nep-rmg New Economics Papers
on Risk Management
Issue of 2020‒04‒27
nineteen papers chosen by
Stan Miles
Thompson Rivers University

  1. The Conditional Risk and Return Trade-Off on Currency Portfolios By Joseph, Byrne; Sakemoto, Ryuta
  2. Systemic Risk and Centrality Revisited:The Role of Interactions By Asgharian, Hossein; Krygier, Dominika; Vilhelmsson, Anders
  3. Banks to basics! Why banking regulation should focus on equity By Pierre Durand; Gaëtan Le Quang
  4. Macroprudential Ring-Fencing By Tomas Konecny; Lukas Pfeifer
  5. Portfolio Configuration and Foreign Entry Decisions: A Juxtaposition of Real Options and Risk Diversification Theories By Rene Belderbos; Tony W Tong; Shubin Wu
  6. What Explains the Post–2011 Trends of Longer Maturities and Rising Default Rates on Auto Loans? By Paul S. Calem; Chellappan Ramasamy; Jenna Wang
  7. Risk characteristics of covered bonds: monitoring beyond ratings By Grothe, Magdalena; Zeyer, Jana
  8. Financial Stability Committees and Basel III Macroprudential Capital Buffers By Rochelle M. Edge; J. Nellie Liang
  9. Inflation at Risk By J. David Lopez-Salido; Francesca Loria
  10. On the Valuation and Analysis of Risky Debt: A Practical Approach Using Raging Migrations By Edwin O. Fischer; Lisa-Maria Kampl; Ines Wöckl
  11. How Do Legislators Value Constituent’s (Statistical) Lives? COVID-19, Partisanship, and Value of a Statistical Life Analysis By Landgrave, Michelangelo Geovanny
  12. Public flood risk mitigation and the homeowner's insurance demand response By Stefan Borsky; Hannah B. Hennighausen
  13. Growth-and-risk trade-off By Laeven, Luc; Perez-Quiros, Gabriel; Rivas, María Dolores Gadea
  14. The Impact of COVID-19 on Iowa's Corn, Soybean, Ethanol, Pork, and Beef Sectors By Chad E. Hart; Dermot J. Hayes; Keri L. Jacobs; Lee L. Schulz; John M. Crespi
  15. Dependence risk analysis in energy, agricultural and precious metals commodities: A pair vine copula approach By Satish Kumar; Aviral K. Tiwari; Ibrahim D. Raheem; Qiang Ji
  16. How Does Supervision Affect Bank Performance during Downturns? By Uyanga Byambaa; Beverly Hirtle; Anna Kovner; Matthew Plosser
  17. "Risk reference charts for speeding based on telematics information" By Montserrat Guillen; Ana M. Pérez-Marín; Manuela Alcañiz
  18. Commodity Price Volatility and the Economic Uncertainty of Pandemics By Dimitrios Bakas; Athanasios Triantafyllou
  19. Attention to the tail(s): global financial conditions and exchange rate risks By Sokol, Andrej; Eguren-Martin, Fernando

  1. By: Joseph, Byrne; Sakemoto, Ryuta
    Abstract: If asset price risk-return relations vary over time based upon changing economic states, standard unconditional models may "wash out" state dependence and fail to identify that additional risk is contingently compensated with higher return. We address this matter by considering conditional risk-return relations for currency portfolios. Doing so within a data rich environment, we also develop broad based measures of investor risk. In general we find that agents require positive compensation for risks in some times and for some investment strategies. Our results identify that relations between currency returns and risk vary over time. Also we find that there are positive risk-return relations on momentum and value currency portfolios during the financial crisis. Furthermore, the risk-return relation on the momentum portfolio is counter-cyclical.
    Keywords: Time-varying Parameters, Currency Carry Trade, Momentum, Value, Conditional Factor Model
    JEL: C12 C58 F3 G11 G15
    Date: 2020–04–07
  2. By: Asgharian, Hossein (Knut Wicksell Centre for Financial Studies, Lund University); Krygier, Dominika (Knut Wicksell Centre for Financial Studies, Lund University); Vilhelmsson, Anders (Knut Wicksell Centre for Financial Studies, Lund University)
    Abstract: We suggest that banks contribute extensively to systemic risk only if they are both “risky” and centrally placed in the financial network. To calculate systemic risk we apply the ∆CoVaR measure of Adrian and Brunnermeier (2016) and measure centrality using detailed US loan syndication data. In agreement with our conjecture our main finding is that centrality is an important determinant of systemic risk but primarily not by its direct effect. Rather, its main influence is to make other firm specific risk measures more important for highly connected banks. A bank’s contribution to systemic risk from a fixed level of Value-at-Risk is about four times higher for a bank with two standard deviations above average centrality compared to a bank with average network centrality. Neglecting this indirect moderation effect of centrality severely underestimates the importance of centrality for “risky” banks and overestimates the effect for “safer” banks.
    Keywords: systemic risk; network centrality; loan syndication; ∆CoVaR; quantile regression
    JEL: G10
    Date: 2019–03–03
  3. By: Pierre Durand; Gaëtan Le Quang
    Abstract: Banking regulation faces multiple challenges that call for rethinking the way it is designed in order to tackle the specific risks associated with banking activities. In this paper, we argue that regulators should focus on designing strong equity requirements instead of implementing several complex rules. Such a constraint in equity is however opposed by the banking industry because of its presumed adverse impact on banks' performance. Resorting to Random Forest regressions on a large dataset of banks balance sheet variables, we show that the ratio of equity over total assets has a clear positive effect on banks' performance, as measured by the return on assets. On the contrary, the impact of this ratio on the shareholder value, as measured by the return on equity, is most of the time weakly negative. Strong equity requirements do not, therefore, impede banks' performance but do reduce the shareholder value. This may be the reason why the banking industry so fiercely opposes strong equity requirements.
    Keywords: Banking regulation ; Capital requirements ; Basel III ; Random Forest Regression
    JEL: C44 G21 G28
    Date: 2020
  4. By: Tomas Konecny; Lukas Pfeifer
    Abstract: This paper focuses on ring-fencing in the specific context of macroprudential policy and its effects on financial integration in the EU over time. It views macroprudential ring-fencing as a restriction on the regulatory capital mobility of cross-border banking groups as a result of macroprudential measures. We find two main factors behind the observed heterogeneity of macroprudential policy with the potential for ring-fencing - credit risk materialisation and the share of foreign-owned banks' assets related to the gradual phase-in of capital reserves. The heterogeneity of risk weights should be partly limited by the new CRD V/CRR II regulatory package and other prudential backstops (such as the leverage ratio requirement and the output floor). On the other hand, the new regulatory package contains limits on structural reserves, which may lead to a situation where regulatory design precludes the application of macroprudential measures corresponding to the level of systemic risk.
    Keywords: Financial stability, macroprudential policy, ring-fencing
    JEL: E58 E61 G18
    Date: 2019–12
  5. By: Rene Belderbos; Tony W Tong; Shubin Wu
    Abstract: Research Summary: Research on foreign market entry has rarely considered that multinational firms’ new entries may be affected by the configuration of their existing affiliates. We argue that in making entry decisions, firms take into account how an entry into a new location helps increase the operational flexibility of their affiliate portfolios due to options to switch operations across affiliates in case of diverging labor cost developments across host countries. We juxtapose this real options based explanation with a risk diversification explanation. Analysis of Japanese multinational firms’ foreign entry decisions suggests that the two explanations are complementary. We also establish portfolio-level boundary conditions to the influence of operational flexibility considerations on entry, in the form of product diversification and the nature of dispersion of labor cost levels.
    Keywords: Market entry, multinational firm, real options, flexibility, risk diversification, portfolio
    Date: 2020–04–16
  6. By: Paul S. Calem; Chellappan Ramasamy; Jenna Wang
    Abstract: This paper quantifies relationships of long-term auto borrowing and auto-loan default to observable borrower characteristics and economic variables. We also quantify the residual components of the trends in long-term borrowing and delinquency not attributable to identifiable factors. Second, our paper provides new evidence on the relationship between longer-term borrowing and auto-loan default risk. We find that observable factors associated with the choice of a long loan term usually indicate an increased risk of default. We also find that the increasing share of long-term loans and the rising frequency of auto-loan default are mostly attributable by nonspecific, year-of-origination (fixed) effects rather than factors observable from our data or observable to lenders. Moreover, although borrowers opting for long loan terms are more likely to default in most comparisons, the increasing share of borrowers selecting a long loan term between 2011 and 2016 did not materially contribute to the rise in default rates. Overall, our analysis highlights the role of unobserved borrower characteristics in driving the recent trends in long-term borrowing and default.
    Keywords: longer-term borrowings; census tract; observable characteristics; default risk; mortgage; unemployment; student loans; household debt; auto lenders; credit cards; longer maturities; HELOC; origination vintages; auto loans
    JEL: C23 G21 D12
    Date: 2020–04–06
  7. By: Grothe, Magdalena; Zeyer, Jana
    Abstract: This paper proposes a set of indicators relevant for the risk characteristics of covered bonds, as based on granular publicly available transparency data. The indicators capture various aspects of cash flow risks related to the issuer, the cover pool and the payment structure. They offer unified risk metrics for the European covered bond universe, which ensures comparability across covered bonds issued by different issuers and rated by different credit rating agencies. The availability of granular risk indicators adds to the overall transparency of the market in the context of risk monitoring. JEL Classification: G12, G24, G21, C30
    Keywords: covered bonds, covered bond transparency data, credit ratings, risk indicators, risk monitoring
    Date: 2020–04
  8. By: Rochelle M. Edge; J. Nellie Liang
    Abstract: We evaluate how a country’s governance structure for macroprudential policy affects its implementation of Basel III macroprudential capital buffers. We find that the probabilities of using the countercyclical capital buffer (CCyB) are higher in countries that have financial stability committees (FSCs) with stronger governance mechanisms and fewer agencies, which reduces coordination problems. These higher probabilities are more sensitive to credit growth, consistent with the CCyB being used to mitigate systemic risk. A country’s probability of using the CCyB is even higher when the FSC or ministry of finance has direct authority to set the CCyB, perhaps because setting the CCyB involves establishing a new macro-financial analytical process to regularly assess systemic risks and allows these new entities to influence the process. These results are consistent with elected officials creating the FSCs with the strongest governance and fewer agencies for functional delegation reasons, but most FSCs are created for symbolic political reasons.
    Keywords: Delegation; Financial stability committees; Credit growth; Macroprudential policy; Countercyclical capital buffer; Bank regulators
    JEL: G21 G28 H11 P16
    Date: 2020–02–18
  9. By: J. David Lopez-Salido; Francesca Loria
    Abstract: We investigate how macroeconomic drivers affect the predictive inflation distribution as well as the probability that inflation will run above or below certain thresholds over the near term. This is what we refer to as Inflation-at-Risk–a measure of the tail risks to the inflation outlook. We find that the recent muted response of the conditional mean of inflation to economic conditions does not convey an adequate representation of the overall pattern of inflation dynamics. Analyzing data from the 1970s reveals ample variability in the conditional predictive distribution of inflation that remains even when focusing on the post-2000 period of stable and low mean inflation. We also document that in the United States and in the Euro Area tight financial conditions carry substantial downside inflation risks, a feature overlooked by much of the literature. Our paper offers a new empirical perspective to existing macroeconomic models, showing that changes in credit conditions are also key to understand the dynamics of the inflation tails.
    Keywords: Quantile regression; Inflation risks
    JEL: C21 E31
    Date: 2020–02–13
  10. By: Edwin O. Fischer (Institute of Finance, Karl-Franzens-University Graz); Lisa-Maria Kampl (Institute of Finance, University of Graz); Ines Wöckl (Institute of Finance, University of Graz)
    Abstract: This paper is concerned with the valuation and analysis of risky debt instruments with arbitrary interest and principal payments subject to default risk. For the valuation, we use a risk-neutral present value model with expected payments for risk-neutral investors and risk-free spot rates. The required risk-neutral default probabilities are derived from historically observable risk-averse migration matrices. Based on this debt valuation, we calculate various key figures for the analysis of risky debt from the point of view of risk-averse investors (e.g., promised and expected yields, yield spreads, Z-spreads, risk premia, risk-averse default probabilities, and risk-averse expected payments). Our approach is well-suited for practical applications, since the parameters required are easily available from observable data.
    Date: 2020–04–08
  11. By: Landgrave, Michelangelo Geovanny
    Abstract: Value of statistical life (VSL) analysis is common place in policy circles to evaluate the effectiveness of policy. As I show using a novel survey experiment with United States' state legislators, actual use of VSL analysis faces several problems. Firstly, policy preferences are inelastic, unchanging, regardless of the cost. Secondly, policy preferences are determined in large by actors' party ID. This means that VSL analysis, in practice, will either encourage policies that are too risky to too risk adverse.
    Date: 2020–04–15
  12. By: Stefan Borsky (University of Graz, Austria); Hannah B. Hennighausen (University of Graz, Austria)
    Abstract: This paper investigates the influence of public risk mitigating activities on individuals' decisions to privately mitigate their disaster risks. We exploit heterogeneity in measures under the Community Rating System in the U.S. to empirically demonstrate that government investment in flood risk communication activities crowd-in private flood insurance demand while activities that lower the flood hazard residents face crowd-out private flood insurance demand. We also give evidence that flood insurance abides by the law of demand: as communities receive price discounts on their insurance policies, demand increases. Our results imply that governments can amplify the price effect by investing in additional risk communication activities, or dilute it by investing in hazard mitigation. This paper contributes to the discussion of the efficacy of disaster risk mitigation strategies and who ultimately bears the costs of natural disasters.
    Keywords: Community Rating System (CRS), flood insurance, behavioral response, risk perception, risk mitigation
    JEL: D12 D83 Q54
    Date: 2020–04
  13. By: Laeven, Luc; Perez-Quiros, Gabriel; Rivas, María Dolores Gadea
    Abstract: We study the effects of credit over the business cycle, distinguishing between expansions and contractions. We find that there is a growth and risk trade-off in the pace of credit growth over the business cycle. While rapid credit growth tends to be followed by deeper recessions, we also find that credit growth has a positive impact on the duration of expansions. This poses a trade-off for the policymaker: Limiting the buildup of financial risk to avoid a deep recession can negatively affect the cumulation of economic growth during the expansion. We show that intermediate levels of credit growth maximize long-term growth while limiting volatility. Macroprudential policies should be used to manage this growth and risk trade-off, striking a balance between allowing expansions to last longer and avoiding deep recessions. JEL Classification: C22, E32, E61
    Keywords: business cycles, credit growth, financial crisis, GDP-at-risk, macroprudential policies
    Date: 2020–04
  14. By: Chad E. Hart (Center for Agricultural and Rural Development (CARD)); Dermot J. Hayes (Center for Agricultural and Rural Development (CARD)); Keri L. Jacobs; Lee L. Schulz (Center for Agricultural and Rural Development (CARD)); John M. Crespi (Center for Agricultural and Rural Development (CARD))
    Abstract: In this study, we estimate the COVID-19 outbreak's revenue impacts on some of Iowa's largest agricultural industries. We estimate overall annual damage of roughly $788 million for corn, $213 million for soybean, over $2.5 billion for ethanol, $658 million for fed cattle, $34 million for calves and feeder cattle, and $2.1 billion for hogs. As more data become available and as the pandemic evolves, these estimates will certainly change, but for now they represent our best assessment of the impact on these industries.
    Date: 2020–04
  15. By: Satish Kumar (ICFAI Foundation for Higher Education, India); Aviral K. Tiwari (Montpellier Business School, Montpellier, France); Ibrahim D. Raheem (EXCAS, Liège, Belgium); Qiang Ji (Beijing, China)
    Abstract: We apply pair vine copulas, specifically the C-vine and R-vine copulas, to examine the conditional multivariate dependence pattern/structure and R-vine copula-based value-at-risk (VaR) to assess financial portfolio risk. We examine the co-dependencies of 13 major commodity markets (which include three energy commodities, six agricultural commodities and four precious metals prices) from 2 January 2003 to 19 December 2016. Dividing our sample into three sub-periods, namely pre-GFC, GFC and post-GFC, we find that the dependencies among commodities undergo changes in a complex manner, changing in different financial conditions, and that the Student-t copula appears on the maximum number of occasions, especially during the GFC period, signifying the existence of fatter tails in the distributions of returns. We further show that the co-dependencies computed using R-vine copulas are best suited to compute the portfolio VaR during the considered time period.
    Keywords: R-vine; VaR; Dependence structure; Tree structure; Commodity markets
    Date: 2019–01
  16. By: Uyanga Byambaa; Beverly Hirtle; Anna Kovner; Matthew Plosser
    Abstract: Supervision and regulation are critical tools for the promotion of stability and soundness in the financial sector. In a prior post, we discussed findings from our recent research paper which examines the impact of supervision on bank performance (see earlier post How Does Supervision Affect Banks?). As described in that post, we exploit new supervisory data and develop a novel strategy to estimate the impact of supervision on bank risk taking, earnings, and growth. We find that bank holding companies (BHCs or “banks”) that receive more supervisory attention have less risky loan portfolios, but do not have lower growth or profitability. In this post, we examine the benefits of supervision over time, and especially during banking industry downturns.
    Keywords: economic downturn; supervision; bank performance
    JEL: E5 G21 G28
    Date: 2020–04–08
  17. By: Montserrat Guillen (Dept. Econometrics, Riskcenter-IREA, Universitat de Barcelona, Av. Diagonal, 690, 08034 Barcelona, Spain); Ana M. Pérez-Marín (Dept. Econometrics, Riskcenter-IREA, Universitat de Barcelona, Av. Diagonal, 690, 08034 Barcelona, Spain); Manuela Alcañiz (Dept. Econometrics, Riskcenter-IREA, Universitat de Barcelona, Av. Diagonal, 690, 08034 Barcelona, Spain)
    Abstract: Reference charts are widely used as a graphical tool for assessing and monitoring children’s growth given gender and age. Here, we propose a similar approach to the assessment of driving risk. Based on telematics data, and using quantile regression models, our methodology estimates the percentiles of the distance driven at speeds above the legal limit depending on drivers’ characteristics and the journeys made. We refer to the resulting graphs as risk reference charts for speeding and illustrate their use for a sample of drivers with Pay-How-You-Drive insurance policies. We find that percentiles of distance driven at excessive speeds depend mainly on total distance driven, the percentage of driving in urban areas and the driver’s gender. However, the impact on the estimated percentile for these covariates is not constant. We conclude that the heterogeneity in the risk of driving long distances above the speed limit can be easily represented using reference charts and that, conversely, individual drivers can be scored by calculating an estimated percentile for their specific case. The dynamics of this risk score can be assessed by recording drivers as they accumulate driving experience and cover more kilometres. Our methodology should be useful for accident prevention and, in the context of Manage-How-You-Drive insurance, reference charts can provide real-time alerts and enhance recommendations for ensuring safety.
    Keywords: Motor insurance, Speed, Telematics, Quantile regression, Reference curves, Risk score JEL classification: C21, G22
    Date: 2020–04
  18. By: Dimitrios Bakas (Department of Economics, Nottingham Trent University, UK; Rimini Centre for Economic Analysis); Athanasios Triantafyllou (Essex Business School, University of Essex, UK)
    Abstract: In this paper, we empirically investigate the impact of pandemics on commodity price volatility. In specific, we explore the impact of economic uncertainty related to global pandemics on the volatility of the S&P GSCI commodity index as well as on the sub-indexes of crude oil and gold. The results show that uncertainty related to pandemics have a strong negative impact on the volatility of commodity markets and especially on crude oil market, while the effect on gold market is positive but less significant. Our findings remain robust to a series of robustness checks.
    Keywords: Pandemics, Commodity Markets, Economic Uncertainty, Volatility
    JEL: C32 Q02 I10
    Date: 2020–04
  19. By: Sokol, Andrej; Eguren-Martin, Fernando
    Abstract: We document how the distribution of exchange rate returns responds to changes in global financial conditions. We measure global financial conditions as the common component of country-specific financial condition indices, computed consistently across a large panel of developed and emerging economies. Based on quantile regression results, we provide a characterisation and ranking of the tail behaviour of a large sample of currencies in response to a tightening of global financial conditions, corroborating (and quantifying) some of the prevailing narratives about safe haven and risky currencies. Our approach delivers a more nuanced picture than one based on standard OLS regression. We then carry out a portfolio sorting exercise to identify the macroeconomic fundamentals associated with such different tail behaviour, and find that currency portfolios sorted on the basis of net foreign asset positions, relative interest rates, current account balances and levels of international reserves display a higher likelihood of large losses in response to a tightening of global financial conditions. JEL Classification: F31, G15
    Keywords: exchange rates, financial conditions indices, global financial cycle, quantile regression, tail risks
    Date: 2020–04

This nep-rmg issue is ©2020 by Stan Miles. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.