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Risk Management for Equity Portfolios of Japanese Banks

  • Ieda, Akira

    (Bank of Japan)

  • Ohba, Toshikazu

    (Nippon Life Insurance Co)

Registered author(s):

    This paper verifies the impact of equity portfolio on bank management, underscoring the importance of managing the risks involved and suggesting "management of sensitivity to equity price risk" as a risk management technique that takes into account the correlation between equity price risk and credit risk. To do this, the paper focuses on the high correlation between "expected default probability estimated by the option-approach (Merton method)" using equity price information and " spread over Libor" observed in the bond market. This is used to calculate sensitivity (delta and vega) to changes in the equity price and its volatility. According to calculations for a sample portfolio, these two sensitivities have a degree of utility in measuring the distribution of risk exposure and in using equity price index futures and options as hedges. In the hedging of vega risk (which tends to reflect credit risk) in particular, long put positions in equity price index options are shown to be potentially effective.

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    File URL: http://www.imes.boj.or.jp/research/papers/english/me17-2-4.pdf
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    Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

    Volume (Year): 17 (1999)
    Issue (Month): 2 (August)
    Pages: 91-117

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    Handle: RePEc:ime:imemes:v:17:y:1999:i:2:p:91-117
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    1. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    2. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
    3. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
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