nep-rmg New Economics Papers
on Risk Management
Issue of 2021‒01‒11
33 papers chosen by

  1. Adjusted Expected Shortfall By Matteo Burzoni; Cosimo Munari; Ruodu Wang
  2. Life-Care Tontines By Hieber, Peter; Lucas, Nathalie
  3. Cybersecurity Risk By Chris Florackis; Christodoulos Louca; Roni Michaely; Michael Weber
  4. A Pandemic Business Interruption Insurance By Alexis Louaas; Pierre Picard
  5. Equity tail risk in the treasury bond market By Mirco Rubin; Dario Ruzzi
  6. Risk reduction by conditional mean risk sharing with application to collaborative insurance By Denuit, Michel; Robert, Christian Y.
  7. Conditional tail expectation decomposition and conditional mean risk sharing for dependent and conditionally independent risks By Denuit, Michel; Robert, Christian Y.
  8. From risk sharing to risk transfer: the analytics of collaborative insurance By Denuit, Michel; Robert, Christian Y.
  9. Stop-loss protection for a large P2P insurance pool By Denuit, Michel; Robert, Christian Y.
  10. Conditional mean risk sharing for dependent risks using graphical models By Denuit, Michel; Robert, Christian Y.
  11. Did COVID-19 Change Life Insurance Offerings? By Timothy F. Harris; Aaron Yelowitz; Charles J. Courtemanche
  12. Wishart-Gamma mixtures for multiperil experience ratemaking, frequency-severity experience rating and micro-loss reserving By Denuit, Michel; Lu, Yang
  13. Multi-asset Generalised Variance Swaps in Barndorff-Nielsen and Shephard model By Subhojit Biswas; Diganta Mukherjee; Indranil SenGupta
  14. Portfolio optimization of euro-denominated funds in French life insurance By Runsheng Gu; Lioudmila Vostrikova; Bruno Séjourné
  15. (When) Do Banks React to Anticipated Capital Reliefs? By Guillaume Arnould; Benjamin Guin; Steven Ongena; Paolo Siciliani
  16. Leveraged Loans: Is High Leverage Risk Priced in? By David Newton; Steven Ongena; Ru Xie; Binru Zhao
  17. Systemic Risk in Financial Networks: A Survey By Matthew O. Jackson; Agathe Pernoud
  18. Tempered Stable Processes with Time Varying Exponential Tails By Young Shin Kim; Kum-Hwan Roh; Raphaël Douady
  19. House Prices and Macroprudential Policies: Evidence from City-level Data in India By Bhupal Singh
  20. Modelling Realized Covariance Matrices: a Class of Hadamard Exponential Models By Bauwens, Luc; Otranto, Edoardo
  21. Does Risk-Taking Behaviour Matter for Bank Efficiency? By Chepngenoh, Florence; Muriu, Peter W; Institute of Research, Asian
  22. Correlation Risk, Strings and Asset Prices By Walter Distaso; Antonio Mele; Grigory Vilkov
  23. Learning from Japan's Experience in Integrated Urban Flood Risk Management By World Bank
  24. Regularized Maximum Diversification Investment Strategy By N'Golo Kone
  25. Supranational Rules, National Discretion: Increasing versus Inflating Regulatory Bank Capital? By Reint Gropp; Thomas C. Mosk; Steven Ongena; Carlo Wix; Ines Simac
  26. Fat Tailed Factors By Jan Rosenzweig
  27. COVID-19 spreading in financial networks: A semiparametric matrix regression model By Monica Billio; Roberto Casarin; Michele Costola; Matteo Iacopini
  28. Crisis Risk Prediction with Concavity from Polymodel By Raphaël Douady; Yao Kuang
  29. Modelling credit risk: evidence for EMV methodology on Portuguese mortgage data By Maria Rosa Borges; Raquel Machado
  30. Risk Sharing Within and Outside the Firm: The Disparate Effects of Wrongful Discharge Laws on Expected Stock Returns By Mahlstedt, Robert; Weber, Rüdiger
  31. An actuarial approach for modeling pandemic risk By Hainaut, Donatien
  32. Ukraine; Technical Assistance Report-Strengthening Budget Formulation and Fiscal Risk Management By International Monetary Fund
  33. Consumer Credit with Over-optimistic Borrowers By Florian Exler; Igor Livshits; James MacGee; Michèle Tertilt

  1. By: Matteo Burzoni (Università degli studi di Milano - Dipartimento di Matematica); Cosimo Munari (University of Zurich - Department of Banking and Finance; Swiss Finance Institute); Ruodu Wang (University of Waterloo - Department of Statistics and Actuarial Science)
    Abstract: We introduce and study the main properties of a class of convex risk measures that refine Expected Shortfall by simultaneously controlling the expected losses associated with different portions of the tail distribution. The corresponding adjusted Expected Shortfalls quantify risk as the minimum amount of capital that has to be raised and injected into a financial position X to ensure that Expected Shortfall ESp(X) does not exceed a pre-specified threshold g(p) for every probability level p\in[0,1]. Through the choice of the benchmark risk profile g one can tailor the risk assessment to the specific application of interest. We devote special attention to the study of risk profiles defined by the Expected Shortfall of a benchmark random loss, in which case our risk measures are intimately linked to second-order stochastic dominance.
    Keywords: Convex Risk Measures, Tail Risk, Adjusted Expected Shortfall, Stochastic Dominance, Capital Adequacy, Optimization With Risk Measures
    JEL: D81 G32 C61
    Date: 2020–08
  2. By: Hieber, Peter (Université catholique de Louvain, LIDAM/ISBA, Belgium); Lucas, Nathalie (Université catholique de Louvain, LIDAM/ISBA, Belgium)
    Abstract: This paper builds on the advantage of pooling mortality and morbidity risks, and their inherent natural hedge. We focus on classical mutual risk pooling schemes, i.e. tontines, and introduce a "life-care tontine", which in addition to retirement income targets the needs of long-term care coverage for an ageing population. This scheme reduces adverse selection costs and is actuarially fair at each time. Pooling heterogeneous risks (i.e. different age groups) is shown to reduce overall risk. The life-care tontine is compared to a classical life-care annuity. Technically, we rely on a backward iteration to deduce the smoothed cashows pattern and the separation of cash-ows in a fixed withdrawal and mortality and/or morbidity credits. We apply our model to real life data, illustrating the adequacy of the proposed tontine scheme.
    Keywords: mutual insurance ; long-term care ; morbidity and mortality risk ; tontines ; pooled annuities ; life-care insurance
    Date: 2020–01–01
  3. By: Chris Florackis (University of Liverpool (UK)); Christodoulos Louca (Cyprus University of Technology); Roni Michaely (University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute); Michael Weber (University of Chicago - Finance)
    Abstract: We develop a novel firm-level measure of cybersecurity risk using textual analysis of cybersecurity- risk disclosures in corporate filings. The measure successfully identifies firms extensively discussing cybersecurity risk in their 10-K, displays intuitive relations with quantitative measures of cybersecurity risk disclosure language, exhibits a positive trend over time, is more prevalent among industries relying more on information technology systems, correlates with several characteristics linked to firms hit by cyber attacks and, importantly, predicts future cyber attacks. Stocks with high exposure to cybersecurity risk exhibit high expected returns on average, but they perform poorly in periods of increasing attention to cybersecurity risk.
    Keywords: Cyber attacks, Risk Disclosures, Textual Analysis, Stock returns
    JEL: G14 G32
    Date: 2020–11
  4. By: Alexis Louaas; Pierre Picard
    Abstract: We analyze how pandemic business interruption coverage can be put in place by building on capitalization mechanisms. The pandemic risk cannot be mutualized since it affects simultaneously a large number of businesses, and furthermore, it has a systemic nature because it goes along with a severe decline in the real economy. However, as shown by COVID-19, pandemics affect economic sectors in a differentiated way: some of them are very severely affected because their activity is strongly impacted by travel bans and constraints on work organisation, while others are more resistant. This opens the door to risk coverage mechanisms based on a portfolio of financial securities, including long-short positions and options in stock markets. We show that such financial investment allow insurers to offer business interruption coverage in pandemic states, while simultaneously hedging the risks associated with the alternation of bullish and bearish non-pandemic states. These conclusions are derived from a theoretical model of corporate risk management, and they are illustrated by numerical simulations, using data from the French stock exchange.
    Keywords: pandemic, business interruption, insurance, corporate risk management
    JEL: G11 G22 G32
    Date: 2020
  5. By: Mirco Rubin (EDHEC Business School); Dario Ruzzi (Bank of Italy)
    Abstract: This paper quantifies the effects of equity tail risk on the US government bond market. We estimate equity tail risk as the option-implied stock market volatility that stems from large negative jumps as in Bollerslev, Todorov and Xu (2015), and assess its value in reduced-form predictive regressions for Treasury returns and an affine term structure model for interest rates. We document that the left tail volatility of the stock market significantly predicts one-month-ahead excess returns on Treasuries both in- and out-of-sample. The incremental value of employing equity tail risk as a return forecasting factor can be of economic importance for a mean-variance investor trading bonds. The estimated term structure model shows that equity tail risk is priced in the US government bond market. Consistent with the theory of flight-to-safety, we find that Treasury prices increase and funds flow from equities into bonds when the perception of tail risk is higher. Our results concerning the predictive power and pricing of equity tail risk extend to major government bond markets in Europe.
    Keywords: bond return predictability, equity tail risk, bond risk premium, flight-to-safety, affine term structure model
    JEL: C52 C58 G12 E43
    Date: 2020–12
  6. By: Denuit, Michel; Robert, Christian Y.
    Abstract: Consider an economic agent who has to select the optimal pool for a risk to be shared with other participants, adopting the conditional mean risk sharing rule. This paper shows that pointwise comparison of the Lorenz or concentration curves associated to the respective total losses of the pools under consideration allows the agent to decide which pool is preferable. The paper then concentrates on independent losses. The monotonicity of the respective contributions of the participants is established with respect to the convex order, showing that increasing the number of participants is always beneficial provided the conditional mean risk sharing rule is used to allocate independent losses among participants. These results are finally applied to collaborative insurance. It is shown that provided individual losses are mutually independent, there always exists a critical number of participants such that collaborative insurance outperforms commercial one.
    Keywords: conditional expectation ; risk pooling ; Lorenz curve ; concentration curve ; convex order
    Date: 2020–01–01
  7. By: Denuit, Michel (Université catholique de Louvain, LIDAM/ISBA, Belgium); Robert, Christian Y.
    Abstract: Conditional tail expectations are often used in risk measurement and capital allocation. Con- ditional mean risk sharing appears to be effective in collaborative insurance, to distribute total losses among participants. This paper develops analytical results for risk allocation among different, correlated units based on conditional tail expectations and conditional mean risk sharing. Results available in the literature for independent risks are extended to correlated ones, in a unified way. The approach is applied to mixture models with correlated latent factors that are often used in insurance studies.
    Keywords: Weighted distributions ; size-biased transform ; mixture models
    Date: 2020–01–01
  8. By: Denuit, Michel (Université catholique de Louvain, LIDAM/ISBA, Belgium); Robert, Christian Y.
    Abstract: Denuit (2019, 2020b) demonstrated that conditional mean risk sharing introduced by Denuit and Dhaene (2012) is the appropriate theoretical tool to share losses in collaborative P2P insurance schemes. Denuit and Robert (2020a,b,c) studied this risk sharing mechanism and established several attractive properties including linear approximations when total losses or the number of participants get large. It is also shown there that the conditional expectation defining the conditional mean risk sharing is asymptotically increasing in the total loss (under mild technical assumptions). This ensures that the risk exchange is Pareto-optimal and that all participants have an interest to keep total losses as small as possible. In this paper, we design a exible system where entry prices can be made attractive compared to the premium of a regular, commercial insurance contract. Participants can also be grouped according to some meaningful criterion, resulting in a hierarchical decomposition of the community. The particular case where realized losses are allocated in proportion of the pure premiums is studied. This applies to losses obeying infinitely divisible distributions, such as compound Poisson or compound Negative Binomial ones as long as severities are identically distributed. Also, participants can just opt for such a proportional mean risk sharing, for simplicity.
    Keywords: Peer-to-Peer (P2P) insurance ; conditional mean risk sharing ; size-biased transform ; comonotonicity
    Date: 2020–01–01
  9. By: Denuit, Michel (Université catholique de Louvain, LIDAM/ISBA, Belgium); Robert, Christian Y.
    Abstract: This paper considers a peer-to-peer (P2P) insurance scheme where the higher layer is transferred to a (re-)insurer and retained losses are distributed among participants according to the conditional mean risk sharing rule proposed by Denuit and Dhaene (2012). The global retention level of the pool of participants grows proportionally with their number. We study the asymptotic behavior of the individual retention levels, as well as individual cash-backs and stop-loss premiums, as the number of participants increases. The probability that the total loss hits the upper layer protected by the stop-loss treaty is also considered. The results depend on the proportional rate of increase of the global retention level with the number of participants, as well as on the existence of the Esscher transform of the losses brought to the pool.
    Keywords: conditional expectation ; risk pooling ; comonotonicity ; Esscher transform ; regularly varying tails
    Date: 2020–01–01
  10. By: Denuit, Michel (Université catholique de Louvain, LIDAM/ISBA, Belgium); Robert, Christian Y.
    Abstract: Conditional mean risk sharing appears to be e_ective in collaborative insurance to distribute total losses among participants. This paper develops analytical results for this risk sharing rule when risks are zero-augmented random variables whose joint occurrences distributions and claim amount distributions are based on network structures and may be characterized by graphical models. More speci_cally we consider the Ising model for occurrences and decomposable graphical models for the claim amount structures. Such models are typically useful for modeling operational risk or cyber security risk.
    Keywords: Graphical models ; Ising model ; decomposable graphs ; size-biased transform
    Date: 2020–01–01
  11. By: Timothy F. Harris; Aaron Yelowitz; Charles J. Courtemanche
    Abstract: The profitability of life insurance offerings is contingent on accurate projections and pricing of mortality risk. The COVID-19 pandemic created significant uncertainty, with dire mortality predictions from early forecasts resulting in widespread government intervention and greater individual precaution that reduced the projected death toll. We analyze how life insurance companies changed pricing and offerings in response to COVID-19 using monthly data on term life insurance policies from Compulife. We estimate event-study models that exploit well-established variation in the COVID-19 mortality rate based on age and underlying health status. Despite the increase in mortality risk and significant uncertainty, we find limited evidence that life insurance companies increased premiums or decreased policy offerings due to COVID-19.
    JEL: D81 I13
    Date: 2020–12
  12. By: Denuit, Michel (Université catholique de Louvain, LIDAM/ISBA, Belgium); Lu, Yang
    Abstract: This paper studies multivariate mixtures with Wishart-Gamma mixing distribution. Af- ter having recalled the definition and main properties of Wishart distributions for random symmetric positive definite matrices, it is shown how they can be used to extend Gamma distributions to the multivariate case, by considering the joint distribution of the diagonal terms. The resulting distribution, which we call Wishart-Gamma distribution, appears to be particularly useful to model correlated random effects in multivariate frequency, severity and duration models, leading to closed form likelihood function and posterior ratemak- ing formula. Three main applications are discussed to demonstrate the versatility of the Wishart-Gamma mixture models: (i) experience rating with several policies or guarantees per policyholder, (ii) experience rating taking into account the correlation between claim fre- quency and severity components, and (iii) dependence modeling between time-to-payment and amount of payment in micro-loss reserving when the ultimate payment is subject to censoring. Besides introducing the Wishart and Wishart-Gamma distributions, we are also among one of the first to employ the techniques such as fractional integral and symbolic calculation in the non-life actuarial literature.
    Keywords: Mutlivariate Gamma distribution ; Laplace transform ; fractional calculus ; symbolic calculation ; Bayesian ratemaking ; credibility ; mixed Poisson distribution ; frailty model
    Date: 2020–01–01
  13. By: Subhojit Biswas; Diganta Mukherjee; Indranil SenGupta
    Abstract: This paper proposes swaps on two important new measures of generalized variance, namely the maximum eigenvalue and trace of the covariance matrix of the assets involved. We price these generalized variance swaps for Barndorff-Nielsen and Shephard model used in financial markets. We consider multiple assets in the portfolio for theoretical purpose and demonstrate our approach with numerical examples taking three stocks in the portfolio. The results obtained in this paper have important implications for the commodity sector where such swaps would be useful for hedging risk.
    Date: 2020–11
  14. By: Runsheng Gu (GRANEM - Groupe de Recherche Angevin en Economie et Management - UA - Université d'Angers - AGROCAMPUS OUEST - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - Institut National de l'Horticulture et du Paysage); Lioudmila Vostrikova (LAREMA - Laboratoire Angevin de Recherche en Mathématiques - UA - Université d'Angers - CNRS - Centre National de la Recherche Scientifique); Bruno Séjourné (GRANEM - Groupe de Recherche Angevin en Economie et Management - UA - Université d'Angers - AGROCAMPUS OUEST - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - Institut National de l'Horticulture et du Paysage)
    Abstract: In this paper, we study a portfolio optimization problem related to the asset management of life insurance companies. In a persistent low-interest-rate environment, the conditions under which the life insurance business operates are modified. To continue to offer a favorable return to the insured, life insurers should allocate more risky assets to their portfolio. But, doing so, they would be exposed to not being able to guarantee the capital. Besides, the maturity of the life insurance market creates potential conditions for massive withdrawals. We address those risk exposures by applying ruin models. We obtain formulae for the first two moments of the value of a life insurance company, depending on its activity and investment strategy. We show that the optimal asset allocation strategies can differ considerably for small changes in certain parameters of the insurer's business: the probability of insolvency, the level of guaranteed capital, and the premium rate.
    Abstract: Dans cet article, nous étudions un problème d'optimisation de portefeuille lié à la gestion d'actifs d'une compagnie d'assurance-vie pour son fonds euro. Dans un environnement persistant de taux bas, les conditions de fonctionnement des activités d'assurance-vie sont modifiées. Pour continuer à offrir une rémunération attractive aux assurés, les assureurs vie devraient introduire davantage d'actifs risqués dans leur portefeuille. Mais, ce faisant, ils s'exposeraient à ne pas pouvoir garantir le capital, ce qui est en contradiction avec les termes du contrat. Par ailleurs, la maturité du marché de l'assurance-vie en France crée des conditions potentielles de retraits massifs. En raison de ces multiples expositions aux risques, nous appliquons des modèles de ruine à ce problème global. Nous déterminons la formulation mathématique des deux premiers moments de la valeur d'une compagnie d'assurance-vie, en fonction de son activité et de sa stratégie d'investissement. Nous résolvons numériquement le problème d'optimisation sous contraintes. Nos résultats permettent de mieux analyser les problèmes de gestion de portefeuille des compagnies. Les stratégies d'allocation d'actifs optimales peuvent varier considérablement pour des changements minimes de certains paramètres de l'activité des assureurs : la probabilité d'insolvabilité, le niveau de capital garanti et le taux de prime.
    Keywords: life insurance,portfolio optimization,low interest rates,ruin theory
    Date: 2020–11–26
  15. By: Guillaume Arnould (Bank of England; Université Paris I Panthéon-Sorbonne - Centre d'Economie de la Sorbonne (CES)); Benjamin Guin (Bank of England); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)); Paolo Siciliani (Bank of England)
    Abstract: We study how banks react to policy announcements during a representative policy cycle involving consultation and publication using a novel dataset on the population of all mortgage transactions and regulatory risk assessments of banks. We demonstrate that banks likely to benefit from lower capital requirements increase the size of this capital relief by permanently investing into low risk assets after the publication of the policy. In contrast, there is no evidence that they already reacted to the early step of the development of the policy, the publication of the consultation paper. We show how these results can be used to estimate a lower bound on the cost of capital for smaller banks, for which such estimates are typically difficult to obtain.
    Keywords: Bank regulation, mortgage lending, supervisory review process, capital requirements
    JEL: G21
    Date: 2020–11
  16. By: David Newton (University of Bath - School of Management); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)); Ru Xie (University of Bath, School of management); Binru Zhao (University of Bath - School of Management)
    Abstract: The economic downturn caused by the Covid-19 pandemic accentuates extant concerns about the leveraged loan market. Using a novel dataset, we show that leveraged loan spreads have declined for nonbank-facilities since the introduction of the Interagency Guidance on Leveraged Lending (IGLL) and the ensuing “frequently asked questions for implementing the March 2013 guidance”. The decline in leveraged loan spreads is significant for highly leveraged borrowers, especially when involving term loans. We further demonstrate that risk shifting issues associated with the high level of Collateralized Loan Obligations issuance strongly explain the decline of nonbank leveraged loan spreads. In addition, a higher degree of information asymmetry, driven by an increase in covenant-lite loan issuance and weaker investor protection, are strongly associated with the narrowed leverage risk premium.
    Keywords: Leverage Risk, Syndicated Loan Pricing, Leveraged Loan, Risk Shifting
    JEL: G21 D82 G34
    Date: 2020–12
  17. By: Matthew O. Jackson; Agathe Pernoud
    Abstract: We provide an overview of the relationship between financial networks and systemic risk. We present a taxonomy of different types of systemic risk, differentiating between direct externalities between financial organizations (e.g., defaults, correlated portfolios and firesales), and perceptions and feedback effects (e.g., bank runs, credit freezes). We also discuss optimal regulation and bailouts, measurements of systemic risk and financial centrality, choices by banks' regarding their portfolios and partnerships, and the changing nature of financial networks.
    Date: 2020–12
  18. By: Young Shin Kim; Kum-Hwan Roh; Raphaël Douady (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: In this paper, we introduce a new time series model having a stochastic exponential tail. This model is constructed based on the Normal Tempered Stable distribution with a time-varying parameter. The model captures the stochastic exponential tail, which generates the volatility smile effect and volatility term structure in option pricing. Moreover, the model describes the time-varying volatility of volatility. We empirically show the stochastic skewness and stochastic kurtosis by applying the model to analyze S\&P 500 index return data. We present the Monte-Carlo simulation technique for the parameter calibration of the model for the S\&P 500 option prices. We can see that the stochastic exponential tail makes the model better to analyze the market option prices by the calibration.
    Keywords: Levy Process,Normal tempered stable distribution,Volatility of volatility,Stochastic exponential tail,Option Pricing
    Date: 2020–11–22
  19. By: Bhupal Singh
    Abstract: This paper examines the efficacy of macroprudential policies in addressing housing prices in a developing country while underscoring the importance of fundamental factors. The estimated models using city-level data for India suggest a strong influence of fundamental factors in driving housing prices. There is compelling evidence of the effectiveness of macroprudential tools viz., Loan-to-value (LTV) ratio, risk weights, and provisioning requirements, in influencing housing price movements. A granular analysis suggests an even stronger impact on housing prices of a change in the regulatory LTV ratio for large-sized vis-à-vis small-sized mortgages, which buttresses their potency in fighting house price speculations. A tightening of the risk weights on the housing assets of banks causes significant downward pressure on house prices. Similarly, regulatory changes in standard asset provisioning on housing loans also influence house prices.
    Date: 2020–12–18
  20. By: Bauwens, Luc (Université catholique de Louvain, LIDAM/CORE, Belgium); Otranto, Edoardo
    Abstract: Time series of realized covariance matrices can be modelled in the conditional autoregressive Wishart model family via dynamic correlations or via dynamic covariances. Extended parameterizations of these models are proposed, which imply a specific and time-varying impact parameter of the lagged realized covariance (or correlation) on the next conditional covariance (or correlation) of each asset pair. The proposed extensions guarantee the positive definiteness of the conditional covariance or correlation matrix with simple parametric restrictions, while keeping the number of parameters fixed or linear with respect to the number of assets. An empirical study on twenty-nine assets reveals that the extended models have superior forecasting performances than their simpler versions.
    Keywords: realized covariances ; dynamic covariances and correlations ; Hadamard exponential matrix
    JEL: C32 C58
    Date: 2020–11–24
  21. By: Chepngenoh, Florence; Muriu, Peter W; Institute of Research, Asian
    Abstract: In pursuit of financial intermediation between borrowers and savers banks are exposed to various risks which affect efficiency. Using annual panel data for the period 2010 to 2019, this paper investigates the influence of risk-taking behaviour on bank efficiency in a developing economy. Data envelopment analysis technique was used to obtain the profit efficiency scores of each bank and Tobit regression to estimate the impact of various components of bank risks on profit efficiency. Estimation results established that credit and liquidity risks, significantly influence bank efficiency. Therefore, banks should maintain quality assets and a stable liquidity position as they significantly impact on efficiency.
    Date: 2020–12–12
  22. By: Walter Distaso (Imperial College Business School); Antonio Mele (University of Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)); Grigory Vilkov (Frankfurt School of Finance & Management)
    Abstract: Many asset pricing theories treat the cross-section of returns volatility and correlations as two intimately related quantities driven by common factors, which hinders achieving a neat definition of a correlation premium. We formulate a model without factors, but with a continuum of securities that have returns driven by a string. In this model, the arbitrage restrictions require that any asset premium links to the granular exposure of the asset returns to shocks in all other asset returns: an average correlation premium. This premium is both statistically and economically significant, and considerably fluctuates, driven by time-varying correlations and global market developments. The model predictions also lead to uncover fresh properties of big stocks. Big stocks display a high degree of market connectivity in bad times, but they are safer than other stocks, thereby providing hedges against times of heightened correlations. Finally, the model also explains the time-series behavior of the premium for the risk of changes in asset correlations (the premium for correlation risk), including its inverse relation with realized correlations.
    Keywords: correlation premium, premium for correlation risk, cross-section of returns, big stocks, arbitrage pricing, string models, implied correlation
    JEL: G11 G12 G13 G17
    Date: 2020–09
  23. By: World Bank
    Keywords: Urban Development - Hazard Risk Management Urban Development - Urban Water & Waste Management Water Resources - Flood Control
    Date: 2020–02
  24. By: N'Golo Kone
    Abstract: The maximum diversification portfolio as defined by Choueifaty (2011) depends on the vector of asset volatilities and the inverse of the covariance matrix of the asset return. In practice, these two quantities need to be replaced by their sample statistics. The estimation error associated with the use of these sample statistics may be amplified due to (near) singularity of the covariance matrix, in financial markets with many assets. This in turn may lead to the selection of portfolios that are far from the optimal regarding standard portfolio performance measures of the financial market. To address this problem, we investigate three regularization techniques, including the ridge, the spectral cut-off, and the Landweber-Fridman approaches in order to stabilize the inverse of the covariance matrix. These regularization schemes involve a tuning parameter that needs to be chosen. In light of this fact, we propose a data-driven method for selecting the tuning parameter. We show that the selected portfolio by regularization is asymptotically efficient with respect to the diversification ratio. In empirical and Monte Carlo experiments, the resulting regularized rules are compared to several strategies, such as the most diversified portfolio, the target portfolio, the global minimum variance portfolio, and the naive 1/N strategy in terms of in-sample and out-of-sample Sharpe ratio performance, and it is shown that our method yields significant Sharpe ratio improvements.
    Keywords: Portfolio selection, Maximum diversification, Regularization
    Date: 2021–01
  25. By: Reint Gropp (Halle Institute for Economic Research); Thomas C. Mosk (University of Zurich, Research Center SAFE); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)); Carlo Wix (Board of Governors of the Federal Reserve System); Ines Simac (KU Leuven)
    Abstract: We study how higher capital requirements introduced at the supranational level affect the regulatory capital of banks across countries. Using the 2011 EBA capital exercise as a quasi-natural experiment, we find that treated banks exploit discretion in the calculation of regulatory capital to inflate their capital ratios without a commensurate increase in their book equity and without a reduction in bank risk. Regulatory capital inflation is more pronounced in countries where credit supply is expected to tighten, suggesting that national authorities forbear their domestic banks to meet supranational requirements, with a focus on short-term economic considerations.
    Keywords: Bank capital requirements, regulatory forbearance
    JEL: G21 G28
    Date: 2020–12
  26. By: Jan Rosenzweig
    Abstract: Standard, PCA-based factor analysis suffers from a number of well known problems due to the random nature of pairwise correlations of asset returns. We analyse an alternative based on ICA, where factors are identified based on their non-Gaussianity, instead of their variance. Generalizations of portfolio construction to the ICA framework leads to two semi-optimal portfolio construction methods: a fat-tailed portfolio, which maximises return per unit of non-Gaussianity, and the hybrid portfolio, which asymptotically reduces variance and non-Gaussianity in parallel. For fat-tailed portfolios, the portfolio weights scale like performance to the power of $1/3$, as opposed to linear scaling of Kelly portfolios; such portfolio construction significantly reduces portfolio concentration, and the winner-takes-all problem inherent in Kelly portfolios. For hybrid portfolios, the variance is diversified at the same rate as Kelly PCA-based portfolios, but excess kurtosis is diversified much faster than in Kelly, at the rate of $n^{-2}$ compared to Kelly portfolios' $n^{-1}$ for increasing number of components $n$.
    Date: 2020–11
  27. By: Monica Billio (Department of Economics, University Of Venice Cà Foscari); Roberto Casarin (Department of Economics, University Of Venice Cà Foscari); Michele Costola (Department of Economics, University Of Venice Cà Foscari); Matteo Iacopini (Vrije Universiteit Amsterdam)
    Abstract: Network models represent a useful tool to describe the complex set of financial relationships among heterogeneous firms in the system. In this paper, we propose a new semiparametric model for temporal multilayer causal networks with both intra- and inter-layer connectivity. A Bayesian model with a hierarchical mixture prior distribution is assumed to capture heterogeneity in the response of the network edges to a set of risk factors including the European COVID-19 cases. We measure the financial connectedness arising from the interactions between two layers defined by stock returns and volatilities. In the empirical analysis, we study the topology of the network before and after the spreading of the COVID-19 disease.
    Keywords: Multilayer networks, financial markets, COVID-19
    JEL: C11 C58 G10
    Date: 2021
  28. By: Raphaël Douady (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Yao Kuang
    Abstract: Financial crises is an important research topic because of their impact on the economy, the businesses and the populations. However, prior research tend to show systemic risk measures which are reactive, in the sense that risk surges after the crisis starts. Few of them succeed in predicting financial crises in advance. In this paper, we first introduce a toy model based on a dynamic regime switching process producing normal mixture distributions. We observe that the relative concavity of various indices increases before a crisis. We use this stylized fact to introduce a measure of concavity from nonlinear Polymodel, as a crisis risk indicator, and test it against known crises. We validate the indicator by using it for a trading strategy that holds long or short positions on S&P 500, depending on the indicator value.
    Keywords: crisis risk,financial crisis,concavity,Polymodel,trading strategy
    Date: 2020–11–22
  29. By: Maria Rosa Borges; Raquel Machado
    Abstract: Traditional credit risk models failed during the recent financial crisis and revealed weaknesses in forecasting and stress testing procedures. One of the main reasons for this failure was the fact that they did not include lifecycle and macroeconomic adverse selection effects. The Exogenous-Maturity-Vintage (EMV) models emerged in this context, in the credit risk literature. In this article, we assess the applicability of the EMV models to a dataset consisting of Portuguese mortgage data between 2007 and 2017, to study the determinants of default rates. We obtain and examine the exogenous, maturity and vintage curves from the dataset under analysis, plotting defaults rates through time, under each of the three component’s logic (default rates by calendar period, by age and by vintage). We show that these curves follow the expected behavior. Finally, we identify a set of explanatory variables suitable to be incorporated in an EMV model specification, for forecasting purposes, and discuss the rationality for their inclusion in the model.
    Keywords: credit risk; EMV models; mortgage loans; default rates; vintages. JEL Classification: G20; G21
    Date: 2020–11
  30. By: Mahlstedt, Robert (University of Copenhagen); Weber, Rüdiger (WU Vienna University of Economics and Business)
    Abstract: We study the effect of wrongful-discharge laws (WDL) on firm-level stock returns. We find disparate effects depending on the exact design of the law. Consistent with rational, risk-based pricing, the effect on returns seems to be linked to how firms share systematic risk with their employees under the respective laws. Firms in states with WDLs prohibiting employers from acting in bad faith have more intra-firm risk sharing and lower expected returns. Vaguer legislation that prohibits discharges in retaliation for acting in accordance with public policy is associated with less intra-firm risk sharing and higher expected returns.
    Keywords: labor protection, expected stock returns, risk sharing
    JEL: G12 J38 G38
    Date: 2020–12
  31. By: Hainaut, Donatien (Université catholique de Louvain, LIDAM/ISBA, Belgium)
    Abstract: This article proposes a model for pandemic risk and two stochastic extensions. It is designed for actuarial valuation of insurance plans providing healthcare and death benefits. The core of our approach relies on a deterministic model that is an efficient alternative to the susceptible-Infected-Recovered (SIR) method. This model explains the evolution of the first waves of COVID-19 in Belgium, Germany, Italy and Spain. Furthermore, it is analytically tractable for fair pure premium calculation. In a first extension, we replace the time by a Gamma stochastic clock. This approach randomizes the timing of the epidemic peak. A second extension consists in adding a Brownian noise and a jump process to explain the erratic evolution of the population of confirmed cases. The jump component allows for local resurgences of the epidemic.
    Keywords: SIR ; epidemic risk ; COVID-19 ; jump-diffusion
    Date: 2020–01–01
  32. By: International Monetary Fund
    Abstract: This Technical Assistance Paper on Ukraine discusses that implementing strategic planning and a medium-term budget framework (MTBF) is a core component of Ukraine’s Public Financial Management (PFM) reform strategy. A pilot MTBF conducted in 2017 formed the basis for amendments to the Budget Code in December 2018, which firmly establish a MTBF as the basis for budget preparation. The amendments also establish a legal basis for related reforms, including regular spending reviews and monitoring and managing risks to public finances. The report also highlights that a central margin should also be established to accommodate budget volatility and meet the costs of genuinely urgent, unavoidable and unforeseeable expenditure pressures that may arise. In order to reinforce spending discipline, the margin should be tightly controlled, centrally managed and transparently reported. Strategic planning should also be improved to provide a stronger basis for integrated policymaking, strategizing, planning and budgeting. Creating a robust strategic planning system would assist in this regard.
    Keywords: Budget planning and preparation;Fiscal risks;Expenditure;Medium-term budget frameworks;Public expenditure review;ISCR,CR,expenditure ceiling,State budget,budget volatility,KSU budget submission,KSU ceiling
    Date: 2019–12–06
  33. By: Florian Exler; Igor Livshits; James MacGee; Michèle Tertilt
    Abstract: I investigate the impact of contactless credit cards (CTCs) on cash use in Canada, using panel data between 2010 and 2017. I show that ignoring unobserved heterogeneity would lead to overstating the impact of CTCs on cash usage in a linear model. Using finite mixture modelling, I provide evidence of the differential impacts of CTCs on the extensive versus intensive margins of cash usage. I use a two-part model, with an exclusion restriction for better identification, to model both margins separately. I obtain that CTC use negatively influences the intensive margin of cash usage but not its extensive margin. There is no clear evidence of an S-curve pattern in the impact of CTCs on cash usage over the sample period.
    Keywords: Credit and credit aggregates; Credit risk management; Financial system regulation and policies
    JEL: E49 G18 K35
    Date: 2020–12

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.