Risk Management

A Modern Perspective

By: Michael K. Ong

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Hardcover | 5 December 2005

At a Glance

Hardcover
764 Pages

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23.5 x 19.05 x 4.14

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Risk models, like all tools that describe and predict behaviors, possess strengths and flaws that can yield consequences both intended and unintended. In this collection of original essays, finance professionals and professors from around the world examine the assumptions and expectations that underlie both financial risk models and the practices and institutions they have engendered. Contributors analyze and evaluate current systems while summarizing our understanding of certain types of risk and describing emerging trends. Subjects range from risk reporting and risk forecasting to enterprise risk management and the effect of behavioral finance on compensation systems. Encouraging practitioners and the academic community to look at risk as it hasn't been looked at before, this book seeks to encourage critical thinking and innovation.

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Non-Fiction Business & Management Management & Management Techniques Management Decision Making Accounting & Finance Finance Credit & Credit Institutions Economics Microeconomics

Enterprise Risk Management
Managing Risk Across the Enterprise: Challenges and Benefits	p. 3
Risk Management in Context	p. 4
Value Proposition of ERM	p. 6
ERM Framework and Implementation	p. 10
Key Challenges and Issues	p. 15
The Future for ERM	p. 16
Asset and Liability Management from an Enterprise-Wide Risk Management Perspective	p. 21
Learning the Hard Way: Breaking Down Barriers in Risk Management Functions	p. 22
The Jarrow-Merton Put Option as a Comprehensive Measure of Total Risk	p. 24
Extracting Business Risk and Default Risk from Options Prices: The Citigroup Example	p. 25
Total Risk as Measured by Reduced Form Credit Models	p. 33
Enhancing ALM's Contribution to Integrated Risk Management	p. 36
Summary and Conclusions	p. 37
Enterprise Risk Management in the Energy and Power Industry	p. 41
Introduction	p. 42
Observations on the Energy and Power Market Landscape	p. 44
Modeling and Measurement Methodologies, Benchmarks, and Objectives	p. 49
Restoration of Confidence and Solidification of Risk Management Practices	p. 56
ERM Strategies for Investors	p. 59
Introduction	p. 60
ERM Goes Mainstream	p. 60
ERM Strategies for Investors	p. 61
Successful ERM for Investors	p. 62
Current Challenges in ERM for Investors	p. 64
Risk Optimization
Risk Budgeting as a Strategic Tool for Pension Plans	p. 69
What is Risk Budgeting?	p. 70
The Risk Budgeting Process for Pension Plans	p. 72
The Tools of Risk Budgeting	p. 74
Conclusions	p. 87
Advanced Risk Budgeting Techniques	p. 89
Introduction	p. 90
What is Risk Budgeting?	p. 91
Risk Attribution	p. 97
Risk Allocation	p. 100
Extensions and New Developments	p. 105
Hedge Fund Investing	p. 113
Introduction	p. 114
Investing for Absolute Returns: From Beta to Alpha	p. 116
Salient Features and Myths	p. 118
The Risk Manager's Roadmap to Paradigm Pitfalls	p. 123
Sharper RAPMs for the New Paradigm: From Omega to AIRAP	p. 132
Paradigm Risk Measures	p. 135
Asset Allocation and Hedge Funds	p. 139
Conclusions	p. 141
The Hedge Fund Paradigm	p. 145
Introduction	p. 146
Hedge Funds Biotope, Regulatory Environment, and Fee Structure	p. 148
Hedge Fund Styles	p. 151
Measuring and Managing Hedge Fund Risks	p. 158
Conclusions	p. 177
Risk Modeling
Retrospective Assessment of Value at Risk	p. 183
Introduction	p. 184
Model Risk	p. 185
Back-Testing VaR Models	p. 188
Conclusions	p. 201
New Challenges in Credit Risk Modeling and Measurement	p. 203
Introduction	p. 204
Risk Types	p. 205
Credit Demand: Products and Modeling Issues	p. 210
Defining Key Credit Concepts	p. 220
Modeling Corporate Credit	p. 225
Estimating Parameters Required for Credit Risk Modeling	p. 235
Introduction	p. 236
Default Risk	p. 237
Exposure at Default	p. 242
Loss Given Default	p. 245
Correlations	p. 249
Determining Loss Given Default and Transaction Ratings in Collateralized Lending with Obligor-Collateral Correlation	p. 253
Introduction and Motivation	p. 254
Expected Loss as a Put Option	p. 256
The Model	p. 258
Model Inputs and Parameters	p. 262
Using the Expected LGD to Obtain Transaction Rating	p. 264
Calibration	p. 267
Risk Sensitivities	p. 269
Conclusions	p. 270
Addendum: Calculation of K	p. 271
Modeling Correlation Risk	p. 273
Introduction	p. 274
The Link Between the Interest Rate Swap Spread and Time-Varying Correlation	p. 274
An Empirical Model of Time-Varying Correlations	p. 278
Conclusions	p. 291
Developing a Framework for Operational Risk Analytics	p. 295
Database Modeling	p. 296
Measuring Operational Risk	p. 298
Framework Integration	p. 306
An Analysis of Value and Risk: The Procter & Gamble-Bankers Trust Case	p. 309
Introduction	p. 310
Literature Review and Our Contribution	p. 312
The 5/30 Option and Associated Spreads	p. 314
Fair Value for Positions in the 5/30 Options and Spreads	p. 317
Market Risk Analysis	p. 328
Conclusions	p. 329
Appendix: Margrabe Model Valuation of 5/30 Option	p. 331
Risk Integration
Integration of Credit and Market Risk	p. 341
Introduction	p. 342
Top-Down Approach	p. 343
Bottom-Up Approach	p. 351
Volatile Exposure	p. 355
Exact Formulation	p. 359
Dependency Concepts	p. 361
Further Extensions	p. 362
Conclusions	p. 363
Mathematical Framework for Integrating Market and Credit Risk	p. 367
Introduction	p. 368
Risk Measures	p. 369
Market and Credit Risk	p. 374
Regulatory Environment	p. 379
Risk Management	p. 383
Conclusions	p. 386
Appendix: Transition and Generator Matrix	p. 388
Integration of Operational Risk Management and the Sarbanes-Oxley Act Section 404	p. 391
Introduction	p. 392
Sarbanes-Oxley Act of 2002	p. 393
Sarbanes-Oxley Section 404	p. 394
COSO Internal Control: Integrated Framework	p. 395
Sarbanes-Oxley Roles and Responsibilities	p. 398
Operational Risk Management Framework	p. 400
Operational Risk Management Roles and Responsibilities	p. 401
Common Elements of Sarbanes-Oxley Act Section 404 and Operational Risk Management	p. 404
Technology as an Enabler	p. 407
Conclusions: Benefits of an Integrated Approach	p. 410
Capital Allocation
Capital Allocation Using Risk Management Tools	p. 415
Introduction	p. 416
From Book Capital to Risk Capital	p. 416
Conceptual Definition of Economic Capital	p. 417
Economic Capital as a Departure from Standard Corporate Finance	p. 419
Modeling of Risk as a Prerequisite for Appropriate Economic Capital Allocation: What are the Types of Risk to be Modeled?	p. 422
Broad Types of Economic Capital Models	p. 425
Capital Attribution	p. 426
Capital Allocation to Business Units	p. 427
Risk-Adjusted Performance: Economic Capital and Shareholder Value Creation	p. 428
Economic Capital as the Cornerstone of Enterprise Risk Management	p. 430
Risk Capital Attribution and Risk-Adjusted Performance Measurement	p. 433
What Purpose Does Risk Capital Serve?	p. 434
Emerging Uses of Risk Capital Numbers	p. 435
RAROC: Risk-Adjusted Return on Capital	p. 437
RAROC in Practice	p. 450
Conclusions	p. 453
Aligning Regulatory Capital with Economic Capital	p. 455
Introduction	p. 456
Role of Regulatory Capital Requirements	p. 459
Allocating Economic Capital Within a Portfolio of Assets	p. 461
Aligning the Two: Introduction to Basel II	p. 463
Critical View	p. 476
Conclusions	p. 478
Aligning Regulatory with Economic Capital: An Alternative Approach to Risk Weights According to Basel II	p. 481
Introduction	p. 482
Asset Correlation	p. 484
Maturity	p. 492
Diversification	p. 495
Flexible Confidence Level	p. 500
Summary	p. 504
Risk Forecasting
Forecasting Extreme Financial Risk	p. 509
Introduction	p. 510
Methods for Modeling Extreme Risk	p. 512
Overview of EVT Theory	p. 515
Applying EVT	p. 528
Conclusions	p. 535
Measuring Financial Extremes	p. 537
Introduction	p. 538
A Brief, Recent History of Financial Risk Modeling	p. 539
Extreme Value Statistics	p. 542
Point Processes	p. 550
The Distribution of Returns and Risk Forecasting	p. 557
Introduction	p. 558
A Simple Trading Model	p. 560
A Volatility Forecasting Model	p. 563
The Return Forecasting Model	p. 566
Risk Forecasting	p. 572
Conditional Expected Loss	p. 578
Concluding Comments	p. 580
Relevance of Volatility Forecasting in Financial Risk Management	p. 583
Introduction	p. 584
Volatility and Volatility Forecast	p. 585
Forecasting Volatility with Daily Data	p. 592
Forecasting Volatility with High-Frequency Data	p. 593
Volatility Processes	p. 595
An Empirical Comparison of the Forecasts	p. 599
Conclusions	p. 602
Risk Reporting
The Evolution of Risk Reporting	p. 607
Introduction	p. 608
Financial Risk	p. 609
From Monolithic Risk Reporting Entities to Decomposed Risky Portfolios	p. 609
From Risk Exposure Measurement to Financial Risk Measurement	p. 610
From Differential to Stochastic Financial Risk Measures	p. 616
From Default-Free to Credit-Oriented Risk Exposure Measures	p. 624
From Current to Future Financial Risk Measures and Reporting	p. 628
Emerging Trends in Risk Reporting	p. 633
Introduction	p. 634
Traditional Risk Reporting Framework	p. 636
Changing Role of Risk Management	p. 640
Regulatory Developments and Demands	p. 642
Quantitative Tools and Techniques	p. 644
Summary Implications for Risk Reporting	p. 648
Conclusions	p. 649
Behavioral Finance and Compensation System
The Role of Behavioral Finance in Risk Management	p. 653
Introduction	p. 654
How Do People Perceive Risks?	p. 656
How Do People Perceive Probabilities?	p. 657
How Do People Establish Confidence Intervals?	p. 658
How Do Investors Perceive Equity Risk?	p. 658
How Do Investors Perceive the Relationship Between Risk and Return?	p. 659
What Factors Determine People's Attitudes Toward Risk?	p. 660
How Important is Framing?	p. 663
What is Regret?	p. 664
What Determines Evaluability?	p. 665
How Does Affect Cause Preference Reversal?	p. 665
How Do Fear and Hope Influence Risk Tolerance?	p. 666
How Do Fear and Hope Influence Judgments About Value?	p. 671
How Do Investors Measure the Risk/Return Trade-Off?	p. 672
How Effective are Groups at Making Decisions?	p. 672
Examples of Psychologically Induced Errors	p. 674
Is Debiasing Possible?	p. 675
Conclusions	p. 675
"Buy on the Rumor" and "Sell on the News"	p. 677
Introduction	p. 679
BRSN Examples	p. 681
BRSN Theory	p. 685
Complexity in the Markets	p. 685
Collective Behavior and Market Anomalies	p. 687
Affect and Market Anomalies	p. 688
Self-Regulation of Behavior	p. 689
Affect and Decision Making	p. 691
Anticipation, Expectation, and Affect	p. 692
Anticipation of Reward: BRSN Stage I	p. 693
Revelation: BRSN Stage II	p. 695
Disappointment: BRSN Stage III	p. 697
Event Selection	p. 698
Discussion	p. 698
Aligning Compensation Systems with Risk Management Objectives	p. 703
Introduction	p. 704
Operational Risk, Darley's Law, and Behavior	p. 705
A Typical Trading Desk Criterial Control System	p. 706
Generalized Problems with Objective Systems	p. 706
Dynamics of Authority Influence and the Impact on Risk	p. 708
High-Profile Misalignments of Incentives and Objectives	p. 709
The Perfect Storm: Joseph Jett and Kidder Peabody	p. 711
The Role of the Risk Manager	p. 713
Mapping Employee Desired Behavior	p. 718
The Risk Manager's Dilemma	p. 720
Conclusions	p. 721
Index	p. 723
Table of Contents provided by Ingram. All Rights Reserved.

Risk Management

A Modern Perspective

At a Glance

Hardcover

Shipping

How to return your order

Defective items

You Can Find This Book In

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