Applying stress-testing on value at risk (VaR) methodologies

In recent years, Value at Risk (VaR) methodologies, i. e., Parametric VaR, Historical Simulation and the Monte Carlo Simulation have experienced spectacular growth within the new regulatory framework which is Basle II. Moreover, complementary analyses such a Stress-testing and Back-testing have also demonstrated their usefulness for financial risk managers. In this paper, we develop an empirical Stress-Testing exercise by using two historical scenarios of crisis. In particular, we analyze the impact of the 11-S attacks (2001) and the Latin America crisis (2002) on the level of risk, previously calculated by different statistical methods. Consequently, we have selected a Spanish stock portfolio in order to focus on market risk

Models of public-private partnerships in megaprojects: the Spanish case

This article provides a literature review of PPP Models, where the clarification of this current confusion and ambiguity constitute the fundamental issue addressed by our research. The systematization of the PPP models is performed by applying six classification criteria based on organizational and financial aspects and focused on the Spanish experience. Additionally, a comparative study of the various schemes applied in European countries is carried out, whereby the concession model implemented successfully in Spain is studied in greater detail. To this end, a megaproject, the first metro line of Seville (Spain) forms the basis of a case-study. When the megaproject is viable through user fees, the public sector can use PPPs to defer payments and as a way to control their deficits and debt without cutting investments in infrastructures and public services. Nevertheless, certain drawbacks should be borne in mind, such as the expenditure commitments of future budgets, the higher cost of private funding, and the necessity for transparency and accountability of PPP contractual arrangements to be improved. Therefore, the aim of this article is to analyze the various forms of PPPs in megaprojects in order to determine the potential efficiency gains that can be achieved in the implementation of these models

Internal models (IRB) in Basel II: an approach to determining the probability of default

The New Accord of Basel, known as Basel II, opens the way for and encourages the implementation of credit entities' own models for measuring their financial risks. In this paper, we focus on the internal models for the assessment of credit risk (IRB), and specifically on the approach to one of their components: the probability of default (PD). Our paper is structured in three sections. In the first section, we present the most significant aspects of the credit risk treatment in Basel II. In the second part, the available financial literature is reviewed. And finally, we undertake an empirical application with the object of determining what is or are the variables that are able to explain why a company defaults. Furthermore, this would serve as a preventive "warning system" for financial entities

Fuzzy Logic and Its Uses in Finance: A Systematic Review Exploring Its Potential to Deal with Banking Crises

The major success of fuzzy logic in the field of remote control opened the door to its application in many other fields, including finance. However, there has not been an updated and comprehensive literature review on the uses of fuzzy logic in the financial field. For that reason, this study attempts to critically examine fuzzy logic as an effective, useful method to be applied to financial research and, particularly, to the management of banking crises. The data sources were Web of Science and Scopus, followed by an assessment of the records according to pre-established criteria and an arrangement of the information in two main axes: financial markets and corporate finance. A major finding of this analysis is that fuzzy logic has not yet been used to address banking crises or as an alternative to ensure the resolvability of banks while minimizing the impact on the real economy. Therefore, we consider this article relevant for supervisory and regulatory bodies, as well as for banks and academic researchers, since it opens the door to several new research axes on banking crisis analyses using artificial intelligence techniques

Bail-In: a sustainable mechanism for rescuing banks

Until the Great Recession, rescuing banks with taxpayers’ money had been the preferred way to deal with banking crises. The dramatic effects of these practices on the real economy highlighted that bailouts are not a sustainable method to resolve troubled banks going forward. As a result, a new regulatory framework has been proposed, forcing the financial industry to move from “bailout” to “bail-in.” Understanding the implications of such a change is key to ensuring the success of these new banking rules. This article aims to build up a comprehensive and unbiased set of research articles in order to draw conclusions about the current status of the academic literature in the field of capital and loss absorption requirements. A research agenda on the topic is also proposed. The methodological approach undertaken is based on ProKnow-C (Knowledge Development Process-Constructivist). We also contribute to the development of Proknow-C methodology by adding a cross-reference extension to the original framework. The results of our analysis point out that further research has to be undertaken on the subject of loss absorption requirements

Hybrid model using logit and nonparametric methods for predicting micro-entity failure

Following the calls from literature on bankruptcy, a parsimonious hybrid bankruptcy model is developed in this paper by combining parametric and non-parametric approaches.To this end, the variables with the highest predictive power to detect bankruptcy are selected using logistic regression (LR). Subsequently, alternative non-parametric methods (Multilayer Perceptron, Rough Set, and Classification-Regression Trees) are applied, in turn, to firms classified as either “bankrupt” or “not bankrupt”. Our findings show that hybrid models, particularly those combining LR and Multilayer Perceptron, offer better accuracy performance and interpretability and converge faster than each method implemented in isolation. Moreover, the authors demonstrate that the introduction of non-financial and macroeconomic variables complement financial ratios for bankruptcy prediction

Risk management according to Basel II: analysis of Spanish financial entities annual reports

El nuevo Acuerdo de Capital, Basilea II marca un punto de partida tanto en la gestión de los riesgos como en las relaciones que habrán de mantener entidades financieras y supervisores. El Acuerdo se configura a través de tres pilares: pilar I, requerimientos mínimos de capital, pilar II, revisión supervisora y pilar III, disciplina de mercado. Nuestro trabajo tiene un doble objetivo. En primer lugar profundizar en el análisis teórico del contenido del tercer pilar, incidiendo especialmente en el tratamiento del riesgo de crédito. Para ello se ha realizado un estudio analítico sobre los contenidos de este pilar en el nuevo acuerdo. Como conclusión se puede extraer que el Acuerdo ha dejado gran parte de los contenidos de este pilar en manos de las propias entidades financieras y en última instancia el control a los reguladores de cada país. En segundo lugar hemos querido conocer el grado de preparación de las entidades de crédito frente al reto que, en materia de riesgo de crédito, les impone el Acuerdo en general y el tercer pilar en particular. Para ello hemos utilizado una muestra de entidades financieras españolas y hemos procedido a estudiar la información contenida en sus memorias anuales en el período 2000 – 2003. Como conclusión de este estudio se puede ver una evolución exponencial con respecto a la información publicada por las entidades, no habiendo prácticamente ninguna información referente a Basilea en el año 2000 y produciéndose un salto, tanto cualitativo como cuantitativo, en el 2001. En el último año del estudio, 2003, prácticamente todas las entidades analizadas aportan datos de los requeridos por Basilea.Basel II, the new Capital Accord, is a landmark regarding both risk management and the relations to be established amongst financial institutions and regulators. It displays a three-pillar structure: Pillar I, minimum capital requirements, Pillar II, supervising review, and Pillar III, market regulation. This study has a twofold purpose. Firstly, focusing upon credit risk, we have realised an analytical study of the Third Pillar as tailored within the new accord. We may conclude this Accord has left most of this pillar content under the responsibility of financial entities and, it ultimately holds each country’s national regulators responsible for controlling the sector. Secondly, we envisage appraising the credit organisms’ level of preparation to respond to the credit risks challenges as posed by the Accord in general, and the Third Pillar in particular. We have thus utilised a sample composed by Spanish financial entities and studied the information disclosed in their annual reports for the time period of 2000 – 2003. The study concludes that the amount of information disclosed by the entities has increased exponentially. It is interesting to highlight there is no information in line with the Basel parameters for the year of 2000. Yet, we are glad to report a qualitative and quantitative leap forward for the year of 2001. Almost all the institutions studied comprise data complying with the Basel requirements for the year 2003

Kernel alternatives to aproximate operational severity distribution: an empirical application

The estimation of severity loss distribution is one the main topic in operational risk estimation. Numerous parametric estimations have been suggested although very few work for both high frequency small losses and low frequency big losses. In this paper several estimation are explored. The good performance of the double transformation kernel estimation in the context of operational risk severity is worthy of a special mention. This method is based on the work of Bolancé and Guillén (2009), it was initially proposed in the context of the cost of claims insurance, and it means an advance in operational risk research

Improving bankruptcy prediction in micro-entities by using nonlinear effects and non-financial variables

The use of non-parametric methodologies, the introduction of non-financial variables, and the development of models geared towards the homogeneous characteristics of corporate sub-populations have recently experienced a surge of interest in the bankruptcy literature. However, no research on default prediction has yet focused on micro-entities (MEs), despite such firms’ importance in the global economy. This paper builds the first bankruptcy model especially designed for MEs by using a wide set of accounts from 1999 to 2008 and applying artificial neural networks (ANNs). Our findings show that ANNs outperform the traditional logistic regression (LR) models. In addition, we also report that, thanks to the introduction of non-financial predictors related to age, the delay in filing accounts, legal action by creditors to recover unpaid debts, and the ownership features of the company, the improvement with respect to the use of solely financial information is 3.6%, which is even higher than the improvement that involves the use of the best ANN (2.6%)

The financial performance of an innovative megaproject

The financial structure of megaprojects, known in the literature as project finance, is characterized by the creation of a legally independent project company financed with a concentrated equity ownership and a high level of non-recourse debt. Research in this field may yield new ideas and theories about the existing theoretical framework on capital structure, stakeholder management and risk management. A case-study is analyzed in this paper: the financial performance of the first metro line in Seville (Spain). In spite of previous cost overruns in the construction stage, the present operation stage is considered successful from the point of view of social and financial profitability, whereby the risks have been theoretically transferred to stakeholders, as defined by Value for Money considerations. The objective of this study involves: first to determine whether this megaproject meets the expectations for which it was created in terms of hope of return of the shareholders, and the expectations of the economic and financial feasibility under a change of subsidy policies; and secondly to determine whether the conditions remain for not including the investment as public debt. This issue is crucial in a budgetary constraint context for the planning of future metro lines. By taking this first experience into account, this article also provides information for potential participants in the projects of the new metro lines, which are currently in the planning stage