Credit Risk and Real Capital: An Examination of Swiss Banking Sector Default Risk Using CVaR

The global financial crisis (GFC) has placed the creditworthiness of banks under intense scrutiny. In particular, capital adequacy has been called into question. Current capital requirements make no allowance for capital erosion caused by movements in the market value of assets. This paper examines default probabilities of Swiss banks under extreme conditions using structural modeling techniques. Conditional Value at Risk (CVaR) and conditional probability of default (CPD) techniques are used to measure capital erosion. Significant increase in probability of default (PD) is found during the GFC period. The market asset value based approach indicates a much higher PD than external ratings indicate. Capital adequacy recommendations are formulated which distinguish between real and nominal capital based on asset fluctuations.Real capital; Financial crisis; Conditional value at risk; Credit risk; Banks; Probability of default; Capital adequacy

Industry Market Value at Risk in Australia

Value at Risk (VaR) is an important issue for banks since its adoption as a primary risk metric in the Basel Accords and the requirement that it is calculated on a daily basis. Relative industry risk measurement is also very important to Banks in their management of risk, such as for setting risk concentration limits and developing investment and credit policy. This paper examines market Value at Risk (VaR) and Conditional VaR (CVaR) in Australia from an industry perspective using a set of Australian industries. VaR and CVaR are compared between these industries over time, and a variety of metrics are used including diversified and undiversified VaR, as well as parametric and nonparametric CVaR methods. There has been no prior investigation of industry based VaR metrics in Australia to the authorsÌ knowledge. The relative riskiness of different industry sectors is examined and using diversified VaR, the study .nds the highest risk is in the Technology Sectors, whilst the lowest risk is found in the Finance and Utilities Sectors. Composite riskiness is also explored and the existence of correlation between industry risk rankings over time is found to depend on the number of years of data used. There is evidence of rank correlation over time using a 7 year window approach, but not when using 1 year data tranches. This highlights the importance of using both short and long time frames in order to cover different economic cycles as well as consider current conditions. It is important to note that there is found to be no significant difference between diversified and undiversified industry VaR rankings, or between parametric and nonparametric CVaR approaches. This means that bankers can be reasonably confident of the robustness of any one of these metrics when calculating and applying them, not only for the purposes of Basel compliance, but also for the determination of relative industry risk.Conditional value at risk (CVaR), Industry risk, Basel compliance

CVaR and Credit Risk Measurement

The link between credit risk and the current financial crisis accentuates the importance of measuring and predicting extreme credit risk. Conditional Value at Risk (CVaR) has become an increasingly popular method for measuring extreme market risk. We apply these CVaR techniques to the measurement of credit risk and compare the probability of default among Australian sectors prior to and during the financial crisis. An in depth understanding of sectoral risk is vital to Banks to ensure that there is not an overconcentration of credit risk in any sector. This paper demonstrates how CVaR methodology can be applied in different economic circumstances and provides Australian Banks with important insights into extreme sectoral credit risk leading up to and during the financial crisis.Conditional Value at Risk (CVaR), Banks, Structural modelling, Probability of default (PD)

The Fluctuating Default Risk of Australian Banks

Australian banks are widely considered to have fared far better during the Global Financial Crisis (GFC) than their global counterparts, continuing to display solid earnings, good capitalisation and strong credit ratings. Nonetheless, Australian banks experienced significant deterioration in the market values of assets. We use the KMV/Merton structural methodology, which incorporates market asset values, to examine default probabilities of Australian banks. We also modify the model to incorporate conditional probability of default which measures extreme credit risk. We find that, during the GFC, based on extreme asset value fluctuations, Australian bank default probabilities fare only slightly better than their global counterparts.Financial crisis; Credit risk; Banks; Default; Capital adequacy

Managerial Discretion in the Use Of Self-Ratings in an Appraisal System: The Antecedents And Consequences

Self-evaluations of performance have elicited the interests of researchers over the last four decades. Supporters attest to the importance of employee involvement in the appraisal process while detractors raise issues concerning leniency, validity and purpose. This study examines the circumstances under which superiors have discretion to ask subordinates to self-evaluate their performance in an ongoing appraisal system. Three primary issues are investigated: the conditions under which superiors requested subordinates to self-evaluate, the relationship between opportunity to self-evaluate and the type of post-appraisal interview that was conducted, and the impact of self-ratings on performance appraisal outcomes. Three hundred twenty-six subordinates responded to questions about the performance appraisal process. Results showed leader-subordinate relationships were strong predictors of opportunity to self-rate. Self-ratings were strongly related to type of interview conducted and had an impact on perceived fairness of ratings. While criticism of self-ratings exists, our findings indicate that voluntary self-ratings, focusing on performance development, have a positive impact on the appraisal process

Volatility and correlations for stock markets in the emerging economies

This paper examines the European investment implications of the recent European Union (EU) expansion to encompass former Eastern bloc economies. What are the risk and return characteristics of these markets pre- and post-EU? What are the implications for investors within the Euro zone? Should investors diversify outside the Central and Eastern Europe (CEE)? The former Eastern bloc economies constitute emerging markets which typically offer attractive risk-adjusted returns for international investors. In this paper, we explore a number of aspects of this important issue and their implications for CEE based investors, culminating in a Markowitz efficient frontier analysis of these markets pre- and post-EU expansion.Emerging Markets; European Union; Portfolio investment