Risks — Open Access Journal of Risk Management

This paper examines how the size of the rolling window, and the frequency used in moving average (MA) trading strategies, affects financial performance when risk is measured. We use the MA rule for market timing, that is, for when to buy stocks and when to shift to the risk-free rate. The important issue regarding the predictability of returns is assessed. It is found that performance improves, on average, when the rolling window is expanded and the data frequency is low. However, when the size of the rolling window reaches three years, the frequency loses its significance and all frequencies considered produce similar financial performance. Therefore, the results support stock returns predictability in the long run. The procedure takes account of the issues of variable persistence as we use only returns in the analysis. Therefore, we use the performance of MA rules as an instrument for testing returns predictability in financial stock markets. Full article

We introduce tools to capture the dynamics of three different pathways, in which the synchronization of human decision-making could lead to turbulent periods and contagion phenomena in financial markets. The first pathway is caused when stock market indices, seen as a set of coupled integrate-and-fire oscillators, synchronize in frequency. The integrate-and-fire dynamics happens due to “change blindness”, a trait in human decision-making where people have the tendency to ignore small changes, but take action when a large change happens. The second pathway happens due to feedback mechanisms between market performance and the use of certain (decoupled) trading strategies. The third pathway occurs through the effects of communication and its impact on human decision-making. A model is introduced in which financial market performance has an impact on decision-making through communication between people. Conversely, the sentiment created via communication has an impact on financial market performance. The methodologies used are: agent based modeling, models of integrate-and-fire oscillators, and communication models of human decision-making. Full article

Variable annuities, as a class of retirement income products, allow equity market exposure for a policyholder’s retirement fund with optional guarantees to limit the downside risk of the market. Management fees andguarantee insurance fees are charged respectively for the market exposure and for the protection from the downside risk. We investigate the pricing of variable annuity guarantees under optimal withdrawal strategies when management fees are present. We consider from both policyholder’s and insurer’s perspectives optimal withdrawal strategies and calculate the respective fair insurance fees. We reveal a discrepancy where the fees from the insurer’s perspective can be significantly higher due to the management fees serving as a form of market friction. Our results provide a possible explanation of lower guarantee insurance fees observed in the market than those predicted from the insurer’s perspective. Numerical experiments are conducted to illustrate the results. Full article

A fluctuation theory and, in particular, a theory of scale functions is developed for upwards skip-free Lévy chains, i.e., for right-continuous random walks embedded into continuous time as compound Poisson processes. This is done by analogy to the spectrally negative class of Lévy processes—several results, however, can be made more explicit/exhaustive in the compound Poisson setting. Importantly, the scale functions admit a linear recursion, of constant order when the support of the jump measure is bounded, by means of which they can be calculated—some examples are presented. An application to the modeling of an insurance company’s aggregate capital process is briefly considered. Full article

We utilize the data of a very large UK automobile loan firm to study the interaction of the characteristics of borrowers and loans in predicting the subsequent loan performance. Our broader findings confirm the earlier research on the issue of subprime auto loans. More importantly, unmarried borrowers living with furnished tenancy agreements who have relatively new jobs have a probability of defaulting of more than 60% compared to an average 7% default rate in overall subprime borrowers in the dataset. Also, in the above category are those who live in a less prosperous part of the UK such as the north-west, are full-time self-employed, have other large loan arrears, fall into the bottom 25% percentile of monthly income, secure loans with high loan to total value (LTV), purchase expensive automobiles with shorter loan duration payment plans, and have a high dependency on government support. This in fact is also true of those who go into arrears, except that the highest probability in this context is around 40% compared to 6% for an overall sample. These findings shall help in the understanding of subprime auto loans performance in relation to borrowers and loan features alongside helping auto finance firms improve predictive models and decision-making. Full article

Background, or systematic, risks are integral parts of many systems and models in insurance and finance. These risks can, for example, be economic in nature, or they can carry more technical connotations, such as errors or intrusions, which could be intentional or unintentional. A most natural question arises from the practical point of view: is the given system really affected by these risks? In this paper we offer an algorithm for answering this question, given input-output data and appropriately constructed statistics, which rely on the order statistics of inputs and the concomitants of outputs. Even though the idea is rooted in complex statistical and probabilistic considerations, the algorithm is easy to implement and use in practice, as illustrated using simulated data. Full article

A quantum mechanics approach is proposed to model non-life insurance risks and to compute the future reserve amounts and the ruin probabilities. The claim data, historical or simulated, are treated as coming from quantum observables and analyzed with traditional machine learning tools. They can then be used to forecast the evolution of the reserves of an insurance company. The following methodology relies on the Dirac matrix formalism and the Feynman path-integral method. Full article

The study considers the product life cycle in the stages of technological innovation, and focuses on how to evaluate the optimal investment strategy and the project value. It applies different product stages (three stages including production innovation, manufacture innovation, and business innovation) factors to different risks to build a technology innovation strategy model. This study of option premiums aims for the best strategy timing for each innovation stage. It shows that the variation of business cycle will affect the purchasing power under the uncertainty of Gross Domestic Product (GDP). In application, the compound binomial options for the manufacture innovation will only be considered after the execution of the production innovation, whereas the operation innovation will only be considered after the execution of the manufacture innovation. Thus, this paper constructs the dynamic investment sequential decision model, assesses the feasibility of an investment strategy, and makes a decision on the appropriate project value and option premiums for each stage under the possible change of GDP. Numerically, the result shows the equity value of the investment is greater than 0. Therefore, this paper recommends the case firm to invest in its innovation project known as one-time passwords. Sensitivity analysis shows when the risk-adjusted discounted rate r increases, the risk of the investment market increases accordingly, hence the equity value must also be higher in order to attract the case firm’s investment interest. Also, the average GDP growth rate u sensitivity analysis results in different phenomena. The equity value gradually decreases when the average GDP growth rate rises. When the average GDP growth rate u rises to a certain extent, however, its equity value is gradually growing. The study investigates the product life cycle innovation investment topic by using the compound binomial options method and therefore provide a more flexible strategy decision compared with other trend forecast criteria. Full article

The paper addresses three objectives: the first is a presentation and overview of some important developments in quantile times series approaches relevant to demographic applications—secondly, development of a general framework to represent quantile regression models in a unifying manner, which can further enhance practical extensions and assist in formation of connections between existing models for practitioners. In this regard, the core theme of the paper is to provide perspectives to a general audience of core components that go into construction of a quantile time series model. The third objective is to compare and discuss the application of the different quantile time series models on several sets of interesting demographic and mortality related time series data sets. This has relevance to life insurance analysis and the resulting exploration undertaken includes applications in mortality, fertility, births and morbidity data for several countries, with a more detailed analysis of regional data in England, Wales and Scotland. Full article

Almost sure bootstrap consistency of the blockwise bootstrap for the Average Value at Risk of single risks is established for strictly stationary $\beta$-mixing observations. Moreover, almost sure bootstrap consistency of a multiplier bootstrap for the Average Value at Risk of collective risks is established for independent observations. The main results rely on a new functional delta-method for the almost sure bootstrap of uniformly quasi-Hadamard differentiable statistical functionals, to be presented here. The latter seems to be interesting in its own right. Full article

We propose a novel credit risk measurement model for Corporate Default Swap (CDS) spreads that combines vector autoregressive regression with correlation networks. We focus on the sovereign CDS spreads of a collection of countries that can be regarded as idiosyncratic measures of credit risk. We model CDS spreads by means of a structural vector autoregressive model, composed by a time dependent country specific component, and by a contemporaneous component that describes contagion effects among countries. To disentangle the two components, we employ correlation networks, derived from the correlation matrix between the reduced form residuals. The proposed model is applied to ten countries that are representative of the recent financial crisis: top borrowing/lending countries, and peripheral European countries. The empirical findings show that the contagion variable derived in this study can be considered as a network centrality measure. From an applied viewpoint, the results indicate that, in the last 10 years, contagion has induced a “clustering effect” between core and peripheral countries, with the two groups further diverging through, and because of, contagion propagation, thus creating a sort of diabolic loop extremely difficult to be reversed. Finally, the outcomes of the analysis confirm that core countries are importers of risk, as contagion increases their CDS spread, whereas peripheral countries are exporters of risk. Greece is an unfortunate exception, as its spreads seem to increase for both idiosyncratic factors and contagion effects. Full article

This study examines the linkages between Brazil, Russia, India, and China (BRICS) stock market returns, country risk ratings, and international factors via Non-linear Auto Regressive Distributed Lags models (NARDL) that allow for testing the asymmetric effects of changes in country risk ratings on stock market returns. We show that BRICS countries exhibit quite a degree of heterogeneity in the interaction of their stock market returns with country-specific political, financial, and economic risk ratings. Positive and negative rating changes in some BRICS countries are found to have significant implications for both local stock market returns, as well as commodity price dynamics. While the commodity market acts as a catalyst for these emerging stock markets in the long-run, we also observe that negative changes in the country risk ratings generally command a higher impact on stock returns, implying the greater impact of bad news on market dynamics. Our findings suggest that not all BRICS nations are the same in terms of how they react to ratings changes and how they interact with global market variables. Full article

There exist several estimators of the regression line in the simple linear regression: Least Squares, Least Absolute Deviation, Right Median, Theil–Sen, Weighted Balance, and Least Trimmed Squares. Their performance for heavy tails is compared below on the basis of a quadratic loss function. The case where the explanatory variable is the inverse of a standard uniform variable and where the error has a Cauchy distribution plays a central role, but heavier and lighter tails are also considered. Tables list the empirical sd and bias for ten batches of one hundred thousand simulations when the explanatory variable has a Pareto distribution and the error has a symmetric Student distribution or a one-sided Pareto distribution for various tail indices. The results in the tables may be used as benchmarks. The sample size is $n=100$ but results for $n=\infty$ are also presented. The error in the estimate of the slope tneed not be asymptotically normal. For symmetric errors, the symmetric generalized beta prime densities often give a good fit. Full article

A justification of the Basel liquidity formula for risk capital in the trading book is given under the assumption that market risk-factor changes form a Gaussian white noise process over 10-day time steps and changes to P&L (profit-and-loss) are linear in the risk-factor changes. A generalization of the formula is derived under the more general assumption that risk-factor changes are multivariate elliptical. It is shown that the Basel formula tends to be conservative when the elliptical distributions are from the heavier-tailed generalized hyperbolic family. As a by-product of the analysis, a Fourier approach to calculating expected shortfall for general symmetric loss distributions is developed. Full article

In this article we introduce the stability analysis of a compound sum: it consists of computing the standardized variation of the survival function of the sum resulting from an infinitesimal perturbation of the common distribution of the summands. Stability analysis is complementary to the classical sensitivity analysis, which consists of computing the derivative of an important indicator of the model, with respect to a model parameter. We obtain a computational formula for this stability from the saddlepoint approximation. We apply the formula to the compound Poisson insurer loss with gamma individual claim amounts and to the compound geometric loss with Weibull individual claim amounts. Full article

We study a toy model of linear-quadratic mean field game with delay. We “lift” the delayed dynamic into an infinite dimensional space, and recast the mean field game system which is made of a forward Kolmogorov equation and a backward Hamilton-Jacobi-Bellman equation. We identify the corresponding master equation. A solution to this master equation is computed, and we show that it provides an approximation to a Nash equilibrium of the finite player game. Full article

The paper analyzes the relationship between the credit default swaps (CDS) spreads for 5-year CDS in Europe and US, and fundamental macroeconomic variables such as regional stock indices, oil prices, gold prices, and interest rates. The dataset includes consideration of multiple industry sectors in both economies, and it is split in two sections, before and after the global financial crisis. The analysis is carried out using multivariate regression of each index vs. the macroeconomic variables, and a Granger causality test. Both approaches are performed on the change of value of the variables involved. Results show that equity markets lead in price discovery, bidirectional causality between interest rate, and CDS spreads for most sectors involved. There is also bidirectional causality between stock and oil returns to CDS spreads. Full article

Co-risk measures and risk contribution measures have been introduced to evaluate the degree of interaction between paired risks in actuarial risk management. This paper attempts to study the ordering behavior of measures on interaction between paired risks. For various co-risk measures and risk contribution measures, we investigate how the marginal distributions and the dependence structure impact on the level of interaction between paired risks. Also, several numerical examples based on Monte Carlo simulation are presented to illustrate the main findings. Full article

With the purpose of introducing dependence between different types of claims, multivariate collective models have recently gained a lot of attention. However, when it comes to the evaluation of the corresponding compound distribution, the problems increase with the dimensionality of the model. In this paper, we consider a multivariate collective model that generalizes a model already studied from the point of view of recursive and FFT evaluation of its distribution, and we extend the same study to the general model. With the intention to see which method works better for this general model, we compare the recursive method with the FFT technique, and emphasize the advantages and drawbacks of each one, based on numerical examples. Full article