As organizations are increasingly engaged in the digital world with greater dependency on data, crime and activism have shifted from the streets to the internet. In this paper, we study the impact of activist hacking campaigns on financial institutions. We look into how target institutions’ deep web and dark web exposure in terms of different risk categories is affected by hacking campaigns, and the interactions of the risk categories during the campaigns. On average, hacking campaigns raise the target institutions’ deep web and dark web exposure by 62 percent per year during the first two years after the campaigns’ start date. Small financial institutions are more vulnerable to the campaigns than large institutions. Further, leaked employee passwords amplify the campaign effect substantially, which allows us to forecast the institutions’ cyber exposure changes during and after the campaigns.
{"title":"Do Hacker Groups Pose a Risk to Organizations? Study on Financial Institutions Targeted by Hacktivists","authors":"J. Keppo, Mikko Niemela","doi":"10.2139/ssrn.3835547","DOIUrl":"https://doi.org/10.2139/ssrn.3835547","url":null,"abstract":"As organizations are increasingly engaged in the digital world with greater dependency on data, crime and activism have shifted from the streets to the internet. In this paper, we study the impact of activist hacking campaigns on financial institutions. We look into how target institutions’ deep web and dark web exposure in terms of different risk categories is affected by hacking campaigns, and the interactions of the risk categories during the campaigns. On average, hacking campaigns raise the target institutions’ deep web and dark web exposure by 62 percent per year during the first two years after the campaigns’ start date. Small financial institutions are more vulnerable to the campaigns than large institutions. Further, leaked employee passwords amplify the campaign effect substantially, which allows us to forecast the institutions’ cyber exposure changes during and after the campaigns.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"53 8","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-07-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114130355","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We provide a survey of recent results on model calibration by Optimal Transport. We present the general framework and then discuss the calibration of local, and local-stochastic, volatility models to European options, the joint VIX/SPX calibration problem as well as calibration to some path-dependent options. We explain the numerical algorithms and present examples both on synthetic and market data.
{"title":"Optimal Transport for Model Calibration","authors":"Ivan Guo, G. Loeper, J. Obłój, Shiyi Wang","doi":"10.2139/ssrn.3876854","DOIUrl":"https://doi.org/10.2139/ssrn.3876854","url":null,"abstract":"We provide a survey of recent results on model calibration by Optimal Transport. We present the general framework and then discuss the calibration of local, and local-stochastic, volatility models to European options, the joint VIX/SPX calibration problem as well as calibration to some path-dependent options. We explain the numerical algorithms and present examples both on synthetic and market data.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"38 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125115895","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Thomas Grüunthaler, Friedrich Lorenz, Paul Meyerhof
We introduce an option-implied proxy for the health of financial intermediaries—the Leverage Bearing Capacity (LBC). LBC is the leverage of a fictitious intermediary that targets a fixed level of risk and rebalances its capital structure on an ongoing basis. Our measure is based on market values, available at any frequency, and naturally incorporates higher moments. We analyze the dynamics of LBC within simulation and event studies and demonstrate that LBC is tightly linked to financial sector uncertainty. Building on an intermediary asset pricing model, we validate that LBC proxies the marginal wealth of intermediaries. Empirically, LBC explains the expected returns across several asset classes and subsumes the explanatory power of existing measures of intermediaries’ health, financial uncertainty, and common risk factors.
{"title":"Option-Based Intermediary Leverage","authors":"Thomas Grüunthaler, Friedrich Lorenz, Paul Meyerhof","doi":"10.2139/ssrn.3719019","DOIUrl":"https://doi.org/10.2139/ssrn.3719019","url":null,"abstract":"We introduce an option-implied proxy for the health of financial intermediaries—the Leverage Bearing Capacity (LBC). LBC is the leverage of a fictitious intermediary that targets a fixed level of risk and rebalances its capital structure on an ongoing basis. Our measure is based on market values, available at any frequency, and naturally incorporates higher moments. We analyze the dynamics of LBC within simulation and event studies and demonstrate that LBC is tightly linked to financial sector uncertainty. Building on an intermediary asset pricing model, we validate that LBC proxies the marginal wealth of intermediaries. Empirically, LBC explains the expected returns across several asset classes and subsumes the explanatory power of existing measures of intermediaries’ health, financial uncertainty, and common risk factors.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"2 3","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"120980020","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In illiquid and fragmented limit order book markets, asynchronously arriving buyers and sellers have a coordination problem. This problem is particularly strong mid-day, when trading is generally thin. We evaluate a market structure reform at Nasdaq Nordic, where the continuous trading session is replaced mid-day by a five-minute call auction. We find that the mid-day call auction works as a coordination device, reducing transitory price impact. The call auction attracts end investors rather than intermediaries. Stocks with greater end investor flows show stronger benefits of the call auction. The results indicate that mid-day auctions can improve continuous markets.
{"title":"Mid-Day Call Auctions","authors":"Jonathan Brogaard, Björn Hagströmer, Caihong Xu","doi":"10.2139/ssrn.3868037","DOIUrl":"https://doi.org/10.2139/ssrn.3868037","url":null,"abstract":"In illiquid and fragmented limit order book markets, asynchronously arriving buyers and sellers have a coordination problem. This problem is particularly strong mid-day, when trading is generally thin. We evaluate a market structure reform at Nasdaq Nordic, where the continuous trading session is replaced mid-day by a five-minute call auction. We find that the mid-day call auction works as a coordination device, reducing transitory price impact. The call auction attracts end investors rather than intermediaries. Stocks with greater end investor flows show stronger benefits of the call auction. The results indicate that mid-day auctions can improve continuous markets.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"24 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115077306","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We study the behavior of linear discriminant functions for binary classification in the infinite-imbalance limit, where the sample size of one class grows without bound while the sample size of the other remains fixed. The coefficients of the classifier minimize an expected loss specified through a weight function. We show that for a broad class of weight functions, the intercept diverges but the rest of the coefficient vector has a finite limit under infinite imbalance, extending prior work on logistic regression. The limit depends on the left tail of the weight function, for which we distinguish three cases: bounded, asymptotically polynomial, and asymptotically exponential. The limiting coefficient vectors reflect robustness or conservatism properties in the sense that they optimize against certain worst-case alternatives. In the bounded and polynomial cases, the limit is equivalent to an implicit choice of upsampling distribution for the minority class. We apply these ideas in a credit risk setting, with particular emphasis on performance in the high-sensitivity and high-specificity regions.
{"title":"Linear Classifiers Under Infinite Imbalance","authors":"P. Glasserman, Mike Li","doi":"10.2139/ssrn.3863653","DOIUrl":"https://doi.org/10.2139/ssrn.3863653","url":null,"abstract":"<br>We study the behavior of linear discriminant functions for binary classification in the infinite-imbalance limit, where the sample size of one class grows without bound while the sample size of the other remains fixed. The coefficients of the classifier minimize an expected loss specified through a weight function. We show that for a broad class of weight functions, the intercept diverges but the rest of the coefficient vector has a finite limit under infinite imbalance, extending prior work on logistic regression. The limit depends on the left tail of the weight function, for which we distinguish three cases: bounded, asymptotically polynomial, and asymptotically exponential. The limiting coefficient vectors reflect robustness or conservatism properties in the sense that they optimize against certain worst-case alternatives. In the bounded and polynomial cases, the limit is equivalent to an implicit choice of upsampling distribution for the minority class. We apply these ideas in a credit risk setting, with particular emphasis on performance in the high-sensitivity and high-specificity regions.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"13 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132269194","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this essay, I argue that employee-funded deferred pay can mitigate misconduct in organizations. Its objective is to internalize some of the fines and settlement costs if justified. Because employees might be required to cover some of the costs imposed on a firm, they may engage in information production and its escalation in the organization to alert others about potentially faulty business decisions. Thus, deferred pay could improve internal governance of the firm and potential cost of misconduct on firm stakeholders, including the public.
{"title":"How Employee-Funded Deferred Pay Can Promote Shared Interest, Control Corporate Misconduct and Faulty Business Decisions","authors":"Hamid Mehran","doi":"10.2139/ssrn.3836274","DOIUrl":"https://doi.org/10.2139/ssrn.3836274","url":null,"abstract":"In this essay, I argue that employee-funded deferred pay can mitigate misconduct in organizations. Its objective is to internalize some of the fines and settlement costs if justified. Because employees might be required to cover some of the costs imposed on a firm, they may engage in information production and its escalation in the organization to alert others about potentially faulty business decisions. Thus, deferred pay could improve internal governance of the firm and potential cost of misconduct on firm stakeholders, including the public.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"48 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124898586","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Interest rate risk measurement and management of non-maturity deposit balances presents a challenge for practitioners and academic researchers as well. The paper provides a review of several methodological approaches focusing on the area of savings accounts rate sensitivity modeling and estimation. The proposed models are tested on a Czech banking sector dataset providing mixed results regarding the cointegration type models generally recommended in the literature. On the other hand, the analysis shows that simpler regression models may provide more robust results if the cointegration tests between the saving accounts rate and the market rate series fail.
{"title":"Interest Rate Risk of Savings Accounts","authors":"J. Witzany, M. Diviš","doi":"10.2139/ssrn.3859429","DOIUrl":"https://doi.org/10.2139/ssrn.3859429","url":null,"abstract":"Interest rate risk measurement and management of non-maturity deposit balances presents a challenge for practitioners and academic researchers as well. The paper provides a review of several methodological approaches focusing on the area of savings accounts rate sensitivity modeling and estimation. The proposed models are tested on a Czech banking sector dataset providing mixed results regarding the cointegration type models generally recommended in the literature. On the other hand, the analysis shows that simpler regression models may provide more robust results if the cointegration tests between the saving accounts rate and the market rate series fail.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"17 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116205308","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
How firms cope with tail risk is an under researched problem in the literature on corporate risk management. This paper presents stylized facts on the nature of revenue shocks based on 65 years worth of Compustat data. We define a Black Swan as an unexpected year-on-year drop in revenue between 30-90%. The rate of Black Swans has increased markedly since the 1970s and there are more pronounced cyclical peaks in the three most recent decades. We also examine the role of three general determinants of firms’ ability to absorb Black Swans: equity capital, liquidity, and operating flexibility. The conclusion to emerge from this analysis is that the deciding factor in mediating the effects of revenue shocks on employment is liquidity. Cash reserves and cash margins make firms less fragile, but neither equity capital nor operating flexibility robustly buffer against Black Swans.
{"title":"The Black Swan Problem: The Role of Capital, Liquidity and Operating Flexibility","authors":"N. Christie, Håkan Jankensgård, N. Marinelli","doi":"10.2139/ssrn.3859637","DOIUrl":"https://doi.org/10.2139/ssrn.3859637","url":null,"abstract":"How firms cope with tail risk is an under researched problem in the literature on corporate risk management. This paper presents stylized facts on the nature of revenue shocks based on 65 years worth of Compustat data. We define a Black Swan as an unexpected year-on-year drop in revenue between 30-90%. The rate of Black Swans has increased markedly since the 1970s and there are more pronounced cyclical peaks in the three most recent decades. We also examine the role of three general determinants of firms’ ability to absorb Black Swans: equity capital, liquidity, and operating flexibility. The conclusion to emerge from this analysis is that the deciding factor in mediating the effects of revenue shocks on employment is liquidity. Cash reserves and cash margins make firms less fragile, but neither equity capital nor operating flexibility robustly buffer against Black Swans.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"37 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123667898","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
I conduct an experiment with senior executives (CEOs, CFOs, controllers) to examine how their risk disclosure quality, with respect to disclosure volume and specificity, is influenced by three factors. First, whether the disclosure behavior is framed internally by the firm as obtaining a gain or avoiding a loss from disclosure. Second, whether the external disclosure regime mandates risk mitigation disclosures that explain how a risk is handled. Third, whether the risk under consideration for disclosure is weakly- or strongly-mitigated. This research question is important because high-quality risk disclosures are challenging to regulate and changing how disclosure behavior is framed could substitute for costly disclosure regulations. I find that a gain frame prompts managers to make more detailed risk disclosures than a loss frame, regardless of the disclosure regime. A loss frame also leads to less detailed and more boilerplate disclosure of weakly-mitigated risks when risk mitigation plans are mandated. Given that the SEC (2016) is considering mandating risk mitigation disclosures similar to the practice in other regimes, my findings provide insights on the limitations of mandating these disclosures. My results suggest that changing managers’ disclosure frame internally through firm initiatives could be more effective in prompting higher quality risk disclosures.
{"title":"Is Framing More Effective Than Regulating Disclosures? The Effects of Risk Disclosure Frame and Regime on Managers’ Disclosure Choices","authors":"Feng Yeo","doi":"10.2139/ssrn.3857658","DOIUrl":"https://doi.org/10.2139/ssrn.3857658","url":null,"abstract":"I conduct an experiment with senior executives (CEOs, CFOs, controllers) to examine how their risk disclosure quality, with respect to disclosure volume and specificity, is influenced by three factors. First, whether the disclosure behavior is framed internally by the firm as obtaining a gain or avoiding a loss from disclosure. Second, whether the external disclosure regime mandates risk mitigation disclosures that explain how a risk is handled. Third, whether the risk under consideration for disclosure is weakly- or strongly-mitigated. This research question is important because high-quality risk disclosures are challenging to regulate and changing how disclosure behavior is framed could substitute for costly disclosure regulations. I find that a gain frame prompts managers to make more detailed risk disclosures than a loss frame, regardless of the disclosure regime. A loss frame also leads to less detailed and more boilerplate disclosure of weakly-mitigated risks when risk mitigation plans are mandated. Given that the SEC (2016) is considering mandating risk mitigation disclosures similar to the practice in other regimes, my findings provide insights on the limitations of mandating these disclosures. My results suggest that changing managers’ disclosure frame internally through firm initiatives could be more effective in prompting higher quality risk disclosures.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131142471","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Mathias S. Kruttli, Phillip J. Monin, Lubomir Petrasek, Sumudu W. Watugala
Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other creditors. Overall, the step back in hedge fund UST activity was primarily driven by fund-specific liquidity management rather than dealer regulatory constraints. Hedge funds exited the turmoil with 20% higher cash holdings and smaller, more liquid portfolios, despite low contemporaneous outflows. This precautionary flight to cash was more pronounced among funds exposed to greater redemption risk through shorter share restrictions. Hedge funds predominantly trading the cash-futures basis faced greater margin pressure and reduced UST exposures and repo borrowing the most. After the market turmoil subsided following Fed intervention, hedge fund returns recovered quickly, but UST exposures did not revert to pre-shock levels over the subsequent months.
{"title":"Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis","authors":"Mathias S. Kruttli, Phillip J. Monin, Lubomir Petrasek, Sumudu W. Watugala","doi":"10.2139/ssrn.3817978","DOIUrl":"https://doi.org/10.2139/ssrn.3817978","url":null,"abstract":"Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other creditors. Overall, the step back in hedge fund UST activity was primarily driven by fund-specific liquidity management rather than dealer regulatory constraints. Hedge funds exited the turmoil with 20% higher cash holdings and smaller, more liquid portfolios, despite low contemporaneous outflows. This precautionary flight to cash was more pronounced among funds exposed to greater redemption risk through shorter share restrictions. Hedge funds predominantly trading the cash-futures basis faced greater margin pressure and reduced UST exposures and repo borrowing the most. After the market turmoil subsided following Fed intervention, hedge fund returns recovered quickly, but UST exposures did not revert to pre-shock levels over the subsequent months.","PeriodicalId":251522,"journal":{"name":"Risk Management & Analysis in Financial Institutions eJournal","volume":"207 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122494635","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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