Value-at-Risk and expected shortfall for rare events

We show that the use of correlations for modeling dependencies may lead to counterintuitive behavior of risk measures, such as Value-at-Risk (VaR) and Expected Short- fall (ES), when the risk of very rare events is assessed via Monte-Carlo techniques. The phenomenon is demonstrated for mixture models adapted from credit risk analysis as well as for common Poisson-shock models used in reliability theory. An obvious implication of this finding pertains to the analysis of operational risk. The alleged incentive suggested by the New Basel Capital Accord (Basel II), amely decreasing minimum capital requirements by allowing for less than perfect correlation, may not necessarily be attainable

Analysis of Potential Co-Benefits for Bicyclist Crash Imminent Braking Systems

In the US, the number of traffic fatalities has had a long term downward trend as a result of advances in the crash worthiness of vehicles. However, these improvements in crash worthiness do little to protect other vulnerable road users such as pedestrians or bicyclists. Several manufacturers have developed a new generation of crash avoidance systems that attempt to recognize and mitigate imminent crashes with non-motorists. While the focus of these systems has been on pedestrians where they can make meaningful contributions to improved safety [1], recent designs of these systems have recognized mitigating bicyclist crashes as a potential co-benefit. This paper evaluates the performance of one system that is currently available for consumer purchase. Because the vehicle manufacturer does not claim effectiveness for their system under all crash geometries, we focus our attention on the crash scenario that has the highest social cost in the US: the cyclist and vehicle on parallel paths being struck from behind. Our analysis of co benefits examines the ability to reduce three measures: number of crashes, fatalities, and a comprehensive measure for social cost that incorporates morbidity and mortality. Test track simulations under realistic circumstances with a realistic surrogate bicyclist target are conducted. Empirical models are developed for system performance and potential benefits for injury and fatality reduction. These models identify three key variables in the analysis: vehicle speed, cyclist speed and cyclist age as key determinants of potential co-benefits. We find that the evaluated system offers only limited benefits for any but the oldest bicycle riders for our tested scenario

Developing a simulator for the Greek electricity market

Following the liberalization of the Greek electricity market, the Greek Regulatory Authority for Energy (RAE) undertook the design and implementation of a simulator for the wholesale market and its interactions with the Natural Gas Transportation System. The simulator consists of several interacting modules representing all key market operations and dynamics including (i) day-ahead scheduling based on bids of market participants, (ii) natural gas system constraints, (iii) unplanned variability of loads and available capacity driven either by uncertain stochastic outcomes or deliberate participant schedule deviations, (iv) real time dispatch, and (v) financial settlement of day ahead and real time schedule differences. The modules are integrated into one software package capable of simulating all market dynamics, deliberate or probabilistic, and their interactions across all relevant time scales. The intended use of the simulator is to elaborate on and allow RAE to investigate the impact of participant decision strategies on market outcomes. The ultimate purpose is to evaluate the effectiveness of Market Rules, whether existing or contemplated, in providing incentives for competitive behaviour and in discouraging gaming and market manipulation. This paper describes the development of the simulator relative to the current Greek Electricity Market Design and key contemplated revisions.simulation; regulatory policy; electricity markets; market design;

The pricing puzzle : the default term structure of collateralised loan obligations

Ambivalence in the regulatory definition of capital adequacy for credit risk has recently stirred the financial services industry to collateral loan obligations (CLOs) as an important balance sheet management tool. CLOs represent a specialised form of Asset-Backed Securitisation (ABS), with investors acquiring a structured claim on the interest proceeds generated from a portfolio of bank loans in the form of tranches with different seniority. By way of modelling Merton-type risk-neutral asset returns of contingent claims on a multi-asset portfolio of corporate loans in a CLO transaction, we analyse the optimal design of loan securitisation from the perspective of credit risk in potential collateral default. We propose a pricing model that draws on a careful simulation of expected loan loss based on parametric bootstrapping through extreme value theory (EVT). The analysis illustrates the dichotomous effect of loss cascading, as the most junior tranche of CLO transactions exhibits a distinctly different default tolerance compared to the remaining tranches. By solving the puzzling question of properly pricing the risk premium for expected credit loss, we explain the rationale of first loss retention as credit risk cover on the basis of our simulation results for pricing purposes under the impact of asymmetric information. Klassifikation: C15, C22, D82, F34, G13, G18, G2