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Article
Publication date: 21 August 2017

Mariya Gubareva and Maria Rosa Borges

The purpose of this paper is to study connections between interest rate risk and credit risk and investigate the inter-risk diversification benefit due to the joint consideration…

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Abstract

Purpose

The purpose of this paper is to study connections between interest rate risk and credit risk and investigate the inter-risk diversification benefit due to the joint consideration of these risks in the banking book containing sovereign debt.

Design/methodology/approach

The paper develops the historical derivative-based value at risk (VaR) for assessing the downside risk of a sovereign debt portfolio through the integrated treatment of interest rate and credit risks. The credit default swaps spreads and the fixed-leg rates of interest rate swap are used as proxies for credit risk and interest rate risk, respectively.

Findings

The proposed methodology is applied to the decade-long history of emerging markets sovereign debt. The empirical analysis demonstrates that the diversified VaR benefits from imperfect correlation between the risk factors. Sovereign risks of non-core emu states and oil producing countries are discussed through the prism of VaR metrics.

Practical implications

The proposed approach offers a clue for improving risk management in regards to banking books containing government bonds. It could be applied to access the riskiness of investment portfolios containing the wider spectrum of assets beyond the sovereign debt. The approach represents a useful tool for investigating interest rate and credit risk interrelation.

Originality/value

The proposed enhancement of the traditional historical VaR is twofold: usage of derivative instruments’ quotes and simultaneous consideration of the interest rate and credit risk factors to construct the hypothetical liquidity-free bond yield, which allows to distil liquidity premium.

Details

The Journal of Risk Finance, vol. 18 no. 4
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 1 February 2004

KEVIN DOWD, DAVID BLAKE and ANDREW CAIRNS

One of the most significant recent developments in the risk measurement and management area has been the emergence of value at risk (VaR). The VaR of a portfolio is the maximum…

Abstract

One of the most significant recent developments in the risk measurement and management area has been the emergence of value at risk (VaR). The VaR of a portfolio is the maximum loss that the portfolio will suffer over a defined time horizon, at a specified level of probability known as the VaR confidence level. The VaR has proven to be a very useful measure of market risk, and is widely used in the securities and derivatives sectors: a good example is the RiskMetrics system developed by J.P. Morgan. VaR measures based on systems such as RiskMetrics' sister, CreditMetrics, have also shown their worth as measures of credit risk, and for dealing with credit‐related derivatives. In addition, VaR can be used to measure cashflow risks and even operational risks. However, these areas are mainly concerned with risks over a relatively short time horizon, and VaR has had a more limited impact so far on the insurance and pensions literatures that are mainly concerned with longer‐term risks.

Details

The Journal of Risk Finance, vol. 5 no. 2
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 15 June 2018

Nafis Alam, Muhammad Bhatti and James T.F. Wong

The purpose of this paper is to investigate the default characteristics of Sukuk issues by corporate firms in Malaysia using value-at-risk (VaR) techniques over a period of 16…

1015

Abstract

Purpose

The purpose of this paper is to investigate the default characteristics of Sukuk issues by corporate firms in Malaysia using value-at-risk (VaR) techniques over a period of 16 years from 2000 to 2015 and across nine economic sectors.

Design/methodology/approach

The paper employs non-parametric and Monte Carlo simulations to estimate Sukuk defaults.

Findings

The authors analyses revealed that the VaR predictions were fairly consistent with the ratings provided by credit rating agencies, despite the limited tradability of Sukuk in the secondary market. The study was able to demonstrate that Sukuk is not riskier than conventional bonds in the Malaysian context.

Research limitations/implications

The research findings suggested that VaR values will depend on the fundamental value of a firm based on the considerations of market, credit and operational risk. It does not rely on the type of debt instrument, whether a Sukuk or conventional bonds.

Practical implications

The use of Sukuk along with conventional bonds as debt instruments creates opportunities for investors and bond issuers globally.

Originality/value

Although Sukuk has generated much interest among financial market players, studies are lacking on how to predict Sukuk defaults and whether Sukuk has the same risk profile compared to conventional bonds.

Details

Managerial Finance, vol. 44 no. 6
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 13 November 2009

Robert Sollis

A misplaced reliance on value at risk (VaR) has been focused on in the media as one of the main reasons for the current financial crisis, and the recently published Turner Review

3739

Abstract

Purpose

A misplaced reliance on value at risk (VaR) has been focused on in the media as one of the main reasons for the current financial crisis, and the recently published Turner Review by the UK Financial Services Authority concurs. The purpose of this paper is to present an introductory overview of VaR and its weaknesses which will be easily understood by non‐technical readers.

Design/methodology/approach

Simple numerical examples utilising real and simulated data are employed to reinforce the main arguments.

Findings

This paper explains that some of the main approaches employed by banks for computing VaR have serious weaknesses. These weaknesses have contributed to the current financial crisis.

Research limitations/implications

Consistent with the introductory nature of this paper, the empirical research is limited to simple examples.

Practical implications

The evidence here suggest that if VaR is to play a major role under future financial regulation then research is required to develop improved estimation techniques and backtesting procedures.

Originality/value

This paper differs from many academic papers on VaR by assuming only a very basic knowledge of mathematics and statistics.

Details

Journal of Financial Regulation and Compliance, vol. 17 no. 4
Type: Research Article
ISSN: 1358-1988

Keywords

Article
Publication date: 1 February 2003

HELMUT MAUSSER

Quantile‐based measures of risk, e.g., value at risk (VaR), are widely used in portfolio risk applications. Increasing attention is being directed toward managing risk, which…

Abstract

Quantile‐based measures of risk, e.g., value at risk (VaR), are widely used in portfolio risk applications. Increasing attention is being directed toward managing risk, which involves identifying sources of risk and assessing the economic impact of potential trades. This article compares the performance of two quantile‐based VaR estimators commonly applied to assess the market risk of option portfolios and the credit risk of bond portfolios.

Details

The Journal of Risk Finance, vol. 4 no. 3
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 1 April 2001

NORBERT J. JOBST and STAVROS A. ZENIOS

Tails probabilities are of paramount importance in shaping the risk profile of portfolios with credit risk sensitive securities. In this context, risk management tools require…

Abstract

Tails probabilities are of paramount importance in shaping the risk profile of portfolios with credit risk sensitive securities. In this context, risk management tools require simulations that accurately capture the tails, and optimization models that limit tail effects. Ignoring tail events in the simulation or using inadequate optimization metrics can have significant effects and reduce portfolio efficiency. The resulting portfolio risk profile can be grossly misrepresented when long‐run performance is optimized without accounting for short‐term tail effects. This article illustrates pitfalls and suggests models to avoid them.

Details

The Journal of Risk Finance, vol. 3 no. 1
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 1 September 2006

Thomas Breuer

Maximum Loss was one of the risk measures proposed as alternatives to Value at Risk following criticism that Value at Risk is not coherent. Although the power of Maximum Loss is…

Abstract

Purpose

Maximum Loss was one of the risk measures proposed as alternatives to Value at Risk following criticism that Value at Risk is not coherent. Although the power of Maximum Loss is recognised for non‐linear portfolios, there are arguments that for linear portfolios Maximum Loss does not convey more information than Value at Risk. This paper argues for the usefulness of Maximum Loss for both linear and non‐linear portfolios.

Design/methodology/approach

This is a synthesis of existing theorems. Results are established by means of counterexamples. The worst case based risk‐return management strategy is presented as a case study.

Findings

For linear portfolios under elliptic distributions Maximum Loss is proportional to Value at Risk, and to Expected Shortfall, with the proportionality constant not depending on the portfolio composition. The paper gives a new example of Value at Risk violating subadditivity, using a portfolio of simple European options. For non‐linear portfolios, Maximum Loss need not even approximately be explained by the sum of Maximum Loss contributions of the individual risk factors. Finally, is proposed a strategy of risk‐return management with Maximum Loss.

Research limitations/implications

The paper is restricted to elliptically distributed risk factors. Although Maximum Loss can be defined for more general continuous and even discrete distributions of risk factor changes, the paper does not address this matter.

Practical implications

The paper proposes an intuitive, computationally easy way how to improve average returns of linear portfolios while reducing worst case losses.

Originality/value

One is a synthesis of existing theorems. The counterexample establishing result is the first example of a portfolio of plain vanilla options violating Value at Risk subadditivity, an effect hitherto only known for portfolios of exotic options. Furthermore, the strategy of risk‐return management with Maximum Loss is original.

Details

Managerial Finance, vol. 32 no. 9
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 31 May 2021

Sebastian Schlütter

This paper aims to propose a scenario-based approach for measuring interest rate risks. Many regulatory capital standards in banking and insurance make use of similar approaches…

Abstract

Purpose

This paper aims to propose a scenario-based approach for measuring interest rate risks. Many regulatory capital standards in banking and insurance make use of similar approaches. The authors provide a theoretical justification and extensive backtesting of our approach.

Design/methodology/approach

The authors theoretically derive a scenario-based value-at-risk for interest rate risks based on a principal component analysis. The authors calibrate their approach based on the Nelson–Siegel model, which is modified to account for lower bounds for interest rates. The authors backtest the model outcomes against historical yield curve changes for a large number of generated asset–liability portfolios. In addition, the authors backtest the scenario-based value-at-risk against the stochastic model.

Findings

The backtesting results of the adjusted Nelson–Siegel model (accounting for a lower bound) are similar to those of the traditional Nelson–Siegel model. The suitability of the scenario-based value-at-risk can be substantially improved by allowing for correlation parameters in the aggregation of the scenario outcomes. Implementing those parameters is straightforward with the replacement of Pearson correlations by value-at-risk-implied tail correlations in situations where risk factors are not elliptically distributed.

Research limitations/implications

The paper assumes deterministic cash flow patterns. The authors discuss the applicability of their approach, e.g. for insurance companies.

Practical implications

The authors’ approach can be used to better communicate interest rate risks using scenarios. Discussing risk measurement results with decision makers can help to backtest stochastic-term structure models.

Originality/value

The authors’ adjustment of the Nelson–Siegel model to account for lower bounds makes the model more useful in the current low-yield environment when unjustifiably high negative interest rates need to be avoided. The proposed scenario-based value-at-risk allows for a pragmatic measurement of interest rate risks, which nevertheless closely approximates the value-at-risk according to the stochastic model.

Details

The Journal of Risk Finance, vol. 22 no. 1
Type: Research Article
ISSN: 1526-5943

Keywords

Book part
Publication date: 29 December 2016

Alberto Burchi and Duccio Martelli

The recent 2008–2009 financial crisis has led international financial authorities to review the existing regulation; the Basel Committee on Banking Supervision has been thus…

Abstract

The recent 2008–2009 financial crisis has led international financial authorities to review the existing regulation; the Basel Committee on Banking Supervision has been thus induced to review the pillars of the Basel Accord (Basel II) in order to strengthen the risk coverage of capital framework (Basel 2.5 and III). These reforms will help to raise capital requirements for the trading book, which represents a major source of losses for internationally financial institutions, especially during crisis periods. In particular, the Committee has introduced a Stressed Value-at-Risk (SVaR) capital requirement, as a new methodology to evaluate market risk.

This chapter aims to shed some lights on the issues major banks have to face when calculating SVaR in the context of emerging markets, pointing out the differences in adopting an estimation model with respect to another one. Our results show a considerable increase in capital requirements especially when new rules are applied to financial markets with high-risk parameters, such as emerging markets are. The increased cost due to higher capital requirements could be a disincentive to investment in markets with higher risk profiles than the developed markets, taking also into account that diversification benefits deriving from investing in emerging economies have shown a decrease over time. The reduction of institutional investors can thus represent a brake on the process of innovation and evolution of emerging markets.

Details

Risk Management in Emerging Markets
Type: Book
ISBN: 978-1-78635-451-8

Keywords

Article
Publication date: 1 March 2002

CLAUDIO ALBANESE, KEN JACKSON and PETTER WIBERG

Regulators require banks to employ value‐at‐risk (VaR) to estimate the exposure of their trading portfolios to market risk, in order to establish capital requirements. However…

Abstract

Regulators require banks to employ value‐at‐risk (VaR) to estimate the exposure of their trading portfolios to market risk, in order to establish capital requirements. However, portfolio‐level VaR analysis is a high‐dimensional problem and hence computationally intensive. This article presents two new portfolio‐based approaches to reducing the dimensionality of the VaR analysis.

Details

The Journal of Risk Finance, vol. 3 no. 4
Type: Research Article
ISSN: 1526-5943

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