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on Risk Management |
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Issue of 2018‒06‒25
fourteen papers chosen by |
| By: | Michael B. Gordy; Alexander J. McNeil |
| Abstract: | We study a class of backtests for forecast distributions in which the test statistic is a spectral transformation that weights exceedance events by a function of the modeled probability level. The choice of the kernel function makes explicit the user's priorities for model performance. The class of spectral backtests includes tests of unconditional coverage and tests of conditional coverage. We show how the class embeds a wide variety of backtests in the existing literature, and propose novel variants as well. In an empirical application, we backtest forecast distributions for the overnight P&L of ten bank trading portfolios. For some portfolios, test results depend materially on the choice of kernel. |
| Keywords: | Backtesting ; Risk management ; Volatility |
| JEL: | C52 G21 G28 G32 |
| Date: | 2018–03–23 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2018-21&r=rmg |
| By: | Escobari, Diego; Jafarinejad, Mohammad |
| Abstract: | We propose a novel approach to model investors' uncertainty using the conditional volatility of investors' sentiment. Working with weekly data on investor sentiment, six major U.S. stock indices, and alternative measures of uncertainty, we run various tests to validate our proposed measure. The estimates show that investors' uncertainty is greater during economic downturns, and it is linked with lower investors' sentiment. In addition, the results support the existence of a positive conditional correlation between sentiment and returns. This positive spillover between sentiment and returns is interpreted as a positive link between investors' uncertainty and market risk. We also find that investors’ uncertainty and market risk are strongly driven by their lagged values. Our measure consistently captures periods of high uncertainty as shown by a positive and highly statistically significant correlation with other existing measures of uncertainty. |
| Keywords: | Conditional Volatility; Dynamic Correlation; DCC-GARCH; Investors’ Uncertainty; Sentiment; Stock Market Risk |
| JEL: | G20 G21 G23 R3 R31 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:86975&r=rmg |
| By: | B. A. Surya |
| Abstract: | This paper presents some new results on Parisian ruin under Levy insurance risk process, where ruin occurs when the process has gone below a fixed level from the last record maximum, also known as the high-water mark or drawdown, for a fixed consecutive periods of time. The law of ruin-time and the position at ruin is given in terms of their joint Laplace transforms. Identities are presented semi-explicitly in terms of the scale function and the law of the Levy process. They are established using recent developments on fluctuation theory of drawdown of spectrally negative Levy process. In contrast to the Parisian ruin of Levy process below a fixed level, ruin under drawdown occurs in finite time with probability one. |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1806.02083&r=rmg |
| By: | Christopher F Baum (Boston College; German Institute for Economic Research (DIW Berlin)); Paola Zerilli (University of York); Liyuan Chen (University of York) |
| Abstract: | The study of volatility in crude oil and natural gas markets and its interaction with returns (leverage) has a broad range of financial impacts both from an hedging point of view and also for forecasting purposes. The main limitation of using daily data is that volatility is not observable. In contrast, intra-day data provide an almost continuous observation of the return series, making volatility observable so that it can be studied in great detail. From an econometric point of view, the employment of intra-day data leads to the estimation of structural parameters of stochastic volatility models using simple moment conditions while fitting all the relevant empirical features of energy and stock index returns. This paper contributes to the current debate by: 1) exploring evidence of leverage effects in energy futures markets versus financial stock indexes (S&P500) and 2) evaluating the impact of leverage on risk forecasting in a VaR and CVaR sense. We find significant evidence of a leverage e§ect for S&P500 and crude oil markets: a negative shock to returns increases volatility in these markets. We also find evidence of an inverse leverage effect for the natural gas market: volatility becomes higher when energy returns increase. We show that the introduction of leverage improves the forecasting ability of the SV model using the RMSE and MAE criteria for all the markets considered. |
| Keywords: | stochastic volatility, leverage effect, energy markets, high frequency data, VaR, CVaR |
| JEL: | C53 C58 G17 G32 Q41 Q47 |
| Date: | 2018–06–15 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:952&r=rmg |
| By: | Yahia Salhi (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon); Pierre-Emmanuel Thérond (Galea & Associés, SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon) |
| Abstract: | Recently, there has been an increasing interest from life insurers to assess their portfolios' mortality risks. The new European prudential regulation, namely Solvency II, emphasized the need to use mortality and life tables that best capture and reflect the experienced mortality, and thus policyholders' actual risk profiles, in order to adequately quantify the underlying risk. Therefore, building a mortality table based on the experience of the portfolio is highly recommended and, for this purpose, various approaches have been introduced into actuarial literature. Although such approaches succeed in capturing the main features, it remains difficult to assess the mortality when the underlying portfolio lacks sufficient exposure. In this paper, we propose graduating the mortality curve using an adaptive procedure based on the local likelihood. The latter has the ability to model the mortality patterns even in presence of complex structures and avoids relying on expert opinions. However, such a technique fails to offer a consistent yet regular structure for portfolios with limited deaths. Although the technique borrows the information from the adjacent ages, it is sometimes not sufficient to produce a robust life table. In the presence of such a bias, we propose adjusting the corresponding curve, at the age level, based on a credibility approach. This consists in reviewing the assumption of the mortality curve as new observations arrive. We derive the updating procedure and investigate its benefits of using the latter instead of a sole graduation based on real datasets. Moreover, we look at the divergences in the mortality forecasts generated by the classic credibility approaches including Hardy–Panjer, the Poisson–Gamma model and the Makeham framework on portfolios originating from various French insurance companies. |
| Keywords: | Prediction,Local Likelihood,Mortality,Credibility,Life Insurance,Graduation,Smoothing |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01391285&r=rmg |
| By: | Lee, Charles M. C. (Stanford University); Qu, Yuanyu (Tsinghua University); Shen, Tao (Tsinghua University) |
| Abstract: | Using a comprehensive sample of reverse merger (RM) transactions, we examine the effects of China's IPO regulations on the prices and returns of its publicly listed stocks. During 2007-2015, unlisted Chinese firms paid an average of 3 to 4 Billion RMB for each listed shell, an amount exceeding 2/3 of the median market capitalization of a listed firm. This large shell premium varies over time and is sensitive to regulatory shocks. In the cross-section, a portfolio that longs (shorts) the highest (lowest) estimated shell probability (ESP) firms earns substantial abnormal returns. Adding an ESP-based factor to five common factors improves return attribution and eliminates the notoriously large Size premium. Consistent with theory, ESP also explains the sensitivity of prices to corporate earnings, and predicts the likelihood of firms to undertake major asset restructurings (MARs). We conclude China's IPO regulations impose a high cost on the functional efficiency of its financial system. |
| JEL: | G12 G18 G34 |
| Date: | 2017–09 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:repec:ecl:stabus:3604&r=rmg |
| By: | Xiao, Tim |
| Abstract: | This paper presents a new model for pricing financial derivatives subject to collateralization. It allows for collateral arrangements adhering to bankruptcy laws. As such, the model can back out the market price of a collateralized contract. This framework is very useful for valuing outstanding derivatives. Using a unique dataset, we find empirical evidence that credit risk alone is not overly important in determining credit-related spreads. Only accounting for both collateral posting and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of derivatives. We also empirically gauge the impact of collateral agreements on risk measurements. Our findings indicate that there are important interactions between market and credit risk. |
| Keywords: | collateralization, asset pricing, plumbing of financial system, swap premium spread, CVA, VaR, interaction between market and credit risk |
| JEL: | D46 D53 E43 G12 G13 G17 |
| Date: | 2017–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:87088&r=rmg |
| By: | Suguru Yamanaka (Musashino University); Misaki Kinoshita (Bank of Japan (currently at Iyo Bank, Ltd. j) |
| Abstract: | This study proposes a credit risk model based on purchase order (PO) information, which is called a gPO-based structural model, hand performs an empirical analysis on credit risk assessment using real PO samples. A time-series model of PO transitions is introduced and the asset value of the borrower firm is obtained using the PO time-series model. Then, we employ a structural framework in which default occurs when the asset value falls below the debt amount, in order to estimate the default probability of the borrower firm. The PO-based structural model enables us to capture borrower firms' precise business conditions on a real-time basis, which is not the case when using only financial statements. With real PO samples provided by some sample firms, we empirically show the effectiveness of our model in estimating default probabilities of the sample firms. One of the advantages of our model is its ability to obtain default probabilities reflecting borrower firms' business conditions, such as trends in PO volumes and credit quality of buyers. |
| Keywords: | Purchase order information; Credit risk, Structural model |
| Date: | 2018–06–15 |
| URL: | http://d.repec.org/n?u=RePEc:boj:bojwps:wp18e11&r=rmg |
| By: | Ilja Boelaars; Roel Mehlkopf |
| Abstract: | A well established believe in the pension industry is that collective pension funds should take more stock market risk (compared to individual retirement accounts) since risk may be shared with future generations. We extend the OLG model of Gollier (2008) by adding labor income risk in the spirit of Benzoni, Collin-Dufresne, and Goldstein (2007) and show that this idea may be misguided. For the empirical range of parameter values reported by Benzoni et. al., we find that optimal risk-sharing actually implies that collective pension funds should take less stock market risk, not more. If labor income and dividend income are co-integrated, efficient risk-sharing policies should transfer risk from future generations to current generations instead of the other way around. Furthermore, we find that the potential welfare gains from intergenerational risk-sharing are significantly lowered. |
| Keywords: | Dynamic portfolio choice; Labor income risk; Pension; Retirement; Intergenerational risk-sharing; Funded pension systems |
| JEL: | H55 G11 G23 J26 J32 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:595&r=rmg |
| By: | Entrop, Oliver; Merkel, Matthias F. |
| Abstract: | In this paper we show that inflation differentials among the countries in the European Monetary Union (EMU) are an economically significant risk to German firms, which make up the largest economy in the EMU. This risk can be interpreted as real "exchange rate exposure" resulting from trade within the euro area. Actually, we find that this EMU exposure is nearly as high as the standard exchange rate exposure caused by trade with non-EMU countries. Moreover, our analysis shows that many of the conventional factors that drive firm-specific exchange rate risk, such as size, debt ratio, asset turnover and foreign business activity, also determine EMU exposure in an economically meaningful way. However, EMU exposure challenges firms' risk management, particularly as it cannot be reduced by standard financial hedging instruments, such as currency derivatives. |
| Keywords: | currency risk,inflation differentials,single-currency area |
| JEL: | F23 F31 G15 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:upadbr:b3118&r=rmg |
| By: | Thomas Dohmen; Simone Quercia; Jana Willrodt |
| Abstract: | We show that the disposition to focus on favorable or unfavorable outcomes of risky situations affects willingness to take risk as measured by the general risk question. We demonstrate that this disposition, which we call risk conception, is strongly associated with optimism, a stable facet of personality and that it predicts real-life risk taking. The general risk question captures this disposition alongside pure risk preference. This enlightens why the general risk question is a better predictor of behavior under risk across different domains than measures of pure risk preference. Our results also rationalize why risk taking is related to optimism. |
| Keywords: | risk taking behavior, optimism, preference measures, risk conception |
| JEL: | D91 C91 D81 D01 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_023_2018&r=rmg |
| By: | Ferran Camprubí i Baiges (Universitat de Barcelona, Spain); Manuela Bosch Príncep (Universitat de Barcelona, Spain) |
| Abstract: | The goal of this research is to analyse how the Spanish insurance companies have managed their investments from the moment the liberalization of the sector begins in view of the future integration in the EEC until the implementation of the Solvency II regime (1984 -2015). The structure of the investment portfolio has been characterized by instruments of conservative risk profile. The main conclusions are summarized as follows: The main asset in the period under review is Spanish public debt, accounting for 27% of the sector's investments. The performance of the portfolio has performed very similar to the average interest rate on Treasury debt. Contrary to what might be expected, the recent sovereign debt crisis in the Eurozone has had no impact on credit risk management, as the deterioration in the credit rating of the Kingdom of Spain has not led to a decline in investment in Spanish public bonds. The sector has redoubled its commitment to this asset, leaving out the dire economic consequences of a degradation of the rating of Spanish public debt to the category of junk bonds. |
| Keywords: | Insurance Investment, Spanish Sovereign Debt Crisis, Credit Risk Management |
| JEL: | G11 G22 N24 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:ahe:dtaehe:1804&r=rmg |
| By: | Lukas Ahnert; Pascal Vogt; Volker Vonhoff; Florian Weigert |
| Abstract: | This paper investigates the impact of stress testing results on bank's equity and CDS performance using a large sample of ten tests from the US CCAR and the European EBA regimes in the time period between 2010 and 2017. We find that passing banks experience positive abnormal equity returns and tighter CDS spreads, while failing banks show strong drops in equity prices and widening CDS spreads. Interestingly, we also document strong market reactions at the announcement date of the stress tests. A bank’s asset quality and its return on equity at the time of the announcement are significant predictors of the pass/fail outcome of a bank. |
| Keywords: | Banks, Stress Testing, Equity Performance, CDS Performance |
| JEL: | G00 G21 G28 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:usg:sfwpfi:2018:14&r=rmg |
| By: | Camilleri, Silvio John; Farrugia, Ritienne |
| Abstract: | This study evaluates the performance of a selection of Alternative Investment Funds (AIFs), and Undertakings for Collective Investment in Transferable Securities Funds (UCITS) which followed a global geographic focus strategy during the period 2010-2016. These two fund structures are governed by different regulatory frameworks, which have evolved and re-shaped over the years. Various yardsticks are employed to evaluate the risk-adjusted performance of the sampled funds, and Monte-Carlo simulations are used to gauge the possible out-of-sample returns. Most of the sampled funds underperformed the benchmark index in terms of their Sharpe and Treynor ratios. Whilst UCITS registered a better overall performance, AIFs outperformed UCITS towards the end of the sample period. This suggests that investors should not assume that one fund structure is inherently superior to the other, since the relative performance may vary over time. |
| Keywords: | AIFs; collective investment funds; performance evaluation; performance persistence; Sharpe ratio; Treynor ratio; UCITS; value-at-risk |
| JEL: | G11 G17 G23 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:87070&r=rmg |