Editor: Farid AitSahlia
Published: 30 Sep 2013
Papers in this issue
by Alfred Hamerle, Thilo Liebig and Hans-Jochen Schropp
by Deepak Jadhav, T. V. Ramanathan and U. V. Naik-Nimbalkar
by Valentin Braun and Andreas Hackethal
by Norman Josephy, Lucia Kimball and Victoria Steblovskaya
Warrington College of Business Administration, University of Florida
The global financial crisis of 2007-8 illustrated the shortcomings of several modeling approaches in a dramatic fashion. Chief among these shortcomings are the bond-like pricing of tranches of collateralized debt obligations, the inadequate estimation of their default risk correlation, the lack of proper accounts of extreme outcomes on volatility and standard risk measures, and the inefficient hedging of certain derivatives. The current issue of The Journal of Risk presents papers focused on these topics.
The first paper in this issue, "The impact of collateralized debt obligation arbitrage on tranching and financial leverage of structured finance securities" by Alfred Hamerle, Thilo Liebig and Hans-Jochen Schropp, is focused on sensitivity to systemic risk and on arbitrage opportunities when market prices and spreads are not available for structured finance securities. In particular, the authors illustrate how these effects are due to the differences between collateralized debt obligation tranches and corporate bonds in light of the grades provided by rating agencies.
In the second paper in this issue, "Portfolio risk forecasting" by Andreas Hackethal and Valentin Braun, asymmetry in both dependence and volatility is examined. This feature captures the stronger dependence between assets during market turmoil than is seen when markets are in an ebullient mood, as well as the corresponding increase and decrease, respectively, of volatility. In so doing, the authors show how accounting for asymmetry results in lower portfolio volatility and downside risk.
Given the lack of coherence of the standard value-at-risk measure, expected shortfall (or conditional value-at-risk) has become a popular alternative risk measure. However, expected shortfall is sensitive to the presence of outliers, such as those that occur in highly volatile environments. Deepak Jadhav, T. V. Ramanathan and U. V. Naik-Nimbalkar therefore propose an improvement on expected shortfall in the third paper of this issue: "Modified expected shortfall: a newrobust coherent risk measure". With this new measure financial institutions can avoid unnecessary additional capital that would otherwise be required if they used the expected shortfall risk measure.
The fourth and final paper in this issue, "Alternative hedging in discrete-time incomplete markets" by Norman Josephy, Lucia Kimball and Victoria Steblovskaya, provides a risk-minimization method for hedging contingent claims in incomplete markets, due in particular to infrequent rebalancing. The authors show their method to be competitive relative to standard local risk minimization and the classic Black-Scholes delta hedge.
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