nep-rmg New Economics Papers
on Risk Management
Issue of 2022‒03‒14
eleven papers chosen by
Stan Miles
Thompson Rivers University

  1. When uncertainty decouples expected and unexpected losses By Mikael Juselius; Nikola Tarashev
  2. Building a Dynamic System of Advanced Risk Management and Risk Assessment of the Company By Denis S. Gusev; Elena G. Demidova; Olga A. Novikova
  3. Industry Characteristics and Financial Risk Spillovers By Wan-Chien Chiua; Juan Ignacio Pe\~na; Chih-Wei Wang
  4. Value at Risk Estimation For the BRICS Countries : A Comparative Study By Ameni Ben Salem; Imene Safer; Islem Khefacha
  5. Background Risk and Small-Stakes Risk Aversion By Xiaosheng Mu; Luciano Pomatto; Philipp Strack; Omer Tamuz
  6. Derivatives Holdings and Systemic Risk in the U.S. Banking Sector By Sergio Mayordomo; Maria Rodriguez-Moreno; Juan Ignacio Pe\~na
  7. Providing Pandemic Business Interruption Coverage with Double Trigger Cat Bonds. By André Schmitt; Sandrine Spaeter
  8. Beyond Merton: Multi-Dimensional Balance Sheet in Default Modeling By Xu, Jack
  9. Non-linear Effects of Market Concentration on the Underwriting Profitability of the Non-life Insurance Sector in Europe By Jan Janku; Ondrej Badura
  10. The Great Margin Call: The Role of Leverage in the 1929 Stock Market Crash By Borowiecki, Karol; Dzieliński, Michał; Tepper, Alexander
  11. Derivatives Risks as Costs in a One-Period Network Model By Dorinel Bastide; St\'ephane Cr\'epey; Samuel Drapeau; Mekonnen Tadese

  1. By: Mikael Juselius; Nikola Tarashev
    Abstract: A parsimonious extension of a well-known portfolio credit-risk model allows us to study a salient stylized fact – abrupt switches between high- and low-loss phases – from a risk-management perspective. As uncertainty about phase switches increases, expected losses decouple from unexpected losses, which reflect a high percentile of the loss distribution. Banks that ignore this decoupling have shortfalls of loss-absorbing resources, which is more detrimental if the portfolio is more diversified within a phase. Likewise, the risk-management benefits of improving phase-switch forecasts increase with diversification. The analysis of these findings leads us to an empirical method for comparing the degree of within-phase default clustering across portfolios.
    Keywords: expected loss provisioning, bank capital, unexpected losses, credit cycles, portfolio credit risk.
    JEL: G21 G28 G32
    Date: 2022–01
  2. By: Denis S. Gusev (Starooskolsky Technological Institute); Elena G. Demidova (Starooskolsky Technological Institute); Olga A. Novikova (Starooskolsky Technological Institute)
    Abstract: The purpose of the research presented in this article is to develop a dynamic system for forecasting and minimizing the risks of an industrial company based on their quantitative assessment. The article considers the conceptual apparatus of the essential content of risk management of an industrial enterprise, reviews the theoretical aspects of risk management systems and the most significant risk management methods from a practical point of view. The methodological apparatus of qualitative and quantitative analysis and risk assessment has been expanded on the basis of some conditionality of risk classification features identified and a systematic approach to the classification of risks of an industrial enterprise has been proposed, taking into account the dynamics of their impact on the object, the stages of building a dynamic risk management system are given. The article substantiates the need to supplement the dynamic risk management system of industrial enterprises with methods of qualitative and quantitative risk assessment in order to form effective risk management strategies
    Date: 2022–01
  3. By: Wan-Chien Chiua; Juan Ignacio Pe\~na; Chih-Wei Wang
    Abstract: This paper proposes a new measure of tail risk spillover. The empirical application provides evidence of significant volatility and tail risk spillovers from the financial sector to many real economy sectors in the U.S. economy in the period from 2001 to 2011. These spillovers increase in crisis periods. The conditional coexceedance in a given sector is positively related to its amount of debt financing, and negatively related to its relative valuation and investment. Real economy sectors which require substantial external financing, and whose value and investment activity are relatively lower, are prime candidates for depreciation in the wake of crisis in the financial sector.
    Date: 2022–02
  4. By: Ameni Ben Salem (Fseg Sousse, University of Sousse); Imene Safer; Islem Khefacha (LaREMFiQ, IHEC of Sousse)
    Date: 2021–12–17
  5. By: Xiaosheng Mu (Princeton University); Luciano Pomatto (Caltech); Philipp Strack (Yale University); Omer Tamuz (Caltech)
    Abstract: We show that under plausible levels of background risk, no theory of choice under risk can simultaneously satisfy the following three economic postulates: (i) Decision makers are risk-averse over small gambles, (ii) their preferences respect stochastic dominance, and (iii) they account for background risk. This impossibility result applies to expected utility theory, prospect theory, rank dependent utility and many other models.
    Keywords: risk, theories of choice
    JEL: D81
    Date: 2021–08
  6. By: Sergio Mayordomo; Maria Rodriguez-Moreno; Juan Ignacio Pe\~na
    Abstract: Foreign exchange and credit derivatives increase the bank's contributions to systemic risk. Interest rate derivatives decrease it. The proportion of non-performing loans over total loans and the leverage ratio have stronger impact on systemic risk than derivatives holdings.
    Date: 2022–02
  7. By: André Schmitt; Sandrine Spaeter
    Abstract: The aim of this paper is to show whether the insurance and reinsurance sectors supplemented by qualified investors in cat bonds can offer business interruption protection due to a pandemic such as COVID-19 at affordable rates. First, we propose a comprehensive numerical model to show how cat bonds can contribute to complement standard (re)insurance even though risks are positively correlated between different firms or sectors. We present the conditions under which fairer coverage can be provided to insured firms. Second, we discuss the characteristics of the triggers that are needed to provide efficient pandemic business interruption cat bonds (PBI cat bonds), which do not exist yet on the market of insurancelinked securities (ILS). The double trigger pandemic bonds we build are structured on a first trigger which is pulled when the World Health Organization (WHO) declares a Public Health Emergency of International Concern (PHEIC). The second trigger determines the payout of the bond based on the modelized business interruption losses of an industry in a country. In this framework, we discuss moral hazard, basis risk, correlation and liquidity issues. Third, to answer the feasibility of our (two-layer) coverage scheme we simulate the life of theoretical PBI bonds at the height of the pandemic. We apply them to the restaurant industry in France and we use data gathered during the COVID-19 pandemic.
    Keywords: pandemic cat bond, business interruption losses, securitization, (re)insurance.
    JEL: G11 Q54 G22
    Date: 2022
  8. By: Xu, Jack
    Abstract: Nearly half a century after Merton’s 1974 paper, the basic framework of modeling a company’s default risk in terms of one-dimensional variable, the total asset value, with fixed debt level has remain unchanged among the work by academic and quantitative modeling community. Under such simplification, the model is unable to correctly defined the state of default, which is a state of negative cash. But more importantly, Merton’s one-dimensional model cannot incorporate the fundamental principle of balanced balance sheet, and thus unable to generate the rich dynamics followed by a company’s multi-dimensional financial state. This article presents an example of 2-dimensional balance sheet that is still analytically solvable to demonstrate the multi-dimensional kinematics of a company’s financial state, and the much more nontrivial default dynamics as a result. The idealized example is for demonstrate purpose only, but the methodology has been extended to higher-dimensional balance sheet to model actual companies and forecast default with computerizable numerical and simulative algorithms.
    Keywords: Default, Models, Balance Sheet, Multi-Dimensional, Dynamics
    JEL: C32 C61
    Date: 2022–02–17
  9. By: Jan Janku; Ondrej Badura
    Abstract: Recent studies argue that more attention needs to be paid to the insurance sector in analyses of the financial sector, as it may be a significant factor in maintaining overall financial stability. In this paper, we analyze the relationship between market concentration and the underwriting profitability of the non-life insurance sector. We find that an increasing level of concentration over time leads, on average, to an increase in underwriting profitability (as proxied by the loss ratio). At high levels of concentration, however, this effect reverses, with rising concentration reducing underwriting profitability. The convex (U-shaped) nature of this relationship implies that the strongest incentives for collusive behavior arise when concentration is lowest. Additionally, we show that during a period of lower rates, weaker interest returns are offset by stronger underwriting results. However, this effect seems to be conditional on a high level of concentration.
    Keywords: Concentration, insurance sector, loss ratio, low interest rates, underwriting profitability
    JEL: C33 G22 G23
    Date: 2021–12
  10. By: Borowiecki, Karol (Department of Economics); Dzieliński, Michał (Stockholm Business School); Tepper, Alexander (Columbia University United States)
    Abstract: The reasons for the Great Crash and why it occurred at that particular time are still debated among economic historians. We contribute to this debate by building on a new model developed by Adrian et al. (2021), which provides a measure of the financial system's potential for financial crises. The evidence suggests that a tightening of margin requirements in the first nine months of 1929 combined with price declines in September and early October caused enough many investors to become constrained that the market was tipped into instability, triggering the sudden crash of October and November.
    Keywords: Leverage; financial crisis; stability ratio; great crash
    JEL: G01 G10 N22
    Date: 2022–02–23
  11. By: Dorinel Bastide (UEVE, LaMME); St\'ephane Cr\'epey (LPSM, UFR 929); Samuel Drapeau (SAIF); Mekonnen Tadese
    Abstract: We present a one-period XVA model encompassing bilateral and centrally cleared trading in a unified framework with explicit formulas for most quantities at hand. We illustrate possible uses of this framework for running stress test exercises on a financial network from a clearing member's perspective or for optimizing the porting of the portfolio of a defaulted clearing member.
    Date: 2022–02

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