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This paper reviews recent research and the first five years of EMU experience with a view to examine the risks that EMU entails for governments, firms, and workers. It also looks at the long-term stability of the euro. Although it has often been emphasized that exchange rate risk is eliminated by EMU, risks can occur for a variety of reasons which are discussed in this paper. More specifically, we consider fiscal policy, rigidity of labor markets, and EMU enlargement as potential sources of risk in the EMU and look at shifts of the importance of different risk components in financial markets resulting from EMU. [ABSTRACT FROM AUTHOR]

As institutional investors are engaged to realize attractive risk-adjusted returns, they can by definition be seen as risk managers. This paper analyzes their risk management behavior from a macro perspective and focuses on their incentives for rational herding. Based on a questionnaire survey we find clear evidence of herding among fund managers in Germany. While all different subgroups of fund managers perceive institutional herding, senior fund managers perceive herding even more strongly than more junior managers. Regarding herding as rational strategy of adapting to incentives, one might ascribe this finding to the higher pressure of success that senior managers face. [ABSTRACT FROM AUTHOR]

This paper provides new evidence on the issue of whether or not there is a contemporaneous relation between the dollar and firm value as measured with stock returns. Prior studies have failed to find any short-term relation between the value of the dollar and the stock price reactions of U.S. multinational firms. Using a different methodology than previous studies, we find a significant average negative drop in stock price across 430 firms on the day that Thailand devalued the bhat, initiating Asia's financial crisis. We also show that this measure of exposure is related to both firm size and several proxies for intensity of foreign and Asian operations. [ABSTRACT FROM AUTHOR]

The paper reports the results of an empirical study into the foreign-exchange-risk management of large German non-financial corporations. The firms' managers were asked about the measurement of exchange risk, about their management strategies, and about organizational issues. The majority of the firms are concerned about managing transaction exposure. Most firms adopted a selective hedging strategy based on exchange-rate forecasts. Only a small minority of firms does not hedge foreign-exchange risk at all, and only few companies hedge their transaction exposure completely. The survey found a number of discrepancies between the positions of the academic literature and corporate practice. The most interesting finding, however, is the widespread use of exchange-rate forecasts and of exchange-risk management strategies based on forecasts (selective hedging). [ABSTRACT FROM AUTHOR]

It is primarily longevity risks which are borne by pension, annuity and long-term care products. The demand for such products has been increasing rapidly, leading to rising concerns about how longevity risks should be properly managed. Difficulties in making long-term forecasts for life expectancies, adverse selection, shortsightedness, and moral hazard problems impede the sound assessment and pricing of such risks and the development of appropriate reinsurance markets. This paper discusses some possible approaches to improving the management of longevity risks. These include finite reinsurance and capital market solutions. It is stressed that governments could lend considerable support to the insurance industry by kick-starting markets for indexed long-term bonds. [ABSTRACT FROM AUTHOR]

Dramatic events in the recent past have drawn attention to catastrophe risk management problems. The devastating terrorist attacks of September 11, 2001 incurred the highest insured losses to date. Furthermore, a trend of increasing losses from natural catastrophes appears to be observable since the late 1980s. The increase in catastrophe losses triggered intensive discussion about the management of catastrophic risk, focusing on three issues. First, considering the loss potential of certain catastrophic events, the insurance markets' capacity does not seem to be sufficient. An approach to address this capacity issue can be seen in passing certain catastrophic risks to investors via securitization. Second, after the events of September 11, 2001, the government's role as a bearer of risk became an increasingly important issue. Finally, as has been recently demonstrated by the floods in Europe of August 2002, problems of protecting against catastrophic threats do not only exist on the supply side but also on the demand side. Thus policymakers are considering the establishment of mandatory insurance for fundamental risks such as flood and windstorm. This paper addresses aspects of these three issues. In particular, we are concerned with the extent to which state or government involvement in the management of catastrophic risk is reasonable. [ABSTRACT FROM AUTHOR]

This paper provides estimators for the default probability and default correlation for a portfolio of obligors. Analogously to rating classes, homogeneous groups of obligors are considered. The estimations are made in a general Bernoulli mixture model with a minimum of assumptions and in a single-factor model. The first case is treated with linear distribution-free estimators and the second case with the maximum-likelihood method. All problems are viewed from different points of origin to address a variety of practical questions. [ABSTRACT FROM AUTHOR]

The problem how to evaluate and monitor the quality of credit risk models has recently received much attention. The discussions about the inclusion of internal models in the Basel Capital Accord highlight this fact. Basel II does not allow the use of full-scale credit portfolio risk models for regulatory capital calculation because regulators are concerned that model quality cannot be validated accurately enough. However, banks are allowed to use internal credit rating systems although it is by far not clear how accurately their quality may be evaluated. This paper discusses the current state-of-the-art concerning methods and empirical results for validating both credit portfolio risk models and internal credit rating systems. In order to allow for a meaningful assessment of the scope and limits of model validation we closely follow and compare our results to the existing literature on validating market risk models. [ABSTRACT FROM AUTHOR]

This paper explores different specifications of conditional return expectations. We compare the most common specification, linear least squares, with nonparametric techniques. Our results indicate that nonparametric regressions capture some nonlinearities in financial data. In-sample forecasts of international stock market returns are improved with nonparametric techniques. However, there is very little out-of-sample prediction power for both linear and nonparametric specifications of conditional expectations. If an asset manager relies on a simple instrumental variable regression framework to forecast stock returns, our results suggest that linear conditional return expectations are a reasonable approximation. [ABSTRACT FROM AUTHOR]

The standard approach to the risk analysis of fixed income portfolios involves a mapping of exposures into representative duration buckets. This approach does not provide a transparent description of the portfolio risk in the case of leveraged portfolios, particularly in the case of portfolios whose primary intent is to trade convexity. In this paper, an alternative approach, based upon Level, Slope and Curvature yield curve factors, is described. The alternative approach offers a linear model of non-linear trading strategies. [ABSTRACT FROM AUTHOR]

This paper addresses the capital requirements based on the RiskMetrics™ framework and the BIS standard model. A case study is developed which shows that the capital requirements can be reduced by applying the more accurate RiskMetrics™ framework. Furthermore it gives an overview of the capital requirement rules for credit risk and operational risk in the Basel II Accord. [ABSTRACT FROM AUTHOR]

There has been substantial public and regulatory attention of late to apparent exploitation of conflicts of interest involving financial services firms based on financial market imperfections and asymmetric information. This paper proposes a workable taxonomy of conflicts of interest in financial services firms, and links it to the nature and scope of activities conducted by such firms, including possible compounding of interest-conflicts in multifunctional client relationships. It lays out the conditions that either encourage or constrain exploitation of conflicts of interest, focusing in particular on the role of information asymmetries and market discipline, including the shareholder-impact of litigation and regulatory initiatives. External regulation and market discipline are viewed as both complements and substitutes — market discipline can leverage the impact of external regulatory sanctions, while improving its granularity though detailed management initiatives applied under threat of market discipline. At the same time, market discipline may help obviate the need for some types of external control of conflict of interest exploitation [ABSTRACT FROM AUTHOR]