nep-rmg New Economics Papers
on Risk Management
Issue of 2020‒06‒29
sixteen papers chosen by

  1. An attempt to derive the Risk Weight Function for the bank By Nguyen, Van Phuong
  2. iConVis: Interactive Visual Exploration of the Default Contagion Risk for Networked-guarantee Loans By Zhibin Niu; Runlin Li; Junqi Wu; Dawei Cheng; Jiawan Zhang
  3. A Computational Approach to Hedging Credit Valuation Adjustment in a Jump-Diffusion Setting By T. van der Zwaard; L. A. Grzelak; C. W. Oosterlee
  4. Stochastic modeling of assets and liabilities with mortality risk By Sergio Alvares Maffra; John Armstrong; Teemu Pennanen
  5. Risk Management and Management Control System, a close relationship in process: Isomorphism in the Italian Municipalities By Monia Castellini; Vincenzo Riso
  6. Uncovering the mesoscale structure of the credit default swap market to improve portfolio risk modelling By Ioannis Anagnostou; Tiziano Squartini; Diego Garlaschelli; Drona Kandhai
  7. A New Look to Three-Factor Fama-French Regression Model using Sample Innovations By Javad Shaabani; Ali Akbar Jafari
  8. Novel Utility-based Life Cycle Models to Optimise Income in Retirement in the Presence of Heterogeneous Preferences By Bonsoo Koo; Athanasios A. Pantelous; Yunxiao Wang
  9. Myanmar; Technical Assistance Report-Banking Supervision and Regulation By International Monetary Fund
  10. Federal Reinsurance for Terrorism Risk and Its Effects on the Budget: Working Paper 2020-04 By Perry Beider; David Torregrosa
  11. Valuation Risk Revalued By de Groot, Oliver; Richter, Alexander; Throckmorton, Nathaniel
  12. False (and Missed) Discoveries in Financial Economics By Campbell R. Harvey; Yan Liu
  13. When the Markets Get COVID: COntagion, Viruses, and Information Diffusion. By Croce, Mariano Massimiliano; Farroni, Paolo; Wolfskeil, Isabella
  14. Reserve Requirements and Bubbles By ASAOKA Shintaro
  15. Do macroeconomic factors affect the credit risk of islamic banks? evidence from Malaysia By Sapian, Safeza; Masih, Mansur
  16. Disasters Everywhere: The Costs of Business Cycles Reconsidered By Jordá, Óscar; Schularick, Moritz; Taylor, Alan M.

  1. By: Nguyen, Van Phuong
    Abstract: According to the Basel Accord II, one of the key factors in the Internal-Ratings Based (IRB) framework is the Risk Weight Function (RWF). Indeed, it uses four risk components including PD, LGD, EAD, and M as input to yield the capital requirement and thereby Risk-Weighted Asset (RWA). Given the extremely important role of the Risk Weight Function, in this project, we aim to derive it mathematically.
    Keywords: Basel Accord II, Homogenous Loan Portfolio, Loss Distribution, Expected Loss, Unexpected Loss, Capital Requirement, Risk-Weight Functions.
    JEL: G00 G10 G11 G21
    Date: 2019–12–01
  2. By: Zhibin Niu; Runlin Li; Junqi Wu; Dawei Cheng; Jiawan Zhang
    Abstract: Groups of enterprises can guarantee each other and form complex networks to obtain loans from commercial banks. During economic slowdown period, the corporate default may spread like a virus and lead to large-scale defaults or even systemic financial crises. To help the financial regulatory authorities and banks manage the risk brought by the networked loans, we identified the default contagion risk as a pivotal issue to take preventive measures, and develop iConVis, an interactive visual analysis tool, to facilitate the closed-loop analysis process. A novel financial metric - contagion effect is formulated to quantify the infectious consequence of the guarantee chains in the network. Based on the metric, we design and implement a serial of novel and coordinated views to address the analysis the financial problem. Experts evaluated the system using real-world financial data. The proposed approach grants them the ability to overturn the previous ad hoc analysis methodology and extends the coverage of the conventional Capital Accord in the banking industry.
    Date: 2020–06
  3. By: T. van der Zwaard; L. A. Grzelak; C. W. Oosterlee
    Abstract: This study contributes to understanding Valuation Adjustments (xVA) by focussing on the dynamic hedging of Credit Valuation Adjustment (CVA), corresponding Profit & Loss (P&L) and the P&L explain. This is done in a Monte Carlo simulation setting, based on a theoretical hedging framework discussed in existing literature. We look at CVA hedging for a portfolio with European options on a stock, first in a Black-Scholes setting, then in a Merton jump-diffusion setting. Furthermore, we analyze the trading business at a bank after including xVAs in pricing. We provide insights into the hedging of derivatives and their xVAs by analyzing and visualizing the cash-flows of a portfolio from a desk structure perspective. The case study shows that not charging CVA at trade inception results in a guaranteed loss. Furthermore, hedging CVA is crucial to end up with a stable trading strategy. In the Black-Scholes setting this can be done using the underlying stock, whereas in the Merton jump-diffusion setting we need to add extra options to the hedge portfolio to properly hedge the jump risk. In addition to the simulation, we derive analytical results that explain our observations from the numerical experiments. Understanding the hedging of CVA helps to deal with xVAs in a practical setting.
    Date: 2020–05
  4. By: Sergio Alvares Maffra; John Armstrong; Teemu Pennanen
    Abstract: This paper describes a general approach for stochastic modeling of assets returns and liability cash-flows of a typical pensions insurer. On the asset side, we model the investment returns on equities and various classes of fixed-income instruments including short- and long-maturity fixed-rate bonds as well as index-linked and corporate bonds. On the liability side, the risks are driven by future mortality developments as well as price and wage inflation. All the risk factors are modeled as a multivariate stochastic process that captures the dynamics and the dependencies across different risk factors. The model is easy to interpret and to calibrate to both historical data and to forecasts or expert views concerning the future. The simple structure of the model allows for efficient computations. The construction of a million scenarios takes only a few minutes on a personal computer. The approach is illustrated with an asset-liability analysis of a defined benefit pension fund.
    Date: 2020–05
  5. By: Monia Castellini; Vincenzo Riso
    Abstract: The role of the risk management was increased in all main literature about management control system in the last years, not only in private but also in the public sector (Rana et al., 2019; Hinna et al., 2018; Chapman, 2001; Broadbent and Guthrie, 1992, p. 137). There are more contributions that explain how risk management practices are a fundamental instrument in the public sector (Rana et al., 2019; Riso and Castellini, 2019; Keban, 2017) and also the International Organisation of Supreme Audit Institutions (afterwards, INTOSAI) guidelines “9130†offer an over view to implement a risk management strategy in the organizations’ management control systems (INTOSAI 9130, 2007). However, in the Italian context is evident that risk management is entered the public sector but the way in which risk management is introduced within organizations is only in the recent literature researched and not empirically explored (Hinna et al., 2018; Woods, 2009; Leung and Isaacs, 2008). This work is a dowel of a wide research project on Risk Management in public sector and tries to contribute bridge this gap analysing the way in which risk management is introduced in the public organizations. Indeed, the analysis about the risk management introduction in the public organizations is conducted through the collection of qualitative data published by the public organizations on its institutional websites. In deep, the analysis pushes to hypothesize that the introduction of the risk management in the municipalities be a phenomenon of mimetic isomorphism, typically put in place when there is uncertainty in the behaviour to be adopted (DiMaggio and Powell, 2000). Furthermore, the developing of the risk management practices in the management control system of the municipalities involves a growth of the managerial skills.
    Keywords: Risk Management; Control System; Public Administration
    JEL: M10 M11
    Date: 2020–06–12
  6. By: Ioannis Anagnostou; Tiziano Squartini; Diego Garlaschelli; Drona Kandhai
    Abstract: One of the most challenging aspects in the analysis and modelling of financial markets, including Credit Default Swap (CDS) markets, is the presence of an emergent, intermediate level of structure standing in between the microscopic dynamics of individual financial entities and the macroscopic dynamics of the market as a whole. This elusive, mesoscopic level of organisation is often sought for via factor models that ultimately decompose the market according to geographic regions and economic industries. However, at a more general level the presence of mesoscopic structure might be revealed in an entirely data-driven approach, looking for a modular and possibly hierarchical organisation of the empirical correlation matrix between financial time series. The crucial ingredient in such an approach is the definition of an appropriate null model for the correlation matrix. Recent research showed that community detection techniques developed for networks become intrinsically biased when applied to correlation matrices. For this reason, a method based on Random Matrix Theory has been developed, which identifies the optimal hierarchical decomposition of the system into internally correlated and mutually anti-correlated communities. Building upon this technique, here we resolve the mesoscopic structure of the CDS market and identify groups of issuers that cannot be traced back to standard industry/region taxonomies, thereby being inaccessible to standard factor models. We use this decomposition to introduce a novel default risk model that is shown to outperform more traditional alternatives.
    Date: 2020–06
  7. By: Javad Shaabani; Ali Akbar Jafari
    Abstract: The Fama-French model is widely used in assessing the portfolio's performance compared to market returns. In Fama-French models, all factors are time-series data. The cross-sectional data are slightly different from the time series data. A distinct problem with time-series regressions is that R-squared in time series regressions is usually very high, especially compared with typical R-squared for cross-sectional data. The high value of R-squared may cause misinterpretation that the regression model fits the observed data well, and the variance in the dependent variable is explained well by the independent variables. Thus, to do regression analysis, and overcome with the serial dependence and volatility clustering, we use standard econometrics time series models to derive sample innovations. In this study, we revisit and validate the Fama-French models in two different ways: using the factors and asset returns in the Fama-French model and considering the sample innovations in the Fama-French model instead of studying the factors. Comparing the two methods considered in this study, we suggest the Fama-French model should be considered with heavy tail distributions as the tail behavior is relevant in Fama-French models, including financial data, and the QQ plot does not validate that the choice of the normal distribution as the theoretical distribution for the noise in the model.
    Date: 2020–06
  8. By: Bonsoo Koo; Athanasios A. Pantelous; Yunxiao Wang
    Abstract: The global shift towards defined-contribution pension schemes has been accompanied by asymmetric risks and new responsibilities for households to plan and fund effectively their own retirement over the years. In this study, expressing and combining preferences for consumption, investment, bequest, public pension entitlement and the choice of reverse mortgage products, we develop several utilitybased life cycle models to facilitate the complex decision-making process that retired households are required to follow to optimise their retirement income. This optimal policy is given in the form of either an analytical or a numerical solution using stochastic dynamic programming. The timing of this paper coincides with the launch of a reverse mortgage style loan, offered by the Australian federal government and allowing retired households to receive an income stream by taking out a loan against the equity in their home. Calibration is performed using real Australian household data.
    Keywords: risk management, stochastic optimal control, life cycle models, retirement income, reverse mortgage, defined contribution
    Date: 2020
  9. By: International Monetary Fund
    Abstract: The CBM requested TA on bank supervision. The expert worked with the management and staff of the FISD over five missions in 2018 and early 2019 to develop a new, more risk-based approach to bank supervision. Two guides were delivered, one on offsite supervision and the other, still in draft form, on risk-based supervision generally, including a risk matrix approach to risk assessment and procedures for examinations. Many pilot applications of the new tools were prepared with FISD staff.
    Date: 2020–06–08
  10. By: Perry Beider; David Torregrosa
    Abstract: This paper describes CBO's methods for estimating the costs of the federal terrorism risk insurance program. It also discusses how estimates of the program's budgetary effects would differ if they were produced using accrual-based measures rather than cash-based measures.
    JEL: G22 H42 H60
    Date: 2020–06–26
  11. By: de Groot, Oliver; Richter, Alexander; Throckmorton, Nathaniel
    Abstract: This paper shows the success of valuation risk-time-preference shocks in Epstein-Zin utility-in resolving asset pricing puzzles rests sensitively on the way it is introduced. The specification used in the literature violates several desirable properties of recursive preferences because the weights in the Epstein-Zin time-aggregator do not sum to one. When we revise the specification in a simple asset pricing model the puzzles resurface. However, when estimating a sequence of increasingly rich 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: Asset Pricing; Equity premium puzzle; recursive utility; Risk-Free Rate Puzzle
    JEL: C15 D81 G12
    Date: 2020–04
  12. By: Campbell R. Harvey; Yan Liu
    Abstract: Multiple testing plagues many important questions in finance such as fund and factor selection. We propose a new way to calibrate both Type I and Type II errors. Next, using a double-bootstrap method, we establish a t-statistic hurdle that is associated with a specific false discovery rate (e.g., 5%). We also establish a hurdle that is associated with a certain acceptable ratio of misses to false discoveries (Type II error scaled by Type I error), which effectively allows for differential costs of the two types of mistakes. Evaluating current methods, we find that they lack power to detect outperforming managers.
    Date: 2020–06
  13. By: Croce, Mariano Massimiliano; Farroni, Paolo; Wolfskeil, Isabella
    Abstract: We quantify the exposure of major financial markets to news shocks about global contagion risk accounting for local epidemic conditions. For a wide cross section of countries, we construct a novel data set comprising (i) announcements related to COVID19, and (ii) high-frequency data on epidemic news diffused through Twitter. Across several classes of financial assets, we provide novel empirical evidence about {financial dynamics (i) around epidemic announcements, (ii) at a daily frequency, and (iii) at an intra-daily frequency.} Formal estimations based on both contagion data and social media activity about COVID19 confirm that the market price of contagion risk is very significant. We conclude that prudential policies aimed at mitigating either global contagion or local diffusion may be extremely valuable.
    Keywords: asset prices; contagion; Epidemic
    JEL: G01 G1 I1
    Date: 2020–04
  14. By: ASAOKA Shintaro
    Abstract: This study investigates the effectiveness of the reserve requirement policy as a preventive measure against economic bubbles. In the existing literature, it has been pointed out that the expansion of bubbles can be prevented by raising the required reserve ratio. The present study demonstrates this may not be the case. If the ratio is below a certain threshold, the conventional policy prediction fails or in other words, raising the required reserve ratio expands a bubble. If, in contrast, the ratio is above the threshold, it prevents the expansion of the bubble (or the conventional prediction holds). In either case, a policy of raising the reserve requirement is welfare reducing in our model. This implies that if the ratio is below the threshold, the optimal policy is to cut the required reserve ratio, which will increase welfare while at the same time that it will reduce the bubble.
    Date: 2020–05
  15. By: Sapian, Safeza; Masih, Mansur
    Abstract: This paper makes an attempt to investigate whether the macroeconomic factors contribute to the credit risk exposure and non-performing financing (NPF) of Islamic banks. Malaysia is taken as a case study. The standard time series techniques are used to analyze the issue. The variables that have been chosen for the study are gross domestic product (GDP), Non-Performing Financing rate, Islamic financing rate (IFR) and unemployment rate (UMPT). The findings tend to indicate that Islamic Financing rate (IFR) stands out as the only factor that had a significant impact on the credit risk exposure and non-performing financing as well as the performance of Islamic banks in the context of Malaysia.
    Keywords: Islamic Banks, Credit Risk, Non-performing Financing, Time Series Analysis, Malaysia
    JEL: C22 C58 E44 G21
    Date: 2018–11–25
  16. By: Jordá, Óscar; Schularick, Moritz; Taylor, Alan M.
    Abstract: Business cycles are costlier and stabilization policies more beneficial than widely thought. This paper shows that all business cycles are asymmetric and resemble mini "disasters". By this we mean that growth is pervasively fat-tailed and non-Gaussian. Using long-run historical data, we show empirically that this is true for all advanced economies since 1870. Focusing on the peacetime sample, we develop a tractable local projection framework to estimate consumption growth paths for normal and financial-crisis recessions. Using random coefficient local projections we get an easy and transparent mapping from the estimates to the calibrated simulation model. Simulations show that substantial welfare costs arise not just from the large rare disasters, but also from the smaller but more frequent mini-disasters in every cycle. In postwar America, households would sacrifice more than 10 percent of consumption to avoid such cyclical fluctuations.
    Keywords: Asymmetry; Fluctuations; local projections; macroprudential policy; Random coefficients
    JEL: E13 E21 E22 E32
    Date: 2020–04

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NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.