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on Risk Management |
|
Issue of 2024‒05‒27
seventeen papers chosen by |
| By: | Tobias Fissler; Fangda Liu; Ruodu Wang; Linxiao Wei |
| Abstract: | Tail risk measures are fully determined by the distribution of the underlying loss beyond its quantile at a certain level, with Value-at-Risk and Expected Shortfall being prime examples. They are induced by law-based risk measures, called their generators, evaluated on the tail distribution. This paper establishes joint identifiability and elicitability results of tail risk measures together with the corresponding quantile, provided that their generators are identifiable and elicitable, respectively. As an example, we establish the joint identifiability and elicitability of the tail expectile together with the quantile. The corresponding consistent scores constitute a novel class of weighted scores, nesting the known class of scores of Fissler and Ziegel for the Expected Shortfall together with the quantile. For statistical purposes, our results pave the way to easier model fitting for tail risk measures via regression and the generalized method of moments, but also model comparison and model validation in terms of established backtesting procedures. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.14136&r=rmg |
| By: | Battulga Gankhuu |
| Abstract: | This paper provides the first and second order derivatives of any risk measures, including VaR and ES for continuous and discrete portfolio loss random variable variables. Also, we give asymptotic results of the first and second order conditional moments for heavy--tailed portfolio loss random variable. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.09646&r=rmg |
| By: | Shahed Ahmmed (Lecturer, Department of Business Administration, Fareast International University, Dhaka, Bangladesh); Shohana Siddique (Lecturer, Department of Business Administration, Fareast International University, Dhaka, Bangladesh) |
| Abstract: | DS30 index consists of 30 high-qualities, blue chip companies' stocks, and it is the most reputed index in the stock market in Bangladesh. This paper tests whether stocks of this index can be used for risk diversification. The objective is to find out how many DS-30 stocks can eliminate 85% of Unsystematic Risk without compromising return. The analysis is based on 5-years of monthly data collected from Dhaka Stock Exchange. In this study, DS-30 stocks are selected and added to an equal weight portfolio, one by one in the descending order of their average monthly return, unless the resulting portfolio is able to eliminate 85% of Unsystematic Risk. This order of selection ensures that, return is not compromised at a cost of diversification. Results show that, it takes only ten DS-30 stocks to accomplish the objective. |
| Keywords: | Diversification, Unsystematic Risk, Systematic Risk, Portfolio Risk Calculation, DS30, Dhaka Stock Exchange, Stock Market, Bangladesh |
| Date: | 2022–12–31 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-04547688&r=rmg |
| By: | Luis Férnandez Lafuerza (Banco de España); Jorge E. Galán (Banco de España) |
| Abstract: | We provide compelling evidence of the association between credit standards at loan origination in the corporate sector and default risk, a topic that has received little attention in the literature in comparison to the study of this relationship in the mortgage market. Using data from the Spanish credit register merged with corporate balance sheet information spanning the last financial cycle, we demonstrate that leverage and debt burden ratios at loan origination are key predictors of future corporate loan defaults. We also show that the deterioration in lending standards is strongly correlated to the build-up of cyclical systemic risk during periods of financial expansions. Specifically, limits on the debt-to-assets ratio and the interest coverage ratio could serve as effective tools to mitigate credit risk during economic expansions. We identify that the strength of these associations varies significantly across different sectors and is dependent on firms’ size, age and the existence of prior relationships with the bank. Real estate firms and small and medium-sized enterprises exhibit the strongest relationship between credit standards and future default. Overall, our findings provide strong support for the effectiveness of macroprudential measures targeting the corporate sector and contribute to providing guidance for the implementation of borrower-based measures in key segments of corporate credit. |
| Keywords: | bank credit, defaults, lending standards, macroprudential policy, non-financial corporations |
| JEL: | C32 E32 E58 G01 G28 |
| Date: | 2024–05 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:2413&r=rmg |
| By: | Marín Díazaraque, Juan Miguel; Romero, Eva; Lopes Moreira Da Veiga, María Helena |
| Abstract: | In this paper, we propose a novel asymmetric stochastic volatility model that uses a heterogeneous autoregressive process to capture the persistence and decay of volatility asymmetry over time, which is different from traditional approaches. We analyze the properties of the model in terms of volatility asymmetry and propagation using a recently introduced concept in the field and find that the new model can generate both volatility asymmetry and propagation effects. We also introduce Data Cloning for parameter estimation, which provides robustness and computational efficiency compared to conventional techniques. Our empirical analysis shows that the new proposal outperforms a recent competitor in terms of in-sample fit and out-of-sample volatility prediction across different financial return series, making it a more effective tool for capturing the dynamics of volatility asymmetry in financial markets. |
| Keywords: | Data cloning; Propagation; Stochastic volatility; Volatility asymmetry |
| Date: | 2024–05–07 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wsrepe:43887&r=rmg |
| By: | Francesco Lancia; Alessia Russo; Tim Worrall |
| Abstract: | How should successive generations insure each other when the young can default on previously promised transfers to the old? This paper studies intergenerational insurance that maximizes the expected discounted utility of all generations subject to participation constraints for each generation. If complete insurance is unattainable, the optimal intergenerational insurance is history-dependent even when the environment is stationary. The risk from a generational shock is spread into the future, with periodic resetting. Interpreting intergenerational insurance in terms of debt, the fiscal reaction function is nonlinear and the risk premium on debt is lower than the risk premium with complete insurance. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.10090&r=rmg |
| By: | Horvath, Blanka; Jacquier, Antoine; Muguruza, Aitor; Søjmark, Andreas |
| Abstract: | The non-Markovian nature of rough volatility makes Monte Carlo methods challenging, and it is in fact a major challenge to develop fast and accurate simulation algorithms. We provide an efficient one for stochastic Volterra processes, based on an extension of Donsker’s approximation of Brownian motion to the fractional Brownian case with arbitrary Hurst exponent H∈(0, 1). Some of the most relevant consequences of this ‘rough Donsker (rDonsker) theorem’ are functional weak convergence results in Skorokhod space for discrete approximations of a large class of rough stochastic volatility models. This justifies the validity of simple and easy-to-implement Monte Carlo methods, for which we provide detailed numerical recipes. We test these against the current benchmark hybrid scheme and find remarkable agreement (for a large range of values of H). Our rDonsker theorem further provides a weak convergence proof for the hybrid scheme itself and allows constructing binomial trees for rough volatility models, the first available scheme (in the rough volatility context) for early exercise options such as American or Bermudan options. |
| Keywords: | binomial trees; fractional brownian motion; functional limit theorems; rough volatility; Early Postdoc.Mobility grant 165248; Imperial CDT in Financial Computing & Analytics; T032146 grant |
| JEL: | G11 |
| Date: | 2024–04–16 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:122848&r=rmg |
| By: | Joaquin Vespignani (Tasmanian School of Business and Economics, University of Tasmania, Australia); Russell Smyth (Department of Economics, Monash University, Clayton, Australia) |
| Abstract: | This paper employs insights from earth science on the financial risk of project developments to present an economic theory of critical minerals. Our theory posits that back-ended critical mineral projects that have unaddressed technical and nontechnical barriers, such as those involving lithium and cobalt, exhibit an additional risk for investors which we term the “back-ended risk premium”. We show that the back-ended risk premium increases the cost of capital and, therefore, has the potential to reduce investment in the sector. We posit that the back-ended risk premium may also reduce the gains in productivity expected from artificial intelligence (AI) technologies in the mining sector. Progress in AI may, however, lessen the back-ended risk premium itself through shortening the duration of mining projects and the required rate of investment through reducing the associated risk. We conclude that the best way to reduce the costs associated with energy transition is for governments to invest heavily in AI mining technologies and research. |
| Keywords: | Critical Minerals, Artificial Intelligence, Risk Premium |
| JEL: | Q02 Q40 Q50 |
| Date: | 2024–05 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2024-08&r=rmg |
| By: | Petkov, Ivan (Northeastern University); Ortega, Francesc (Queens College, CUNY) |
| Abstract: | Many studies have investigated flood risk and insurance coverage in the 100-year flood zone, but much less is known about the periphery of the flood zone. We present a new approach to estimate flood risk and insurance take-up in the vicinity of the flood zone based on building-level inundation data. We illustrate our approach using data for New York after hurricane Sandy. We show that flood risk falls rapidly as we move away from the flood zone, but remains fairly high for properties located within 250 meters of the flood zone. We also document substantial voluntary insurance take-up in this area prior to the storm, reflecting homeowners' perception of flood risk. Next, we show that experiencing flooding during Sandy led to large increases in flood insurance coverage in the flood zone and its periphery. But, while in the flood zone the increase vanished after 3 years, it was highly persistent in the periphery. By using information on the types of insurance policies purchased by homeowners, we provide evidence that strongly suggests that periphery residents who experienced flooding revised upwardly their beliefs about flood risk and adapted by purchasing (affordable) flood insurance. |
| Keywords: | flood risk, flood insurance, FEMA, NFIP, hurricane Sandy |
| JEL: | Q54 G22 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp16922&r=rmg |
| By: | Jos\'e Moran; Angelo Secchi; Jean-Philippe Bouchaud |
| Abstract: | We revisit "granular models of firm growth" that have been proposed in the literature to explain the anomalously slow decrease of growth volatility with firms size and how this phenomenon shapes the distribution of their growth rates. In these models, firms' sales are viewed as collections of independent "sub-units", and these non-trivial statistical properties occur as a direct result of the fat-tailed distribution of the number or sizes of these sub-units. We present and discuss new theoretical results on the relation between firm size and growth rate statistics. Our results can be understood by noting that granular models imply the existence of three types of firms: well-diversified firms, with a size evenly distributed among several sub-units; firms with many sub-units but with their total size concentrated on only a handful of them, and lastly firms which are poorly diversified simply because they are made up of a small number of sub-units. We establish new empirical facts about growth rates and their relation with size. As predicted by the model, the distribution of growth rate volatilities is to a good approximation {independent of firm size}, once rescaled by the average size-conditioned volatility. However, the tail of this distribution is much too thin to be consistent with a granular mechanism. Moreover, the moments of growth volatility scale with size in a way that is at odds with theoretical predictions. We also find that the distribution of growth rates rescaled by firm-specific volatility, which is predicted to be Gaussian by all the models we consider, remains very fat-tailed in the data, even for large firms. This paper, in ruling out the granularity scenario, suggests that the overarching mechanisms underlying the growth of firms are not satisfactorily understood, and argues that they deserve further theoretical investigations. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.15226&r=rmg |
| By: | He, Yi; Einmahl, John (Tilburg University, School of Economics and Management) |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutis:5d01cb7e-d528-406d-8c24-c004b13014bb&r=rmg |
| By: | Perry Singleton (Center for Policy Research, Maxwell School, Syracuse University, 426 Eggers Hall, Syracuse, NY 13244) |
| Abstract: | In a model of occupational safety, biased perceptions of risk decrease welfare, which may justify government regulation. Bias is examined empirically by the correlation between subjective and objective risk, the former measured by self-reported exposure to death on the job. The correlation is negligible among workers with no high school diploma, consistent with underestimating risk in more dangerous occupations, and strongest among more educated workers when objective risk is specific to harmful and noxious substances, which in psychological studies rank high in dread. Biased perceptions of risk may also lead to biased estimates of value of statistical life. VSL estimates are negligible across all education levels using the all cause fatality rate, but consistently greater among more educated workers using the fatality rate due to harmful and noxious substances, upwards of $70 million and more. Optimal policy is considered, including an illustrative simulation of a risk ceiling. |
| Keywords: | Compensating wage differentials, value of statistical life, occupational safety, risk perception |
| JEL: | J31 J81 |
| Date: | 2024–05 |
| URL: | http://d.repec.org/n?u=RePEc:max:cprwps:263&r=rmg |
| By: | Márcio Mateus |
| Abstract: | In this paper we investigate the determinants of the loss given default (LGD) of mortgage loans in Portugal. Exploring loan-level data from the Portuguese Central Credit Register, we show that the original LTV (oLTV) ratio is by far the most important determinant of the LGD of mortgage loans, but the relation between these two variables is not linear. A higher oLTV ratio is associated with a higher LGD of mortgage loans, but only above a certain threshold. We provide evidence that the critical area in the relationship between these two variables lies in a range between 80% and 100%. Our results also highlight the importance of the house price cycle history in explaining the LGD, with distinct short and long-term effects. In the short-term we find a negative correlation between house prices and LGD, meaning that a house price increase just before loan origination seems to contribute to the decrease of the LGD in the future. In the long-term the correlation is positive, which suggests that the higher the house price has increased in the past, the higher the future LGD is expected to be. |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ptu:wpaper:w202318&r=rmg |
| By: | Giulio Cifarelli |
| Abstract: | The pricing of six highly liquid futures commodity contracts is investigated using a Markov switching procedure. The data set spans an exceptionally turbulent time period, characterized by a complex interplay of economic/financial and political shocks. Markov switching analysis exploits time series nonlinearity in order to identify the nature and the timing of the implicit changes of regime. Building on a HAM framework, we use the time varying parameterization of the transition probability estimates in order to link these shifts to exogenous variables. We provide in this way additional information on the co-movement of the time series and on their eventual regime shifts. The WTI oil futures price and DJIA stock index turn out to be the main common drivers of the changes in regime of most futures commodity prices. |
| Keywords: | HAM Commodity pricing, Markov Switching, Time-Varying Transition Probabilities |
| JEL: | G11 G12 G18 Q40 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:frz:wpaper:wp2023_11.rdf&r=rmg |
| By: | E. Emanuel Rapsch |
| Abstract: | A general theory of stochastic decision forests reconciling two concepts of information flow -- decision trees and refined partitions on the one hand, filtrations from probability theory on the other -- is constructed. The traditional "nature" agent is replaced with a one-shot lottery draw that determines a tree of a given decision forest, while each "personal" agent is equipped with an oracle providing updates on the draw's result and makes partition refining choices adapted to this information. This theory overcomes the incapacity of existing approaches to extensive form theory to capture continuous time stochastic processes like Brownian motion as outcomes of "nature" decision making in particular. Moreover, a class of stochastic decision forests based on paths of action indexed by time is constructed, covering a large fraction of models from the literature and constituting a first step towards an approximation theory for stochastic differential games in extensive form. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.12332&r=rmg |
| By: | Manuel Amador; Javier Bianchi |
| Abstract: | We examine banking regulation in a macroeconomic model of bank runs. We construct a general equilibrium model where banks may default because of fundamental or self-fulfilling runs. With only fundamental defaults, we show that the competitive equilibrium is constrained efficient. However, when banks are vulnerable to runs, banks’ leverage decisions are not ex-ante optimal: individual banks do not internalize that higher leverage makes other banks more vulnerable. The theory calls for introducing minimum capital requirements, even in the absence of bailouts. |
| JEL: | E32 E44 E58 G01 G21 G33 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:32341&r=rmg |
| By: | Carlos Cantú; Rocío Gondo; Berenice Martinez |
| Abstract: | We quantify the trade-offs of using reserve requirements (RR) as a financial stability tool. A tightening in RR reduces the amplitude of the credit cycle. This lowers the frequency and strength of financial stress episodes but at a cost of lower growth in credit and economic activity. We find that the gains from a lower probability and magnitude of financial stress episodes are greater than the costs from the initial reduction in economic activity. In addition, we find that RR have a stronger effect on emerging market economies than in advanced economies, both in terms of costs and benefits. Finally, we find that uniform RR have a stronger effect than RR that differenciate by maturity or currency. |
| Keywords: | reserve requirements, macroprudential policy, financial stress episodes, early-warning system, financial cycle |
| JEL: | E44 E58 F41 G01 G28 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1182&r=rmg |