nep-rmg New Economics Papers
on Risk Management
Issue of 2020‒08‒10
27 papers chosen by

  1. Operational Risk Capital By Thomas Conlon; Xing Huan; Steven Ongena
  2. Predicting Downside Risks to House Prices and Macro-Financial Stability By Andrea Deghi; Mitsuru Katagiri; Sohaib Shahid; Nico Valckx
  3. The Implications of Tail Dependency Measures for Counterparty Credit Risk Pricing By J. C. Arismendi-Zambrano; Vladimir Belitsky; Vinicius Amorim Sobreiro; Herbert Kimura
  4. Bank Risk-Taking and Monetary Policy Transmission: Evidence from China By Xiaoming Li; Zheng Liu; Yuchao Peng; Zhiwei Xu
  5. Dissecting Time-Varying Risk Exposures in Cryptocurrency Markets By Daniele Bianchi; Massimo Guidolin; Manuela Pedio
  6. On Single Point Forecasts for Fat-Tailed Variables By Nassim Nicholas Taleb; Yaneer Bar-Yam; Pasquale Cirillo
  7. Forecasting Financial Vulnerability in the US: A Factor Model Approach By Hyeongwoo Kim; Wen Shi
  8. Where Do Institutional Investors Seek Shelter when Disaster Strikes? Evidence from COVID-19 By Simon Glossner; Pedro Matos; Stefano Ramelli; Alexander F. Wagner
  9. Optimal insurance coverage of low-probability catastrophic risks By Alexis Louaas; Pierre Picard
  10. Risk framing and business model adaptation: A conceptualization based on threat-rigidity theory By Aarøen, Camilla; Selart, Marcus
  11. The Risk-Taking Channel in the US: A GVAR Approach By Alzuabi, Raslan; Caglayan, Mustafa; Mouratidis, Kostas
  12. Inflation at risk from Covid-19 By Ryan Niladri Banerjee; Aaron Mehrotra; Fabrizio Zampolli
  13. Value of Life and Annuity Demand By Pashchenko, Svetlana; Porapakkarm, Ponpoje
  14. The Banking View of Bond Risk Premia By Haddad, Valentin; Sraer, David
  15. Sharing of longevity basis risk in pension schemes with income-drawdown guarantees By Ankush Agarwal; Christian-Oliver Ewald; Yongjie Wang
  16. Audit fees and corporate innovation: Auditors' response to corporate innovation By Kim, Hyung-Tae; Lee, Seungwon; Park, Sung-Jin; Lee, Brandon
  17. Identifying indicators of systemic risk By Hartwig, Benny; Meinerding, Christoph; Schüler, Yves
  18. Systemic Risk: a Network Approach By Jean-Baptiste Hasse
  19. The Hansen ratio in mean--variance portfolio theory By Ale\v{s} \v{C}ern\'y
  20. How Accurate Are RetireesÕ Assessments of Their Retirement Risk? By Wenliang Hou
  21. Taming the Green Swan: How to improve climate-related financial risk assessments By Julia Anna Bingler; Chiara Colesanti Senni
  22. Investors' risk attitudes in the pandemic and the stock market: new evidence based on internet searches By Marlene Amstad; Giulio Cornelli; Leonardo Gambacorta; Dora Xia
  23. How Exposed Are Retirement Savings to Market Risk? By Anqi Chen; Nilufer Gok
  24. Portfolio choice with time horizon risk By Alexis Direr
  25. How should a points pension system be managed? By Antoine Bozio; Simon Rabaté; Audrey Rain; Maxime Tô
  26. Modelling and Forecasting Macroeconomic Downside Risk By Delle-Monache, Davide; De-Polis, Andrea; Petrella, Ivan
  27. China’s Evolving Exchange Rate Regime By Sonali Das

  1. By: Thomas Conlon (University College Dublin); Xing Huan (University of Warwick - Accounting Group); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR))
    Abstract: We study the response of banks to the introduction of a new capital requirement relating to operational risk. To isolate the effect of this new regulation on realized operational risk losses, we take advantage of the partial US implementation relative to full European adoption. Operational risk losses are reduced in treated banks. The extent of loss reduction depends upon the measurement approach used to calibrate operational risk capital requirements. Banks with low institutional ownership and those without binding regulatory capital constraints also present significant loss reduction. We link these findings to incentives for improved risk management and governance post treatment.
    Keywords: Bank Regulation, Basel II, Measurement Approach, Monitoring, Operational Risk
    Date: 2020–07
  2. By: Andrea Deghi; Mitsuru Katagiri; Sohaib Shahid; Nico Valckx
    Abstract: This paper predicts downside risks to future real house price growth (house-prices-at-risk or HaR) in 32 advanced and emerging market economies. Through a macro-model and predictive quantile regressions, we show that current house price overvaluation, excessive credit growth, and tighter financial conditions jointly forecast higher house-prices-at-risk up to three years ahead. House-prices-at-risk help predict future growth at-risk and financial crises. We also investigate and propose policy solutions for preventing the identified risks. We find that overall, a tightening of macroprudential policy is the most effective at curbing downside risks to house prices, whereas a loosening of conventional monetary policy reduces downside risks only in advanced economies and only in the short-term.
    Keywords: Global financial crisis, 2008-2009;Demand;Interest rate increases;Housing prices;Financial crises;House Prices,Growth at Risk,Panel Quantile Regression,Early Warning Models,Macroprudential Policy,Monetary Policy,WP,emerge market economy,quantile,house price,financial condition,policy measure
    Date: 2020–01–17
  3. By: J. C. Arismendi-Zambrano (Department of Economics, Finance and Accounting, Maynooth University, Ireland & ICMA Centre, Henley Business School, University of Reading, Whiteknights, Reading, United Kingdom.); Vladimir Belitsky (cUniversity of São Paulo, Institute of Mathematics and Statistics, Department of Statistic, São Paulo, 05508–090, Brazil.); Vinicius Amorim Sobreiro (University of Brasília, Department of Management, Campus Darcy Ribeiro, Brasília, 70910–900, Brazil.); Herbert Kimura (University of Brasília, Department of Management, Campus Darcy Ribeiro, Brasília, 70910–900, Brazil.)
    Abstract: This paper investigates the counterparty credit risk of interest rate swaps positions using the credit valuation adjustment (CVA) measure, and examines the potential dependency relationships between the probability of default (PD) and exposure at default (EAD). We empirically tested, using interest rate swaption implied market volatilities, three tail dependency models: a Basel III Committee independent model, a Gaussian copula dependent model, and a Wrong Way Risk (WWR) with copula dependency approach. The results show that the CVA underestimation when using a Gaussian copula for modelling the dependence of PD and EAD is about 51%–362% compared to using WWR, and the underestimation between using the standardised Basel independent model and using the Gaussian copula is about 527%–1609%, including the period of the 2007/2008 crisis. This has important implications for regulators, financial institutions, and credit risk managers when calculating counterparty risk.
    Keywords: Credit risk, Counterparty Credit Risk, Credit Value Adjustment, Dependency of credit risk components, Pricing swaps.
    JEL: G10 G13 G33
    Date: 2020
  4. By: Xiaoming Li; Zheng Liu; Yuchao Peng; Zhiwei Xu
    Abstract: We present evidence that monetary policy easing reduces bank risk-taking but exacerbates capital misallocation in China after implementing the Basel III capital regulationsin2013. Thenewregulationstightenedbankcapitalrequirementsandintroduced a new risk-weighting approach to calculating the capital adequacy ratio (CAR). To meet tightened capital requirements, a bank can boost its effective CAR by raising capital or by increasing the share of lending to low-risk borrowers. Using confidential loan-level data from a large Chinese commercial bank, merged with firm-level data on a large set of manufacturing firms, we document robust evidence that a monetary policy expansion raises the share of new bank loans to state-owned enterprises (SOEs) after 2013, but not before, because SOE loans receive high credit ratings under government guarantees. Since SOEs are on average less productive than private firms, shifts in bank lending toward SOEs exacerbate capital misallocations, reducing aggregate productivity. We construct a two-sector general equilibrium model with bank portfolio choices and show that, under calibrated parameters, an expansionary monetary policy shock raises the share of bank lending to SOEs, leading to persistent declines in total factor productivity that partially offset the expansionary effects of monetary policy.
    Keywords: risk assessment; Monetary policy - China; risk management; china
    JEL: E52 G18 G21 O42
    Date: 2020–08
  5. By: Daniele Bianchi; Massimo Guidolin; Manuela Pedio
    Abstract: In this paper we take an empirical asset pricing perspective and investigate the dominant view (possibly, an instinctive reflection of the media hype surrounding the surge of Bitcoin valuations) that cryptocurrencies represent a new asset class, spanning risks and payoffs sufficiently different from the traditional ones. Methodologically, we rely on a flexible dynamic econometric model that allows not only time-varying coefficients, but also allow that the entire forecasting model be changing over time. We estimate such model by looking at the time variation in the exposures of major cryptocurrencies to stock market risk factors (namely, the six Fama French factors), to precious metal commodity returns, and to cryptocurrency-specific risk-factors (namely, crypto-momentum, a sentiment index based on Google searches, and supply factors, i.e., electricity and computer power). The main empirical results suggest that cryptocurrencies are not systematically exposed to stock market factors, precious metal commodities or supply factors with the exception of some occasional spikes of the coecients during our sample. On the contrary, crypto assets are characterized by a time-varying but significant exposure to a sentiment index and to crypto-momentum. Despite the lack of predictability compared to traditional asset classes, cryptocurrencies display considerable diversification power in a portfolio perspective and as such they can lead to a moderate improvement in the realized Sharpe ratios and certainty equivalent returns within the context of a typical portfolio problem.
    Keywords: Cryptocurrencies, predictability, portfolio diversification, dynamic model averaging, time-varying, parameter regressions.
    JEL: E40 E52
    Date: 2020
  6. By: Nassim Nicholas Taleb; Yaneer Bar-Yam; Pasquale Cirillo
    Abstract: We discuss common errors and fallacies when using naive "evidence based" empiricism and point forecasts for fat-tailed variables, as well as the insufficiency of using naive first-order scientific methods for tail risk management. We use the COVID-19 pandemic as the background for the discussion and as an example of a phenomenon characterized by a multiplicative nature, and what mitigating policies must result from the statistical properties and associated risks. In doing so, we also respond to the points raised by Ioannidis et al. (2020).
    Date: 2020–07
  7. By: Hyeongwoo Kim; Wen Shi
    Abstract: This paper presents a factor-based forecasting model for the financial market vulnerability, measured by changes in the Cleveland Financial Stress Index (CFSI). We estimate latent common factors via the method of the principal components from 170 monthly frequency macroeconomic data in order to out-of-sample forecast the CFSI. Our factor models outperform both the random walk and the autoregressive benchmark models in out-of-sample predictability at least for the short-term forecast horizons, which is a desirable feature since financial crises often come to a surprise realization. Interestingly, the first common factor, which plays a key role in predicting the financial vulnerability index, seems to be more closely related with real activity variables rather than nominal variables. We also present a binary choice version factor model that estimates the probability of the high stress regime successfully.
    Keywords: Financial Stress Index; Method of the Principal Component; Out-of-Sample Forecast; Relative Root Mean Square Prediction Error; Diebold-Mariano-West Statistic; Ordered Probit Model
    JEL: E44 E47 G01 G17
    Date: 2020–07
  8. By: Simon Glossner (University of Virginia - Darden School of Business); Pedro Matos (University of Virginia - Darden School of Business; European Corporate Governance Institute (ECGI)); Stefano Ramelli (University of Zurich - Department of Banking and Finance); Alexander F. Wagner (University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swiss Finance Institute)
    Abstract: Institutional investors played a crucial role in the COVID-19 market crash. U.S. stocks with higher institutional ownership -- in particular, those held more by active, short-term, and domestic institutions -- performed worse. An analysis of changes in holdings through the first quarter of 2020 reveals that mutual funds, investment advisors, and pension funds favored stocks with strong financials (low debt and high cash), whereas hedge funds sold stocks indiscriminately. None of these institutional investor groups appear to have actively tilted their portfolios toward firms with better environmental and social performance. Data from a large discount brokerage indicate that retail investors acted as liquidity providers. Overall, the results suggest that when a tail risk realizes, institutional investors express a preference for "hard" measures of firm resilience.
    Keywords: Cash holdings, Coronavirus, Corporate debt, COVID-19, ESG, Event study, Financial crisis, Institutional ownership, Leverage, Pandemic, Retail investors, Robinhood, SARS-CoV-2, Tail risk
    JEL: G01 G12 G14 G32 F14
    Date: 2020–07
  9. By: Alexis Louaas (CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - CNRS - Centre National de la Recherche Scientifique - X - École polytechnique - ENSAE ParisTech - École Nationale de la Statistique et de l'Administration Économique); Pierre Picard (CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - CNRS - Centre National de la Recherche Scientifique - X - École polytechnique - ENSAE ParisTech - École Nationale de la Statistique et de l'Administration Économique)
    Abstract: Catastrophic risks are often characterised by a low probability , a high severity and a large number of affected individuals. Taking these specificities into account, we analyse the capacity of insurance contracts to provide coverage for those risks, independently from the market failures frequently observed in practice. On the demand side, we characterise individual preferences under which the willingness to pay for the coverage of large losses remains significant, although their occurrence probability is very small. On the supply side, the correlation between individual losses affects the insurance pricing through the insurers' cost of capital. Analysing the interaction between demand and supply yields the key determinants of insurability and of a socially optimal risk sharing strategy.
    Keywords: risk aversion,capital costs JEL classification: D81,catastrophic risk,Disaster insurance,D86,G22,G28 *
    Date: 2020–06–19
  10. By: Aarøen, Camilla; Selart, Marcus
    Abstract: Firm leaders’ inclination to adapt their business model is sensitive to how risk is framed (as an external threat or an opportunity) in the macro-economic environment. We apply threat-rigidity theory to examine the relationship between risk framing and business model adaptation. We also investigate if emotionality has explanatory value for how managers adapt to business models. We test our hypotheses in a field experiment involving 134 Scandinavian managers. Here, we relate managers’ inclinations to adapt to different business models to different risk scenarios. The results reveal that, in general, managers are more risk seeking in gain scenarios than in loss scenarios. This finding is in line with the threat-rigidity theory. Emotionality was found to relate more to risk aversion than to risk seeking in the domain of potential gain. We argue that emotionality has explanatory value for how managers adapt to business models, because emotions are key influences on risk perception.
    Date: 2020–06–08
  11. By: Alzuabi, Raslan; Caglayan, Mustafa; Mouratidis, Kostas
    Abstract: Using a panel of large US banks, we examine banks' risk-taking behaviour in response to monetary policy shocks. Our investigation provides support for the presence of a risk-taking channel: banks' nonperforming loans increase in the medium to long-run following an expansionary monetary policy shock. We also find that banks' capital structure plays an important role in explaining bank's risk-taking appetite. Impulse response analysis shows that shocks emanating from larger banks spillover to the rest of the sector but no such effect is observed for smaller banks. These findings are confirmed for banks' Z-score.
    Keywords: Risk-taking channel: GVAR: Monetary policy shocks; Spillover effects; Impulse response analysis
    JEL: E44 E52 G01
    Date: 2020–06–01
  12. By: Ryan Niladri Banerjee; Aaron Mehrotra; Fabrizio Zampolli
    Abstract: The pandemic has increased downside tail risks in advanced economies (AEs), while it has increased both downside and upside tail risks in emerging market economies (EMEs). The collapse in output and oil prices, on balance, increases downside inflation risks. Recent exchange rate depreciations increase upside risks to inflation in EMEs. Tighter financial conditions raise both downside and upside risks. In AEs, the increase in downside risks is more prominent.
    Date: 2020–07–23
  13. By: Pashchenko, Svetlana; Porapakkarm, Ponpoje
    Abstract: How does the value of life affect annuity demand? To address this question, we construct a portfolio choice problem with three key features: i) agents have access to life-contingent assets, ii) they always prefer living to dying, iii) agents have non-expected utility preferences. We show that as utility from being alive increases, annuity demand decreases (increases) if agents are more (less) averse to risk rather than to intertemporal fluctuations. Put differently, if people prefer early resolution of uncertainty, they are less interested in annuities when the value of life is high. Our findings have two important implications. First, we get better understanding of the well-known annuity puzzle. Second, we argue that the observed low annuity demand provides evidence that people prefer early rather than late resolution of uncertainty.
    Keywords: annuities, value of a statistical life, portfolio choice problem, life-contingent assets, longevity insurance
    JEL: D91 G11 G22
    Date: 2020–05–30
  14. By: Haddad, Valentin; Sraer, David
    Abstract: Banks' balance-sheet exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with optimal risk management, a banking counterpart to the household Euler equation. In equilibrium, the bond risk premium compensates banks for bearing fluctuations in interest rates. When banks' exposure to interest rate risk increases, the price of this risk simultaneously rises. We present a collection of empirical observations supporting this view, but also discuss several challenges to this interpretation.
    Date: 2019–12
  15. By: Ankush Agarwal; Christian-Oliver Ewald; Yongjie Wang
    Abstract: This work studies a stochastic control problem for a pension scheme which provides an income-drawdown policy. The manager and members agree to share the investment risk based on a risk-sharing rule. The objective is to maximise both sides’ utilities by controlling the investment strategy and benefit withdrawals. We use stochastic affine class models to describe the force of mortality and consider a longevity bond whose coupon payment is linked to a survival index. We also investigate the longevity basis risk, which arises when the members’ and the longevity bond’s reference populations correlate imperfectly. By applying the dynamic programming principle to solve the corresponding HJB equations, we derive optimal solutions for the single and sub-population cases. Our numerical results show that both manager and members benefit from sharing the risk. Moreover, even in the presence of longevity basis risk, we demonstrate that the longevity bond acts as an effective hedging instrument.
    Keywords: Pension scheme, longevity basis risk, mortality-linked instrument, stochastic control, dynamic programming principle
    JEL: G11
    Date: 2020–02
  16. By: Kim, Hyung-Tae; Lee, Seungwon; Park, Sung-Jin; Lee, Brandon
    Abstract: We investigate the extent to which a client’s innovative effort affects the level of audit effort and whether the innovative-effort efficiency can attenuate the demand for greater audit effort associated with a client’s risky research-and-development (R&D) investments. We find that a client firm’s strategic emphasis on corporate innovations may require greater audit effort, but the efficiency of a firm’s innovative effort can attenuate the demand for heightened audit effort against risky, innovative efforts. Findings suggest that the external auditor does not always discourage corporate innovation as the efficiency of a firm’s innovation may lower the client business risk perceived by an auditor.
    Keywords: Corporate innovation; Auditors; Research and development; Risk management
    JEL: M42 O32
    Date: 2019–05–27
  17. By: Hartwig, Benny; Meinerding, Christoph; Schüler, Yves
    Abstract: We operationalize the definition of systemic risk provided by the IMF, BIS, and FSB and derive testable hypotheses to identify indicators of systemic risk. We map these hypotheses into a two-stage hierarchical testing framework, combining insights from the early-warning literature on financial crises with recent advances on growth-at-risk. Applying this framework to a set of candidate variables, we find that the Basel III credit-to-GDP gap does not indicate systemic risk coherently across G7 countries. Credit growth and house price growth also do not pass our test in many cases. By contrast, a composite financial cycle signals systemic risk consistently for all countries except Canada. Overall, our results suggest that systemic risk may be consistently measured only once the turning points of indicators have been observed. Therefore, pre-emptive countercyclical macroprudential policy may smooth the financial cycle in boom phases, which then indirectly mitigates the amount of systemic risk in the future.
    Keywords: systemic risk,macroprudential regulation,forecasting,growth-at-risk,financial cycles
    JEL: E37 E44 G17
    Date: 2020
  18. By: Jean-Baptiste Hasse (Aix-Marseille Univ, CNRS, EHESS, Ecole Centrale, AMSE, Marseille, France)
    Abstract: We propose a new measure of systemic risk based on interconnectedness, defined as the level of direct and indirect links between financial institutions in a correlation-based network. Deriving interconnectedness in terms of risk, we empirically show that within a financial network, indirect links are strengthened during systemic events. The relevance of our measure is illustrated at both local and global levels. Our framework offers policymakers a useful toolbox for exploring the real-time topology of the complex structure of dependencies in financial systems and for measuring the consequences of regulatory decisions.
    Keywords: financial networks, interconnectedness, systemic risk, spillover
    JEL: G01 G15 G21
    Date: 2020–07
  19. By: Ale\v{s} \v{C}ern\'y
    Abstract: It is shown that the ratio between the mean and the $L^2$-norm leads to a particularly parsimonious description of the mean-variance efficient frontier and the dual pricing kernel restrictions known as the Hansen-Jagannathan (HJ) bounds. Because this ratio has not appeared in economic theory previously, it seems appropriate to name it the Hansen ratio. The initial treatment of the mean-variance theory via the Hansen ratio is extended in two directions, to monotone mean-variance preferences and to arbitrary Hilbert space setting. A multiperiod example with IID returns is also discussed.
    Date: 2020–07
  20. By: Wenliang Hou
    Abstract: Retirees with limited financial resources face numerous risks, including out-living their money (longevity risk), investment losses (market risk), unexpected health expenses (health risk), the unforeseen needs of family members (family risk), and even retirement benefit cuts (policy risk). This study systematically values and ranks the financial impacts of these risks from both the objective and subjective perspectives and then compares them to show the gaps between retireesÕ actual risks and their perceptions of the risks in a unified framework. It finds that 1) under the empirical analysis, the greatest risk is longevity risk, followed by health risk; 2) under the subjective analysis, retirees perceive market risk as the highest-ranking risk due to their exaggeration of market volatility; and 3) the longevity risk and health risk are valued less in the subjective ranking than in the objective ranking, because retirees underestimate their life spans and their health costs in late life.
    Date: 2020–07
  21. By: Julia Anna Bingler (Center of Economic Research (CER-ETH), ETH Zurich, Switzerland); Chiara Colesanti Senni (CER-ETH Zurich and Council on Economic Policies, Seefeldstrasse 60, 8008 Zurich)
    Abstract: Climate-related financial risks might have the potential to trigger the next systemic financial crisis, as recently stated by the Bank of International Settlements. In consequence, understanding these so-called Green Swan risks should be a key priority in financial decision-making and supervision. However, a systematic approach and a comprehensive theory on climate-adjusted financial risk metrics is still missing. This study is a first step to fill this gap, with a focus on transition risks. Drawing on insights from climate science, economics and finance research, we derive a set of important criteria to ensure that climate risk tools provide high quality, comparable, and decisionrelevant results. We then use a sample of 16 climate transition risk tools and conduct two lines of research: First, by aid of descriptive analysis, we assess the tools’ coverage of risk sources and financial assets, their inputs (i.e. underlying climate scenarios), and their outputs (i.e. climate-adjusted financial metrics). Second, we use the previously defined criteria for an in-depth analysis of the quality, comparability and decision-relevance of the tools. The results will be presented at the individual tool level, and at the meta level. Based on the results of our descriptive and criteria-based analysis, we derive potential next steps for tool provider, conclusions for potential tool users, and guidelines for supervisory authorities. The analysis could be used as starting point for building a comprehensive theory of meaningful climate-related financial risk indicators, aid practitioners to select the tools best suited to their needs and use cases, and inform regulatory processes on financial climate risk assessment principles.
    Keywords: Financial risk models, Financial pricing models, Transition risks, Climate risk tools, Climate-adjusted financial risk indicators
    JEL: C83 D53 D81 G12 G32 Q54
    Date: 2020–07
  22. By: Marlene Amstad; Giulio Cornelli; Leonardo Gambacorta; Dora Xia
    Abstract: The sharp drop and subsequent rebound in global stock markets in the current pandemic focuses attention on changes in investors' risk attitudes. A new Covid-19 risk attitude (CRA) index for 61 markets, based on internet searches in Google and Baidu, does a good job at capturing investors' attitudes toward pandemic-related risks. Stock markets are more sensitive to changes in the CRA index in more financially developed economies. Stock markets are less sensitive in jurisdictions that have restricted mobility less and that have enacted other containment measures against the pandemic.
    Date: 2020–06–26
  23. By: Anqi Chen; Nilufer Gok
    Abstract: As the COVID-19 pandemic emerged in early 2020, the stock market Ð as measured by the Dow Jones Wilshire 5000 Ð declined by 35 percent between its February peak and March trough. While the market has largely recovered since then, it remains very volatile and exposes household savings to continued market risk. During the February to March period, the value of equities in employer-sponsored retirement plans and household portfolios fell by $14.2 trillion. Of that decline, $4.4 trillion occurred in 401(k)s and Individual Retirement Accounts (IRAs), $1.8 trillion in public and private defined benefit plans, and $8.0 trillion in household non-retirement assets. This brief documents where the declines occurred and the extent to which retirement accounts are exposed to equity market risk. The first section looks at overall trends in the stock market and household exposure. The second section breaks down the decline in equity values by source. And the third section focuses specifically on retirement assets. This information is interesting and important in its own right. But, as the final section concludes, the declines also highlight the fragility of our retirement plans. More than two-thirds of the drop in retirement plan equity holdings was in defined contribution plans. As defined benefit plans become rare, households increasingly bear the full brunt of market turmoil. Much of the discussion about reforming private sector retirement plans has focused on extending coverage. But the current financial downturn also underlines the need to construct arrangements where the full market risk does not fall on retirement plan participants.
    Date: 2020–06
  24. By: Alexis Direr (LEO - Laboratoire d'Économie d'Orleans - UO - Université d'Orléans - Université de Tours - CNRS - Centre National de la Recherche Scientifique)
    Abstract: I study the allocation problem of investors who hold their portfolio until a target wealth is attained. The strategy suppresses final wealth uncertainty but creates an investment time horizon risk. I begin with a simple mean variance model transposed in the duration domain, then study a dynamic portfolio choice problem with Generalized Expected Discounted Utility preferences. Using long-term US return data, I show in the mean variance model that a large amount of time horizon risk can be diversified away by investing a significant share of equities. In the dynamic model, more impatient investors are also more averse to timing risk and invest less in equities. The equity share is downward trending with accumulated wealth relative to its target. J.E.L. codes: D8, E21
    Keywords: portfolio choice,risk aversion,timing risk
    Date: 2020–06–24
  25. By: Antoine Bozio (IPP - Institut des politiques publiques, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Simon Rabaté (IPP - Institut des politiques publiques, Centraal Planbureau); Audrey Rain (IPP - Institut des politiques publiques); Maxime Tô (IPP - Institut des politiques publiques, UCL - University College of London [London], Institute for Fiscal Studies)
    Abstract: A points system, operating at defined yield, makes it possible to rethink how pension systems are managed. Instead of having to make repeated ad hoc changes to the parameters of the system, it is possible to define change rules that other guarantees to future pensioners, as regards not only their entitlements but also the long-term sustainability of the system. In this brief, and based on simulations of a variety of shocks to the pension system, we study what management rules deserve to be chosen. Two rules absolutely must be selected: firstly the growth in the value of the pension point should match the growth in salaries; and secondly converting the points into pension should take into account the life expectancy of each generation (cohort). A third rule that is important for the long term, is the relationship between the rules for index-linking claimed pensions and the amounts of the pensions when they start being claimed. This rule should serve as a guide to managers so that they can steer the system towards an equilibrium that is not based on too low an index-linking of the pensions. Such management implies high institutional autonomy for the system, whereby the managers need to be accountable for the finnancial equilibrium and for the risks to pension revaluation.
    Date: 2019–06
  26. By: Delle-Monache, Davide (Bank of Italy); De-Polis, Andrea (University of Warwick); Petrella, Ivan (University of Warwick)
    Abstract: We investigate the relation between downside risk to the economy and the financial markets within a fully parametric model. We characterize the complete predictive distribution of GDP growth employing a Skew-t distribution with time- varying location, scale, and shape, for which we model both secular trends and cyclical changes. Episodes of downside risk are characterized by increasing negative asymmetry, which emerges as a clear feature of the data. Negatively skewed pre- dictive distributions arise ahead and during recessions, and tend to be anticipated by tightening of financial conditions. Indicators of excess leverage and household credit outstanding are found to be significant drivers of downside risk. Moreover, the Great Recession marks a significant shift in the unconditional distribution of GDP growth, which has featured a distinct negative skewness since then. The model delivers competitive out-of-sample (point and density) forecasts, improving upon standard benchmarks, especially due to financial conditions providing a strong signal of increasing downside risk.
    Keywords: business cycles ; financial conditions ; downside risk ; skewness ; score-driven models ;
    JEL: E37
    Date: 2020
  27. By: Sonali Das
    Abstract: China’s exchange rate regime has undergone gradual reform since the move away from a fixed exchange rate in 2005. The renminbi has become more flexible over time but is still carefully managed, and depth and liquidity in the onshore FX market is relatively low compared to other countries with de jure floating currencies. Allowing a greater role for market forces within the existing regime, and greater two-way flexibility of the exchange rate, are important steps to build on the progress already made. This should be complemented by further steps to develop the FX market, improve FX risk management, and modernize the monetary policy framework.
    Keywords: Exchange markets;Real effective exchange rates;Central banks;Exchange rate policy;Nominal effective exchange rate;reminbi,exchange rate,foreign exchange market,liquidity,RMB,PBC,central parity,renminbi
    Date: 2019–03–07

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