Abstract
We examine a specific portfolio credit derivative, an Asset Protection Scheme (APS), and its applicability as a discretionary regulatory tool to reduce asymmetric information and help restore the capital base of troubled banks. The APS can be a fair-valued contract with an appropriate structure of incentives. We apply two alternative multivariate structural default risk models: the classical Gaussian Merton model and a model based on Normal Inverse Gaussian processes. Using a data set on annual farm level data from 1996 to 2009, we use the Danish agricultural sector as a case study and price an APS on an agricultural loan portfolio. We compute the economic capital for this loan portfolio with and without an APS. Moreover, we illustrate how model risk in the form of parameter uncertainty is reduced when an APS is attached to the loan portfolio.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
The UK farm land value for the year 2009 was not available at the time of writing.
The parameters α 1 and α 2 equal those used for the APSs implemented in the UK.
References
Akerlof G (1970) The market for “lemons”: quality uncertainty and the market mechanism. Q J Econ 84(3):488–500
Andersen H (2011) Procyclical implications of Basel II: can the cyclicality of capital requirements be contained? J Financial Stability 7(3):138–154
Barndorff-Nielsen O (1997) Normal inverse Gaussian distributions and stochastic volatility modelling. Scand J Stat 24(1):1–13
Bartlett M (1950) Periodogram analysis and continuous spectra. Biometrika 37(1–2):1–16
Bruyère R, Cont R, Copinot R, Fery L, Jaeck C, Spitz T (2006) Credit derivatives and structured credit: a guide for investors. Wiley, New York
Cont R, Tankov P (2004) Financial modelling with jump processes. Chapman & Hall/CRC
Cox J, Ingersoll Jr J, Ross S (1985) A theory of the term structure of interest rates. Econometrica 53(2):385–407
Danmarks Nationalbank (2009) Financial stability 2009, 1st half. Available from Danmarks Nationalbank, www.nationalbanken.dk
DeMarzo P (2005) The pooling and tranching of securities: a model of informed intermediation. Rev Financ Stud 18(1):1–35
Eberlein E, Kluge W (2007) Calibration of Lévy term structure models. In: Advances in mathematical finance, pp 147–172
HM Treasury (2009a) Royal Bank of Scotland: details of asset protection scheme and launch of the asset protection agency. Available from www.hm-treasury.gov.uk
HM Treasury (2009b) UK asset protection scheme. Available from www.hm-treasury.gov.uk
Jorion P (1997) Value at risk. Irwin Homewood, IL
Kalemanova A, Schmid B, Werner R (2007) The normal inverse Gaussian distribution for synthetic CDO pricing. J Deriv 14(3):80–94
Katchova AL, Barry PJ (2005) Credit risk models and agricultural lending. Am J Agr Econ 87(1):194–205
Kretzschmar G, McNeil AJ, Kirchner A (2010) Integrated models of capital adequacy—why banks are undercapitalised. J Bank Financ 34(12):2838–2850
Luciano E, Schoutens W (2006) A multivariate jump-driven financial asset model. Quant Finance 6(5):385–402
McNeil AJ, Frey R, Embrechts P (2005) Quantitative risk management: concepts, techniques, and tools. Princeton University Press, Princeton
Merton RC (1974) On the pricing of corporate debt: the risk structure of interest rates. J Financ 29(2):449–470
Raible S (2000) Lévy processes in finance: theory, numerics, and empirical facts. Doctoral thesis, University of Freiburg
Rydberg T (1997) The normal inverse Gaussian Lévy process: simulation and approximation. Stoch Models 13(4):887–910
Stokes JR, Brinch BM (2001) Valuing agricultural mortgage-backed securities. J Agric Appl Econ 33(3):493–511
The Royal Bank of Scotland Group (RBS) (2009) The Royal Bank of Scotland Group plc (RBS)—announcement on the APS and state aid discussions. Available from www.rbs.com
US Department of Agriculture (2009) Census of agriculture 2007. Available from www.agcensus.usda.gov
Acknowledgements
We thank the Danish Agricultural Advisory Service (Landbrugsraadgivningen) for providing us the data set on Danish farms. We also thank Peter Løchte Jørgensen, Elisa Nicolato and David Skovmand for valuable comments. Furthermore, we are thankful to the participants at the Nordic Finance Network Workshop 2010, the 14th International Congress on Insurance: Mathematics and Economics 2010, the International Conference on Financial Intermediation, Competition and Risk 2011, and the Systemic Risk, Basel III, Financial Stability and Regulation 2011 where the paper has been presented.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Grosen, A., Jessen, P. & Kokholm, T. An asset protection scheme for banks exposed to troubled loan portfolios. J Econ Finan 38, 568–588 (2014). https://doi.org/10.1007/s12197-012-9233-z
Published:
Issue Date:
DOI: https://doi.org/10.1007/s12197-012-9233-z
Keywords
- Asset Protection Scheme
- Asymmetric Information
- Regulation
- Credit Risk
- Portfolio Credit Derivative
- Normal Inverse Gaussian