nep-rmg New Economics Papers
on Risk Management
Issue of 2023‒11‒27
twelve papers chosen by
Stan Miles, Thompson Rivers University

  1. Beyond VaR and CVaR: Topological Risk Measures in Derivative Markets By Amit Kumar Jha
  2. Understanding and managing blockchain protocol risks By Alex Nathan; Dimosthenis Kaponis; Saul Lustgarten
  3. No-Arbitrage Deep Calibration for Volatility Smile and Skewness By Kentaro Hoshisashi; Carolyn E. Phelan; Paolo Barucca
  4. The leverage anomaly in U.S. bank stock returns By Venmans, Frank
  5. Risk management in Islamic finance: Beyond conventional norms By Jihane Jaouad; Ali Ouchekkir
  6. Social Insurance against a Short Life: Ante-Mortem versus Post-Mortem Policies By Ponthiere, Gregory
  7. Easier said than done: Predicting downside risks to house prices in Croatia By Tihana Škrinjarić
  8. Balancing Volatility and Returns in the Czech National Bank's Foreign Exchange Portfolio By Tomas Adam; Ales Michl; Michal Skoda
  9. How should the long-term investor harvest variance risk premiums? By Dörries, Julian; Korn, Olaf; Power, Gabriel J.
  10. Risk of incident cardiovascular diseases at national and subnational levels in Iran from 2000 to 2016 and projection through 2030: Insights from Iran STEPS surveys By Ebrahimi, Hedyeh; Masinaei, Masoud; Aminorroaya, Arya; Aryan, Zahra; Mehdipour, Parinaz; Rostam-Abadi, Yasna; Ahmadi, Naser; Saeedi Moghaddam, Sahar; Pishgar, Farhad; Ghanbari, Ali; Rezaei, Nazila; Takian, Amirhossein; Farzadfar, Farshad
  11. Risk and Uncertainty Analysis of Commercial Real Estate Developments: A Comparison of Traditional and Contemporary Approaches By Uduakobong E. Akpan; Olusegun A. Ogunba; Timothy T. Ayodele
  12. Living in a world of disappearing nature: physical risk and the implications for financial stability By Lelli, Chiara; Parisi, Laura; Heemskerk, Irene; Boldrini, Simone; Ceglar, Andrej

  1. By: Amit Kumar Jha
    Abstract: This paper introduces a novel approach to financial risk assessment by incorporating topological data analysis (TDA), specifically cohomology groups, into the evaluation of derivatives portfolios. The study aims to go beyond traditional risk measures like Value at Risk (VaR) and Conditional Value at Risk (CVaR), offering a more nuanced understanding of market complexities. Using both simulated and real-world data, we develop a new topological risk measure, termed Density Change Under Stress (DCUS). Preliminary results indicate a significant change in the density of the point cloud representing the financial time series during stress conditions, suggesting that DCUS may offer additional insights into portfolio risk and has the potential to complement existing risk management tools.
    Date: 2023–10
  2. By: Alex Nathan; Dimosthenis Kaponis; Saul Lustgarten
    Abstract: This paper addresses the issue of blockchain protocol risks, a foundational category of risks affecting Distributed Ledger Technology (DLT) which underpins digital assets, smart contracts, and decentralised applications. It presents a comprehensive risk management framework developed in collaboration with financial institutions, blockchain development teams and regulators that applies a traditional risk management taxonomy to address certain overlooked blockchain protocol risks. The approach offers a structured way to identify, measure, monitor and report blockchain protocol risks. The paper provides real-world use cases to demonstrate the practicality and implementation of the proposed framework. The findings of this work contribute to the evolving understanding of blockchain protocol risks and provide valuable insights on how these risks affect the adoption of DLT by financial institutions.
    Date: 2023–10
  3. By: Kentaro Hoshisashi; Carolyn E. Phelan; Paolo Barucca
    Abstract: Volatility smile and skewness are two key properties of option prices that are represented by the implied volatility (IV) surface. However, IV surface calibration through nonlinear interpolation is a complex problem due to several factors, including limited input data, low liquidity, and noise. Additionally, the calibrated surface must obey the fundamental financial principle of the absence of arbitrage, which can be modeled by various differential inequalities over the partial derivatives of the option price with respect to the expiration time and the strike price. To address these challenges, we have introduced a Derivative-Constrained Neural Network (DCNN), which is an enhancement of a multilayer perceptron (MLP) that incorporates derivatives in the output function. DCNN allows us to generate a smooth surface and incorporate the no-arbitrage condition thanks to the derivative terms in the loss function. In numerical experiments, we apply the stochastic volatility model with smile and skewness parameters and simulate it with different settings to examine the stability of the calibrated model under different conditions. The results show that DCNNs improve the interpolation of the implied volatility surface with smile and skewness by integrating the computation of the derivatives, which are necessary and sufficient no-arbitrage conditions. The developed algorithm also offers practitioners an effective tool for understanding expected market dynamics and managing risk associated with volatility smile and skewness.
    Date: 2023–10
  4. By: Venmans, Frank
    Abstract: This article examines the relationship between capital ratios and returns on US bank stocks between 1973 and 2019. Banks with low capital ratios do not have higher, but rather lower returns than banks with intermediate levels of capital. This is not explained by standard risk factors. As a result, risk-adjusted returns (alphas) of lowcapital banks are negative. Moreover, the stock returns exhibit a delayed reaction to changes in capital ratios. Low-capital banks that further increase their debt have high abnormal returns on the day of announcement, but tend to have low risk-adjusted returns in the 9 months that follow. The paper uncovers several explanations for this leverage anomaly: under-priced default risk, under-priced systematic risk and sensitivity to idiosyncratic volatility.
    Keywords: asset pricing anonaly; bank regulation; capital requirements; leverage
    JEL: G12 G14 G21 G32
    Date: 2021–11–01
  5. By: Jihane Jaouad (LERSG - Laboratoire d’Études et de Recherches en Sciences de Gestion, FSJES – Agdal, Université Mohammed V de Rabat. Maroc.); Ali Ouchekkir (LERSG - Laboratoire d’Études et de Recherches en Sciences de Gestion, FSJES – Agdal, Université Mohammed V de Rabat. Maroc.)
    Abstract: At a time when Islamic finance is experiencing rapid growth worldwide, it is essential to better understand and deepen risk management within this sector to strengthen its resilience and stability. The aim of this article is to analyze the specific risks inherent in Islamic finance and the corresponding approaches to risk management. It also examines the relevance and applicability of the Basel prudential accords to the specific context of Islamic banks. Greater harmonization between Islamic financial practices and international regulatory standards will contribute to the emergence of a stronger, more innovative Islamic financial sector, aligned with the ethical principles of Sharia law. To achieve this objective, our research is based on a theoretical and conceptual approach. To this end, an in-depth literature review is conducted with the aim of clarifying the key underlying concepts and presenting the various risks facing Islamic finance. Historical developments and current risk management methodologies are also reviewed. The results show that Islamic finance faces a wide range of threats, encompassing both generic risks common to the financial sector and specific risks arising from its religious ethos. While significant progress has been made in terms of risk management, more needs to be done to adapt existing tools and frameworks to the particularities of Islamic participative finance. The new prudential requirements introduced in Basel III appear insufficiently calibrated to the singularities of Islamic banking. Implications point to the need to develop innovative solutions aligned with Sharia precepts, while regulators are called upon to design a tailor-made prudential framework to support this rapidly expanding sector. Although limited to the banking sector, this documented research fills a gap in the literature on a subject that is both crucial and little investigated, providing a solid foundation for future academic work and informing the thinking and decisions of industry practitioners.
    Abstract: Alors que la finance islamique connaît une croissance rapide à l'échelle mondiale, il est essentiel de mieux comprendre et d'approfondir la gestion des risques au sein de ce secteur pour renforcer sa résilience et sa stabilité. Cet article a pour objectif d'analyser les risques spécifiques inhérents à la finance islamique ainsi que les approches correspondantes en matière de gestion des risques. Il examine également la pertinence et l'applicabilité des accords prudentiels de Bâle au contexte particulier des banques islamiques. Une meilleure harmonisation entre les pratiques financières islamiques et les normes réglementaires internationales, contribue à l'émergence d'un secteur financier islamique plus solide, innovant et aligné sur les principes éthiques de la Charia. Pour atteindre cet objectif, notre recherche s'appuie sur une approche théorique et conceptuelle, pour ce faire, une revue de littérature approfondie est conduite dans le but de clarifier les concepts-clés sous-jacents et de présenter les différents risques auxquels la finance islamique est confrontée. L'évolution historique et les méthodologies actuelles de gestion des risques sont également passées en revue. Les résultats mettent en évidence que la finance islamique fait face à un large éventail de menaces, englobant à la fois des risques génériques communs au secteur financier, mais également des risques spécifiques découlant de son éthique religieuse. Si des progrès significatifs ont été accomplis concernant la maîtrise des risques, des efforts restent à fournir pour adapter les outils et cadres existants aux particularités de la finance participative islamique. Les nouvelles exigences prudentielles instaurées dans Bâle III apparaissent insuffisamment calibrées vis-à-vis des singularités des banques islamiques. Les implications soulignent la nécessité de développer des solutions innovantes alignées sur les préceptes de la Charia, tandis que les autorités de régulation sont appelées à concevoir un cadre prudentiel sur-mesure pour soutenir ce secteur en pleine expansion. Bien que limitée au secteur bancaire, cette recherche documentée comble un manque dans la littérature sur un sujet à la fois crucial et peu investigué, fournissant ainsi une base solide pour de futurs travaux académiques et éclairant les réflexions et décisions des praticiens du secteur.
    Keywords: Islamic finance, Conventional finance, Risk, Risk management, Basel accords, Finance islamique, Finance conventionnelle, Risque, Gestion des riques, Accords de Bale
    Date: 2023–08–25
  6. By: Ponthiere, Gregory
    Abstract: Welfare States do not insure citizens against the risk of premature death, i.e., the risk of having a short life. Using a dynamic OLG model with risky lifetime, this paper compares two insurance devices reducing well-being volatility due to the risk of early death: (i) an ante-mortem age-based statistical discrimination policy that consists of an allowance given to all young adults (including the unidentified adults who will die early); (ii) a post-mortem subsidy on accidental bequests due to early death. Each policy is financed by taxing old-age consumption. Whereas each device can yield full insurance, the youth allowance is shown to imply a higher lifetime well-being at the stationary equilibrium. The marginal utility of consumption exceeding the marginal utility of giving when being dead, the youth allowances system is, despite imperfect targeting, a more effi cient mechanism of insurance against the risk of early death.
    Keywords: premature death, mortality risk, social insurance, inheritance, lifecycle models
    JEL: J10 J17 I31 E21 H55
    Date: 2023
  7. By: Tihana Škrinjarić (Bank of England, United Kingdom Author-Name2: Maja Sabol Author-Name2-First: Maja Author-Name2-Last: Sabol Author-Email2: Author-Workplace-Name2: European Parliament)
    Abstract: House price dynamics are particularly interesting for macroprudential policymakers due to their effects on financial stability and future macroeconomic performance. As the main goal of macroprudential policy is to mitigate systemic risks, it is essential to monitor the central tendency of future house price growth dynamics and focus on downside risks and their possible materialization. This research, the first of its kind applied to the Croatian housing market, tries to identify and capture the main drivers of house price-at-risk (HaR) for the period between 2002Q1 and 2022Q3. It also predicts downside risks to future real house price growth. Based on the quantile regression results, we conclude that downside risks on housing market have increased in recent years. The approach is found to be insightful to monitor the uncertainty of the forecasts and decomposing the drivers to house price forecasting. Our results have implications for a range of policies that influence housing markets.
    Keywords: financial stability, macroprudential policy, quantile regression, growth at risk, house price dynamics, downside risks
    JEL: E32 E44 E58 G01 G28 C22
    Date: 2023–11–08
  8. By: Tomas Adam; Ales Michl; Michal Skoda
    Abstract: This paper discusses the implications of possible changes in the composition of the Czech National Bank's foreign exchange reserves, which are large by international standards and account for about 98% of the CNB's assets and are thus crucial for its earnings. Starting from the allocation as of October 31, 2022, we test how the risk-return characteristics change under the following three hypotheses: (i) increasing the share of equities from about 18% to, for example, 20%, (ii) increasing the amount of gold to, for example, 100 tons (from about 0.5% to 4.5% of the reserves), (iii) reducing the share of euro-denominated assets from 46% to, for example, 40%. The results suggest that if asset prices followed the pattern of the last 20 years, increasing the share of equities to 20% would increase the expected return on the portfolio, while the volatility would increase only slightly. Next, increasing the amount of gold to 100 tons could increase the expected return on the portfolio, while its volatility, measured in Czech koruna, would decrease. Reducing the share of euro-denominated assets, on the other hand, could slightly increase the expected return on the portfolio but could also significantly increase the volatility of the returns measured in Czech koruna, and is therefore not appropriate.
    Keywords: Central bank finances, foreign exchange reserves, foreign exchange reserve management, portfolio choice
    JEL: E44 E58 F31 G11
    Date: 2022–09
  9. By: Dörries, Julian; Korn, Olaf; Power, Gabriel J.
    Abstract: Derivatives strategies that aim to earn variance risk premiums are exposed to sharp price declines during market crises, calling into question their suitability for the longterm investor. Our paper defines, analyzes, and proposes potential solutions to three problems (payoff, leverage and finite maturity) linked to designing suitable variancebased investment strategies. We conduct an empirical study of such strategies for the S&P 500 index options market and find strong effects of certain design elements on risk and return. Overall, our results show that variance strategies can be attractive to the long-term investor if properly designed.
    Keywords: Variance Risk Premium, Variance Factor, Trading Strategies, Long-term Investor
    JEL: G10 G11 G23
    Date: 2023
  10. By: Ebrahimi, Hedyeh; Masinaei, Masoud; Aminorroaya, Arya; Aryan, Zahra; Mehdipour, Parinaz; Rostam-Abadi, Yasna; Ahmadi, Naser; Saeedi Moghaddam, Sahar; Pishgar, Farhad; Ghanbari, Ali; Rezaei, Nazila; Takian, Amirhossein; Farzadfar, Farshad
    Abstract: Cardiovascular Disease (CVD) is the leading cause of death in developing countries. CVD risk stratification guides the health policy to make evidence-based decisions. To provide current picture and future trend of CVD risk in the adult Iranian population. Nationally representative datasets of 2005, 2006, 2007, 2008, 2009, 2011, and 2016 STEPwise approach to non-communicable diseases risk factor surveillance (STEPS) studies were used to generate the 10-year and 30-year risks of CVD based on Framingham, Globorisk, and World Health Organization (WHO) risk estimation models. Trend of CVD risk was calculated from 2000 until 2016 and projected to 2030. In 2016, based on Framingham model, 14.0% of the Iranian, aged 30 to 74, were at great risk (≥20%) of CVD in the next 10 years (8.0% among females, 20.7% among males). Among those aged 25 to 59, 12.7% had ≥45% risk of CVD in the coming 30 years (9.2% among females, 16.6 among males). In 2016, CVD risk was higher among urban area inhabitants. Age-standardized Framingham 10-year CVD risk will increase 32.2% and 19%, from 2000 to 2030, in females and males, respectively. Eastern provinces had the lowest and northern provinces had the greatest risk. This study projected that CVD risk has increased from 2000 to 2016 in Iran. Without further risk factor modification, this trend will continue until 2030. We have identified populations at higher risks of CVD to guide future intervention.
    Date: 2023
  11. By: Uduakobong E. Akpan; Olusegun A. Ogunba; Timothy T. Ayodele
    Abstract: The study assessed the degree to which the traditional NPV captured the risk and uncertainty inherent in real estate development projects in Lagos, Nigeria, using case studies. This was with a view to enhancing real estate investment decision making in developing countries of Africa. Two commercial real estate developments were selected as case studies for the study. Probabilistic risk analysis models (risk adjusted discount rate and certainty equivalent models) were used to assess the risk inherent in the development projects while real option analysis (Samuelson Mckean Model) was used to test the effect of flexibility on the investments (uncertainty analysis). The methodology involved first carrying out an appraisal of the case studies using the traditional NPV. Thereafter, the appraisal outcomes of the NPV analysis were compared to outcomes using contemporary models (risk and uncertainty analysis). The findings of the study showed that the contemporary models - which were not much in use in the study area - provided much more profound investment advice for clients and a much more robust basis for client decision making than the traditional NPV model. The study concluded that contemporary models deserve to be in much more use in the developing economies of Africa.
    Keywords: Development appraisal; NPV; real option analysis; Risk Analysis
    JEL: R3
    Date: 2023–01–01
  12. By: Lelli, Chiara; Parisi, Laura; Heemskerk, Irene; Boldrini, Simone; Ceglar, Andrej
    Abstract: The loss of biodiversity and the degradation of natural ecosystems pose a significant threat to the broader economy and financial stability that central banks and financial supervisors cannot ignore. To gain further insights into the implications of nature and ecosystem service degradation for financial stability, this study assesses the dependencies of euro area non-financial corporations and banks on different ecosystem services. The study then develops a method to capture banks’ credit portfolio sensitivity to possible future changes in the provision of ecosystem services. Our results show that 75% of all corporate loan exposures in the euro area have a strong dependency on at least one ecosystem service. We also find that loan portfolios may be significantly affected if nature degradation continues its current trend, with greater vulnerabilities concentrated in certain regions and economic sectors. JEL Classification: C55, G21, G38, Q5
    Keywords: biodiversity loss, economy, ENCORE, impact, input-output table, materiality score, nature degradation, nexus
    Date: 2023–11

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