nep-rmg New Economics Papers
on Risk Management
Issue of 2020‒01‒20
twenty-six papers chosen by
Stan Miles
Thompson Rivers University

  1. Optimal reinsurance for risk over surplus ratios By Erik B{\o}lviken; Yinzhi Wang
  2. Risk Management Maturity Assessment at Central Banks By Elie Chamoun; Nicolas Denewet; Antonio Manzanera; Sanjeev Matai
  3. Company-specific characteristics and the choice of hedge accounting for derivatives reporting: Malaysian case By Abdullah, Azrul Bin
  5. Systematic Banking Crises: The Relationship Between Concentration and Interbank Connections. By Andrea Calef
  6. The Accuracy of Agency Ratings By Bandyopadhyay, Arindam
  7. Pay-As-You-Drive Insurance Pricing Model By Safoora Zarei; Ali R. Fallahi
  8. Capital Flows at Risk: Taming the Ebbs and Flows By R. G Gelos; Lucyna Gornicka; Robin Koepke; Ratna Sahay; Silvia Sgherri
  9. How much is optimal reinsurance degraded by error? By Yinzhi Wang; Erik B{\o}lviken
  10. Set-Valued Risk Measures as Backward Stochastic Difference Inclusions and Equations By \c{C}a\u{g}{\i}n Ararat; Zachary Feinstein
  11. The Evolving Market for U.S. Sovereign Credit Risk By Nina Boyarchenko; Or Shachar
  12. Hedging problems for Asian options with transactions costs By Serguei Pergamenchtchikov; Alena Shishkova
  13. What’s in A(AA) Credit Rating? By Nina Boyarchenko; Or Shachar
  14. Valuation Risk Revalued By Oliver de Groot; Alexander W. Richter; Nathanial A. Throckmorton
  15. A comment on fitting Pareto tails to complex survey data By Rafael Wildauer; Jakob Kapeller
  16. Capital Flows and Bank Risk-Taking. By Pozo, Jorge
  17. The Impact of Liquidity Risk on Internal and External Factors By Abdul Latif, Nurul Atikah
  18. Audi AG’s Liquidity Risk and Corporate Governance By Lee, Mun Chen
  19. How do market movements affect options prices? By Krzysztof Echaust
  20. Understanding the dual formulation for the hedging of path-dependent options with price impact By Bruno Bouchard; Xiaolu Tan
  21. Corporate Governance and Liquidity Risk of Bank of China By YAN, SHIWEI
  22. Corporate Governance and Liquidity Risk of Starbucks Company By Lin, Lili
  23. Risk management for sovereign financing within a debt sustainability framework By Marialena Athanasopoulou; Andrea Consiglio; Aitor Erce; Angel Gavilan; Edmund Moshammer; Stavros A. Zenios
  24. Coalition-Proof Risk Sharing Under Frictions By Harold L. Cole; Dirk Krueger; George J. Mailath; Yena Park
  25. Relationship between Interest Rate and Stock Price: Empirical Evidence from Developed and Developing Countries By Alam, Md. Mahmudul; Uddi, Gazi Salah
  26. Risk Management and Value Creation: Empirical Findings from Government Linked Companies in Malaysia By Said, Jamaliah; Alam, Md. Mahmudul; Abdullah, Nik Herda Nik; Zulkarnain, Nur Nadiah

  1. By: Erik B{\o}lviken; Yinzhi Wang
    Abstract: Optimal reinsurance when Value at Risk and expected surplus is balanced through their ratio is studied, and it is demonstrated how results for risk-adjusted surplus can be utilized. Simplifications for large portfolios are derived, and this large-portfolio study suggests a new condition on the reinsurance pricing regime which is crucial for the results obtained. One or two-layer contracts now become optimal for both risk-adjusted surplus and the risk over expected surplus ratio, but there is no second layer when portfolios are large or when reinsurance prices are below some threshold. Simple approximations of the optimum portfolio are considered, and their degree of degradation compared to the optimum is studied which leads to theoretical degradation rates as the number of policies grows. The theory is supported by numerical experiments which suggest that the shape of the claim severity distributions may not be of primary importance when designing an optimal reinsurance program. It is argued that the approach can be applied to Conditional Value at Risk as well.
    Date: 2019–12
  2. By: Elie Chamoun; Nicolas Denewet; Antonio Manzanera; Sanjeev Matai
    Abstract: Effective risk management at central banks is best enabled by a sound framework embedded throughout the organization that supports the design and execution of risk management activities. To evaluate the risk management practices at a central bank, the Safeguards Assessments Division of the IMF’s Finance Department developed a tool that facilitates stocktaking of elements that are present and categorizes the function based on its maturity. Tailored recommendations are then provided to the central bank which provide a roadmap to advance the risk management function.
    Date: 2019–12–27
  3. By: Abdullah, Azrul Bin (Universiti Teknologi MARA, Perlis Branch, Arau Campus)
    Abstract: This study investigates the choice of applying hedge accounting among Malaysian listed companies in reporting their use of derivatives for hedging activities. Based on a sample of 300 Malaysian listed companies, we found that only 162 companies (54%) use derivatives to hedge their financial risk exposure and only 30% of those companies choose to apply hedge accounting. In addition, this study examines the relationship between company-specific characteristics and the choice to apply hedge accounting. The logistic regression results show that the decision to apply hedge accounting by Malaysian companies is positively influenced by company size and leverage. The implications of the findings are discussed and some conclusions are drawn.
    Date: 2018–11–25
  4. By: Mulia, Teti; Afriyeni, Afriyeni
    Abstract: The purpose of this research is to find out how the implementation of operational risk management at the Teller Unit of PT. Bank Pembangunan Daerah Sumatera Barat. Methods of collecting data for this study were collected through interviews with related parties. Data analysis method in this study uses descriptive method with an inductive mindset that explains the results of research on facts that occur in the field which are then analyzed according to existing theories. Based on the results of this study it was found that PT. Bank Pembangunan Daerah Sumatera Barat has implemented operational risk management at the teller unit. This is indicated by the minimum of undesirable events such as the risk of counterfeit money, errors in inputting the nominal and account number at the time of the transaction, the shortfall or excess payment to the customer, the shortfall or excess when receiving the customer's deposit, the risk of incorrect transfer / mutation input.
    Date: 2018–12–26
  5. By: Andrea Calef (University of East Anglia)
    Abstract: In this paper I study the extent to which the nexus between concentration and interbank linkages affects financial stability, using data for a sample of 19,689 banks in 69 countries from 1995 to 2014. I find that high levels of interbank exposures decrease the probability of observing a systemic banking crisis, when the banking system is either highly concentrated or fragmented. The relationship between concentration and stability is found to be non-monotonic, as predicted by Martinez-Miera & Repullo (2010), although not U-shaped.
    Keywords: banking crisis, systemic risk, market structure; interbank linkages, network, contagion.
    JEL: G01 G21 G28
    Date: 2020–01–15
  6. By: Bandyopadhyay, Arindam
    Abstract: Recently, regulators as well market participants have raised serious concerns about the validity of external credit ratings in predicting true status of corporate default risk in India. This article seeks to compare historical rating trends in India along with the global benchmarks. CRAs need to provide more insight about corporate rating movements to enable banks to derive early warning signals about inherent credit risk. The kind of risk indicators need to be disclosed has been highlighted in this article.
    Keywords: Credit Risk, Agency Rating, Validation
    JEL: A10 G20
    Date: 2019–08–07
  7. By: Safoora Zarei; Ali R. Fallahi
    Abstract: Every time drivers take to the road, and with each mile that they drive, exposes themselves and others to the risk of an accident. Insurance premiums are only weakly linked to mileage, however, and have lump-sum characteristics largely. The result is too much driving, and too many accidents. In this paper, we introduce some useful theoretical results for Pay-As-You-Drive in Automobile insurances. We consider a counting process and also find the distribution of discounted collective risk model when the counting process is non-homogeneous Poisson.
    Date: 2019–12
  8. By: R. G Gelos; Lucyna Gornicka; Robin Koepke; Ratna Sahay; Silvia Sgherri
    Abstract: The volatility of capital flows to emerging markets continues to pose challenges to policymakers. In this paper, we propose a new framework to answer critical policy questions: What policies and policy frameworks are most effective in dampening sharp capital flow movements in response to global shocks? What are the near- versus medium-term trade-offs of different policies? We tackle these questions using a quantile regression framework to predict the entire future probability distribution of capital flows to emerging markets, based on current domestic structural characteristics, policies, and global financial conditions. This new approach allows policymakers to quantify capital flows risks and evaluate policy tools to mitigate them, thus building the foundation of a risk management framework for capital flows.
    Date: 2019–12–20
  9. By: Yinzhi Wang; Erik B{\o}lviken
    Abstract: The literature on optimal reinsurance does not deal with how much the effectiveness of such solutions is degraded by errors in parameters and models. The issue is investigated through both asymptotics and numerical studies. It is shown that the rate of degradation is often $O(1/n)$ as the sample size $n$ of historical observations becomes infinite. Criteria based on Value at Risk are exceptions that may achieve only $O(1/\sqrt{n})$. These theoretical results are supported by numerical studies. A Bayesian perspective on how to integrate risk caused by parameter error is offered as well.
    Date: 2019–12
  10. By: \c{C}a\u{g}{\i}n Ararat; Zachary Feinstein
    Abstract: Scalar dynamic risk measures in continuous time are commonly represented as backward stochastic differential equations. There are two possible extensions for scalar backward stochastic differential equations for the set-valued framework: (1) backward stochastic differential inclusions; or (2) set-valued backward stochastic differential equations. In this work, the discrete-time setting is investigated with difference inclusions and difference equations in order to provide insights for such differential representations for set-valued dynamic risk measures.
    Date: 2019–12
  11. By: Nina Boyarchenko; Or Shachar
    Abstract: How should we measure market expectations of the U.S. government failing to meet its debt obligations and thereby defaulting? A natural candidate would be to use the spreads on U.S. sovereign single-name credit default swaps (CDS): since a CDS provides insurance to the buyer for the possibility of default, an increase in the CDS spread would indicate an increase in the market-perceived probability of a credit event occurring. In this post, we argue that aggregate measures of activity in U.S. sovereign CDS mask a decrease in risk-forming transactions after 2014. That is, quoted CDS spreads in this market are based on few, if any, market transactions and thus may be a misleading indicator of market expectations.
    Keywords: US sovereign CDS
    JEL: G1
    Date: 2020–01–06
  12. By: Serguei Pergamenchtchikov; Alena Shishkova
    Abstract: In this paper, we consider the problem of hedging Asian options in financial markets with transaction costs. For this, we use the asymptotic hedging approach. The main task of asymptotic hedging in financial markets with transaction costs is to prove the probability convergence of the terminal value of the investment portfolio to the payment function when the number of portfolio revisions tends to be $n$ to infinity. In practice, this means that the investor, using such a strategy, is able to compensation payments for all financial transactions, even if their number increases unlimitedly.
    Date: 2020–01
  13. By: Nina Boyarchenko; Or Shachar
    Abstract: Rising nonfinancial corporate business leverage, especially for riskier “high-yield” firms, has recently received increased public and supervisory scrutiny. For example, the Federal Reserve’s May 2019 Financial Stability Report notes that “growth in business debt has outpaced GDP for the past 10 years, with the most rapid growth in debt over recent years concentrated among the riskiest firms.” At the upper end of the credit spectrum, “investment-grade” firms have also increased their borrowing, while the number of higher-rated firms has decreased. In fact, there are currently only two U.S. companies rated AAA: Johnson & Johnson and Microsoft. In this post, we examine recent trends in the issuance of investment-grade corporate bonds and argue that the combination of increased BAA issuance and virtually nonexistent AAA issuance both reduces the usefulness of the BAA–AAA spread as a credit risk indicator and poses a financial stability concern.
    Keywords: BAA-AAA spread; bond issuance; corporate credit risk
    JEL: G3
    Date: 2020–01–08
  14. By: Oliver de Groot; Alexander W. Richter; Nathanial A. Throckmorton
    Abstract: This paper shows the recent success of valuation risk (time-preference shocks in EpsteinZin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. When we revise the preferences to satisfy the restriction in a simple asset pricing model, the puzzles resurface. However, when estimating a sequence of Bansal-Yaron long-run risk models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.
    Keywords: Epstein-Zin Utility; Asset Pricing; Equity Premium Puzzle; Risk-Free Rate Puzzle
    JEL: D81 G12
    Date: 2019–07
  15. By: Rafael Wildauer (University of Greenwich); Jakob Kapeller
    Abstract: Taking survey data on household wealth as our major example, this short paper discusses some of the issues applied researchers are facing when fitting (type I) Pareto distributions to complex survey data. The major contribution of this paper is twofold: First, we propose a new and intuitive way of deriving Gabaix and Ibragimov’s (2011) bias correction for Pareto tail estimations from which the generalization to complex survey data follows naturally. Second, we summarise how Kolmogorov-Smirnof and Cramer-von-Mises goodness of fit tests can be generalized to complex survey data. Taken together we think the paper provides a concise and useful presentation of the fundamentals of Pareto tail fitting with complex survey data.
    Keywords: Pareto distribution, complex survey data, wealth distribution
    JEL: C46 C83 D31
    Date: 2020–01
  16. By: Pozo, Jorge (Banco Central de Reserva del Perú)
    Abstract: I build up a framework to study the dynamics of the default probability of banks and the excess bank risk-taking in an emerging economy. I calibrate the model for the 1998 Peruvian economy. The novelty result is that an infinity-period model creates an intertemporal channel that amplifies banks' incentives to take excessive risk. I simulate the sudden stop that hit Peru in 1998 as a negative shock on the foreign borrowing limit of banks. The model accurately predicts the substantial short-term rise in the morosity rate through the rise of the excess bank risk-taking after the sudden stop.
    Keywords: Sudden stop, bank risk-taking, prudential policy.
    JEL: E44 F41 G01 G21 G28
    Date: 2019–12
  17. By: Abdul Latif, Nurul Atikah
    Abstract: This study is to investigate the relationship between liquidity risk with internal and external factors risk. This research is very important to the Target Corporation, it is because, they want to know their performance of the company such as the profitability, liquidity risk, operational risk, market risk, credit risk and also to know their corporate governance index. They also can make a planning if they know what kinds of things that will influence their performance of the company. So the problem is they can face a bankruptcy if they do not know what are influenced to their performance.
    Keywords: the profitability, liquidity risk, operational risk, market risk, credit risk and corporate governance index.
    JEL: G3 G32
    Date: 2019–11–18
  18. By: Lee, Mun Chen
    Abstract: Liquidity risk management is very important to every company to mange their company’s liquidity. The aim of this study attempts to investigate the firm-specific factor (internal factors), macroeconomic (external factors), and firm-specific factor, macroeconomic influence towards liquidity risk in Audi AG. The method of the study is regression analysis of Audi by using the SPSS Statistic 25 System. This study is based on annual report of 5 years, from 2014 to 2018. The liquidity risk of Audi AG show in the regression analysis has greater influence by operating ratio (firm-specific factor) in company and inflation rate (macroeconomic) in German.
    Keywords: liquidity risk, firm-specific factors, macroeconomics and corporate governance.
    JEL: G3 O16
    Date: 2019–10–15
  19. By: Krzysztof Echaust (Pozna? University of Economics and Business)
    Abstract: According to the theory of financial engineering the valuation of financial instruments takes place in the risk-neutral pricing framework. In this case, the valuation of financial instruments is made without taking into account the risk and, as a consequence, the influence of market movements on options valuation is ignored. In this work, we try to check whether the valuation of call and put is independent on the condition of the capital market. We analyse investors propensity to buy call options during the bull market and put options during market downturns. In this study 678 options series listed on Warsaw Stock Exchange are considered in the period from 2007 to 2018. The results of the conducted research indicate differences in the valuation of both types of options. Put options are priced with a higher level of volatility in times of extreme risk, but the valuation of call options does not depend on situation on the financial market.
    Keywords: implied volatility, option, call, put, pricing
    JEL: G13 G10
    Date: 2019–10
  20. By: Bruno Bouchard (CEREMADE); Xiaolu Tan
    Abstract: We consider a general path-dependent version of the hedging problem with price impact of Bouchard et al. (2019), in which a dual formulation for the super-hedging price is obtained by means of PDE arguments, in a Markovian setting and under strong regularity conditions. Using only probabilistic arguments, we prove, in a path-dependent setting and under weak regularity conditions, that any solution to this dual problem actually allows one to construct explicitly a perfect hedging portfolio. From a pure probabilistic point of view, our approach also allows one to exhibit solutions to a specific class of second order forward backward stochastic differential equations, in the sense of Cheridito et al. (2007). Existence of a solution to the dual optimal control problem is also addressed in particular settings. As a by-product of our arguments, we prove a version of It{\^o}'s Lemma for path-dependent functionals that are only C^{0,1} in the sense of Dupire.
    Date: 2019–12
  21. By: YAN, SHIWEI
    Abstract: The aim of this study is to exam the relationship between the return on asset (ROA) and the internal, external factors of the companies.Kupiec, P. , & Lee, Y. (2012), stated that ROA is very useful statistic for comparing the profitability of banks. The companies I had chosen for this study are Bank of China.I collected this bank’s data from 2014 to 2018.The independent variables used for this study are current ratio,credit risk,operating margin,CGI, GDP,inflation, interest rate,and exchange rate, while the dependent variable is ROA. We used SPSS to analyse the statistics and the relationship between the dependent variable and the independent variables.
    Keywords: ROA, Bank of China,independent variables ,dependent variable
    JEL: G3 G32 O16
    Date: 2019–11–21
  22. By: Lin, Lili
    Abstract: The purpose of this study is to measure the corporate governance and its impact to the firm performance and risk of Starbucks. The research method for this study was to perform regression analysis on Starbucks using the SPSS system. The study found that the Starbucks' liquidity has been relatively stable over the past five years. Regression analysis shows that Starbucks' liquidity risk is affected by the return on assets (internal factors) and the US gross domestic product (external factors).
    Keywords: Liquidity risk,macroeconomics and corporate governance
    JEL: G3 O1 O16
    Date: 2019–11–16
  23. By: Marialena Athanasopoulou; Andrea Consiglio; Aitor Erce; Angel Gavilan; Edmund Moshammer; Stavros A. Zenios
    Abstract: The mix of instruments used to finance a sovereign is a key determinant of debt sustainability through its effect on funding costs and risks. We extend standard debt sustainability analysis to incorporate debt-financing decisions in the presence of macroeconomic, financial, and fiscal risks. We optimize the maturity of debt instruments to trade off borrowing costs with refinancing risk. Risk is quantified with a coherent measure of tail risk of financing needs, conditional Flow-at-Risk. A constraint on the pace of reduction of debt stocks is also imposed, and we model the effect of debt stocks on the yield curve through endogenous risk and term premia. On a simulated economy, we show that the cost-risk and flow-stock trade-offs embedded in issuance decisions are key determinants of the evolution of debt dynamics and are economically significant. Comparing three alternative optimizing strategies and some simple fixed-issuance rules, we also draw lessons on when and why optimizing matters the most. This depends on the risk tolerance level, the size, cost, and maturity of legacy debt, and the sensitivity of interest rates to debt. Our model quantifies thresholds for the minimum level of refinancing risks and the maximum pace of debt reduction that a sovereign could reach given its economic fundamentals. Going beyond those thresholds is only feasible through adjustments of gross financing needs, and an extension of the baseline model identifies the hot spots for these adjustments, computing their minimum size and optimal timing. Our findings inform policy decisions concerning both official sector borrowing and public finance, with a focus not only on minimizing interest payments but also on managing refinancing risks and increasing debt dynamics.
    Keywords: overeign 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: 2018–10–11
  24. By: Harold L. Cole (University of Pennsylvania); Dirk Krueger (University of Pennsylvania); George J. Mailath (University of Pennsylvania); Yena Park (University of Rochester)
    Abstract: We analyze e?cient risk-sharing arrangements when coalitions may deviate. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any deviating coalition rely on a belief in future cooperation, and we treat the contracting conditions of original and deviating coalitions symmetrically. We show that better belief coordination (higher social capital) tightens incentive constraints since it facilitates both the formation of the original as well as a deviating coalition. As a consequence, the payo? of successfully formed coalitions might be declining in the degree of belief coordination and equilibrium allocations might feature resource burning or utility burning.
    Keywords: Financial Coalition, Limited Enforcement, Risk Sharing, Coalition-Proof Equi-librium
    JEL: E21 G22 D11 D91
    Date: 2019–01–08
  25. By: Alam, Md. Mahmudul (Universiti Utara Malaysia); Uddi, Gazi Salah
    Abstract: Stock exchange and interest rate are two crucial factors 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 share market efficiency based on the monthly data from January 1988 to March 2003 and also shows empirical relationship between stock index and interest rate for fifteen developed and developing countries- Australia, Bangladesh, Canada, Chile, Colombia, Germany, Italy, Jamaica, Japan, Malaysia, Mexico, Philippine, S. Africa, Spain, and Venezuela. Stationarity of market return is tested and found none of this stock market follows random walk model, means not efficient in weak form. To investigate the reasons of market inefficiency, relationship between share price and interest rate, and changes of share price and changes of interest rate were determined through both time series and panel regressions. For all of the countries it is found that interest rate has significant negative relationship with share price and for six countries it is found that changes of interest rate has significant negative relationship with changes of share price. So, if the interest rate is considerably controlled for these countries, it will be the great benefit of these countries’ stock exchange through demand pull way of more investors in share market, and supply push way of more extensional investment of companies.
    Date: 2019–02–23
  26. By: Said, Jamaliah; Alam, Md. Mahmudul (Universiti Utara Malaysia); Abdullah, Nik Herda Nik; Zulkarnain, Nur Nadiah
    Abstract: This study is an attempt to assess the status of current level of value creation among the Government Linked Companies (GLCs) in Malaysia. This study collected primary data based on a set of questionnaire survey among 134 executives and managers of GLCs in Malaysia. The data were collected based on opinions of the ten factors of value creation practices by using the five-point Likert scale. The data were analysed using descriptive statistics. Further, the reliability of the data was tested using Cronbach’s alpha test, the validity of the data was tested by checking the normality test through skewness and kurtosis, and the consistency of the data was tested using factor analysis. On an average, 80.6% of the respondents agreed that they focus on these factors of value creation. Overall, the federal owned GLCs place more emphasis on certain elements of value creation than the state owned GLCs. Among the elements of value creation, the state owned GLCs emphasize the most on quality development and brand value creation, where the federal owned GLCs emphasized the most on reputation. The GLCs engaged in service sector emphasized the most on brand value and the GLCs engaged in manufacturing sector emphasized the most on customer satisfaction and quality development. This study suggest that GLCs in Malaysia improve the overall value creation by emphasizing on responsiveness, average return on investment, sales growth, profit growth and average return on sales.
    Date: 2019–02–28

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