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on Risk Management |
| By: | Alejandro Rodriguez Dominguez |
| Abstract: | Portfolio's optimal drivers for diversification are common causes of the constituents' correlations. A closed-form formula for the conditional probability of the portfolio given its optimal common drivers is presented, with each pair constituent-common driver joint distribution modelled by Gaussian copulas. A conditional risk-neutral PDE is obtained for this conditional probability as a system of copulas' PDEs, allowing for dynamical risk management of a portfolio as shown in the experiments. Implied conditional portfolio volatilities and implied weights are new risk metrics that can be dynamically monitored from the PDEs or obtained from their solution. |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2401.00949&r=rmg |
| By: | Shah, Anand; Bahri, Anu |
| Abstract: | This study proposes a new risk measure for stablecoins, that is based on the probability of the stablecoin’s price hitting a threshold exchange rate post which the stablecoin is subjected to the risk of “break the buck/ death spiral”. We also juxtapose the risk measure computed using different models - Vasicek, CIR, ARMA+GARCH and Vasicek+GARCH and suggest the policy implication of the estimated model parameters - rate of reversion (a) and long term mean exchange rate (b) for stablecoin issuers. The study compares the volatility behaviour of the stablecoins with that of the traditional cryptocurrency, Bitcoin, equity index, NASDAQ composite and fiat currency, EURO. Stablecoins tend to be “stable” barring the events such as Terra – Luna crisis, FTX Bankruptcy and Silicon Valley Bank crisis. Traditional asset backed stablecoins – Tether, USD Coin, Binance USD and True USD are less risky than the decentralized algorithmic stablecoin, FRAX and decentralized cryptoasset backed stablecoin, DAI. The proposed risk measure could be of utility to the stablecoin issuers of algorithmic and cryptoasset backed stablecoins and the regulators for setting the capital requirement to guard against the break the buck/ death spiral risk. |
| Keywords: | Cryptocurrency, Stablecoins, Terra – Luna crisis, FTX Bankruptcy, Silicon Valley Bank crisis, Risk Measure, VaR, Vasicek, CIR, GARCH, Bitcoin, Tether, USD Coin, Binance USD, True USD, DAI, FRAX |
| JEL: | F31 G01 G11 G15 G23 G28 |
| Date: | 2023–12–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119646&r=rmg |
| By: | Josef Sveda; Jiri Panos; Vojtech Siuda |
| Abstract: | We propose an improved methodology for modelling potential scenario paths of banks' risk-weighted assets, which drive the denominator of capital adequacy ratios. Our approach centres on modelling the internal risk structure of bank portfolios and thus aims to provide more accurate estimations than the common portfolio level approaches used in top-down stress testing frameworks. This should reduce the likelihood of significant misestimation of risk-weighted assets, which can lead to unjustifiably high or low solvency measures and induce false perceptions about banks' financial health. The proposed methodology is easy to replicate and suitable for various applications, including stress testing and calibration of macroprudential tools. After the methodology is introduced, we show how our proposed approach compares favourably to the methods typically used. Subsequently, we use our approach to estimate the potential increase in risk weights due to a cyclical deterioration in credit parameters and the corresponding setup of the countercyclical capital buffer for the Czech banking sector. Finally, an illustrative, hands-on example is provided in the Appendix. |
| Keywords: | Countercyclical capital buffer, credit portfolio structure, risk weighted exposure, stress-testing |
| JEL: | E58 G21 G28 G29 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:cnb:wpaper:2023/15&r=rmg |
| By: | Eduardo Abi Jaber (Xiaoyuan); Shaun (Xiaoyuan); Li |
| Abstract: | An extensive empirical study of the class of Volterra Bergomi models using SPX options data between 2011 and 2022 reveals the following fact-check on two fundamental claims echoed in the rough volatility literature: Do rough volatility models with Hurst index $H \in (0, 1/2)$ really capture well SPX implied volatility surface with very few parameters? No, rough volatility models are inconsistent with the global shape of SPX smiles. They suffer from severe structural limitations imposed by the roughness component, with the Hurst parameter $H \in (0, 1/2)$ controlling the smile in a poor way. In particular, the SPX at-the-money skew is incompatible with the power-law shape generated by rough volatility models. The skew of rough volatility models increases too fast on the short end, and decays too slow on the longer end where "negative" $H$ is sometimes needed. Do rough volatility models really outperform consistently their classical Markovian counterparts? No, for short maturities they underperform their one-factor Markovian counterpart with the same number of parameters. For longer maturities, they do not systematically outperform the one-factor model and significantly underperform when compared to an under-parametrized two-factor Markovian model with only one additional calibratable parameter. On the positive side: our study identifies a (non-rough) path-dependent Bergomi model and an under-parametrized two-factor Markovian Bergomi model that consistently outperform their rough counterpart in capturing SPX smiles between one week and three years with only 3 to 4 calibratable parameters. \end{abstract} |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2401.03345&r=rmg |
| By: | Gabriel Bruneau; Javier Ojea Ferreiro; Andrew Plummer; Marie-Christine Tremblay; Aidan Witts |
| Abstract: | Our study aims to gain insight on financial stability and climate transition risk. We develop a methodological framework that captures the direct effects of a stressful climate transition shock as well as the indirect—or systemic—implications of these direct effects. We apply this framework using data from the Canadian financial system. To capture the direct effects, we leverage the climate transition scenarios and financial risk assessment methods developed for the Bank of Canada and the Office of the Superintendent of Financial Institutions climate scenario analysis pilot project. We examine the direct effects—in the form of credit, market and liquidity risks—of the climate transition shock on financial system entities within the scope of our study. Specifically, we look at the public and private assets and derivatives portfolios of deposit-taking institutions, life insurance companies, pension funds and investment funds. To assess the indirect effects from the potential spread of the climate transition shock across an interconnected financial system, we extend an agent-based model to explore shock transmission channels such as cross-holding positions, business similarities, common exposures and fire sales. This model considers behavioural assumptions and rules, allowing us to understand the interconnectedness of the financial system. This work strengthens our understanding of how distinct entities within the financial system could be impacted by and respond to climate transition risks and opportunities, and of the potential channels through which those risks and opportunities may spread. More generally, this work contributes to building standardized systemic risk assessment and monitoring tools. |
| Keywords: | Climate change; Financial stability; Financial institutions; Financial markets; Economic models |
| JEL: | Q54 C63 G01 G10 G20 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:23-32&r=rmg |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | I study the impact of giant oil field discoveries on default risk. I document that interest rate spreads of emerging economies increase by 1.3 percentage points following a discovery of median size. I develop a sovereign default model with investment, three-sector production, and oil discoveries. Following a discovery, borrowing and investment increase. Capital reallocates from manufacturing toward oil and non-traded sectors, increasing the volatility of tradable income. Borrowing increases default risk and higher volatility increases the risk premium, both of which increase spreads. Discoveries generate welfare gains of 0.44 percent. Insurance against low oil prices increases these gains to 0.60. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Oil Discoveries |
| JEL: | F34 F41 Q33 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202404&r=rmg |
| By: | Vahidin Jeleskovic; Claudio Latini; Zahid I. Younas; Mamdouh A. S. Al-Faryan |
| Abstract: | The growing interest in cryptocurrencies has drawn the attention of the financial world to this innovative medium of exchange. This study aims to explore the impact of cryptocurrencies on portfolio performance. We conduct our analysis retrospectively, assessing the performance achieved within a specific time frame by three distinct portfolios: one consisting solely of equities, bonds, and commodities; another composed exclusively of cryptocurrencies; and a third, which combines both 'traditional' assets and the best-performing cryptocurrency from the second portfolio.To achieve this, we employ the classic variance-covariance approach, utilizing the GARCH-Copula and GARCH-Vine Copula methods to calculate the risk structure. The optimal asset weights within the optimized portfolios are determined through the Markowitz optimization problem. Our analysis predominantly reveals that the portfolio comprising both cryptocurrency and traditional assets exhibits a higher Sharpe ratio from a retrospective viewpoint and demonstrates more stable performances from a prospective perspective. We also provide an explanation for our choice of portfolio optimization based on the Markowitz approach rather than CVaR and ES. |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2401.00507&r=rmg |
| By: | Kaufmann, Christoph; Leyva, Jaime; Storz, Manuela |
| Abstract: | The euro area insurance sector and its relevance for real economy financing have grown significantly over the last two decades. This paper analyses the effects of monetary policy on the size and composition of insurers’ balance sheets, as well as the implications of these effects for financial stability. We find that changes in monetary policy have a significant impact on both sector size and risk-taking. Insurers’ balance sheets grow materially after a monetary loosening, implying an increase of the sector’s financial intermediation capacity and an active transmission of monetary policy through the insurance sector. We also find evidence of portfolio re-balancing consistent with the risk-taking channel of monetary policy. After a monetary loosening, insurers increase credit, liquidity and duration risk-taking in their asset portfolios. Our results suggest that extended periods of low interest rates lead to rising financial stability risks among non-bank financial intermediaries. JEL Classification: E52, G11, G22, G23 |
| Keywords: | monetary policy transmission, non-bank financial intermediation, portfolio re-balancing, risk-taking |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20242892&r=rmg |
| By: | Zhukovskiy, Vladislav; Zhukovskaya, Lidia; Mukhina, Yulia |
| Abstract: | The novelty of the approach presented below is that each person in a conflict (player) seeks not only to increase his payoff but also to reduce his risk, taking into account a possible realization of any uncertainty from a given admissible set. A new concept, the so-called strongly-guaranteed Nash equilibrium in payoffs and risks, is introduced and its existence in mixed strategies is proved under standard assumptions of the theory of noncooperative games, i.e., compactness and convexity of the sets of players’ strategies and continuity of the payoff functions. |
| Keywords: | Savage–Niehans risk, minimax regret, uncertainties, oncooperative game, optimal solution |
| JEL: | C00 C02 |
| Date: | 2023–06–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119395&r=rmg |
| By: | Tao Wang |
| Abstract: | Models of microeconomic consumption (including those used in heterogeneous-agent macroeconomic models) typically calibrate the size of income risk to match panel data on household income dynamics. But, for several reasons, what is measured as risk from such data may not correspond to the risk perceived by the agent. This paper instead uses data from the Federal Reserve Bank of New York’s Survey of Consumer Expectations to directly calibrate perceived income risks. One of several examples of the implications of heterogeneity in perceived income risks is increased wealth inequality stemming from differential precautionary saving motives. I also explore the implications of the fact that the perceived risk is lower than the calibrated level of risk either because of unobserved heterogeneity by researchers or because of overconfidence by the agents. |
| Keywords: | Monetary policy; Monetary Policy and Uncertainty; Business Fluctuations and Cycles |
| JEL: | D14 E21 E71 G51 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:23-59&r=rmg |
| By: | Viral V. Acharya; V. Ravi Anshuman; S. Vish Viswanathan |
| Abstract: | We examine the desirability of granting “safe harbor” provisions to creditors of financial intermediaries in sale-and-repurchase (repo) contracts. Exemption from an automatic stay in bankruptcy enables financial intermediaries to raise greater liquidity and induces entry of intermediaries with higher leverage during normal times. This liquidity creation occurs, however, at the cost of ex-post inefficiency when there are adverse aggregate shocks to the fundamental quality of collateral underlying the contracts. When exempt from bankruptcy, creditors of highly leveraged financial intermediaries respond to such shocks by engaging in collateral liquidations. Financial arbitrage by less leveraged financial intermediaries equilibrates returns from acquiring collateral at fire-sale prices and returns from real-sector lending, inducing higher lending rates, a deterioration in endogenous asset quality, and in the extremis, a credit crunch for the real sector. Given this distributive externality, taming the leverage cycle by not granting safe harbors, i.e., requiring an automatic stay on repo contracts in bankruptcy, can be not only ex-post optimal, but also ex-ante optimal, especially for illiquid collateral with high exposure to aggregate risk. |
| JEL: | D62 G01 G21 G28 G33 K11 K12 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:32027&r=rmg |
| By: | Ana L. Abeliansky (Department of Economics, Vienna University of Economics and Business); Klaus Prettner (Department of Economics, Vienna University of Economics and Business); Roman Stoellinger (Department of Economics, Vienna University of Economics and Business) |
| Abstract: | We propose a model of production featuring the trade-off between employing workers versus employing robots and analyze the extent to which this trade-off is altered by the emergence of a highly transmissible infectious disease. Since workers are - in contrast to robots - susceptible to pathogens and also spread them at the workplace, the emergence of a new infectious disease should reduce demand for human labor. According to the model, the reduction in labor demand concerns automatable occupations and increases with the viral transmission risk. We test the model's predictions using Austrian employment data over the period 2015-2021, during which the COVID-19 pandemic increased the infection risk at the workplace substantially. We find a negative effect on occupation-level employment emanating from the higher viral transmission risk in the COVID years. As predicted by the model, a reduction in employment is detectable for automatable occupations but not for non-automatable occupations. |
| Keywords: | Automation, robots, pandemics, viral transmission risk, occupational employment, shadow cost of human labor |
| JEL: | I14 J21 J23 J32 O33 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:wiw:wiwwuw:wuwp352&r=rmg |
| By: | Jaromir Baxa (Institute of Economic Studies of the Faculty of Social Sciences, Charles University, Prague, Czech Republic & The Czech Academy of Sciences, Institute of Information Theory and Automation, Prague, Czech Republic); Tomas Sestorad (Institute of Economic Studies of the Faculty of Social Sciences, Charles University, Prague, Czech Republic & The Czech Academy of Sciences, Institute of Information Theory and Automation, Prague, Czech Republic & The Czech National Bank, Prague, Czech Republic) |
| Abstract: | Several alternative news-based Economic Policy Uncertainty indices have been developer for Spain and a few other European countries. These alternative indices differ in the selection of keywords, newspaper coverage, and a scaling factor that is used to calculate the EPU index from the raw news data. Using the generalized forecast error variance decompositions of the time-varying parameter VAR model and the analysis of dynamic connectedness, we show that the restriction to include only domestic news affects estimated spillovers substantially, leading to different qualitative and quantitative assessments of uncertainty spillovers in Europe. Therefore, not all EPU indices are the same. |
| Keywords: | Uncertainty, Forecast error variance decomposition, Spillovers |
| JEL: | C32 F42 F45 |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2024_03&r=rmg |