Demand for insurance in a portfolio setting

This paper takes an additional step toward analyzing the demand for insurance in the context of a portfolio model. An investor is endowed with a portfolio containing a risky and riskless asset that can be augmented by purchasing insurance. Here, insurance is paid for by reducing the quantity of the risky insurable asset, holding the quantity of the riskless asset fixed. In the standard insurance demand model, insurance is paid for by reducing the amount of the riskless asset. This distinction leads to a different insurance demand function because the opportunity cost of purchasing insurance is now random.     

A portfolio view of consumer credit

To compute risk-adjusted returns and gauge the volatility of their portfolios, lenders need to know the covariances of their loans’ returns with aggregate returns. We use unique credit bureau data to measure individuals’ ‘covariance risk’, i.e., the covariance of their default risk with aggregate consumer default rates, and more generally to analyze the distribution of credit, including the effects of credit scores. We find significant heterogeneity in covariance risk across consumers. Also, the amount of credit they obtain significantly increases with their credit scores, and decreases with their covariance risk (especially revolving credit), though the effect of covariance risk is smaller.     

Contagion effect on bond portfolio risk measures in a hybrid credit risk model

This paper illustrates how modelling the contagion effect among assets of a given bond portfolio changes the risk perception associated to it. This empirical work is developed in a hybrid credit risk framework that incorporates recovery rate risk. Dependence structures among firms and between external shocks affecting firms together are considered. The presence of correlations among firm leverage ratios and the interrelation between default probabilities and recovery rates produces clusters of defaults with low recovery rates. This has a major impact on standard risk measures such as Value-at-Risk and conditional tail expectation. Consequently, an appropriate measurement of the contagion has a tremendous effect on the capital requirement of many financial institutions.     

Interacting particle systems for the computation of rare credit portfolio losses

In this paper, we introduce the use of interacting particle systems in the computation of probabilities of simultaneous defaults in large credit portfolios. The method can be applied to compute small historical as well as risk-neutral probabilities. It only requires that the model be based on a background Markov chain for which a simulation algorithm is available. We use the strategy developed by Del Moral and Garnier in (Ann. Appl. Probab. 15:2496–2534, 2005) for the estimation of random walk rare events probabilities. For the purpose of illustration, we consider a discrete-time version of a first passage model for default. We use a structural model with stochastic volatility, and we demonstrate the efficiency of our method in situations where importance sampling is not possible or numerically unstable.      

Checking for asymmetric default dependence in a credit card portfolio: A copula approach

Traditional credit risk models adopt the linear correlation as a measure of dependence and assume that credit losses are normally-distributed. However some studies have shown that credit losses are seldom normal and the linear correlation does not give accurate assessment for asymmetric data. Therefore it is possible that many credit models tend to misestimate the probability of joint extreme defaults.This paper employs Copula Theory to model the dependence across default rates in a credit card portfolio of a large UK bank and to estimate the likelihood of joint high default rates. Ten copula families are used as candidates to represent the dependence structure. The empirical analysis shows that, when compared to traditional models, estimations based on asymmetric copulas usually yield results closer to the ratio of simultaneous extreme losses observed in the credit card portfolio.Copulas have been applied to evaluate the dependence among corporate debts but this research is the first paper to give evidence of the outperformance of copula estimations in portfolios of consumer loans. Moreover we test some families of copulas that are not typically considered in credit risk studies and find out that three of them are suitable for representing dependence across credit card defaults.     

A semiparametric model for the systematic factors of portfolio credit risk premia

The aim of this paper is to investigate the empirical relationship between daily fluctuations in the risk premium for holding a large diversified credit portfolio, which we approximate by a benchmark credit index, and some tradeable market factors which capture systematic risk. The analysis is based on an adaptive nonparametric modelling approach which allows for the data-driven estimation of the nonlinear dynamic relationship between portfolio credit risk premia and their hypothetical components. Our main finding is that the empirical weights of the systematic factors display sudden jumps during market crises and a less intense time-dependent behaviour during normal market conditions. In addition, we find that during market crises the directions of the empirical relationships are often inconsistent with ordinary economic intuition, as they are influenced by the specific circumstances of financial markets distress.     

From insurance risk to credit portfolio management: a new approach to pricing CDOs

We present a new approach for pricing collateralized debt obligations (CDOs) which takes into account the issue of the market incompleteness. In particular, we develop a suitable extension of the actuarial framework proposed by Bayraktar et al. [Valuation of mortality risk via the instantaneous Sharpe ratio: Applications to life annuities. J. Econ. Dyn. Control, 2009, 33, 676–691], Milevsky et al. [Financial valuation of mortality risk via the instantaneous Sharpe-ratio: Applications to pricing pure endowments. Working Paper, 2007. Available at: http://arxiv.org/abs/0705.1302], Young [Pricing life insurance under stochastic mortality via the instantaneous Sharpe ratio: Theorems and proofs. Technical Report, 2007. Available at: http://arxiv.org/abs/0705.1297] and Young [Pricing life insurance under stochastic mortality via the instantaneous Sharpe ratio. Insurance: Math. Econ., 2008, 42, 691–703], which is based on the so-called instantaneous Sharpe ratio. Such a procedure allows us to incorporate the attitude of investors towards risk in a direct and rational way and, in addition, is also suitable for dealing with the often illiquid CDO market. Numerical experiments are presented which reveal that the market incompleteness can have a strong effect on the pricing of CDOs, and allows us to explain the high bid-ask spreads that are frequently observed in the markets.     

Bayesian inference for generalized linear mixed models of portfolio credit risk

The aims of this paper are threefold. First, we highlight the usefulness of generalized linear mixed models (GLMMs) in the modelling of portfolio credit default risk. The GLMM-setting allows for a flexible specification of the systematic portfolio risk in terms of observed fixed effects and unobserved random effects, in order to explain the phenomena of default dependence and time-inhomogeneity in historical default data. Second, we show that computational Bayesian techniques such as the Gibbs sampler can be successfully applied to fit models with serially correlated random effects, which are special instances of state space models. Third, we provide an empirical study using Standard and Poor's data on U.S. firms. A model incorporating rating category and sector effects, and a macroeconomic proxy variable for state-of-the-economy suggests the presence of a residual, cyclical, latent component in the systematic risk.     

The impact of credit rating announcements on credit default swap spreads

We document the ability of the credit default swap (CDS) market to anticipate favorable as well as unfavorable credit rating change (RC) announcements based on more extensive samples of credit rating events and CDS spreads than previous studies. We obtain four new results. In contrast to prior published studies, we find that corporate RC upgrades do have a significant impact on CDS spreads even though they are still not as well anticipated as downgrades. Second, CreditWatch (CW) and Outlook (OL) announcements, after controlling for prior credit rating events, lead to significant CARs at the time positive CW and OL credit rating events are announced. Third, we extend prior results by showing that changes in CDS spreads for non-investment-grade credits contain information useful for estimating the probability of negative credit rating events. Fourth, we find that the CDS spread impact of upgrades but not downgrades is magnified during recessions and that upgrades and downgrades also differ as to the impact of simultaneous CW/OL announcements, investment-grade/speculative-grade crossovers, current credit rating, market volatility, and industry effects.     

Bayesian inference for issuer heterogeneity in credit ratings migration

Rating transition matrices for corporate bond issuers are often based on fitting a discrete time Markov chain model to homogeneous cohorts. Literature has documented that rating migration matrices can differ considerably depending on the characteristics of the issuers in the pool used for estimation. However, it is also well known in the literature that a continuous time Markov chain gives statistically superior estimates of the rating migration process. It remains to verify and quantify the issuer heterogeneity in rating migration behavior using a continuous time Markov chain. We fill this gap in the literature. We provide Bayesian estimates to mitigate the problem of data sparsity. Default data, especially when narrowing down to issuers with specific characteristics, can be highly sparse. Using classical estimation tools in such a situation can result in large estimation errors. Hence we adopt Bayesian estimation techniques. We apply them to the Moodys corporate bond default database. Our results indicate strong country and industry effects on the determination of rating migration behavior. Using the CreditRisk+ framework, and a sample credit portfolio, we show that ignoring issuer heterogeneity can give erroneous estimates of Value-at-Risk and a misleading picture of the risk capital. This insight is consistent with some recent findings in the literature. Therefore, given the upcoming Basel II implementation, understanding issuer heterogeneity has important policy implications.     

The impact of securitization on the expansion of subprime credit

This paper investigates the relationship between securitization activity and the extension of subprime credit. The analysis is motivated by two sets of compelling empirical facts. First, the origination of subprime mortgages exploded between the years 2003 and 2005. Second, the securitization of subprime loans increased substantially over the same time period, driven primarily by the five largest independent broker/dealer investment banks. We argue that the relative shift in the securitization activity of investment banks was driven by forces exogenous to factors impacting lending decisions in the primary mortgage market and resulted in lower ZIP code denial rates, higher subprime origination rates, and higher subsequent default rates. Consistent with recent findings in the literature, we provide evidence that the increased securitization activity of investment banks reduced lenders' incentives to carefully screen borrowers.     

Transition to the Euro and its impact on country portfolio diversification

By examining the impact of the introduction of the Euro on stock markets and on country diversification within the Eurozone, the evidence does not suggest a high risk to the stock market to justify a risk premium as a result of currency union. Although the Euro market integration has increased inter-country correlations, it does not preclude gains from international diversification, which partially rely on the non-Eurozone countries for an optimal portfolio in a mean-variance framework. Furthermore, the empirical evidence supports that there is a significant stationarity of average correlations over time between pre-Euro and post-Euro periods, and it has improved since the introduction of the Euro. Also, results show that the Euro produced a change in volatility with a different pace within the Eurozone vis-à-vis non-Eurozone countries, to support a direct and opposite relationship between volatility and correlation.     

The impact of international portfolio composition on consumption risk sharing

Recent empirical work has shown that ongoing international financial integration facilitates cross-country consumption risk sharing. These studies typically find that countries with high equity home bias exhibit relatively low international consumption risk sharing. We extend this line of research and demonstrate that it is not only a country's equity home bias that prevents consumption risk sharing. In addition, the composition of a country's foreign asset portfolio plays an important role. Using panel-data regression for a group of OECD countries over the period 1980–2007, we show that foreign investment bias has additional explanatory power for consumption risk sharing.     

The impact of mergers on credit union service provision

In this paper we conduct an empirical exercise in which we attempt to provide answers to three questions concerning credit union mergers: (i) do members of acquiring credit unions benefit from mergers?; (ii) do members of acquired credit unions benefit from mergers?; and (iii) what are the characteristics of relatively successful, and relatively unsuccessful, mergers? Our empirical exercise is based on annual samples of nearly 6000 credit unions, including nearly 300 merger participants, during the 1988–1995 period. We find member service provision to have improved in acquired credit unions, and to have been unchanged in acquiring credit unions. We also provide three separate analyses, from three different perspectives, of the role of various characteristics of merging credit unions in determining the success of mergers.     

Credit agency regulation and the impact of credit ratings in the international bond market

The use of credit ratings in financial and other legal documents — both in the USA and Europe —, has led to a situation in which the major rating agencies have become (largely unwilling) participants in the legislative process. This situation has become partly formalized in the US (and is being repeated elsewhere in the European Union, Eastern Europe and Latin America) through the creation of officially ‘recognized’ agencies whose ratings now carry the imprimatur of the Securities and Exchange Commission. The purpose of this paper is to contribute to the debate on the necessity for formal legal status to be sustained in the market for bond credit ratings. In this context, the criteria for a credible rating agency are examined and evidence is provided on one element of the criteria which is under-researched: namely, the impact of the ratings in the market place. The influence of rating agencies in international capital markets is assessed through an analysis of the impact of ratings on the yields of bonds, represented by a comprehensive sample of actively traded debt. The sample contains analysis of ratings introductions on both new and seasoned debt and also examines the impact of ratings revisions. It is concluded that official recognition has no market-based role and it is argued that ratings are used by regulators because of the success of the major agencies in performing their market function.     

外包模式下信用卡PBOC迁移的设计与实现

银行卡EMV迁移,是指银行卡从磁条卡向符合EMV标准的IC芯片卡转变,或由非EMV标准IC卡向与EMV标准兼容的方向转变。PBOC借贷记标准规范,是中国人民银行制定的基于EMV Leve12／Leve11之上的金融IC卡规范,是与VIS（VISA金融IC卡规范）和MCHIP（万事达卡金融IC卡规范）并肩的EMV产品规范。PBOC迁移将成为全球背景下EMV迁移的重要一环。     

The impact of securitization on credit rationing: Empirical evidence

We study whether banks’ involvement into different types of securitization activity – asset backed securities (ABS) and covered bonds – in Spain influences credit supply before and during the financial crisis. While both ABS and covered bonds were hit by the crisis, the former were hit more severely. Employing a disequilibrium model to identify credit rationing, we find that firms with banks that were more involved in securitization see their credit constraints more relaxed in normal periods. In contrast, only greater covered bonds issuance reduces credit rationing during crisis periods whereas ABS aggravates these firms’ credit rationing in crisis periods. Our results are in line with the theoretical predictions that a securitization instrument that retains risk (covered bond) may induce a more prudent risk behavior of banks than an instrument that provides risk transferring (ABS).     

The impact of portfolio diversification on mean reverting components of stock indices

Positive autocorrelations are introduced into stock index portfolios when they are formed from individual stock indices while negative autocorrelations are induced in returns by increasing the investment horizon. Using monthly data of six international stock indices, this paper examines the diversification effect with different investment horizons on autocorrelations of stock index portfolios. The results show that portfolio diversification does not alter the impact of the investment horizon on autocorrelations. Different investment horizons, however, have great impact on the diversification effect on autocorrelations. With short (long) horizons, the average autocorrelation coefficient increases (decreases) with an increase in the portfolio size, suggesting that mean-reverting component dominates the delayed adjustment effect in long horizons and vice versa in short horizons. Our results are robust across two 10-year sub-periods.The author would like to thank an anonymous referee of this Journal for the comments on an earlier version of this paper and the Research Committee of Hong Kong Baptist University for the financial support in this research.     

A statistical analysis of the impact of monetary policy on credit union lending

In this paper, a polynomial distributed lag regression model has been employed to determine the responsiveness of credit union consumer installment lending to changes in monetary policy. Estimation of the model leads to the following conclusions: (a) the model provides an adequate statistical representation of credit union reaction to monetary policy, (b) over time, credit union lending behavior has come to react more quickly to changes in monetary policy, and (c) over time, the degree, or strength, of response of lending behaviour to changes in monetary policy has weakend. The model is also applied to commercial bank consumer installment lending with similar results.