
on Risk Management 
Issue of 2021‒08‒30
seventeen papers chosen by 
By:  Dario Caldara; Chiara Scotti; Molin Zhong 
Abstract:  We study the joint conditional distribution of GDP growth and corporate credit spreads using a stochastic volatility VAR. Our estimates display significant cyclical comovement in uncertainty (the volatility implied by the conditional distributions), and risk (the probability of tail events) between the two variables. We also find that the interaction between two shocksa main business cycle shock as in Angeletos et al. (2020) and a main financial shockis crucial to account for the variation in uncertainty and risk, especially around crises. Our results highlight the importance of using multivariate nonlinear models to understand the determinants of uncertainty and risk. 
Keywords:  Uncertainty; Tail risk; Joint conditional distributions; Main shocks 
JEL:  C53 E23 E32 E44 
Date:  2021–08–19 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgif:1326&r= 
By:  Farmer, J. Doyne; Kleinnijenhuis, Alissa; NahaiWilliamson, Paul; Wetzer, Thom 
Abstract:  We propose a structural framework for the development of systemwide financial stress tests with multiple interacting contagion, amplification channels and heterogeneous financial institutions. This framework conceptualises financial systems through the lens of five building blocks: financial institutions, contracts, markets, constraints, and behaviour. Using this framework, we implement a systemwide stress test for the European financial system. We obtain three key findings. First, the financial system may be stable or unstable for a given microprudential stress test outcome, depending on the system's shockamplifying tendency. Second, the 'usability' of banks' capital buffers (the willingness of banks to use buffers to absorb losses) is of great consequence to systemic resilience. Third, there is a risk that the size of capital buffers needed to limit systemic risk could be severely underestimated if calibrated in the absence of systemwide approaches. 
Keywords:  Systemic risk, stress testing, financial contagion, financial institutions, capital requirements, macroprudential policy 
JEL:  G17 G21 G23 G28 C63 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:amz:wpaper:202014&r= 
By:  Ragnar Levy Gudmundarson; Manuel Guerra; Alexandra Bugalho de Moura 
Abstract:  In this work the ruin probability of the Lundberg risk process is used as a criterion for determining the optimal security loading of premia in the presence of pricesensitive demand for insurance. Both single and aggregated claim processes are considered and the independent and the dependent cases are analyzed. For the singlerisk case, we show that the optimal loading does not depend on the initial reserve. In the multiple risk case we account for arbitrary dependency structures between different risks and for dependencies between the probabilities of a client acquiring policies for different risks. In this case, the optimal loadings depend on the initial reserve. In all cases the loadings minimizing the ruin probability do not coincide with the loadings maximizing the expected profit. 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2108.10075&r= 
By:  Bryan, Calvin; Manning, Dale; Goemans, Christopher; Sloggy, Matthew R. 
Keywords:  Agricultural and Food Policy, Institutional and Behavioral Economics, Risk and Uncertainty 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:ags:aaea21:312784&r= 
By:  Sébastien Betermier; Nicholas Byrne; JeanSébastien Fontaine; Hayden Ford; Jason Ho; Chelsea Mitchell 
Abstract:  “Reach for yield”—This is the commonly heard explanation for why pension plans shift their portfolios toward alternative assets. But we show that the new portfolios also hold more bonds, offer lower average returns and produce smaller and less volatile solvency deficits. These shifts are part of a broader strategy to reduce solvency risk. 
Keywords:  Financial institutions; Financial markets; Financial system regulation and policies 
JEL:  G11 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:bca:bocsan:2120&r= 
By:  Matteo Michielon; Asma Khedher; Peter Spreij 
Abstract:  Riskneutral default probabilities can be implied from credit default swap (CDS) market quotes. In practice, mid CDS quotes are used as inputs, as their riskneutral counterparts are not observable. We show how to imply riskneutral default probabilities from bid and ask quotes directly by means of formulating the CDS calibration problem to bid and ask market quotes within the conic finance framework. Assuming the riskneutral distribution of the default time to be driven by a Poisson process we prove, under mild liquidityrelated assumptions, that the calibration problem admits a unique solution that also allows to jointly calculate the implied liquidity of the market. 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2108.06578&r= 
By:  International Monetary Fund 
Abstract:  The IMF’s Vulnerability Exercise (VE) is a crosscountry exercise that identifies countryspecific nearterm macroeconomic risks. As a key element of the Fund’s broader risk architecture, the VE is a bottomup, multisectoral approach to risk assessments for all IMF member countries. The VE modeling toolkit is regularly updated in response to global economic developments and the latest modeling innovations. The new generation of VE models presented here leverages machinelearning algorithms. The models can better capture interactions between different parts of the economy and nonlinear relationships that are not well measured in ”normal times.” The performance of machinelearningbased models is evaluated against more conventional models in a horserace format. The paper also presents direct, transparent methods for communicating model results. 
Keywords:  Risk Assessment, Supervised Machine Learning, Prediction, Sudden Stop, Exchange Market Pressure, Fiscal Crisis, Debt, Financial Crisis, Economic Crisis, Economic Growth 
Date:  2021–05–07 
URL:  http://d.repec.org/n?u=RePEc:imf:imftnm:2021/003&r= 
By:  Sebastian Jaimungal; Silvana Pesenti; Ye Sheng Wang; Hariom Tatsat 
Abstract:  We present a reinforcement learning (RL) approach for robust optimisation of riskaware performance criteria. To allow agents to express a wide variety of riskreward profiles, we assess the value of a policy using rank dependent expected utility (RDEU). RDEU allows the agent to seek gains, while simultaneously protecting themselves against downside events. To robustify optimal policies against model uncertainty, we assess a policy not by its distribution, but rather, by the worst possible distribution that lies within a Wasserstein ball around it. Thus, our problem formulation may be viewed as an actor choosing a policy (the outer problem), and the adversary then acting to worsen the performance of that strategy (the inner problem). We develop explicit policy gradient formulae for the inner and outer problems, and show its efficacy on three prototypical financial problems: robust portfolio allocation, optimising a benchmark, and statistical arbitrage 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2108.10403&r= 
By:  SungJe Byun; Aaron L. Game; Alexander Jiron; Pavel Kapinos; Kelly Klemme; Bert Loudis 
Abstract:  The COVID19 recession resulted in historic unemployment and a significant shock to much of the service sector. Despite these macroeconomic challenges, banks' riskbased capital buffers remain high and the number of bank failures remains low. Government relief programs, including the Coronavirus Aid, Relief, and Economic Security (CARES) Act, both directly and indirectly helped stabilize bank balance sheets during the crisis. 
Date:  2021–07–30 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgfn:202107303&r= 
By:  Giancarlo Corsetti; Anna Lipinska; Giovanni Lombardo 
Abstract:  Crises and tail events have asymmetric effects across borders, raising the value of arrangements improving insurance of macroeconomic risk. Using a twocountry DSGE model, we provide an analytical and quantitative analysis of the channels through which countries gain from sharing (tail) risk. Riskier countries gain in smoother consumption but lose in relative wealth and average consumption. Safer countries benefit from higher wealth and better average terms of trade. Calibrated using the empirical distribution of moments of GDPgrowth across countries, the model suggests nonnegligible quantitative effects. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation. 
Keywords:  International risk sharing; Asymmetry; Fat tails; Welfare 
JEL:  F15 F41 G15 
Date:  2021–08–06 
URL:  http://d.repec.org/n?u=RePEc:fip:fedgif:1324&r= 
By:  Dal Borgo, Mariela (Bank of Mexico) 
Abstract:  This paper examines empirically the effect of the level of personal bankruptcy protection in the US on householdsâ€™ demand for financial assets. A Chapter 7 bankruptcy allows protecting the home equity up to a certain limit or "exemption". Previous literature shows that such exemption biases investment towards home equity. This paper tests whether it also lowers investment in stocks, which are not protected in bankruptcy. Using an instrumental variable approach, I estimate a lower stock market participation when the home equity is below the exemption, but the result is not robust, and households at higher risk of bankruptcy do not exhibit a stronger response. Moreover, investment in home equity is not higher when the home is fully protected. These findings suggest no substantial portfolio distortions from the level of home equity that is protected in bankruptcy. 
Keywords:  Personal bankruptcy law; Home equity protection; Stock market participation; Portfolio allocation JEL Classification: D14; G00; G11; K35 
Date:  2021 
URL:  http://d.repec.org/n?u=RePEc:cge:wacage:564&r= 
By:  Lori Chappell (KBR) 
Abstract:  Excess relative risk (ERR) and excess absolute risk (EAR) are important metrics typically used in radiation epidemiology studies. Most studies of longterm radiation effects in Japanese atomic bomb survivors feature Poisson regression of grouped survival data. Risks are modeled on the excess risk scale using linear and loglinear functions of regression parameters, which are generally formulated to produce both ERR and EAR as output. Given the specific assumptions underlying these models, they are dubbed ERR and EAR models, respectively. Typically, these models are fit using the Epicure software that was specifically designed to fit these models, and they are difficult to reproduce in more accessible software. The flexibility of the bayesmh command can be utilized to fit these models within a Bayesian framework, which may increase accessibility in the broader statistical and epidemiological communities. In this presentation, I detail ERR and EAR model fitting and assumptions, and I give an example of how the models can be fit in Stata using Bayesian methods. 
Date:  2021–08–07 
URL:  http://d.repec.org/n?u=RePEc:boc:scon21:29&r= 
By:  Benoît Carmichael; Gilles Boevi Koumou; Kevin Moran 
Abstract:  We use an equivalent form of Markowitz's meanvariance utility function, based on Rao's Quadratic Entropy (RQE), to enrich the standard capital asset pricing model (CAPM), both in the presence and in the absence of a riskfree asset. The resulting equilibrium, which we denote RQECAPM, offers important new insights about the pricing of risk. Notably, it reveals that the reason for which the standard CAPM does not price idiosyncratic risk is not only because the market portfolio is law of large numbers diversifed but also because the model implicitly assumes agents' total risk aversion and their correlation diversifcation risk preference balance each other exactly. We then demonstrate that idiosyncratic risk is priced in a general RQECAPM where agents' total risk aversion and their correlation diversifcation risk preference coeffcients are not necessary equal. Our general RQECAPM therefore offers a unifying way of thinking about the pricing of idiosyncratic risk, including cases where such risk is negatively priced, and is relevant for the literature assessing the idiosyncratic risk puzzle. It also provides a natural theoretical underpinning for the empirical tests of the CAPM or the pricing of idiosyncratic risk performed in some existence studies. Nous utilisons une forme équivalente de la fonction d'utilité moyennevariance de Markowitz, basée sur l'entropie quadratique de Rao (RQE), pour enrichir le modèle standard d'évaluation des actifs financiers (CAPM), à la fois en présence et en l'absence d'un actif sans risque. L'équilibre qui en résulte, que nous désignons par RQECAPM, offre de nouvelles perspectives importantes sur l'évaluation du risque. Il révèle notamment que la raison pour laquelle le CAPM standard n'évalue pas le risque idiosyncratique n'est pas seulement due au fait que le portefeuille du marché est diversifié par la loi des grands nombres, mais aussi au fait que le modèle suppose implicitement que l'aversion totale au risque des agents et leur préférence pour le risque de diversification de la corrélation s'équilibrent exactement. Nous démontrons ensuite que le risque idiosyncratique est évalué dans un RQECAPM général où l'aversion totale au risque des agents et leurs coefficients de préférence pour le risque de diversification de la corrélation ne sont pas nécessairement égaux. Notre modèle RQECAPM général offre donc une façon unifiée de penser à la tarification du risque idiosyncratique, y compris les cas où ce risque est évalué négativement, et est pertinent pour la littérature évaluant l'énigme du risque idiosyncratique. Il fournit également une base théorique naturelle pour les tests empiriques du MEDAF ou de la tarification du risque idiosyncratique effectués dans certaines études d'existence. 
Keywords:  Rao's Quadratic Entropy,MeanVariance Model,Capital Asset Pricing Model,Idiosyncratic Risk,Correlation Diversiffcation, Entropie quadratique de Rao,modèle moyennevariance,modèle d'évaluation des actifs financiers,risque idiosyncratique,corrélation et diversification 
JEL:  G11 G12 
Date:  2021–08–23 
URL:  http://d.repec.org/n?u=RePEc:cir:cirwor:2021s28&r= 
By:  Narayana R. Kocherlakota 
Abstract:  This paper studies the public debt implications of a class of Aiyagari (1994)Bewley (1977)Huggett (1993) (ABH) models of incomplete insurance in which agents face a nearzero probability of a highly adverse outcome. In generic models of this kind, there exists a public debt bubble, so that the government is able to borrow at a real interest rate that is perpetually below the economic growth rate. Given an equilibrium with a public debt bubble, the primary deficit and the level of debt are both strictly increasing in the real interest rate and in the fraction of government expenditures used for lumpsum transfers. There is no upper bound on the deficit level or longrun debt level that is sustainable in equilibrium. In a public debt bubble, regardless of its size, agents are better off in the long run if the government chooses policies that give rise to a larger debt and primary deficit. 
JEL:  E62 H62 H63 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:29138&r= 
By:  Adrian FernandezPerez (AUT  Auckland University of Technology); AnaMaria Fuertes (Sir John Cass Business School); Joelle Miffre (Audencia Business School) 
Abstract:  This paper studies the energy futures risk premia that can be extracted through longshort portfolios that exploit heterogeneities across contracts as regards various characteristics or signals and integrations thereof. Investors can earn a sizeable premium of about 8% and 12% per annum by exploiting the energy futures contract risk associated with the hedgers' net positions and rollyield characteristics, respectively, in line with predictions from the hedging pressure hypothesis and theory of storage. Simultaneously exploiting various signals towards styleintegration with alternative weighting schemes further enhances the premium. In particular, the styleintegrated portfolio that equally weights all signals stands out as the most effective. The findings are robust to transaction costs, data mining and subperiod analyses. 
Keywords:  Integration,Longshort portfolios,Risk premium,Energy futures markets 
Date:  2021–10–01 
URL:  http://d.repec.org/n?u=RePEc:hal:journl:hal03312959&r= 
By:  Ben Jann (University of Bern) 
Abstract:  In this talk, I will present a new Stata command that unites a variety of methods to describe (univariate) statistical distributions. Covered are density estimation, histograms, cumulative distribution functions, probability distributions, quantile functions, Lorenz curves, percentile shares, and a large collection of summary statistics, such as classical and robust measures of location, scale, skewness, and kurtosis, as well as inequality, concentration, and poverty measures. Particular features of the command are that it provides consistent standard errors supporting complex sample designs for all covered statistics and that the simultaneous analysis of multiple statistics across multiple variables and subpopulations is possible. Furthermore, the command supports covariate balancing based on reweighting techniques (inverse probability weighting and entropy balancing), including appropriate correction of standard errors. Standarderror estimation is implemented in terms of influence functions, which can be stored for further analysis, for example, in RIF regressions or counterfactual decompositions. 
Date:  2021–08–07 
URL:  http://d.repec.org/n?u=RePEc:boc:scon21:1&r= 
By:  Yixiao Lu; Yihong Wang; Tinggan Yang 
Abstract:  In this paper, a new numerical method based on adaptive gradient descent optimizers is provided for computing the implied volatility from the BlackScholes (BS) option pricing model. It is shown that the new method is more accurate than the close form approximation. Compared with the NewtonRaphson method, the new method obtains a reliable rate of convergence and tends to be less sensitive to the beginning point. 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2108.07035&r= 