Financial Risk Management Models, History, and Institutions

by Malz, Allan M.

• ISBN13: 9780470481806
• ISBN10: 0470481803
• Edition: 1st
• Format: Hardcover
• Copyright: 2011-10-04
• Publisher: Wiley

Summary

An in-depth look at the tools and techniques professionals use to address financial risksRisk and uncertainty, as Allan Malz explains in his ground-breaking new book, are two completely different concepts. Risk is a quantifiable uncertainty that can be modeled, while uncertainty defines non-quantifiable outcomes that are not always known. Part art and part science, the study of risk remains a relatively new discipline in finance and economics that continues to be refined. Financial crisis, rather than destroying the need for risk management, has given even great nuance and meaning to what risks exist and can be managed and controlled, and a taxonomy of new risks that need to be explored in ever more meaningful ways. This definitive guide on financial risk Explores all the tools and techniques needed to cope with risk Addresses state of the art approaches to modeling and managing risks Investigates stress tests in periods of heightened uncertainty, and the impact that variables such as liquidity and correlations can have on risk mitigation Provides practicing risk professionals with useful rules of thumb, intuitions, and insights gleaned from Malz's entire career as risk researcher, chief risk officer, and financial market regulator outside his classroom at Columbia UniversityInformative and engaging, this book will help you understand why risk has become its own essential discipline on Wall Street and beyond.

Author Biography

ALLAN M. MALZ is a Senior Analytical Advisor in the Markets Group at the Federal Reserve Bank of New York, where he has also worked on implementation of the Fed's emergency liquidity programs to address the financial crisis. Before rejoining the Fed, he was chief risk officer at several multi-strategy hedge fund management firms. Previously, Malz was head of research at RiskMetrics Group, which he joined on its spinoff from J.P. Morgan. Malz spent his earlier career at the New York Fed as a researcher and foreign exchange trader. His research, which includes forecasting financial crises, risk measurement for options, and estimation of risk-neutral probability distributions, has been published in a number of industry and academic journals. Malz holds a PhD in economics from Columbia University, where he also teaches a graduate course in financial risk management.

Table of Contents

List of Figures	p. xvii
Preface	p. xxi
Financial Risk in a Crisis-Prone World	p. 1
Some History: Why Is Risk a Separate Discipline Today?	p. 1
The Scope of Financial Risk	p. 34
Market Risk Basics	p. 43
Arithmetic, Geometric, and Logarithmic Security Returns	p. 44
Risk and Securities Prices: The Standard Asset Pricing Model	p. 49
The Standard Asset Distribution Model	p. 63
Portfolio Risk in the Standard Model	p. 75
Benchmark Interest Rates	p. 88
Value-at-Risk	p. 93
Definition of Value-at-Risk	p. 94
Volatility Estimation	p. 99
Modes of Computation	p. 108
Short Positions	p. 113
Expected Shortfall	p. 114
Nonlinear Risks and the Treatment of Bonds and Options	p. 119
Nonlinear Risk Measurement and Options	p. 121
Yield Curve Risk	p. 136
VaR for Default-Free Fixed Income Securities Using The Duration and Convexity Mapping	p. 148
Portfolio VaR for Market Risk	p. 159
The Covariance and Correlation Matrices	p. 160
Mapping and Treatment of Bonds and Options	p. 162
Delta-Normal VaR	p. 163
Portfolio VAR via Monte Carlo simulation	p. 174
Option Vega Risk	p. 175
Credit and Counterparty Risk	p. 191
Defining Credit Risk	p. 192
Credit-Risky Securities	p. 193
Transaction Cost Problems in Credit Contracts	p. 196
Default and Recovery: Analytic Concepts	p. 199
Assessing creditworthiness	p. 204
Counterparty Risk	p. 207
The Merton Model	p. 213
Credit Factor Models	p. 222
Credit Risk Measures	p. 226
Spread Risk and Default Intensity Models	p. 231
Credit Spreads	p. 231
Default Curve Analytics	p. 235
Risk-Neutral Estimates of Default Probabilities	p. 241
Spread Risk	p. 261
Portfolio Credit Risk	p. 265
Default Correlation	p. 266
Credit Portfolio Risk Measurement	p. 270
Default Distributions and Credit VaR with the Single-Factor Model	p. 275
Using Simulation and Copulas to Estimate Portfolio Credit Risk	p. 284
Structured Credit Risk	p. 297
Structured Credit Basics	p. 297
Credit Scenario Analysis of a Securitization	p. 309
Measuring Structured Credit Risk via Simulation	p. 318
Standard Tranches and Implied Credit Correlation	p. 337
Issuer and Investor Motivations for Structured Credit	p. 342
Alternatives to the Standard Market Risk Model	p. 349
Real-World Asset Price Behavior	p. 349
Alternative Modeling Approaches	p. 363
The Evidence on Non-Normality in Derivatives Prices	p. 372
Assessing the Quality of Risk Measures	p. 393
Model Risk	p. 393
Backtesting of VaR	p. 407
Coherence of VaR Estimates	p. 414
Liquidity and Leverage	p. 421
Funding Liquidity Risk	p. 422
Markets for Collateral	p. 437
Leverage and Forms of Credit in Contemporary Finance	p. 448
Transactions Liquidity Risk	p. 461
Liquidity Risk Measurement	p. 464
Liquidity and Systemic Risk	p. 469
Risk Control and Mitigation	p. 477
Defining Risk Capital	p. 478
Risk Contributions	p. 480
Stress Testing	p. 499
Sizing Positions	p. 506
Risk Reporting	p. 509
Hedging and Basis Risk	p. 512
Financial Crises	p. 517
Panics, Runs, and Crashes	p. 519
Self-Reinforcing Mechanisms	p. 539
Behavior of Asset Prices During Crises	p. 548
Causes of Financial Crises	p. 562
Anticipating Financial Crises	p. 583
Financial Regulation	p. 597
Scope and Structure of Regulation	p. 598
Methods of Regulation	p. 605
Public Policy Toward Financial Crises	p. 621
Pitfalls in Regulation	p. 635
Technical Notes	p. 653
Binomial Distribution	p. 653
Quantiles and Quantile Transformations	p. 654
Normal and Lognormal Distributions	p. 656
Hypothesis Testing	p. 661
Monte Carlo Simulation	p. 662
Homogeneous Functions	p. 664
Further Reading	p. 666
Abbreviations	p. 667
References	p. 671
Index	p. 701
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