Showing papers on "Financial risk published in 2007"

Banks' risk management: a comparison study of UAE national and foreign banks

Abstract: Purpose – The purpose of this research is to examine the degree to which the UAE banks use risk management practices and techniques in dealing with different types of risk. The secondary objective is to compare risk management practices between the two sets of banks.Design/methodology/approach – The authors developed a modified questionnaire, divided into two parts. The first part covers six aspects: understanding risk and risk management; risk identification; risk assessment and analysis; risk monitoring; risk management practices; and credit risk analysis. This part includes 43 closed‐ended questions based on an interval scale. The second part consists of two closed‐ended questions based on an ordinal scale dealing with two topics: methods of risk identification, and risks facing the sample banks.Findings – This study found that the three most important types of risk facing the UAE commercial banks are foreign exchange risk, followed by credit risk, then operating risk. It also found that the UAE banks ...

Financial Synergies and the Optimal Scope of the Firm: Implications for Mergers, Spinoffs, and Structured Finance

Abstract: Multiple activities may be separated financially, allowing each to optimize its financial structure, or combined in a firm with a single optimal financial structure. We consider activities with nonsynergistic operational cash flows, and examine the purely financial benefits of separation versus merger. The magnitude of financial synergies depends upon tax rates, default costs, relative size, and the riskiness and correlation of cash flows. Contrary to accepted wisdom, financial synergies from mergers can be negative if firms have quite different risks or default costs. The results provide a rationale for structured finance techniques such as asset securitization and project finance. DECISIONS THAT ALTER THE SCOPE of the firm are among the most important faced by management, and among the most studied by academics. Mergers and spinoffs are classic examples of such decisions. More recently, structured finance has seen explosive growth: Asset securitization exceeded $6.8 trillion in 2004, and Esty and Christov (2002) report that in 2001, more than half of capital investments with costs exceeding $500 million were financed on a separate project basis. 1 Ye tf inancial theory has made little headway in explaining structured finance. Positive or negative operational synergies are often cited as a prime motivation for decisions that change the scope of the firm. A rich literature addresses the roles of economies of scope and scale, market power, incomplete contracting, property rights, and agency costs in determining the optimal boundaries of the firm. 2 But operational synergies are difficult to identify in the case of asset securitization and structured finance.

Corporate credit risk modeling and the macroeconomy

Abstract: Despite a surge in the research efforts put into modeling credit and default risk during the past decade, few studies have incorporated the impact that macroeconomic conditions have on business defaults. In this paper, we estimate a duration model to explain the survival time to default for borrowers in the business loan portfolio of a major Swedish bank over the period 1994–2000. The model takes both firm-specific characteristics, such as accounting ratios and payment behaviour, loan-related information, and the prevailing macroeconomic conditions into account. The output gap, the yield curve and consumers’ expectations of future economic development have significant explanatory power for the default risk of firms. We also compare our model with a frequently used model of firm default risk that conditions only on firm-specific information. The comparison shows that while the latter model can make a reasonably accurate ranking of firms’ according to default risk, our model, by taking macro conditions into account, is also able to account for the absolute level of risk.

A technical guide

Abstract: This appraisal guide and its companion resource manual incorporate the latest microfinance knowledge and best practices to form a comprehensive guide that analysts can use to evaluate microfinance institutions (MFIs). This guide is primarily for funders and their qualified consultants who analyze the MFIs. This guide is organized in the form of an outline of a complete appraisal report. A complete report covers seven areas: Overview-summarizes the MFI's vision and mission, organizational strengths and weaknesses, and macroeconomic, political, and other external factors. Institution-describes the MFI's ownership and governance, organizational structure, regulation and supervision, management, external relationships, human resource management, information and communications technology, information availability and quality, internal controls, and external auditing. Products-analyze the MFI's voluntary savings, lending, and financial and non-financial products. Social performance-assesses how well the MFI translates its social goals into practice, looking at systems, outreach, and potential for achieving impact. Loan portfolio quality-reviews how the MFI measures, monitors, and manages its loan portfolio, including delinquency and write-offs. Financial performance and risk management-analyzes the MFI's financial performance, risk management, and financial ratios. Business planning-evaluates the MFI's strategic and business planning processes and financial projections.

New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability

Abstract: This paper proposes a new approach to improve the way central banks can analyze and manage the financial risks of a national economy It is based on the modern theory and practice of contingent claims analysis (CCA), which is successfully used today at the level of individual banks by managers, investors, and regulators The basic analytical tool is the risk-adjusted balance sheet, which shows the sensitivity of the enterprise's assets and liabilities to external "shocks" At the national level, the sectors of an economy are viewed as interconnected portfolios of assets, liabilities, and guarantees -- some explicit and others implicit Traditional approaches have difficulty analyzing how risks can accumulate gradually and then suddenly erupt in a full-blown crisis The CCA approach is well-suited to capturing such "non-linearities" and to quantifying the effects of asset-liability mismatches within and across institutions Risk-adjusted CCA balance sheets facilitate simulations and stress testing to evaluate the potential impact of policies to manage systemic risk

Risk-Constrained Bidding Strategy With Stochastic Unit Commitment

Abstract: This paper develops optimal bidding strategies based on hourly unit commitment in a generation company (GENCO) that participates in energy and ancillary services markets. The price-based unit commitment problem with uncertain market prices is modeled as a stochastic mixed integer linear program. The market price uncertainty is modeled using the scenario approach, Monte Carlo simulation is applied to generate scenarios, scenario reduction techniques are applied to reduce the size of the stochastic price-based unit commitment problem, and postprocessing is applied based on marginal cost of committed units to refine bidding curves. The financial risk associated with market price uncertainty is modeled using expected downside risk, which is incorporated explicitly as a constraint in the problem. Accordingly, the proposed method provides a closed-loop solution to devising specific strategies for risk-based bidding in a GENCO. Illustrative examples show the impact of market price uncertainty on GENCO's hourly commitment schedule and discuss the way GENCOs could decrease financial risks by managing expected payoffs

The determinants of forward‐looking information in annual reports of UAE companies

Abstract: Purpose – This paper aims to empirically explore the underlying factors that may affect the extent to which forward‐looking information is disclosed.Design/methodology/approach – This study uses a list of forward‐looking keywords to demonstrate the differences, if any, in the level of disclosure among firms and between sectors. The sample includes 46 companies listed in either the Dubai financial market or the Abu Dubai securities market. Statistical analysis is performed using a backward regression.Findings – Debt ratio and profitability are found to be significant; however, sector type, firm size, and auditor size are found to have insignificant association with the level of forward‐looking information disclosed in UAE annual reports.Practical implications – A number of users, such as investors, lenders, and auditors, may find these results beneficial. These users may consider the results of this study when they are dealing with firms that have low profitability and high financial risk. Accordingly, the...

Bank Ownership, Market Structure and Risk

Abstract: This paper presents a model of a banking industry with heterogeneous banks that delivers predictions on the relationship between banks' risk of failure, market structure, bank ownership, and banks' screening and bankruptcy costs. These predictions are explored empirically using a panel of individual banks data and ownership information including more than 10,000 bank-year observations for 133 non-industrialized countries during the 1993-2004 period. Four main results obtain. First, the positive and significant relationship between bank concentration and bank risk of failure found in Boyd, De Nicolo and Al Jalal (2006) is stronger when bank ownership is taken into account, and it is strongest when state-owned banks have sizeable market shares. Second, conditional on country and firm specific characteristics, the risk profiles of foreign (state-owned) banks are significantly higher than (not significantly different from) those of private domestic banks. Third, private domestic banks do take on more risk as a result of larger market shares of both state-owned and foreign banks. Fourth, the model rationalizes this evidence if both state-owned and foreign banks have either larger screening and/or lower bankruptcy costs than private domestic banks, banks' differences in market shares, screening or bankruptcy costs are not too large, and loan markets are sufficiently segmented across banks of different ownership.

Cost Overruns and Demand Shortfalls in Urban Rail and Other Infrastructure

Abstract: Risk, including economic risk, is increasingly a concern for public policy and management. The possibility of dealing effectively with risk is hampered, however, by lack of a sound empirical basis for risk assessment and management. This article demonstrates the general point for cost and demand risks in urban rail projects. The article presents empirical evidence that allow valid economic risk assessment and management of urban rail projects, including benchmarking of individual or groups of projects. Benchmarking of the Copenhagen Metro is presented as a case in point. The approach developed is proposed as a model for other types of policies and projects in order to improve economic and financial risk assessment and management in policy and planning.

Conflicts in Managed Care

Abstract: This article examines conflicts of interest in managed health care. It focuses on conflicts that arise due to physicians sharing financial risk, and case management and how these affect patient choice and informed consent. It suggests some ways to address these conflicts of interest.

Cost overruns and demand shortfalls in urban rail and other infrastructure

Abstract: Risk, including economic risk, is increasingly a concern for public policy and management. The possibility of dealing effectively with risk is hampered, however, by lack of a sound empirical basis for risk assessment and management. This article demonstrates the general point for cost and demand risks in urban rail projects. The article presents empirical evidence that allow valid economic risk assessment and management of urban rail projects, including benchmarking of individual or groups of projects. Benchmarking of the Copenhagen Metro is presented as a case in point. The approach developed is proposed as a model for other types of policies and projects in order to improve economic and financial risk assessment and management in policy and planning.

Financial Risk Management for Islamic Banking and Finance

Abstract: Principles of Islamic Finance Risk Management Issues in Islamic Financial Contracts Basel II& IFSB for Islamic Financial Risk Market Risk in Islamic Finance Credit Risk in Islamic Finance Operational Risk in Islamic Finance Concluding Remarks

Introduction to Applied Stress Testing

Abstract: Stress testing is a useful and increasingly popular, yet sometimes misunderstood, method of analyzing the resilience of financial systems to adverse events. This paper aims to help demystify stress tests, and illustrate their strengths and weaknesses. Using an Excel-based exercise with institution-by-institution data, readers are walked through stress testing for credit risk, interest rate and exchange rate risks, liquidity risk and contagion risk, and are guided in the design of stress testing scenarios. The paper also describes the links between stress testing and other analytical tools, such as financial soundness indicators and supervisory early warning systems. Furthermore, it includes surveys of stress testing practices in central banks and the IMF.

Are the Fama-French Factors Proxying Default Risk?

Abstract: In this paper we investigate the contention that the Fama-French (1993) model's ability to explain cross-sectional variation in equity returns occurs because the Fama-French factors, SMB and HML, are proxying for default risk. To assess the default risk hypothesis, we augment the CAPM and the Fama-French model with a default factor and run system regressions of the default enhanced models using the GMM approach. Our key findings are that: 1) default risk is not priced in equity returns; and, 2) the Fama-French factors are not proxying for default risk. Although our findings suggest that SMB and HML are not proxying for default risk, our analysis indicates that the Fama-French factors are capturing some form of priced risk. However, what type of risk the Fama-French factors are capturing remains an open question.

How Does Financial Globalization Affect Risk Sharing? Patterns and Channels

Abstract: In theory, one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing. This paper provides a comprehensive empirical evaluation of the patterns of risk sharing among different groups of countries and examines how international financial integration has affected the evolution of these patterns. Using a variety of empirical techniques, we conclude that there is at best a modest degree of international risk sharing, and certainly nowhere near the levels predicted by theory. In addition, only industrial countries have attained better risk sharing outcomes during the recent period of globalization. Developing countries have, by and large, been shut out of this benefit. The most interesting result is that even emerging market economies, which have experienced large increases in cross-border capital flows, have seen little change in their ability to share risk. We find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefit of financial globalization. In particular, our results suggest that portfolio debt, which has dominated the external liability stocks of most emerging markets until recently, is not conducive to risk sharing.

Modelling Transparency in Disclosure: The Case of Foreign Exchange Risk Management

Abstract: When managers choose not to disclose all the relevant information in their possession in their financial statements, there is an information gap between the managers and users and consequently a lack of transparency We model the degree of transparency observed when disclosures of foreign exchange (FX) risk management in financial statements are compared to managerial information on FX risk management policy, as evidenced in questionnaire responses In this comparative study of US and UK firms we find incomplete disclosure in both samples but with differing aspects In the US case, the information gap is lower where the information has higher relevance or firms with higher financial risk (greater leverage) are signalling the extent of risk, but the gap is greater where firms are in competitive product markets For the UK sample, the information gap is significantly lower where firms have higher financial risk or higher liquidity but the gap is greater where the shares are more closely held We conclude that modelling and explaining this aspect of incomplete accounting disclosure in an international setting must be sufficiently flexible to accommodate national differences in managerial behaviour

Market-Consistent Actuarial Valuation

Abstract: Introduction- Stochastic discounting- Valuation portfolio in life insurance- Financial risks- Valuation portfolio in non-life insurance- Selected topics

The Risks of Financial Institutions

Abstract: Until about twenty years ago, the consensus view on the cause of financial-system distress was fairly simple: a run on one bank could easily turn to a panic involving runs on all banks, destroying some and disrupting the financial system. Since then, however, a series of events such as emerging-market debt crises, bond-market meltdowns, and the Long-Term Capital Management episode has forced a rethinking of the risks facing financial institutions and the tools available to measure and manage these risks. "The Risks of Financial Institutions" examines the various risks affecting financial institutions and explores a variety of methods to help institutions and regulators more accurately measure and forecast risk. The contributors--from academic institutions, regulatory organizations, and banking--bring a wide range of perspectives and experience to the issue. The result is a volume that points a way forward to greater financial stability and better risk management of financial institutions."

How Does Financial Globalization Affect Risk Sharing? Patterns and Channels

Abstract: In theory, one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing. In this paper, we provide a comprehensive empirical evaluation of the patterns of risk sharing among different groups of countries and examine how international financial integration has affected the evolution of risk sharing patterns. Using a variety of empirical techniques, we conclude that there is at best a modest degree of international risk sharing, and certainly nowhere near the levels predicted by theory. In addition, only industrial countries have attained better risk sharing outcomes during the recent period of globalization. Developing countries have, by and large, been shut out of this benefit. The most interesting result is that even emerging market economies, which have witnessed large increases in cross-border capital flows, have seen little change in their ability to share risk. We find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefit of financial globalization. In particular, our results suggest that portfolio debt, which has dominated the external liability stocks of most emerging markets until recently, is not conducive to risk sharing.

Strong Evidence for Gender Differences in Investment

Abstract: Are men more willing to take financial risks than women? The answer to this important question is not clear from the existing literature. We propose a novel approach to this issue, in which we both assemble the data from many experiments with thousands of participants in a simple investment game, and also conduct our own experiments. The previous experiments were not designed to investigate a gender difference and were conducted by different researchers in different countries, with different instructions, durations, payments, subject pools, etc. We find a very consistent result that women invest less, and thus appear to be more risk averse than men in their financial investments.

The Equity Premium Puzzle: A Review

Abstract: Introduction Empirical Facts Is the Equity Premium a Premium for Bearing Non-diversifiable Risk? Risk Based Explanations of the Equity Premium Non-risk Based Explanations of the Equity Premium Concluding Comments References

What Makes a Stock Risky? Evidence from Sell-Side Analysts' Risk Ratings

Abstract: We examine the determinants and the informativeness of financial analysts' risk ratings using a large sample of research reports issued by Salomon Smith Barney, now Citigroup, over the period 1997-2003. We find that the crosssectional variation in risk ratings is largely explained by variables commonly viewed as measures of risk, such as idiosyncratic risk, size, book-to-market, and leverage. In addition, earnings-based measures of risk, such as earnings quality and accounting losses, also contribute to explaining the cross-sectional variation in the risk ratings. Finally, we document that the risk ratings can be used to predict future return volatility after controlling for other predictors of future volatility. We conclude that analysts play an important role as providers of information about investment risk.

Method and system to improve engineered system decisions and transfer risk

Abstract: A method and system are provided to improve industrial engineered systems such as oil well drilling decisions and transfer risk. The method and system each include an interactive decision-support planning tool that aids a user as to how to select a portfolio of engineered systems and entities that the systems will process such as aircraft engines and flights, rigs and reserves, apparatus configuration, apparatus inspection, apparatus on line sensors, dynamic operations decisioning for the apparatus and drill path or asset dispatching and a contractual incentive to allocate risks to stakeholders best positioned to abate them. The decision support will reduce a fleet's financial risk associated with the cost of operations below that achievable without using the interactive decision-support planning tool and/or increase financial return associated with the cost of activity above that achievable without using the interactive decision-support planning tool, such that the financial risk and/or financial return are allocated in a desired manner among a plurality of operations stakeholders.

Medical Expenditure Risk and Household Portfolio Choice

Abstract: Medical expenses are an increasingly important contributor to household financial risk. We examine the effect of medical expenditure risk on the willingness of Medicare beneficiaries to hold risky assets. Using a discrete factor maximum likelihood method to address the endogeneity of insurance choices, we find that having a moderately protective Medigap or employer supplemental policy increases risky asset holding by 7.1 percentage points relative to those without supplemental coverage, while participation in a highly protective Medicare HMO increases risky asset holding by 13.0 percentage points. Our results highlight an important link between the availability of health insurance and financial behavior.

Handling Weather Related Risks Through the Financial Markets: Considerations of Credit Risk, Basis Risk, and Hedging

Abstract: The profits of many businesses are strongly affected by weather related events, and insurance against weather related risks (acts of God) has been a traditional domain for transfer of (certain) of these risks. Recent innovations in the capital market have now provided financial instruments to transfer and hedge some of these risks. Unlike insurance solutions, however, using these financial derivative instruments creates a situation in which the return to the purchaser of the instrument is no longer perfectly correlated with the loss experienced. Such a mismatch creates new risks which must be examined and evaluated as part of ascertaining cost effective risk management plans. Two newly engendered risks, basis risk (the risk created by the fact that the return from the financial derivative is a function of weather at a prespecified geographical location which may not be identical to the location of the firm) and credit risk (the risk that the counterparty to the derivative contract may not perform), are analyzed in this article. Using custom tailored derivatives from the over the counter market can decrease basis risk, but increases credit risk. Using standardized exchange traded derivatives decreases credit risk but increases basis risk. Here also the effectiveness of using hedging methods involving forwards and futures having linear payoffs (linear hedging) and methods using derivatives having nonlinear payoffs such as those involving options (nonlinear hedging) for the purpose of hedging basis risk are examined jointly with credit risk.