Tapas MISHRA
    Abstract: Despite an inherent share of unpredictability, asset prices such as in stock and Bitcoin markets are naturally driven by significant magnitudes of memory; depending on the strength of path dependence, prices in such markets can be (at least partially) predicted. Being able to predict asset prices is always a boon for investors, more so, if the forecasts are largely unconditional and can only be explained by the series’ own historical trajectories. Although memory dynamics have been exploited in forecasting stock prices, Bitcoin market pose additional challenge, because the lack of proper financial theoretic model limits the development of adequate theory-driven empirical construct. In this paper, we propose a class of autoregressive fractionally integrated moving average (ARFIMA) model with asymmetric exponential generalized autoregressive score (AEGAS) errors to accommodate a complex interplay of ‘memory’ to drive predictive performance (an out-of-sample forecasting). Our conditional variance includes leverage effects, jumps and fat tail-skewness distribution, each of which affects magnitude of memory both the stock and Bitcoin price system would possess enabling us to build a true forecast function. We estimate several models using the Skewed Student-t maximum likelihood and find that the informational shocks in asset prices, in general, have permanent effects on returns. The ARFIMA-AEGAS is appropriate for capturing volatility clustering for both negative (long Value-at-Risk) and positive returns (short Value-at-Risk). We show that this model has better predictive performance over competing models for both long and/or some short time horizons. The predictions from this model beats comfortably the random walk model. Accordingly, we find that the weak efficiency assumption of financial markets stands violated for all price returns studied over longer time horizon.
    Keywords: Asset price; Forecasting; Memory; ARFIMA-AEGAS; Leverage effects and jumps; Market Efficiency.
    JEL: C14 C58 C22 G17
    Date: 2019
  2. By: Seixas, Mário; Barbosa, António
    Abstract: Abstract In 1995, the Basel Accords introduced an alternative method to compute the market risk charge through the use of a risk model developed internally by the financial institution. These internal models, based on the Value-at-Risk (VaR), follow certain rules that are defined under the Basel Accords. From this moment on, risk analysts and financial academics focused their attentions on how to accurately estimate the VaR in order to reduce the regulatory capital. However, considering the market risk framework defined in the Basel Accords, the best strategy to optimize the regulatory capital may not lie in truthfully disclosing an accurate VaR estimation. In this study, we propose to solve, through dynamic programming, for the optimal policy function for disclosing the reported VaR based on the estimated value that minimizes the daily capital charge. This policy function will provide the optimal percentage of the estimated 1-day VaR that should be disclosed, taking into account the impact that this disclosure decision will have in future capital charges, by managing the rules defined in the Basel Accords. Our goal is to prove that truthful disclosure of an accurately estimated VaR is suboptimal. The main results from our investigation show that using the optimal reporting strategy leads to an average daily reduction in the capital requirements of 4.32% in a simulated environment, compared with a normal strategy of always truthfully disclosing the estimated 1-day VaR, and leads to an average daily saving of 7.22% when applied to our S&P500 test portfolio.
    Keywords: Value-at-Risk, Regulatory Capital, Market Risk Charge, Optimal Disclosure, Dynamic Programming
    JEL: G11 G17 G28 G32
    Date: 2019
  3. By: Anna Denkowska; Stanis{\l}aw Wanat
    Abstract: This work is an answer to the EIOPA 2017 report. It follows from the latter that in order to assess the potential systemic risk we should take into account the build-up of risk and in particular the risk that arises in time, as well as the interlinkages in the financial sector and the whole economy. Our main tools used to analyse the systemic risk dynamics in the European insurance sector during the years 2005-2019 are the topological indices of minimum spanning trees (MST) and the deltaCoVaR measure. We address the following questions: 1) What is the contribution to systemic risk of each of the 28 largest European insurance companies whose list includes also those appearing on the G-SIIs list? 2) Does the analysis of the deltaCoVaR of those 28 insurance companies and the conclusions we draw agree with the our claims from our latest article [Wanat S., Denkowska A. 2019]. In clear: does the most important contribution to systemic risk come from the companies that have the highest betweenness centrality or the highest degree in the MST obtained?
    Date: 2019–11
  4. By: Toni Ahnert; Martin Kuncl
    Abstract: Third parties often assume default risk at loan origination in return for a fee. Insurance, various guarantees and external credit enhancements protect the owner of the loan against borrower default. Governments often assume such default risk through guarantees for various types of loans, including mortgages, student loans and small business loans. The widespread use of loan default insurance raises important questions: What is the impact of loan insurance on secondary market liquidity and on lending standards in primary markets? And is there a role for government intervention? We propose a simple model of lending where borrowers are screened at loan origination and lenders can learn about loan quality over time. Lenders can transfer the loan default risk to outside financiers at loan origination through loan insurance. Alternatively, they can transfer the default risk after a liquidity shock or after learning about loan quality by selling the loan in the secondary market. The model features a trade-off between secondary market liquidity and lending standards. The timing of risk transfer affects this trade-off. Loan insurance lowers the lending standards but improves the liquidity in secondary markets with a net improvement in welfare. Since lenders do not take into account the positive benefit of insurance on the liquidity in the market for uninsured loans, there is insufficient loan insurance in equilibrium. This implies that a regulator can improve welfare by subsidizing loan default insurance. We also consider a policy of outright loan purchases and show that while it is optimal to have it as an option to rule out inferior equilibria, only a policy of insurance subsidy is optimally used in equilibrium.
    Keywords: Financial Institutions; Financial markets; Financial system regulation and policies
    JEL: G01 G21 G28
    Date: 2019–12
  5. By: Sebastien Valeyre; Denis Grebenkov (LPMC - Laboratoire de physique de la matière condensée - X - École polytechnique - CNRS - Centre National de la Recherche Scientifique); Sofiane Aboura (CEREG - Centre de Recherche sur la gestion et la Finance - DRM UMR 7088 - Université Paris-Dauphine)
    Abstract: The correlation matrix is the key element in optimal portfolio allocation and risk management. In particular, the eigenvectors of the correlation matrix corresponding to large eigenvalues can be used to identify the market mode, sectors and style factors. We investigate how these eigenvalues depend on the time scale of securities returns in the U.S. market. For this purpose, one-minute returns of the largest 533 U.S. stocks are aggregated at different time scales and used to estimate the correlation matrix and its spectral properties. We propose a simple lead-lag factor model to capture and reproduce the observed timescale dependence of eigenvalues. We reveal the emergence of several dominant eigenvalues as the time scale increases. This important finding evidences that the underlying economic and financial mechanisms determining the correlation structure of securities depend as well on time scales.
    Keywords: Time scale dependence,Security returns,Correlation matrix,Lead–lag effect,Transaction impact,Market inefficiency
    Date: 2019
  6. By: Michael B. Giles; Abdul-Lateef Haji-Ali
    Abstract: Computing risk measures of a financial portfolio comprising thousands of options is a challenging problem because (a) it involves a nested expectation requiring multiple evaluations of the loss of the financial portfolio for different risk scenarios and (b) evaluating the loss of the portfolio is expensive and the cost increases with its size. In this work, we look at applying Multilevel Monte Carlo (MLMC) with adaptive inner sampling to this problem and discuss several practical considerations. In particular, we discuss a sub-sampling strategy that results in a method whose computational complexity does not increase with the size of the portfolio. We also discuss several control variates that significantly improve the efficiency of MLMC in our setting.
    Date: 2019–12
  7. By: Petteri Piiroinen; Lassi Roininen; Martin Simon
    Abstract: We construct a data-driven statistical indicator for quantifying the tail risk perceived by the EURGBP option market surrounding Brexit-related events. We show that under lognormal SABR dynamics this tail risk is closely related to the so-called martingale defect and provide a closed-form expression for this defect which can be computed by solving an inverse calibration problem. In order to cope with the the uncertainty which is inherent to this inverse problem, we adopt a Bayesian statistical parameter estimation perspective. We probe the resulting posterior densities with a combination of optimization and adaptive Markov chain Monte Carlo methods, thus providing a careful uncertainty estimation for all of the underlying parameters and the martingale defect indicator. Finally, to support the feasibility of the proposed method, we provide a Brexit "fever curve" for the year 2019.
    Date: 2019–12
  8. By: David Alary (LERNA - Laboratoire d'Economie des ressources Naturelles - INRA - Institut National de la Recherche Agronomique); Franck Bien (LEDa - Laboratoire d'Economie de Dauphine - CNRS - Centre National de la Recherche Scientifique - IRD - Institut de Recherche pour le Développement - Université Paris-Dauphine)
    Abstract: In this note, we consider an adverse selection problem involving an insurance market à la Rothschild-Stiglitz. We assume that part of the loss is uninsurable as in the case with health care or environmental risk. We characterize sufficient conditions such that adverse selection by itself does not distort competitive insurance contracts. A sufficiently large uninsurable loss provides an incentive to high-risk policy holders not to mimic low-risk policy holders without distorting the optimal coverage.
    Keywords: Adverse Selection,Background risk,Optimal Contract
    Date: 2019–12–02
  9. By: Jan Bierlant; Sven Buitendag; Eustasio Del Barrio; Marc Hallin
    Abstract: All multivariate extensions of the univariate theory of risk measurement run into the same fundamental problem of the absence, in dimension d > 1, of a canonical ordering of Rd. Based on measure transportation ideas, several attempts have been made recently in the statistical literature to overcome that conceptual difficulty. In Hallin (2017), the concepts of center-outward distribution and quantile functions are developed as generalisations of the classical univariate concepts of distribution and quantile functions, along with their empirical versions. The center-outward distribution function F± is a homeomorphic cyclically monotone mapping from Rd \ F−1 ± (0) to the open punctured unit ball Bd \ {0}, while its empirical counterpart F(n) ± is a cyclically monotone mapping from the sample to a regular grid over Bd. In dimension d = 1, F± reduces to 2F − 1, while F(n) ± generates the same sigma-field as traditional univariate ranks. The empirical F(n) ± ,however, involves a large number of ties, which is impractical in the context of risk measurement. We therefore propose a class of smooth approximations Fn,ξ (ξ a smoothness index) of F(n) ± as an alternative to the interpolation developed in del Barrio et al. (2018). This approximation allows for the computation of some new empirical risk measures, based either on the convex potential associated with the proposed transports, or on the volumes of the resulting empirical quantile regions. We also discuss the role of such transports in the evaluation of the risk associated with multivariate regularly varying distributions. Some simulations and applications to case studies illustrate the value of the approach.
    Date: 2019–12
  10. By: Hui Chen; Winston Wei Dou; Leonid Kogan
    Abstract: We introduce an information-based fragility measure for GMM models that are potentially misspecified and unstable. A large fragility measure signifies a GMM model's lack of internal refutability (weak power of specification tests) and external validity (poor out-of-sample fit). The fragility of a set of model-implied moment restrictions is tightly linked to the quantity of additional information the econometrician can obtain about the model parameters by imposing these restrictions. Our fragility measure can be computed at little cost even for complex dynamic structural models. We illustrate its applications via two models: a rare-disaster risk model and a long-run risk model.
    JEL: C52 D81 E32 G12
    Date: 2019–11
  11. By: Burns, Christopher
    Keywords: Agricultural Finance, Farm Management
    Date: 2019–02
  12. By: International Monetary Fund
    Abstract: The Malta FSAP stress testing exercise took place immediately following the IMF’s 2018 Euro Area FSAP and concurrently with the 2018 stress test of the European Banking Authority (EBA). A comprehensive set of stress tests and interconnectedness analyses were conducted to assess the resilience of Malta’s financial system and shed light on potential vulnerabilities, complementing the euro area FSAP and EBA exercises by tailoring the scope and depth to the Maltese financial system. The solvency stress test covered 11 banks representing 93 percent of the banking sector assets (excluding foreign branches) and diverse business models.
    Keywords: Financial crises;Bank credit;Financial institutions;Macroprudential policies and financial stability;Financial services;ISCR,CR,domestic bank,MFSA,large exposure,solvency,cross-sectoral
    Date: 2019–11–21
  13. By: International Monetary Fund
    Abstract: The insurance sector in Malta is relatively large and sophisticated. The sector has grown significantly since Malta’s accession to the European Union (EU) in 2004, and its total assets amounted to €11.9 billion (105 percent of gross domestic product (GDP)) at end-2017. Its sophisticated structure is evidenced by the presence of four professional reinsurers, eight captive insurers, 14 protected cell companies (PCC), and one reinsurance special purpose vehicle (SPV). The life insurance and reinsurance industries are highly concentrated.
    Keywords: Financial crises;Financial regulation and supervision;Macroprudential policies and financial stability;Financial services;Economic conditions;ISCR,CR,MFSA,security sector,insurer,regulated entity,insurance group
    Date: 2019–11–21
  14. By: Razak, Nurlaely; Sjahruddin, Herman; Astuti, Niken Probondani; Syakhrun, A. Muh.
    Abstract: Riset ini mencoba mengeksplorasi pengaruh Kecukupan Modal dan Penyaluran Kredit terhadap Profitabilitas pada PT. Bank Negara Indonesia Tbk., PT. Bank Rakyat Indonesia Tbk, dan PT. Bank Tabungan Negara Tbk, serta PT. Bank Mandiri Tbk Tahun 2011-2014. Pendekatan penelitian ini menggunakan pendekatan kuantitatif. Pengambilan data pada penelitian ini dilaksanakan pada pusat informasi pasar modal Makassar perwakilan Bursa Efek Indonesia. Data dihitung secara proporsional dalam bentuk persentase untuk setiap triwulannya, sehingga jumlah data yang akan dianalisis sebanyak 64 unit data yang sekaligus digunakan sebagai sampel. Hasil analisis regresi ganda memberikan bukti bahwa Kecukupan Modal (Capital Adequacy Ratio) beperngaruh positif tidak signifikan dan Penyaluran Kredit berpengaruh positif signifikan terhadap Profitabilitas
    Date: 2017–11–18
  15. By: Johannes G. Jaspersen; Marc A. Ragin; Justin R. Sydnor
    Abstract: Can measured risk attitudes and associated structural models predict insurance demand? In an experiment (n = 1,730), we elicit measures of utility curvature, probability weighting, loss aversion, and preference for certainty and use them to parameterize seventeen common structural models (e.g., expected utility, cumulative prospect theory). Subjects also make twelve insurance choices over different loss probabilities and prices. The insurance choices show coherence and some correlation with various risk-attitude measures. Yet all the structural models predict insurance poorly, often less accurately than random predictions. Simpler prediction heuristics show more promise for predicting insurance choices across different conditions.
    JEL: D01 D81 G22
    Date: 2019–11
  16. By: Barbe, Martin
    Keywords: Agricultural Finance, Crop Production/Industries, Risk and Uncertainty
    Date: 2019–02
  17. By: International Monetary Fund
    Abstract: In the aftermath of Euromaidan revolution early 2014, the public demand for local selfgovernment and devolution of power, brought fiscal decentralization to the top of the reform agenda. As a result, a decentralization reform was introduced in late 2014, which helped to improve subnational government’s financial capacity, self-sufficiency, and flexibility. The reform resulted in an overall improvement of subnational government finances. Compared with 2014, own revenues of subnational governments increased, while current expenditure declined. This created additional space for capital expenditure, which almost doubled as a percent of GDP, from 2014 to 2016. Overall subnational governments recorded a combined surplus of 1.0 and 0.7 percent of GDP in 2015 and 2016, respectively. Despite these significant reforms and positive fiscal outcomes, Ukraine’s subnational finance system is still facing important challenges, which are described below, together with proposed measures to address them.
    Keywords: Fiscal policy;Treasury management;Tax policy;National budgets;Public finance;ISCR,CR,subnational,SNG,local budget,MTBF,expenditure responsibility
    Date: 2019–11–25
  18. By: Alam, Md. Mahmudul (Universiti Utara Malaysia); Uddin, Gazi Salah
    Abstract: Stock exchange and interest rate are two crucial factor of economic growth of a country. The impacts of interest rate on stock exchange provide important implications for monitory policy, risk management practices, financial securities valuation and government policy towards financial markets. This study seeks evidence supporting the existence of market efficiency on the Dhaka Stock Exchange (DSE) based on the daily general price index 1994 to 2005 and also shows empirical relationship between stock index and interest rate in Bangladesh based on monthly data from May 1992 to June 2004. Stationary of market return is tested and found DSE Index does not follow random walk model indicate DSE is not efficient in week form. The linear relationship between share price and interest rate, share price and growth of interest rate, growth of share price and interest rate, and growth of share price and growth of interest rate were determined through ordinary least-square (OLS) regression. For all of the cases, included and excluded outlier, it is found that Interest Rate has significant negative relationship with Share Price and Growth of Interest Rate also has significant negative relationship with Growth of Share Price. So if the interest rate is considerably controlled in Bangladesh than it will be the great benefit of Dhaka Stock Exchange through demand pull way of more investor in share market and supply pull way of more extensional investment of companies.
    Date: 2019–02–23
  19. By: International Monetary Fund
    Abstract: To strengthen the medium-term orientation of the budget, the authorities have committed to implement a full-fledged medium-term budget framework (MTBF) as part of their Public Financial Management Reform Strategy (2017–21). A pilot MTBF exercise was launched for the 2018 budget cycle, which will inform the roll-out of a more complete MTBF in 2019. The development of the MTBF has been supported by several FAD technical assistance missions in recent years, including in April this year. The 2018–20 draft Budget Declaration, submitted to the Cabinet of Ministers on June 1, is a major step forward in terms of establishing a medium-term orientation to budget planning. For the first time, important elements of a MTBF were included in the budget documentation, including the presentation of detailed medium-term macroeconomic and fiscal forecasts and expenditure ceilings for 2018–20.
    Keywords: Social security funds;Risk management;Financial statements;Fiscal policy;Fiscal space;ISCR,CR,SOEs,MTBF,KSU,cmu,medium-term
    Date: 2019–11–15
  20. By: Burrell, Hamish (Tasmanian School of Business & Economics, University of Tasmania); Vespignani, Joaquin (Tasmanian School of Business & Economics, University of Tasmania)
    Abstract: This study establishes the first empirical evidence of the impact of economic uncertainty shocks on industry-level investment, output and employment in Australia. We find the Construction and Financial and Insurance Services industries are the most impacted by a shock to economic uncertainty. Statistically significant declines are observed for investment, output and employment in the Construction industry, and in terms of magnitude, the declines in output and employment are the largest across all industries studied. Likewise, the Financial and Insurance Services industry experiences declines across investment, output and employment, and undergoes the largest decline in investment in comparison to all other industries examined. Economic uncertainty explains the most substantial portion of the variation in Financial and Insurance Services investment and output, highlighting the detrimental effect it has on the Financial and Insurance Services industry. Furthermore, Health Care and Social Assistance output and Professional, Scientific and Technical Services investment experience considerable declines, and in contrast, Public Administration and Safety is shown to be the least impacted industry.
    Keywords: economic uncertainty, economic uncertainty shocks, SVAR, Australian economy, Australian industries
    JEL: C10 C32 E00 E30
    Date: 2019
  21. By: Setyawati, Irma
    Abstract: The edition and the sale of the country's obligation letter/government bond give the impact to the banking sector, monetary, and fiscal, as well as the monitory authority. The objective of the study is to verify the impact of the edition and the sale of the government bond for lndonesia economy. The methods used are descriptive analysis of the collected data from library research and other resources related to the topic.The research found that the impact to the Capital Adequacy Ratio is getting better, the impact to the monetary is the increase of the money quantity as much as the interest payment given by the government conserving the government bond property, the impact to the monetary authority is the decrease of liquidity support and the increase of lndonesian Bank outstanding to the government. The sale of government bond gives fresh fund to the government which can be invested, to the productivity asset, to support the process of economy recovery Post print
    Date: 2017–11–24
  22. By: Setyawati, Irma; Alamsyah, Doni Purnama
    Abstract: This studies aims to determine the development of Capital Adequacy Ratio, Loan to Deposit Ratio, statutory reserves and net profit before tax in the year 2004-2008. This studies also determine the effect of Capital Adequacy Ratio, Loan to Deposit Ratio, statutory reserves to net income before taxes in PT Bank Mandiri, Tbk 2004-2008. Analysis tool is the multiple regression. The results of this study noted the development of Capital Adequacy Ratio, Loan to Deposit Ratio, statutory reserves and net profit in the year 2004-2008 is likely to increase every year (Post print)
    Date: 2017–11–25

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