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Advanced Financial Risk Management: Tools and Techniques for Integrated Credit Risk and Interest Rate Risk Management, 2nd Edition

Book Description

Practical tools and advice for managing financial risk, updated for a post-crisis world

Advanced Financial Risk Management bridges the gap between the idealized assumptions used for risk valuation and the realities that must be reflected in management actions. It explains, in detailed yet easy-to-understand terms, the analytics of these issues from A to Z, and lays out a comprehensive strategy for risk management measurement, objectives, and hedging techniques that apply to all types of institutions. Written by experienced risk managers, the book covers everything from the basics of present value, forward rates, and interest rate compounding to the wide variety of alternative term structure models.

Revised and updated with lessons from the 2007-2010 financial crisis, Advanced Financial Risk Management outlines a framework for fully integrated risk management. Credit risk, market risk, asset and liability management, and performance measurement have historically been thought of as separate disciplines, but recent developments in financial theory and computer science now allow these views of risk to be analyzed on a more integrated basis. The book presents a performance measurement approach that goes far beyond traditional capital allocation techniques to measure risk-adjusted shareholder value creation, and supplements this strategic view of integrated risk with step-by-step tools and techniques for constructing a risk management system that achieves these objectives.

  • Practical tools for managing risk in the financial world

  • Updated to include the most recent events that have influenced risk management

  • Topics covered include the basics of present value, forward rates, and interest rate compounding; American vs. European fixed income options; default probability models; prepayment models; mortality models; and alternatives to the Vasicek model

Comprehensive and in-depth, Advanced Financial Risk Management is an essential resource for anyone working in the financial field.

Table of Contents

  1. Cover
  2. Contents
  3. Title
  4. Copyright
  5. Dedication
  6. Introduction: Wall Street Lessons from Bubbles
  7. Part One: Risk Management: Definitions and Objectives
    1. Chapter 1: A Risk Management Synthesis
      1. Risk Management: Definitions and Objectives
      2. Advances in Integrated Risk Management and Institutional Barriers to Progress
      3. Measuring the Trade-Offs between Risk and Return
      4. When Bad Things Happen to Good People
      5. U.S. Savings and Loan Crisis
      6. Long-Term Capital Management
      7. The 2006–2011 Credit Crisis
      8. A Thousand Cuts
      9. Notes
    2. Chapter 2: Risk, Return, Performance Measurement, and Capital Regulation
      1. Practical Quantification of Risk
      2. Perils and Pitfalls in the Measurement of Risk: The Impact of Selection Bias
      3. Biases in Return vs. a Relative Benchmark
      4. Historical Value at Risk: Selection Bias Again
      5. Monte Carlo–Based Value at Risk
      6. Expected Losses on Tranches of Collateralized Debt Obligations
      7. Measuring Return: Market vs. Accounting Returns
      8. Introduction to Transfer Pricing: Extracting Interest Rate Risk in a Financial Accounting Context
      9. Performance Measurement and Capital Regulation
      10. Perspectives on Measuring Risk: One Source of Risk or Many Sources of Risk?
      11. Interest Rate Risk Management Evolution
      12. Equity Risk Management Evolution
      13. Option Risk Management Evolution
      14. Credit Risk Management Evolution
      15. Managing Risk and Strategy, Business by Business
      16. Risk and Strategy Management in a Complex Financial Institution
      17. What Causes Financial Institutions to Fail?
      18. The Role of Capital in Risk Management and Business Strategy
      19. Capital-Based Risk Management in Banking Today: Pros and Cons
      20. History of Capital-Based Regulations in Commercial Banking
      21. Notes
  8. Part Two: Risk Management Techniques for Interest Rate Analytics
    1. Chapter 3: Interest Rate Risk Introduction and Overview
      1. Background Information on Movements in the U.S. Treasury Yield Curve
      2. A Step-by-Step Approach to Analyzing Interest Rate Risk
      3. The Interest Rate Risk Safety Zone
      4. Notes
    2. Chapter 4: Fixed Income Mathematics
      1. Modern Implications of Present Value
      2. Price, Accrued Interest, and Value
      3. Calculation of Accrued Interest
      4. Present Value
      5. The Basic Present Value Calculation
      6. Calculating the Value of a Fixed Coupon Bond with Principal Paid at Maturity
      7. Calculating the Coupon of a Fixed Coupon Bond with Principal Paid at Maturity When the Value Is Known
      8. The Value of an Amortizing Loan
      9. Calculating the Payment Amount of an Amortizing Bond When the Value Is Known
      10. Calculating the Value of a Floating-Rate Bond or Loan with Principal Paid at Maturity
      11. Compound Interest Conventions and Formulas
      12. Compounding Formulas and Present Value Factors P(t)
      13. Yields and Yield-to-Maturity Calculations
      14. The Formula for Yield to Maturity
      15. Yield to Maturity for Long or Short First Coupon Payment Periods
      16. Calculating Forward Interest Rates and Bond Prices
      17. Implied Forward Interest Rates on Zero-Coupon Bonds
      18. Implied Forward Zero-Coupon Bond Prices
      19. Present Value of Forward Fixed Coupon Bond
      20. Implied Forward Price on a Fixed Coupon Bond
      21. Implied Forward Coupon on a Fixed Coupon Bond
      22. Other Forward Calculations
      23. Summary
      24. Notes
    3. Chapter 5: Yield Curve Smoothing
      1. Example A: Stepwise Constant Yields and Forwards vs. Nelson-Siegel
      2. Deriving the Form of the Yield Curve Implied by Example A
      3. Fitting the Nelson-Siegel Approach to Sample Data
      4. Example D: Quadratic Yield Splines and Related Forward Rates
      5. Deriving the Form of the Yield Curve Implied by Example D
      6. Example F: Cubic Yield Splines and Related Forwards
      7. Deriving the Form of the Yield Curve Implied by Example F Assumptions
      8. Example H: Maximum Smoothness Forward Rates and Related Yields
      9. Deriving the Parameters of the Quartic Forward Rate Curves Implied by Example H Assumptions
      10. Comparing Yield Curve and Forward Rate Smoothing Techniques
      11. Trading Off Smoothness vs. the Length of the Forward Rate Curve
      12. The Shimko Test for Measuring Accuracy of Smoothing Techniques
      13. Smoothing Yield Curves Using Coupon-Bearing Bond Prices as Inputs
      14. Appendix: Proof of the Maximum Smoothness Forward Rate Theorem
      15. Notes
    4. Chapter 6: Introduction to Heath, Jarrow, and Morton Interest Rate Modeling
      1. Objectives of the Example and Key Input Data
      2. Key Implications and Notation of the HJM Approach
      3. Pseudo-Probabilities
      4. The Formula for Zero-Coupon Bond Price Shifts
      5. Building the Bushy Tree for Zero-Coupon Bonds Maturing at Time T = 2
      6. Building the Bushy Tree for Zero-Coupon Bonds Maturing at Time T = 4
      7. Valuation in the HJM Framework
      8. Valuation of a Zero-Coupon Bond Maturing at Time T = 4
      9. Valuation of a Coupon-Bearing Bond Paying Annual Interest
      10. Valuation of a Digital Option on the One-Year U.S. Treasury Rate
      11. Conclusion
    5. Chapter 7: HJM Interest Rate Modeling with Rate and Maturity-Dependent Volatility
      1. Objectives of the Example and Key Input Data
      2. Key Implications and Notation of the HJM Approach
      3. Pseudo-Probabilities
      4. The Formula for Zero-Coupon Bond Price Shifts
      5. Building the Bushy Tree for Zero-Coupon Bonds Maturing at Time T = 2
      6. Building the Bushy Tree for Zero-Coupon Bonds Maturing at Time T = 4
      7. Valuation in the HJM Framework
      8. Valuation of a Zero-Coupon Bond Maturing at Time T = 4
      9. Valuation of a Coupon-Bearing Bond Paying Annual Interest
      10. Valuation of a Digital Option on the One-Year U.S. Treasury Rate
      11. Conclusion
    6. Chapter 8: HJM Interest Rate Modeling with Two Risk Factors
      1. Probability of Yield Curve Twists in the U.S. Treasury Market
      2. Objectives of the Example and Key Input Data
      3. Introducing a Second Risk Factor Driving Interest Rates
      4. Key Implications and Notation of the HJM Approach
      5. Pseudo-Probabilities
      6. Valuation in the HJM Framework
      7. Valuation of a Zero-Coupon Bond Maturing at Time T = 4
      8. Valuation of a Coupon-Bearing Bond Paying Annual Interest
      9. Valuation of a Digital Option on the One-Year U.S. Treasury Rate
      10. Replication of HJM Example 3 in Common Spreadsheet Software
      11. Conclusion
    7. Chapter 9: HJM Interest Rate Modeling with Three Risk Factors
      1. Probability of Yield Curve Twists in the U.S. Treasury Market
      2. Objectives of the Example and Key Input Data
      3. Risk Factor 1: Annual Changes in the One-Year U.S. Treasury Spot Rate
      4. Alternative Specifications of the Interest Rate Volatility Surface
      5. Key Implications and Notation of the HJM Approach
      6. Pseudo-Probabilities
      7. Valuation in the HJM Framework
      8. Valuation of a Zero-Coupon Bond Maturing at Time T = 4
      9. Valuation of a Coupon-Bearing Bond Paying Annual Interest
      10. Valuation of a Digital Option on the One-Year U.S. Treasury Rate
      11. Conclusion
      12. Note
    8. Chapter 10: Valuation, Liquidity, and Net Income
      1. How Many Risk Factors are Necessary to Accurately Model Movements in the Risk-Free Yield Curve?
      2. Revisiting the Phrase “No Arbitrage”
      3. Valuation, Liquidity Risk, and Net Income
      4. Risk-Neutral and Empirical Probabilities of Interest Rate Movements
      5. Monte Carlo Simulation Using HJM Modeling
      6. Common Pitfalls in Interest Rate Risk Management
      7. Summarizing the Problems with Interpolated Monte Carlo Simulation for Risk Analysis
      8. Notes
    9. Chapter 11: Interest Rate Mismatching and Hedging
      1. Political Factions in Interest Rate Risk Management
      2. Making a Decision on Interest Rate Risk and Return: The Safety Zone
      3. Obvious Interest Rate Risk Decisions
      4. Assessing the Risk and Return Trade-Offs from a Change in Interest Rate Risk
    10. Chapter 12: Legacy Approaches to Interest Rate Risk Management
      1. Gap Analysis and Simulation Models
      2. Measuring Interest Rate Risk: A Review
      3. Legacy Rate Risk Tools: Interest Rate Sensitivity Gap Analysis
      4. The Safety Zone
      5. What’s Wrong with Gap Analysis?
      6. Legacy Rate Risk Tools: Multiperiod Simulation
      7. Modeling the Maturity Structure of a Class of Assets
      8. Macaulay’s Duration: The Original Formula
      9. Using Duration for Hedging
      10. Comparing a Duration Hedge with Hedging in the HJM Framework
      11. Duration: The Traditional Market Convention
      12. The Perfect Duration Hedge: The Difference between the Original Macaulay and Conventional Durations
      13. Convexity and Its Uses
      14. Conclusion
      15. Note
    11. Chapter 13: Special Cases of Heath, Jarrow, and Morton Interest Rate Modeling
      1. What is an Academic Term Structure Model and Why Was It Developed?
      2. The Vocabulary of Term Structure Models
      3. Ito’s Lemma
      4. Ito’s Lemma for More Than One Random Variable
      5. Using Ito’s Lemma to Build a Term Structure Model
      6. Duration as a Term Structure Model
      7. Conclusions about the Use of Duration’s Parallel Shift Assumptions
      8. The Vasicek and Extended Vasicek Models
      9. The Merton Term Structure Model: Parallel Yield Curve Shifts
      10. The Extended Merton Model
      11. The Vasicek Model
      12. The Extended Vasicek–Hull and White Model
      13. Alternative Term Structure Models
      14. Reprising the HJM Approach
      15. Appendix A: Deriving Zero-Coupon Bond Prices in the Extended Merton/Ho and Lee Model
      16. Appendix B: Deriving Zero-Coupon Bond Prices in the Vasicek Model
      17. Appendix C: Valuing Zero-Coupon Bonds in the Extended Vasicek Model
      18. Notes
    12. Chapter 14: Estimating the Parameters of Interest Rate Models
      1. Revisiting the Meaning of No Arbitrage
      2. A Framework for Fitting Term Structure Models
      3. Fitting Zero-Coupon Bond Prices and Volatility Parameters Jointly
      4. Steps in Fitting the Interest Rate Volatility Assumptions
      5. Interest Rate Parameter Fitting in Practical Application
      6. Note
  9. Part Three: Risk Management Techniques for Credit Risk Analytics
    1. Chapter 15: An Introduction to Credit Risk
      1. Market Prices for Credit Risk
      2. Critical Sources of Market Data on Credit Risk
      3. Increased Accuracy in Pricing
      4. Increased Clarity in Corporate Strategy
      5. Increased Sophistication in Risk Management
      6. Increased Precision in Measuring the Safety and Soundness of Financial Institutions
      7. Credit Default Swaps: The Dangers of Market Manipulation
      8. Daily Nondealer Trading Volume for 1,090 Reference Names
      9. Credit Default Swap Trading Volume in Municipals and Sub-Sovereigns
      10. Credit Default Swap Trading Volume in Sovereign Credits
      11. Implications of CDS Trading Volume Data
      12. Notes
    2. Chapter 16: Reduced Form Credit Models and Credit Model Testing
      1. The Jarrow-Turnbull Model
      2. The Jarrow Model
      3. Zero-Coupon Bond Prices in the Jarrow Model
      4. Fitting the Jarrow Model to Bond Prices, Credit Derivatives Prices, and Historical Default Databases
      5. Correlations in Default Probabilities
      6. The Jarrow and Jarrow-Turnbull Models: A Summary
      7. Tests of Credit Models Using Historical Data
      8. An Introduction to Credit Model Testing
      9. Misunderstandings about Credit Model Testing
      10. The Two Components of Credit Model Performance
      11. The Predictive Capability of the Jarrow-Chava Reduced Form Model Default Probabilities
      12. Reduced Form Model vs. Merton Model Performance
      13. Consistency of Estimated and Actual Defaults
      14. Recent Results from North America
      15. The Falkenstein and Boral Test
      16. Performance of Credit Models vs. Naïve Models of Risk
      17. Testing Credit Models: The Analogy with Interest Rates
      18. Appendix: Converting Default Intensities to Discrete Default Probabilities
      19. Notes
    3. Chapter 17: Credit Spread Fitting and Modeling
      1. Introduction to Credit Spread Smoothing
      2. The Market Convention for Credit Spreads
      3. A Better Convention for Credit Model–Independent Credit Spreads
      4. Credit Spread Smoothing Using Yield Curve–Smoothing Techniques
      5. Fitting Credit Spreads with Cubic Splines
      6. Maximum Smoothness Forward Credit Spreads
      7. Comparing Results
      8. Data Problems with Risky Issuers
      9. Determinants of Credit Spread Levels
      10. The Credit Risk Premium: The Supply and Demand for Credit
      11. Conclusion
      12. Notes
    4. Chapter 18: Legacy Approaches to Credit Risk
      1. The Rise and Fall of Legacy Ratings
      2. Ratings: What They Do and Don’t Do
      3. Through the Cycle vs. Point in Time, a Distinction without a Difference
      4. Stress Testing, Legacy Ratings, and Transition Matrices
      5. Transition Matrices: Analyzing the Random Changes in Ratings from One Level to Another
      6. Moral Hazard in “Self-Assessment” of Ratings Accuracy by Legacy Rating Agencies
      7. Comparing the Accuracy of Ratings and Reduced Form Default Probabilities
      8. Problems with Legacy Ratings in the 2006 to 2011 Credit Crisis
      9. The Jarrow-Merton Put Option and Legacy Ratings
      10. The Merton Model of Risky Debt
      11. The Intuition of the Merton Model
      12. The Basic Merton Model
      13. Valuing Multipayment Bonds with the Merton Model of Risky Debt
      14. Estimating the Probability of Default in the Merton Model
      15. Implying the Value of Company Assets and Their Return Volatility σ
      16. Mapping the Theoretical Merton Default Probabilities to Actual Defaults
      17. The Merton Model When Interest Rates are Random
      18. The Merton Model with Early Default
      19. Loss Given Default in the Merton Model
      20. Copulas and Correlation between the Events of Default of Two Companies
      21. Problems with the Merton Model: Summing Up
      22. Appendix
      23. Notes
    5. Chapter 19: Valuing Credit Risky Bonds
      1. The Present Value Formula
      2. Valuing Bonds with No Credit Risk
      3. Simulating the Future Values of Bonds with No Credit Risk
      4. Current and Future Values of Fixed Income Instruments: HJM Background and a Straight Bond Example
      5. Valuation of a Straight Bond with a Bullet Principal Payment at Maturity
      6. Valuing an Amortizing Loan
      7. Valuing Risk-Free, Floating-Rate Loans
      8. Valuing Bonds with Credit Risk
      9. Simulating the Future Values of Bonds with Credit Risk
      10. Valuing the Jarrow-Merton Put Option
    6. Chapter 20: Credit Derivatives and Collateralized Debt Obligations
      1. Credit Default Swaps: Theory
      2. Credit Default Swaps: Practice
      3. Collateralized Debt Obligations: Theory
      4. Collateralized Debt Obligations: A Worked Example of Reduced Form Simulation
      5. Collateralized Debt Obligations: Practice
      6. The Copula Method of CDO Valuation: A Postmortem
      7. Valuing the Jarrow–Merton Put Option
      8. Notes
  10. Part Four: Risk Management Applications: Instrument by Instrument
    1. Chapter 21: European Options on Bonds
      1. Example: European Call Option on Coupon-Bearing Bond
      2. Example: Coupon-Bearing Bond with Embedded European Call Option
      3. European Options on Defaultable Bonds
      4. HJM Special Case: European Options in the One-Factor Vasicek Model
      5. Options on Coupon-Bearing Bonds
      6. The Jarrow-Merton Put Option
    2. Chapter 22: Forward and Futures Contracts
      1. Forward Contracts on Zero-Coupon Bonds
      2. Eurodollar Futures-Type Forward Contracts
      3. Futures on Zero-Coupon Bonds: The Sydney Futures Exchange Bank Bill Contract
      4. Futures on Coupon-Bearing Bonds: Dealing with the Cheapest to Deliver Option
      5. Eurodollar and Euroyen Futures Contracts
      6. Defaultable Forward and Futures Contracts
      7. Note
    3. Chapter 23: European Options on Forward and Futures Contracts
      1. Valuing Options on Forwards and Futures: Notations and Useful Formulas
      2. European Options on Forward Contracts on Zero-Coupon Bonds
      3. European Options on Forward Rate Agreements
      4. European Options on a Eurodollar Futures-Type Forward Contract
      5. Defaultable Options on Forward and Futures Contracts
      6. Note
    4. Chapter 24: Caps and Floors
      1. Caps as European Options on Forward Rate Agreements
      2. Forming Other Cap-Related Securities
      3. Value of a Loan with a Cap and a Floor
      4. Measuring the Credit Risk of Counterparties on Caps and Floors
      5. Note
    5. Chapter 25: Interest Rate Swaps and Swaptions
      1. Interest Rate Swap Basics
      2. Valuing the Interest Rate Swaps
      3. The Observable Fixed Rate in the Swap Market
      4. An Introduction to Swaptions
      5. Notes
    6. Chapter 26: Exotic Swap and Options Structures
      1. Arrears Swaps
      2. Digital Option
      3. Digital Range Notes
      4. Range Floater
      5. Other Derivative Securities
      6. Credit Risk and Exotic Derivatives Structures
    7. Chapter 27: American Fixed Income Options
      1. An Overview of Numerical Techniques for Fixed Income Option Valuation
      2. An Example of Valuation of a Callable Bond with a Three-Factor HJM Bushy Tree
      3. What is the Par Coupon on a Callable Bond?
      4. An Example of Valuation of a Rationally Prepaid Amortizing Loan
      5. Finite Difference Methods
      6. Binomial Lattices
      7. Trinomial Lattices
      8. HJM Valuation of American Fixed Income Options When Default Risk is Present
      9. Notes
    8. Chapter 28: Irrational Exercise of Fixed Income Options
      1. Analysis of Irrationality: Criteria for a Powerful Explanation
      2. The Transactions Cost Approach
      3. Irrational Exercise of European Options
      4. The Irrational Exercise of American Options
      5. Implied Irrationality and Hedging
      6. Credit Risk and Irrational Prepayment Behavior
    9. Chapter 29: Mortgage-Backed Securities and Asset-Backed Securities
      1. Transactions Costs, Prepayments, Default, and Multinomial Logit
      2. Legacy Prepayment Analysis of Mortgage-Backed Securities
      3. Legacy Approaches: Option-Adjusted Spread
      4. Implications for OAV Spread, CMOs, and ARMs
      5. Logistic Regression, Credit Risk, and Prepayment
      6. Mortgage-Servicing Rights: The Ultimate Structured Product
      7. An Introduction to the Valuation of Mortgage-Servicing Rights
      8. Comparing Best Practice and Common Practice in Valuing and Hedging Mortgage-Servicing Rights
      9. Conclusion
      10. Notes
    10. Chapter 30: Nonmaturity Deposits
      1. The Value of the Deposit Franchise
      2. Total Cash Flow of Nonmaturity Deposits
      3. Specifying the Rate and Balance Movement Formulas
      4. The Impact of Bank Credit Risk on Deposit Rates and Balances
      5. Case Study: German Three-Month Notice Savings Deposits
      6. The Regulators’ View
      7. Conclusion
      8. Notes
    11. Chapter 31: Foreign Exchange Markets
      1. Setting the Stage: Assumptions for the Domestic and Foreign Economies
      2. Foreign Exchange Forwards
      3. Numerical Methods for Valuation of Foreign Currency Derivatives
      4. Legacy Approaches to Foreign Exchange Options Valuation
      5. Implications of a Term Structure Model-Based FX Options Formula
      6. The Impact of Credit Risk on Foreign Exchange Risk Formulas
      7. Notes
    12. Chapter 32: Impact of Collateral on Valuation Models
      1. The Impact of Changing Home Prices on Collateral Values in the Credit Crisis
      2. Modeling Variations in Collateral Values
      3. The Impact of Collateral Values on a Rationally Prepaid Mortgage
      4. Conclusions about the Impact of Collateral Values
    13. Chapter 33: Pricing and Valuing Revolving Credit and Other Facilities
      1. Analyzing Revolving Credit and Other Facilities
      2. Fluctuating Credit Risk and Revolving Credit Drawdowns
      3. Incorporating Links between Credit Quality and Line Usage
      4. Is a Line of Credit a Put Option on the Debt of the Issuer?
    14. Chapter 34: Modeling Common Stock and Convertible Bonds on a Default-Adjusted Basis
      1. Modeling Equities: The Traditional Fund Management Approach
      2. Modeling Equities: The Derivatives Approach
      3. Modeling Equities: A Credit Risk–Adjusted Approach
      4. Options on the Common Stock of a Company That Can Go Bankrupt
      5. Convertible Bonds of a Company That Can Go Bankrupt
      6. Note
    15. Chapter 35: Valuing Insurance Policies and Pension Obligations
      1. Life Insurance: Mortality Rates vs. Default Probabilities
      2. Pension Obligations
      3. Property and Casualty Insurance
      4. The Jarrow-Merton Put Option
      5. Notes
  11. Part Five: Portfolio Strategy and Risk Management
    1. Chapter 36: Value-at-Risk and Risk Management Objectives Revisited at the Portfolio and Company Level
      1. The Jarrow-Merton Put Option as a Measure of Total Risk: An Example
      2. A Four-Question Pass–Fail Test for Financial Institutions’ CEOs and Boards of Directors
      3. Is Your Value-at-Risk from Value-at-Risk?
      4. VaR vs. the Put Option for Capital Allocation
      5. Why Are the VaR and Put Approaches So Different: Self-Insurance vs. Third-Party Insurance
      6. Calculating the Jarrow-Merton Put Option Value and Answering the Key 4 + 26 Questions
      7. Valuing and Simulating the Jarrow-Merton Put Option
      8. What’s the Hedge?
      9. Liquidity, Performance, Capital Allocation, and Own Default Risk
      10. Note
    2. Chapter 37: Liquidity Analysis and Management
      1. Liquidity Risk Case Studies from the Credit Crisis
      2. Case Studies in Liquidity Risk
      3. Implications of the Credit Crisis History for Liquidity Risk Management and Analysis
      4. Determining the Optimal Liquidity Strategy
      5. Summing Up
      6. Notes
    3. Chapter 38: Performance Measurement
      1. Transaction-Level Performance Measurement vs. Portfolio-Level Performance Measurement
      2. Plus Alpha Benchmark Performance vs. Transfer Pricing
      3. Why Default Risk Is Critical in Performance Measurement of Equity Portfolios
      4. “Plus Alpha” Performance Measurement in Insurance and Banking
      5. Decomposing the Reasons for Plus or Minus Alpha in a Fixed Income Portfolio
      6. A Worked Example of Modern Fixed Income Performance Attribution
      7. The Jarrow-Merton Put Option and Capital
      8. Using the Jarrow-Merton Put Option for Capital Allocation
      9. Summing Up
      10. Notes
    4. Chapter 39: Managing Institutional Default Risk and Safety and Soundness
      1. Step 1: Admitting the Possibility of Failure
      2. Managing the Probability of Failure
      3. Controlling the Probability of Failure through the Credit Cycle
      4. Hedging Total Risk to Maximize Shareholder Value
      5. Implications for Basel II, Basel III, and Solvency II
      6. Simulating Your Own Probability of Default
      7. Note
    5. Chapter 40: Information Technology Considerations
      1. Common Practice in Risk Management Systems: Dealing with Legacy Systems
      2. Upgrading the Risk Infrastructure: The Request for Proposal Process
      3. Paid Pilots as Final Proof of Concept
      4. Keys to Success in Software Installation
      5. Vendor Size: Larger Vendor or Small Vendor?
      6. Being a Best Practice User
    6. Chapter 41: Shareholder Value Creation and Destruction
      1. Do No Harm
      2. Measure the Need to Change
      3. Rating Your Primary Risk System
      4. Master the Politics and Exposition of Risk Management: Shareholder Value Creation
      5. Daily Management Reporting of Total Risk
      6. Moving from Common Practice to Best Practice
      7. The Senior Management Perspective
      8. The Middle Management Perspective
      9. The Working-Level Perspective
      10. Getting Help to Create Shareholder Value
      11. Postscript
      12. Notes
  12. Bibliography
  13. Index