University of California at Irvine
This issue of the Journal of Risk marks the third year of existence of the journal. The journal is making good progress in its mission to disseminate academic and practitioner research into financial risk management. The increasing flow of good paper has allowed us to increase the number of published papers, while maintaining high quality standards.
The first paper, "Incorporating Severity Variations into Credit Risk," by Burgisser, Kurth, and Wagner, presents an implementable strategy for incorporating systematic and idiosyncratic recovery risk into a widely-used model of credit risk. Current generations of credit risk models ignore the effect of systematic risk in recoveries. The authors show, however, that this factor can significantly affect the distribution of credit losses.
Next, "Optimal Slice of a Block Trade," by Konishi, presents a useful extension of the Almgren/Chriss paper on liquidity previously published in this journal. The explicit solutions obtained in the earlier work have the unrealistic property that the time scale of optimal trading is independent of the initial portfolio size. Intuition suggests that larger portfolios should be traded more slowly. This paper confirms this intuition, and provides analytical solution to the optimal liquidation problem.
The paper, "Volatility Modeling in the Presence of Measurement Errors," by Anderson and Agren examines the effect of measurement errors on volatility measures. The authors show that measurement error can significantly affect estimation of GARCH and stochastic volatility models, biasing measures of kurtosis and correlations and causing an overestimation of VAR.
The fourth paper, "Managing the Risk of Relative Price Changes by Splitting Index Linked Bonds," by Aziz, Katz, and Prisman, examines the benefits of inflation-linked bonds. The authors point out that allowing consumers to invest in inflation-linked bonds indexed to various components of the inflation rate (e.g. energy, food, housing, health care) provides better hedging and improves welfare. The analysis provides numerical estimates of the gains from stripping index-linked bonds, which are shown to be considerable.
Finally, the paper, "Insurance and Reinsurance Contracts as Complex Derivatives: Application to Multiple Peril Policies," by Jung and Ramezani, prices multiple peril insurance schemes by breaking them down into option payoffs, which are priced by simulation techniques. The paper examines multiple peril crop insurance, income protection contracts, and crop revenue coverage contracts. The paper shows that government-granted reinsurance is an explicit subsidy provided to insurers.
The mission of the Journal of Risk is to further our understanding of risk management. Contributions to the journal are welcome from academics, practitioners, and regulators in the field. With this in mind, authors are encouraged to submit full-length papers.