nep-rmg New Economics Papers
on Risk Management
Issue of 2020‒03‒23
twenty-one papers chosen by
Stan Miles
Thompson Rivers University

  1. Mortgage-related bank penalties and systemic risk among U.S. banks By Vaclav Broza; Evzen Kocenda
  2. Sector connectedness in the Chinese stock markets By Ying-Ying Shen; Zhi-Qiang Jiang; Jun-Chao Ma; Gang-Jin Wang; Wei-Xing Zhou
  3. The De Vylder-Goovaerts conjecture holds true within the diffusion limit By Stefan Ankirchner; Christophette Blanchet-Scalliet; Nabil Kazi-Tani
  4. Estimation and Inference about Tail Features with Tail Censored Data By Yulong Wang; Zhijie Xiao
  5. Jumps in Energy and Non-Energy Commodities By Elie Bouri; Rangan Gupta
  6. The Economic Outlook By John C. Williams
  7. Pruebas de tensión bancaria: experiencia en los principales mercados financieros del mundo y en Chile By Lemus, Antonio; Nuñez, Marco
  8. Financial Variables as Predictors of Real Growth Vulnerability By Lucrezia Reichlin; Giovanni Ricco; Thomas Hasenzagl
  9. Large-Maturity Smiles for an Affine Jump-Diffusion Model By Nian Yao; Zhiqiu Li; Zhichao Ling; Junfeng Lin
  10. Does Leverage Predict Delinquency in Consumer Lending? Evidence from Peru By Walter Cuba
  11. Jumps in Geopolitical Risk and the Cryptocurrency Market: The Singularity of Bitcoin By Elie Bouri; Rangan Gupta; Xuan Vinh Vo
  12. What is the information value of bank's stress tests? An investigation using banks' bond split ratings By Moustapha Daouda Dala; Isabelle Distinguin; Alain Sauviat
  13. Predictive intraday correlations in stable and volatile market environments: Evidence from deep learning By Ben Moews; Gbenga Ibikunle
  14. Do Banks Price Environmental Risk? Evidence from a Quasi Natural Experiment in the People’s Republic of China By Huang, Bihong; Punzi, Maria Teresa; Wu, Yu
  15. Pecuniary Externalities, Bank Overleverage, and Macroeconomic Fragility By Ryo Kato; Takayuki Tsuruga
  16. Time-Varying Pricing of Risk in Sovereign Bond Futures Returns By Barbora Malinska
  17. A weighted finite difference method for American and Barrier options in subdiffusive Black-Scholes Model By Grzegorz Krzy\.zanowski; Marcin Magdziarz
  18. Better than gold? A review of the Bitcoin Standard 2nd revision By Kristoffer Mousten Hansen
  19. The More the Merrier? A Machine Learning Algorithm for Optimal Pooling of Panel Data By Marijn A. Bolhuis; Brett Rayner
  20. Measuring Natural Risks in the Philippines : Socioeconomic Resilience and Wellbeing Losses By Walsh,Brian James; Hallegatte,Stephane
  21. A Joint Foreign Currency Risk Management Approach for Sovereign Assets and Liabilities By Cangoz,Mehmet Coskun; Sulla,Olga; Wang,ChunLan; Dychala,Christopher Benjamin

  1. By: Vaclav Broza (Institute of Economic Studies, Charles University); Evzen Kocenda
    Abstract: We analyze link between mortgage-related regulatory penalties levied on banks and the level of systemic risk in the U.S. banking industry. We employ a frequency decomposition of volatility spillovers to draw conclusions about system-wide risk transmission with short-, medium-, and long-term dynamics. We find that after the possibility of a penalty is first announced to the public, long-term systemic risk among banks tends to increase. Short- and medium-term risk marginally declines. In contrast, a settlement with regulatory authorities leads to a decrease in the long-term systemic risk. Our analysis is robust with respect to several criteria.
    Keywords: bank, financial stability, global financial crisis, mortgage, penalty, systemic risk
    JEL: C14 C58 G14 G21 G28 K41
    Date: 2020–03
  2. By: Ying-Ying Shen (ECUST); Zhi-Qiang Jiang (ECUST); Jun-Chao Ma (ECUST); Gang-Jin Wang (HNU); Wei-Xing Zhou (ECUST)
    Abstract: Uncovering the risk transmitting path within economic sectors in China is crucial for understanding the stability of the Chinese economic system, especially under the current situation of the China-US trade conflicts. In this paper, we try to uncover the risk spreading channels by means of volatility spillovers within the Chinese sectors using stock market data. By applying the generalized variance decomposition framework based on the VAR model and the rolling window approach, a set of connectedness matrices is obtained to reveal the overall and dynamic spillovers within sectors. It is found that 17 sectors (mechanical equipment, electrical equipment, utilities, and so on) are risk transmitters and 11 sectors (national defence, bank, non-bank finance, and so on) are risk takers during the whole period. During the periods with the extreme risk events (the global financial crisis, the Chinese interbank liquidity crisis, the Chinese stock market plunge, and the China-US trade war), we observe that the connectedness measures significantly increase and the financial sectors play a buffer role in stabilizing the economic system. The robust tests suggest that our results are not sensitive to the changes of model parameters. Our results not only uncover the spillover effects within the Chinese sectors, but also highlight the deep understanding of the risk contagion patterns in the Chinese stock markets.
    Date: 2020–02
  3. By: Stefan Ankirchner (Institut für Mathematik - Friedrich-Schiller-Universität Jena); Christophette Blanchet-Scalliet (PSPM - Probabilités, statistique, physique mathématique - ICJ - Institut Camille Jordan [Villeurbanne] - ECL - École Centrale de Lyon - Université de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - INSA Lyon - Institut National des Sciences Appliquées de Lyon - Université de Lyon - INSA - Institut National des Sciences Appliquées - UJM - Université Jean Monnet [Saint-Étienne] - CNRS - Centre National de la Recherche Scientifique); Nabil Kazi-Tani (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon)
    Abstract: The De Vylder and Goovaerts conjecture is an open problem in risk theory, stating that the finite time ruin probability in a standard risk model is greater or equal to the corresponding ruin probability evaluated in an associated model with equalized claim amounts. Equalized means here that the jump sizes of the associated model are equal to the average jump in the initial model between 0 and a terminal time T. In this paper, we consider the diffusion approximations of both the standard risk model and its associated risk model. We prove that the associated model, when conveniently renor-malized, converges in distribution to a Gaussian process satisfying a simple SDE. We then compute the probability that this diffusion hits the level 0 before time T and compare it with the same probability for the diffusion approximation for the standard risk model. We conclude that the De Vylder and Goovaerts conjecture holds true for the diffusion limits.
    Keywords: Equalized claims,Ruin probability,Risk theory,Diffusion approximations
    Date: 2019–06
  4. By: Yulong Wang; Zhijie Xiao
    Abstract: This paper considers estimation and inference about tail features when the observations beyond some threshold are censored. We first show that ignoring such tail censoring could lead to substantial bias and size distortion, even if the censored probability is tiny. Second, we propose a new maximum likelihood estimator (MLE) based on the Pareto tail approximation and derive its asymptotic properties. Third, we provide a small sample modification to the MLE by resorting to Extreme Value theory. The MLE with this modification delivers excellent small sample performance, as shown by Monte Carlo simulations. We illustrate its empirical relevance by estimating (i) the tail index and the extreme quantiles of the US individual earnings with the Current Population Survey dataset and (ii) the tail index of the distribution of macroeconomic disasters and the coefficient of risk aversion using the dataset collected by Barro and Urs{\'u}a (2008). Our new empirical findings are substantially different from the existing literature.
    Date: 2020–02
  5. By: Elie Bouri (USEK Business School, Holy Spirit University of Kaslik, Jounieh, Lebanon); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa)
    Abstract: Jumps in the price process of assets represent a sort of tail risk and are found to affect many aspects of asset pricing, volatility modelling, and asset allocation. In this paper, we detect price jumps in the realized volatility series of a wide set of commodity futures and find evidence of a jumpy behaviour, especially in energy and agricultural commodities. We examine whether the realized volatilities of commodity futures jump together and find evidence that co-jumping is significant and generally clustered within the commodity groups, suggesting some sort of segmentation regarding the tail risk behaviour across energy, agricultural, and metals commodities. Additional analysis shows that price jumps and macroeconomic news surprises tend to occur together in specific commodities such as crude oil, which confirms earlier findings about the sensitivity of crude oil to news about the economy.
    Keywords: Realized volatility, energy and non-energy commodities, jumps, co-jumps, macroeconomic news
    Date: 2020–02
  6. By: John C. Williams
    Abstract: Remarks at Foreign Policy Association, New York City.
    Keywords: coronavirus; COVID-19; financial markets; risk management; federal funds rate; target range; monetary policy
    Date: 2020–03–05
  7. By: Lemus, Antonio; Nuñez, Marco
    Abstract: Resumen El presente documento realiza una descripción del proceso de pruebas de tensión bancaria, tanto en los principales mercados financieros del mundo como en Chile. Para ello se discute y describe, qué son las pruebas de tensión bancaria, cuál es su origen, para qué sirven, las etapas incluidas, los elementos que incluyen, y los puntos relevantes en su implementación. Se destaca que, si bien las pruebas de tensión bancaria son una herramienta importante para detectar vulnerabilidades en el sector bancario, estas deben ser complementadas con la supervisión in-situ y la visión de los propios bancos. En Chile la nueva Ley General de Bancos, al incorporar principios de Basilea III, daría un mayor soporte legal a las pruebas de tensión bancaria. Summary This document describes the bank stress tests process, both in the main financial markets of the world and in Chile. Thus discusses and describes, what are the bank stress tests, what is their origin, what are they for, the stages and the elements they include, and the relevant points in their implementation. The document emphasizes that, although bank stress tests are an essential tool to detect vulnerabilities in the banking sector, they must be considered a complement to the on-site supervision and the banks own vision. By incorporating Basel III principles, the recent General Bank Act would provide legal support and strength bank stress testing in Chile.
    Keywords: Pruebas de tensión bancaria, Regulador, Chile
    JEL: G21 G28 G32 K33
    Date: 2020–03
  8. By: Lucrezia Reichlin (London Business School, Now-Casting Economics, and CEPR); Giovanni Ricco (University of Warwick and OFCE-SciencesPo, and CEPR); Thomas Hasenzagl (University of Minnesota)
    Abstract: We evaluate the role of financial conditions as predictors of macroeconomic risk first in the quantile regression framework of Adrian et al. (2019b), which allows for non-linearities, and then in a novel linear semi-structural model as proposed by Hasenzagl et al. (2018). We distinguish between price variables such as credit spreads and stock variables such as leverage. We find that (i) although the spreads correlate with the left tail of the conditional distribution of GDP growth, they provide limited advanced information on growth vulnerability; (ii) nonfinancial leverage provides a leading signal for the left quantile of the GDP growth distribution in the 2008 recession; (iii) measures of excess leverage conceptually similar to the Basel gap, but cleaned from business cycle dynamics via the lenses of the semi-structural model, point to two peaks of accumulation of risks – the eighties and the first eight years of the new millennium, with an unstable relationship with business cycle chronology.
    Keywords: Financial cycle, business cycle, credit, financial crises, downside risk, entropy, quantile regressions
    JEL: E32 E44 C32 C53
    Date: 2020–02
  9. By: Nian Yao; Zhiqiu Li; Zhichao Ling; Junfeng Lin
    Abstract: In this paper, we study the asymptotic behaviors of implied volatility of an affine jump-diffusion model. Let log stock price under risk-neutral measure follow an affine jump-diffusion model, we show that an explicit form of moment generating function for log stock price can be obtained by solving a set of ordinary differential equations. A large-time large deviation principle for log stock price is derived by applying the G\"{a}rtner-Ellis theorem. We characterize the asymptotic behaviors of the implied volatility in the large-maturity and large-strike regime using rate function in the large deviation principle. The asymptotics of the Black-Scholes implied volatility for fixed-maturity, large-strike and fixed-maturity, small-strike regimes are studied. Numerical results are provided to validate the theoretical work.
    Date: 2020–02
  10. By: Walter Cuba (Central Reserve Bank of Peru)
    Abstract: This paper examines to what extent household leverage—as measured by the debt-to-income (DTI) ratio—predicts delinquency in Peru’s consumer credit market. A model is estimated to assess the relation between delinquency and the DTI ratio. The initial and current DTI ratios are assessed as delinquency predictors. The results confirm that the current DTI ratio is effective for predicting delinquency. This evidence supports its use in financial regulation to improve household credit risk assessment and control.
    Keywords: Household finance, credit risk, consumer delinquency
    JEL: G20 G21 D12
    Date: 2020–03–02
  11. By: Elie Bouri (USEK Business School, Holy Spirit University of Kaslik, Jounieh, Lebanon); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa); Xuan Vinh Vo (University of Economics Ho Chi Minh City, Ho Chi Minh City, Vietnam)
    Abstract: Are price discontinuities in cryptocurrencies jointly related to large swings in geopolitical risk? This is a relevant question to answer given recent news from the press that Bitcoin’s large price swings are driven by large swings in the level of geopolitical risk. We answer this question by examining first the jump incidence of daily returns for Bitcoin and other leading cryptocurrencies via the application of the approach of Laurent et al. (2016) and then by studying the co-jumps using logistic regressions. Preliminary results show that the price behaviour of all cryptocurrencies under study is jumpy. Further analyses show reasonable evidence to imply that co-jumps are significant for the case of Bitcoin only. This finding nicely complements previous studies arguing that Bitcoin is a hedge against geopolitical risk.
    Keywords: Geopolitical risk, Bitcoin, Cryptocurrencies, Jumps, GARCH
    Date: 2020–02
  12. By: Moustapha Daouda Dala (Epoka University, Department of Banking and Finance, Rruga Tirane-Rinas Km 12, 1032, Vore, Tirana, Albania); Isabelle Distinguin (LAPE - Laboratoire d'Analyse et de Prospective Economique - IR SHS UNILIM - Institut Sciences de l'Homme et de la Société - UNILIM - Université de Limoges); Alain Sauviat (LAPE - Laboratoire d'Analyse et de Prospective Economique - IR SHS UNILIM - Institut Sciences de l'Homme et de la Société - UNILIM - Université de Limoges)
    Abstract: We study the informative value of stress tests by investigating the impact of the disclosure of their results on banks' bonds split ratings taken as a measure of bank opacity. We consider bonds jointly rated by Moody's and Standard & Poor's and issued by banks that participated to the European and US banks' stress tests. Our results suggest that the disclosure of stress results has mixed effect on split ratings. Our findings also suggest a frequent divergence of interpretation of the stress test results between the two rating agencies meaning that information would not be as relevant as hoped by regulators. Market players certainly could not extract an unambiguous signal from all the results disclosed by the stress tests.
    Keywords: stress tests,credit rating,split rating,banks' opacity
    Date: 2020–02–12
  13. By: Ben Moews; Gbenga Ibikunle
    Abstract: Standard methods and theories in finance can be ill-equipped to capture highly non-linear interactions in financial prediction problems based on large-scale datasets, with deep learning offering a way to gain insights into correlations in markets as complex systems. In this paper, we apply deep learning to econometrically constructed gradients to learn and exploit lagged correlations among S&P 500 stocks to compare model behaviour in stable and volatile market environments, and under the exclusion of target stock information for predictions. In order to measure the effect of time horizons, we predict intraday and daily stock price movements in varying interval lengths and gauge the complexity of the problem at hand with a modification of our model architecture. Our findings show that accuracies, while remaining significant and demonstrating the exploitability of lagged correlations in stock markets, decrease with shorter prediction horizons. We discuss implications for modern finance theory and our work's applicability as an investigative tool for portfolio managers. Lastly, we show that our model's performance is consistent in volatile markets by exposing it to the environment of the recent financial crisis of 2007/2008.
    Date: 2020–02
  14. By: Huang, Bihong (Asian Development Bank Institute); Punzi, Maria Teresa (Asian Development Bank Institute); Wu, Yu (Asian Development Bank Institute)
    Abstract: This paper maps the risk arising from the transition to a low-emission economy and studies its transmission channels within the financial system. The environmental dynamic stochastic general equilibrium (E-DSGE) model shows that tightening environmental regulations deteriorates firms' balance sheets as it internalizes the pollution costs, which consequentially accelerates the risks that the financial system faces. This empirical study, which employs the Clean Air Action that the Chinese government launched in 2013 as a quasi-experiment, supports the theoretical implications. The analysis of a unique dataset containing 1.3 million loans shows that the default rates of high-polluting firms rose by around 50% along their environmental policy exposure. At the same time, the loan spread charged to such firms increased by 5.5% thereafter.
    Keywords: environmental DSGE Model; Clean Air Action; lending spread; default rate
    JEL: E32 E50 H23 Q43
    Date: 2019–07–05
  15. By: Ryo Kato; Takayuki Tsuruga
    Abstract: Pecuniary externalities in models with financial friction justify macroprudential policies for preventing economic agents’ excessive risk taking. We extend the Diamond and Rajan (2012) model of banks with the production factors and explore how a pecuniary externality affects a bank’s leverage. We show that the laissez-faire banks in our model take on excessive risks compared with the constrained social optimum. Our numerical simulations suggest that the crisis probability is 2--3 percentage points higher in the laissez-faire economy than in the constrained social optimum.
    Date: 2020–03
  16. By: Barbora Malinska (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic)
    Abstract: We examine time-varying explanatory power of realized moments on subsequent bond futures excess returns using more than 12 years of high-frequency data from U.S. and German sovereign bond markets. We detect realized volatility and realized kurtosis to carry valuable information for next-day open-close excess returns on the U.S. market which is not priced in traditional bond return predictors such as term or default spreads. Most importantly, we reveal the bond excess return predictability to be significantly dynamic and to increase during crisis period. Whereas the realized volatlity reveals to have negative effect on next-day excess returns, effect of realized kurtosis is switching from positive effect in the time of 2007-2009 financial crisis to negative values after 2014.
    Keywords: Realized moments, bond pricing, risk-return trade-off, high-frequency data, time-varying coeffcients
    JEL: C32 C55 G12
    Date: 2020–03
  17. By: Grzegorz Krzy\.zanowski; Marcin Magdziarz
    Abstract: This paper is focused on American option pricing in the subdiffusive Black Scholes model. Two methods for valuing American options in the considered model are proposed. The weighted scheme of the finite difference (FD) method is derived and the main properties of the method are presented. The Longstaff-Schwartz method is applied for the discussed model and is compared to the previous method. In the article it is also shown how to valuate wide range of Barrier options using the FD approach. The proposed FD method has $2-\alpha$ order of accuracy with respect to time, where $\alpha\in(0, 1)$ is the subdiffusion parameter, and 2 with respect to space. The paper is a continuation of [13], where the derivation of the governing fractional differential equation, similarly as the stability and convergence analysis can be found.
    Date: 2020–03
  18. By: Kristoffer Mousten Hansen (GRANEM - Groupe de Recherche Angevin en Economie et Management - Institut National de l'Horticulture et du Paysage - AGROCAMPUS OUEST - UA - Université d'Angers)
    Date: 2020
  19. By: Marijn A. Bolhuis; Brett Rayner
    Abstract: We leverage insights from machine learning to optimize the tradeoff between bias and variance when estimating economic models using pooled datasets. Specifically, we develop a simple algorithm that estimates the similarity of economic structures across countries and selects the optimal pool of countries to maximize out-of-sample prediction accuracy of a model. We apply the new alogrithm by nowcasting output growth with a panel of 102 countries and are able to significantly improve forecast accuracy relative to alternative pools. The algortihm improves nowcast performance for advanced economies, as well as emerging market and developing economies, suggesting that machine learning techniques using pooled data could be an important macro tool for many countries.
    Date: 2020–02–28
  20. By: Walsh,Brian James; Hallegatte,Stephane
    Abstract: Traditional risk assessments use asset losses as the main metric to measure the severity of a disaster. This paper proposes an expanded risk assessment based on a framework that adds socioeconomic resilience and uses wellbeing losses as its main measure of disaster severity. Using a new, agent-based model that represents explicitly the recovery and reconstruction process at the household level, this risk assessment provides new insights into disaster risks in the Philippines. First, there is a close link between natural disasters and poverty. On average, the estimates suggest that almost half a million Filipinos per year face transient consumption poverty due to natural disasters. Nationally, the bottom income quintile suffers only 9 percent of the total asset losses, but 31 percent of the total wellbeing losses. The average annual wellbeing losses due to disasters in the Philippines is estimated at US$3.9 billion per year, more than double the asset losses of US$1.4 billion. Second, the regions identified as priorities for risk-management interventions differ depending on which risk metric is used. Cost-benefit analyses based on asset losses direct risk reduction investments toward the richest regions and areas. A focus on poverty or wellbeing rebalances the analysis and generates a different set of regional priorities. Finally, measuring disaster impacts through poverty and wellbeing impacts allows the quantification of the benefits from interventions like rapid post-disaster support and adaptive social protection. Although these measures do not reduce asset losses, they efficiently reduce their consequences for wellbeing by making the population more resilient.
    Keywords: Inequality,Natural Disasters,Disaster Management,Hazard Risk Management,Social Risk Management,Disability,Services&Transfers to Poor,Access of Poor to Social Services,Economic Assistance
    Date: 2019–01–31
  21. By: Cangoz,Mehmet Coskun; Sulla,Olga; Wang,ChunLan; Dychala,Christopher Benjamin
    Abstract: An asset and liability management framework for managing risks arising from sovereign foreign exchange obligations requires a joint analysis of (i) the external financial liabilities resulting from a country's sovereign debt and (ii) the foreign exchange assets of its central bank. Governments often issue sizable amounts of debt denominated in foreign currencies, subjecting their fiscal positions to foreign exchange volatilities. Prudent management of a sovereign?s foreign exchange position under an asset and liability management framework enables governments to mitigate risks at the lowest possible cost, hence increasing resilience to external shocks. Based on the challenges associated with the implementation of an asset and liability management framework, this study recommends a practical approach that includes analysis of the foreign exchange positions of central bank reserves and central government debt portfolios and optimization of the net position. The proposed model is tested, using the foreign exchange reserve and external debt data of seven countries (Albania, Ghana, FYR Macedonia, South Africa, the Republic of Korea, Tunisia, and Uruguay). The paper employs quantitative methods to explore the impact of an overarching asset and liability management strategy and integrated approach on the efficient management of foreign exchange risk. It provides policy recommendations on ways to minimize the risk of foreign exchange mismatches and increase the return on foreign exchange reserves.
    Keywords: External Debt,Strategic Debt Management,Debt Markets,Public Sector Economics,Public Finance Decentralization and Poverty Reduction,Fiscal&Monetary Policy,Public Sector Administrative&Civil Service Reform,Public Sector Administrative and Civil Service Reform,De Facto Governments,Democratic Government,Financial Crisis Management&Restructuring
    Date: 2019–02–05

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