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Financial Risk Management: Models, History, and Institutions

Book 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

  1. Cover Page
  2. Title Page
  3. Copyright
  4. Dedication
  5. Contents
  6. List of Figures
  7. Preface
  8. CHAPTER 1: Financial Risk in a Crisis-Prone World
    1. 1.1 SOME HISTORY: WHY IS RISK A SEPARATE DISCIPLINE TODAY?
    2. 1.2 THE SCOPE OF FINANCIAL RISK
    3. FURTHER READING
  9. CHAPTER 2: Market Risk Basics
    1. 2.1 ARITHMETIC, GEOMETRIC, AND LOGARITHMIC SECURITY RETURNS
    2. 2.2 RISK AND SECURITIES PRICES: THE STANDARD ASSET PRICING MODEL
    3. 2.3 THE STANDARD ASSET DISTRIBUTION MODEL
    4. 2.4 PORTFOLIO RISK IN THE STANDARD MODEL
    5. 2.5 BENCHMARK INTEREST RATES
    6. FURTHER READING
  10. CHAPTER 3: Value-at-Risk
    1. 3.1 DEFINITION OF VALUE-AT-RISK
    2. 3.2 VOLATILITY ESTIMATION
    3. 3.3 MODES OF COMPUTATION
    4. 3.4 SHORT POSITIONS
    5. 3.5 EXPECTED SHORTFALL
    6. FURTHER READING
  11. CHAPTER 4: Nonlinear Risks and the Treatment of Bonds and Options
    1. 4.1 NONLINEAR RISK MEASUREMENT AND OPTIONS
    2. 4.2 YIELD CURVE RISK
    3. 4.3 VAR FOR DEFAULT-FREE FIXED INCOME SECURITIES USING THE DURATION AND CONVEXITY MAPPING
    4. FURTHER READING
  12. CHAPTER 5: Portfolio VaR for Market Risk
    1. 5.1 THE COVARIANCE AND CORRELATION MATRICES
    2. 5.2 MAPPING AND TREATMENT OF BONDS AND OPTIONS
    3. 5.3 DELTA-NORMAL VAR
    4. 5.4 PORTFOLIO VAR VIA MONTE CARLO SIMULATION
    5. 5.5 OPTION VEGA RISK
    6. FURTHER READING
  13. CHAPTER 6: Credit and Counterparty Risk
    1. 6.1 DEFINING CREDIT RISK
    2. 6.2 CREDIT-RISKY SECURITIES
    3. 6.3 TRANSACTION COST PROBLEMS IN CREDIT CONTRACTS
    4. 6.4 DEFAULT AND RECOVERY: ANALYTIC CONCEPTS
    5. 6.5 ASSESSING CREDITWORTHINESS
    6. 6.6 COUNTERPARTY RISK
    7. 6.7 THE MERTON MODEL
    8. 6.8 CREDIT FACTOR MODELS
    9. 6.9 CREDIT RISK MEASURES
    10. FURTHER READING
  14. CHAPTER 7: Spread Risk and Default Intensity Models
    1. 7.1 CREDIT SPREADS
    2. 7.2 DEFAULT CURVE ANALYTICS
    3. 7.3 RISK-NEUTRAL ESTIMATES OF DEFAULT PROBABILITIES
    4. 7.4 SPREAD RISK
    5. FURTHER READING
  15. CHAPTER 8: Portfolio Credit Risk
    1. 8.1 DEFAULT CORRELATION
    2. 8.2 CREDIT PORTFOLIO RISK MEASUREMENT
    3. 8.3 DEFAULT DISTRIBUTIONS AND CREDIT VAR WITH THE SINGLE-FACTOR MODEL
    4. 8.4 USING SIMULATION AND COPULAS TO ESTIMATE PORTFOLIO CREDIT RISK
    5. FURTHER READING
  16. CHAPTER 9: Structured Credit Risk
    1. 9.1 STRUCTURED CREDIT BASICS
    2. 9.2 CREDIT SCENARIO ANALYSIS OF A SECURITIZATION
    3. 9.3 MEASURING STRUCTURED CREDIT RISKVIA SIMULATION
    4. 9.4 STANDARD TRANCHES AND IMPLIED CREDIT CORRELATION
    5. 9.5 ISSUER AND INVESTOR MOTIVATIONS FOR STRUCTURED CREDIT
    6. FURTHER READING
  17. CHAPTER 10: Alternatives to the Standard Market Risk Model
    1. 10.1 REAL-WORLD ASSET PRICE BEHAVIOR
    2. 10.2 ALTERNATIVE MODELING APPROACHES
    3. 10.3 THE EVIDENCE ON NON-NORMALITY IN DERIVATIVES PRICES
    4. FURTHER READING
  18. CHAPTER 11: Assessing the Quality of Risk Measures
    1. 11.1 MODEL RISK
    2. 11.2 BACKTESTING OF VAR
    3. 11.3 COHERENCE OF VAR ESTIMATES
    4. FURTHER READING
  19. CHAPTER 12: Liquidity and Leverage
    1. 12.1 FUNDING LIQUIDITY RISK
    2. 12.2 MARKETS FOR COLLATERAL
    3. 12.3 LEVERAGE AND FORMS OF CREDIT IN CONTEMPORARY FINANCE
    4. 12.4 TRANSACTIONS LIQUIDITY RISK
    5. 12.5 LIQUIDITY RISK MEASUREMENT
    6. 12.6 LIQUIDITY AND SYSTEMIC RISK
    7. FURTHER READING
  20. CHAPTER 13: Risk Control and Mitigation
    1. 13.1 DEFINING RISK CAPITAL
    2. 13.2 RISK CONTRIBUTIONS
    3. 13.3 STRESS TESTING
    4. 13.4 SIZING POSITIONS
    5. 13.5 RISK REPORTING
    6. 13.6 HEDGING AND BASIS RISK
    7. FURTHER READING
  21. CHAPTER 14: Financial Crises
    1. 14.1 PANICS, RUNS, AND CRASHES
    2. 14.2 SELF-REINFORCING MECHANISMS
    3. 14.3 BEHAVIOR OF ASSET PRICES DURING CRISES
    4. 14.4 CAUSES OF FINANCIAL CRISES
    5. 14.5 ANTICIPATING FINANCIAL CRISES
    6. FURTHER READING
  22. CHAPTER 15: Financial Regulation
    1. 15.1 SCOPE AND STRUCTURE OF REGULATION
    2. 15.2 METHODS OF REGULATION
    3. 15.3 PUBLIC POLICY TOWARD FINANCIAL CRISES
    4. 15.4 PITFALLS IN REGULATION
    5. FURTHER READING
  23. APPENDIX A: Technical Notes
    1. A.1 BINOMIAL DISTRIBUTION
    2. A.2 QUANTILES AND QUANTILE TRANSFORMATIONS
    3. A.3 NORMAL AND LOGNORMAL DISTRIBUTIONS
    4. A.4 HYPOTHESIS TESTING
    5. A.5 MONTE CARLO SIMULATION
    6. A.6 HOMOGENEOUS FUNCTIONS
    7. FURTHER READING
  24. APPENDIX B: Abbreviations
  25. APPENDIX C: References
  26. Index