Van Son Lai

The impact of the Gramm-Leach-Bliley act on the financial services industry

This paper examines the impact of Gramm-Leach-Bliley Act across three main sectors of the financial services industry: commercial banks, insurance companies, and brokerage firms, taking account of the wealth effect associated with the announcement. We find that the law has a differential impact across the financial services industry. All three industries have gained due to this law with commercial banks benefiting most, followed by the insurance industry. Further, the results show that larger firms benefited more in both the banking and insurance industries and exposure to systematic risk was reduced for all sectors of the financial services industry after this regulation passed.

On Financial Guarantee Insurance under Stochastic Interest Rates

We extend the financial guarantee insurance literature by modeling, under stochastic interest rates, private financial guarantees when the guarantor potentially defaults. By performing numerical simulations under plausible parameters values, we characterize the differential impact of the incorporation of stochasticity of interest rates on the valuation of both public and private guarantees.

Risk-Based Capital and Credit Insurance Portfolios

This paper analyzes the risk-management practices of a vulnerable credit insurer by studying the effects of time-varying correlations, asset risks and loan maturities on the risk-based capital that backs credit insurance portfolios. Since asset correlations may change over a business cycle, we have analyzed these effects by means of a one-factor Gaussian stochastic model as part of an extended contingent claims analysis. Our results show the need to account for cyclical changes to correlations in the pricing of credit insurance. When compared with the reserve of risk-based capital recommended by the Basel II Internal Ratings-Based (IRB) approach, our model provides a better capital buffer against extreme credit losses, especially in times of recession and/or in a risky business environment. Using a risk-adjusted performance metric (RAPM), we find insurers perform better when insuring relatively short-term loans. We also make several policy recommendations on creating a reserve of risk-based capital to protect against possible loan losses.

The Valuation of Catastrophe Bonds with Exposure to Currency Exchange Risk

In this paper, we present a new model that takes an arbitrage approach to the valuation of catastrophic risk bonds (CAT bonds). The model considers the sponsors exposure to currency exchange risk and the risk of catastrophic events. We use a jump-diffusion process for catastrophic events, a three-dimensional stochastic process for the exchange rate and domestic and foreign interest rates, and a hedging cost for the currency risk to derive a semi-closed-form formula for the CAT bond price. We also extend to three factors Joshi and Leungs (2007) Monte Carlo simulation approach to obtain numerical results showing the following: in addition to catastrophic risk, the CAT bond price is affected mainly by the volatility of the exchange rate and its correlations with domestic and foreign interest rates. The first two factors have a negative impact while the third has a positive impact.

An Analysis of Portfolios of Insured Debts

This article analyzes multi-year risk management decisions in portfolios of insured debts or credit insurance. This is done by investigating risk reduction through portfolio diversification, increased insuring capacity and changes in contracts maturities. We propose a contingent-claims model that includes many realistic features such as coupon payments, stochastic interest rate and stochastic cash flows volatility. We distinguish between two types of portfolios: ‘closed’ and ‘opened’. We find that for a given riskiness level of insurers capital, an optimal value of credit insurance can be obtained by appropriate risk diversification and/or increased insurers capital. Our simulation results show that for insurers with high risk exposure, portfolio risk diversification is more effective than increasing insuring capacity. For a creditworthy insurer, increasing the size of the insurer’s capital can lead to significant improvement in the value of the credit insurance portfolio. This suggests that alternative risk transfer techniques, which provide synthetic (or contingent) capital to the insurer, should be considered in an integrated risk management.

Hedging Flood Losses Using Cat Bonds

Abstract In this paper, we develop a methodology to model the risk of losses resulting from a natural disaster in which the intensity parameter of the non-homogeneous Poisson process has an upward trend and a seasonal component. We apply this model to losses due to floods in the Financial Assistance Program of the Government of Quebec (Canada). We use the historically observed risk premiums to assess the financial costs for the government if it had issued such instruments to hedge risk linked to floods.

An empirical investigation of asset-liability management of small US commercial banks

A simultaneous equation model is developed that jointly determines net interest margin and various maturity gaps. Using annual data for the majority of the population of insured commercial banks, this model is estimated for the years 1984 to 1987 (the only years for which repricing data were collected). For banks with assets of less than

On the Value of Municipal Bond Insurance: An Empirical Analysis

300 million, it is found that net interest margin is significantly associated with various maturity gaps. This framework is highly relevant to thousands of small banks for which accounting flows (such as net interest income) are the primary indicators of the effectiveness of asset liability management. One policy implication of this study is that the Federal Reserve may resume collecting repricing data (its collection was discontinued after 1987), at least for small banks with assets less than

Hedging Portfolios of Financial Guarantees

300 million because repricing data reveals important information about small banks exposure to interest rate risk, and these banks are less subject to market discipline.

Investment Incentives in Project Finance in the Presence of Partial Loan Guarantees

Using a large sample of municipal bond data from 2001 to 2010 in the U.S., this paper documents the time variation of the value of municipal bond insurance, estimated from the insured and uninsured bonds yield at issue differentials. We find that insured municipal bonds carry significant lower yields at issue compared to those of the equivalent uninsured bonds before 2008. However, this cost saving disappeared with the aftermath of the subprime credit crisis. We find that the supply of bonds and the level of market interest rates to have significant positive impacts on the time-varying value of bond insurance. We also detect asymmetric response of these yield differentials to rises and declines of market interest rates. Economic intuition suggests that the value of municipal bond insurance is a function of business cycles but our tests support the contrary, which may be explained by the habitat preference of municipal bonds issues.