nep-rmg New Economics Papers
on Risk Management
Issue of 2020‒04‒13
seventeen papers chosen by
Stan Miles
Thompson Rivers University

  1. Predicting tail events in a RIA-EVT-Copula framework By Wei-Zhen Li; Jin-Rui Zhai; Zhi-Qiang Jiang; Gang-Jin Wang; Wei-Xing Zhou
  2. Total systemic risk statistics By Fei Sun
  3. The market impact of systemic risk capital surcharges By Gündüz, Yalin
  4. The effect of possible EU diversification requirements on the risk of banks’ sovereign bond portfolios By Craig, Ben; Giuzio, Margherita; Paterlini, Sandra
  5. Estimation and Inference about Tail Features with Tail Censored Data By Yulong Wang; Zhijie Xiao
  6. Long-term bank lending and the transfer of aggregate risk By Reiter, Michael; Zessner-Spitzenberg, Leopold
  7. Modelling and understanding count processes through a Markov-modulated non-homogeneous Poisson process framework By Benjamin Avanzi; Greg Taylor; Bernard Wong; Alan Xian
  8. Le risque économique : la difficile agrégation des risques à l'échelle des exploitations et des filières By Martial Phélippé-Guinvarc'H; J. Cordier
  9. How People React to Pension Risk By Salamanca, Nicolás; de Grip, Andries; Sleijpen, Olaf
  10. Conclusions of the first European Conference on Risk Perception, Behaviour, Management and Response By Samuel Rufat; Alexander Fekete
  11. Does improved information improve incentives? By Chaigneau, Pierre; Edmans, Alex; Gottlieb, Daniel
  12. Does Geographical Complexity of Colombian Financial Conglomerates Increase Banks’ Risk? The Role of Diversification, Regulatory Arbitrage and Funding Costs By Cardozo, Pamela; Morales-Acevedo, Paola; Murcia, Andrés; Pacheco, Beatriz
  13. Higher-Order Income Risk over the Business Cycle By Christopher Busch; Alexander Ludwig
  14. Shaking Things Up: On the Stability of Risk and Time Preferences By Beine, Michel; Charness, Gary; Dupuy, Arnaud; Joxhe, Majlinda
  15. Grandpa, grandpa, tell me the one about Bitcoin being a safe haven: Evidence from the COVID-19 pandemics By Ladislav Kristoufek
  16. Unexpected deposit flows, off-balance sheet funding liquidity risk and bank loan production By Thierno Barry; Alassane Diabaté; Amine Tarazi
  17. European instruments against the Corona crisis in comparison By Matthes, Jürgen; Demary, Markus

  1. By: Wei-Zhen Li (ECUST); Jin-Rui Zhai (ECUST); Zhi-Qiang Jiang (ECUST); Gang-Jin Wang (HNU); Wei-Xing Zhou (ECUST)
    Abstract: Predicting the occurrence of tail events is of great importance in financial risk management. By employing the method of peak-over-threshold (POT) to identify the financial extremes, we perform a recurrence interval analysis (RIA) on these extremes. We find that the waiting time between consecutive extremes (recurrence interval) follow a $q$-exponential distribution and the sizes of extremes above the thresholds (exceeding size) conform to a generalized Pareto distribution. We also find that there is a significant correlation between recurrence intervals and exceeding sizes. We thus model the joint distribution of recurrence intervals and exceeding sizes through connecting the two corresponding marginal distributions with the Frank and AMH copula functions, and apply this joint distribution to estimate the hazard probability to observe another extreme in $\Delta t$ time since the last extreme happened $t$ time ago. Furthermore, an extreme predicting model based on RIA-EVT-Copula is proposed by applying a decision-making algorithm on the hazard probability. Both in-sample and out-of-sample tests reveal that this new extreme forecasting framework has better performance in prediction comparing with the forecasting model based on the hazard probability only estimated from the distribution of recurrence intervals. Our results not only shed a new light on understanding the occurring pattern of extremes in financial markets, but also improve the accuracy to predict financial extremes for risk management.
    Date: 2020–04
  2. By: Fei Sun
    Abstract: Systemic risk is a critical factor not only for financial markets but also for risk management. In this paper, we consider a special class of risk statistics, named total systemic risk statistics. Our result provides a new approach for dealing with systemic risk. By further developing the properties related to total systemic risk statistics, we are able to derive dual representation for such risk.
    Date: 2020–03
  3. By: Gündüz, Yalin
    Abstract: This paper tests whether an increase or decrease of the capital surcharge for being a global systemically important bank (G-SIB) envisaged by regulators has an impact on the CDS prices of these banks. We find evidence that the CDS spreads of a G-SIB bank increase (decrease) after the announcement of a higher (lower) capital surcharge. However, this effect is temporary, as the mean CDS spreads revert to pre-announcement level, dropping sharply after the initial rise. Our analysis contributes to the debate on whether being designated as a G-SIB bank necessarily leads to implicit "too-big-to-fail" subsidies. The findings imply that the investors immediately update their beliefs on the systemic risk of the bank after the bucket reallocation announcement and temporarily demand more hedging against systemic risk.
    Keywords: Too-big-to-fail,CDS spreads,systemically important banks,G-SIBs,G-SIB capital surcharges
    JEL: G21 G28
    Date: 2020
  4. By: Craig, Ben; Giuzio, Margherita; Paterlini, Sandra
    Abstract: Recent policy discussion includes the introduction of diversification requirements for sovereign bond portfolios of European banks. In this paper, we evaluate the possible effects of these constraints on risk and diversification in the sovereign bond portfolios of the major European banks. First, we capture the dependence structure of European countries' sovereign risks and identify the common factors driving European sovereign CDS spreads by means of an independent component analysis. We then analyse the risk and diversification in the sovereign bond portfolios of the largest European banks and discuss the role of “home bias”, i.e. the tendency of banks to concentrate their sovereign bond holdings in their domicile country. Finally, we evaluate the effect of diversification requirements on the tail risk of sovereign bond portfolios. Under our assumptions about how banks rebalance their portfolio to respond to the new requirements, demanding that banks modify their holdings to increase their portfolio diversification may be ineffective in reducing portfolio risk, including tail risk. JEL Classification: G01, G11, G21, G28
    Keywords: bank regulation, diversification, home bias, sovereign-bank nexus, sovereign risk
    Date: 2020–03
  5. By: Yulong Wang (Syracuse University); Zhijie Xiao (Boston College)
    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 Ursúa (2008). Our new empirical findings are substantially different from the existing literature.
    Keywords: Extreme Value theory, power law, extreme quantile, tail index
    JEL: C4
    Date: 2020–03–20
  6. By: Reiter, Michael (IHS, Vienna and NYU Abu Dhabi); Zessner-Spitzenberg, Leopold (Vienna Graduate School of Economics and IHS, Vienna)
    Abstract: Long-term debt contracts transfer aggregate risk from borrowing firms to lending banks. When aggregate shocks increase the future default probability of firms, banks are not compensated for the default risk of existing contracts. If banks are highly leveraged, this can lead to financial instability with severe repercussions in the real economy. To study this mechanism quantitatively, we build a macroeconomic model of financial intermediation with long-term defaultable loan contracts and calibrate it to match aggregate firm and bank exposure to business cycle risks. Our model exhibits banking crises that closely resemble observed crisis episodes. We find that such crises do not arise in an economy with short-term debt. Our results on the role of long-term debt completely reverse if financial regulation is implemented to increase banks' risk bearing capacity. The financial sector is then well equipped to take on the aggregate risk, such that long-term lending stabilizes the business cycle by providing insurance to the corporate sector.
    Keywords: Banking, Financial frictions, Maturity transformation
    JEL: E32 E43 E44 G01 G21
    Date: 2020–04
  7. By: Benjamin Avanzi; Greg Taylor; Bernard Wong; Alan Xian
    Abstract: The Markov-modulated Poisson process is utilised for count modelling in a variety of areas such as queueing, reliability, network and insurance claims analysis. In this paper, we extend the Markov-modulated Poisson process framework through the introduction of a flexible frequency perturbation measure. This contribution enables known information of observed event arrivals to be naturally incorporated in a tractable manner, while the hidden Markov chain captures the effect of unobservable drivers of the data. In addition to increases in accuracy and interpretability, this method supplements analysis of the latent factors. Further, this procedure naturally incorporates data features such as over-dispersion and autocorrelation. Additional insights can be generated to assist analysis, including a procedure for iterative model improvement. Implementation difficulties are also addressed with a focus on dealing with large data sets, where latent models are especially advantageous due the large number of observations facilitating identification of hidden factors. Namely, computational issues such as numerical underflow and high processing cost arise in this context and in this paper, we produce procedures to overcome these problems. This modelling framework is demonstrated using a large insurance data set to illustrate theoretical, practical and computational contributions and an empirical comparison to other count models highlight the advantages of the proposed approach.
    Date: 2020–03
  8. By: Martial Phélippé-Guinvarc'H (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université); J. Cordier
    Abstract: Economic risk: The challenging aggregation of risks across the farms and sectors The article explains the relevance of the copula and the theory of extreme values in the evaluation of agricultural risk. In the classical approach, the multiple risks allow a diversification of the risks, bringing useful financial compensations within the exploitation or the sector. This approach is widely used in portfolio management according to the central limit theorem (CLT). The article outlines and illustrates the cases where the CLT is not applicable because of the form of the statistical links, the loss evaluation or the extreme values.
    Abstract: L'article expose l'intérêt de la théorie des copules et des valeurs extrêmes dans l'évaluation du risque agricole. Dans une approche classique, les multiples risques sont agrégés selon une diversification des risques, apportant des compensations économiques utiles au sein de l'exploitation ou de la filière. Elle est largement utilisée en gestion de portefeuille et s'appuie sur le théorème central limite (TCL). L'article expose et illustre les cas où le TCL ne s'applique pas à cause de la forme des liens statistiques, de l'évaluation de l'impact économique ou des valeurs extrêmes.
    Keywords: Copulas,Extreme Value Theory,Risk Management,Accumulated risk,Gestion des risques,Théorie des valeurs extrêmes,Copules,Mots-clés : Cumul de risques
    Date: 2019
  9. By: Salamanca, Nicolás (Melbourne Institute of Applied Economic and Social Research); de Grip, Andries (ROA, Maastricht University); Sleijpen, Olaf (Maastricht University)
    Abstract: We show that people exposed to greater pension risk are less likely to invest in risky assets. We exploit a reform that links people's future pension benefits to their pension funds' funding ratio—a measure of the fund's financial health—making funding ratios a fund-specific measure of pension risk. The effect of pension risk is stronger for people who are better informed about their pensions, for retirees and pension-age non-retirees, and for wealthier people. The funding ratio does not affect investments in a pre-reform period, nor does it affect bequest intentions, (expected) retirement, or the motivations for saving.
    Keywords: individual portfolio choice, background risk, retirement planning, pension reform, The Netherlands
    JEL: D14 J22
    Date: 2020–03
  10. By: Samuel Rufat (MRTE - Laboratoire Mobilités, Réseaux, Territoires, Environnements - UCP - Université de Cergy Pontoise - Université Paris-Seine); Alexander Fekete (Institute of Rescue Engineering and Civil Protection)
    Date: 2019
  11. By: Chaigneau, Pierre; Edmans, Alex; Gottlieb, Daniel
    Abstract: This paper studies the value of more precise signals on agent performance in an optimal contracting model with endogenous effort. With limited liability, the agent's wage is increasing in output only if output exceeds a threshold, else it is zero regardless of output. If the threshold is sufficiently high, the agent only beats it, and is rewarded for increasing output through greater effort, if there is a high noise realization. Thus, a fall in output volatility reduces effort incentives—information and effort are substitutes—offsetting the standard effect that improved information lowers the cost of compensation. We derive conditions relating the incentive effect to the underlying parameters of the agency problem.
    Keywords: executive compensation; limited liability; options; relative performance evaluation; risk management
    JEL: D86 G32 G34 J33
    Date: 2018–11–01
  12. By: Cardozo, Pamela; Morales-Acevedo, Paola; Murcia, Andrés; Pacheco, Beatriz
    Abstract: During the last decade Colombian international financial conglomerates (IFC) expanded abroad, significantly increasing their geographical complexity. This paper analyzes the effect of this change in geographical complexity on the risk level of individual Colombian banks. We use monthly bank-level data on financial indicators and complexity measures for the period 2007- 2018. We use the Z-score as a measure of bank risk and the number of countries in which a Colombian IFC has foreign banks subsidiaries as a measure of geographical complexity. Our results suggest that complexity is associated with higher levels of individual bank risk, as a result of an expansion to countries with large GDP co-movements and lower regulatory qualities. In addition, we find that banks with access to international funding respond differently to monetary policy changes. In particular, during periods of domestic monetary policy tightening (loosening), individual banks of complex IFCs present higher (lower) levels of risk, suggesting that the monetary policy risk taking channel is affected by the level of geographical complexity.
    Keywords: Bank risk; Geographical complexity; Monetary policy
    JEL: E52 F65 G21 G28 G32
    Date: 2020–04
  13. By: Christopher Busch (Universitat Autonoma de Barcelona); Alexander Ludwig (SAFE, University of Mannheim)
    Abstract: We extend the canonical income process with persistent and transitory risk to shock distributions with left-skewness and excess kurtosis, to which we refer as higher-order risk. We estimate our extended income process by GMM for household data from the United States. We find countercyclical variance and procyclical skewness of persistent shocks. All shock distributions are highly leptokurtic. The existing tax and transfer system reduces dispersion and left-skewness of shocks. We then show that in a standard incomplete-markets life-cycle model, first, higher-order risk has sizable welfare implications, which depend crucially on risk attitudes of households; second, higher-order risk matters quantitatively for the welfare costs of cyclical idiosyncratic risk; third, higher-order risk has non-trivial implications for the degree of self-insurance against both transitory and persistent shocks.
    Keywords: labor income risk, business cycle, GMM estimation, skewness, persistent and transitory income shocks, risk attitudes, life-cycle model
    JEL: D31 E24 E32 H31 J31
    Date: 2020–03
  14. By: Beine, Michel (University of Luxembourg); Charness, Gary (University of California, Santa Barbara); Dupuy, Arnaud (University of Luxembourg); Joxhe, Majlinda (University of Luxembourg)
    Abstract: We conduct a survey and incentivized lab-in-the-field experimental tasks in Tirana, Albania. While the original purpose of our study was to examine whether and how deep parameters such as time and risk preferences affect the intention to migrate, our study was transformed into a natural experiment owing to two large earthquakes that shook the Tirana area during our data-collection period. These events provide us with a rare opportunity to gather evidence (including a preearthquake control) on the effect of natural disasters on time and risk preferences. We find unambiguous effects towards more risk aversion and impatience for affected individuals. Moreover, as it turns out, the second earthquake amplified the effect of the first one, suggesting that experiences cumulate in their influence on these preferences.
    Keywords: time preferences, risk preferences, natural disaster, Albania, migration
    JEL: B49 C90 D91 F22
    Date: 2020–03
  15. By: Ladislav Kristoufek
    Abstract: Bitcoin being a safe haven asset is one of the traditional stories in the cryptocurrency community. However, during its existence and relevant presence, i.e. approximately since 2013, there has been no severe situation on the financial markets globally to prove or disprove this story until the COVID-19 pandemics. We study the quantile correlations of Bitcoin and two benchmarks -- S\&P500 and VIX -- and we make comparison with gold as the traditional safe haven asset. The Bitcoin safe haven story is shown and discussed to be unsubstantiated and far-fetched, while gold comes out as a clear winner in this contest.
    Date: 2020–03
  16. By: Thierno Barry (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges); Alassane Diabaté (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges); Amine Tarazi (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges)
    Abstract: In this paper, we use U.S. commercial banks' data to investigate whether the effect of unexpected deposit flows on loan production depends on banks' exposure to off-balance sheet funding liquidity risk. We find that lending is sensitive to deposit shocks at small banks but not at large ones. Furthermore, for small banks, the increase in lending explained by unexpected deposit inflows depends on how much they are exposed to funding liquidity risk stemming from their off-balance sheets, as measured by the level of unused commitments. Small banks more exposed to such funding liquidity risk tend to extend fewer new loans. Our results indicate that unexpected deposit inflows from, for instance, the failure of other banks or market disruptions might not as easily be fueled again to borrowers.
    Keywords: unexpected deposit flows,loan production,off-balance sheet funding liquidity risk
    Date: 2020–03–24
  17. By: Matthes, Jürgen; Demary, Markus
    Abstract: Various European instruments for countries particularly affected by the Corona crisis are currently under discussion. In this article several requirements will be established and the existing proposals will be measured against them. The instrument of Corona bonds is considered most effective - provided that German policymakers accept the risk-sharing associated with them.
    Date: 2020

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