Credit Risk Management In and Out of the Financial Crisis New Approaches to Value at Risk and Other Paradigms

by Saunders, Anthony; Allen, Linda

• ISBN13: 9780470478349
• ISBN10: 0470478349
• Edition: 3rd
• Format: Hardcover
• Copyright: 2010-05-03
• Publisher: Wiley

Summary

A classic book on credit risk management is updated to reflect the current economic crisisCredit Risk Management In and Out of the Financial Crisis dissects the 2007-2008 credit crisis and provides solutions for professionals looking to better manage risk through modeling and new technology. This book is a complete update to Credit Risk Measurement: New Approaches to Value at Risk and Other Paradigms, reflecting events stemming from the recent credit crisis.Authors Anthony Saunders and Linda Allen address everything from the implications of new regulations to how the new rules will change everyday activity in the finance industry. They also provide techniques for modeling-credit scoring, structural, and reduced form models-while offering sound advice for stress testing credit risk models and when to accept or reject loans. Breaks down the latest credit risk measurement and modeling techniques and simplifies many of the technical and analytical details surrounding them Concentrates on the underlying economics to objectively evaluate new models Includes new chapters on how to prevent another crisis from occurringUnderstanding credit risk measurement is now more important than ever. Credit Risk Management In and Out of the Financial Crisis will solidify your knowledge of this dynamic discipline.

Author Biography

Anthony Saunders is the John M. Schiff Professor of Finance and former chair of the Department of Finance at the Stern School of Business at New York University. He holds positions on the Board of Academic Consultants of the Federal Reserve Board of Governors as well as the Council of Research Advisors for the Federal National Mortgage Association, and has been a visiting scholar at the Comptroller of the Currency and at the International Monetary Fund.

Linda Allen is the Presidential Professor of Finance at the Zicklin School of Business at Baruch College, City University of New York (CUNY), and Adjunct Professor of Finance at the Stern School of Business, New York University. She has been a member of the Standard & Poor's Academic Council since its formation in 2004. Professor Allen has published extensively in top academic journals in finance and economics.

Table of Contents

List of Abbreviations	p. xi
Preface	p. xv
Bubbles and Crises: The Global Financial Crisis of 2007–2009
Setting the Stage for Financial Meltdown	p. 3
Introduction	p. 3
The Changing Nature of Banking	p. 3
Reengineering Financial Institutions and Markets	p. 17
Summary	p. 21
Ratings Comparisons for the Three Major Rating Agencies	p. 23
The Three Phases of the Credit Crisis	p. 24
Introduction	p. 24
Bursting of the Credit Bubble	p. 24
Credit Crisis in the Mortgage Market	p. 29
The Crisis Spreads—Liquidity Risk	p. 33
The Lehman Failure—Underwriting and Political Intervention Risk	p. 37
Summary	p. 43
The Crisis and Regulatory Failure	p. 45
Introduction	p. 45
Crisis Intervention	p. 45
Looking Forward: Restructuring Plans	p. 52
Summary	p. 64
Probability of Default Estimation
Loans as Options: The Moody's KMV Model	p. 67
Introduction	p. 67
The Link between Loans and Options	p. 67
The Moody's KMV Model	p. 70
Testing the Accuracy of EDF™ Scores	p. 74
Critiques of Moody's KMV EDF™ Scores	p. 86
Summary	p. 93
Merton's Valuation Model	p. 93
Moody's KMV RiskCalc™	p. 95
Reduced Form Models: Kamakura's Risk Manager	p. 98
Introduction	p. 98
Deriving Risk-Neutral Probabilities of Default	p. 99
Generalizing the Discrete Model of Risky Debt Pricing	p. 102
The Loss Intensity Process	p. 105
Kamakura's Risk Information Services (KRIS)	p. 108
Determinants of Bond Spreads	p. 110
Summary	p. 114
Understanding a Basic Intensity Process	p. 114
Other Credit Risk Models	p. 117
Introduction	p. 117
Credit Scoring Systems	p. 117
Mortality Rate Systems	p. 121
Artificial Neural Networks	p. 125
Comparison of Default Probability Estimation Models	p. 127
Summary	p. 131
Estimation of Other Model Parameters
A Critical Parameter: Loss Given Default	p. 135
Introduction	p. 135
Academic Models of LGD	p. 135
Disentangling LGD and PD	p. 142
Moody's KMV's Approach to LGD Estimation	p. 143
Kamakura's Approach to LGD Estimation	p. 146
Summary	p. 146
The Credit Risk of Portfolios and Correlations	p. 148
Introduction	p. 148
Modern Portfolio Theory (MPT): An Overview	p. 149
Applying MPT to Nontraded Bonds and Loans	p. 150
Estimating Correlations across Nontraded Assets	p. 152
Moody's KMV's Portfolio Manager	p. 153
Kamakura and Other Reduced Form Models	p. 161
Summary	p. 165
Putting the Parameters Together
The VAR Approach: CreditMetrics and Other Models	p. 169
Introduction	p. 169
The Concept of Value at Risk	p. 170
Capital Requirements	p. 177
Technical Issues and Problems	p. 180
The Portfolio Approach in CreditMetrics	p. 184
Summary	p. 195
Calculating the Forward Zero Curve for Loan Valuation	p. 195
Estimating Unexpected Losses Using Extreme Value Theory	p. 200
The Simplified Two-Asset Subportfolio Solution to the N-Asset Portfolio Case	p. 202
CreditMetrics and Swap Credit Risk	p. 202
Stress Testing Credit Risk Models: Algorithmics Mark-to-Future	p. 208
Introduction	p. 208
Back-Testing Credit Risk Models	p. 209
Using the Algorithmics Mark-to-Future Model	p. 215
Stress Testing U.S. Banks in 2009	p. 220
Summary	p. 227
RAROC Models	p. 228
Introduction	p. 228
What Is RAROC?	p. 228
RAROC, ROA, and RORAC	p. 229
Alternative Forms of RAROC	p. 230
The RAROC Denominator and Correlations	p. 235
RAROC and EVA	p. 238
Summary	p. 238
Credit Risk Transfer Mechanisms
Credit Derivatives	p. 243
Introduction	p. 243
Credit Default Swaps	p. 244
Credit Securitizations	p. 259
Financial Firms' Use of Credit Derivatives	p. 269
CDS Spreads and Rating Agency Rating Systems	p. 269
Summary	p. 271
Pricing the CDS Spread with Counterparty Credit Risk Exposure	p. 272
Capital Regulation	p. 274
Introduction	p. 274
The 2006 Basel II Plan	p. 275
Summary	p. 296
Loan Rating Systems	p. 297
Notes	p. 303
Bibliography	p. 341
Index	p. 365
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