Market Risk Exposure Research Articles

Does Fintech Affect Bank Profitability? Empirical Insights from Malaysia

Objectives: This study investigates the influence of Fintech on the profitability of Malaysian banks. It aims to assess both accounting measures, such as Return on Assets (ROA) and Net Interest Margin (NIM), and market performance measures, including Tobin's Q. The research utilizes bank-level metrics like the intangible asset ratio and the ATM-to-branch ratio, along with a country-level Fintech index that combines data on ATM, smartphone usage, and internet penetration. The study seeks to understand the complex dynamics between Fintech investments and bank profitability, providing insights for various stakeholders, including policymakers, banks, investors, and consumers. Methods: The research employs a panel regression analysis to explore the relationship between Fintech developments and bank profitability. The analysis covers publicly listed banks in Malaysia from 2010 to 2022. Key variables include the intangible asset ratio as a proxy for IT investment in Fintech, the ATM-to-branch ratio, and a comprehensive Fintech index at the country level. The study also considers market risk exposure, using Value at Risk (VaR) as an indicator. The approach is grounded in the resource-based view theory, suggesting that Fintech can provide competitive advantages through data analytics, mobile technology, and enhanced cybersecurity. Results: The findings reveal that Fintech investments at the bank level, indicated by the intangible asset ratio, have a positive impact on NIM. This supports the notion that technology-driven innovations can enhance profitability. However, the study also uncovers a contrasting effect at the country level, where broader Fintech development appears to negatively impact bank profitability. This suggests a more complex interplay between technological advancement and market dynamics, including increased competition from digital payment systems and peer-to-peer lending platforms. Additionally, the research highlights that banks with higher exposure to market risk, as indicated by VaR, tend to achieve better profitability metrics, such as ROA, NIM, and Tobin's Q. Conclusion: The study concludes that while Fintech investments at the bank level can enhance profitability, broader Fintech development in the country may pose challenges to traditional banking profitability due to increased competition and market disruption. The results underscore the importance of strategic agility, advanced risk management, and innovation in banking practices to navigate the evolving financial landscape. The findings offer valuable insights for stakeholders, emphasizing the need for tailored regulatory approaches, strategic investments in technology, and innovations that focus on consumer needs. This nuanced understanding of the Fintech-bank profit nexus can help guide more informed decision-making in the industry.

The time-varying effects of geopolitical risk on mutual fund risk taking.

Based on a time-varying parameter vector autoregression model with stochastic volatility (TVP-VAR-SV), this paper investigates the dynamic effects of geopolitical risk on mutual fund risk taking in China across three-time horizons and at three selected time points. Overall, the impulse responses are time-varying and we find a negative effect of geopolitical risk on mutual fund risk taking until 2015, with the short-term effect being the most pronounced, suggesting that when professional investors such as mutual fund managers are faced with the stock valuation uncertainty due to a geopolitical shock, they choose to reduce market risk exposures. After 2015, the short-term effect begins to diminish and gradually turns positive, which could be explained by the fact that with the increasing abundance and diversification of investment instruments, fund managers have more effective investment tools and more sophisticated trading strategies to hedge against geopolitical risk, rather than reducing market risk exposure. Further, we explore the heterogeneous effects of eight types of geopolitical risk and three types of mutual fund. The results indicate that the effect of geopolitical actions is stronger than that of geopolitical threats, while the effect of narrow geopolitical risk is stronger than that of broad geopolitical risk. Moreover, we find that the response of the risk taking of growth funds to the geopolitical risk is weaker than that of balanced and income funds.

Diversifying and hedging REIT portfolios with cryptocurrencies: Evidence from global and regional REIT indices

Hedging the financial risk of portfolios of securitized real estate assets is daunting because of the unique nature of the underlying assets and because no direct market exists to trade on property-related derivatives. In this paper, we conduct a global study of the diversification and risk mitigation benefits of cryptocurrencies for REIT stocks. Specifically, we examine the dynamic relationship between Bitcoin and REIT indices obtained from multiple countries and regions of the world. We also explore whether portfolios of REIT stocks that are hedged with Bitcoin futures obtain significant improvement in portfolio risk mitigation and return performance. Furthermore, given that Bitcoin and REIT stocks are prone to large volatility swings, we examine the nature of the tail dependences in the multivariate distributions of our REIT indices universe and Bitcoin using Archimedean copula functions. Lastly, we compare the market risk of Bitcoin-hedged REIT portfolios to the unhedged portfolios of REIT stocks using value-at-risk. We find region-specific benefits from using Bitcoin to hedge REIT exposure. Furthermore, we show that using Bitcoin to dynamically hedged REIT portfolios had minimal impact on the bivariate and multivariate joint distributions of REIT portfolios. We also find evidence of region-specific reductions in the market risk exposure of dynamically hedged REIT portfolios relative to unhedged and naively hedged REIT portfolios. We posit that Bitcoin could improve the mean-variance frontiers of REIT investors in countries with higher market friction and lower global integration.

Seasonality, Monetary Supply and Taiwanese Momentum

Abstract For the Taiwanese stock market, evidence from the present study documents significant reversal in January-February, but strong momentum in March-December when there are increases of lagged M1B. Moreover, the M1B-induced momentum manifests only over economic expansion, rather than economic recession. Both the reversal and the momentum can be partly explained by unrealized capital gains, implying the disposition effect to some extent driving both phenomena since Grinblatt and Han (2005) used unrealized capital gains as a proxy for the disposition effect. We further find the reversal primarily occurring in January, implying reverse disposition trading occurring before the beginning of a year. As there are no capital gain taxes levied in Taiwan, the reverse disposition trading cannot be related to tax-loss selling as in U.S. Furthermore, time-varying market risk exposure cannot explain the reversal in most cases. For the March-December momentum, apart from unrealized capital gains, the CAPM and the Fama-French 3-factor models can each to some extent explain the momentum. JEL classification numbers: G10, G11, G19. Keywords: Price momentum; Reversal; Disposition effect; Emerging stock market.

Market risk exposure determinants during the COVID-19 outbreak: between competitiveness and inequality

PurposeThe objective of this research is to identify the economic, demographic, sanitary and even cultural factors which explain the variability in the cross-section of returns in different markets globally during the first weeks after the outbreak of COVID-19.Design/methodology/approachBuilding on the event study methodology and using seemingly unrelated equations, the authors created several indicators on the impact of the pandemic in 75 different markets. Then, and using cross-sectional regressions robust to heteroscedasticity and using an algorithm to select independent variables from more than 30 factors, the authors determine which factors were behind the different stock market reactions to the pandemic.FindingsHigher currency depreciation, inflation, interest rate or government deficit led to higher returns, while higher life expectancy, ageing population, GDP per capita or health spending led to the opposite effect. However, the positive effect of competitiveness and the negative effect of income inequality stand out for their statistical and economic significance.Originality/valueThis research provides a global view of investors' reaction to an extreme and unique event. Using a sample of 75 capital markets and testing the relevance of more than 30 variables from all categories, it is, to the authors' knowledge, the largest and most ambitious study of its kind.

The Impact of Market Risk Exposure on Banks’ Financial Performance: Evidence from the MENA Region

The Impact of Market Risk Exposure on Banks’ Financial Performance: Evidence from the MENA Region

Regulation and De-Risking: Theoretical and Empirical Insights

The purpose of the Bank for International Settlements regulatory agenda, as implemented by financial regulators globally, has been to make banks safer and reduce the likelihood of systemic events. Using an original model of bank profit maximisation under a regulatory constraint, we statistically examine how market risk exposure has interacted with financial performance and capital structure, to see if the Basel regulatory agenda concerning the quantity, quality and liquidity of capital, has prompted changes in banking behaviour as measured by exposure to market risk. Breaking new ground, we empirically explore how the regulatory agenda has affected the largest banks. We analyse if the regulatory agenda has succeeded in aligning the cost of capital with their exposure to market risk, measured by Value at Risk; or if regulations have induced changes to banking activities. We find rather than regulation inducing changes to the rate at which unchanged risk exposure is capitalised; it leads to changes in the nature of exposures. Risk has declined along with financial performance while the cost of capital is largely unchanged. A consequence of regulation may be to encourage the migration of riskier activities to organisations where it may be borne more cheaply.

Concentrated Holdings by Funds: Putting All Your Eggs in the Same Basket

Diversification is a fundamental principle for investors when forming a portfolio. When investing in mutual funds and exchange-traded funds (ETFs), purchasing a single fund comes with the benefit of indirectly holding a large number of securities; however, many funds are not as diversified as some may expect. This article documents the large concentration of portfolio holdings of many funds. The degree of concentration varies based on fund investment objective, size, and structure. High levels of concentration often are tied to managers making active bets on the portfolio weights of holdings. This concentration relates to higher idiosyncratic risk (risk originating from factors tied to a specific security or small group of assets) and, for sector and style funds, greater market risk exposure. Even though many funds make large bets on the same stocks and have overlapping holdings, a strategy of investing in multiple funds with a similar objective can often lead to much lower portfolio concentration and reduces idiosyncratic risk.

Quantum computing for financial risk measurement

Quantum computing allows a significant speed-up over traditional CPU- and GPU-based algorithms when applied to particular mathematical challenges such as optimisation and simulation. Despite promising advances and extensive research in hard- and software developments, currently available quantum systems are still largely limited in their capability. In line with this, practical applications in quantitative finance are still in their infancy. This paper analyses requirements and concrete approaches for the application to risk management in a financial institution. On the examples of Value-at-Risk for market risk and Potential Future Exposure for counterparty credit risk, the main contribution lies in going beyond textbook illustrations and instead exploring must-have model features and their quantum implementations. While conceptual solutions and small-scale circuits are feasible at this stage, the leap needed for real-life applications is still significant. In order to build a usable risk measurement system, the hardware capacity—measured in number of qubits—would need to increase by several magnitudes from their current value of about 10^2. Quantum noise poses an additional challenge, and research into its control and mitigation would need to advance in order to render risk measurement applications deployable in practice. Overall, given the maturity of established classical simulation-based approaches that allow risk computations in reasonable time and with sufficient accuracy, the business case for a move to quantum solutions is not very strong at this point.

Dynamic Banking Systemic Risk Accumulation under Multiple-Risk Exposures.

Much of the existing research on banking systemic risk focuses on static single-risk exposures, and there is a lack of research on multiple-risk exposures. The reality is that the banking system is facing an increasingly complex environment, and dynamic measures of multiple-risk integration are essential. To reveal the risk accumulation process under the multi-risk exposures of the banking system, this article constructs a dynamic banking system as the research object and combines geometric Brownian motion, the BSM model, and the maximum likelihood estimate method. This article also aims to incorporate three types of exposures (interbank lending market risk exposures, entity industry credit risk exposures, and market risk exposures) within the same framework for the first time and builds a model of the dynamic evolution of banking systemic risk under multiple exposures. This study included the collection of a large amount of real data on banks, entity industries, and market risk factors, and used the ΔCoVaR model to evaluate the systemic risk of the China banking system from the point of view of the accumulation of risk from different exposures, revealing the dynamic process of risk accumulation under the integration of multiple risks within the banking system, as well as the contribution of different exposures to banking systemic risk. The results showed that the banking systemic risk of China first increased and then decreased with time, and the rate of risk accumulation is gradually slowing down. In terms of the impact of different kinds of exposures on system losses, the credit risk exposure of the entity industry had the greatest impact on the banking systemic risk among the three kinds of exposures. In terms of the contribution of the interbank lending market risk to the systemic risk, the Bank of Communications, China Everbright Bank, and Bank of Beijing contributed the most. In terms of the contribution of the bank-entity industry credit risk to the systemic risk, the financial industry, accommodation and catering industry, and manufacturing industry contributed the most. Considering the contribution of market risk to the systemic risk, the Shanghai Composite Index, the Hang Seng Composite Index, and the Dow Jones Index contributed the most. The research in this paper enriches the existing banking systemic risk research perspective and provides a reference for the regulatory decisions of central banks.

Corporate Sustainability in the Wake of the COVID-19 Global Pandemic: Does CSR Enhance Corporate Survival during a Market Crisis?

This study investigates the effect of the COVID-19 global pandemic on the relationship between corporate social responsibility (CSR) and a firm’s sustainability. Prior studies on related topics empirically argue that CSR activities are highly likely to positively impact corporate sustainability. If this is true, firms that engage in CSR activities should demonstrate a higher degree of sustainability than their counterparts during the recent COVID-19 global pandemic. Using a sample of 390 Korean listed companies from 2019 to 2020, we find that CSR has no significant relationship with firm value variations as a proxy for sustainability during the COVID-19 global pandemic period. Our findings suggest that firms that engage in more active CSR activities do not appear to mitigate the market risk associated with the COVID-19 global pandemic compared to their counterparts who engage in less active CSR activities. That is, CSR does not provide a significant cushion that alleviates a firm’s market risk exposure, as heralded by COVID-19. Unlike previous studies that argue that CSR has positive effects on sustainability, our studies suggest that CSR’s impact on sustainability seems to be significantly lowered when uncontrollable market risks occur. It is important to note that this study has methodological limitations in that it was analyzed using proxy variables for CSR and sustainability measurement in Korea. For future studies, it would be insightful to expand the CSR concept to ESG and conduct research using longer-term data in the post-pandemic era.

Estimating the precision of market risk within the tiger cub economies’ region through VaR backtesting

The purpose of this paper is to estimate the market risk exposure within the Tiger Cub Economies regions in calm and stormy market conditions. The secondary objective of the empirical research is to determine the reliability and accuracy of the market risk model used by most banking sectors within the region as the primary tool for mitigating potential systematic risk. The precision of the market risk model was assessed using the 250-day trading data of major indices from five emerging ASEAN countries or known as the Tiger Cub Economies stretching from January 2018 until December 2021. It consists of two sub-samples which are known as before and during the pandemic COVID-19. The current study contributes to the existing literature on the ability of the VaR-HS model in estimating accurate market risk exposure in light of the recent pandemic COVID19 within the Tiger Cub Economies region. Interestingly, it is also evident that inaccurate VaR-HS tend to overestimate the risk and VaR-GARCH tends to severely underestimate the measures during extreme market conditions. Finally, by recalibrating models that severely over/understate the risk during pandemic stormy market conditions in SETi and VNI indices, it is also imperative that RiskMetrics EWMA could improve the estimation measures in an extreme market event by putting more weights on the most recent volatility memory. The current study reveals new insights where in the event of a crisis, HS-VaR estimates tend to be overstated while GARCH-VaR measures could be understated where it is evident that EWMA-VaR estimates could provide a better measure of market risk exposure, particularly during stormy periods.

Tail-risk spillovers from China to G7 stock market returns during the COVID-19 outbreak: A market and sectoral analysis

This study uses a combination of copulas and CoVaR to investigate risk spillovers from China to G7 countries before and during the COVID-19 pandemic. Using daily data on stock and equity sectors for the period from January 1, 2013 to June 9, 2021, the main empirical results show that, before the COVID-19 pandemic, stock markets were positively related and systemic risk was comparable for all countries. However, during the COVID-19 outbreak, the level of dependence increased for all G7 countries and the upside–downside risk spillovers become on average higher for all stock markets, with the exception of Japan. Our results also provide evidence of higher market risk exposure to information from China for the technology and energy sectors. Moreover, we find an asymmetric risk spillover from China to the G7 stock markets, with higher intensity in downside risk spillovers before and during COVID-19 spread.

Climate change risk: Demands and expectations imposed on banks

For several years, there has been discussion about whether climate change risk is a fundamentally new type of risk or can be subsumed under market, credit, operational and systemic risk in the financial industry. The European Central Bank’s current ‘climate risk stress test’ is a milestone marking a shift in that discussion, from a normative one to a perspective on actual exposures and quantitative data. This shift is linked with regulatory guidelines about how climate change risk should be integrated into banks’ risk frameworks, but also comes with some expectations for banks to actively steer funding to the green transformation. We now understand climate change better than ever and are able to estimate the physical damages it will cause (ie the estimated probability distribution of damages from additional ‘extreme events’). This can be mapped to credit exposures by region (eg river valleys) and by industry segment (eg agriculture) as elaborated in the ‘climate risk stress test’. This paper provides a first step for extending the approach from actual exposures to expected losses by comparing the effects of ‘normal’ weather events with the additional climate-change-related events. However, sophisticated models are required to separate the climate-change-related excess of rare but severe events from extreme weather events that are not related to climate change. In contrast to the earlier static concept of ‘stranded assets’, a ‘transition risk’ would be the result of ‘disorderly’ pathways to a low carbon economy rather than a transparent and consistent road map. A sudden and abrupt increase in the price of carbon (or of greenhouse gas emissions in general) would travel along a transmission chain in the economy, eventually affecting banks’ credit and market risk exposure. Determining the effect of such a step function on an estimated loss distribution is methodologically challenging, especially because there are limited data on historical events. The actual transmission will be even more complicated as political decisions interact with social acceptance and there is a (new) risk of the lack of societal consensus. This paper discusses this challenge, using a schematic model of the political decision on and societal reaction to carbon prices and the consequences for carbon-intensive industry sectors and consumers and citizens. Finally, regulators have expectations of how banks should contribute to a ‘green deal’ and bridge the gap between political commitments and economic measures. This task for the financial services industry — ‘steering credit’ — turns out to be a new source of risk for the societal ‘licence to operate’, into which more insight is required. This paper disentangles the various elements as a step towards a better understanding of the challenges that climate-changerelated risk poses to banks.

Rising Market Risk Exposure of Municipal Water Service Providers in Distressed Cities

Rising Market Risk Exposure of Municipal Water Service Providers in Distressed Cities

Crude oil risk forecasting using mode decomposition based model

The crude oil markets have been transformed into more risky market environment with the increasing level of complexity and volatility in recent years. More accurate and reliable risk estimates increasingly depends on the better understanding and modeling of the crude oil market risk exposure. In this paper, we propose a new MD VaR based risk forecasting model, using multiple Mode Decomposition models and the Quantile Regression Neural Network (QRNN) model. This model takes a semi-parametric data-driven approach to calculate VaR by combining forecasts for both normal and transient market risk exposure at different scales. The transient risk factor is extracted using dynamically selected Mode Decomposition model such as EMD and EEMD. The optimal scale is identified and modeled using QRNN model. Our empirical results using major crude oil data show that MD VaR based risk forecasting model significantly improves the reliability of VaR forecasting.

Stability versus Volatility: Hungarian Experiences with the First Five Years of Solvency II Regarding Quantitative Elements

It has been more than five years since the introduction of the Solvency II framework (S2), which determines how insurers should operate in Europe, and this allows for a detailed analysis of Hungarian developments. The new approach in S2 that makes it similar to banking regulation, including the market-consistent valuation principles and the application of a risk-based capital requirement, has stood the test of time in recent years: the various shocks did not undermine the stability of the Hungarian sector. This was largely due to the recommendation of the central bank of Hungary (Magyar Nemzeti Bank, MNB) on holding a volatility capital buffer. This is because the robust capital position of the sector as a whole has been maintained in the context of 50–100-basis point reductions in capital adequacy levels in certain individual cases, which justifies the use of the capital buffer. The balanced capital position was also influenced by the conservative investment strategy, which resulted in one of the lowest market risk exposures in Europe, against the backdrop of huge government securities holdings, even by international standards.

Like worker, like union? Labor market risk exposure, white-collar predominance and trade unions’ policy advocacy

AbstractThis study seeks to advance the scholarship on trade union heterogeneity. Expanding on previous research, we develop a theoretical framework that distinguishes unions along two dimensions—members’ labor market risk exposure and the predominance of white-collar workers—that help shape their labor market policy preferences and advocacy. The framework is then assessed in a within-country mixed-methods analysis. We first document how members in 35 Swedish unions map onto the two dimensions, using fine-grained survey data, and then qualitatively analyze the advocacy of seven unions with different membership characteristics. Our results confirm the relevance of isolating the two dimensions in analyses of both membership preferences and elite advocacy. These findings contrast with existing accounts of the contemporary Swedish union movement and carry implications for many other countries with fragmented union landscapes. They particularly demonstrate the importance of disaggregating union membership in micro- and macro-level research involving unions and their power resources.

Effect of Market Risk and Operational Risk Exposures on Profitability of Life Insurance Companies in Kenya

Effect of Market Risk and Operational Risk Exposures on Profitability of Life Insurance Companies in Kenya

Evaluating the Performance of Alternative Strategies Relative to Long-Only Public Market Benchmarks

The performance of alternative strategies is notoriously challenging to analyze. Beside the fact that managers often profess to be agnostic as to the kind of risk they should be taking, investors often seek a well-defined risk management process. The current literature provides solid insights as to the benefit of various forms of risk factor analysis, the results of which can then be used as a means to assess actual manager performance. This article follows on that line of thought, with an important modification: the use of rolling betas relative to a qualitatively identified public market proxy. The author finds that the results point to significant volatility in betas, suggesting that managers indeed vary their market risk exposure over time; on the other hand, he finds that alphas derived from this methodology tend to be lower and less volatile than those computed based on a fixed strategic risk exposure. He postulates that the results may well be more representative of reality. <b>Key Findings</b> ▪ Hedge fund performance is notoriously difficult to assess, particularly relative to a market benchmark. Trying to allocate return between market or risk exposure and skill and to allocate excess return between tactical risk management and security or instrument selection has been quite difficult. ▪ Performance analysis practices within the asset management industry cover a wide range of approaches from peer comparisons to public market benchmarks. ▪ The use of statistically computed beta factors relative to a qualitatively derived principal strategy risk can afford a better perspective of public market opportunities and thus of relative performance analysis as compared with a public market benchmark.