State-Uncertainty preferences and the Risk Premium in the Exchange rate market

This paper introduces state-uncertainty preferences into the Lucas (1982) economy, showing that this type of preferences helps to explain the exchange rate risk premium. Under these preferences we can distinguish between two factors driving the exchange rate risk premium: “macroeconomic risk” and “the risk associated with variation in the private agents’ perception on the level of uncertainty”. State-uncertainty preferences amount to assuming that a given level of consumption will yield a higher level of utility the lower is the level of uncertainty perceived by consumers. Furthermore, empirical evidence from three main European economies in the transition period to the euro provides empirical support for the modelForecasting, subspace methods, combining forecasts.

Optimal Risk Management Before, During and After the 2008-09 Financial Crisis

In this paper we advance the idea that optimal risk management under the Basel II Accord will typically require the use of a combination of different models of risk. This idea is illustrated by analyzing the best empirical models of risk for five stock indexes before, during, and after the 2008-09 financial crisis. The data used are the Dow Jones Industrial Average, Financial Times Stock Exchange 100, Nikkei, Hang Seng and Standard and Poor?s 500 Composite Index. The primary goal of the exercise is to identify the best models for risk management in each period according to the minimization of average daily capital requirements under the Basel II Accord. It is found that the best risk models can and do vary before, during and after the 2008-09 financial crisis. Moreover, it is found that an aggressive risk management strategy, namely the supremum strategy that combines different models of risk, can result in significant gains in average daily capital requirements, relative to the strategy of using single models, while staying within the limits of the Basel II Accord.

Has the Basel II Accord Encouraged Risk Management During the 2008-09 Financial Crisis?

The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. In this paper we define risk management in terms of choosing sensibly from a variety of risk models, discuss the selection of optimal risk models, consider combining alternative risk models, discuss the choice between a conservative and aggressive risk management strategy, and evaluate the effects of the Basel II Accord on risk management. We also examine how risk management strategies performed during the 2008-09 financial crisis, evaluate how the financial crisis affected risk management practices, forecasting VaR and daily capital charges, and discuss alternative policy recommendations, especially in light of the financial crisis. These issues are illustrated using Standard and Poor's 500 Index, with an emphasis on how risk management practices were monitored and encouraged by the Basel II Accord regulations during the financial crisis.

"Has the Basel II Accord Encouraged Risk Management During the 2008-09 Financial Crisis?"

The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. In this paper we define risk management in terms of choosing sensibly from a variety of risk models, discuss the selection of optimal risk models, consider combining alternative risk models, discuss the choice between a conservative and aggressive risk management strategy, and evaluate the effects of the Basel II Accord on risk management. We also examine how risk management strategies performed during the 2008-09 financial crisis, evaluate how the financial crisis affected risk management practices, forecasting VaR and daily capital charges, and discuss alternative policy recommendations, especially in light of the financial crisis. These issues are illustrated using Standard and Poor's 500 Index, with an emphasis on how risk management practices were monitored and encouraged by the Basel II Accord regulations during the financial crisis.

Optimal Risk Management Before, During and After the 2008-09 Financial Crisis

In this paper we advance the idea that optimal risk management under the Basel II Accord will typically require the use of a combination of different models of risk. This idea is illustrated by analyzing the best empirical models of risk for five stock indexes before, during,and after the 2008-09 financial crisis. The data used are the Dow Jones Industrial Average, Financial Times Stock Exchange 100, Nikkei, Hang Seng and Standard and Poor’s 500 Composite Index. The primary goal of the exercise is to identify the best models for risk management in each period according to the minimization of average daily capital requirements under the Basel II Accord. It is found that the best risk models can and do vary before, during and after the 2008-09 financial crisis. Moreover, it is found that an aggressive risk management strategy, namely the supremum strategy that combines different models of risk, can result in significant gains in average daily capital requirements, relative to the strategy of using single models, while staying within the limits of the Basel II Accord.Financial portfolios, daily capital charges, frequency of violations, magnitude of violations, optimizing strategy, risk forecasts, value-at-risk, green zone, red zone.

"A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk"

Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) have to communicate their daily risk estimates to the monetary authorities at the beginning of the trading day, using a variety of Value-at-Risk (VaR) models to measure risk. Sometimes the risk estimates communicated using these models are too high, thereby leading to large capital requirements and high capital costs. At other times, the risk estimates are too low, leading to excessive violations, so that realised losses are above the estimated risk. In this paper we analyze the profit maximizing problem of an ADI subject to capital requirements under the Basel II Accord as ADI's have to choose an optimal VaR reporting strategy that minimizes daily capital charges. Accordingly, we suggest a dynamic communication and forecasting strategy that responds to violations in a discrete and instantaneous manner, while adapting more slowly in periods of no violations. We apply the proposed strategy to Standard&Poor's 500 Index and show there can be substantial savings in daily capital charges, while restricting the number of violations to within the Basel II penalty limits.

"Optimal Risk Management Before, During and After the 2008-09 Financial Crisis"

In this paper we advance the idea that optimal risk management under the Basel II Accord will typically require the use of a combination of different models of risk. This idea is illustrated by analyzing the best empirical models of risk for five stock indexes before, during, and after the 2008-09 financial crisis. The data used are the Dow Jones Industrial Average, Financial Times Stock Exchange 100, Nikkei, Hang Seng and Standard and Poor's 500 Composite Index. The primary goal of the exercise is to identify the best models for risk management in each period according to the minimization of average daily capital requirements under the Basel II Accord. It is found that the best risk models can and do vary before, during and after the 2008-09 financial crisis. Moreover, it is found that an aggressive risk management strategy, namely the supremum strategy that combines different models of risk, can result in significant gains in average daily capital requirements, relative to the strategy of using single models, while staying within the limits of the Basel II Accord.

A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk

Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) have to communicate their daily risk estimates to the monetary authorities at the beginning of the trading day, using a variety of Value-at-Risk (VaR) models to measure risk. Sometimes the risk estimates communicated using these models are too high, thereby leading to large capital requirements and high capital costs. At other times, the risk estimates are too low, leading to excessive violations, so that realised losses are above the estimated risk. In this paper we analyze the profit maximizing problem of an ADI subject to capital requirements under the Basel II Accord as ADI's have to choose an optimal VaR reporting strategy that minimizes daily capital charges. Accordingly, we suggest a dynamic communication and forecasting strategy that responds to violations in a discrete and instantaneous manner, while adapting more slowly in periods of no violations. We apply the proposed strategy to Standard & Poor's 500 Index and show there can be substantial savings in daily capital charges, while restricting the number of violations to within the Basel II penalty limits.

The Effects Of Macroeconomic And Policy Uncertainty On Exchange Rate Risk Premium

The goal of this paper is to identify the main determinants of the risk premium in some European currency markets just before the EMU. To that extent, we start from Lucas (1982) exchange rate model and derive an analytical expression for the forward premium. This expression includes money and production variables and it is quite standard, except for the inclusion of macroeconomic policy risk. Under some standard assumptions, this formula simplifies substantially and becomes amenable to regression analysis. Then, using standard measures of money and production, as well as interest rate swaps as indicators of macroeconomic policy risk, the theoretical expression is estimated. We provide evidence suggesting that it is policy uncertainty, much more than fundamental macroeconomic uncertainty, which determined risk premium over the convergence process to the euro. Whether these results can be extended to similar experiences for other currency unions remains open for future research

Seasonal Flutuations and Equilibrium Models of Exchange Rate

Most of the evidence on dynamic equilibrium exchange rate models is based on seasonally adjusted consumption data. Equilibrium models have not worked well in explaining the actual exchange rate. However, the use of seasonally adjusted data might be responsible for the spurious rejection of the model. This paper presents a new equilibrium model for the exchange rates that incorporates seasonal preferences. The fit of the model to the data is evaluated for five industrialized countries using seasonally unadjusted data. Our findings indicate that a model with seasonal preferences can generate monthly time series of the exchange rate without seasonality even when the variables that theoretically determine the exchange rate show clear seasonal behaviours. Further, the model can generate theoretical exchange rates with the same order of integration than actual exchange rates, and in some cases, with the same stochastic trend