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Advances in Financial Risk Management This page intentionally left blank Advances in Financial Risk Management Corporates, Intermediaries and Portfolios Editedby Jonathan A. Batten MonashUniversity,Melbourne,Australia Peter MacKay HongKongUniversityofScienceandTechnology and Niklas Wagner DepartmentofBusinessandEconomics,UniversityofPassau,Germany Editorialmatter,selectionandintroduction©JonathanA.Batten,PeterMacKay andNiklasWagner2013 Remainingchapters©Respectiveauthors2013 Softcover reprint of the hardcover 1st edition 2013 978-1-137-02508-1 Allrightsreserved.Noreproduction,copyortransmissionofthis publicationmaybemadewithoutwrittenpermission. Noportionofthispublicationmaybereproduced,copiedortransmitted savewithwrittenpermissionorinaccordancewiththeprovisionsofthe Copyright,DesignsandPatentsAct1988,orunderthetermsofanylicence permittinglimitedcopyingissuedbytheCopyrightLicensingAgency, SaffronHouse,6–10KirbyStreet,LondonEC1N8TS. Anypersonwhodoesanyunauthorizedactinrelationtothispublication maybeliabletocriminalprosecutionandcivilclaimsfordamages. Theauthorshaveassertedtheirrightstobeidentifiedastheauthorsofthis workinaccordancewiththeCopyright,DesignsandPatentsAct1988. Firstpublished2013by PALGRAVEMACMILLAN PalgraveMacmillanintheUKisanimprintofMacmillanPublishersLimited, registeredinEngland,companynumber785998,ofHoundmills,Basingstoke, HampshireRG216XS. PalgraveMacmillanintheUSisadivisionofStMartin’sPressLLC, 175FifthAvenue,NewYork,NY10010. PalgraveMacmillanistheglobalacademicimprintoftheabovecompanies andhascompaniesandrepresentativesthroughouttheworld. Palgrave®andMacmillan®areregisteredtrademarksintheUnitedStates, theUnitedKingdom,Europeandothercountries ISBN 978-1-349-43874-7 ISBN 978-1-137-02509-8 (eBook) DOI 10.1057/9781137025098 Thisbookisprintedonpapersuitableforrecyclingandmadefromfully managedandsustainedforestsources.Logging,pulpingandmanufacturing processesareexpectedtoconformtotheenvironmentalregulationsofthe countryoforigin. AcataloguerecordforthisbookisavailablefromtheBritishLibrary. AcatalogrecordforthisbookisavailablefromtheLibraryofCongress. Contents ListofFigures vii ListofTables x Preface xiii NotesonContributors xix Part I Corporate 1 StrategicRiskManagementandProductMarketCompetition 3 TimR.AdamandAmritaNain 2 TheCash-FlowRiskofCorporateMarketInvestments 30 CraigO.Brown 3 ForeignCurrencyHedgingandFirmValue:ADynamic PanelApproach 57 ShaneMagee 4 Repurchases,EmployeeStockOptionGrants,andHedging 81 DanielA.Rogers 5 DoManagersExhibitLossAversioninTheirRiskManagement Practices?EvidencefromtheGoldMiningIndustry 105 TimR.Adam,ChitruS.Fernando,andEvgeniaGolubeva Part II Intermediaries 6 DoesSecuritizationAffectBanks’LiquidityRisk?TheCase ofItaly 127 FrancescaBattagliaandMariaMazzuca 7 StressTestingInterconnectedBankingSystems 148 RodolfoMainoandKalinTintchev 8 EstimatingEndogenousLiquidityUsingTransactionandOrder BookInformation 181 PhilippeDurand,YalinGündüzandIsabelleThomazeau 9 The2008UKBankingCrash:EvidencefromOptionImplied Volatility 201 HaYanRaymondSo,TarikDriouchi,andZhiyuanSimonTan v vi Contents 10 InternationalPortfolioDiversificationandthe2007 FinancialCrisis 225 JacekNiklewskiandTimothyRodgers 11 AHybridFuzzyGJR-GARCHModelingApproachforStock MarketVolatilityForecasting 253 LeandroMaciel PartIII Portfolios 12 RobustConsumptionandPortfolioRulesWhenAssetReturns ArePredictable 287 AbrahamLioui 13 ADiversificationMeasureforPortfoliosofRiskyAssets 312 GabrielFrahmandChristofWiechers 14 HedgeFundPortfolioAllocationwithHigherMomentsand MVGModels 331 AsmerildaHitajandLorenzoMercuri 15 TheStatisticsoftheMaximumDrawdowninFinancial TimeSeries 347 AlessandroCasatiandSergeTabachnik 16 OntheEffectivenessofDynamicStockIndexPortfolio Hedging:EvidencefromEmergingMarketsFutures 364 MohammadS.HasanandTaufiqChoudhry 17 AnOptimalTimingApproachtoOptionPortfolioRisk Management 391 TimLeungandPengLiu Index 405 Figures 2.1 Anexample:Google 33 7.1 Macrofinancialstresstestingframework 151 7.2 Slowdownscenario:averagebank’sportfoliolossdistribution 162 7.3 Quantileregressionlines 163 7.4 Systemicriskscenarios 165 7.5 CoVaRnetworkstructure 169 8.1 StockpricesversuscumulatedquantityforAccorstocksason 5July2011 187 8.2 Timeevolutionof−λandofthetotalquantityofassets between5and29July2011 189 9.1 Targetandprecedingperiodstimelineforsignalingtests 206 9.2 BankIVversusVIXandVFTSE 215 9.3 BankIVversusshareprice 217 10.1 Weeklylogarithmicreturnsshowninpercentagesoverthe period12July2002to11May2012 231 10.2 RelationshipbetweenweeklylogarithmicreturnstoUSand developedregionstockindices 234 10.3 RelationshipbetweenweeklylogarithmicreturnstoUSand emerging/frontiercountrystockindices 239 11.1 MainstagesoftheDEalgorithm 262 11.2 DEmutationschemeintwo-dimensionalparametricspace 264 11.3 DEuniformcrossoverschemeexample 265 11.4 DailyclosingstockpriceindexesforS&P500andIbovespa 269 11.5 S&P500andIbovespadailyreturns 270 11.6 ThemembershipfunctionsfortheS&P500andIbovespa indexes 271 11.7 BoxplotoftheDEalgorithmfordifferentvaluesofmutation scalingparameter(F)accordingtotheobjectivefunctionE(x) valueforS&P500andIbovespa 271 11.8 BoxplotoftheDEalgorithmfordifferentvaluesofcrossover rate(Cr)accordingtotheobjectivefunctionE(x)valuefor S&P500andIbovespa 272 11.9 ObjectivefunctionE(x)evaluatedusingDEalgorithmforS&P 500andIbovespa 273 12.1 Thetotaldemandfortheriskyasset,thehedgingdemand andtheconsumptiontowealthratioasafunctionofthe investor’shorizon 301 vii viii ListofFigures 12.2 Thetotaldemandfortheriskyasset,thehedgingdemand andtheconsumptiontowealthratioasafunctionofthe marketriskpremium 302 12.3 Thetotaldemandfortheriskyasset,thehedgingdemand, theconsumptiontowealthratioandtheparameterof preferenceforrobustnessasafunctionofthecorrelation betweentheriskyassetandthestatevariable 304 12.4 Thetotaldemandfortheriskyasset,thehedgingdemand andtheconsumptiontowealthratioasafunctionofthe interestrate 305 12.5 Thetotaldemandfortheriskyasset,thehedgingdemand andtheconsumptiontowealthratioasafunctionofthe volatilityofthestatevariable 306 12.6 Thetotaldemandfortheriskyasset,thehedgingdemand andtheconsumptiontowealthratioasafunctionofthe statevariable’slongrunmean 307 12.7 Thetotaldemandfortheriskyasset,thehedgingdemand andtheconsumptiontowealthratioasafunctionofthe statevariable’sspeedofmeanreversion 308 13.1 Biasedandunbiasedvarianceestimates 317 13.2 Variancesofnaiveportfoliosin1965 323 13.3 Variancesofnaiveportfoliosin2009 324 13.4 Variancesofglobalminimum-varianceportfoliosin1965 325 13.5 Variancesofglobalminimum-varianceportfoliosin2009 326 13.6 Averagevarianceof40-assetnaiveportfolios 326 13.7 Averagevarianceof40-assetglobalminimum-variance portfolios 327 13.8 Diversificationofequally-weightedportfoliosin2009 327 13.9 Diversificationofequally-weightedportfoliosfrom1965to 2009 328 14.1 Jointdensitiesandcorrespondingisolinescombination1 336 14.2 Jointdensitiesandcorrespondingisolinescombination2 337 14.3 Jointdensitiesandcorrespondingisolinescombination3 338 14.4 Jointdensitiesandcorrespondingisolinescombination4 339 14.5 EstimatedVG,estimatednormalandempiricaldensities 341 15.1 NumericalestimatesofMDD 350 15.2 Unconditionalμ=0.1,σ =0.2,T=1y 355 15.3 MDDrelatedperformancefiguresobtainedwhenconsidering theunderlyinglog-returnseitherasiidorasa AR(1)-GARCH(1,1)serieswithnon-zeroskewness. 357 ListofFigures ix 15.4 Onthetop:timeevolutionoftheMDDofthehistoricalS&P 500andUS30-yearsyieldseriesbetween1January2002and 31December2009comparedwiththein-sampleexpectation valuesandtheirconfidenceintervalscomputedbytheMonte Carlocode.Onthebottom:timeevolutionoftheMDDof thehistoricalS&P500andUS30-yearsyieldseriesbetween1 January2010and15March2010comparedwiththe out-of-sampleexpectationvalueandtheirconfidenceintervals computedbytheMonteCarlocode 360 16.1 GARCH-Xtime-varyinghedgeratios 373 17.1 Thepayoffandmarketpriceofalongstraddleoverthe underlyingstockprice 397 17.2 Theliquidationboundariesofalongstraddleoverdifferent valuesofμ 399 17.3 Payoffandmarketpriceofalongbutterflyoverstockprice 400 17.4 Theliquidationboundariesofalongbutterflyoverdifferent valuesofμ 401

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