Risk Assessment: Decisions in Banking and Finance PDF
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Risk Assessment Georg Bol Svetlozar T. Rachev ● ● Reinhold Würth (Editors) Risk Assessment Decisions in Banking and Finance Physica-Verlag A Springer Company Editors Prof. Dr. Georg Bol Prof. Dr. h.c. mult. Reinhold Würth Prof. Dr. Svetlozar T. Rachev Reinhold-Würth-Str. 12-17 University of Karlsruhe (TH) 74653 Künzelsau-Gaisbach Kollegium am Schloss, Geb. 20.12 Germany 76131 Karlsruhe Germany [email protected] [email protected] ISBN 978-3-7908-2049-2 e-ISBN 978-3-7908-2050-8 DOI: 10.1007/978-3-7908-2050-8 Contributions to Economics ISSN 1431-1933 Library of Congress Control Number: 2008929529 © 2009 Physica-Verlag Heidelberg This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permissions for use must always be obtained from Physica-Verlag. Violations are liable for prosecution under the German Copyright Law. The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Cover design: WMXDesign GmbH, Heidelberg Printed on acid-free paper 9 8 7 6 5 4 3 2 1 springer.com Preface On April 5–7, 2006, the 9th Econometric Workshop with the title “Risk Assessment: Decisions in Banking and Finance” was held at the University of Karlsruhe (TH), Germany. The workshop was organized by the Institute for Statistics and Mathematical Economics and the Adolf Wu¨rth GmbH & Co.KG, Ku¨nzelsau. More than 20 invited speakers and 70 participants at- tended the workshop. The papers presented at the conference dealt with new approaches and solutions in the field of risk assessment and management, covering all types of risk (i.e., market risk, credit risk, and operational risk). This volume includes 12 of the papers presented at the workshop. We are delighted with the range of papers, especially from practitioners. Many people have contributed to the success of the workshop: Sebastian Kring and Sven Klussmeier did the major part of organizing the workshop. The organizational skills of Markus Ho¨chst¨otter, Wei Sun, Theda Schmidt, NadjaSafronova,andAksanaHurynovichprovedindispensable.JensBu¨chele und Lyuben Atanasov were responsible for the technical infrastructure while Thomas Plum prepared the design for this volume. All of their help is very much appreciated. TheorganizationcommitteewishesalsotothanktheSchoolofEconomics and Business Engineering, Vice-Dean Professor Dr. Christof Weinhardt, and Professor Dr. Frank Fabozzi (Yale University’s School of Management) for their cooperation. Last but certainly not least we thank Professor Dr. h.c. Reinhold Wu¨rth and the Adolf Wu¨rth GmbH & Ko.KG for their generous support of this conference. Karlsruhe, Georg Bol April 2008 Svetlozar T. Rachev Reinhold Wu¨rth Contents Automotive Finance: The Case for an Industry-Specific Approach to Risk Management Christian Diekmann.............................................. 1 Evidence on Time-Varying Factor Models for Equity Portfolio Construction Markus Ebner and Thorsten Neumann.............................. 11 Time Dependent Relative Risk Aversion Enzo Giacomini, Michael Handel, and Wolfgang K. Ha¨rdle............ 15 Portfolio Selection with Common Correlation Mixture Models Markus Haas and Stefan Mittnik................................... 47 A New Tempered Stable Distribution and Its Application to Finance Young Shin Kim, Svetlozar T. Rachev, Michele Leonardo Bianchi, and Frank J. Fabozzi ............................................. 77 Estimation of α-Stable Sub-Gaussian Distributions for Asset Returns Sebastian Kring, Svetlozar T. Rachev, Markus Ho¨chst¨otter, and Frank J. Fabozzi.......................................................111 Risk Measures for Portfolio Vectors and Allocation of Risks Ludger Ru¨schendorf ..............................................153 The Road to Hedge Fund Replication: The Very First Steps Lars Jaeger .....................................................165 Asset Securitisation as a Profits Management Instrument Markus Schmidtchen .............................................205 VIII Contents Recent Advances in Credit Risk Management Frances Cowell, Borjana Racheva, and Stefan Tru¨ck..................215 Stable ETL Optimal Portfolios and Extreme Risk Management Svetlozar T. Rachev, R. Douglas Martin, Borjana Racheva, and Stoyan Stoyanov........................................................235 Pricing Tranches of a CDO and a CDS Index: Recent Advances and Future Research Dezhong Wang, Svetlozar T. Rachev, and Frank J. Fabozzi ............263 Automotive Finance: The Case for an Industry-Specific Approach to Risk Management Christian Diekmann Department of Econometrics, Statistics and Mathematical Finance, University of Karlsruhe, Germany, [email protected] 1 Introduction Automotive finance has come to represent a significant portion of many financial institutions’ portfolios. The list of these institutions includes finan- cial service entities of automotive groups as well as banks, bank-owned and independent finance companies. All of them face the need to assess and man- agetherisksoftheiractivitiesintheautomotivesector.Theserisksdependto largeextentonthedynamicsofthemarketformotorvehicles.Understanding thesedynamicswellenoughisanessentialprerequisitefordealingadequately with the financial risk they imply. The requirements imposed on providers of financial services in the automotive business clearly go beyond the standard techniques applied to the assessment and the management of risk in tradi- tional banking. This is the reason why, in virtual absence of literature on this subject, the present contribution is concerned with the specific aspects to be considered when managing risk in automotive finance. 2 Automotive Finance Thesignificantroleautomotivefinanceplaystodayshouldbeseenagainstthe backgroundthatthemarketformotorvehicleshasmaturedinmostcountries over the past two decades while economic growth has slowed down. The face oftheindustryservingthismarkethaskeptchangingduringthisperiodmore rapidly than ever before. Three major trends can be identified: • A global race for economies of scale, resulting in a series of mergers and take-overs1 accompanied by an extreme expansion of production capacity. 1 Actually the number of independent manufacturers of motor vehicles has halved since the mid 80s. 2 C. Diekmann • Anintenseproductdifferentiationwithconstantexpansionofproductline, shortening life cycles and accelerated technological innovation, with con- sumers demanding a wider choice of products. • A series of cost cutting and productivity enhancements based on best practice techniques, lean production, just-in-time methods, modulization, outsourcing and joint ventures. One of the effects of these changes has been a shift of value-added from ve- hicle producers (OEMs) to their suppliers induced by the need to cut costs and achieve greater flexibility in response to the needs of the market. At the same time, however, vehicle producers started to move downstream, moti- vatedbythefactthat,accordingtoindustryexperts,almosttwo-thirdsofthe total profits generated over the lifetime of a car originate from downstream rather than from upstream activities (Table 1). Finance and insurance alone account for about one quarter of total profits. This strategic expansion of ac- tivities, aiming at selling customers mobility rather than vehicles, has largely contributed to the dynamic growth of automotive captives. Today the financial service entities of automotive groups operate on a global scale and manage significant portfolios (Table 2). Well above 40% of annualsalesinpassengercarsintheworld’sleadingautomotivemarkets–the USandGermany–arefinancedorleasedbycaptives.Asaresult,theseentities have not only become a crucial element in the sales strategies of their par- ent companies but have become major profit contributors. The most striking examples are the two large US manufacturers who operate profitable finance entities while losing money on their industrial activities (Table 3). Table 1. Profit contributions in the automotive value chain [8] Up-stream activities Manufacturer 16% Systems & modules suppliers 7% Component specialists 8% Standard parts suppliers 2% Raw material providers 5% 38% Down-stream activities New car retailing 5% Leasing & financing 9% Insurance business 15% Used car retailing 12% Car rental business 4% Service & parts business 17% 62% Automotive Finance 3 Table 2. Automotive portfolios (2004, bn Euro) [2] Captive Portfolio GMAC 143.9 FMCC 123.4 DC FS 97.9 T FS 63.3 VW FS 51.9 BMW FS 43.5 RCI Banque 21.9 PSA Banque 21.5 Volvo FS 7.1 Table 3. Profit contributions by financial services (2004, US $ m)a 2004 Total Financial services Group Net revenue Op. profit Net revenue Op. profit Profit contribution (%) GM 193,517 1,192 31,972 4,316 362.08 DCX 192,319 7,790 18,871 1,692 21.72 FMC 171,652 4,853 24,518 5,008 103.19 TMC 163,637 15,772 6,782 1,381 8.76 VW 121,177 2,207 11,864 1,261 57.16 PSA 75,320 3,452 2,371 712 20.64 Nissan 70,087 7,781 3,361 611 7.85 BMW 60,389 4,841 11,205 701 14.49 Renault 55,458 3,294 3,159 605 19.970 Estimates based on 2004 annual reports. Figures may be biased due to accounting issues Although captives dominate the automotive finance market they are far from having total control of it (Table 4). The situation in the US where com- mercialbanksandothertypesoffinancialinstitutionsaccountforabouthalfof therelevantmarketmayserveasanexample.Itshouldbenotedthatcaptives andtheircompetitorsshowverydifferentcharacteristics.Captivespursueau- tomotive financeasacoreactivity andbenefitfromthecloserelationtotheir parent group. This gives them the advantage of a superior representation at the point of sale and low costs of distribution. Another benefit is that the manufacturers favour incorporating incentives into finance rates rather than givingdirectdiscounts.Ontheotherhand,captiveshaveasomewhatdifferent mission from that of other lending institutions. Their job is to support brand sales, acquisition new and keeping existing customers on board. This means the customer is viewed not only from the perspective of a lending institution but also from that of an automotive manufacturer. Therefore, in spite of gen- erating profits they do not follow unbiased financial objectives. In contrast, 4 C. Diekmann Table4.Outstandingfinancereceivables:USloans&leasesautomotivebusiness[6] Indirect (US $ bn) Captives 580 Large Banks 205 Independent Finance 200 Credit Unions 40 Small Banks 15 Total 1,040 Direct (US $ bn) Credit Unions 95 Small Banks 60 Independent Finance 25 Large Banks 20 Internet Only 20 Online Mixed 20 Total 240 banks and other financial institutions pursue pure profit targets. They rather view automotive finance as another area of their credit and leasing business. A potential advantage particularly banks have over captives is a stronger po- sition in refinancing. Besides, captives and commercial banks there are two other types of financial service providers in the market. The first category consists of independent finance companies who often focus on sub-segments of the automotive finance market, e.g. the sub-prime, used vehicle or fleet business. The second category comprises internet and direct lenders whose focus is to increase returns by saving distribution costs, regularly trying to disintermediate the dealer network. It should be seen however, that while automotive finance enjoyed a pe- riod of exuberant growth in the past, the market is beginning to show signs of saturation. Competition intensifies spilling over from the vehicle markets andleavinglessscopeforconservativebusinesspolicies.Generatingprofitable growthinthisenvironmentcallsformaintainingacarefulbalancebetweenrisk and return in the future. This leads us to a more specific analysis of the risks involved in the automotive finance business. 3 Risk Assessment The theory of risk management has made significant advances over recent years. However, most studies undertaken in this field have been concerned withcorporatedefaultriskandriskassessmentinthecaseoftraditionalbank
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