Financial risk management : models, history, and institutions
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Bibliographic Information
Financial risk management : models, history, and institutions
（Wiley finance series）
J. Wiley & Sons, c2011
- : cloth
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Includes bibliographical references (p. 671-699) and index
Description and Table of Contents
Description
Financial risk has become a focus of financial and nonfinancial firms, individuals, and policy makers. But the study of risk remains a relatively new discipline in finance and continues to be refined. The financial market crisis that began in 2007 has highlighted the challenges of managing financial risk. Now, in Financial Risk Management, author Allan Malz addresses the essential issues surrounding this discipline, sharing his extensive career experiences as a risk researcher, risk manager, and central banker. The book includes standard risk measurement models as well as alternative models that address options, structured credit risks, and the real-world complexities or risk modeling, and provides the institutional and historical background on financial innovation, liquidity, leverage, and financial crises that is crucial to practitioners and students of finance for understanding the world today. Financial Risk Management is equally suitable for firm risk managers, economists, and policy makers seeking grounding in the subject. This timely guide skillfully surveys the landscape of financial risk and the financial developments of recent decades that culminated in the crisis. The book provides a comprehensive overview of the different types of financial risk we face, as well as the techniques used to measure and manage them. Topics covered include:
Market risk, from Value-at-Risk (VaR) to risk models for options
Credit risk, from portfolio credit risk to structured credit products
Model risk and validation
Risk capital and stress testing
Liquidity risk, leverage, systemic risk, and the forms they take
Financial crises, historical and current, their causes and characteristics
Financial regulation and its evolution in the wake of the global crisis
And much more
Combining the more model-oriented approach of risk management-as it has evolved over the past two decades-with an economist's approach to the same issues, Financial Risk Management is the essential guide to the subject for today's complex world.
Table of Contents
List of Figures xvii
Preface xxi
Chapter 1 Financial Risk in a Crisis-Prone World 1
1.1 Some History: Why Is Risk a Separate Discipline Today? 1
1.1.1 The Financial Industry Since the 1960s 2
1.1.2 The "Shadow Banking System" 9
1.1.3 Changes in Public Policy Toward the Financial System 15
1.1.4 The Rise of Large Capital Pools 17
1.1.5 Macroeconomic Developments Since the 1960s: From the Unraveling of Bretton Woods to the Great Moderation 20
1.2 The Scope of Financial Risk 34
1.2.1 Risk Management in Other Fields 34
Further Reading 41
Chapter 2 Market Risk Basics 43
2.1 Arithmetic, Geometric, and Logarithmic Security Returns 44
2.2 Risk and Securities Prices: The Standard Asset Pricing Model 49
2.2.1 Defining Risk: States, Security Payoffs, and Preferences 50
2.2.2 Optimal Portfolio Selection 54
2.2.3 Equilibrium Asset Prices and Returns 56
2.2.4 Risk-Neutral Probabilities 61
2.3 The Standard Asset Distribution Model 63
2.3.1 Random Walks and Wiener Processes 64
2.3.2 Geometric Brownian Motion 71
2.3.3 Asset Return Volatility 74
2.4 Portfolio Risk in the Standard Model 75
2.4.1 Beta and Market Risk 76
2.4.2 Diversification 82
2.4.3 Efficiency 85
2.5 Benchmark Interest Rates 88
Further Reading 91
Chapter 3 Value-at-Risk 93
3.1 Definition of Value-at-Risk 94
3.1.1 The User-Defined Parameters 97
3.1.2 Steps in Computing VaR 98
3.2 Volatility Estimation 99
3.2.1 Short-Term Conditional Volatility Estimation 99
3.2.2 The EWMA Model 104
3.2.3 The GARCH Model 106
3.3 Modes of Computation 108
3.3.1 Parametric 108
3.3.2 Monte Carlo Simulation 109
3.3.3 Historical Simulation 111
3.4 Short Positions 113
3.5 Expected Shortfall 114
Further Reading 116
Chapter 4 Nonlinear Risks and the Treatment of Bonds and Options 119
4.1 Nonlinear Risk Measurement and Options 121
4.1.1 Nonlinearity and VaR 123
4.1.2 Simulation for Nonlinear Exposures 126
4.1.3 Delta-Gamma for Options 127
4.1.4 The Delta-Gamma Approach for General Exposures 134
4.2 Yield Curve Risk 136
4.2.1 The Term Structure of Interest Rates 138
4.2.2 Estimating Yield Curves 141
4.2.3 Coupon Bonds 144
4.3 VaR for Default-Free Fixed Income Securities Using the Duration and Convexity Mapping 148
4.3.1 Duration 149
4.3.2 Interest-Rate Volatility and Bond Price Volatility 150
4.3.3 Duration-Only VaR 152
4.3.4 Convexity 154
4.3.5 VaR Using Duration and Convexity 155
Further Reading 156
Chapter 5 Portfolio VaR for Market Risk 159
5.1 The Covariance and Correlation Matrices 160
5.2 Mapping and Treatment of Bonds and Options 162
5.3 Delta-Normal VaR 163
5.3.1 The Delta-Normal Approach for a Single Position Exposed to a Single Risk Factor 164
5.3.2 The Delta-Normal Approach for a Single Position Exposed to Several Risk Factors 166
5.3.3 The Delta-Normal Approach for a Portfolio of Securities 168
5.4 Portfolio VAR via Monte Carlo simulation 174
5.5 Option Vega Risk 175
5.5.1 Vega Risk and the Black-Scholes Anomalies 176
5.5.2 The Option Implied Volatility Surface 180
5.5.3 Measuring Vega Risk 183
Further Reading 190
Chapter 6 Credit and Counterparty Risk 191
6.1 Defining Credit Risk 192
6.2 Credit-Risky Securities 193
6.2.1 The Economic Balance Sheet of the Firm 193
6.2.2 Capital Structure 194
6.2.3 Security, Collateral, and Priority 195
6.2.4 Credit Derivatives 196
6.3 Transaction Cost Problems in Credit Contracts 196
6.4 Default and Recovery: Analytic Concepts 199
6.4.1 Default 199
6.4.2 Probability of Default 200
6.4.3 Credit Exposure 201
6.4.4 Loss Given Default 201
6.4.5 Expected Loss 202
6.4.6 Credit Risk and Market Risk 204
6.5 Assessing creditworthiness 204
6.5.1 Credit Ratings and Rating Migration 204
6.5.2 Internal Ratings 207
6.5.3 Credit Risk Models 207
6.6 Counterparty Risk 207
6.6.1 Netting and Clearinghouses 209
6.6.2 Measuring Counterparty Risk for Derivatives Positions 209
6.6.3 Double Default Risk 211
6.6.4 Custodial Risk 211
6.6.5 Mitigation of Counterparty Risk 212
6.7 The Merton model 213
6.8 Credit Factor Models 222
6.9 Credit Risk Measures 226
6.9.1 Expected and Unexpected Loss 228
6.9.2 Jump-to-Default Risk 229
Further Reading 229
Chapter 7 Spread Risk and Default Intensity Models 231
7.1 Credit Spreads 231
7.1.1 Spread Mark-to-Market 233
7.2 Default Curve Analytics 235
7.2.1 The Hazard Rate 237
7.2.2 Default Time Distribution Function 239
7.2.3 Default Time Density Function 239
7.2.4 Conditional Default Probability 240
7.3 Risk-Neutral Estimates of Default Probabilities 241
7.3.1 Basic Analytics of Risk-Neutral Default Rates 242
7.3.2 Time Scaling of Default Probabilities 245
7.3.3 Credit Default Swaps 246
7.3.4 Building Default Probability Curves 250
7.3.5 The Slope of Default Probability Curves 259
7.4 Spread Risk 261
7.4.1 Mark-to-Market of a CDS 261
7.4.2 Spread Volatility 262
Further Reading 264
Chapter 8 Portfolio Credit Risk 265
8.1 Default Correlation 266
8.1.1 Defining Default Correlation 266
8.1.2 The Order of Magnitude of Default Correlation 270
8.2 Credit Portfolio Risk Measurement 270
8.2.1 Granularity and Portfolio Credit Value-at-Risk 270
8.3 Default Distributions and Credit VaR with the Single-Factor Model 275
8.3.1 Conditional Default Distributions 275
8.3.2 Asset and Default Correlation 279
8.3.3 Credit VaR Using the Single-Factor Model 281
8.4 Using Simulation and Copulas to Estimate Portfolio Credit Risk 284
8.4.1 Simulating Single-Credit Risk 286
8.4.2 Simulating Joint Defaults with a Copula 288
Further Reading 295
Chapter 9 Structured Credit Risk 297
9.1 Structured Credit Basics 297
9.1.1 Capital Structure and Credit Losses in a Securitization 301
9.1.2 Waterfall 305
9.1.3 Issuance Process 307
9.2 Credit Scenario Analysis of a Securitization 309
9.2.1 Tracking the Interim Cash Flows 309
9.2.2 Tracking the Final-Year Cash Flows 314
9.3 Measuring Structured Credit Risk via Simulation 318
9.3.1 The Simulation Procedure and the Role of Correlation 318
9.3.2 Means of the Distributions 323
9.3.3 Distribution of Losses and Credit VaR 327
9.3.4 Default Sensitivities of the Tranches 333
9.3.5 Summary of Tranche Risks 336
9.4 Standard Tranches and Implied Credit Correlation 337
9.4.1 Credit Index Default Swaps and Standard Tranches 338
9.4.2 Implied Correlation 340
9.4.3 Summary of Default Correlation Concepts 341
9.5 Issuer and Investor Motivations for Structured Credit 342
9.5.1 Incentives of Issuers 343
9.5.2 Incentives of Investors 345
Further Reading 346
Chapter 10 Alternatives to the Standard Market Risk Model 349
10.1 Real-World Asset Price Behavior 349
10.2 Alternative Modeling Approaches 363
10.2.1 Jump-Diffusion Models 363
10.2.2 Extreme Value Theory 365
10.3 The Evidence on Non-Normality in Derivatives Prices 372
10.3.1 Option-Based Risk-Neutral Distributions 372
10.3.2 Risk-Neutral Asset Price Probability Distributions 380
10.3.3 Implied Correlations 387
Further Reading 390
Chapter 11 Assessing the Quality of Risk Measures 393
11.1 Model Risk 393
11.1.1 Valuation Risk 395
11.1.2 Variability of VaR Estimates 395
11.1.3 Mapping Issues 397
11.1.4 Case Study: The 2005 Credit Correlation Episode 399
11.1.5 Case Study: Subprime Default Models 405
11.2 Backtesting of VaR 407
11.3 Coherence of VaR Estimates 414
Further Reading 419
Chapter 12 Liquidity and Leverage 421
12.1 Funding Liquidity Risk 422
12.1.1 Maturity Transformation 422
12.1.2 Liquidity Transformation 423
12.1.3 Bank Liquidity 425
12.1.4 Structured Credit and Off-Balance-Sheet Funding 429
12.1.5 Funding Liquidity of Other Intermediaries 432
12.1.6 Systematic Funding Liquidity Risk 434
12.2 Markets for Collateral 437
12.2.1 Structure of Markets for Collateral 438
12.2.2 Economic Function of Markets for Collateral 441
12.2.3 Prime Brokerage and Hedge Funds 443
12.2.4 Risks in Markets for Collateral 445
12.3 Leverage and Forms of Credit in Contemporary Finance 448
12.3.1 Defining and Measuring Leverage 448
12.3.2 Margin Loans and Leverage 454
12.3.3 Short Positions 455
12.3.4 Derivatives 456
12.3.5 Structured Credit 460
12.3.6 Asset Volatility and Leverage 460
12.4 Transactions Liquidity Risk 461
12.4.1 Causes of Transactions Liquidity Risk 461
12.4.2 Characteristics of Market Liquidity 463
12.5 Liquidity Risk Measurement 464
12.5.1 Measuring Funding Liquidity Risk 464
12.5.2 Measuring Transactions Liquidity Risk 466
12.6 Liquidity and Systemic Risk 469
12.6.1 Funding Liquidity and Solvency 469
12.6.2 Funding and Market Liquidity 471
12.6.3 Systemic Risk and the "Plumbing" 471
12.6.4 "Interconnectedness" 473
Further Reading 474
Chapter 13 Risk Control and Mitigation 477
13.1 Defining Risk Capital 478
13.2 Risk Contributions 480
13.2.1 Risk Contributions in a Long-Only Portfolio 481
13.2.2 Risk Contributions Using Delta Equivalents 485
13.2.3 Risk Capital Measurement for Quantitative Strategies 490
13.3 Stress Testing 499
13.3.1 An Example of Stress Testing 501
13.3.2 Types of Stress Tests 504
13.4 Sizing Positions 506
13.4.1 Diversification 506
13.4.2 Optimization and Implied Views 507
13.5 Risk Reporting 509
13.6 Hedging and Basis Risk 512
Further Reading 516
Chapter 14 Financial Crises 517
14.1 Panics, Runs, and Crashes 519
14.1.1 Monetary and Credit Contraction 519
14.1.2 Panics 528
14.1.3 Rising Insolvencies 535
14.1.4 Impairment of Market Functioning 537
14.2 Self-Reinforcing Mechanisms 539
14.2.1 Net Worth and Asset Price Declines 540
14.2.2 Collateral Devaluation 542
14.2.3 Risk Triggers 543
14.2.4 Accounting Triggers 547
14.3 Behavior of Asset Prices During Crises 548
14.3.1 Credit Spreads 549
14.3.2 Extreme Volatility 551
14.3.3 Correlations 556
14.4 Causes of Financial Crises 562
14.4.1 Debt, International Payments, and Crises 563
14.4.2 Interest Rates and Credit Expansion 570
14.4.3 Procyclicality: Financial Causes of Crises 575
14.4.4 Models of Bubbles and Crashes 578
14.5 Anticipating Financial Crises 583
14.5.1 Identifying Financial Fragility 583
14.5.2 Macroeconomic Predictors of Financial Crises 585
14.5.3 Asset-Price Predictors of Financial Crises 585
Further Reading 591
Chapter 15 Financial Regulation 597
15.1 Scope and Structure of Regulation 598
15.1.1 The Rationale of Regulation 598
15.1.2 Regulatory Authorities 601
15.2 Methods of Regulation 605
15.2.1 Deposit Insurance 606
15.2.2 Capital Standards 608
15.2.3 Bank Examinations and Resolution 619
15.3 Public Policy Toward Financial Crises 621
15.3.1 Financial Stability Policies 621
15.3.2 Lender of Last Resort 628
15.4 Pitfalls in Regulation 635
15.4.1 Moral Hazard and Risk Shifting 636
15.4.2 Regulatory Evasion 643
15.4.3 Unintended Consequences 645
Further Reading 647
Appendix A Technical Notes 653
A.1 Binomial Distribution 653
A.2 Quantiles and Quantile Transformations 654
A.3 Normal and Lognormal Distributions 656
A.3.1 Relationship between Asset Price Levels and Returns 656
A.3.2 The Black-Scholes Distribution Function 657
A.4 Hypothesis Testing 661
A.5 Monte Carlo Simulation 662
A.5.1 Fooled by Nonrandomness: Random Variable Generation 663
A.5.2 Generating Nonuniform Random Variates 664
A.6 Homogeneous Functions 664
Further Reading 666
Appendix B Abbreviations 667
Appendix C References 671
Index 701
by "Nielsen BookData"