Browsing by Subject "Risk Management"

Now showing 1 - 3 of 3
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    Essays On Banking
    (2019-06) Kishore, Kaushalendra
    This thesis consists of two essays. In the first essay I try to explain why risk managers exist and provide a reason for risk management failure. Banks rely on risk managers to prevent their employees from making high risk low value investments. Why can't the CEOs directly incentivize their employees to choose the most profitable investment? I show that having a separate risk manager is more profitable for banks and is also socially efficient. This is because there is conflict between proving incentive to choose the most profitable investment and providing incentives to exert effort on those investments. Hence, if the tasks are split between a risk manager who approves the investments and a loan officer (or trader) who exerts effort, then both optimal investment choice and optimal effort can be achieved. I further examine some reasons for risk management failure wherein a CEO may ignore the risk manager when the latter is risk averse and suggests safe investments. As is usually the case before a financial crisis, my model predicts that the CEO is more likely to ignore the risk manager when the risky investments are yielding higher profits. The second essay studies the impact of expectation of bailout of a credit insurance firm on the investment strategies of the counterparty banks. If the failure of credit insurance firm may result in the bankruptcy of its counterparty banks, then the regulator will be forced to bail it out. This imperfectly targeted time inconsistent policy incentivizes the banks to make correlated investments ex ante. All banks want their assets to fail exactly at the time when the bailout is occurring to indirectly benefit from the bailout of the insurance firm and hence they make correlated investments. I build a model in which correlated investment by banks, under priced insurance contracts and a systemically important insurance firm arise endogenously and show that while credit insurance helps in risk sharing during good times, it can also create systemic risk. I also show that putting a limit on size of insurance firm can mitigate this problem.
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    Evaluating weather derivatives and crop insurance for farm production risk management in Southern Minnesota.
    (2011-11) Chung, Wonho
    Agriculture is one of the most weather sensitive industries and weatherrelated risks are a major source of crop production risk exposure. One method of hedging the risk exposure has been through the use of crop insurance. However, the crop insurance market suffers from several problems of asymmetric information and systemic weather risk. Without government subsidies or reinsurance crop insurers would have to pass the cost of bearing the risk exposures to farmers. The rising cost of the federal crop insurance program has been an incentive for the government to seek alternative ways to reduce the cost. Weather derivatives have been suggested as a potential risk management tool to solve the problems. Previous studies have shown that weather derivatives are an effective means of hedging agricultural production risk. Yet, it is unclear what role weather derivatives will play as a risk management tool compared with the existing federal crop insurance program. This study compares the hedging cost and effectiveness of weather options with those of crop insurance for soybean and corn production in four counties of southern Minnesota. We calculate weather option premium by using daily simulation method and compare hedging effectiveness by several risk indicators: certainty equivalence, risk premium, Sharpe ratio, and value at risk. Our results show that the hedging effectiveness of using weather options is limited at the farm level compared with crop insurance products. This is because weather options insure against adverse weather events causing damage at the county level, while crop insurance protects farmers against the loss of their crops directly at the farm level as well as at the county level. Thus, individual farmers will continue to use crop insurance with government subsidy for their production risk management. However, we observe that the hedging effectiveness of using weather options increases as the level of spatial aggregation increases from farm level to county level to four-county aggregate level. This implies that the government as a reinsurer can reduce idiosyncratic yield risk by aggregating the individual risk exposures at the county or higher level, and hedge the remaining systemic weather risk by purchasing weather options in the financial market. As a result, weather derivatives could be used by the government as a hedging tool to reduce the social cost of the federal crop insurance program, since the government currently does not hedge their risk exposures in the program. Against our expectation based on the conventional wisdom, geographic basis risk is not significant in hedging our local weather risk with non-local exchange market weather options based on Minneapolis. It is likely due to the fact that the Midwest area including Minnesota has relatively homogeneous (or less variable) weather conditions and crop yields across the counties compared to other U.S. regions. The result indicates that we can hedge local weather risk with non-local exchange market weather derivatives in southern Minnesota. However, it should be applied cautiously to other locations, crops, or other types of weather derivatives, considering spatial correlation of weather variables between a specific farm location and a weather index reference point.
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    Three Essays on Corporate Finance and Labor
    (2017-06) Qiu, Yue
    My dissertation investigates the interaction between corporate finance and labor market. It contains three chapters. Chapter 1 studies the strategic role of debt structure in improving the bargaining position of a firm's management relative to its non-financial stakeholders. Debt structure is essential for strategic bargaining because it affects the ease of renegotiating debt contracts and thus the credibility of bankruptcy threats. Debt structure is shown to be adjusted as a response to an increase in non-financial stakeholders' negotiation power. Using NLRB labor union election as a laboratory setting and employing a regression discontinuity design, we find that passing a labor union election leads to an increase in the ratio of public debt to total assets and a decrease in the ratio of bank debt to total assets in the following three years after elections, whereas there is no significant change in the level of total debt. The syndication size of newly issued bank loans increases while creditor ownership concentration decreases once the vote share for unions passes the winning threshold. Further analyses confirm that the debt structure adjustments after union certification are more likely driven by the strategic concerns of management rather than more constrained access to bank loans. Finally, we also show that the degree of wage concessions is strongly related to a firm's debt structure using the airline industry as an empirical setting. Chapter 2 is co-authored with Tracy Yue Wang. In this study, we measure firms' exposures to skilled labor risk by the intensity of such discussions in their 10-Ks. We find that this measure effectively captures firm risk due to the mobility of skilled labor. We then examine the impact of skilled labor risk on firms' compensation policies. To overcome the reverse causality potentially present in the equilibrium relation between skilled labor risk and compensation policies, we use housing market factors that affect home owners' mobility as instruments for local firms' skilled labor risk, based on the insight that talents are likely homeowners. Consistent with theories on optimal compensation design in the presence of mobile talents, our results suggest that firms facing higher skilled labor risk use substantially more incentive pay for both top executives and employees below the top rank. Those firms also ex ante offer a higher level of pay to skilled labor. Finally, we find that firms facing higher skilled labor risk invest more in strengthening employee relations, but such investment tend to be concentrated in compensation and benefits related dimensions. Overall, our study suggests that the mobility of skilled labor is an important determinant of corporate compensation policies, affecting the split of surplus between firms' owners and employees. Chapter 3 studies the effect of labor adjustment costs on corporate risk management. Labor adjustment costs attenuate the correlation between a firm's internal fund and its investment opportunities and create more incentives for the firm to smooth cash flows. We find that firms in which employees are more protected by labor market institutions use more derivative contracts for risk management. We further find that firms that rely more on skilled labor engage in more derivative hedging since labor with higher skill is associated with larger adjustment costs. Such an effect is attenuated when the mobility of skilled labor is restricted.