Showing papers on "Financial risk published in 1998"

Are women more risk averse

Abstract: We find that single women exhibit relatively more risk aversion in financial decision making than single men. Using U.S. sample data, we examine household holdings of risky assets to determine whether there are gender differences in financial risk taking. As wealth increases, the proportion of wealth held as risky assets is estimated to increase by a smaller amount for single women than for single men. Gender differences in financial risk taking are also influenced by age, race, and number of children. Greater financial risk aversion may provide an explanation for women's lower levels of wealth compared with men's. (JEL J16, D81, G11)

Agency Costs, Risk Management, and Capital Structure

Abstract: The joint determination of capital structure and investment risk is examined. Optimal capital structure reflects both the tax advantages of debt less default costs (Modigliani and Miller (1958, 1963)), and the agency costs resulting from asset substitution (Jensen and Meckling (1976)). Agency costs restrict leverage and debt maturity and increase yield spreads, but their importance is small for the range of environments considered. Risk management is also examined. Hedging permits greater leverage. Even when a firm cannot precommit to hedging, it will still do so. Surprisingly, hedging benefits often are greater when agency costs are low. THE CHOICE OF INVESTMENT FINANCING, and its link with optimal risk exposure, is central to the economic performance of corporations. Financial economics has a rich literature analyzing the capital structure decision in qualitative terms. But it has provided relatively little specific guidance. In contrast with the precision offered by the Black and Scholes (1973) option pricing model and its extensions, the theory addressing capital structure remains distressingly imprecise. This has limited its application to corporate decision making. Two insights have profoundly shaped the development of capital structure theory. The arbitrage argument of Modigliani and Miller (M-M) (1958, 1963) shows that, with fixed investment decisions, nonfirm claimants must be present for capital structure to affect firm value. The optimal amount of debt balances the tax deductions provided by interest payments against the external costs of potential default. Jensen and Meckling (J-M) (1976) challenge the M-M assumption that investment decisions are independent of capital structure. Equityholders of a levered firm, for example, can potentially extract value from debtholders by increasing investment risk after debt is in place: the "asset substitution" problem. Such predatory behavior creates agency costs that the choice of capital structure must recognize and control.

User interface for a financial advisory system

Abstract: A user interface for a financial advisory system is provided. According to one aspect of the present invention, a user may interactively explore how changes in one or more input decisions such as a risk tolerance, a savings level, and a retirement age affect one or more output values such as a probability of achieving a financial goal or an indication of short-term risk. A first and second visual indication are concurrently displayed. The first visual indication includes input mechanisms, such as slider bars, for receiving the input decisions. The second visual indication includes a set of output values that are based upon the input decisions and a recommended set of financial products. After updated values for the input decisions are received via the input mechanisms, a new recommended set of financial products and a new set of output values may be determined based upon the updated values. The second visual indication may then be updated to reflect the new set of output values. According to another aspect of the present invention, a graphical input mechanism for receiving a desired level of investment risk may be calibrated. A set of available financial products, such as a set of mutual funds, and a predefined volatility, such as the volatility of the Market Portfolio are received. The settings associated with the graphical input mechanism are constrained based upon the set of available financial products. Additionally, the calibration of the units of the graphical input mechanism may be expressed as a relationship between the volatility associated with a setting of the graphical input mechanism and the predefined volatility.

Risk Management in Banking

Abstract: Now in its third edition, this seminal work by Joel Bessis has been comprehensively revised and updated to take into account the changing face of risk management. Fully restructured, featuring new material and discussions on new financial products, derivatives, Basel II, credit models based on time intensity models, implementing risk systems and intensity models of default, it also includes a section on Subprime that discusses the crisis mechanisms and makes numerous references throughout to the recent stressed financial conditions. The book postulates that risk management practices and techniques remain of major importance, if implemented in a sound economic way with proper governance. Risk Management in Banking, Third Edition considers all aspects of risk management emphasizing the need to understand conceptual and implementation issues of risk management and examining the latest techniques and practical issues, including: Asset-Liability Management Risk regulations and accounting standards Market risk models Credit risk models Dependencies modeling Credit portfolio models Capital Allocation Risk-adjusted performance Credit portfolio management Building on the considerable success of this classic work, the third edition is an indispensable text for MBA students, practitioners in banking and financial services, bank regulators and auditors alike.

Beyond Value at Risk: The New Science of Risk Management

Abstract: A Comprehensive Guide to Value at Risk and Risk Management Risk management and measurement are now, without doubt, the hottest topics in the finance world. Today, quantifying risk management is not only a management tool - but is also used by regulators for banks and finance houses. Beyond Value at Risk provides a comprehensive guide to recent developments and existing approaches to VaR and risk management, going beyond traditional approaches to the subject and offering a new, far-reaching perspective on investment, hedging and portfolio decision-making. The key to this distinctive approach is a new decision rule - the 'Generalised Sharpe Rule', and its practical applications. Beyond Value at Risk provides the answers to key questions, including: How to implement VaR and related systems in the real world How to make vital investment decisions and estimate their effect How to make hedging decisions How to manage a portfolio It offers financial professionals, academics and students comprehensive coverage of VaR both in theory and practice.

Perceiving and managing business risks: differences between entrepreneurs and bankers

Abstract: We compared entrepreneurs with bankers in their perception and management of a variety of risks. Problems included financial risk, risk to human life and health, and risk of a natural disaster. Cluster analysis and content analysis of think-aloud protocols revealed surprising details. Entrepreneurs accept risk as given and focus on controlling the outcomes at any given level of risk; they also frame their problem spaces with personal values and assume greater personal responsibility for the outcomes. Bankers focus on target outcomes — attempting to control risk within structured problem spaces and avoiding situations where they risk higher levels of personal responsibility.

Hedging and Coordinated Risk Management: Evidence From Thrift Conversions

Abstract: We provide an explanation for hedging as a means of allocating rather than reducing risk. We argue that when increases in total risk are costly, firms optimally allocate risk by reducing (increasing) exposure to risks that provide zero (positive) economic rents. Our evidence shows that mutual thrifts that convert to stock institutions increase total risk following conversion, consistent with their increased abilities and incentives for risk taking. They achieve this increase by hedging interest-rate risk and increasing credit risk. We provide some evidence that risk-management activities are related to growth capacity and management compensation structure attained at conversion.

Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management

Abstract: Recent literature has trumpeted the claim that extreme value theory (EVT) holds promise for accurate estimation of extreme quantiles and tail probabilities of financial asset returns, and hence hold promise for advances in the management of extreme financial risks. Our view, based on a disinterested assessment of EVT from the vantage point of financial risk management, is that the recent optimism is partly appropriate but also partly exaggerated, and that at any rate much of the potential of EVT remains latent. We substantiate this claim by sketching a number of pitfalls associate with use of EVT techniques. More constructively, we show how certain of the pitfalls can be avoided, and we sketch a number of explicit research directions that will help the potential of EVT to be realized.

Factors affecting contractors' risk of cost overburden

Abstract: Cost overruns create a significant financial risk to both contractors and owners However, in spite of the risks involved the history of the construction industry is full of projects that were completed with significant cost overruns Contractors used to be able to cover their cost overburdens with their markups However, with diminishing markups, even marginal cost overburdens can easily wipe out their profits and even lead to a financial overburden Therefore, contractors need to identify major risk sources causing cost overburdens in advance to be proactive in managing them This paper reviews and describes uncontrollable risk sources that affect the contractor’s risk of cost overburden Sources of these risks relate to factors affecting the cost estimate and the final cost of a project and include factors specific to the cost estimator, the project design, construction, and the project environment The paper describes each of these factors in detail and gives specific examples based on a survey of the relevant literature

Type a and risk taking in everyday money matters

Abstract: The purpose of the present study is to extend previous research investigating personality factors as determinants of financial risk taking in everyday money matters (e.g., personal investments and household affairs). Type A and Type B subjects were asked to make a series of everyday financial decisions that varied in degree of risk. Type A individuals took greater financial risks than Type B individuals. The results provide additional support for the influence of personality factors in everyday financial risk-taking behavior and demonstrated another area of risk taking associated with the Type A behavior pattern not previously identified.

Horizon Problems and Extreme Events in Financial Risk Management

Abstract: Is volatility forecastability important for long-horizon risk management, or is a traditional constant-volatility assumption adequate? In this paper, the authors address this question, exploring the interface between long-horizon financial risk management and long-horizon volatility forecastability and, in particular, whether long-horizon volatility is forecastable enough such that volatility models are useful for long-horizon risk management.

Operational tools in the management of financial risks

Abstract: I: Multivariate Data Analysis and Multicriteria Analysis in Portfolio Selection Proposal for the Composition of a Solvent Portfolio with Chaos Theory and Data Analysis D Karapistolis, et al An Entropy Risk Aversion in Portfolio Selection A Scarelli Multicriteria Decision Making and Portfolio Management with Arbitrage Pricing Theory Ch Hurson, N Ricci-Xella II: Multivariate Data Analysis and Multicriteria Analysis in Business Failure, Corporate Performance and Bank Bankruptcy The Application of the Multi-Factor Model in the Analysis of Corporate Failure EM Vermeulen, et al Multivariate Analysis for the Assessment of Corporate Performance: The Case of Greece Y Caloghirou, et al Stable Set Internally Maximal: A Classification Method with Overlapping A Couturier, B Fioleau A Multicriteria Approach for the Analysis and Prediction of Business Failure in Greece C Zopounidis, et al A New Rough Set Approach to Evaluation of Bankruptcy Risk S Greco, et al FINCLAS: A Multicriteria Decision Support System for Financial Classification Problems C Zopounidis, M Doumpos A Mathematical Approach of Determining Bank Risks Premium J Gupta, Ph Spieser III: Linear and Stochastic Programming in Portfolio Management Designing Callable Bonds Using Simulated Annealing MR Holmer, et al Towards Sequential Sampling Algorithms for Dynamic Portfolio Management Z Chen, et al The Defeasance in the Framework of Finite Convergence in Stochastic Programming Ph Spieser, A Chevalier Mathematical Programming and Risk Management of Derivative Securities L Clewlow, et al IV: Fuzzy Sets and Artificial Intelligence Techniques in Financial Decisions Financial Risk in Investment J Gil-Aluja The Selection of a Portfolio Through a Fuzzy Genetic Algorithm: The POFUGENA Model E Lopez-Gonzalez, et al Predicting Interest Rates Using Artificial Neural Networks Th Politof, D Ulmer V: Multicriteria Analysis in Country Risk Evaluation Assessing Country Risk Using Multicriteria Analysis M Doumpos, et al Author Index

VAR Plus: Fat Tails in Financial Risk Management

Abstract: To ensure a competent regulatory framework with respect to Value-at-Risk for establishing Bank's capital adequacy requirements, as promoted by the Basle Committee, then the parametrical approach to estimate VaR needs to incorporate fat tails, apparent in the return distributions of financial assets. This paper provides a simple method to obtain accurate parametric VaR measures by including a specific measure for the tail fatness of an asset's return distribution. We provide evidence for the accuracy of these VaR+ estimates by comparing different parametric VaR estimators for bi-weekly returns on US stock and bond returns.

The Allocation of Risk

Abstract: The allocation of risk function pervades the financial system. Risk-averse individuals are made better-off by expanded risk-sharing opportunities that allow them to shed unwanted risks and to acquire preferred risks. Welfare is enhanced by the fact that individuals can fashion preferred contingent patterns of consumption and can better manage risks associated with real investments that may not otherwise be made (in the absence of risk sharing). The risk allocation function also allows for, according to the principle of comparative advantage, the separation of funding from risk-bearing in investments. Given these real benefits, economic organizational and arrangements will naturally evolve to facilitate the efficient allocation of risk bearing. And while a wide variety of risk allocation mechanisms have developed, all approaches to risk management are in fact based on the concepts of either hedging, diversification, or insurance. Firms are large and growing users of risk management instruments, such as derivatives, even though in theory firm-level risk management is irrelevant in a perfect economy. And government is an important element in the financial system's overall risk allocation function, but it is it's potentially larger role as regulator of the rapidly growing global over-the-counter derivatives market that has received attention lately. Indeed, the debate on the over-the-counter derivatives market is emblematic of the general concerns about the impact of financial innovation on the stability of the financial system. One of the objectives of this chapter is to inform this debate through a description and discussion of the risk allocation function.

An Extended Family of Financial-Risk Measures

Abstract: Recalling the class of risk measures introduced by Stone [1973], the authors survey measures from different academic disciplines—including psychology, operations research, management science, economics, and finance—that have been introduced since 1973. We introduce a general class of risk measures that extends Stone's class to include these new measures. Finally, we give four axioms that describe necessary attributes of a good financial risk measure and show which of the measures surveyed satisfy these. We demonstrate that all measures that satisfy our axioms, as well as those that do not but are commonly used in finance, belong to our new generalized class.

Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management

Abstract: Recent literature has trumpeted the claim that extreme value theory (EVT) holds promise for accurate estimation of extreme quantiles and tail probabilities of financial asset returns, and hence hold promise for advances in the management of extreme financial risks. Our view, based on a disinterested assessment of EVT from the vantage point of financial risk management, is that the recent optimism is partly appropriate but also partly exaggerated, and that at any rate much of the potential of EVT remains latent. We substantiate this claim by sketching a number of pitfalls associate with use of EVT techniques. More constructively, we show how certain of the pitfalls can be avoided, and we sketch a number of explicit research directions that will help the potential of EVT to be realized.

The East Asia crisis and corporate finances : the untold micro story

Abstract: Explanations of the causes of the Asian crisis have focused on macroeconomic factors leading to the crisis. This paper offers a complementary corporate distress perspective linking the crisis to corporate finances. Key ratios for companies in various countries are presented in the paper. The global benchmarking imposes a consistent cross-border analysis of financial risk and performance, and sheds light on the crisis. The study provides a statistical review of the financial practices and performance of corporates in Asia: Hong Kong, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand benchmarked against financials of corporates in other countries: Latin America, and industrialized countries: France, Germany, Japan and USA. A thematic point that comes across in all the results of the corporate financial analysis is unsustainable rapid (and probably excessive) investment in fixed assets financed by excessive borrowing in some Asian countries- e.g., Indonesia, Korea and Thailand. The East Asian investment-spending spree resulted in poor profitability, reflected in low, and declining return on equity, and return on capital employed. It leads to the conclusion that at the core of the corporate crisis were financial excesses that violated prudent financial practices, and eventually lead to the inevitable financial distress we are witnessing. Therefore, the empirical findings presented in the paper lend credence to the view advanced by Krugman that crony capitalism was at the core of the crisis. Crony capitalism was manifested in supportive bad policies-e.g., implicit government guarantees, and poor banking supervision- that lead to poor credit allocation decisions in the banking dominated financial system. Preliminary findings suggest as well vast differences in Economic Value Added between countries- developing and developed alike. The conclusions from an economic value added approach indicate that in an era of increasing capital mobility, corporates are not adhering to global standards in creating shareholder value. The analysis leads to policy conclusions.

Competition and convergence in financial markets : the German and Anglo-American models

Abstract: Section and chapter headings: Preface. Introduction (S.W. Black, M. Moersch). I Who Governs Firms? The changing role of banks and corporate governance in Germany: evolution towards the market? (U. Schroder, A. Schrader). The German system of corporate governance - a model which should not be imitated (E. Wenger, C. Kaserer). Is a supervisory board valuable? the French evidence (Gang Shyy, V. Vijayraghavan). II Financial Constraints and Investment Behavior. German investment financing: an international comparison (J. Corbett, T. Jenkinson). Investment, liquidity constraints, and bank relationships: evidence from German manufacturing firms (J.A. Elston). Financial structure, investment and economic growth in OECD countries (S.W. Black, M. Moersch). III Comparing Financial Systems and Regulatory Regimes. Universal versus specialized banks (A. Steinherr). Convergence of financial systems and regulatory policy challenges in Europe and in the United States (C. Dziobek, J.R. Garrett). The management of financial risks at German nonfinancial firms: the cast of metallgesellschaft (A.B. Frankel, D.E. Palmer). IV European Monetary Unification. Is a 2-speed system in Europe the answer to the conflict between the German and the Anglo-Saxon models of monetary control? (M. Demertzis et al.). Monetary integration between economies with different financial structures (S. Collignon). V Financial Structure for Transition Economies. Towards universal banking - risks and benefits for transition economies (C.M. Buch). Financial integration in North America and Europe among neighboring countries at different stages of development (G.M. von Furstenberg, B. Hofer). Index.

What Credit Market Indicators Tell Us

Abstract: John Duca shows that interest rate spreads and loan surveys should be interpreted carefully when assessing the availability of credit and its impact on the economy. This is especially true of interest rate spread indicators, some of which reflect prepayment, liquidity, or default risk premiums that have different economic implications. It can be helpful to decompose spreads before drawing economic inferences from the structure of interest rates. Spreads between yields on non-top-grade private-sector bonds and Treasury bonds, in particular, have a large prepayment premium in addition to a time-varying default risk premium. It is also important to recognize that even some decomposed spreads include more than one type of risk premium. In this regard, a widening of some yield spreads that contain a small default risk component, such as the Aaa-Treasury spread, could reflect a rise in prepayment or liquidity risk premiums, whose magnitudes may be hard to identify separately.

Banks, Risk and FAS 105 Disclosures

Abstract: This study examines whether Financial Accounting Standard No. 105 (FAS105) footnote disclosures of off-balance-sheet financial instruments and derivatives provide risk-relevant information in addition to that provided by the balance sheet alone. A theoretical model relates market and industry risk measures to FAS105 disclosures. Empirical tests of the model reveal that these disclosures do provide risk-relevant numbers although the results are not uniformly strong. The balance sheet financial instruments explain 42 percent of the variation in market risk and 45 percent of the variation in industry-level risk among 499 U.S. commercial bank holding companies. FAS105 disclosures of off-balance-sheet instruments and derivative positions, explain an additional 5 to 7 percent of the variation. Stronger evidence is presented that shows that certain controversial classes of derivatives are not associated with increased levels of market and industry risk. This latter evidence stands in contrast to the current notion that derivative contracts, especially interest rate and currency swaps, increase overall bank riskiness. Results also corrovorate the FASB categorization of classes of financial instruments along two important risk dimensions: credit risk and market risk.

Implementing Publicly Funded Risk Contracts With Community Mental Health Organizations

Abstract: The study analyzed the experience of the Los Angeles County Department of Mental Health with implementation of new contractual arrangements for services for patients with severe mental illness. The arrangements shifted the financial risk for treatment to community organizations and paid a fixed annual rate per enrolled patient without further adjustment for severity of illness. Patients were assigned to the program based on high prior treatment costs. The new contractual approach enhanced programs' flexibility and accountability and increased their emphasis on principles of psychosocial rehabilitation. Challenges in implementation included disenrollment of the majority of assigned patients by the community organizations at risk for high treatment costs. Prior treatment costs for continuing cases, while high, were lower than those for disenrolled cases. Existing information systems provided limited clinical and cost data, making it difficult to monitor providers' performance. Risk contracting required subs...

Value at risk: uses and abuses

Abstract: Value at risk (or “VAR”) is a method of measuring the financial risk of an asset, portfolio, or exposure over some specified period of time. By facilitating the consistent measurement of risk across different assets and activities, VAR allows companies to monitor, report, and control their risks in a manner that efficiently relates risk control to desired and actual economic exposures. Nevertheless, reliance on VAR can result in serious problems when improperly used, and would-be users of VAR are advised to consider the following three pieces of advice: ▪ First, VAR is a tool for firms engaged in total value risk management. Companies concerned not with the value of a stock of assets and liabilities over a specific time horizon, but rather with the volatility of a flow of funds, are often better off eschewing VAR altogether in favor of a measure of cash flow volatility. ▪ Second, VAR should be applied very carefully to companies that practice “selective” risk management those firms that choose to take certain risks as a part of their primary business. When VAR is reported in such situations without estimates of corresponding expected profits, the information conveyed by the VAR estimate can be extremely misleading. ▪ Third, as a number of recent derivatives disasters are used to illustrate, no form of risk measurement including VAR–is a substitute for good management. Risk management as a process encompasses much more than just risk measurement. Indeed, risk measurement (whether using VAR or some of the alternatives proposed in this article) is pointless without a well-developed organizational infrastructure and IT system capable of supporting the complex and dynamic process of risk taking and risk control.

The Cost of Conservatism: Extreme Returns, Value-at Risk, and the Basle Multiplicaiton Factor

Abstract: We argue that most current methodologies for value-at-risk (VaR) underestimate the VaR, and are therefore ill-suited for market risk capital. Better VaR methods are available, such as the tail-fitting method proposed here. However, financial institutions may be relctant to use those mehtods since current market risk regulations may, perversely, provide incentives for banks to underestimate the VaR.

The use of the preference disaggregation analysis in the assessment of financial risks

Abstract: Multicriteria decision aid (MCDA) provides several methodologies which are well adapted in the assessment of financial risks which are best studied from the sorting point of view. A well known approach in MCDA is based on preference disaggregation, which has already been used in ranking problems, but it is also applicable in sorting problems. Based on the preference disaggregation approach, this paper proposes a multicriteria methodology for the study of financial risks. The UTADIS method and two of its variants are presented, and their relative classi-fication ability in assessing financial risks is evaluated through five real world financial applications involving the prediction of corporate failure, the assessment of credit card applications, the assessment of credit risk, portfolio selection and country risk evaluation

Perceiving and Managing Business Risks: Differences between Entrepreneurs and Bankers

Abstract: Enquiring about the "risk propensity" of entrepreneurs is misguided, because all economic actors deal with risk and uncertainty. The success of entrepreneurs is tied closely to the way in which they perceive and manage risk. This study compares bankers and entrepreneurs in their cognitive approaches to solving problems involving a variety of risks; relevant is not risk propensity, but feelings of control and responsibility and personal values. Verbal think-aloud protocols were used to analyze the responses and thought processes of four bankers and four entrepreneurs in Pittsburgh, to a set of problems. Five problems were posed, involving financial risk, risk to human life and health, and risk of natural disaster. Content analysis identified five variables: ability to control possible returns to the decision; ability to control risks involved in the problem; factors internal to the firm; factors external to the firm; and personal considerations in the decision. The various problem spaces were defined as issues of risk, issues of control, or a function of values and personal responsibility. Entrepreneurs were found to accept risk and focus on controlling outcomes at any level of risk; they frame problem spaces with personal values and assume greater personal responsibility for affecting outcomes. Bankers use target outcomes as reference points; they attempt to control risk within existing structured problem spaces to avoid situations where they are exposed to higher levels of personal responsibility. (TNM)

Fundamentals of financial institutions management

Abstract: Part 1 Introduction: why are financial intermediaries special? financial markets - the fundamentals the financial services industry - depository institutions the financial services industry - insurance companies the financial services industry - security firms and investment banks the financial services industry - finance companies the financial services industry - mutual funds evaluating the performance of financial institutions risks of financial intermediation. Part 2 Measuring and managing risk on the balance sheet: credit risk - credit analysis and lending risk credit risk - loan portfolio risk loan sales and asset securitization liquidity risk liability and liquidity management deposit insurance and other liability guarantees capital adequacy management of interest rate risk - I management of interest rate risk - II market risk. Part 3 Managing risk off the balance sheet: off-balance sheet activities futures and forwards options swaps. Part 4 Measurements and management of other types of risk: operation cost and technology risk product diversification geographic expansion - domestic and international foreign exchange risk sovereign risk.

Risk diversity across restaurants: An empirical analysis

Abstract: Particular financial characteristics of a restaurant firm may be used to predict whether that company is a good investment risk.

Elements for a Theory of Financial Risks

Abstract: Estimating and controlling large risks has become one of the main concern of financial institutions This requires the development of adequate statistical models and theoretical tools (which go beyond the traditionnal theories based on Gaussian statistics), and their practical implementation Here we describe three interrelated aspects of this program: we first give a brief survey of the peculiar statistical properties of the empirical price fluctuations We then review how an option pricing theory consistent with these statistical features can be constructed, and compared with real market prices for options We finally argue that a true `microscopic' theory of price fluctuations (rather than a statistical model) would be most valuable for risk assessment A simple Langevin-like equation is proposed, as a possible step in this direction