The financial crisis of 2008–9 highlighted the critical role of financial institutions’ credit ratings. Since then, efforts to develop better rating methodologies have intensified. This issue of The Journal of Risk begins with a paper that offers an empirical study to help identify promising approaches. This is followed by papers that address topics of ongoing interest in risk management: namely, portfolio risk measurement, currency risk and extreme stock price movements.
In “Rating migrations of US financial institutions: are different outcomes equivalent?”, Huong Dieu Dang conducts an empirical analysis that shows clear heterogeneity in rating financial institutions. Specifically, time-varying hazard rates in the Cox model follow different paths depending on whether they refer to upgrades or downgrades, and the latter are significantly more affected by rating history.
The second paper in this issue, “From log-optimal portfolio theory to risk measures: logarithmic expected shortfall” by Giorgio Arici and Marco Dalai, contains a proposal for a risk measure that helps practitioners to focus on uncertain portfolio growth rates; this makes it unlike standard measures, which are tied to a specific time period. The proposed measure is particularly useful in instances with short sales constraints where a significant loss cannot be recouped by extended leverage, for example.
In our third paper, “Currency risk in foreign currency accounts for small and medium-sized businesses”, Lorenzo Reus assesses the effectiveness of currency hedging as performed by small firms, which lack the resources of much larger ones. Further, small firms are more exposed to cashflow uncertainty and are often limited to using infrequent and simple hedging contracts. Reus develops analytic expressions to measure the performance of forward-based hedges and illustrates their effectiveness using five different currencies, including one from an emerging economy.
While firms are generally exposed to the overall market, extreme price movements of their stocks are often associated with their intrinsic information transparency. A feature of stock ownership in China, where significant portions of shares are held by a few state-owned companies, is central to our fourth and final paper: “The impact of the cross-shareholding network on extreme price movements: evidence from China” by Jie Cao and Fenghua Wen. The authors use various centrality measures to show that firms that occupy central positions are less prone to extreme price movements due to their ability to collect or disseminate information more easily thanks to their multitude of links.
Warrington College of Business, University of Florida
This study employs a competing risks approach to examine the rating migrations of US financial institutions (FIs) during the period 1984–2006.
In this paper, the authors propose a modification of expected shortfall that does not treat all losses equally. We do this in order to represent the worries surrounding big drops that are typical of multiperiod investors.
This paper estimates the currency exposure before and after the hedging of active foreign currency (FC) accounts, using stochastic models for spot exchange rates and cashflow movements.
By using information about the ownership structure of listed companies from 2004 to 2016, the authors construct the cross-shareholding network for each year and examine the effects of the network position of a firm on extreme price movement.