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on Risk Management |
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Issue of 2010‒08‒14
six papers chosen by |
| By: | Chen Zhou |
| Abstract: | This paper studies why the micro-prudential regulations fails to maintain a stable financial system by investigating the impact of micro-prudential regulation on the systemic risk in a cross-sectional dimension. We construct a static model for risk-taking behavior of financial institutions and compare the systemic risks in two cases with and without a capital requirement regulation. In a system with a capital requirement regulation, the individual risk-taking of the financial institutions are lower, whereas the systemic linkage within the system is higher. With a proper systemic risk measure combining both individual risks and systemic linkage, we find that, under certain circumstance, the systemic risk in a regulated system can be higher than that in a regulation-free system. We discuss a sufficient condition under which the systemic risk in a regulated system is always lower. Since the condition is based on comparing balance sheets of all institutions in the system, it can be verified only if information on risk-taking behaviors and capital structures of all institutions are available. This suggests that a macro-prudential framework is necessary for establishing banking regulations towards the stability of the financial system as a whole. |
| Keywords: | Banking regulation; systemic risk; capital requirement; macro-prudential regulation |
| JEL: | G28 G32 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:256&r=rmg |
| By: | Pavel V. Shevchenko |
| Abstract: | Estimation of the operational risk capital under the Loss Distribution Approach requires evaluation of aggregate (compound) loss distributions which is one of the classic problems in risk theory. Closed-form solutions are not available for the distributions typically used in operational risk. However with modern computer processing power, these distributions can be calculated virtually exactly using numerical methods. This paper reviews numerical algorithms that can be successfully used to calculate the aggregate loss distributions. In particular Monte Carlo, Panjer recursion and Fourier transformation methods are presented and compared. Also, several closed-form approximations based on moment matching and asymptotic result for heavy-tailed distributions are reviewed. |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1008.1108&r=rmg |
| By: | Paolo Fegatelli |
| Abstract: | This study shows how the misconception of the option value of deposit insurance by Merton (1977) and its later misuse by Keeley and Furlong (1990), among others, have led some literature supporting the adoption of binding non-risk-based capital requirements to derive incorrect conclusions about their efficacy. This study further shows that what Merton defines as the option value of deposit insurance is actually a component of a bank?s limited liability option under a third-party deposit guarantee. As such, it is already included in the value of the bank?s equity capital, and the flawed definition makes the Keeley-Furlong model internally incoherent. |
| Keywords: | Capital requirements, Credit risk, Deposit insurance, Prudential regulation, Portfolio approach |
| JEL: | G21 G28 G11 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:bcl:bclwop:cahier_etudes_46&r=rmg |
| By: | Matteo Barigozzi (Solvay Brussels School of Economics and Management, Université libre de Bruxelles); Christian T. Brownlees (Stern School of Business, New York University); Giampiero M. Gallo (Università degli Studi di Firenze, Dipartimento di Statistica "G. Parenti"); David Veredas (Solvay Brussels School of Economics and Management, Université libre de Bruxelles) |
| Abstract: | When observed over a large panel, measures of risk (such as realized volatilities) usually exhibit a secular trend around which individual risks cluster. In this article we propose a vector Multiplicative Error Model achieving a decomposition of each risk measure into a common systematic and an idiosyncratic component, while allowing for contemporaneous dependence in the innovation process. As a consequence, we can assess how much of the current asset risk is due to a system wide component, and measure the persistence of the deviation of an asset specific risk from that common level. We develop an estimation technique, based on a combination of seminonparametric methods and copula theory, that is suitable for large dimensional panels. The model is applied to two panels of daily realized volatilities between 2001 and 2008: the SPDR Sectoral Indices of the S&P500 and the constituents of the S&P100. Similar results are obtained on the two sets in terms of reverting behavior of the common nonstationary component and the idiosyncratic dynamics to with a variable speed that appears to be sector dependent. |
| Keywords: | Systematic risk, idiosyncratic risk, Multiplicative Error Model, seminonparametric, copula. |
| JEL: | C32 C51 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:fir:econom:wp2010_06&r=rmg |
| By: | Enkelejd Hashorva; Anthony G. Pakes; Qihe Tang |
| Abstract: | In this paper we discuss the asymptotic behaviour of random contractions $X=RS$, where $R$, with distribution function $F$, is a positive random variable independent of $S\in (0,1)$. Random contractions appear naturally in insurance and finance. Our principal contribution is the derivation of the tail asymptotics of $X$ assuming that $F$ is in the max-domain of attraction of an extreme value distribution and the distribution function of $S$ satisfies a regular variation property. We apply our result to derive the asymptotics of the probability of ruin for a particular discrete-time risk model. Further we quantify in our asymptotic setting the effect of the random scaling on the Conditional Tail Expectations, risk aggregation, and derive the joint asymptotic distribution of linear combinations of random contractions. |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1008.0126&r=rmg |
| By: | Yochanan Shachmurove (Department of Economics, the City Collge of the City University of New York) |
| Abstract: | The examination of U.S. crises reveals that the current financial crisis follows past patterns. An investment bubble creates excess demand for new financing instruments. During the railroad bubbles of the nineteenth century loans were issued at a pace higher than many companies could pay back. The current housing bubble originated from issuing sub-prime mortgages that assume that housing prices would only rise. The increased demand for credit induces financial innovations and instruments that circumvent existing regulations. Inevitably, the bubble bursts. The history of financial crises teaches that policy reforms and new regulations cannot prevent future financial crises. |
| Keywords: | Financial Crises; Financial Regulations and Reforms; Banking Panics; Banking Runs; Nineteenth and Twentieth Century Crises; Bankruptcies; Federal Reserve Bank; Subprime Mortgage; Troubled Asset Relief Program (TARP); Collateralized Debt Obligations (CDO); Mortgage Backed Securities (MBO); Glass-Steagall Act; J.P. Morgan Chase; Bear Stearns; Augustus Heinze; Timothy Geithner; Paul Volcker |
| JEL: | E0 E3 E44 E5 E6 N0 N1 N2 G0 G18 G38 |
| Date: | 2010–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:10-027&r=rmg |