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This paper investigates a novel behavioral feature of recursive preferences: aversion to risks that persist over time, or simply \textit{correlation aversion}. Greater persistence provides information about future consumption but reduces…
In normal times, it is assumed that financial institutions operating in non-overlapping sectors have complementary and distinct outcomes, typically reflected in mostly uncorrelated outcomes and asset returns. Such is the reasoning behind…
We analyze the potential of reinsurance for reversing the current trend of decreasing capital guarantees in life insurance products. Providing an insurer with an opportunity to shift part of the financial risk to a reinsurer, we solve the…
Debt aversion can have severe adverse effects on financial decision-making. We propose a model of debt aversion, and design an experiment involving real debt and saving contracts, to elicit and jointly estimate debt aversion with…
I develop a tractable adverse-selection model comparing secured bank loans and bonds when both pledge collateral but differ in effective liquidation efficiency. A small wedge in recovery rates generates coexistence, a sharp bank-bond…
Mixed Probit models are widely applied in many fields where prediction of a binary response is of interest. Typically, the random effects are assumed to be independent but this is seldom the case for many real applications. In the credit…
The authors examine the concept of probability of default for asset-backed loans. In contrast to unsecured loans it is shown that probability of default can be defined as either a measure of the likelihood of the borrower failing to make…
A controversy involving loan loss provisions in banks concerns their relationship with the business cycle. While international accounting standards for recognizing provisions (incurred loss model) would presumably be pro-cyclical,…
We introduce a new regression method that relates the mean of an outcome variable to covariates, under the "adverse condition" that a distress variable falls in its tail. This allows to tailor classical mean regressions to adverse…
We set up a structural model to study credit risk for a portfolio containing several or many credit contracts. The model is based on a jump--diffusion process for the risk factors, i.e. for the company assets. We also include correlations…
A scenario in which regulators take the drastic step of requiring coverage of all venture bank investment loans using interbank borrowed funds is considered. In this scenario, a minimal amount of default insurance is used, such that Tier 1…
Conditional forecasts of risk measures play an important role in internal risk management of financial institutions as well as in regulatory capital calculations. In order to assess forecasting performance of a risk measurement procedure,…
We derive simple return models for several classes of bond portfolios. With only one or two risk factors our models are able to explain most of the return variations in portfolios of fixed rate government bonds, inflation linked government…
Analysis of the 2007-8 credit crisis has concentrated on issues of relaxed lending standards, and the perception of irrational behaviour by speculative investors in real estate and other assets. Asset backed securities have been extensively…
Sustainable financial markets play an important role in the functioning of human society. Still, the detection and prediction of risk in financial markets remain challenging and draw much attention from the scientific community. Here we…
Foreign exchange and credit derivatives increase the bank's contributions to systemic risk. Interest rate derivatives decrease it. The proportion of non-performing loans over total loans and the leverage ratio have stronger impact on…
In general, homeowners refinance in response to a decrease in interest rates, as their borrowing costs are lowered. However, it is worth investigating the effects of refinancing after taking the underlying costs into consideration. Here we…
We compare two models of corporate default by calculating the Jeffreys-Kullback-Leibler divergence between their predicted default probabilities when asset correlations are either high or low. Our main results show that the divergence…
Excessive leverage, i.e. the abuse of debt financing, is considered one of the primary factors in the default of financial institutions. Systemic risk results from correlations between individual default probabilities that cannot be…
Banks in the interbank network can not assess the true risks associated with lending to other banks in the network, unless they have full information on the riskiness of all the other banks. These risks can be estimated by using network…