Journal of Operational Risk

Risk.net

An operational risk-based regime-switching model for stock prices

Takashi Kanamura

  • This paper proposes a new risk-based regime switching model for stock prices to examine the impact of operational risk events on stock prices. 
  • In empirical studies for Volkswagen, Asahi Kasei, and Toshiba, log prices in operational risk regimes have higher volatilities than log prices in market risk regimes. 
  • For Volkswagen and Asahi Kasei, the operational risk regime has a mean-reversion of log prices while the market risk regime does not. For Toshiba, we cannot observe any mean-reversions for either regime. 

This paper proposes a new risk-based regime-switching model for stock prices, using the price–volume relation to examine the effect of the operational risk events of industrial companies on stock prices. The model demonstrates that market risk, credit risk and operational risk should be represented by three different profiles. Empirical studies of operational risk are presented to estimate the parameters of mean-reverting regime-switching models using the stock prices of Volkswagen AG, Asahi Kasei Corporation and Toshiba Corporation. These companies have all experienced operational risk events: the violation of the Clean Air Act in the United States, the data manipulation issue of construction piles in Japan, and accounting fraud in Japan, respectively. The results show that log prices in operational risk regimes have higher volatilities than log prices in market risk regimes for Volkswagen, Asahi Kasei and Toshiba. This may suggest that operational risk triggers higher volatility than usual. The results for Volkswagen and Asahi Kasei show that the operational risk regime has a mean reversion of log prices, while the market risk regime does not. This may suggest that the impact of operational risk does not persist for long, due to its mean-reversion properties. In addition, the model suggests that the mean reversion of log prices may come from the behavior of market participants as observed through the trading volume during operational risk periods. In contrast, for Toshiba’s case, we cannot observe any mean reversions for either regime, which implies the trading volume does not have any mean-reverting property. Because the impact of operational risk on Toshiba is a more severe case than the other two examples, it is possible that market participants may accelerate the huge decline of Toshiba’s stock prices.

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