A New Approach to Comparing VaR Estimation Methods


Journal of Derivatives

hiver 2008, vol. 16, n°2, pp.54-66

Départements : Finance, GREGHEC (CNRS)

Mots clés : Value-at-Risk, Bank Trading Revenue, Backtesting, Coverage Test

Value-at-risk (VaR), despite its known shortcomings, has become established as the most commonly used measure of risk exposure. But many variants of procedures for implementing VaR exist. Some variants use historical data with or without simulations, while others assume parametric models, such as GARCH, with parameters estimated from past data. And, of course, different users might focus on different VaR cutoffs: 5%, 1%, and so on. Perignon and Smith use an innovative method of extracting daily values for bank revenues from their annual reports to explore which VaR methods empirically work best. A second innovation discussed in the article is how to measure the accuracy of tail estimation at multiple points in the tail. The results suggest that, in estimating VaR for banks, parametric methods work best

Acquisition of Information in Financial Markets


Review of Economic Studies

octobre 2008, vol. 75, n°4

Départements : Finance

In their paper "Information Acquisition in Financial Markets" (this journal, ), Barlevy and Veronesi present a model of a one-period financial market, and claim that for an open set of parameter values, the value of information increases with the mass of informed agents. That claim is shown here to be false. The property of strategic substitution is robust in their model.

Applying Regret Theory to Investment Choices: Currency Hedging Decisions

S. Michenaud, B. SOLNIK

Journal of International Money and Finance

septembre 2008, vol. 27, n°5

Départements : Finance

Mots clés : Regret aversion, Loss aversion, Hedging, Portfolio choices

We apply regret theory, an axiomatic behavioral theory, to derive closed-form solutions to optimal currency hedging choices. Investors experience regret of not having chosen the ex post optimal hedging decision. Hence, investors anticipate their future experience of regret and incorporate it in their objective function. We derive a model of financial decision-making with two components of risk: traditional risk (volatility) and regret risk. We find results that are in sharp contrast with traditional expected utility, loss aversion, or disappointment aversion theories. We discuss the empirical implications of our model and its ability to explain observed hedging behavior.

Competition for Order Flow Smart Order Routing Systems

T. FOUCAULT, A.J. Menkveld

The Journal of Finance

février 2008, vol. 63, n°1, pp.119-158

Départements : Finance, GREGHEC (CNRS)

We study changes in liquidity following the introduction of a new electronic limit order market when, prior to its introduction, trading is centralized in a single limit order market. We also study how automation of routing decisions and trading fees affect the relative liquidity of rival markets. The theoretical analysis yields three main predictions: (i) consolidated depth is larger in the multiple limit order markets environment, (ii) consolidated bid-ask spread is smaller in the multiple limit order markets environment and (iii) the liquidity of the entrant market relative to that of the incumbent market increases with the level of automation for routing decisions (the proportion of "smart routers"). We test these predictions by studying the rivalry between the London Stock Exchange (entrant) and Euronext (incumbent) in the Dutch stock market. The main predictions of the model are supportedMarket fragmentation, centralized limit order book, smart routers, trading fees, trade-throughs

Do Banks Overstate their Value-at-Risk ?

C. PERIGNON, Z. Deng, Z. Wang

Journal of Banking and Finance

mai 2008, vol. 32, n°5, pp.783-794

Départements : Finance, GREGHEC (CNRS)

Mots clés : Value-at-Risk (VaR), Capital requirement, Backtesting

This paper is the first empirical study of banks’ risk management systems based on non-anonymous daily Value-at-Risk (VaR) and profit-and-loss data. Using actual data from the six largest Canadian commercial banks, we uncover evidence that banks exhibit a systematic excess of conservatism in their VaR estimates. The data used in this paper have been extracted from the banks’ annual reports using an innovative Matlab-based data extraction method. Out of the 7354 trading days analyzed in this study, there are only two exceptions, i.e. days when the actual loss exceeds the disclosed VaR, whereas the expected number of exceptions with a 99% VaR is 74. For each sample bank, we extract from historical VaRs a risk-overstatement coefficient, ranging between 19 and 79%. We attribute VaR overstatement to several factors, including extreme cautiousness and underestimation of diversification effects when aggregating VaRs across business lines and/or risk categories. We also discuss the economic and social cost of reporting inflated VaRs

Entrepreneurs and new ideas


The RAND Journal of Economics

Winter 2008, vol. 39, n°4, pp.1105-1125

Départements : Finance

RAND Journal of EconomicsVol. 39, No. 4, Winter 2008pp. 1105–1125Entrepreneurs and new ideasBruno Biais∗andEnrico Perotti∗∗We study how early-stage new ideas are turned into successful businesses. Even promising ideascan be unprofitable if they fail on one dimension, such as technical feasibility, correspondenceto market demand, legality, or patentability. To screen good ideas, the entrepreneur needs to hireexperts who evaluate the idea along their dimensions of expertise. Sharing the idea, however,creates the risk that the expert would steal it. Yet, the idea-thief cannot contact any otherexpert, lest he should in turn steal the idea. Thus, stealing leads to incomplete screening and isunattractive if the information of the other expert is critical and highly complementary. In suchcases, the entrepreneur can form a partnership with the experts, thus granting them the advantageof accessing each other’s information. Yet, very valuable ideas cannot be shared because it is tootempting to steal them

Globalization and the dynamics of cultural identity


Journal of International Economics

décembre 2008, vol. 76, n°2, pp.356-370

Départements : Finance, GREGHEC (CNRS)

Mots clés : Cultural identity, Cultural transmission, International trade

This paper presents a simple model where micro-founded dynamics of cultural identity are endogenous and interact with an international trade equilibrium. This process generates a strong home bias under autarky. We then show that goods market integration causes a phenomenon of cultural divergence, whereby the distributions of cultures become more dissimilar across countries and one of the cultures that existed under autarky ultimately disappears. By way of contrast, we show that social integration causes cultural convergence and can counterbalance the effects of goods market integration.Cultural identityCultural transmissionInternational trade

How Common are Common Return Factors across Nyse and Nasdaq?

A. Goyal, C. PERIGNON, C. Villa

Journal of Financial Economics

décembre 2008, vol. 90, n°3, pp.252-271

Départements : Finance, GREGHEC (CNRS)

Mots clés : Risk factors, Factor analysis, Asset pricing, Arbitrage pricing theory, Common subspace

We entertain the possibility of pervasive factors that are not common across two (or more) groups of securities. We propose and implement a general procedure to estimate the space spanned by common and group-specific pervasive factors. In our empirical analysis, we study the factor structure of excess returns on stocks traded on the NYSE and Nasdaq using our methodology. We find that there are only two common pervasive factors that govern the returns for both NYSE and Nasdaq. At the same time, the NYSE and Nasdaq each have one more group-specific factor that is not the same across the two exchanges. Our results point to the absence of complete similarity between the factors driving the returns on these exchanges

Impact of Overwhelming Joy on Consumer Demand

J-M. Falter, C. PERIGNON, O. Vercruysse

Journal of Sports Economics

février 2008, vol. 9, n°1, pp.20-42

Départements : Finance, GREGHEC (CNRS)

Mots clés : Demand for sports, Externalities

In this article, the authors identify the period following a Soccer World Cup victory as a period of overwhelming joy for the winning country, and they test the impact of a World Cup victory on the demand for soccer in this country. After controlling for the main determinants of attendance, the authors find that consumer demand has positively, significantly, and durably shifted in France following the 1998 World Cup. They also show that the rise in demand is stronger in the nine cities that hosted the World Cup and that the World Cup effect persists for percentage attendance after they control for season ticket holders. Finally, the authors find supportive evidence to their claim that exceptional performance improves sport popularity when analyzing soccer attendance in several control countries, attendance for a potential substitute for soccer in France, and other episodes of overwhelming joy

Implications of the Sharpe ratio as a performance measure in multi-period settings

T. Wang, J. Cvitanic, A. LAZRAK

Journal of Economic Dynamics and Control

mai 2008, vol. 32, n°5, pp.1622-1649

Départements : Finance

We study effects of using Sharpe ratio as a performance measure for compensating money managers in a dynamic market. We demonstrate that the manager's focus on the short horizon is detrimental to the long-horizon investor. When the returns are iid, the performance loss is significant, even when horizons are not very different. When the returns are mean reverting, the performance loss is exacerbated. We show that the manager's strategy tends to increase (decrease) the risk in the latter part of the optimization period after a bad (good) performance in the earlier part of the period, in agreement with empirical observations.*INVESTMENT advisors*CAPITALISTS & financiers*BUSINESSPEOPLE*FINANCIAL risk