nep-rmg New Economics Papers
on Risk Management
Issue of 2021‒10‒11
fifteen papers chosen by



  1. A Method for Predicting VaR by Aggregating Generalized Distributions Driven by the Dynamic Conditional Score By Shijia Song; Handong Li
  2. Exploring the market risk profiles of U.S. and European life insurers By Grochola, Nicolaus; Browne, Mark Joseph; Gründl, Helmut; Schlütter, Sebastian
  3. Value-at-Risk forecasting model based on normal inverse Gaussian distribution driven by dynamic conditional score By Shijia Song; Handong Li
  4. Liquidity Stress Testing in Asset Management -- Part 3. Managing the Asset-Liability Liquidity Risk By Thierry Roncalli
  5. Risk-Taking and Tail Events Across Trading Institutions By Brice Corgnet; Camille Cornand; Nobuyuki Hanaki
  6. Predicting Credit Risk for Unsecured Lending: A Machine Learning Approach By K. S. Naik
  7. Error Analysis of a Model Order Reduction Framework for Financial Risk Analysis By Andreas Binder; Onkar Jadhav; Volker Mehrmann
  8. Uncertainty, volatility and the persistence norms of financial time series By Simon Rudkin; Wanling Qiu; Pawel Dlotko
  9. Representation of probability distributions with implied volatility and biological rationale By Felix Polyakov
  10. Stochastic volatility model with range-based correction and leverage By Yuta Kurose
  11. A New Multivariate Predictive Model for Stock Returns By Jianying Xie
  12. Income Risk Inequality: Evidence from Spanish Administrative Records By Manuel Arellano; Stéphane Bonhomme; Micole De Vera; Laura Hospido; Siqi Wei
  13. Investigating Growth at Risk Using a Multi-country Non-parametric Quantile Factor Model By Todd E. Clark; Florian Huber; Gary Koop; Massimiliano Marcellino; Michael Pfarrhofer
  14. Banks' risk-taking within a banking union By Farnè, Matteo; Vouldis, Angelos
  15. Credit Rating Agencies: Evolution or Extinction? By Dimitriadou, Athanasia; Agrapetidou, Anna; Gogas, Periklis; Papadimitriou, Theophilos

  1. By: Shijia Song; Handong Li
    Abstract: Constructing a more effective value at risk (VaR) prediction model has long been a goal in financial risk management. In this paper, we propose a novel parametric approach and provide a standard paradigm to demonstrate the modeling. We establish a dynamic conditional score (DCS) model based on high-frequency data and a generalized distribution (GD), namely, the GD-DCS model, to improve the forecasts of daily VaR. The model assumes that intraday returns at different moments are independent of each other and obey the same kind of GD, whose dynamic parameters are driven by DCS. By predicting the motion law of the time-varying parameters, the conditional distribution of intraday returns is determined; then, the bootstrap method is used to simulate daily returns. An empirical analysis using data from the Chinese stock market shows that Weibull-Pareto -DCS model incorporating high-frequency data is superior to traditional benchmark models, such as RGARCH, in the prediction of VaR at high risk levels, which proves that this approach contributes to the improvement of risk measurement tools.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.02953&r=
  2. By: Grochola, Nicolaus; Browne, Mark Joseph; Gründl, Helmut; Schlütter, Sebastian
    Abstract: Market risks account for an integral part of life insurers' risk profiles. This paper explores the market risk sensitivities of insurers in two large life insurance markets, namely the U.S. and Europe. Based on panel regression models and daily market data from 2012 to 2018, we analyze the reaction of insurers' stock returns to changes in interest rates and CDS spreads of sovereign counterparties. We find that the influence of interest rate movements on stock returns is more than 50% larger for U.S. than for European life insurers. Falling interest rates reduce stock returns in particular for less solvent firms, insurers with a high share of life insurance reserves and unit-linked insurers. Moreover, life insurers' sensitivity to interest rate changes is seven times larger than their sensitivity towards CDS spreads. Only European insurers significantly suffer from rising CDS spreads, whereas U.S. insurers are immunized against increasing sovereign default probabilities.
    Keywords: Life insurance,interest rate risk,credit risk
    JEL: G01 G18 G22
    Date: 2021
    URL: http://d.repec.org/n?u=RePEc:zbw:icirwp:3921&r=
  3. By: Shijia Song; Handong Li
    Abstract: Under the framework of dynamic conditional score, we propose a parametric forecasting model for Value-at-Risk based on the normal inverse Gaussian distribution (Hereinafter NIG-DCS-VaR), which creatively incorporates intraday information into daily VaR forecast. NIG specifies an appropriate distribution to return and the semi-additivity of the NIG parameters makes it feasible to improve the estimation of daily return in light of intraday return, and thus the VaR can be explicitly obtained by calculating the quantile of the re-estimated distribution of daily return. We conducted an empirical analysis using two main indexes of the Chinese stock market, and a variety of backtesting approaches as well as the model confidence set approach prove that the VaR forecasts of NIG-DCS model generally gain an advantage over those of realized GARCH (RGARCH) models. Especially when the risk level is relatively high, NIG-DCS-VaR beats RGARCH-VaR in terms of coverage ability and independence.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.02492&r=
  4. By: Thierry Roncalli
    Abstract: This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers the modeling of the liability liquidity risk (or funding liquidity), the second dimension is dedicated to the modeling of the asset liquidity risk (or market liquidity), whereas the third dimension considers the management of the asset-liability liquidity risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. In this third and last research paper focused on managing the asset-liability liquidity risk, we explore the ALM tools that can be put in place to control the liquidity gap. These ALM tools can be split into three categories: measurement tools, management tools and monitoring tools. In terms of measurement tools, we focus on the computation of the redemption coverage ratio (RCR), which is the central instrument of liquidity stress testing programs. We also study the redemption liquidation policy and the different implementation methodologies, and we show how reverse stress testing can be developed. In terms of liquidity management tools, we study the calibration of liquidity buffers, the pros and cons of special arrangements (redemption suspensions, gates, side pockets and in-kind redemptions) and the effectiveness of swing pricing. In terms of liquidity monitoring tools, we compare the macro- and micro-approaches of liquidity monitoring in order to identify the transmission channels of liquidity risk.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.01302&r=
  5. By: Brice Corgnet (Univ Lyon, emlyon business school, GATE UMR 5824, F-69130 Ecully, France); Camille Cornand (Univ Lyon, CNRS, GATE L-SE UMR 5824, F-69130 Ecully, France); Nobuyuki Hanaki (Institute for Social and Economic Research, Osaka University)
    Abstract: We study the reaction of investors to tail events across trading institutions. We conduct experiments in which investors bid on a financial asset that delivers a small positive reward in more than 99% of the cases and a large loss otherwise. The baseline treatment uses a repeated BDM mechanism whereas the market treatment replaces the uniform draw of the BDM mechanism by a uniform draw over the bids of the other participants. Our design is such that bids should not differ across treatments in normal times while allowing for potential differences to emerge after tail events have occurred. We find that markets tend to exacerbate the reaction of investors to tail losses and we attribute this effect to emotions.
    Keywords: Tail events, trading institutions, experimental finance, emotions and risk
    JEL: C91 C92 G41 D91
    Date: 2021
    URL: http://d.repec.org/n?u=RePEc:gat:wpaper:2117&r=
  6. By: K. S. Naik
    Abstract: Since the 1990s, there have been significant advances in the technology space and the e-Commerce area, leading to an exponential increase in demand for cashless payment solutions. This has led to increased demand for credit cards, bringing along with it the possibility of higher credit defaults and hence higher delinquency rates, over a period of time. The purpose of this research paper is to build a contemporary credit scoring model to forecast credit defaults for unsecured lending (credit cards), by employing machine learning techniques. As much of the customer payments data available to lenders, for forecasting Credit defaults, is imbalanced (skewed), on account of a limited subset of default instances, this poses a challenge for predictive modelling. In this research, this challenge is addressed by deploying Synthetic Minority Oversampling Technique (SMOTE), a proven technique to iron out such imbalances, from a given dataset. On running the research dataset through seven different machine learning models, the results indicate that the Light Gradient Boosting Machine (LGBM) Classifier model outperforms the other six classification techniques. Thus, our research indicates that the LGBM classifier model is better equipped to deliver higher learning speeds, better efficiencies and manage larger data volumes. We expect that deployment of this model will enable better and timely prediction of credit defaults for decision-makers in commercial lending institutions and banks.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.02206&r=
  7. By: Andreas Binder (MathConsult GmbH, Linz, Austria); Onkar Jadhav (MathConsult GmbH, Linz, Austria; Institute of Mathematics, TU Berlin, Berlin, Germany); Volker Mehrmann (Institute of Mathematics, TU Berlin, Berlin, Germany)
    Abstract: A parametric model order reduction (MOR) approach for simulating the high dimensional models arising in financial risk analysis is proposed on the basis of the proper orthogonal decomposition (POD) approach to generate small model approximations for the high dimensional parametric convection-diffusion reaction partial differential equations (PDE). The proposed technique uses an adaptive greedy sampling approach based on surrogate modeling to efficiently locate the most relevant training parameters, thus generating the optimal reduced basis. The best suitable reduced model is procured such that the total error is less than a user-defined tolerance. The three major errors considered are the discretization error associated with the full model obtained by discretizing the PDE, the model order reduction error, and the parameter sampling error. The developed technique is analyzed, implemented, and tested on industrial data of a puttable steepener under the two-factor Hull-White model. The results illustrate that the reduced model provides a significant speedup with excellent accuracy over a full model approach, demonstrating its potential applications in the historical or Monte Carlo value at risk calculations.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.00774&r=
  8. By: Simon Rudkin; Wanling Qiu; Pawel Dlotko
    Abstract: Norms of Persistent Homology introduced in topological data analysis are seen as indicators of system instability, analogous to the changing predictability that is captured in financial market uncertainty indexes. This paper demonstrates norms from the financial markets are significant in explaining financial uncertainty, whilst macroeconomic uncertainty is only explainable by market volatility. Meanwhile, volatility is insignificant in the determination of norms when uncertainty enters the regression. Persistence norms therefore have potential as a further tool in asset pricing, and also as a means of capturing signals from financial time series beyond volatility.
    Date: 2021–09
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.00098&r=
  9. By: Felix Polyakov
    Abstract: Economic and financial theories and practice essentially deal with uncertain future. Humans encounter uncertainty in different kinds of activity, from sensory-motor control to dynamics in financial markets, what has been subject of extensive studies. Representation of uncertainty with normal or lognormal distribution is a common feature of many of those studies. For example, proposed Bayessian integration of Gaussian multisensory input in the brain or log-normal distribution of future asset price in renowned Black-Scholes-Merton (BSM) model for pricing contingent claims. Standard deviation of log(future asset price) scaled by square root of time in the BSM model is called implied volatility. Actually, log(future asset price) is not normally distributed and traders account for that to avoid losses. Nevertheless the BSM formula derived under the assumption of constant volatility remains a major uniform framework for pricing options in financial markets. I propose that one of the reasons for such a high popularity of the BSM formula could be its ability to translate uncertainty measured with implied volatility into price in a way that is compatible with human intuition for measuring uncertainty. The present study deals with mathematical relationship between uncertainty and the BSM implied volatility. Examples for a number of common probability distributions are presented. Overall, this work proposes that representation of various probability distributions in terms of the BSM implied volatility profile may be meaningful in both biological and financial worlds. Necessary background from financial mathematics is provided in the text.
    Date: 2021–09
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.03517&r=
  10. By: Yuta Kurose
    Abstract: This study presents contemporaneous modeling of asset return and price range within the framework of stochastic volatility with leverage. A new representation of the probability density function for the price range is provided, and its accurate sampling algorithm is developed. A Bayesian estimation using Markov chain Monte Carlo (MCMC) method is provided for the model parameters and unobserved variables. MCMC samples can be generated rigorously, despite the estimation procedure requiring sampling from a density function with the sum of an infinite series. The empirical results obtained using data from the U.S. market indices are consistent with the stylized facts in the financial market, such as the existence of the leverage effect. In addition, to explore the model's predictive ability, a model comparison based on the volatility forecast performance is conducted.
    Date: 2021–09
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.00039&r=
  11. By: Jianying Xie
    Abstract: One of the most important studies in finance is to find out whether stock returns could be predicted. This research aims to create a new multivariate model, which includes dividend yield, earnings-to-price ratio, book-to-market ratio as well as consumption-wealth ratio as explanatory variables, for future stock returns predictions. The new multivariate model will be assessed for its forecasting performance using empirical analysis. The empirical analysis is performed on S&P500 quarterly data from Quarter 1, 1952 to Quarter 4, 2019 as well as S&P500 monthly data from Month 12, 1920 to Month 12, 2019. Results have shown this new multivariate model has predictability for future stock returns. When compared to other benchmark models, the new multivariate model performs the best in terms of the Root Mean Squared Error (RMSE) most of the time.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.01873&r=
  12. By: Manuel Arellano (CEMFI, Centro de Estudios Monetarios y Financieros); Stéphane Bonhomme (University of Chicago); Micole De Vera (CEMFI, Centro de Estudios Monetarios y Financieros); Laura Hospido (Banco de España); Siqi Wei (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: In this paper we use administrative data from the social security to study income dynamics and income risk inequality in Spain between 2005 and 2018. We construct individual measures of income risk as functions of past employment history, income, and demographics. Focusing on males, we document that income risk is highly unequal in Spain: more than half of the economy has close to perfect predictability of their income, while some face considerable uncertainty. Income risk is inversely related to income and age, and income risk inequality increases markedly in the recession. These findings are robust to a variety of specifications, including using neural networks for prediction and allowing for individual unobserved heterogeneity.
    Keywords: Spain, income dynamics, administrative data, income risk, inequality.
    JEL: D31 E24 E31 J31
    Date: 2021–09
    URL: http://d.repec.org/n?u=RePEc:cmf:wpaper:wp2021_2109&r=
  13. By: Todd E. Clark; Florian Huber; Gary Koop; Massimiliano Marcellino; Michael Pfarrhofer
    Abstract: We develop a Bayesian non-parametric quantile panel regression model. Within each quantile, the response function is a convex combination of a linear model and a non-linear function, which we approximate using Bayesian Additive Regression Trees (BART). Cross-sectional information at the pth quantile is captured through a conditionally heteroscedastic latent factor. The non-parametric feature of our model enhances flexibility, while the panel feature, by exploiting cross-country information, increases the number of observations in the tails. We develop Bayesian Markov chain Monte Carlo (MCMC) methods for estimation and forecasting with our quantile factor BART model (QF-BART), and apply them to study growth at risk dynamics in a panel of 11 advanced economies.
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:arx:papers:2110.03411&r=
  14. By: Farnè, Matteo; Vouldis, Angelos
    Abstract: We study the relationship between banks’ size and risk-taking in the context of supranational banking supervision. Consistently with theoretical work on banking unions and in contrast to analyses emphasising incentives underpinned by the too-big-to-fail effect, we find an inverse relationship between banks’ size and non-performing loan growth for a sample of European banks. Evidence is provided that the mechanism operates through the enhanced organisational efficiency of the supranational set-up rather than incentives alignment among the supervisors and the banks. JEL Classification: F33, G21, G28, G32, C20
    Keywords: banking union, euro area, non-performing loans, supervision, too-big-to-fail
    Date: 2021–10
    URL: http://d.repec.org/n?u=RePEc:ecb:ecbwps:20212595&r=
  15. By: Dimitriadou, Athanasia (University of Derby); Agrapetidou, Anna (Democritus University of Thrace, Department of Economics); Gogas, Periklis (Democritus University of Thrace, Department of Economics); Papadimitriou, Theophilos (Democritus University of Thrace, Department of Economics)
    Abstract: Credit Rating Agencies (CRAs) have been around for more than 150 years. Their role evolved from mere information collectors and providers to quasi-official arbitrators of credit risk throughout the global financial system. They compiled information that -at the time- was too difficult and costly for their clients to gather on their own. After the 1929 big market crash, they started to play a more formal role. Since then, we see a growing reliance of investors on the CRAs ratings. After the global financial crisis of 2007, the CRAs became the focal point of criticism by economists, politicians, the media, market participants and official regulatory agencies. The reason was obvious: the CRAs failed to perform the job they were supposed to do financial markets, i.e. efficient, effective and prompt measuring and signaling of financial (default) risk. The main criticism was focusing on the “issuer-pays system”, the relatively loose regulatory oversight from the relevant government agencies, the fact that often ratings change ex-post and the limited liability of CRAs. Many changes were implemented to the operational framework of the CRAs, including public disclosure of CRA information. This is designed to facilitate "unsolicited" ratings of structured securities by rating agencies that are not paid by the issuers. This combined with the abundance of data and the availability of powerful new methodologies and inexpensive computing power can bring us to the new era of independent ratings: The not-for-profit Independent Credit Rating Agencies (ICRAs). These can either compete or be used as an auxiliary risk gauging mechanism free from the problems inherent in the traditional CRAs. This role can be assumed by either public or governmental authorities, national or international specialized entities or universities, research institutions, etc. Several factors facilitate today the transition to the ICRAs: the abundance data, cheaper and faster computer processing the progress in traditional forecasting techniques and the wide use of new forecasting techniques i.e. Machine Learning methodologies and Artificial Intelligence systems.
    Keywords: Credit rating agencies; banking; forecasting; support vector machines; artificial intelligence
    JEL: C02 C15 C40 C45 C54 E02 E17 E27 E44 E58 E61 G20 G23 G28
    Date: 2021–10–04
    URL: http://d.repec.org/n?u=RePEc:ris:duthrp:2021_009&r=

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