This paper proposes a new model for computing value-at-risk forecasts. The model is fully nonparametric and easy to implement. Further, it incorporates information about the market’s perceived uncertainty about the future. The forward-looking information is obtained from the option market via the Chicago Board Options Exchange’s implied volatility index (VIX). Using S&P 500 data from 1990 to 2010 we find that the use of option implied volatility compares favorably with generalized autoregressive conditional heteroscedasticity (GARCH)-type models in terms of forecast performance. By comparing the model primarily used in the banking sector to our new model, we find that a financial institution using our model has on average a lower market induced capital requirement (MCR). However, during the time period leading up to the financial crisis our model gives a 40% higher MCR.
{"title":"Nonparametric Forward-Looking Value-at-Risk","authors":"Marcus Nossman, Anders Vilhelmsson","doi":"10.21314/JOR.2014.287","DOIUrl":"https://doi.org/10.21314/JOR.2014.287","url":null,"abstract":"This paper proposes a new model for computing value-at-risk forecasts. The model is fully nonparametric and easy to implement. Further, it incorporates information about the market’s perceived uncertainty about the future. The forward-looking information is obtained from the option market via the Chicago Board Options Exchange’s implied volatility index (VIX). Using S&P 500 data from 1990 to 2010 we find that the use of option implied volatility compares favorably with generalized autoregressive conditional heteroscedasticity (GARCH)-type models in terms of forecast performance. By comparing the model primarily used in the banking sector to our new model, we find that a financial institution using our model has on average a lower market induced capital requirement (MCR). However, during the time period leading up to the financial crisis our model gives a 40% higher MCR.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2014-04-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67717935","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the dynamic linkages in credit risk between the money market and the derivatives market during 2004–9. We use the T-bill–Eurodollar (TED) spread to measure credit risk in the money market and the credit default swap (CDS) index spread for the derivatives market. The linkages are measured by a dynamic conditional correlation – Glosten–Jagannathan–Runkle – generalized auto regressive conditional heteroscedasticity model. The results show that the correlation between the TED spread and the CDS index spread fluctuated around zero prior to the crisis. While the correlation increased before the crisis, it moved notably higher during the crisis. Finally, the correlation fell in early 2009 but persisted at a level between 0.05 and 0.1, higher than the precrisis period.
{"title":"Dynamic Linkages in Credit Risk: Modeling the Time-Varying Correlation between the Money and Derivatives Markets Over the Crisis Period","authors":"Weiou Wu, D. McMillan","doi":"10.21314/jor.2013.270","DOIUrl":"https://doi.org/10.21314/jor.2013.270","url":null,"abstract":"This paper examines the dynamic linkages in credit risk between the money market and the derivatives market during 2004–9. We use the T-bill–Eurodollar (TED) spread to measure credit risk in the money market and the credit default swap (CDS) index spread for the derivatives market. The linkages are measured by a dynamic conditional correlation – Glosten–Jagannathan–Runkle – generalized auto regressive conditional heteroscedasticity model. The results show that the correlation between the TED spread and the CDS index spread fluctuated around zero prior to the crisis. While the correlation increased before the crisis, it moved notably higher during the crisis. Finally, the correlation fell in early 2009 but persisted at a level between 0.05 and 0.1, higher than the precrisis period.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"109 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2013-12-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67717887","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Aumann and Serrano (2008) introduce the index of riskiness to quantify the risk of a gamble. We discuss for which gambles this index of riskiness exists by considering the acceptance behavior of CARA-agents. Since for several relevant distributions riskiness is not defined, we suggest an extension of riskiness to all gambles. We prove that this extension is unique and that it satisfies the central duality axiom. Finally, we derive closed-form solutions of extended riskiness and list some applications.
{"title":"Existence and Computation of the Aumann-Serrano Index of Riskiness and Its Extension","authors":"K. Schulze","doi":"10.2139/ssrn.1156933","DOIUrl":"https://doi.org/10.2139/ssrn.1156933","url":null,"abstract":"Aumann and Serrano (2008) introduce the index of riskiness to quantify the risk of a gamble. We discuss for which gambles this index of riskiness exists by considering the acceptance behavior of CARA-agents. Since for several relevant distributions riskiness is not defined, we suggest an extension of riskiness to all gambles. We prove that this extension is unique and that it satisfies the central duality axiom. Finally, we derive closed-form solutions of extended riskiness and list some applications.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2013-11-27","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.2139/ssrn.1156933","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"68148454","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Experimental evidence and opinions of market professionals suggest that mental accounting influences option prices. I explore the implications of mental accounting of a call option with its underlying for risk management. If mental accounting influences prices and the Black Scholes approach is used, then for in-the-money call options, delta-risk is under-estimated, gamma-risk is over-estimated, and the extent of time decay is under-estimated. Covered call writing is significantly more profitable with mental accounting than without it. Formulas for Greeks adjusted for mental accounting are put forward.
{"title":"Managing Option Trading Risk when Mental Accounting Influences Prices","authors":"Hammad Siddiqi","doi":"10.2139/ssrn.2377889","DOIUrl":"https://doi.org/10.2139/ssrn.2377889","url":null,"abstract":"Experimental evidence and opinions of market professionals suggest that mental accounting influences option prices. I explore the implications of mental accounting of a call option with its underlying for risk management. If mental accounting influences prices and the Black Scholes approach is used, then for in-the-money call options, delta-risk is under-estimated, gamma-risk is over-estimated, and the extent of time decay is under-estimated. Covered call writing is significantly more profitable with mental accounting than without it. Formulas for Greeks adjusted for mental accounting are put forward.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2013-11-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.2139/ssrn.2377889","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"68157199","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
For several years leading up to the outbreak of the financial crisis, growth in the use of arbitrage collateralized debt obligations (CDOs) was explosive. In this paper, we discuss potential sources of such arbitrage opportunities, in particular, potential gains due to “bond-like pricing”. For this purpose, we examine the risk profiles of CDOs in some detail, which reveals significant differences between CDO tranches and corporate bonds, in particular concerning a considerably increased sensitivity to systematic risks. Treating the structured products as single name instruments allows us to quantify these differences. We then price CDO tranches approximately with the Merton model, similar to corporate bonds. Using a sample CDO portfolio, we describe some opportunities for “CDO arbitrage” when investors consider corporate and CDO bonds as substitute investments and use bond-like pricing. We then discuss how tranches with high systematic risk can be generated and how CDO arrangers can exploit this to their advantage. It comes as no surprise that precisely these types of structures featured in many of the CDOs issued prior to the outbreak of the financial crisis.
{"title":"The Impact of Collateralized Debt Obligation Arbitrage on Tranching and Financial Leverage of Structured Finance Securities","authors":"A. Hamerle, Thilo Liebig, Hans-Jochen Schropp","doi":"10.21314/JOR.2013.267","DOIUrl":"https://doi.org/10.21314/JOR.2013.267","url":null,"abstract":"For several years leading up to the outbreak of the financial crisis, growth in the use of arbitrage collateralized debt obligations (CDOs) was explosive. In this paper, we discuss potential sources of such arbitrage opportunities, in particular, potential gains due to “bond-like pricing”. For this purpose, we examine the risk profiles of CDOs in some detail, which reveals significant differences between CDO tranches and corporate bonds, in particular concerning a considerably increased sensitivity to systematic risks. Treating the structured products as single name instruments allows us to quantify these differences. We then price CDO tranches approximately with the Merton model, similar to corporate bonds. Using a sample CDO portfolio, we describe some opportunities for “CDO arbitrage” when investors consider corporate and CDO bonds as substitute investments and use bond-like pricing. We then discuss how tranches with high systematic risk can be generated and how CDO arrangers can exploit this to their advantage. It comes as no surprise that precisely these types of structures featured in many of the CDOs issued prior to the outbreak of the financial crisis.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2013-09-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67717802","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We present an alternative approach to hedging in incomplete markets. A corresponding alternative risk-minimization algorithm that identifies an optimal hedging portfolio consistent with initial capital and an investor-chosen risk criterion is developed. Having been introduced in earlier works by Josephy et al, it is adapted here to facilitate a comparison with both quadratic and piece wise linear local risk-minimization approaches reported in the work of Coleman et al. Numerical results establish that the alternative approach is competitive and frequently better than the local risk-minimization approaches. Various quantitative and qualitative comparisons are made between the local risk-minimization approaches and our alternative hedging approach.
{"title":"Alternative Hedging in a Discrete-Time Incomplete Market","authors":"N. Josephy, L. Kimball, V. Steblovskaya","doi":"10.21314/JOR.2013.268","DOIUrl":"https://doi.org/10.21314/JOR.2013.268","url":null,"abstract":"We present an alternative approach to hedging in incomplete markets. A corresponding alternative risk-minimization algorithm that identifies an optimal hedging portfolio consistent with initial capital and an investor-chosen risk criterion is developed. Having been introduced in earlier works by Josephy et al, it is adapted here to facilitate a comparison with both quadratic and piece wise linear local risk-minimization approaches reported in the work of Coleman et al. Numerical results establish that the alternative approach is competitive and frequently better than the local risk-minimization approaches. Various quantitative and qualitative comparisons are made between the local risk-minimization approaches and our alternative hedging approach.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2013-09-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67717865","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article proposes a formula for a market stress-test of a portfolio. The formula is motivated by some recent and old developments in random matrix theory and a requirement that it be explicitly invariant under a change of basis of risk factors. It has a natural interpretation as the standard deviation stressed by two effects: a correlation shear due to uncertainty of estimation from a finite sample and an additional stress due to the unobserved market risk factors. An example application for a relative-value portfolio of crude oil futures is presented.
{"title":"General Covariance, the Spectrum of Riemannium and a Stress Test Calculation Formula","authors":"Piotr Chmielowski","doi":"10.2139/ssrn.2257592","DOIUrl":"https://doi.org/10.2139/ssrn.2257592","url":null,"abstract":"This article proposes a formula for a market stress-test of a portfolio. The formula is motivated by some recent and old developments in random matrix theory and a requirement that it be explicitly invariant under a change of basis of risk factors. It has a natural interpretation as the standard deviation stressed by two effects: a correlation shear due to uncertainty of estimation from a finite sample and an additional stress due to the unobserved market risk factors. An example application for a relative-value portfolio of crude oil futures is presented.","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2013-06-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"68036685","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
{"title":"Deriving the minimal amount of risk capital for property-liability insurance companies utilizing asset liability management","authors":"M. Schmautz, Niklas Lampenius","doi":"10.21314/JOR.2013.262","DOIUrl":"https://doi.org/10.21314/JOR.2013.262","url":null,"abstract":"","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"15 1","pages":"35-55"},"PeriodicalIF":0.7,"publicationDate":"2013-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67718055","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
{"title":"Real estate investment trust return dynamics and value-at-risk under alternative classes of model specifications","authors":"Jung-Suk Yu","doi":"10.21314/JOR.2013.265","DOIUrl":"https://doi.org/10.21314/JOR.2013.265","url":null,"abstract":"","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"15 1","pages":"3-33"},"PeriodicalIF":0.7,"publicationDate":"2013-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67717770","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
{"title":"Public visibility and risk-related disclosures in Portuguese credit institutions","authors":"J. Oliveira, L. L. Rodrigues, R. Craig","doi":"10.21314/JOR.2013.264","DOIUrl":"https://doi.org/10.21314/JOR.2013.264","url":null,"abstract":"","PeriodicalId":46697,"journal":{"name":"Journal of Risk","volume":"15 1","pages":"57-90"},"PeriodicalIF":0.7,"publicationDate":"2013-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"67718164","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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