nep-rmg New Economics Papers
on Risk Management
Issue of 2022‒09‒05
eleven papers chosen by
Stan Miles
Thompson Rivers University

  1. One-factor model of liquidity risk By Osadchiy, Maksim
  2. The Disciplining Effect of Supervisory Scrutiny in the EU-Wide Stress Test By Cosimo Pancaro; Christoffer Kok; Carola Müller; Steven Ongena
  3. On the implied volatility of Asian options under stochastic volatility models By Elisa Al\`os; Eulalia Nualart; Makar Pravosud
  4. Contagion from market price impact: a price-at-risk perspective By Fukker, Gábor; Kaijser, Michiel; Mingarelli, Luca; Sydow, Matthias
  5. Valuation of European firms during the Russia-Ukraine war By Bougias, Alexandros; Episcopos, Athanasios; Leledakis, George N.
  6. Risk modeling with option-implied correlations and score-driven dynamics By Marco Piña; Rodrigo Herrera
  7. Stress tests and capital requirement disclosures: do they impact banks' lending and risk-taking decisions? By Paul Konietschke; Steven Ongena; Aurea Ponte Marques
  8. Application of Hawkes volatility in the observation of filtered high-frequency price process in tick structures By Kyungsub Lee
  9. Persuading Risk-Conscious Agents: A Geometric Approach By Jerry Anunrojwong; Krishnamurthy Iyer; David Lingenbrink
  10. Pricing commodity index options By Alberto Manzano; Emanuele Nastasi; Andrea Pallavicini; Carlos V\'azquez
  11. Extreme Value Inference for General Heterogeneous Data By Einmahl, John; He, Y.

  1. By: Osadchiy, Maksim
    Abstract: Credit and liquidity risks at the bank level depend on idiosyncratic and systematic (market) risks at the firm level. Portfolio effect transforms idiosyncratic risk into expected factor and leaves only systematic risk. Dependence only on market risk allows evaluating credit and liquidity risk using one-factor models. Since market risk is common to both credit risk and liquidity risk, it is useful to evaluate their joint distribution in a closed form. The one-factor Vasicek model was designed to evaluate credit risk – the probability distribution of the portfolio loss. The one-factor model proposed in the paper is designed to evaluate liquidity risk. Combination of credit risk and liquidity risk models is used to evaluate the joint distribution of credit and liquidity risks.
    Keywords: liquidity risk; credit risk; Vasicek model; barrier option; IRB
    JEL: G21 G32 G33
    Date: 2022–07–24
  2. By: Cosimo Pancaro (European Central Bank (ECB)); Christoffer Kok (European Central Bank (ECB)); Carola Müller (Center for Latin American Monetary Studies – CEMLA; Halle Institute for Economic Research); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR))
    Abstract: Relying on confidential supervisory data related to the 2016 EU-wide stress test, this paper presents novel empirical evidence that supervisory scrutiny associated to stress testing has a disciplining effect on bank risk. We find that banks that participated in the 2016 EU-wide stress test subsequently reduced their credit risk relative to banks that were not part of this exercise. Relying on new metrics for supervisory scrutiny that measure the quantity, potential impact, and duration of interactions between banks and supervisors during the stress test, we find that the disciplining effect is stronger for banks subject to more intrusive supervisory scrutiny during the exercise. We also find that a strong risk management culture is a prerequisite for the supervisory scrutiny to be effective. Finally, we show that a similar disciplining effect is not exerted neither by higher capital charges nor by more transparency and related market discipline induced by the stress test.
    Keywords: Stress Testing, Credit risk, Internal Models, Banking Supervision, banking regulation
    Date: 2022–08
  3. By: Elisa Al\`os; Eulalia Nualart; Makar Pravosud
    Abstract: In this paper we study the short-time behavior of the at-the-money implied volatility for arithmetic Asian options with fixed strike price. The asset price is assumed to follow the Black-Scholes model with a general stochastic volatility process. Using techniques of the Malliavin calculus such as the anticipating Ito's formula we first compute the level of the implied volatility of the option when the maturity converges to zero. Then, we find and short maturity asymptotic formula for the skew of the implied volatility that depends on the roughness of the volatility model. We apply our general results to the SABR model and the rough Bergomi model, and provide some numerical simulations that confirm the accurateness of the asymptotic formula for the skew.
    Date: 2022–08
  4. By: Fukker, Gábor; Kaijser, Michiel; Mingarelli, Luca; Sydow, Matthias
    Abstract: Overlapping portfolios constitute a well-recognised source of risk, providing a channel for financial contagion induced by the market price impact of asset deleveraging. We introduce a novel method to assess the market price impact on a security-by-security basis from historical daily traded volumes and price returns. Systemic risk within the euro area financial system of banks and investment funds is then assessed by considering contagion between individual institutions’ portfolio holdings under a severe stress scenario. As a result, we show how the bias of more homogeneous estimation techniques, commonly employed for market impact, might lead to loss estimates that are more than twice as large as losses estimated with heterogeneous price impact parameters. Another new feature in this work is the application of a price-at-risk measure instead of the average market price impact to evaluate the tail risk of possible market price movements in scenarios of different severity. Our results also show that system-level losses at the tail can be three times higher than average losses using the same scenario. JEL Classification: G01, G12, G17, G23, G32
    Keywords: fire sales, indirect contagion, overlapping portfolios, price impact, quantile regression
    Date: 2022–08
  5. By: Bougias, Alexandros; Episcopos, Athanasios; Leledakis, George N.
    Abstract: We infer the asset value dynamics of European firms during the Russia-Ukraine war via the structural model of Merton (1974). Using high-frequency stock price data, we find that the war led to lower corporate security prices and higher asset volatility, eventually shifting asset values closer to the default region. On average, the balance sheet of European firms is expected to shrink by 2.05% and their 1-year default probability to increase from 0.32% to 2.12%. Regression analysis on asset and equity returns as well as default probability changes suggests that these effects are stronger for firms with large revenue exposure to Russia.
    Keywords: European firms; Merton model; Russia-Ukraine war; Asset returns; Default risk
    JEL: G12 G14 G32
    Date: 2022–07–16
  6. By: Marco Piña; Rodrigo Herrera
    Abstract: In this paper we make use of option-implied volatilities to build a time-varying implied correlation matrix. Then, we use this matrix to estimate jointly both the covariance matrix of the returns and the implied covariance matrix dynamics. Finally, we do a backtest and show that the proposed model can effectively use the risk-neutral information to model the variance of the returns and to forecast the Value-at-Risk. Our results show that the model obtains results comparable to the benchmark while considerably reducing the number of estimated parameters.
    Date: 2021–11
  7. By: Paul Konietschke (European Central Bank (ECB)); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR)); Aurea Ponte Marques (European Central Bank (ECB))
    Abstract: How do banks respond to changes in capital requirements as a result of the stress tests? Does the disclosure of stress test results matter? To answer these questions, we study the impact of European stress tests on banks' lending, their corresponding risk-taking, the ensuing effect on their profitability and the respective publication effect. Exploiting the centralised European stress tests in conjunction with two unique confidential databases containing (i) stress test information for the 2016 and 2018 exercises covering a total of 93 and 87 banks, respectively; and (ii) quarterly supervisory information on approximately 1,000 banks (stress-tested and non-tested), allow us to implement a dynamic difference-in-differences strategy for a comparable sample of banks. We find that banks participating in the stress tests reallocate credit away from riskier borrowers and towards safer ones in the household sector, making them in general safer but also less profitable. This is especially the case for the set of banks part of the Supervisory Review and Evaluation Process with undisclosed stress tests, which were also not disclosing their Pillar 2 Requirements voluntarily. Our results confirm that the publication of capital requirements can have a disciplinary effect since banks publishing their requirements tend to have more robust capital ratios, which improves market discipline and financial stability.
    Keywords: Stress-testing, Credit supply, Profitability, Financial stability, Market discipline
    JEL: E51 E58 G21 G28
    Date: 2022–08
  8. By: Kyungsub Lee
    Abstract: The Hawkes model is suitable for describing self and mutually exciting random events. In addition, the exponential decay in the Hawkes process allows us to calculate the moment properties in the model. However, due to the complexity of the model and formula, few studies have been conducted on the performance of Hawkes volatility. In this study, we derived a variance formula that is directly applicable under the general settings of both unmarked and marked Hawkes models for tick-level price dynamics. In the marked model, the linear impact function and possible dependency between the marks and underlying processes are considered. The Hawkes volatility is applied to the mid-price process filtered at 0.1-second intervals to show reliable results; furthermore, intraday estimation is expected to have high utilization in real-time risk management. We also note the increasing predictive power of intraday Hawkes volatility over time and examine the relationship between futures and stock volatilities.
    Date: 2022–07
  9. By: Jerry Anunrojwong; Krishnamurthy Iyer; David Lingenbrink
    Abstract: We consider a persuasion problem between a sender and a receiver whose utility may be nonlinear in her belief; we call such receivers risk-conscious. Such utility models arise when the receiver exhibits systematic biases away from expected-utility-maximization, such as uncertainty aversion (e.g., from sensitivity to the variance of the waiting time for a service). Due to this nonlinearity, the standard approach to finding the optimal persuasion mechanism using revelation principle fails. To overcome this difficulty, we use the underlying geometry of the problem to develop a convex optimization framework to find the optimal persuasion mechanism. We define the notion of full persuasion and use our framework to characterize conditions under which full persuasion can be achieved. We use our approach to study binary persuasion, where the receiver has two actions and the sender strictly prefers one of them at every state. Under a convexity assumption, we show that the binary persuasion problem reduces to a linear program, and establish a canonical set of signals where each signal either reveals the state or induces in the receiver uncertainty between two states. Finally, we discuss the broader applicability of our methods to more general contexts, and illustrate our methodology by studying information sharing of waiting times in service systems.
    Date: 2022–08
  10. By: Alberto Manzano; Emanuele Nastasi; Andrea Pallavicini; Carlos V\'azquez
    Abstract: We present a stochastic local volatility model for derivative contracts on commodity futures. The aim of the model is to be able to recover the prices of derivative claims both on futures contracts and on indices on futures strategies. Numerical examples for calibration and pricing are provided for the S&P GSCI Crude Oil excess-return index.
    Date: 2022–08
  11. By: Einmahl, John (Tilburg University, School of Economics and Management); He, Y. (Tilburg University, School of Economics and Management)
    Date: 2022

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