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on Risk Management |
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Issue of 2024‒05‒20
thirteen papers chosen by |
| By: | Richard Ostrander |
| Abstract: | Remarks at the BIS Central Bank Legal Experts’ Meeting, Bank for International Settlements, Basel, Switzerland. |
| Keywords: | legal risk; risk management |
| Date: | 2024–04–19 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsp:98149&r=rmg |
| By: | Abdulnasser Hatemi-J |
| Abstract: | Connectedness measures the degree at which a time-series variable spills over volatility to other variables compared to the rate that it is receiving. The idea is based on the percentage of variance decomposition from one variable to the others, which is estimated by making use of a VAR model. Diebold and Yilmaz (2012, 2014) suggested estimating this simple and useful measure of percentage risk spillover impact. Their method is symmetric by nature, however. The current paper offers an alternative asymmetric approach for measuring the volatility spillover direction, which is based on estimating the asymmetric variance decompositions introduced by Hatemi-J (2011, 2014). This approach accounts explicitly for the asymmetric property in the estimations, which accords better with reality. An application is provided to capture the potential asymmetric volatility spillover impacts between the three largest financial markets in the world. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.12997&r=rmg |
| By: | Hałaj, Grzegorz; Hipp, Ruben |
| Abstract: | We evaluate the effects of contagion and common exposure on banks’ capital through a regression design inspired by the structural VAR literature and derived from the balance sheet identity. Contagion can occur through direct exposures, fire sales, and market-based sentiment, while common exposures result from portfolio overlaps. We estimate the structural regression on granular balance sheet and interbank exposure data of the Canadian banking market. First, we document that contagion varies in time, with the highest levels around the Great Financial Crisis and lowest levels during the pandemic. Second, we find that after the introduction of Basel III the relative importance of risks has changed, hinting that sources of systemic risk have changed structurally. Our new framework complements traditional stress-tests focused on single institutions by providing a holistic view of systemic risk. JEL Classification: G21, C32, C51, L14 |
| Keywords: | banking, contagion, networks, structural estimation, systemic risk |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20242929&r=rmg |
| By: | Yanwei Jia |
| Abstract: | This paper studies continuous-time risk-sensitive reinforcement learning (RL) under the entropy-regularized, exploratory diffusion process formulation with the exponential-form objective. The risk-sensitive objective arises either as the agent's risk attitude or as a distributionally robust approach against the model uncertainty. Owing to the martingale perspective in Jia and Zhou (2023) the risk-sensitive RL problem is shown to be equivalent to ensuring the martingale property of a process involving both the value function and the q-function, augmented by an additional penalty term: the quadratic variation of the value process, capturing the variability of the value-to-go along the trajectory. This characterization allows for the straightforward adaptation of existing RL algorithms developed for non-risk-sensitive scenarios to incorporate risk sensitivity by adding the realized variance of the value process. Additionally, I highlight that the conventional policy gradient representation is inadequate for risk-sensitive problems due to the nonlinear nature of quadratic variation; however, q-learning offers a solution and extends to infinite horizon settings. Finally, I prove the convergence of the proposed algorithm for Merton's investment problem and quantify the impact of temperature parameter on the behavior of the learning procedure. I also conduct simulation experiments to demonstrate how risk-sensitive RL improves the finite-sample performance in the linear-quadratic control problem. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.12598&r=rmg |
| By: | Rei Iwafuchi; Yasumasa Matsuda |
| Abstract: | The market for investment trusts of large-scale portfolios, including index funds, continues to grow, and high-dimensional volatility estimation is essential for assessing the risks of such portfolios. However, multivariate volatility models suitable for high-dimensional data have not been extensively studied. This paper introduces a new framework based on the Spatial AR model, which provides fast and stable estimation, and demonstrates its application through simulations using historical data from the S&P 500. |
| Date: | 2024–05 |
| URL: | http://d.repec.org/n?u=RePEc:toh:dssraa:141&r=rmg |
| By: | Victor Cardenas |
| Abstract: | The document provides an overview of financial climate risks. It delves into how climate change impacts the global financial system, distinguishing between physical risks (such as extreme weather events) and transition risks (stemming from policy changes and economic transitions towards low carbon technologies). The paper underlines the complexity of accurately defining financial climate risk, citing the integration of climate science with financial risk analysis as a significant challenge. The paper highlights the pivotal role of microfinance institutions (MFIs) in addressing financial climate risk, especially for populations vulnerable to climate change. The document emphasizes the importance of updating risk management practices within MFIs to explicitly include climate risk assessments and suggests leveraging technology to improve these practices. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.07331&r=rmg |
| By: | Yuliyan Mitkov (University of Bonn); Ulrich Schüwer (Goethe University Frankfurt) |
| Abstract: | We use tools from survival analysis to study the equilibrium probability of bank failure in a model with imperfect correlation in loan defaults where a systematic risk factor and idiosyncratic frailty factors govern borrower credit worth. We derive several surprising results: in equilibrium, a bank can be more likely to fail with less risky than with more risky borrowers. In addition, the equilibrium relationship between borrower and bank risk can be fundamentally altered by a greater dispersion of the frailty factors, similar to how mixing items of different durability can fundamentally change the overall aging pattern. |
| Keywords: | Correlated defaults, borrower heterogeneity, bank failure, survival analysis |
| JEL: | G21 G28 E43 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:294&r=rmg |
| By: | Masanori Hirano |
| Abstract: | Derivative hedging and pricing are important and continuously studied topics in financial markets. Recently, deep hedging has been proposed as a promising approach that uses deep learning to approximate the optimal hedging strategy and can handle incomplete markets. However, deep hedging usually requires underlying asset simulations, and it is challenging to select the best model for such simulations. This study proposes a new approach using artificial market simulations for underlying asset simulations in deep hedging. Artificial market simulations can replicate the stylized facts of financial markets, and they seem to be a promising approach for deep hedging. We investigate the effectiveness of the proposed approach by comparing its results with those of the traditional approach, which uses mathematical finance models such as Brownian motion and Heston models for underlying asset simulations. The results show that the proposed approach can achieve almost the same level of performance as the traditional approach without mathematical finance models. Finally, we also reveal that the proposed approach has some limitations in terms of performance under certain conditions. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.09462&r=rmg |
| By: | Tommaso Proietti (CEIS & DEF, University of Rome "Tor Vergata") |
| Abstract: | The concept of drawdown quantifies the potential loss in the value of a financial asset when it deviates from its historical peak. It plays an important role in evaluating market risk, portfolio construction, assessing risk-adjusted performance and trading strategies. This paper introduces a novel measurement framework that produces, along with the drawdown and its dual (the drawup), two Markov chain processes representing the current lead time with respect to the running maximum and minimum, i.e., the number of time units elapsed from the most recent peak and trough. Under relatively unrestrictive assumptions regarding the returns process, the chains are homogeneous and ergodic. We show that, together with the distribution of asset returns, they determine the properties of the drawdown and drawup time series, in terms of size, serial correlation, persistence and duration. Furthermore, they form the foundation of a new algorithm for dating peaks and troughs of the price process delimiting bear and bull market phases. The other contributions of this paper deal with out-of-sample prediction and robust estimation of the drawdown. |
| Keywords: | Financial time series; risk measures; dating bear and bull markets |
| JEL: | C22 C58 E32 |
| Date: | 2024–05–03 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:576&r=rmg |
| By: | Ragnar Enger Juelsrud; Ella Getz Wold |
| Abstract: | In this paper we use a novel natural experiment and Norwegian tax data to quantify the causal impact of unemployment risk on individual savings. We show theoretically that higher unemployment risk increases liquid savings and has an ambiguous impact on illiquid savings in partial equilibrium. In line with the model predictions, our empirical results confirm that a one percentage point increase in unemployment rates increases liquid savings by 1.3 percent in the cross-section. Reassuringly, this effect is driven by low-tenured workers, who face the highest increase in risk. Illiquid savings remain unaffected, implying an increase in the overall liquidity of individual saving portfolios. Using two independent approaches to quantify the overall importance of the unemployment risk channel in explaining saving dynamics during recessions, we find that at least 80% of the recession-induced increase in liquid savings can be explained by higher unemployment risk. |
| Keywords: | Unemployment risk, precautionary savings, portfolio allocation, household finance, recessions, uncertainty |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:bbq:wpaper:0006&r=rmg |
| By: | Javier Gil-Bazo; Raffaele Santioni |
| Abstract: | Exploiting the Securities Holdings Statistics from the Eurosystem, we study the relation between shareholder country concentration and flow risk for euro area mutual funds. We find that funds with a more geographically dispersed investor base experience more volatile flows. The link between shareholder country concentration and flow risk is a widespread phenomenon: It holds for funds investing in different asset classes and in different regions. However, we find no difference in net performance between funds with more and less concentrated shareholders, which suggests that any potential costs of investors’ geographic dispersion are offset by either enhanced liquidity management or superior performance. Additional tests reveal that investors in funds with higher geographic shareholder dispersion are more sensitive to fund performance, consistently with a clientele effect driving our findings. Finally, we show that the positive association between geographic investor dispersion and flow risk holds for different measures of flow risk and is not driven by institutional investors, non-euro area investors, or the COVID-19 episode. |
| Keywords: | geographic shareholder dispersion, mutual-fund flow risk, mutual fund fragility, cross-border funds |
| JEL: | G23 G11 G17 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:1440&r=rmg |
| By: | Claudia Ceci; Alessandra Cretarola |
| Abstract: | We investigate the optimal reinsurance problem in the risk model with jump clustering features introduced in [7]. This modeling framework is inspired by the concept initially proposed in [15], combining Hawkes and Cox processes with shot noise intensity models. Specifically, these processes describe self-exciting and externally excited jumps in the claim arrival intensity, respectively. The insurer aims to maximize the expected exponential utility of terminal wealth for general reinsurance contracts and reinsurance premiums. We discuss two different methodologies: the classical stochastic control approach based on the Hamilton-Jacobi-Bellman (HJB) equation and a backward stochastic differential equation (BSDE) approach. In a Markovian setting, differently from the classical HJB-approach, the BSDE method enables us to solve the problem without imposing any requirements for regularity on the associated value function. We provide a Verification Theorem in terms of a suitable BSDE driven by a two-dimensional marked point process and we prove an existence result relaying on the theory developed in [27] for stochastic Lipschitz generators. After discussing the optimal strategy for general reinsurance contracts and reinsurance premiums, we provide more explicit results in some relevant cases. Finally, we provide comparison results that highlight the heightened risk stemming from the self-exciting component in contrast to the externally-excited counterpart and discuss the monotonicity property of the value function. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.11482&r=rmg |
| By: | Graziano, Marco; Habib, Maurizio Michael |
| Abstract: | This paper investigates the sensitivity of the demand for safe government debt to currency unhedged and hedged excess returns in a sample of US mutual funds. We find evidence of active rebalancing towards government bonds that offer relatively higher returns on an unhedged basis, in particular euro denominated securities. The size of the effect is large, leading to a change in portfolio share by around one percentage point on average in response to a change by one percentage point in the currency-specific excess return. Interestingly, mutual funds rebalance their portfolio towards currencies, such as the Japanese yen, that display large deviations in the covered interest parity and offer higher returns than US Treasuries on an hedged basis. Finally, when global financial risk is on the rise, US mutual fund managers repatriate their investments towards US government debt securities, mainly at the expenses of euro-denominated ones. Our results imply that deviations in pricing conditions like uncovered and covered interest parity for sovereign bonds affect capital flows from the United States towards other major currency areas. JEL Classification: F3, G11, G12, G15, G23 |
| Keywords: | covered interest parity, government bonds, mutual funds, safe assets, search for yield |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20242931&r=rmg |