Market Risk Exposure Research Articles

Effect of operational and market risk exposures on financial performance of DT-Saccos in Kenya

The main aim of the investigation was to analyze the effect of operational and market risk exposures on the financial performance of DT-SACCOs in Kenya. The specific objectives of the study were to; assess the effect of operating expense risk exposure on the financial performance of DT-SACCOs in Kenya; To establish the effect of operation efficiency risk exposure on the financial performance of DT-SACCOs in Kenya; Effect of interest rate risk exposure on the financial performance of DT-SACCOs in Kenya; Effect of foreign exchange rate risk exposure on the financial performance of DT-SACCOs in Kenya. Effect of operational and market risk exposure on the financial performance of DT-SACCOs in Kenya. The study used panel data between the years 2010-2019 which was 10 years period. The results revealed that at both bivariate and multivariate regression operating expense risk, operating efficiency and foreign exchange risk exposure had a significant effect on the financial performance of DT-SACCOs in Kenya. Only interest rate risk exposure did not have a significant effect on the financial performance of DT-SACCOs in Kenya.

Did COVID-19 increase equity market risk exposure? Evidence from China, the UK, and the US

ABSTRACT By studying equity market returns to China, the UK, and the US, we explore the key question of whether the COVID-19 pandemic changes the risk exposure of equity markets, which is fundamental to market stability and investor confidence. Using data from the World Health Organization and Bloomberg, our full sample covers the period 3 July 2019 to 15 December 2020 which facilities a subsample (Normal, Shock, Endurance) analysis. Utilizing Value-at-Risk (VaR) metrics as our risk exposure measure, we find that 1) There exists a sharp increase in equity market risk exposure across the three equity markets. 2) A stronger pandemic impact is found in different market capitalization segments – China, large-cap; the UK, small-cap; the US, mid-cap. 3) Generally, investors consider the number of new cases as a more worrying factor than deaths while UK investors are sensitive to both. Our observations suggest that given limited resources but rising demands from both businesses and households for government assistance, a one-size-fits-all policy to support market recovery would be sub-optimal.

Asset Allocation with Liquidity-Adjusted Market Risk Modeling: Empirical Relevance to Multiple-Asset Portfolios

In this paper, the author demonstrate a practical approach for measurement, management and control of market risk exposure for financial trading portfolios. This approach is based on the renowned concept of Liquidity-Adjusted Value at Risk (L-VaR) along with the creation of a software tool utilizing matrix-algebra technique under the notion of different correlation factors and liquidation horizons.

On the Evaluation of LVaR During the Closeout Liquidity Horizon

In this paper, we launch a practical modus-operandi for the assessment of potential market risk exposures for financial trading portfolios by providing an investment management perspective from the 2007-2009 global financial crisis. This proposed tactic is based on the renowned concept of Liquidity-Adjusted Value-at-Risk (LVaR) along with the innovation of a risk-engine algorithm that can estimate LVaR for both long and short-sales positions.

Measuring Market Risk of Commercial Banks Implementing VaR with Historical Simulation Approach

This paper attempts to picture the impact of the market risk of ten commercial banks located in Bangladesh with the help of a non-parametric model known as the Historical Simulation Approach over the course of eight years. These banks' daily stock prices were used as inputs and analyzed in Microsoft Excel by means of Percentile and LN function. The study revealed market risk exposure as third, second-and first-generation banks from the least to the highest. It also pointed out the ups and downs of these banks' share prices in the selected period. Further analysis showed the portfolio VaR estimation for different time intervals. JEL classification numbers: G32. Keywords: Value-at-risk, Historical Simulation, Market Risk, Confidence Interval.

Risk management with expected shortfall

This article studies optimal, dynamic portfolio and wealth/consumption policies of expected utility-maximizing investors who must also manage market-risk exposure which is measured by expected shortfall (ES). We find that ES managers can incur larger losses when losses occur, compared to benchmark managers. A general-equilibrium analysis reveals that the presence of ES managers increases the market volatility during periods of significant financial market stress. We propose weighted shortfall, a coherent and moreover spectral risk measure, that can rectify the shortcomings of ES.

Measuring risk exposure in the banking sectors: evidence from Gulf Cooperation countries

PurposeUsing capital asset pricing model (CAPM) and the Z-risk index based on weekly data, this study aims to estimate yearly unsystematic, total, three systematic and insolvency risks in the Gulf Cooperation Council (GCC) countries for the period 2010–2018. The findings of CAPM show positive systematic market risk exposure in all GCC countries for all years, which support the contribution of stock markets to bank prices and returns. The mixed signs of systematic interest rate and exchange rate risks in GCC countries provide hedging opportunities, diversification strategies and regional cooperation, which help risk managers to hedge and stabilize their portfolios against interest rate and exchange rate fluctuations. Therefore, it is necessary that managers and policymakers develop a monitoring system on factors affecting bank insolvency risks to avoid bankruptcies and insolvencies.Design/methodology/approachThis study uses the three-factor CAPM and Z-risk index to measure six types of risks. The CAPM uses market information to estimate the sensitivity of banks to the fluctuations of equity markets, debt markets and foreign exchange markets. Sharpe (1964), Lintner (1965) and Treynor (1965) developed a single-factor CAPM and the coefficient of the model was called systematic market risk. The single-factor CAPM highlights stock markets as the only non-diversifiable source of systematic risks, whereas Stone (1974) and Jorion (1990) highlighted interest rate and exchange rate fluctuations as the other types of non-diversifiable systematic risks. The following functional form in equation (1) estimates five types of risks using CAPM.FindingsThe findings of CAPM show positive systematic market risk exposure in all GCC countries for all years, which support the contribution of stock markets to bank prices and returns based on CAPM theory. The mixed signs of systematic interest rate and exchange rate risks in GCC countries support hedging opportunities and diversification strategies which may help risk managers to hedge and stabilize their portfolios against the fluctuations of interest rate and exchange rate. Although, this policy may decrease the profits of banking sectors but at the same time it would stabilize the portfolios and prevent bankruptcies and big losses because of the fluctuations of interest rate. Moreover, a bank has a better chance to have more liquidity position during financial crises because of the diversifications into different regional markets.Research limitations/implicationsTherefore, this study contributes to the existing literature by using risk measurement by a three-factor CAPM and the Z-risk index as discussed further in methodology.Originality/valueIt is necessary that managers and policymakers develop a monitoring system on factors affecting bank insolvency risks to avoid bankruptcies and insolvencies.

Cross-sectional Variation of Option Implied Volatility Skew

The slope of the option implied volatility plot against the strike reflects the risk-neutral skewness of the underlying security's conditional return distribution. We identify two principal risk sources that contribute to the cross-sectional variation of individual stock options' implied volatility skew: the market risk exposure of the stock's return and the company's default risk. Once controlled for these two risk exposures and the implied volatility level, the remaining idiosyncratic variation of the implied volatility skew reflects more of investor expectation and sentiment on the stock's future price movement and can be used to predict future stock returns with more accuracy.

Estimating beta: The international evidence

Abstract This paper examines the estimation of global and local betas for a large set of Developed and Emerging international markets. Estimators based on daily data clearly outperform those based on monthly or quarterly data. For global and local market betas, the optimal window length is at roughly 24 and 12 months, respectively, for most Developed Markets. It tends to be somewhat longer for Emerging Markets. The best estimators include a double-shrinkage, a long memory (FI), and a simple combination approach. For hedging the market risk exposure in anomaly portfolios, the FI and combination estimators also perform overall best.

Least Quartic Regression Criterion to Evaluate Systematic Risk in the Presence of Co-Skewness and Co-Kurtosis

This article proposes a new method for the estimation of the parameters of a simple linear regression model which is based on the minimization of a quartic loss function. The aim is to extend the traditional methodology, based on the normality assumption, to also take into account higher moments and to provide a measure for situations where the phenomenon is characterized by strong non-Gaussian distribution like outliers, multimodality, skewness and kurtosis. Although the proposed method is very general, along with the description of the methodology, we examine its application to finance. In fact, in this field, the contribution of the co-moments in explaining the return-generating process is of paramount importance when evaluating the systematic risk of an asset within the framework of the Capital Asset Pricing Model. We also illustrate a Monte Carlo test of significance on the estimated slope parameter and an application of the method based on the top 300 market capitalization components of the STOXX® Europe 600. A comparison between the slope coefficients evaluated using the ordinary Least Squares (LS) approach and the new Least Quartic (LQ) technique shows that the perception of market risk exposure is best captured by the proposed estimator during market turmoil, and it seems to anticipate the market risk increase typical of these periods. Moreover, by analyzing the out-of-sample risk-adjusted returns we show that the proposed method outperforms the ordinary LS estimator in terms of the most common performance indices. Finally, a bootstrap analysis suggests that significantly different Sharpe ratios between LS and LQ yields and Value at Risk estimates can be considered more accurate in the LQ framework. This study adds insights into market analysis and helps in identifying more precisely potentially risky assets whose extreme behavior is strongly dependent on market behavior.

A real options based decision support tool for R&D investment: Application to CO2 recycling technology

We propose a practice relevant real options based decision support tool to aid in the practical evaluation of R&D investments in technology. Using a Poisson process to simulate the discrete progress typical of advancements in R&D, we take explicit account of the technical risk of the technology development, while market risk exposure and the effect of learning-by-doing through operating the technology is also explicitly modelled. We present a compound real option design, where a European real option structure is used to model the fixed length term typical of early phase research, which is exercisable into an American real option structure to model a subsequent phase R&D. In this latter phase, a successful outcome is acted upon immediately to operationalise the technology. We propose a simulation approach, which models R&D progress in a stylised logistic function or ’S-shape’ form, capturing the typically slow rate of R&D progress at the start of the early phase, through to more rapid improvement as the R&D advances, which then slows again as the limitations of the R&D are approached. We propose a business appropriate and workable economic meaning to this progress in the R&D process. We demonstrate the decision support tool with an application to evaluating the R&D investment potential in CO2 recycling technology, where an energy commodity is produced.

Private Real Estate Returns, Style Drift, and Procyclical Risk Taking

This paper documents that development exposure is an important determinant of private real estate returns and market risk exposure. It also documents that open-end private real estate funds have time-varying, procyclical market risk exposure through their development activities. As such, these funds are disproportionately exposed to the downside of the market cycle. Lastly, I find that fund flow pressure is the primary driver of time-varying development exposure. Funds buy a higher proportion of safe, liquid assets compared to risky, illiquid assets when they have larger unfulfilled subscriptions. While this increases assets under management quicker, it also hurts existing investors by decreasing their market risk exposure at the time when it is the most desirable and beneficial. Additionally, funds stop developing as redemption requests increase, leading to lower market risk exposure when the market recovers.

Research on Dynamic Evolution of Systemic Risk in Chinese Banking System

Systemic risk is not only related to the contagious risk of interbank market risk exposure, but also to the credit risk exposure. At the same time, the dynamic characteristics of banking system also affect the systemic risk. A large number of studies have revealed the contagious risk of interbank market risk exposure, but the systematic risk research that considers these factors at the same time is still rare. Therefore, the present paper constructs dynamically evolving banking systemic risk assessment model under double risk exposures in the same framework that includes two parts: one is the assessment of credit risk; the other is the contagious risk. On the assessment of credit risk, we use Geometric Brownian Motion in physics and Monte Carlo simulation calculation method based on the big data of the stock market. On the assessment of contagious risk, we use the method of Geometric Brownian Motion in physics and minimum density method. Then we use data of 205 Banks and 3,017 listed companies in 18 industries in Chinese to study the dynamic evolution law of the Chinese banking systemic risk. The results show that the evolution characteristics of credit risk of 18 real industries can be divided into 4 types which are stability after decline, increase in fluctuation, decrease in fluctuation, and fluctuation. The systemic risk of Chinese banking system with the double risk exposures gradually increased with the evolution of time, and then stabilized at a certain degree. Among them, the initial increase of contagious risk is fast, and then stable; the credit risk starts small, slowly increases, and eventually stabilizes. The evolution degree of contagious risk is higher than that of credit risk. Large banks have the strongest ability to withstand the impact of double risk exposures, while foreign banks have the weakest.

Estimating Beta: The International Evidence

This paper examines the estimation of global and local betas for a large set of Developed and Emerging international markets. Estimators based on daily data clearly outperform those based on monthly or quarterly data. For global and local market betas, the optimal window length is at roughly 24 and 12 months, respectively, for most Developed Markets. It tends to be somewhat longer for Emerging Markets. The best estimators include a double-shrinkage, a long memory (FI), and a simple combination approach. For hedging the market risk exposure in anomaly portfolios, the FI and combination estimators also perform overall best.

The Present-Value Model of the Exchange Rate with a Persistently Time-Varying Risk Premium: Evidence from the Dollar-Yen Rate

In this study, I formulate a present value model of the exchange rate with a risk premium and introduce exchange rate risk exposure as a factor of the persistently time-varying risk premium. The present value model incorporates expectations for the distant future, and therefore, indicates that spot exchange rate variations reflect changes in long-run future interest rate differential and exchange rate expectations, in addition to a risk premium for long-run risk exposure. I also conduct empirical analyses using mainly the USD/JPY rate and other exchange rates against the USD. The Japanese current account balance provides a better estimation of the change in USD/JPY rate market risk exposure as USD invoiced trades are prevalent in Japan. Then, I demonstrate the possibility that a persistently time-varying risk premium offsets the effect of the interest rate differential on exchange rate variations, which can be a solution to the uncovered interest rate parity puzzle.

Explaining inclusivity in energy transitions: Local and community energy in Aotearoa New Zealand

International literature on citizen, local and community energy (LCE) has grown exponentially but has focussed on European and North American context. This paper contributes to understanding inclusivity in country-specific energy transition pathways, setting out an empirical analysis of grassroots energy innovation practices in a country that has to date followed an incumbent-led energy transition pathway – Aotearoa (New Zealand). A groundswell of emerging LCE initiatives face protracted feasibility stages and high failure rates, primarily due to lack of market access and risk exposure, and a lack of policy co-ordination and streamlining, with no popularised articulation of a collective energy transition strategy as such. Barring changes in discourse, regulation, and institutional arrangements, future LCE development is likely to be oriented primarily to accommodate utility-scale renewable energy through energy efficiency and demand side management. Within this unsupportive regime context however, we observe uniquely resourced forms of LCE, and identify strategies and policies for a more inclusive pathway. Our findings reveal the limits of grassroots agency and the dependence of wider diffusion of LCE on an enabling institutional context, suggesting there are understudied transition pathways in which opportunities for LCE are relatively constrained.

Volume Dynamics around FOMC Announcements

The stock market volume decreases in anticipation of FOMC announcements and increases afterward. I find, in the cross-section, that stocks with higher market risk exposure experience greater volume changes. I also find that volume dynamics around FOMC announcements are unlikely to be attributable to changes in volatility. Instead, they are linked to discretionary liquidity trading resulting from the presence of private information. I set up a model that guides my investigation of the information environment in the stock market around FOMC announcements. Consistent with the model’s implication, volume dynamics are accompanied by changes in the information environment. I find that information asymmetry increases ahead of FOMC announcements, but only for high-beta stocks.

Designing optimal jet fuel hedging strategies for airlines – Why hedging will not always reduce risk exposure

Using a historical simulation based Value at Risk (VaR) model, we provide the first empirical study quantifying the benefits and the costs associated with the fuel hedging activities of airlines. More specifically, we quantify the jet fuel risk exposure and estimate the cash collateral required to support jet fuel hedging using exchange traded futures. The results from our VaR model suggest that although hedging significantly reduces risk exposure, the associated collateral costs are large enough to offset, to a large extent, the potential financial benefits of the hedge to airlines. Increasing the hedging ratio beyond 60–70% results in a marginal reduction in the market risk exposure but significantly increases the cash collateral requirements. Our results demonstrate that the amount of cash collateral is a key factor in hedging decisions of airlines and, while this somewhat contradicts extant literature, is consistent with recent management practice.

Return Orthogonality and True Diversification Benefits of BRIC Securities

In this study, the author examines and compares the US market risk exposure and true diversification benefits of emerging markets closed-end funds and exchange-traded funds. The author uses a two-factor econometric model and orthogonal returns to isolate both, US direct market risk and true diversification. Results show that exchange-traded funds that invest in emerging markets are a better vehicle for US-based investors to gain international diversification. In comparison to closed-end funds, exchange-traded funds provide truer international diversification and have less exposure to US market risk. TOPICS:Mutual fund performance, exchange-traded funds and applications

Corporate risk exposures, disclosure, and derivatives use: A longitudinal study

AbstractWe conduct firm and industry‐level examinations of key market risk exposures deemed material by managers over the period 2002–2016. We find that risk exposures have expanded in line with firms’ growth and globalization and that managers strategically select disclosure formats in recognition of firms’ demand for capital market access and need to protect proprietary information. Currency derivatives use has surpassed that of interest rate derivatives and, conditioned on a firm having the associated risk exposure, commodity derivatives use is the highest. Finally, we find large increases in risk exposures concurrent with the initiation of derivatives use.