Risk Hedging Research Articles

Mind the Income Gap - Partial Hedging of Interest Rate Risk within Banks' Business Model

We implement a recently established approach to investigate interest rate risk of banks with extensive engagement in maturity transformation. Therefore, we contribute to the emerging literature contradicting modern banking theory's view on interest rate risk as inevitable consequence of banks' maturity mismatch. We find evidence for an alignment of banks' interest income and expense sensitivities which might indicate an implied interest rate risk hedge by their business model. Banks with lower expense sensitivities show significantly higher loan maturities and higher loan proportions in their balance sheets. However, we also confirm a remaining exposure to changing market rates. Our results shed light on an implicit hedging mechanism within the traditional business model of banks, its (in)completeness, and consequences for adequate regulation.

ИННОВАЦИОННЫЕ ТЕХНОЛОГИИ ПРОЕКТИРОВАНИЯ И УПРАВЛЕНИЯ ПРОЕКТАМИ В ОБЛАСТИ ЦИФРОВОЙ СРЕДЫ

The article discusses the issues of digital transformation of information modeling of real estate objects. Innovative architectural design tools are used to efficiently exchange between isolated information storages when using big data, the Internet of Things, digital twins and artificial intelligence throughout the life cycle in the implementation of investment and construction projects. The influence of virtual and augmented reality using digital technologies on predictive modeling of construction objects, identification and hedging of potential risks, optimization of the construction process and monitoring of the implementation of projects in the field of construction has been substantiated.

Quadratic Hedging of Futures Term Structure Risk in Merchant Energy Trading Operations

Quadratic Hedging of Futures Term Structure Risk in Merchant Energy Trading Operations

Hedging Longevity Risk in Defined Contribution Pension Schemes

Pension schemes all over the world are under increasing pressure to efficiently hedge the longevity risk posed by ageing populations. In this work, we study an optimal investment problem for a defined contribution pension scheme which decides to hedge the longevity risk using a mortality-linked security, typically a longevity bond. The pension scheme invests in the risky assets available in the market, including the longevity bond, by using the contributions from a representative scheme member to ensure a minimum guarantee such that the member is able to purchase a lifetime annuity upon retirement. We transform this constrained optimal investment problem into an unconstrained problem by replicating a self-financing portfolio of future contributions from the member and the minimum guarantee provided by the scheme. We solve the resulting optimisation problem using the dynamic programming principle and through a series of numerical studies reveal that the longevity risk has an important impact on the performance of investment strategies. Our results provide mathematical evidence supporting the use of mortality-linked securities for efficient hedging of the longevity risk.

РEER-TO-PEER-КРЕДИТОВАНИЕ КАК АЛЬТЕРНАТИВА БАНКОВСКОМУ КРЕДИТОВАНИЮ

The article considers the mechanism of P2P-lending as lending by individuals to other individuals, through specially created online platforms, in which the lender and borrower are directly connected, without the participation of traditional financial intermediaries. The essence, peculiarities and distinctive characteristics of P2P lending in comparison with a traditional bank loan are defined, such as: banks performing the functions of financial intermediation, asset transformation, liquidity and payment operations, and the absence of an intermediary in R2R lending; monitoring and processing of data by banks, assessment of credit quality; diversification and hedging of credit risks by banks. Dynamics of development of world and domestic markets of P2P-lending has been investigated. The main indicators and conditions of P2P lending were analyzed by the largest Russian companies: Fingooroo, City of Money, Вдолг.ру, Loanberry, Bezbank (minimum and maximum amount of investments, average loan amount, average loan rate, minimum and maximum loan rate). It was determined that a feature of P2P lending is its attractiveness for unscrupulous borrowers, in addition, the current Russian P2P lending is characterized by a lack of regulation and supervision, which increases the risks of potential investors. The study highlighted the main advantages and disadvantages of P2P lending for lenders and borrowers. It is noted that the lack of traditional intermediary functions of a financial intermediary in online sites is primarily due to the need to find a balance between certain costs and the advantages of P2P sites over traditional banks. It is formulated that the risks of online sites compared to banks are associated with the safety of investments, the lack of guarantees of a refund, and the advantages are greater freedom and accessibility for the participants in the transaction

Национальная климатическая политика: концептуальные основы и проблемы адаптации

Global climate change threatens the continued existence of mankind. The rate of warming in Russia, which is 2.5 times higher than the rate of growth of the global average temperature, can lead to huge environmental and financial losses. Thus, it is increasingly necessary to modernise and develop methods and tools for adaptive regulation of national climate policy to increase its efficiency at the regional and federal levels. To this end, the methods of content analysis, grouping, modelling, comparative and correlation analysis, as well as an information asymmetry approach were used in the research. The paper substantiates the necessity of a transition from autarky and directionality to the integration of regions and the federation based on adaptation and preventive measures. The periodic assessment of climate change and relevant contributing factors should be replaced by the continuous management and regional monitoring of climate risks. Stressing the importance of transparency and comparability of information on climate risks, the research distinguished anthropogenic risks, risks of reducing the quality of life and moral climate risks. In order to promote climate preservation, an organisational and economic mechanism for the implementation of climate policy was developed, whose main function is the regional environmental management. Assessment of the decoupling effect and ranking of the constituent entities of the Russian Federation in terms of the relationship between energy intensity and climate intensity proved the feasibility of using the proposed indicators to increase the efficiency of the organisational and economic mechanism. Regulatory and financial support for the mechanism can be provided by introducing a quota market, green certificates and bonds, insurance and risk hedging strategies based on a scenario approach and online-management models. The research results can be used for the digitalisation of national climate policy, as well as for the development of regional and municipal climate strategies, programmes, projects.

Financial engineering to optimize risk management in banks based on Interest Rate Swaps to better hedge the exposure to interest rate fluctuations the case of banks in Syria

The banking system is affected by uncertainties related to the evolution of pandemic. One of the identified risks is that of a fluctuation of rates. Volatility of Interest rates is one of the major risks for the banking system. Therefore, financial engineering can be used as a very important hedging practice for banks against such a risk. The aim of this study is to develop a risk hedging mechanism to better overcome market volatility by hedging position against the exposure to interest rate risk based on credit derivatives. Therefore, this study uses Interest Rate Swaps (IRS)s to better hedge the exposure of banks to interest rate fluctuations in stress conditions giving consideration to the case study of banks in Syria in optimizing hedging practices based on Interest Rate Swaps. The aim is to use financial engineering to provide banks with a hedging technique to better absorb shocks in times of stress conditions. This has been discussed and illustrated with visual model diagrams. The case study of banks in Syria is not just the story of individual banks but a window into how to hedge the exposure of banks in stress conditions. In the end, most banking crises are quite similar. The recommendations set out in this study provide banks with an optimized hedging practice which is not part of current financial engineering at banks in Syria.

On the Problems of Transformation of High-Tech Production Systems

The presented study addresses the problems of managing the transformation of high-tech production systems (PS) to maintain the enterprise’s competitiveness in the long term.Aim. The study identifies efficient approaches to forecasting the timeline, economic and social prospects of PS transformations.Tasks. The authors assess the existing methodological framework for innovation management aimed at changing the scientific and technical potential of the PS and the government’s role in facilitating investment activity.Methods. This study is based on the fundamental principles of systems theory and comprehensive consideration of the issues of managing changes in economic systems through analysis.Results. The proposed assessments and comments can be taken into account when developing a methodology for forming an adequate management response to the predicted change in the external conditions of PS operation. The scientific and technical potential of high-tech enterprises is created, among other things, through long-term research, but the economic prospects of using research results are unpredictable. The experience of building the US national innovation system confirms the important role of the government in managing the commercialization of research results.Conclusions. The development of the Russian economy depends on the timeliness and reasonable sufficiency of the formation of the scientific and technical potential of the PS. The formation of the Russian national innovation system is a prerequisite for creating a favorable institutional environment for innovation, and the authors believe that it will lay the groundwork for the reproduction of capital in real production and hedging of risks associated with these processes.

Static hedging of weather and price risks in electricity markets

We present the closed-form solution to the problem of hedging price and quantity risks for energy retailers (ER), using financial instruments based on electricity price and weather indexes. Our model considers an ER who is intermediary in a regulated electricity market. ERs buy a fixed quantity of electricity at a variable cost and must serve a variable demand at a fixed cost. Thus ERs are subject to both price and quantity risks. To hedge such risks, an ER could construct a portfolio of financial instruments based on price and weather indexes. We construct the closed form solution for the optimal portfolio for the mean-VaR model in the discrete setting. Our model does not make any distributional assumption.

The impact of wind power and electricity demand on the relevance of different short-term electricity markets: The Nordic case

Electricity wholesale markets are undergoing rapid transformation due to the increasing shares of variable renewable energy sources. We therefore asked whether trading activity is shifting from the traditionally dominant day-ahead market into the markets closer to real time. We studied the relevance of different electricity markets indirectly by analysing the price spreads between day-ahead, intraday and regulating power markets. We estimated vector autoregressive models for Denmark, Sweden and Finland for the period from 2015 to 2017 and studied the interrelationships between the price spreads and the effects of wind forecast and demand forecast errors, and other exogenous variables. We found that wind forecast errors do affect price spreads in areas with large shares of wind power generation. Demand forecast errors have an impact on almost all price spreads, except in areas with relatively low consumption. Interestingly, while the impact of demand forecasts was relatively stable over the studied years, the effects of wind forecasts became more important each year. As a conclusion, markets closer to real time are becoming more important due to the increasing shares of wind power, and their role as reference prices relevant for price risk hedging, capacity markets, and other decision making will probably increase in the future.

Towards robust investment decisions and policies in integrated energy systems planning: Evaluating trade-offs and risk hedging strategies for remote communities

Policy and investment decisions in developing clean energy strategies for remote communities are subject to multiple uncertainties that impact overall strategy outcomes, including those related to environmental emissions and energy costs. In this context, robust modeling approaches are required that can clarify potential outcomes while subject to such uncertainties. This work introduces a novel modeling framework that enables enhanced decision making in energy systems planning for remote communities, which for the first time takes into account context-specific decision-maker attitudes towards multiple inter-related uncertainties and various energy solution philosophies. In particular, multiple energy system configurations are evaluated by simultaneously minimizing the levelised cost of energy and fuel consumption, with a test case for a specific community in the Northwest Territories, Canada. The concept of model robustness and validity together with the stochastic nature of uncertain parameters are combined in a multi-objective optimization framework that elucidates the full spectrum of energy solutions available in such a remote Arctic context. Introducing known uncertainties in renewable energy characteristics was found to reduce overall energy yields from the renewable energy technologies. Specifically, the deterministic renewable energy penetration of 69% from a specific energy system configuration reduced to a mean of 51% after the inclusion of uncertainties via probabilistic simulation. Conversely, diesel fuel consumption increased to 750,000 L/yr (mean) from its initial deterministic value of 447,470 L/yr. Holistic energy solutions which include both supply and demand-side considerations are also analyzed. Specifically, a reduced community domestic heating load of 40% was achieved via retrofit of high performance building fabric enclosures evaluated in conjunction with renewable energy supply options. Ultimately, insights and real-world applications have been synthesized to provide coherent recommendations on strategies to address energy security, energy affordability and environmental sustainability, along with meaningful propositions towards Indigenous community-led energy projects in a range of contexts.

Generalized FTRs for hedging inter-nodal pricing risk

tIn liberalised wholesale power markets, risk averse market participants seek to enter into hedge contracts referenced to their local pricing node to offset the price and volume risks they face. In typical power markets, a range of inter-temporal hedge products emerge to meet these needs, such as swaps, caps, or load-following hedges. But some market participants also face risks from trading across pricing locations. To facilitate the hedging of these risks, many liberalised wholesale power markets make available an inter-nodal hedging instrument known as fixed-volume Financial Transmission Rights (FTRs). But, with the increasing penetration of intermittent and peaking generation, very few market participants trade in a fixed volume of electricity; most market participants cannot effectively hedge their inter-nodal pricing risks using fixed-volume instruments. To solve this problem, we propose a generalization of the concept of FTRs. Specifically, we propose that for each conventional hedge contract traded in the market, such as a Cap or Floor, a matching generalized Financial Transmission Right is made available to the market. We show that traders can form a portfolio of these generalized FTRs (G-FTRs) which matches the supply curve of a generator or the demand curve of a load. We show that, given access to a full range of G-FTRs, traders can offer generators, loads, and the system operator the hedge contracts they need to fully insulate themselves from all risk while taking the market risk on themselves. This approach offers the potential for a substantial improvement in the effectiveness of hedging of inter-nodal pricing risk in liberalised wholesale electricity markets.

Price of climate risk hedging under uncertainty

In this manuscript, we examine the welfare benefits of climate risk hedges and the effects of climate uncertainty on optimal portfolios with different investment horizons. We consider the case when an investor who trades in a stock market also holds a claim that pays off when an adverse climate scenario materializes. The optimal investment strategy, the price of the claim, and the cost of climate change uncertainty are derived. It is shown that climate uncertainty reduces stock investment. Furthermore, an increase in climate uncertainty decreases investor’s welfare, even when climate risk hedging instruments are available.

Management of Exchange Rate Risk in SMEs

Exchange rate fluctuations represent a challenge for the internationalization of all firms, both big and small. This paper reflects on two aspects of the exchange rate challenge - (i) the exchange rate pass-through and (ii) hedging of exchange rate risk and how SMEs manage these two aspects of exchange rate risk. The exchange rate challenges that SMEs face might differ from the risks larger firms are exposed to, and their management of the risks might vary. In family-owned SMEs, longer planning horizons than listed firms might imply a weaker exchange rate pass-through, while smaller financial buffers might pull pass-through rules in the opposite direction for the same SMEs. When considering hedging, the paper argues for both operational hedging and external hedging to represent a management challenge for SMEs, pushing the exchange rate risk towards the forefront of the factors hampering internationalization among SMEs.

IMPACT OF CREDIT RISK AND CAPITAL ADEQUACY ON ISLAMIC AND CONVENTIONAL BANKING HEDGING

This study aims to examine the relationship between credit risk and capital adequacy with the banking hedging of Islamic and conventional banks in Yemen. A sample of 4 conventional banks and 3 Islamic banks was used during (2012-2017). Using Pearson correlation and regression analysis, the study concludes that there is a statistically significant relationship between credit risk and banking hedging and a strong statistically significant relationship between capital adequacy and banking hedging. Based on the type of bank, results indicate a negative relationship but no statistical significance between conventional banks' credit risk and banking hedging. There is a statistically significant relationship between credit risk and banking hedging of Islamic banks. Capital adequacy positively interacts with the banking hedging in both banks.

Liquidity and Risk Management with Ambiguity

We formulate a robust theory of liquidity and risk management based on two fundamental frictions: 1) the entrepreneur cannot alienate his human capital, and 2) the entrepreneur worries about model uncertainty and seek robust decisions. In line with max-min expected utility, a robust entrepreneur makes decisions under some endogenous worst case, which generates significant distortions for risk-sharing, corporate investment, and consumption. With regard to concern for ambiguity aversion, the entrepreneur optimally responds by lowering the maximal debt capacity, under-investing and under-consuming. However, the impacts of ambiguity on risk hedging is ambiguous due to the interactions between robustness and limited commitment constraints. These distortions are greater the more financially constrained the firm is. Furthermore, we show that the optimal consumption rule is no longer deterministic but stochastic when taking the preference for robustness into account. Implications for implied ambiguity premium and persistent productivity shocks are also studied.

Emerging markets financial sector debt: A Markov‐switching study of interest rate sensitivity

AbstractWe provide an empirical study on the sensitivity of capital gains of emerging market financial sector debts to the U.S. Treasury market in a three‐state Markov‐switching framework. Specifically, we model the capital gains change in a debt portfolio consisting of emerging market bonds as a linear regression of the capital gains change in a portfolio consisting of U.S. Treasury bonds in which the regression coefficients are allowed to switch between three regimes. Our analysis spans the period 2003–2016. We identify three regimes corresponding to positive sensitivity, insensitivity and negative sensitivity and provide economic explanations of our findings. We find that negative sensitivity regimes mostly occurred during the financial crisis. Our research advances understanding of the financial economics that governs the interdependence of interest rate risk and credit risk. By reassessing interest rate risk management through the prism of the downside risk hedge, our results shed light on how financial institutions may better withstand adverse financial conditions.

Multivariate continuous-time modeling of wind indexes and hedging of wind risk

With the introduction of the exchange-traded German wind power futures, opportunities for German wind power producers to hedge their volumetric risk are present. We propose two continuous-time multivariate models for wind power utilization at different wind sites, and discuss the properties and estimation procedures for the models. Applying the models to wind index data for wind sites in Germany and the underlying wind index of exchange-traded wind power futures contracts, the estimation results of both models suggest that they capture key statistical features of the data. We show how these models can be used to find optimal hedging strategies using exchange-traded wind power futures for the owner of a portfolio of so-called tailor-made wind power futures. Both in-sample and out-of-sample hedging scenarios are considered, and, in both cases, significant variance reductions are achieved. Additionally, the risk premium of the German wind power futures is analysed, leading to an indication of the risk premium of tailor-made wind power futures.

Can satellite‐based weather index insurance improve the hedging of yield risk of perennial non‐irrigated olive trees in Spain?*

Olive oil yields fluctuate strongly due to their dependence on sufficient precipitation. An interesting option to hedge the yield risk in olive cultivation could be satellite‐based weather index insurance. Therefore, we implement index insurance as a hedging alternative for non‐irrigated olive groves using MODerate‐resolution Imaging Spectroradiometer (MODIS) satellite data. For this purpose, we focus on the Spanish region of Andalusia, given its importance in olive production at the international level. We calculate three satellite indices: the Vegetation Condition Index (VCI), the Temperature Condition Index (TCI) and the Vegetation Health Index (VHI). Meteorological indices related to temperature and precipitation are used as benchmarks. Firstly, we estimate the periods that have the greatest influence on the critical vegetative phase of olives, which extends from March to September. Based on the indices, insurance contracts are designed using a copula approach, which is then employed to evaluate their hedging effectiveness. On average, the hedging effectiveness of VCI‐, VHI‐ and TCI‐based weather index insurance contracts amounts to 38 per cent, 38 per cent and 29 per cent, respectively. Moreover, VCI‐ and VHI‐based weather index insurance contracts outperform traditional weather index insurance contracts based on precipitation (by 29 per cent) and temperature (by 16 per cent) indices.

Организационный механизм трансграничной торговли сырьевыми товарами

The article analyzes the basic strategies and business models of international commodity trade. The success factors of the organization of an effective system of commodity sales are highlighted: 1) a reliable network of global communication, which is provided by highly qualified personnel; 2) the ability to attract resources in international financial markets; 3) control over the objects of the basic logistics infrastructure of cross-border trade; 4) timely digital transformation of business. The article concludes that the current organizational mechanism for cross-border commodity trade is based on the following key success factors: an effective network of global business contacts, access to Bank financing and risk hedging tools, qualified personnel, and effective digitalization of business processes. The intersection of the competencies that lie in these planes allows us to obtain a stable competitive advantage in the most important commodity markets for the world economy. From a practical point of view, the greatest synergy of the key success factors of cross-border trade is achieved in the main hubs, which is important to take into account when implementing projects to build organizations that are competitive in foreign markets.