nep-rmg New Economics Papers
on Risk Management
Issue of 2015‒10‒10
fifteen papers chosen by



  1. Modeling financial sector joint tail risk in the euro area By Lucas, André; Schwaab, Bernd; Zhang, Xin
  2. Use of Derivatives and Financial Stability in Turkish Banking Sector By F. Dilvin Ta; Ufuk Tutan
  3. Efficient Randomized Quasi-Monte Carlo Methods For Portfolio Market Risk By Halis Sak; \.Ismail Ba\c{s}o\u{g}lu
  4. Higher bank capital requirements and mortgage pricing: evidence from the Countercyclical Capital Buffer (CCB) By Christoph Basten; Catherine Koch
  5. Conditional risk measures in a bipartite market structure By Oliver Kley; Claudia Kl\"uppelberg; Gesine Reinert
  6. Maximum Entropy Evaluation of Asymptotic Hedging Error under a Generalised Jump-Diffusion Model By Farzad Alavi Fard; Firmin Doko Tchakota; Sivagowry Sriananthakumar
  7. What's in a ball? Constructing and characterizing uncertainty sets By Thomas Kruse; Judith C. Schneider; Nikolaus Schweizer
  8. Dynamics of multivariate default system in random environment By Nicole El Karoui; Monique Jeanblanc; Ying Jiao
  9. Systemic risk rankings and network centrality in the European banking sector By De Bruyckere, Valerie
  10. A New International Database on Financial Fragility By S. Andrianova, B. Baltagi, T. Beck, P. Demetriades, D. Fielding, S.G. Hall, S. Koch, R. Lensink, J. Rewilak and P. Rousseau
  11. Fire Sale Bank Recapitalizations By Bertsch, Christoph; Mariathasan, Mike
  12. Score Driven Exponentially Weighted Moving Averages and Value-at-Risk Forecasting By Lucas, André; Zhang, Xin
  13. Exchange Risk Management and the Choice of Invoice Currency: 2014 Questionnaire Survey of Japanese Overseas Subsidiaries (Japanese) By ITO Takatoshi; KOIBUCHI Satoshi; SATO Kiyotaka; SHIMIZU Junko
  14. Cobweb diagram as a tool for assesing changes in the most important financial stability risks By Nadeþda Siòenko; Olga Lielkalne
  15. Shortfall from Maximum Convexity By Matthew Ginley

  1. By: Lucas, André (VU University Amsterdam); Schwaab, Bernd (European Central Bank); Zhang, Xin (Research Department, Central Bank of Sweden)
    Abstract: We develop a novel high-dimensional non-Gaussian modeling framework to infer measures of conditional and joint default risk for many financial sector firms. The model is based on a dynamic Generalized Hyperbolic Skewed-t block-equicorrelation copula with time-varying volatility and dependence parameters that naturally accommodates asymmetries, heavy tails, as well as non-linear and time-varying default dependence. We apply a conditional law of large numbers in this setting to define joint and conditional risk measures that can be evaluated quickly and reliably. We apply the modeling framework to assess the joint risk from multiple defaults in the euro area during the 2008–2012 financial and sovereign debt crisis. We document unprecedented tail risks during 2011–2012, as well as their steep decline after subsequent policy actions.
    Keywords: dynamic equicorrelation; generalized hyperbolic distribution; law of large numbers; large portfolio approximation
    JEL: C32 G21
    Date: 2015–06–01
    URL: http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0308&r=all
  2. By: F. Dilvin Ta (Yasar University, Department of Business Administration); Ufuk Tutan (Yasar University, Department of Economics)
    Abstract: The aim of this paper is to analyze the impact of derivatives use on the stability of the banks that are operating in Turkish banking system for the period between 2005 and 2014, which is the period after the establishment of Turkish Derivatives Exchange. The risk of a bank is defined as a probability of default and Z-index is calculated for each bank. The results show that derivative instruments significantly increase the risks of banks; on the other hand bank risk is not a significant determinant of derivative usage. Liquid assets also increase and interest revenues decrease the risk of banks. When the determinants of derivative portolio is analyzed it is understood that larger banks and foreign banks and banks with larger loan portfolio and liquid assets hold more of derivative products and banks which have higher interest revenues to total assets are more likely to engage in traditional banking activities.
    Keywords: Bank risk, Z-index, derivative usage, Turkish banking sector
    JEL: G20
    URL: http://d.repec.org/n?u=RePEc:sek:iacpro:2805197&r=all
  3. By: Halis Sak; \.Ismail Ba\c{s}o\u{g}lu
    Abstract: We consider the problem of simulating loss probabilities and conditional excesses for linear asset portfolios under the t-copula model. Although in the literature on market risk management there are papers proposing efficient variance reduction methods for Monte Carlo simulation of portfolio market risk, there is no paper discussing combining the randomized quasi-Monte Carlo method with variance reduction techniques. In this paper, we combine the randomized quasi-Monte Carlo method with importance sampling and stratified importance sampling. Numerical results for realistic portfolio examples suggest that replacing pseudorandom numbers (Monte Carlo) with quasi-random sequences (quasi-Monte Carlo) in the simulations increases the robustness of the estimates once we reduce the effective dimension and the non-smoothness of the integrands.
    Date: 2015–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:1510.01593&r=all
  4. By: Christoph Basten; Catherine Koch
    Abstract: How has the CCB affected mortgage pricing after Switzerland became the first country to activate this Basel III macroprudential tool? By analyzing a database with several offers per mortgage request, we construct a picture of mortgage supply and demand. We find, first, that the CCB changes the composition of mortgage supply, as relatively capital-constrained and mortgage-specialized banks raise prices more than their competitors do. Second, risk-weighting schemes linked to borrower risk do not amplify the CCB's effect. To conclude, changes in the supply composition suggest that the CCB has achieved its intended effect in shifting mortgages from less resilient to more resilient banks, but stricter capital requirements do not appear to have discouraged less resilient banks from risky mortgage lending.
    Keywords: banks, macroprudential policy, capital requirements, mortgage pricing
    Date: 2015–09
    URL: http://d.repec.org/n?u=RePEc:bis:biswps:511&r=all
  5. By: Oliver Kley; Claudia Kl\"uppelberg; Gesine Reinert
    Abstract: In this paper we study the effect of network structure between agents and objects on measures for systemic risk. We model the influence of sharing large exogeneous losses to the financial or (re)insuance market by a bipartite graph. Using Pareto-tailed losses and multivariate regular variation we obtain asymptotic results for systemic conditional risk measures based on the Value-at-Risk and the Conditional Tail Expectation. These results allow us to assess the influence of an individual institution on the systemic or market risk and vice versa through a collection of conditional systemic risk measures. For large markets Poisson approximations of the relevant constants are provided in the example of an insurance market. The example of an underlying homogeneous random graph is analysed in detail, and the results are illustrated through simulations.
    Date: 2015–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:1510.00616&r=all
  6. By: Farzad Alavi Fard (RMIT University); Firmin Doko Tchakota (School of Economics, University of Adelaide); Sivagowry Sriananthakumar (RMIT University)
    Abstract: In this paper we propose a maximum entropy estimator for the asymptotic distribution of the hedging error for options. Perfect replication of financial derivatives is not possible, due to market incompleteness and discrete-time hedging. We derive the asymptotic hedging error for options under a generalised jump-diffusion model with kernel biased, which nests a number of very important processes in finance. We then obtain an estimation for the distribution of hedging error by maximising ShannonÂ’s entropy subject to a set of moment constraints, which in turn yield the value-at-risk and expected shortfall of the hedging error. The significance of this approach lies in the fact that the maximum entropy estimator allows us to obtain a consistent estimate of the asymptotic distribution of hedging error, despite the non-normality of the underlying distribution of returns.
    Keywords: Generalized Jump, kernel biased, Asymptotic Hedging Error, Esscher Transform, Maximum Entropy Density, Value-at-Risk, Expected Shortfall
    JEL: C13 C51 G13
    Date: 2015–09
    URL: http://d.repec.org/n?u=RePEc:adl:wpaper:2015-17&r=all
  7. By: Thomas Kruse; Judith C. Schneider; Nikolaus Schweizer
    Abstract: In the presence of model risk, it is well-established to replace classical expected values by worst-case expectations over all models within a fixed radius from a given reference model. This is the "robustness" approach. We show that previous methods for measuring this radius, e.g. relative entropy or polynomial divergences, are inadequate for reference models which are moderately heavy-tailed such as lognormal models. Worst cases are either infinitely pessimistic, or they rule out the possibility of fat-tailed "power law" models as plausible alternatives. We introduce a new family of divergence measures which captures intermediate levels of pessimism.
    Date: 2015–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:1510.01675&r=all
  8. By: Nicole El Karoui (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UP7 - Université Paris Diderot - Paris 7 - CNRS); Monique Jeanblanc (Laboratoire Analyse et Probabilités - Université d'Evry-Val d'Essonne - PRES Universud Paris - Fédération de Mathématiques d'Evry Val d'Essonne); Ying Jiao (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1)
    Abstract: We consider a multivariate default system where random environmental information is available. We study the dynamics of the system in a general setting and adopt the point of view of change of probability measures. We also make a link with the density approach in the credit risk modelling. In the particular case where no environmental information is concerned, we pay a special attention to the phenomenon of system weakened by failures as in the classical reliability system.
    Keywords: prediction process, system weakened by failures,Multiple defaults, density approach, change of probability measure
    Date: 2015–09–30
    URL: http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01205753&r=all
  9. By: De Bruyckere, Valerie
    Abstract: This paper presents a methodology to calculate the Systemic Risk Ranking of financial institutions in the European banking sector using publicly available information. The pro- posed model makes use of the network structure of financial institutions by including the stock return series of all listed banks in the financial system. Furthermore, a wide set of common risk factors (macroeconomic risk factors, sovereign risk, financial risk and housing price risk) is included to allow these factors to affect the banks. The model uses Bayesian Model Averaging (BMA) of Locally Weighted Regression models (LOESS), i.e. BMA-LOESS. The network structure of the financial sector is analysed by computing measures of network centrality (degree, closeness and betweenness) and it is shown that this information can be used to provide measures of the systemic importance of institutions. Using data from 2005 (2nd quarter) to 2013 (3rd quarter), this paper provides further insight into the time-varying importance of risk factors and it is shown that the model produces superior conditional out-of-sample forecasts (i.e. projections) than a classical linear Bayesian multi-factor model. JEL Classification: C52, C58, G15, G21
    Keywords: bank stock returns, Bayesian model averaging, financial networks, locally weighted regression, systemic risk
    Date: 2015–09
    URL: http://d.repec.org/n?u=RePEc:ecb:ecbwps:20151848&r=all
  10. By: S. Andrianova, B. Baltagi, T. Beck, P. Demetriades, D. Fielding, S.G. Hall, S. Koch, R. Lensink, J. Rewilak and P. Rousseau
    Abstract: We present a new database on financial fragility for 124 countries over 1998 to 2012. In addition to commercial banks, our database incorporates investment banks and real estate and mortgage banks, which are thought to have played a central role in the recent financial crisis. Furthermore, it also includes cooperative banks, savings banks and Islamic banks, that are often thought to have different risk appetites than do commercial banks. As a result, the total value of financial assets in our database is around 50% higher than that accounted for by commercial banks alone. We provide eight different measures of financial fragility, each focussing on a different aspect of vulnerability in the financial system. Alternative selection rules for our variables distinguish between institutions with different levels of reporting frequency.
    Keywords: Financial Fragility, mortgage
    Date: 2015
    URL: http://d.repec.org/n?u=RePEc:rza:wpaper:534&r=all
  11. By: Bertsch, Christoph (Research Department, Central Bank of Sweden); Mariathasan, Mike (University of Vienna)
    Abstract: We develop a general equilibrium model of banks’ capital structure, featuring heterogeneous portfolio risk and an imperfectly elastic supply of bank equity stemming from financial market segmentation. In our model, equity is costly and serves as a buffer against insolvency. Banks are ex-ante identical, but may need to recapitalize by selling equity claims after their portfolio risk becomes public knowledge. When the need to issue outside equity arises simultaneously in a large number of banks, the market for equity becomes crowded. Reminiscent of asset fire sales, banks do not fully internalize the effect of their individual equity issuance on the endogenous cost of equity and their future ability to recapitalize. As a result, they are inefficiently under-capitalized in equilibrium, and the incidence of insolvency is inefficiently high. This constrained inefficiency provides a new rationale for macroprudential capital regulation that arises despite the absence of deposit insurance, moral hazard, and asymmetric information; it also has implications for the regulation of payout policies and the design of bank stress testing.
    Keywords: Macroprudential policy; capital regulation; capital structure; financial market segmentation; incomplete markets; constrained inefficiency
    JEL: D50 D60 G21 G28
    Date: 2015–09–01
    URL: http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0312&r=all
  12. By: Lucas, André (VU University Amsterdam and Tinbergen Institute); Zhang, Xin (Research Department, Central Bank of Sweden)
    Abstract: A simple methodology is presented for modeling time variation in volatilities and other higher-order moments using a recursive updating scheme similar to the familiar RiskMetricsTM approach. We update parameters using the score of the forecasting distribution. This allows the parameter dynamics to adapt automatically to any nonnormal data features and robusti es the subsequent estimates. The new approach nests several of the earlier extensions to the exponentially weighted moving average (EWMA) scheme. In addition, it can easily be extended to higher dimensions and alternative forecasting distributions. The method is applied to Value-at-Risk forecasting with (skewed) Student's t distributions and a time-varying degrees of freedom and/or skewness parameter. We show that the new method is competitive to or better than earlier methods in forecasting volatility of individual stock returns and exchange rate returns.
    Keywords: dynamic volatilities; dynamic higher-order moments; integrated generalized autoregressive score models; Exponentially Weighted Moving Average (EWMA); Value-at-Risk (VaR)
    JEL: C51 C52 C53 G15
    Date: 2015–09–01
    URL: http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0309&r=all
  13. By: ITO Takatoshi; KOIBUCHI Satoshi; SATO Kiyotaka; SHIMIZU Junko
    Abstract: This study presents new findings of Japanese overseas subsidiaries' foreign exchange risk management and the choice of invoice currency, based on the 2014 RIETI Questionnaire Survey of Japanese Overseas Subsidiaries. First, 60% of Japanese subsidiaries conducted exchange risk management and chose the invoice currency on a discretionary basis. Second, Japanese subsidiaries increased U.S. dollar invoicing transactions, and a marked increase in the use of Asian currencies was not observed. Third, the effect of exchange rate changes on the subsidiaries' pricing behavior differed between the yen appreciation and depreciation periods. Fourth, Japanese subsidiaries reduced the use of the yen in trade with Japan in recent years. Only Japanese subsidiaries in China increased the share of renminbi invoicing trade, and subsidiaries in other Asian economies seldom chose renminbi invoicing in external trade, except for their trade with China.
    Date: 2015–10
    URL: http://d.repec.org/n?u=RePEc:eti:rdpsjp:15054&r=all
  14. By: Nadeþda Siòenko (Bank of Latvia); Olga Lielkalne (Bank of Latvia)
    Abstract: The Discussion Paper analyses a risk cobweb diagram employed as an additional analytical tool for monitoring and assessing financial stability risks in Latvia. The aim of the risk cobweb diagram is to depict the most important financial stability risks across specified risk categories and the direction of their changes in a single chart. The risk cobweb diagram and the dynamics of the index corresponding to each risk category and its components make it possible to visualise and analyse development of external and domestic macrofinancial risks and vulnerability changes of the banking sector in Latvia by assessing the credit risk of non-financial corporations and households, profitability and solvency risks of credit institutions, as well as funding and liquidity risks. The Discussion Paper gives the overview of the use of the risk cobweb diagram and its methodology in other countries. It also outlines the process of the development of such a diagram in Latvia and describes selected risk categories an indicators. The Discussion Paper concludes that the results of the back-testing of the risk cobweb diagram have been adequate. In 2008 and 2009, the risk category assessments of the risk cobweb diagram signalled threats to financial stability, while risk category indices and their components allowed the identification of the areas where accumulation and materialisation of financial stability risks occurred. Keywords: financial stability, risk cobweb diagram, risk categories, monitoring of financial system stability, assessment of financial system stabilityThe Discussion Paper analyses a risk cobweb diagram employed as an additional analytical tool for monitoring and assessing financial stability risks in Latvia. The aim of the risk cobweb diagram is to depict the most important financial stability risks across specified risk categories and the direction of their changes in a single chart. The risk cobweb diagram and the dynamics of the index corresponding to each risk category and its components make it possible to visualise and analyse development of external and domestic macrofinancial risks and vulnerability changes of the banking sector in Latvia by assessing the credit risk of non-financial corporations and households, profitability and solvency risks of credit institutions, as well as funding and liquidity risks. The Discussion Paper gives the overview of the use of the risk cobweb diagram and its methodology in other countries. It also outlines the process of the development of such a diagram in Latvia and describes selected risk categories and indicators. The Discussion Paper concludes that the results of the back-testing of the risk cobweb diagram have been adequate. In 2008 and 2009, the risk category assessments of the risk cobweb diagram signalled threats to financial stability, while risk category indices and their components allowed the identification of the areas where accumulation and materialisation of financial stability risks occurred. Keywords: financial stability, risk cobweb diagram, risk categories, monitoring of financial system stability, assessment of financial system stability.
    Keywords: assessment of financial system stability, financial stability, monitoring of financial system stability, risk categories, risk cobweb diagram
    JEL: E32 E44 E58 G10
    Date: 2015–07–17
    URL: http://d.repec.org/n?u=RePEc:ltv:dpaper:201501&r=all
  15. By: Matthew Ginley
    Abstract: We review the dynamics of the returns of Leveraged Exchange Traded Funds (LETFs) and propose a new measure of realized volatility: Shortfall from Maximum Convexity. We show that SMC has a more intuitive interpretation and provides more statistical information compared to the traditionally used sample standard deviation when applied to LETF returns, a dataset where normality and independence do not hold.
    Date: 2015–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:1510.00941&r=all

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