nep-rmg New Economics Papers
on Risk Management
Issue of 2023‒10‒30
fourteen papers chosen by
Stan Miles, Thompson Rivers University

  1. Options-based systemic risk, financial distress, and macroeconomic downturns By Bevilacqua, Mattia; Tunaru, Radu; Vioto, Davide
  2. Ein neuer Ansatz zur Frequenzmodellierung im Versicherungswesen (A new Approach to frequency modeling in risk theory) By Dietmar Pfeifer
  3. Sizing Strategies for Algorithmic Trading in Volatile Markets: A Study of Backtesting and Risk Mitigation Analysis By S. M. Masrur Ahmed
  4. How Do Political Tensions and Geopolitical Risks Impact Oil Prices? By Valérie Mignon; Jamel Saadaoui
  5. Modeling Collateralization and Its Economic Significance By Lee, David
  6. Can Green Bonds be a Safe Haven for Equity Investors? By Flavin, Thomas; Sheenan, Lisa
  7. Green Bonds, Conventional Bonds and Geopolitical Risk By Sheenan, Lisa
  8. The Risk of External Financial Crisis By Cavallo, Eduardo A.; Fernández-Arias, Eduardo
  9. Default Risk and Transition Dynamics with Carbon Shocks By Sujan Lamichhane
  10. Assessing Macro-Fiscal Risk for Latin American and Caribbean Countries By Valencia, Oscar; Parra, Diego A.; Díaz, Juan Camilo
  11. Dissecting the Idiosyncratic Volatility Puzzle: A Fundamental Analysis Approach By Zhaobo Zhu; Wenjie Ding; Yi Jin; Dehua Shen
  12. Quantifying Lottery Choice Complexity By Benjamin Enke; Cassidy Shubatt
  13. Essays on credit rating agencies in China By Liu, Yan
  14. Can altruism lead to a willingness to take risks? By Stark, Oded

  1. By: Bevilacqua, Mattia; Tunaru, Radu; Vioto, Davide
    Abstract: We extract an option-implied measure for systemic risk, the Systemic Options Value-at-Risk (SOVaR), from put option prices that can capture the buildup stage of systemic risk in the financial sector earlier than the standard systemic risk measures (SRMs). Our measure exhibits more timely early warning signals of main events around the global financial crisis than the main SRMs. SOVaR shows significant predictive power for macroeconomic downturns as well as future recessions up to one year ahead. Our results are robust to various specifications, breakdowns of financial sectors, and controlling for other main risk measures proposed in the literature.
    Keywords: financial distress; financial stability; macro-finance; options prices; systemic risk; funding the Systemic Risk Centre is gratefully acknowledged [grant number ES/K002309/1 and ES/R009724/1
    JEL: G14 G20
    Date: 2023–09–01
  2. By: Dietmar Pfeifer
    Abstract: The collective risk model differentiates usually between claims frequencies (and their distribution) and claim sizes (and their distribution). For the claims frequencies typically classical discrete distributions are considered, such as Binomial-, Negative binomial- or Poisson distributions. Since these distributions sometimes do not really fit to the data we propose a different approach here for claim frequencies via random proportions of the number of insurance contracts. This approach also allows for a statistical goodness-of-fit test via quantile-quantile-plots and can likewise be applied to the modelling of claim size distributions.
    Date: 2023–08
  3. By: S. M. Masrur Ahmed
    Abstract: Backtest is a way of financial risk evaluation which helps to analyze how our trading algorithm would work in markets with past time frame. The high volatility situation has always been a critical situation which creates challenges for algorithmic traders. The paper investigates different models of sizing in financial trading and backtest to high volatility situations to understand how sizing models can lower the models of VaR during crisis events. Hence it tries to show that how crisis events with high volatility can be controlled using short and long positional size. The paper also investigates stocks with AR, ARIMA, LSTM, GARCH with ETF data.
    Date: 2023–09
  4. By: Valérie Mignon; Jamel Saadaoui
    Abstract: This paper assesses the effect of US-China political relationships and geopolitical risks on oil prices. To this end, we consider two quantitative measures, the Political Relationship Index (PRI) and the Geopolitical Risk Index (GPR), and rely on structural VAR and local projection methodologies. Our findings show that improved US-China relationships, as well as higher geopolitical risks, drive up the price of oil. In fact, unexpected shocks in the political relationship index are associated with optimistic expectations of economic activity, whereas unexpected shocks in the geopolitical risk index also reflect fears of supply disruption. Political tensions and geopolitical risks are thus complementary causal drivers of oil prices, the former being linked to consumer expectations and the latter to the prospects of aggregate markets.
    Keywords: Oil prices, political relationships, geopolitical risk, China.
    JEL: Q4 F51 C32
    Date: 2023
  5. By: Lee, David
    Abstract: ABSTRACT This article presents a new model of collateralization. We study the economic impact of collateralization on the plumbing of the financial system. The model gives an integrated view of different collateral arrangements. We show that the effect of collateral on asset prices is significant. Our study shows that a poorly designed collateral agreement can actually increase credit risk. We find evidence that collateral posting regimes that are originally designed and utilized for contracts subject to bilateral credit risk (e.g., a swap) may not work properly for contracts subject to multilateral credit risk (e.g., a CDS) in the presence of default correlations. These findings contradict the prevailing beliefs in financial markets about collateralization.
    Keywords: collateralization, collateral posting, credit support annex, credit risk modeling, the plumbing of financial system, derivatives valuation subject to credit risk.
    JEL: G12 G17 G24 O11 O16
    Date: 2023–09–23
  6. By: Flavin, Thomas; Sheenan, Lisa
    Abstract: We investigate if green bonds can act as a safe-haven asset for equity investors by analysing their relationship with stocks and other alternative safe havens, namely sovereign bonds and gold. Safe havens are defined as assets that exhibit zero or negative comovement with equity during a stock market downturn. We analyse the interrelationships between the asset classes using the Marginal Expected Shortfall of Acharya et al. (2017) and by comparing the regime-dependent GIRFs from a Markovswitching VAR model. Our results suggest that green bonds are not safe haven assets for equity investors but rather show positive comovement during periods of market stress. The sovereign bond is the most consistent in delivering diversification benefits across market conditions, while gold acts as a safe-haven asset during all regimes except during rare periods of extreme turbulence.
    Keywords: Green bonds, Contagion, Financial crisis, Markov-switching VAR
    JEL: C15 C34 Q56
    Date: 2023
  7. By: Sheenan, Lisa
    Abstract: This paper analyses linkages between green, conventional (corporate and sovereign) bond markets and geopolitical risk in high and low volatility periods between 2014 and 2022 using a Markov-switching VAR (MS-VAR) framework. The results indicate that geopolitical risk significantly affects green bonds in periods of high volatility, but does not do so to conventional bond markets. Green bond markets are significantly affected by sovereign and corporate bonds in both regimes, with stronger effects from corporate bonds evident in high volatility periods. This suggests that green bonds behave differently to conventional bonds and may be more susceptible to geopolitical risk and contagion.
    Keywords: Green bonds, Geopolitical Risk, Markov Switching
    JEL: G10 G11 C34
    Date: 2023
  8. By: Cavallo, Eduardo A.; Fernández-Arias, Eduardo
    Abstract: This paper explores the empirical determinants of external crises on a world panel dataset of 62 countries over the fifty-year period 1970-2019 and estimates their risk trade-offs with the aim of informing macrofinancial prudential policies. The determinants include countries external balance sheets, macroeconomic imbalances, and structural and global factors. It finds that information on the composition of gross positions in countries external financial portfolios is required to gauge the risk of external crisis: debt liabilities are the riskiest component, FDI liabilities are half as risky, and FDI assets are the most protective. Macroeconomic imbalances increase risk but are usually not the key drivers of crises. Adverse global shocks significantly leverage domestic risks. International reserves are powerful risk mitigants that provide high insurance value. The evidence shows that advanced economies are structurally more resilient to withstand exposure to weak external portfolios, macroeconomic imbalances, and global shocks. For the average country the risk of external crisis is on a declining trend mainly driven by improvements in the composition of external portfolio assets magnified by increasing financial integration as well as rising international reserves.
    Keywords: External crisis;Financial crisis;Macroeconomic imbalances;External debt;Foreign Direct Investment;External assets and liabilities;External balance sheet;International reserves
    JEL: F30 F34 G01 G15 H63
    Date: 2022–11
  9. By: Sujan Lamichhane
    Abstract: Climate mitigation policies are being introduced around the world to limit global warming, generating new risks to the economy. This paper develops a continuous time heterogeneous agents model to study the impact of carbon pricing policy shocks on corporate default risk and the consequent transition dynamics. We derive a closed-form solution to corporate default probability based on firms' intertemporal optimization decisions and explicitly characterize the transition speed. This allows for studying policy implications in an analytically tractable way. The model is calibrated to different US corporate sectors to quantify the heterogeneous effects of carbon price shocks. While carbon-intensive sectors face increased default risks, there are notable asymmetric effects within sectors. Higher carbon prices increase default risk but also induce faster transition towards the new post-shock steady state with a highly non-linear impact. Our results suggest that once a range of possible price shocks are accounted for, the increase in the cost of capital/risk premiums might be sharply different across sectors.
    Keywords: Default risk; climate risk; carbon price; transition dynamics; cost of capital; risk premium.; climate mitigation policy; carbon price shock; policy shock; price shock; default rate; Debt default; Greenhouse gas emissions; Manufacturing; Global
    Date: 2023–08–25
  10. By: Valencia, Oscar; Parra, Diego A.; Díaz, Juan Camilo
    Abstract: This paper provides a comprehensive early warning system (EWS) that balances the classical signaling approach with the best-realized machine learning (ML) model for predicting fiscal stress episodes. Using accumulated local effects (ALE), we compute a set of thresholds for the most informative variables that drive the correlation between predictors. In addition, to evaluate the main country risks, we propose a leading fiscal risk indicator, highlighting macro, fiscal and institutional attributes. Estimates from different models suggest significant heterogeneity among the most critical variables in determining fiscal risk across countries. While macro variables have higher relevance for advanced countries, fiscal variables were more significant for Latin American and Caribbean (LAC) and emerging economies. These results are consistent under different liquidity-solvency metrics and have deepened since the global financial crisis.
    Keywords: Forecasting;early warning signal;Fiscal policy
    JEL: C53 H63 E62
    Date: 2022–10
  11. By: Zhaobo Zhu (Audencia Business School, Shenzhen University [Shenzhen]); Wenjie Ding (SYSU - Sun Yat-Sen University [Guangzhou]); Yi Jin (MUST - Macau University of Science and Technology); Dehua Shen (NKU - Nankai University)
    Abstract: This paper argues fundamental information help resolve information uncertainty that leads to high idiosyncratic volatility premium. The IVOL-return relation is negative for stocks with poor fundamental strength but positive for stocks with strong fundamental strength. The arrival of fundamental news weakens the negative IVOL effect. Our findings are robust for alternative model specifications. Moreover, the negative IVOL effect dominates the positive IVOL effect due to arbitrage asymmetry that buying is easier than short selling stocks. Consistent with arbitrage asymmetry, the negative IVOL effect is stronger for stocks with low institutional ownership and following high investor sentiment. Overall, we provide a simple fundamental-based explanation for idiosyncratic volatility puzzle.
    Keywords: Idiosyncratic Volatility, Fundamental Strength, Arbitrage Asymmetry
    Date: 2023–10–01
  12. By: Benjamin Enke; Cassidy Shubatt
    Abstract: We develop interpretable, quantitative indices of the objective and subjective complexity of lottery choice problems that can be computed for any standard dataset. These indices capture the predicted error rate in identifying the lottery with the highest expected value, where the predictions are computed as convex combinations of choice set features. The most important complexity feature in the indices is a measure of the excess dissimilarity of the cumulative distribution functions of the lotteries in the set. Using our complexity indices, we study behavioral responses to complexity out-of-sample across one million decisions in 11, 000 unique experimental choice problems. Complexity makes choices substantially noisier, which can generate systematic biases in revealed preference measures such as spurious risk aversion. These effects are very large, to the degree that complexity explains a larger fraction of estimated choice errors than proximity to indifference. Accounting for complexity in structural estimations improves model fit substantially.
    JEL: D03
    Date: 2023–09
  13. By: Liu, Yan (Tilburg University, School of Economics and Management)
    Date: 2023
  14. By: Stark, Oded
    Abstract: I study attitudes towards risk taking in cases where a person relates to others positively, namely altruistically. This study is needed because it is unclear how altruism influences the inclination of an altruistic person to take risks. Will this person’s risk-taking behavior differ if the utility of another person does not enter his utility function? Does being altruistic cause a person to become more reluctant to take risks because a risky undertaking turning sour will also damage his ability to make altruistic transfers? Or does altruism induce a person to resort to risky behavior because the reward for a successful outcome is amplified by the outcome facilitating a bigger transfer to the beneficiary of the altruistic act? Specifically, holding constant other variables, I ask: is an altruistic person more risk averse or less risk averse than a comparable person who is not altruistic? In response to this question, using a simple model in which preferences are represented by a logarithmic utility function, I show that an altruistic person who is an active donor (benefactor) is less risk averse than a comparable person who is not altruistic: altruism is a cause of greater willingness to take risks. The finding that the altruism trait causes greater willingness to take risks has not previously been noted in the existing literature.
    Keywords: Risk and Uncertainty
    Date: 2023–10–08

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