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on Risk Management |
| By: | Bowden, Roger |
| Abstract: | Decisions to modify the firm's natural exposure by using derivatives should be referenced back to the maximisation of corporate value. Every firm has a natural exposure to adversity, costs that typically start well in advance of bankruptcy. The implicit value of the resulting adversity or hazard options extends a long shadow over corporate value, even in better states, and this is what hedging is designed to neutralise. The framework is used to integrate corporate value maximisation, value at risk and expected utility theory. Value at risk can be regarded as a socially imposed devise to neutralise the shareholders' limited liability exit option and will often result in over-hedging. It may be not optimal to hedge in adverse conditions: one should hedge the prospect but not the event. Modifiers such as leverage, exposure uncertainty, market incompleteness, competition and bank regulation can be explored within the same framework. |
| Keywords: | Adversity options, Capital adequacy, Conditional value at risk, Corporate value, Non Cooperative games, Generalised value at risk, Utility alignment, Hazard options, Hedging, |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:vuw:vuwecf:33498 |
| By: | Bowden, Roger |
| Abstract: | “Mine is a long and sad tale”, said the Mouse, turning to Alice and sighing. “ It is a long tail certainly, ” said Alice, looking down with wonder at the Mouse’s tail; “but why do you call it sad ?” And she kept on puzzling about it while the mouse was speaking…" Contexts such as value at risk or venture capital require local uncertainty measures, as distinct from properties of the entire distribution such as differential entropy. Applications such as value at risk and options pricing can be illuminated by means of a regime-specific concept of directional entropy. The latter enables a change of measure to an equivalent logistic distribution, one that has the same total and directional entropies at the given marker, e.g. value at risk critical point or option strike price. This is done via a scaling function that can be interpreted as a Radon-Nikodym derivative and used in its own right as a risk metric. Value at risk rescaling adjusts the critical probability to capture the long tail risk. Directional entropy can be used to identify regions of maximal exposure to new information, which can actually increase entropy rather than collapse it. |
| Keywords: | Differential entropy, Discovery processes, Expected Shortfall, Logistic distribution, Mutual information, Value at risk rescaling, Venture capital, |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:vuw:vuwecf:33481 |
| By: | Bowden, Roger |
| Abstract: | Generalised value at risk (GVaR) adds a conditional value at risk or censored mean lower bound to the standard value at risk and considers portfolio optimisation problems in the presence of both constraints. For normal distributions the censored mean is synonymous with the statistical hazard function, but this is not true for fat-tailed distributions. The latter turn out to imply much tighter bounds for the admissible portfolio set and indeed for the logistic, an upper bound for the portfolio variance that yields a simple portfolio choice rule. The choice theory in GVaR is in general not consistent with classic Von Neumann Morgenstern utility functions for money. A re-specification is suggested to make it so that gives a clearer picture of the economic role of the respective constraints. This can be used analytically to explore the choice of portfolio hedges. |
| Keywords: | Admissible set, Censored mean, Conditional value at risk, Effective utility functions, Generalised value at risk, Hazard functions, Hedging, Portfolio choice, Value at risk, |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:vuw:vuwecf:33502 |
| By: | Bowden, Roger; Zhu, Jennifer |
| Abstract: | Fund and other investments often exhibit longer run volatility associated with macroeconomic or other dynamics to an extent inconsistent with the efficient market accumulation model. Volatility and performance models or metrics based on one-period returns or simple extensions can fail to pick up this, resulting in sub-optimal investment policies, or welfare losses if exit happens to be forced at the wrong time. We show how to use wavelet analysis to resolve problems of detection, attribution and welfare measurement, including assigning volatility metrics and path risk, while dynamic value at risk ideas can be applied to establish clearance points relative to any benchmark comparator path. Generalisations of the spectral utility function can guide investment policy or be used to design optimal portfolios. Band pass portfolios can be designed that smooth investor exposure to long or short run instabilities in investment value. |
| Keywords: | Band pass portfoilios, Path risk, Portfolio theory, Spectral utility functions, Long term volatility, Value at risk, |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:vuw:vuwecf:33488 |
| By: | Schick, Manuel; Opschoor, Anne |
| Abstract: | This paper proposes forecasting joint tail risks for key macroeconomic indicators, GDP growth, inflation, and unemployment, using the US Survey of Professional Forecasters (SPF). By incorporating SPF consensus forecasts into the conditional mean of AR-GARCH-type models, the accuracy of univariate and multivariate predictive densities is significantly improved. Modeling a constant correlation matrix captures strong dependencies, particularly between GDP growth and unemployment. Using US data from 1990 to 2024, we show that the joint modeling framework enables scenario-based analysis in which predictive densities, conditioned on adverse developments in other variables, differ substantially from the baseline marginal distributions. The framework allows for a formal out-of-sample evaluation of joint predictive densities and a transparent assessment of conditional tail risks. |
| Keywords: | Growth-at-Risk; Multivariate Predictive Densities; GARCH; Tail Risk; Macroeconomic Forecasting |
| Date: | 2026–04–24 |
| URL: | https://d.repec.org/n?u=RePEc:awi:wpaper:771 |
| By: | Bowden, Roger; Zhu, Jennifer; Cho, Jin Seo |
| Abstract: | Directional calls are often more successful than precise value prediction, particularly at certain times, when underlying fundamentals suggest a breakout from the stable range. We adapt the categorical directional framework implicit in binomial or trinominal step processes to establish nonhomogeneous multinomial directional probabilities over coarser time intervales and show how such frameworks can be used for forecasting the hedging, including dynamic persistence. Problems of signal compression and outcome definition can be addressed using methods analogous to neuronal nets and fuzzy membership functions. the methods are applied to derive forecasting and conditional hedge procedures for foreign exchange exposures. |
| Keywords: | Conditional value at risk, Foreign exchange forecasting, Fuzzy regimes, Hidden Markov models, Non-homogenous multinomial process, |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:vuw:vuwecf:33487 |
| By: | Gleb Kozliakov; Emile A. Marin; Sanjay R. Singh |
| Abstract: | Can idiosyncratic risk explain the equity premium? We revisit this question using a novel measure of imperfect risk sharing, implied by a large class of heterogeneous-agent models, constructed using household-level panel data. We identify a group of households – with relatively high income but low net worth – whose consumption is sufficiently volatile and risky to explain 94% of the observed U.S. Sharpe ratio. In contrast, the consumption dynamics of high net-worth individuals predict a negative Sharpe ratio and so do not constitute the relevant pricing factor, consistent with models featuring wealth motives. |
| Keywords: | uninsurable idiosyncratic risk; heterogeneous agents; wealth dynamics; equity premium |
| JEL: | G12 B52 E21 |
| Date: | 2026–03–31 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedfwp:103059 |
| By: | Joseph S. Briggs; Ciaran Rogers; Christopher Tonetti |
| Abstract: | We study consumer demand for savings, life insurance, annuities, and long-term care insurance using novel survey data and a structural life-cycle model. We document that individuals perceive substantial insurance nonpayment risk, and these beliefs predict ownership. Embedding elicited beliefs into an incomplete-markets model alongside additional real-world insurance features, we match empirical patterns of low participation. Relative to a no-insurance benchmark, access to existing imperfect insurance reduces median wealth by 16% and generates a modest 0.6% welfare gain. Eliminating nonpayment risk would substantially increase insurance ownership, yield a further 11% decline in median savings, and generate an additional 1.7% welfare gain. |
| JEL: | D14 E21 G22 |
| Date: | 2026–04 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35122 |
| By: | Giannoulakis, Michael |
| Abstract: | This chapter investigates the interconnectedness of non-performing loans (NPLs) across 30 European economies, including the UK, using the Diebold–Yilmaz spillover index. Employing a linear VAR model of order 2 and Lanne–Nyberg variance decomposition on 12-period-ahead forecast errors over 2010Q1–2022Q2, the analysis reveals a persistently high total spillover index, indicating strong cross-country linkages in NPL dynamics. The results uncover an important asymmetry: economies that emerged from the global financial crisis in a relatively resilient position often act as net transmitters of NPL spillovers, while more vulnerable banking systems typically absorb them as receivers. This finding challenges the conventional view that fragility is the primary source of contagion, instead highlighting the role of resilient systems in propagating shocks through regional financial networks. The paper contributes to understanding the interplay between macroeconomic stability and credit risk transmission, with implications for European financial stability policy and cross-border supervision. |
| Keywords: | NPL; credit risk; spillovers; financial crisis |
| Date: | 2025–07–15 |
| URL: | https://d.repec.org/n?u=RePEc:gpe:wpaper:51103 |
| By: | Mario Giarda; Ignacio Rojas; Sergio Salgado |
| Abstract: | his paper characterizes the income dynamics of Chile, a fast-growing small-open economy, using 21 years of highquality administrative data of labor earnings for the population of formal workers. We find a significant decline in income inequality up to the 90th percentile of the distribution. During the same period, income volatility increased, and the skewness of earnings growth became negative, especially after the COVID recession, indicating a shift in the sources of workers’ earnings risk. Using monthly earnings data, we show that rather than unemployment risk, it is earnings fluctuations that occur within an employment relation and in transitions between employers that are the major contributor to the negative skewness of earnings growth that is typically observed in a recession. |
| Date: | 2025–12 |
| URL: | https://d.repec.org/n?u=RePEc:chb:bcchwp:1063 |
| By: | Elías Albagli; Guillermo Carlomagno; Javier Ledezma; María Teresa Reszczynski |
| Abstract: | We propose a structural framework to uncover the key forces shaping global asset prices and financial conditions. Our approach identifies seven distinct shocks: four U.S.-centric (growth, monetary policy, common risk premium, and a novel dollar-hedging risk), alongside a global hedging risk premium, a China-growth shock and an emerging market-specific risk premium shock. Using daily financial data from 2010–2025, we estimate a Structural VAR to trace how these shocks propagate across advanced and emerging economies. Our contributions are threefold. First, we introduce a real-time monitoring tool that provides structural interpretation and scenario analysis, equipping policymakers with a unified lens to assess asset price dynamics. Second, we improve shock identification through three innovations: (i) incorporating the dollar-hedging risk shock to explain anomalies observed since 2025, (ii) improving U.S. shock identification by leveraging non-U.S. data, and (iii) highlighting the pivotal role of Chinagrowth shocks in shaping emerging-market conditions. Finally, we develop a novel Financial Conditions Index (FCI) grounded in structural shocks, enabling country-specific assessments and enhancing interpretability. Unlike traditional FCIs, our index directly links financial conditions to their economic drivers, improving realtime monitoring and outperforming existing alternatives in nowcasting economic activity. |
| Date: | 2026–04 |
| URL: | https://d.repec.org/n?u=RePEc:chb:bcchwp:1080 |
| By: | Mirjalili, Seyed hossein; Keshtgar, Nafiseh; Abdurahimian, Mohammad Hossein; Fakhar poor, saeed |
| Abstract: | This study aims to identify the macroeconomic factors influencing the likelihood of a banking crisis in Iran, with a particular focus on macroprudential policy. We employed a discrete econometric model (Logit/Probit) using data from 2011 to 2023. The independent variables include the loan-to-deposit ratio (LTD) as a proxy for macroprudential policy, the interbank interest rate as a proxy for monetary policy, as well as the inflation rate and exchange rate volatility as indicators of macroeconomic instability. The positive and significant coefficient of LTD confirms that liquidity risk arising from excessive credit expansion is the main domestic factor increasing the probability of a crisis. The strong and positive coefficients for inflation and exchange rate volatility suggest that macroeconomic and currency shocks threaten financial stability by deteriorating asset quality and increasing loan defaults. The coefficient for the interbank rate implies the dominance of the disciplinary and supervisory effects of monetary policy over liquidity risk, meaning that a targeted increase in the policy rate by the central bank effectively reduces the probability of a crisis by imposing higher costs on riskier banks. Overall, the findings indicate that financial stability in Iran is influenced by short-term liquidity management and macroeconomic shocks, and that macroprudential policy plays an effective role in curbing risk-taking behavior. |
| Keywords: | Banking crisis; macroprudential policy; Loan to Deposit ratio; Exchange Rate Volatility; Systemic risk. |
| JEL: | G28 |
| Date: | 2025–11–06 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:128879 |
| By: | Gorodnichenko, Yuriy (University of California, Berkeley); Kudlyak, Marianna (Federal Reserve Bank of San Francisco, Hoover Institution, CEPR, IZA); Lobozynska, Sophia (Ivan Franko National University of Lviv); Skomorovych, Iryna (Ivan Franko National University of Lviv); Vladychyn, Ulyana (Ivan Franko National University of Lviv); Kovalyuk, Andriy (Ivan Franko National University of Lviv); Snovydovych, Iryna (Ivan Franko National University of Lviv) |
| Abstract: | We elicit reservation wage premia for relocating to two Ukrainian cities, using a household survey conducted in mid-April to mid-July 2024 during the Russian invasion of Ukraine: high-risk Kharkiv (near the frontline) and moderate-risk Kyiv. Risk tolerance is a strong predictor of willingness to move to Kharkiv - the most risk-averse have roughly half the odds of the most risk-tolerant - but matters much less for Kyiv. This asymmetry is difficult to reconcile with the hypothesis that risk tolerance merely proxies for general mobility preferences. Separately estimating the elasticity of intertemporal substitution (EIS~0.04), we find that including it renders risk tolerance insignificant for Kyiv but not for Kharkiv - a pattern illuminated by the Epstein-Zin separation of risk aversion and the EIS: risk aversion adds predictive power only when danger is high, while the EIS operates equally for both cities as a common relocation-cost channel. The very low EIS implies that relocation incentives structured as future benefits may be ineffective; frontloaded subsidies are more likely to influence behavior. |
| Keywords: | risk preferences, elasticity of intertemporal substitution, migration, compensating differentials, Ukraine, war |
| JEL: | D15 D81 J61 R23 |
| Date: | 2026–04 |
| URL: | https://d.repec.org/n?u=RePEc:iza:izadps:dp18557 |