Editorial

3 pages, 161 KiB

Open AccessEditorial

Editorial for Special Issue “Finance, Financial Risk Management and their Applications”

by Leunglung Chan

Int. J. Financial Stud. 2018, 6(4), 83; https://doi.org/10.3390/ijfs6040083 - 08 Oct 2018

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We are pleased to announce the Special Issue on the Finance, Financial Risk Management and their Applications in the International Journal of Financial Studies. This Special Issue collects papers pertaining to several lines of research related to finance and financial risks. This Guest [...] Read more.

We are pleased to announce the Special Issue on the Finance, Financial Risk Management and their Applications in the International Journal of Financial Studies. This Special Issue collects papers pertaining to several lines of research related to finance and financial risks. This Guest Editor’s note synthesizes the contributing authors’ propositions and findings regarding these developments and hopes that new areas can be opened for future researches. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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23 pages, 1196 KiB

Open AccessFeature PaperArticle

Optimal Timing to Trade along a Randomized Brownian Bridge

by Tim Leung, Jiao Li and Xin Li

Int. J. Financial Stud. 2018, 6(3), 75; https://doi.org/10.3390/ijfs6030075 - 30 Aug 2018

Cited by 10 | Viewed by 4315

Abstract

This paper studies an optimal trading problem that incorporates the trader’s market view on the terminal asset price distribution and uninformative noise embedded in the asset price dynamics. We model the underlying asset price evolution by an exponential randomized Brownian bridge (rBb) and [...] Read more.

This paper studies an optimal trading problem that incorporates the trader’s market view on the terminal asset price distribution and uninformative noise embedded in the asset price dynamics. We model the underlying asset price evolution by an exponential randomized Brownian bridge (rBb) and consider various prior distributions for the random endpoint. We solve for the optimal strategies to sell a stock, call, or put, and analyze the associated delayed liquidation premia. We solve for the optimal trading strategies numerically and compare them across different prior beliefs. Among our results, we find that disconnected continuation/exercise regions arise when the trader prescribe a two-point discrete distribution and double exponential distribution. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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20 pages, 326 KiB

Open AccessArticle

Bank Interest Margin, Multiple Shadow Banking Activities, and Capital Regulation

by Jyh-Horng Lin, Shi Chen and Fu-Wei Huang

Int. J. Financial Stud. 2018, 6(3), 63; https://doi.org/10.3390/ijfs6030063 - 03 Jul 2018

Cited by 11 | Viewed by 3948

Abstract

In this paper, we develop a contingent claim model to evaluate a bank’s equity and liabilities that integrates the premature default risk conditions with loan rate-setting behavioral mode and multiple shadow banking activities under capital regulation. The barrier options theory of corporate security [...] Read more.

In this paper, we develop a contingent claim model to evaluate a bank’s equity and liabilities that integrates the premature default risk conditions with loan rate-setting behavioral mode and multiple shadow banking activities under capital regulation. The barrier options theory of corporate security valuation is applied to the contingent claims of a bank. The barrier reports that default can occur at any time before the maturity date. We focus on a type of earning-asset portfolio, consisting of balance-sheet banking activities of loans and liquid assets and shadow banking activities of wealth management products (WMPs) and entrusted loans (ELs). The optimal bank interest margin, i.e., the spread between the loan rate and the deposit rate, is derived and analyzed. The results provide an alternative explanation for the decline in bank interest margins, which better fits the narrative evidence on bank spread behavior under capital regulation in particular during a financial crisis. Raising either WMPs or ELs leads to a transfer of wealth from equity holders to the debt holders, and hence increases the deposit insurance liabilities. We also show that the multiple shadow banking activities of WMPs and ELs captured by scope equities may produce superior return performance for the bank. Tightened capital requirements may reinforce the superior return performance by a surge in shadow banking activities that makes the bank less prudent and more prone to risk-taking at a reduced margin, thereby adversely affecting banking stability. We demonstrate that financial disturbance may be created because of the potential for shadow banking activities to spill over to regular banking activities and damage the real economy. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

17 pages, 3162 KiB

Open AccessArticle

Cross Hedging Stock Sector Risk with Index Futures by Considering the Global Equity Systematic Risk

by Wen-Chung Hsu and Hsiang-Tai Lee

Int. J. Financial Stud. 2018, 6(2), 44; https://doi.org/10.3390/ijfs6020044 - 18 Apr 2018

Cited by 6 | Viewed by 3366

Abstract

This article investigates the effectiveness of TAIEX (Taiwan Stock Exchange) futures, Taiwan 50 futures, and nonfinance nonelectronics subindex (NFNE) futures for cross hedging the price risk of stock sector indices traded on the Taiwan stock exchange. A state-dependent volatility spillover GARCH hedging strategy [...] Read more.

This article investigates the effectiveness of TAIEX (Taiwan Stock Exchange) futures, Taiwan 50 futures, and nonfinance nonelectronics subindex (NFNE) futures for cross hedging the price risk of stock sector indices traded on the Taiwan stock exchange. A state-dependent volatility spillover GARCH hedging strategy is developed to capture the regime switching global equity volatility spillover effect. Empirical results show that the NFNE futures exhibit superior effectiveness as an instrument for hedging stock sector exposures compared with the TAIEX and Taiwan 50 futures. Simultaneous hedge using both NFNE and MSCI (Morgan Stanley Capital International) world index futures further improves the hedging effectiveness compared with the hedging strategy using only the NFNE futures. This shows the importance of hedging the global equity systematic risk of stock sectors by considering the comovement between domestic and global equity markets. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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20 pages, 378 KiB

Open AccessFeature PaperArticle

Quantifying Correlation Uncertainty Risk in Credit Derivatives Pricing

by Colin Turfus

Int. J. Financial Stud. 2018, 6(2), 39; https://doi.org/10.3390/ijfs6020039 - 03 Apr 2018

Cited by 3 | Viewed by 3361

Abstract

We propose a simple but practical methodology for the quantification of correlation risk in the context of credit derivatives pricing and credit valuation adjustment (CVA), where the correlation between rates and credit is often uncertain or unmodelled. We take the rates model to [...] Read more.

We propose a simple but practical methodology for the quantification of correlation risk in the context of credit derivatives pricing and credit valuation adjustment (CVA), where the correlation between rates and credit is often uncertain or unmodelled. We take the rates model to be Hull–White (normal) and the credit model to be Black–Karasinski (lognormal). We summarise recent work furnishing highly accurate analytic pricing formulae for credit default swaps (CDS) including with defaultable Libor flows, extending this to the situation where they are capped and/or floored. We also consider the pricing of contingent CDS with an interest rate swap underlying. We derive therefrom explicit expressions showing how the dependence of model prices on the uncertain parameter(s) can be captured in analytic formulae that are readily amenable to computation without recourse to Monte Carlo or lattice-based computation. In so doing, we crucially take into account the impact on model calibration of the uncertain (or unmodelled) parameters. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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22 pages, 605 KiB

Open AccessFeature PaperArticle

An Empirical Investigation of Risk-Return Relations in Chinese Equity Markets: Evidence from Aggregate and Sectoral Data

by Thomas C. Chiang and Yuanqing Zhang

Int. J. Financial Stud. 2018, 6(2), 35; https://doi.org/10.3390/ijfs6020035 - 26 Mar 2018

Cited by 12 | Viewed by 4640

Abstract

This paper investigates the risk-return relations in Chinese equity markets. Based on a TARCH-M model, evidence shows that stock returns are positively correlated with predictable volatility, supporting the risk-return relation in both aggregate and sectoral markets. Evidence finds a positive relation between stock [...] Read more.

This paper investigates the risk-return relations in Chinese equity markets. Based on a TARCH-M model, evidence shows that stock returns are positively correlated with predictable volatility, supporting the risk-return relation in both aggregate and sectoral markets. Evidence finds a positive relation between stock return and intertemporal downside risk, while controlling for sentiment and liquidity. This study suggests that the U.S. stress risk or the world downside risk should be priced into the Chinese stocks. The paper concludes that the risk-return tradeoff is present in the GARCH-in-mean, local downside risk-return, and global risk-return relations. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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27 pages, 1478 KiB

Open AccessFeature PaperArticle

Gas Storage Valuation and Hedging: A Quantification of Model Risk

by Patrick Hénaff, Ismail Laachir and Francesco Russo

Int. J. Financial Stud. 2018, 6(1), 27; https://doi.org/10.3390/ijfs6010027 - 05 Mar 2018

Cited by 11 | Viewed by 5691

Abstract

This paper focuses on the valuation and hedging of gas storage facilities, using a spot-based valuation framework coupled with a financial hedging strategy implemented with futures contracts. The contributions of this paper are two-fold. Firstly, we propose a model that unifies the dynamics [...] Read more.

This paper focuses on the valuation and hedging of gas storage facilities, using a spot-based valuation framework coupled with a financial hedging strategy implemented with futures contracts. The contributions of this paper are two-fold. Firstly, we propose a model that unifies the dynamics of the futures curve and spot price, and accounts for the main stylized facts of the US natural gas market such as seasonality and the presence of price spikes in the spot market. Secondly, we evaluate the associated model risk, and show not only that the valuation is strongly dependent upon the dynamics of the spot price, but more importantly that the hedging strategy commonly used in the industry leaves the storage operator with significant residual price risk. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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18 pages, 1221 KiB

Open AccessFeature PaperArticle

Noise Reduction in a Reputation Index

by Peter Mitic

Int. J. Financial Stud. 2018, 6(1), 19; https://doi.org/10.3390/ijfs6010019 - 07 Feb 2018

Cited by 2 | Viewed by 3577

Abstract

Assuming that a time series incorporates “signal” and “noise” components, we propose a method to estimate the extent of the “noise” component by considering the smoothing properties of the state-space of the time series. A mild degree of smoothing in the state-space, applied [...] Read more.

Assuming that a time series incorporates “signal” and “noise” components, we propose a method to estimate the extent of the “noise” component by considering the smoothing properties of the state-space of the time series. A mild degree of smoothing in the state-space, applied using a Kalman filter, allows for noise estimation arising from the measurement process. It is particularly suited in the context of a reputation index, because small amounts of noise can easily mask more significant effects. Adjusting the state-space noise measurement parameter leads to a limiting smoothing situation, from which the extent of noise can be estimated. The results indicate that noise constitutes approximately 10% of the raw signal: approximately 40 decibels. A comparison with low pass filter methods (Butterworth in particular) is made, although low pass filters are more suitable for assessing total signal noise. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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16 pages, 2758 KiB

Open AccessArticle

A Logistic Regression Based Auto Insurance Rate-Making Model Designed for the Insurance Rate Reform

by Zhengmin Duan, Yonglian Chang, Qi Wang, Tianyao Chen and Qing Zhao

Int. J. Financial Stud. 2018, 6(1), 18; https://doi.org/10.3390/ijfs6010018 - 07 Feb 2018

Cited by 11 | Viewed by 5771

Abstract

Using a generalized linear model to determine the claim frequency of auto insurance is a key ingredient in non-life insurance research. Among auto insurance rate-making models, there are very few considering auto types. Therefore, in this paper we are proposing a model that [...] Read more.

Using a generalized linear model to determine the claim frequency of auto insurance is a key ingredient in non-life insurance research. Among auto insurance rate-making models, there are very few considering auto types. Therefore, in this paper we are proposing a model that takes auto types into account by making an innovative use of the auto burden index. Based on this model and data from a Chinese insurance company, we built a clustering model that classifies auto insurance rates into three risk levels. The claim frequency and the claim costs are fitted to select a better loss distribution. Then the Logistic Regression model is employed to fit the claim frequency, with the auto burden index considered. Three key findings can be concluded from our study. First, more than 80% of the autos with an auto burden index of 20 or higher belong to the highest risk level. Secondly, the claim frequency is better fitted using the Poisson distribution, however the claim cost is better fitted using the Gamma distribution. Lastly, based on the AIC criterion, the claim frequency is more adequately represented by models that consider the auto burden index than those do not. It is believed that insurance policy recommendations that are based on Generalized linear models (GLM) can benefit from our findings. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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301 KiB

Open AccessArticle

Risk Culture during the Last 2000 Years—From an Aleatory Society to the Illusion of Risk Control

by Udo Milkau

Int. J. Financial Stud. 2017, 5(4), 31; https://doi.org/10.3390/ijfs5040031 - 01 Dec 2017

Cited by 5 | Viewed by 5750

Abstract

The culture of risk is 2000 years old, although the term “risk” developed much later. The culture of merchants making decisions under uncertainty and taking the individual responsibility for the uncertain future started with the Roman “Aleatory Society”, continued with medieval sea merchants, [...] Read more.

The culture of risk is 2000 years old, although the term “risk” developed much later. The culture of merchants making decisions under uncertainty and taking the individual responsibility for the uncertain future started with the Roman “Aleatory Society”, continued with medieval sea merchants, who made business “ad risicum et fortunam”, and sustained to the culture of entrepreneurs in times of industrialisation and dynamic economic changes in the 18th and 19th century. For all long-term commercial relationships, the culture of honourable merchants with personal decision-making and individual responsibility worked well. The successful development of sciences, statistics and engineering within the last 100 years led to the conjecture that men can “construct” an economical system with a pre-defined “clockwork” behaviour. Since probability distributions could be calculated ex-post, an illusion to control risk ex-ante became a pattern in business and banking. Based on the recent experiences with the financial crisis, a “risk culture” should understand that human “Strength of Knowledge” is limited and the “unknown unknown” can materialise. As all decisions and all commercial agreements are made under uncertainty, the culture of honourable merchants is key to achieve trust in long-term economic relations with individual responsibility, flexibility to adapt and resilience against the unknown. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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332 KiB

Open AccessArticle

Impending Doom: The Loss of Diversification before a Crisis

by Libin Yang, William Rea and Alethea Rea

Int. J. Financial Stud. 2017, 5(4), 29; https://doi.org/10.3390/ijfs5040029 - 14 Nov 2017

Cited by 7 | Viewed by 3898

Abstract

We present four methods of assessing the diversification potential within a stock market, and two of these are based on principal component analysis. They were applied to the Australian stock exchange for the years 2000 to 2014 and all show a consistent picture. [...] Read more.

We present four methods of assessing the diversification potential within a stock market, and two of these are based on principal component analysis. They were applied to the Australian stock exchange for the years 2000 to 2014 and all show a consistent picture. The potential for diversification declined almost monotonically in the three years prior to the 2008 financial crisis, leaving investors poorly diversified at the onset of the Global Financial Crisis. On one of the four measures, the diversification potential declined even further in the 2011 European debt crisis and the American credit downgrade. Full article

(This article belongs to the Special Issue Finance, Financial Risk Management and their Applications)

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