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on Risk Management |
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Issue of 2020‒06‒08
25 papers chosen by |
| By: | Irani, Rustom; Iyer, Rajkamal; Peydró, José-Luis; Meisenzahl, Ralf |
| Abstract: | We investigate the connections between bank capital regulation and the prevalence of lightly regulated nonbanks (shadow banks) in the U.S. corporate loan market. For identification, we exploit a supervisory credit register of syndicated loans, loan-time fixed-effects, and shocks to capital requirements arising from surprise features of the U.S. implementation of Basel III. We find that less-capitalized banks reduce loan retention, particularly among loans with higher capital requirements and at times when capital is scarce, and nonbanks step in. This reallocation has important spillovers: during the 2008 crisis, loans funded by nonbanks with fragile liabilities are less likely to be rolled over and experience greater price volatility. |
| Keywords: | shadow banks,risk-based capital regulation,Basel III,intercations between banks and nonbanks,trading by banks,non-performing loans |
| JEL: | G01 G21 G23 G28 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:216799&r=all |
| By: | Stefano Battiston; Petr Jakubik; Irene Monasterolo; Keywan Riahi; Bas van Ruijven (EIOPA) |
| Abstract: | In the first collaboration between climate economists, climate financial risk modellers and financial regulators, we apply the CLIMAFIN framework described in Battiston at al. (2019) to provide a forward-looking climate transition risk assessment of the sovereign bonds’ portfolios of solo insurance companies in Europe. We consider a scenario of a disorderly introduction of climate policies that cannot be fully anticipated and priced in by investors. First, we analyse the shock on the market share and profitability of carbon-intensive and low-carbon activities under climate transition risk scenarios. Second, we define the climate risk management strategy under uncertainty for a risk averse investor that aims to minimise her largest losses. Third, we price the climate policies scenarios in the probability of default of the individual overeign bonds and in the bonds’ climate spread. Finally, we estimate the largest gains/losses on the insurance companies’ portfolios conditioned to the climate scenarios. We find that the potential impact of a disorderly transition to low-carbon economy on insurers portfolios of sovereign bonds is moderate in terms of its magnitude. However, it is non-negligible in several scenarios. Thus, it should be regularly monitored and assessed given the importance of sovereign bonds in insurers’ investment portfolios. |
| Keywords: | insurance, climate risk, sovereign bonds |
| JEL: | G11 G12 G22 |
| Date: | 2019–12 |
| URL: | http://d.repec.org/n?u=RePEc:eio:thafsr:15&r=all |
| By: | Ahmad Hajihasani; Ali Namaki; Nazanin Asadi; Reza Tehrani |
| Abstract: | Value-at-risk is one of the important subjects that extensively used by researchers and practitioners for measuring and managing uncertainty in financial markets. Although value-at-risk is a common risk control instrument, but there are criticisms about its performance. One of these cases, which has been studied in this research, is the value-at-risk underestimation during times of crisis. In these periods, the non-Gaussian behavior of markets intensifies and the estimated value-at-risks by normal models are lower than the real values. In fact, during times of crisis, the probability density of extreme values in financial return series increases and this heavy-tailed behavior of return series reduces the accuracy of the normal value-at-risk estimation models. A potential approach that can be used to describe non-Gaussian behavior of return series, is Tsallis entropy framework and non-extensive statistical methods. In this paper, we have used non-extensive value at risk model for analyzing the behavior of financial markets during times of crisis. By applying q-Gaussian probability density function, we can see a better value-at-risk estimation in comparison with the normal models, especially during times of crisis. We showed that q-Gaussian model estimates value-at-risk better than normal model. Also we saw in the mature markets, it is obvious that the difference of value-at-risk between normal condition and non-extensive approach increase more than one standard deviation during times of crisis, but in the emerging markets we cannot see a specific pattern. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2005.09036&r=all |
| By: | Farmer, J Doyne (Institute for New Economic Thinking, University of Oxford,); Kleinnijenhuis, Alissa M (Institute for New Economic Thinking, University of Oxford, UK and MIT Sloan School of Management, Massachusetts Institute of Technology,); Nahai-Williamson, Paul (Bank of England); Wetzer, Thom (Faculty of Law, University of Oxford) |
| Abstract: | We propose a structural framework for the development of system-wide financial stress tests with multiple interacting contagion, amplification channels and heterogeneous financial institutions. This framework conceptualises financial systems through the lens of five building blocks: financial institutions, contracts, markets, constraints, and behaviour. Using this framework, we implement a system-wide stress test for the European financial system. We obtain three key findings. First, the financial system may be stable or unstable for a given microprudential stress test outcome, depending on the system’s shock-amplifying tendency. Second, the ‘usability’ of banks’ capital buffers (the willingness of banks to use buffers to absorb losses) is of great consequence to systemic resilience. Third, there is a risk that the size of capital buffers needed to limit systemic risk could be severely underestimated if calibrated in the absence of system-wide approaches. |
| Keywords: | Systemic risk; stress testing; financial contagion; financial institutions; capital requirements; macroprudential policy |
| JEL: | C63 G17 G21 G23 G28 |
| Date: | 2020–05–14 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0861&r=all |
| By: | Mendicino, Caterina; Nikolov, Kalin; Suarez, Javier; Supera, Dominik; Ramirez, Juan-Rubio |
| Abstract: | We study the interaction between borrowers' and banks' solvency in a quantitative macroeconomic model with financial frictions in which bank assets are a portfolio of defaultable loans. We show that ex-ante imperfect diversification of bank lending generates bank asset returns with limited upside but significant downside risk. The asymmetric distribution of these returns and their implications for the evolution of bank net worth are important for capturing the frequency and severity of twin default crises – simultaneous rises in firm and bank defaults associated with sizeable negative effects on economic activity. As a result, our model implies higher optimal capital requirements than common specifications of bank asset returns, which neglect or underestimate the impact of borrower default on bank solvency. JEL Classification: G01, G28, E44 |
| Keywords: | bank capital requirements, bank default, financial crises, firm default |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20202414&r=all |
| By: | Giuseppe Storti; Chao Wang |
| Abstract: | A new semi-parametric Expected Shortfall (ES) estimation and forecasting framework is proposed. The proposed approach is based on a two step estimation procedure. The first step involves the estimation of Value-at-Risk (VaR) at different levels through a set of quantile time series regressions. Then, the ES is computed as a weighted average of the estimated quantiles. The quantiles weighting structure is parsimoniously parameterized by means of a Beta function whose coefficients are optimized by minimizing a joint VaR and ES loss function of the Fissler-Ziegel class. The properties of the proposed approach are first evaluated with an extensive simulation study using various data generating processes. Two forecasting studies with different out-of-sample sizes are conducted, one of which focuses on the 2008 Global Financial Crisis (GFC) period. The proposed models are applied to 7 stock market indices and their forecasting performances are compared to those of a range of parametric, non-parametric and semi-parametric models, including GARCH, Conditional AutoRegressive Expectile (CARE, Taylor 2008), joint VaR and ES quantile regression models (Taylor, 2019) and simple average of quantiles. The results of the forecasting experiments provide clear evidence in support of the proposed models. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2005.04868&r=all |
| By: | Budhi Surya; Wenyuan Wang; Xianghua Zhao; Xiaowen Zhou |
| Abstract: | This paper discusses Parisian ruin problem with capital injection for Levy insurance risk process. Capital injection takes place at the draw-down time of the surplus process when it drops below a pre-specified function of its last record maximum. The capital is continuously paid to keep the surplus above the draw-down level until either the surplus process goes above the record high or a Parisian type ruin occurs, which is announced at the first instance the surplus process has undergone an excursion below the record for an independent exponential period of time consecutively since the time the capital was first injected. Some distributional identities concerning the excursion are presented. Firstly, we give the Parisian ruin probability and the joint Laplace transform (possibly killed at the first passage time above a fixed level of the surplus process) of the ruin time, surplus position at ruin, and the total capital injection at ruin. Secondly, we obtain the $q$-potential measure of the surplus process killed at Parisian ruin. Finally, we give expected present value of the total discounted capital payments up to the Parisian ruin time. The results are derived using recent developments in fluctuation and excursion theory of spectrally negative Levy process and are presented semi explicitly in terms of the scale function of the Levy process. Some numerical examples are given to facilitate the analysis of the impact of initial surplus and frequency of observation period to the ruin probability and to the expected total capital injection. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2005.09214&r=all |
| By: | Ramiro Losada; Ricardo Laborda |
| Abstract: | This paper analyses the connectedness among non-alternative collective investment schemes and with their underlying securities markets. The results show that non-alternative collective investment schemes should not be taken as important in terms of propa-gation of shocks and they may play a limited role from a systemic point view, an outcome that may be confirmed by the second main result of the paper. There is not a long run relationship (cointegration) between the connectedness from non-alternative collective schemes with their underlying markets and the financial systemic risk. On the other hand, in the short run, the way that a negative shock in the financial systemic risk causes an increase in the level of connectedness is shown although the opposite cannot be said; a negative shock in the level of connectedness does not cause a rise in the measure of the financial systemic risk. |
| Keywords: | Connectedness, investment schemes, UCITS, securities markets, systemic risk |
| JEL: | G23 G18 C53 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:cnv:wpaper:dt_71en&r=all |
| By: | Reinhardt, Dennis (Bank of England); Reynolds, Stephen (Bank of England); Sowerbutts, Rhiannon (Bank of England); van Hombeeck, Carlos (Bank of England) |
| Abstract: | We examine how banks’ cross-border lending reacts to changes in liquidity regulation using a new dataset on Individual Liquidity Guidance (ILG), which was enacted in the UK from 2000 to 2015 and is similar to the Basel III Liquidity Coverage Ratio. A one percentage point increase in liquidity requirements to total assets reduces UK resident banks’ cross-border lending growth by around 0.6 percentage points and both bank and non-bank lending are affected. But quality matters: an increase in the holdings of High Quality Liquid Asset (HQLA) qualifying sovereign debt offsets some of the reduction in total cross-border lending growth. Furthermore, the strongest reduction is driven by foreign subsidiaries from countries where sovereigns do not issue HQLA; in contrast subsidiaries from countries issuing HQLA are able to protect their lending to unrelated entities and cut their intragroup lending instead. Banks with a higher deposit share as a consequence of established retail operations, such as those headquartered in the UK, are also able to offset the effects of increases of liquidity requirement on cross-border lending. |
| Keywords: | Liquidity regulation; liquidity requirements; external lending; intensity of prudential regulations |
| JEL: | F36 G21 G28 |
| Date: | 2020–05–21 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0860&r=all |
| By: | Alin Marius Andries (Alexandru Ioan Cuza University - Faculty of Economics and Business Administration); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)); Nicu Sprincean (Alexandru Ioan Cuza University of Iasi); Radu Tunaru (University of Sussex) |
| Abstract: | In this paper we gauge the degree of interconnectedness and quantify the linkages between global and other systemically important institutions, and the global financial system. We document that the two groups and the financial system become more interconnected during the global financial crisis when linkages across groups grow. In contrast, during tranquil times linkages within groups prevail. Global systemically important banks contribute most to system-wide distress, but are also most exposed. Other systemically important institutions bear more individual market risk. The two groups and the global financial system also co-vary for periods of up to 60 days. In sum, both groups perform in ways that defy any straightforward categorization. |
| Keywords: | systemic risk, interconnectedness, bank networks |
| JEL: | G21 D85 G01 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp2040&r=all |
| By: | Abbassi, Puriya; Iyer, Rajkamal; Peydró, José-Luis; Soto, Paul E. |
| Abstract: | Regulation needs effective supervision; but regulated entities may deviate with unobserved actions. For identification, we analyze banks, exploiting ECB's asset-quality-review (AQR) and supervisory security and credit registers. After AQR announcement, reviewed banks reduce riskier securities and credit (also overall securities and credit supply), with largest impact on riskiest securities (not on riskiest credit), and immediate negative spillovers on asset prices and firm-level credit supply. Exposed (unregulated) nonbanks buy the shed risk. AQR drives the results, not the end-of-year. After AQR compliance, reviewed banks reload riskier securities, but not riskier credit, with medium-term negative firm-level real effects (costs of supervision/safe-assets increase). |
| Keywords: | Asset quality review,stress tests,supervision,risk-masking,costs of safe assets |
| JEL: | E58 G21 G28 H63 L51 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:262020&r=all |
| By: | Wenqian Huang; Előd Takáts |
| Abstract: | We investigate empirically how the balance sheet characteristics of central counterparties (CCPs) affect their modelling of credit risk. CCPs set initial margin (IM), i.e., the collateral for transactions, to limit counterparty credit risk. When a CCP's IM model fails on a large scale, the CCP could fail too, losing its skin-in-the-game capital. We find that higher skin-in-the-game is significantly a ssociated with more p rudent modelling, in contrast to profits (a proxy for franchise value) and forms of capital other than skin-in-the-game. The results may help to inform the ongoing policy debate on how to incentivise prudent credit risk management at CCPs. |
| Keywords: | central counterparties (CCPs), capital, risk-taking |
| JEL: | F34 F42 G21 G38 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:866&r=all |
| By: | Caroline Hillairet (CMAP - Centre de Mathématiques Appliquées - Ecole Polytechnique - X - École polytechnique - CNRS - Centre National de la Recherche Scientifique); Olivier Lopez (LSTA - Laboratoire de Statistique Théorique et Appliquée - UPMC - Université Pierre et Marie Curie - Paris 6 - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | In this paper, we propose a general framework to design accumulation scenarios that can be used to anticipate the impact of a massive cyber attack on an insurance portfolio. The aim is also to emphasize the role of countermeasures in stopping the spread of the attack over the portfolio, and to quantify the benefits of implementing such strategies of response. Our approach consists of separating the global dynamic of the cyber event (that can be described through compartmental epidemiological models), the effect on the portfolio, and the response strategy. This general framework allows us to obtain Gaussian approximations for the corresponding processes, and sharp confidence bounds for the losses. A detailed simulation study, which mimics the effects of a Wannacry scenario, illustrates the practical implementation of the method. |
| Keywords: | Cyber insurance,emerging risks,counting processes,compartmental epi- demiological models,risk theory |
| Date: | 2020–05–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-02564462&r=all |
| By: | Filippo Curti; W. Scott Frame; Atanas Mihov |
| Abstract: | This study demonstrates that, among large U.S. bank holding companies (BHCs), the largest ones are exposed to more operational risk. Specifically, they have higher operational losses per dollar of total assets, a result largely driven by the BHCs' failure to meet professional obligations to clients and/or faulty product design. Operational risk at the largest U.S. institutions is also found to: (i) be particularly persistent, (ii) have a counter-cyclical component (higher losses occur during economic downturns) and (iii) materialize through more frequent tail-risk events. We illustrate two plausible channels of BHC size that contribute to operational risk – institutional complexity and moral hazard incentives arising from “too-big-to-fail." Our findings have important implications for large banking organization performance, risk and supervision. |
| Keywords: | Banking organizations; Size; Operational risk; Tail risk; Recessions |
| JEL: | G20 G21 |
| Date: | 2020–05–29 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddwp:88097&r=all |
| By: | Adriana Grasso (Bank of Italy); Juan Passadore (EIEF); Facundo Piguillem (EIEF and CEPR) |
| Abstract: | The recent debate about the falling labor share has brought the attention to the income shares’ trends, but less attention has been devoted to their variability. In this paper, we analyze how their fluctuations can be insured between workers and capitalists, and the corresponding implications for financial markets. We study a neoclassical growth model with aggregate shocks that affect income shares and financial frictions that prevent firms from fully insuring idiosyncratic risk. We examine theoretically how aggregate risk sharing is distorted by the combination of idiosyncratic risk and moving shares. Accumulation of safe assets by firms and risky assets by households emerges naturally as a tool to insure income shares’ risk. We calibrate the model to the U.S. economy and show that low rates, rising capital shares, and accumulation of safe assets by firms and risky assets by households can be rationalized by persistent shocks to the labor share. |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:eie:wpaper:2009&r=all |
| By: | Huang, qhuang |
| Abstract: | We document a significantly positive relationship between executive compensation and risk-taking of Chinese listed banks over the 2007–2018 period. The finding is robust to the risk measures (Z-score, systematic risk and stock return volatility) used, the way to calculate executive compensation, and model specifications as well as estimation techniques. Further analysis suggests that bank past performance (captured by return on equity) strongly moderates the relationship between executive compensation and risk-taking. We also find a modest U-shaped association of bank Z-score with executive compensation. Our study appears to support the regulation on executive compensation for the sake of bank stability. |
| Keywords: | Executive compensation; Bank risk; Bank performance; Z-score; Chinese banks |
| JEL: | G21 M12 |
| Date: | 2020–04–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:100377&r=all |
| By: | Christopher Busch; David Domeij; Fatih Guvenen; Rocio Madera |
| Abstract: | Recent studies have shown that idiosyncratic labor income risk becomes more left-skewed during recessions. This procyclical skewness arises from a combination of higher downside risk and lower chances of upward surprises during recessions. While this much is known, some important open questions remain. For example, how robust are these patterns across countries that differ in their institutions and policies, as well as across genders, education groups, and occupations, among others? What is the contribution of wages versus hours to procyclical skewness of earnings changes? To what extent can skewness fluctuations in individual earnings be smoothed within households or with government policies? Using panel data from the United States, Germany, Sweden, and France, we find four main results. First, the skewness of individual income growth (before-tax/transfer) is procyclical while its variance is flat and acyclical in all three countries. Second, this result holds even for full-time workers continuously employed in the same establishment, indicating that the hours margin is not the main driver; additional analyses of hours and wages confirm that both margins are important. Third, within-household smoothing does not seem effective at mitigating skewness fluctuations. Fourth, tax-and-transfer policies blunt some of the largest declines in incomes, reducing procyclical fluctuations in skewness. |
| Keywords: | idiosyncratic income risk, skewness, countercyclical risk |
| JEL: | D31 E24 E32 H31 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:1180&r=all |
| By: | Sucarrat, Genaro |
| Abstract: | The log-GARCH model provides a flexible framework for the modelling of economic uncertainty, financial volatility and other positively valued variables. Its exponential specification ensures fitted volatilities are positive, allows for flexible dynamics, simplifies inference when parameters are equal to zero under the null, and the log-transform makes the model robust to jumps or outliers. An additional advantage is that the model admits ARMA-like representations. This means log-GARCH models can readily be estimated by means of widely available software, and enables a vast range of well-known time-series results and methods. This chapter provides an overview of the log-GARCH model and its ARMA representation(s), and of how estimation can be implemented in practice. After the introduction, we delineate the univariate log-GARCH model with volatility asymmetry ("leverage"), and show how its (nonlinear) ARMA representation is obtained. Next, stationary covariates ("X") are added, before a first-order specification with asymmetry is illustrated empirically. Then we turn our attention to multivariate log-GARCH-X models. We start by presenting the multivariate specification in its general form, but quickly turn our focus to specifications that can be estimated equation-by-equation - even in the presence of Dynamic Conditional Correlations (DCCs) of unknown form. Next, a multivariate non-stationary log-GARCH-X model is formulated, in which the X-covariates can be both stationary and/or nonstationary. A common critique directed towards the log-GARCH model is that its ARCH terms may not exist in the presence of inliers. An own Section is devoted to how this can be handled in practice. Next, the generalisation of log-GARCH models to logarithmic Multiplicative Error Models (MEMs) is made explicit. Finally, the chapter concludes. |
| Keywords: | Financial return, volatility, ARCH, exponential GARCH, log-GARCH, Multivariate GARCH |
| JEL: | C22 C32 C51 C58 |
| Date: | 2018–08–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:100386&r=all |
| By: | Bubeck, Johannes; Maddaloni, Angela; Peydró, José-Luis |
| Abstract: | We show that negative monetary policy rates induce systemic banks to reach-for-yield. For identification, we exploit the introduction of negative deposit rates by the European Central Bank in June 2014 and a novel securities register for the 26 largest euro area banking groups. Banks with more customer deposits are negatively affected by negative rates, as they do not pass negative rates to retail customers, in turn investing more in securities, especially in those yielding higher returns. Effects are stronger for less capitalized banks, private sector (financial and non-financial) securities and dollar-denominated securities. Affected banks also take higher risk in loans. |
| Keywords: | negative rates,non-standard monetary policy,reach-for-yield,securities,banks |
| JEL: | E43 E52 E58 G01 G21 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:216806&r=all |
| By: | Schüler, Yves |
| Abstract: | The Basel III framework advises considering a reference indicator at the country level to guide the setting of the countercyclical capital buffer: the credit-to-GDP gap. In this paper, I provide empirical evidence suggesting that the credit-to-GDP gap is subject to spurious medium-term cycles, i.e. artificial boom-bust cycles with a maximum duration of around 40 years. |
| Keywords: | Basel III,Hodrick-Prescott filter,detrending |
| JEL: | C10 E32 E58 G01 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:282020&r=all |
| By: | Jiexia Ye; Juanjuan Zhao; Kejiang Ye; Chengzhong Xu |
| Abstract: | Stock price movement prediction is commonly accepted as a very challenging task due to the extremely volatile nature of financial markets. Previous works typically focus on understanding the temporal dependency of stock price movement based on the history of individual stock movement, but they do not take the complex relationships among involved stocks into consideration. However it is well known that an individual stock price is correlated with prices of other stocks. To address that, we propose a deep learning-based framework, which utilizes recurrent neural network (RNN) and graph convolutional network (GCN) to predict stock movement. Specifically, we first use RNN to model the temporal dependency of each related stock' price movement based on their own information of the past time slices, then we employ GCN to model the influence from involved stock based on three novel graphs which represent the shareholder relationship, industry relationship and concept relationship among stocks based on investment decisions. Experiments on two stock indexes in China market show that our model outperforms other baselines. To our best knowledge, it is the first time to incorporate multi-relationships among involved stocks into a GCN based deep learning framework for predicting stock price movement. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2005.04955&r=all |
| By: | Dempsey, Kyle P. |
| Abstract: | I analyze the impact of raising capital requirements on the quantity, composition, and riskiness of aggregate investment in a model in which firms borrow from both bank and non-bank lenders. The bank funds loans with insured deposits and costly equity, monitors borrowers, and must maintain a minimum capital to asset ratio. Non-banks have deep pockets and competitively price loans. A tight capital requirement on the bank reduces risk-shifting and decreases bank leverage, reducing the risk of costly bank failure. In response, though, the bank can change both price and non-price contract terms. This may induce firms to substitute out of bank finance, leading to a theoretically ambiguous effect on the profile of aggregate investment. Quantitatively, I find that the bank's incentive to insure itself against issuing costly equity and competition from the non-bank sector mutes the long run impact of raising capital requirements. Increasing the capital requirement from 8% to 26% eliminates bank failures with effectively no change in the quantity or riskiness of aggregate investment. JEL Classification: G2, E5, E6, E32, E44 |
| Keywords: | banking, business cycles, capital requirements |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20202415&r=all |
| By: | Busch, Christopher; Ludwig, Alexander |
| Abstract: | We extend the canonical income process with persistent and transitory risk to shock distributions with left-skewness and excess kurtosis, to which we refer as higher-order risk. We estimate our extended income process by GMM for household data from the United States. We find countercyclical variance and procyclical skewness of persistent shocks. All shock distributions are highly leptokurtic. The existing tax and transfer system reduces dispersion and left-skewness of shocks. We then show that in a standard incomplete-markets life-cycle model, first, higher-order risk has sizable welfare implications, which depend crucially on risk attitudes of households; second, higher-order risk matters quantitatively for the welfare costs of cyclical idiosyncratic risk; third, higher-order risk has non-trivial implications for the degree of self-insurance against both transitory and persistent shocks. |
| Keywords: | Labor Income Risk,Business Cycle,GMM Estimation,Skewness,Persistent and Transitory Income Shocks,Risk Attitudes,Life-Cycle Model |
| JEL: | D31 E24 E32 H31 J31 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:zewdip:20022&r=all |
| By: | Periklis Brakatsoulas (Institute of Economic Studies, Faculty of Social Sciences, Charles University Opletalova 26, 110 00, Prague, Czech Republic; Institute of Information Theory and Automation of the Czech Academy of Sciences, Pod Vodarenskou vezi 4, 182 00 Prague 8, Czech Republic); Jiri Kukacka (Institute of Economic Studies, Faculty of Social Sciences, Charles University Opletalova 26, 110 00, Prague, Czech Republic) |
| Abstract: | We develop a four-factor model intended to capture size, value, and credit rating transition patterns in excess returns for a panel of predominantly mid- and large-cap entities. Using credit transition matrices and rating histories from 48 US issuers, we provide evidence to support a statistically significant negative downgrade risk premium in excess returns, suggesting that stocks at higher risk of failure tend to deliver lower returns. The performance of the model remains robust across several estimation methods. Panel Granger causality test results indicate that there indeed is a Granger-causal relationship from credit rating transition probabilities to excess returns. Our paper thus provides a new methodology to generate firm-level downgrade probabilities and the basis for further empirical validation and development of Fama-French-type models under financial distress. |
| Keywords: | Asset pricing, credit risk, panel data, stock returns, transition matrices. |
| JEL: | G11 G12 G14 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2020_13&r=all |
| By: | Marco Pagano (Università di Napoli Federico II, CSEF, EEIF, CEPR and ECGI); Christian Wagner (WU Vienna University of Economics and Business and Vienna Graduate School of Finance (VGSF)); Josef Zechner (WU Vienna University of Economics and Business, Vienna Graduate School of Finance (VGSF) and CEPR) |
| Abstract: | This paper investigates whether security markets price the effect of social distancing on firms' operations. We document that firms that are more resilient to social distancing significantly outperformed those with lower resilience during the COVID-19 outbreak, even after controlling for the standard risk factors. Similar cross-sectional return differentials already emerged before the COVID- 19 crisis: the 2014-19 cumulative return differential between more and less resilient firms is of similar size as during the outbreak, suggesting growing awareness of pandemic risk well in advance of its materialization. Finally, we use stock option prices to infer the market's return expectations after the onset of the pandemic: even at a two-year horizon, stocks of more pandemic-resilient firms are expected to yield significantly lower returns than less resilient ones, reflecting their lower exposure to disaster risk. Hence, going forward, markets appear to price exposure to a new risk factor, namely, pandemic risk. |
| Keywords: | asset pricing, rare disasters, social distance, resilience, pandemics. |
| JEL: | G01 G11 G12 G13 G14 Q51 Q54 |
| Date: | 2020–05–18 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:563&r=all |