nep-rmg New Economics Papers
on Risk Management
Issue of 2021‒05‒10
seventeen papers chosen by

  1. Efficiency or resiliency? Corporate choice between financial and operational hedging By Acharya, Viral V.; Almeida, Heitor; Amihud, Yakov; Liu, Ping
  2. Credit, capital and crises: a GDP-at-Risk approach By Aikman, David; Bridges, Jonathan; Hacioglu Hoke, Sinem; O'Neill, Cian; Raja, Akash
  3. Aggregate Cyber-Risk Management in the IoT Age: Cautionary Statistics for (Re)Insurers and Likes By Ranjan Pal; Ziyuan Huang; Xinlong Yin; Sergey Lototsky; Swades De; Sasu Tarkoma; Mingyan Liu; Jon Crowcroft; Nishanth Sastry
  4. Capital flows-at-risk: push, pull and the role of policy By Eguren-Martin, Fernando; O’Neill, Cian; Sokol, Andrej; Berge, Lukas von dem
  5. Why did bank stocks crash during COVID-19? By Acharya, Viral V.; Engle III, Robert F; Steffen, Sascha
  6. New Moneys under the New Normal? Bitcoin and Gold Interdependence during COVID Times By Agnese, Pablo; Thoss, Jonathan
  7. Social Responsibility and Bank Resiliency By Gehrig, Thomas; Iannino, Maria Chiara; Unger, Stephan
  8. Risk, ambiguity, and the value of diversification By Loic Berger; Louis Eeckhoudt
  9. Capital Flows at Risk: Taming the Ebbs and Flows By Gelos, Gaston; Gornicka, Lucyna; Koepke, Robin; Sahay, Ratna; Sgherri, Silvia
  10. Supranational Rules, National Discretion: Increasing versus Inflating Regulatory Bank Capital? By Gropp, Reint; Mosk, Thomas; Ongena, Steven; Simac, Ines; Wix, Carlo
  11. Contingent Contracts in Banking: Insurance or Risk Magnification? By Gersbach, Hans
  12. Fractional Barndorff-Nielsen and Shephard model: applications in variance and volatility swaps, and hedging By Nicholas Salmon; Indranil SenGupta
  13. Risk Perceptions and Protective Behaviors: Evidence from COVID-19 Pandemic By M. Kate Bundorf; Jill DeMatteis; Grant Miller; Maria Polyakova; Jialu L. Streeter; Jonathan Wivagg
  14. Credit-to-GDP ratios. Non-linear trends and persistence: Evidence from 44 OECD economies By Juan Carlos Cuestas; Luis A. Gil-Alana; Maria Malmierca
  15. Leveraged property cycles By Jaccard, Ivan
  16. Probability Premium and Attitude Towards Probability By Louis R. Eeckhoudt; Roger J. A. Laeven
  17. Downside and Upside Uncertainty Shocks By Forni, Mario; Gambetti, Luca; Sala, Luca

  1. By: Acharya, Viral V.; Almeida, Heitor; Amihud, Yakov; Liu, Ping
    Abstract: We propose that firms face two potential defaults: Financial default on their debt obli- gations and operational default such as a failure to deliver on obligations to customers. Hence, financially constrained firms substitute between saving cash for financial hedg- ing to mitigate financial default risk, and spending on operational hedging, which mitigates operational default risk. Whereas corporate financial hedging increases in leverage, operational hedging declines in leverage. This results in a positive relation- ship between operational spread (markup) and financial leverage or credit risk, which is stronger for financially constrained firms.We present empirical evidence supporting this relationship.
    Keywords: Financial constraints; financial default; liquidity; operational default; resilience; Risk management
    JEL: G31 G32 G33
    Date: 2021–03
  2. By: Aikman, David; Bridges, Jonathan; Hacioglu Hoke, Sinem; O'Neill, Cian; Raja, Akash
    Abstract: Using quantile regressions applied to a panel dataset of 16 advanced economies, we examine how downside risk to growth over the medium term is affected by a set of macroprudential indicators. We find that credit and property price booms, and wide current account deficits increase downside risks 3 to 5 years ahead. However, such downside risks can be partially mitigated by increasing the capital ratio of the banking system. We show that GDP-at-Risk, defined as the the 5th quantile of the projected GDP growth distribution three years ahead, deteriorated in the US in the run-up to the Global Financial Crisis, driven by rapid growth in credit and house prices alongside a widening current account deficit. Our results suggest such indicators could provide useful information for the stance of macroprudential policy.
    Keywords: Financial Stability; GDP-at-Risk; local projections; macroprudential policy; quantile regressions
    JEL: G01 G18 G21
    Date: 2021–03
  3. By: Ranjan Pal; Ziyuan Huang; Xinlong Yin; Sergey Lototsky; Swades De; Sasu Tarkoma; Mingyan Liu; Jon Crowcroft; Nishanth Sastry
    Abstract: In this paper, we provide (i) a rigorous general theory to elicit conditions on (tail-dependent) heavy-tailed cyber-risk distributions under which a risk management firm might find it (non)sustainable to provide aggregate cyber-risk coverage services for smart societies, and (ii)a real-data driven numerical study to validate claims made in theory assuming boundedly rational cyber-risk managers, alongside providing ideas to boost markets that aggregate dependent cyber-risks with heavy-tails.To the best of our knowledge, this is the only complete general theory till date on the feasibility of aggregate cyber-risk management.
    Date: 2021–05
  4. By: Eguren-Martin, Fernando; O’Neill, Cian; Sokol, Andrej; Berge, Lukas von dem
    Abstract: We characterise the probability distributions of various categories of gross capital flows conditional on information contained in financial asset prices in a panel of emerging market economies, with a focus on ‘tail’ events. Our framework, based on the quantile regression methodology, allows for a separate role of push- and pull-type factors, and because it is based on high-frequency data, can quantify the likelihood of different outturns before official capital flows data are released. We find that both push and pull factors have heterogeneous effects across the distributions of gross capital flows, which are most marked in the left tails. We also explore the role of various policies, and find that macroprudential and capital flows management measures are stabilising, leading to lower chances of either large portfolio inflows or out flows. JEL Classification: F32, F34, G15
    Keywords: capital controls, capital flight, capital flows, capital flow surges, financial conditions indices, macroprudential policy, push versus pull, quantile regression, retrenchment, sudden stops
    Date: 2021–04
  5. By: Acharya, Viral V.; Engle III, Robert F; Steffen, Sascha
    Abstract: We study the crash of bank stock prices during the COVID-19 pandemic. We find evidence consistent with a "credit line drawdown channel". Stock prices of banks with large ex-ante exposures to undrawn credit lines as well as large ex-post gross drawdowns decline more. The effect is attenuated for banks with higher capital buffers. These banks reduce term loan lending, even after policy measures were implemented. We conclude that bank provision of credit lines appears akin to writing deep out-of-the-money put options on aggregate risk; we show how the resulting contingent leverage and stock return exposure can be incorporated tractably into bank capital stress tests.
    Keywords: bank capital; COVID-19; Credit lines; liquidity risk; loan supply; Pandemic; stress tests
    JEL: G01 G21
    Date: 2021–03
  6. By: Agnese, Pablo (UIC Barcelona); Thoss, Jonathan (Luxembourg Stock Exchange)
    Abstract: Bitcoin in particular and so-called cryptocurrencies in general have shaken up the financial world and seem to be claiming an increasing size of the market share. These new virtual assets present investors with significant opportunities, but also with significant risks. This paper analyzes the connection between one such crypto, bitcoin, and other traditional assets (e.g. metals) in times of financial turbulence. Our impulse-response function and variance decomposition analyses indicate that, as of late, bitcoin has become increasingly interdependent with gold, and seems just as suitable to hedge against market uncertainty—we believe this is a very timely conclusion given the pervasive uncertainty that dominates post-pandemic life.
    Keywords: bitcoin, gold, COVID-19, impulse response
    JEL: G15 G12 G11
    Date: 2021–04
  7. By: Gehrig, Thomas; Iannino, Maria Chiara; Unger, Stephan
    Abstract: We provide transatlantic evidence about the relation between social responsibility and resiliency in the banking industry. We analyse various measures of resiliency, an exposure measure (SRISK) and a contribution measure (Delta CoVaR) to systemic risk, as well as measures of systematic risk (beta) and insolvency risk (z-score). Social responsibility is measured by Thomson Reuters' ESG-scores and their subcategories, both according to the older Asset 4 and the present TR ESG Refinitiv classification. We find that the social aggregate score significantly enhances resiliency in all dimensions and in both classifications. On the level of subcategories, we identify significant common resiliency enhancing factor proxies for long-term orientation, such as product responsibility and workforce training, while short-term objectives proxied by shareholder orientation tend to relate to lower levels of resiliency. Looking deeper into the components of each ESG pillar, we also discover significant transatlantic differences mainly related to the different organization of labour markets as well as the board structure.
    Keywords: bank resiliency; capital shortfall; ESG-scores; Financial Stability; sustainable banking; systemic risk
    JEL: F33 G12 G21 G24 M14
    Date: 2021–02
  8. By: Loic Berger (CNRS, IESEG School of Management, Univ. Lille, UMR 9221-LEM, F-59000 Lille, France); Louis Eeckhoudt (IESEG School of Management, UMR 9221-LEM, F-59000 Lille, France)
    Abstract: Diversification is a basic economic principle that helps to hedge against uncertainty. It is therefore intuitive that both risk aversion and ambiguity aversion should positively affect the value of diversification. In this paper, we show that this intuition (1) is true for risk aversionbut (2) is not necessarily true for ambiguity aversion. We derive sufficient conditions, showing that, contrary to the economic intuition, ambiguity and ambiguity aversion may actually reduce the diversification value.
    Keywords: Diversification, ambiguity aversion, model uncertainty, hedging
    JEL: D81
    Date: 2021–04
  9. By: Gelos, Gaston; Gornicka, Lucyna; Koepke, Robin; Sahay, Ratna; Sgherri, Silvia
    Abstract: The volatility of capital flows to emerging markets continues to pose challenges to policymakers. In this paper, we propose a new quantile regression framework to predict the entire future probability distribution of capital flows to emerging markets, based on changes in global financial conditions, domestic structural characteristics, and policies. The approach allows us to differentiate between short- and medium-term effects. We find that FX- and macroprudential interventions are effective in mitigating downside risks to portfolio flows stemming from adverse global shocks, while tightening of capital controls in response appears to be counterproductive. Good institutional frameworks are not able to shield countries from the increased volatility of portfolio flows in the immediate aftermath of global shocks. However, they do contribute to a more rapid bounce-back of foreign flows over the medium term.
    Keywords: capital controls; Capital Flows; emerging markets; foreign-exchange intervention; macroprudential policies
    JEL: E52 F32 F38 G28
    Date: 2021–02
  10. By: Gropp, Reint; Mosk, Thomas; Ongena, Steven; Simac, Ines; Wix, Carlo
    Abstract: We study how higher capital requirements introduced at the supranational and implemented at the national level affect the regulatory capital of banks across countries. Using the 2011 EBA capital exercise as a quasi-natural experiment, we find that affected banks inflate their levels of regulatory capital without a commensurate increase in their book equity and without a reduction in bank risk. This observed regulatory capital inflation is more pronounced in countries where credit supply is expected to tighten. Our results suggest that national authorities forbear their domestic banks to meet supranational requirements, with a focus on short-term economic considerations.
    Keywords: Capital requirements; EBA capital exercise; national forbearance
    JEL: G21
    Date: 2021–02
  11. By: Gersbach, Hans
    Abstract: What happens when banks compete with deposit and loan contracts contingent on macroeconomic shocks? We show that the private sector insures the banking system efficiently against banking crises through such contracts when banks focus on expected profit maximization and failing banks go bankrupt. When risks are large, banks may shift part of the risk to depositors who receive state-contingent contracts. Repackaging of the risk among depositors can improve welfare. In contrast, when failing banks are rescued, new phenomena such as risk creation or magnification emerge, which would not occur with non-contingent contracts. In particular, depositors receive non-contingent contracts with comparatively high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, banks overinvest and generate large macroeconomic risks, even if the underlying productivity risk is small or zero.
    Keywords: Financial intermediation - Macroeconomics risks - State-contingent contracts - Banking regulation
    JEL: D41 E4 G2
    Date: 2021–03
  12. By: Nicholas Salmon; Indranil SenGupta
    Abstract: In this paper, we introduce and analyze the fractional Barndorff-Nielsen and Shephard (BN-S) stochastic volatility model. The proposed model is based upon two desirable properties of the long-term variance process suggested by the empirical data: long-term memory and jumps. The proposed model incorporates the long-term memory and positive autocorrelation properties of fractional Brownian motion with $H>1/2$, and the jump properties of the BN-S model. We find arbitrage-free prices for variance and volatility swaps for this new model. Because fractional Brownian motion is still a Gaussian process, we derive some new expressions for the distributions of integrals of continuous Gaussian processes as we work towards an analytic expression for the prices of these swaps. The model is analyzed in connection to the quadratic hedging problem and some related analytical results are developed. The amount of derivatives required to minimize a quadratic hedging error is obtained. Finally, we provide some numerical analysis based on the VIX data. Numerical results show the efficiency of the proposed model compared to the Heston model and the classical BN-S model.
    Date: 2021–05
  13. By: M. Kate Bundorf; Jill DeMatteis; Grant Miller; Maria Polyakova; Jialu L. Streeter; Jonathan Wivagg
    Abstract: We analyze data from a survey we administered during the COVID-19 pandemic to investigate the relationship between people's subjective risk beliefs and their protective behaviors. We report three main findings. First, on average, people substantially overestimate the absolute level of risk associated with economic activity, but have correct signals about their relative risk. Second, people who believe that they face a higher risk of infection are more likely to report avoiding economic activities. Third, government mandates restricting economic behavior attenuate the relationship between subjective risk beliefs and protective behaviors.
    JEL: H0 I1
    Date: 2021–04
  14. By: Juan Carlos Cuestas (Department of Economics and Finance, Tallinn University of Technology, Estonia; IEI and Department of Economics, Universitat Jaume I, Castellón, Spain); Luis A. Gil-Alana (Department of Economics, University of Navarra, Spain); Maria Malmierca (Faculty of Law and Business , University Villanueva, Madrid, Spain)
    Abstract: In this article we investigate the degree of persistence in the credit-to-GDP ratio in 44 OECD economies in the context of nonlinear deterministic trends. In particular, we use Chebyshev’s polynomials in time, which allow us to model changes in the data in a smoother way than by structural breaks. Our results indicate that approximately one quarter of the series display non-linear structures, and only Argentina displays a mean reverting pattern. Policy implications of the results obtained are discussed at the end of the manuscript.
    Keywords: Chebyshev polynomials; fractional integration; persistence; private debt
    JEL: C22 G30 G51
    Date: 2021
  15. By: Jaccard, Ivan
    Abstract: This paper studies the effects of imperfect risk-sharing between lenders and borrowers on commercial property prices and leverage. The key friction is that agents use different discount rates to evaluate future flows. Eliminating this pecuniary externality generates large reductions in the volatility of real estate prices and credit. Therefore, policies that enhance risk-sharing between lenders and borrowers reduce the magnitude of boom-bust cycles in real estate prices. We also introduce health shocks to study the effect of the COVID-19 crisis on the commercial property market. JEL Classification: E32, E44, G10, E23
    Keywords: asset pricing, incomplete markets, leverage cycle, pecuniary externalities
    Date: 2021–04
  16. By: Louis R. Eeckhoudt; Roger J. A. Laeven
    Abstract: Employing a generalized definition of Pratt (1964) and Arrow's (1965, 1971) probability premium, we introduce a new concept of attitude towards probability. We illustrate in a problem of risk sharing that whether attitude towards probability is a first-order or second-order phenomenon has important economic applications. By developing a local approximation to the probability premium, we show that the canonical rank-dependent utility model usually exhibits attitude towards probability of first order, whereas under the dual theory with smooth probability weighting functions attitude towards probability is a second-order trait.
    Date: 2021–04
  17. By: Forni, Mario; Gambetti, Luca; Sala, Luca
    Abstract: An increase in uncertainty is not contractionary per se. What generates a significant downturn of economic activity is a widening of the left tail of the expected distribution of growth, the downside uncertainty. On the contrary, an increase of the right tail, the upside uncertainty, is mildly expansionary. The reason for why uncertainty shocks have been previously found to be contractionary is because movements in downside uncertainty dominate existing empirical measures of uncertainty. The results are obtained using a new econometric approach which combines quantile regressions and structural VARs.
    Keywords: Quantile regression; Skewness; uncertainty; VAR models
    JEL: C32 E32
    Date: 2021–03

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