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Measuring and Managing Liquidity Risk

Book Description

A fully up-to-date, cutting-edge guide to the measurement and management of liquidity risk

Written for front and middle office risk management and quantitative practitioners, this book provides the ground-level knowledge, tools, and techniques for effective liquidity risk management. Highly practical, though thoroughly grounded in theory, the book begins with the basics of liquidity risks and, using examples pulled from the recent financial crisis, how they manifest themselves in financial institutions. The book then goes on to look at tools which can be used to measure liquidity risk, discussing risk monitoring and the different models used, notably financial variables models, credit variables models, and behavioural variables models, and then at managing these risks. As well as looking at the tools necessary for effective measurement and management, the book also looks at and discusses current regulation and the implication of new Basel regulations on management procedures and tools.

The book is accompanied by web-based tools, including example spreadsheets to illustrate many of the more complex topics in the book.

Table of Contents

  1. Cover Page
  2. Title Page
  3. Copyright
  4. Dedication
  5. Contents
  6. Preface
  7. About the authors
  8. Abbreviations and acronyms
  9. Part I: Liquidity and banking activity
    1. 1: Banks as lemons?
      1. 1.1 INTRODUCTION
      2. 1.2 THE FIRST WAVE
      3. 1.3 BANKS AS LEMONS?
      4. 1.4 THE RESPONSE
      5. 1.5 THE SECOND WAVE
      6. 1.6 CONCLUSION
    2. 2: A journey into liquidity
      1. 2.1 INTRODUCTION
      2. 2.2 CENTRAL BANK LIQUIDITY
      3. 2.3 FUNDING LIQUIDITY
      4. 2.4 MARKET LIQUIDITY
      5. 2.5 THE VIRTUOUS CIRCLE
      6. 2.6 THE VICIOUS CIRCLE
      7. 2.7 SECOND-ROUND EFFECTS
      8. 2.8 THE ROLE OF THE CENTRAL BANK, SUPERVISION AND REGULATION
      9. 2.9 CONCLUSIONS
    3. 3: Too big to fail
      1. 3.1 INTRODUCTION
      2. 3.2 WHEN GIANTS FALL
      3. 3.3 A HARD LESSON
      4. 3.4 CLOSER SUPERVISION
      5. 3.5 G-SIFI REGULATIONS
      6. 3.6 THE NEXT STEPS
      7. 3.7 CONCLUSION
    4. 4: The new framework
      1. 4.1 INTRODUCTION
      2. 4.2 SOME BASIC LIQUIDITY RISK MEASURES
      3. 4.3 THE FIRST MOVER
      4. 4.4 BASEL III: THE NEW FRAMEWORK FOR LIQUIDITY RISK MEASUREMENT AND MONITORING
      5. 4.5 INSIDE THE LIQUIDITY COVERAGE RATIO
      6. 4.6 THE OTHER METRICS
      7. 4.7 INTRADAY LIQUIDITY RISK
      8. 4.8 BEYOND THE RATIOS
      9. 4.9 CONCLUSION
    5. 5: Know thyself!
      1. 5.1 INTRODUCTION
      2. 5.2 SOME CHANGES ON THE LIABILITIES SIDE
      3. 5.3 THE ROLE OF LEVERAGE
      4. 5.4 THE ORIGINATE-TO-DISTRIBUTE BUSINESS MODEL
      5. 5.5 THE LIQUIDITY FRAMEWORK
      6. 5.6 STRESS-TESTING AND CONTINGENCY FUNDING PLAN
      7. 5.7 THE CEBS IDENTITY CARD
      8. 5.8 CONCLUSIONS
      9. 5.9 APPENDIX: THE CEBS IDENTITY CARD ANNEX(CEBS [ 98 ])
  10. Part II: Tools to Manage Liquidity risk
    1. 6: Monitoring liquidity
      1. 6.1 A TAXONOMY OF CASH FLOWS
      2. 6.2 LIQUIDITY OPTIONS
      3. 6.3 LIQUIDITY RISK
      4. 6.4 QUANTITATIVE LIQUIDITY RISK MEASURES
      5. 6.5 THE TERM STRUCTURE OF EXPECTED LIQUIDITY
      6. 6.6 CASH FLOWS AT RISK AND THE TERM STRUCTURE OF LIQUIDITY AT RISK
    2. 7: Liquidity buffer and term structure of funding
      1. 7.1 INTRODUCTION
      2. 7.2 LIQUIDITY BUFFER AND COUNTERBALANCING CAPACITY
      3. 7.3 THE FIRST CAUSE OF THE NEED FOR A LIQUIDITY BUFFER: MATURITY MISMATCH
      4. 7.4 FUNDING ASSETS WITH SEVERAL LIABILITIES
      5. 7.5 ACTUAL SCENARIOS SEVERER THAN PREDICTED
      6. 7.6 THE TERM STRUCTURE OF AVAILABLE FUNDING AND THE LIQUIDITY BUFFER
      7. 7.7 NON-MATURING LIABILITIES
      8. 7.8 THE SECOND CAUSE OF THE LIQUIDITY BUFFER: COLLATERAL MARGINING
      9. 7.9 THE THIRD CAUSE OF THE LIQUIDITY BUFFER: OFF-BALANCE-SHEET COMMITMENTS
      10. 7.10 BASEL III REGULATION AND LIQUIDITY BUFFER
    3. 8: Models for market risk factors
      1. 8.1 INTRODUCTION
      2. 8.2 STOCK PRICES AND FX RATES
      3. 8.3 INTEREST RATE MODELS
      4. 8.4 DEFAULT PROBABILITIES AND CREDIT SPREADS
      5. 8.5 EXPECTED AND MINIMUM LIQUIDITY GENERATION CAPACITY OF AVAILABLE BONDS
      6. 8.6 FAIR HAIRCUT FOR REPO TRANSACTIONS AND COLLATERALIZED LOANS
      7. 8.7 ADJUSTMENTS TO THE VALUE OF ILLIQUID BONDS
      8. APPENDIX 8.A EXPECTATION VALUE OF THE BOND WITH SELLING PROBABILITY AND SPREAD
    4. 9: Behavioural models
      1. 9.1 INTRODUCTION
      2. 9.2 PREPAYMENT MODELLING
      3. 9.3 SIGHT DEPOSIT AND NON-MATURING LIABILITY MODELLING
      4. 9.4 CREDIT LINE MODELLING
      5. APPENDIX 9.A GENERAL DECOMPOSITION OF HEDGING SWAPS
      6. APPENDIX 9.B ACCURACY OF MORTGAGE RATE APPROXIMATION
      7. APPENDIX 9.C ACCURACY OF THE APPROXIMATED FORMULA FOR CORRELATED MORTGAGE RATE AND PREPAYMENT INTENSITY
      8. APPENDIX 9.D CHARACTERISTIC FUNCTION OF THE INTEGRAL
  11. Part III: Pricing Liquidity risk
    1. 10: The links between credit risk and funding cost
      1. 10.1 INTRODUCTION
      2. 10.2 THE AXIOM
      3. 10.3 CASH FLOW FAIR VALUES AND DISCOUNTING
      4. 10.4 CRITIQUE OF DEBIT VALUE ADJUSTMENT
      5. 10.5 DVA FOR DERIVATIVE CONTRACTS
      6. 10.6 EXTENSION TO POSITIVE RECOVERY AND LIQUIDITY RISK
      7. 10.7 DYNAMIC REPLICATION OF DVA
      8. 10.8 RECAPITULATION OF RESULTS
      9. 10.9 ACCOUNTING STANDARD AND DVA
      10. 10.10 DISTINCTION BETWEEN PRICE AND VALUE
    2. 11: Cost of liquidity and fund transfer pricing
      1. 11.1 INTRODUCTION
      2. 11.2 PRINCIPLES OF TRANSFER PRICING
      3. 11.3 FUNDING AND BANKING ACTIVITY
      4. 11.4 BUILDING A FUNDING CURVE
      5. 11.5 INCLUDING THE FUNDING COST IN LOAN PRICING
      6. 11.6 MONITORING FUNDING COSTS AND RISK CONTROL OF REFUNDING RISK
      7. 11.7 FUNDING COSTS AND ASSET/LIABILITY MANAGEMENT
      8. 11.8 INTERNAL FUND TRANSFER PRICING SYSTEM
      9. 11.9 BEST PRACTICES AND REGULATION
    3. 12: Liquidity risk and the cost of funding in derivative contracts
      1. 12.1 PRICING OF DERIVATIVE CONTRACTS UNDER COLLATERAL AGREEMENTS
      2. 12.2 PRICING OF COLLATERALIZED DERIVATIVE CONTRACTS WHEN MORE THAN ONE CURRENCY IS INVOLVED
      3. 12.3 VALUATION OF NON-COLLATERALIZED INTEREST RATE SWAPS INCLUDING FUNDING COSTS
    4. 13: A sort of conclusion: towards a new treasury?
      1. 13.1 INTRODUCTION
      2. 13.2 ORGANIZATION OF THE TREASURY AND THE DEALING ROOM
      3. 13.3 BANKING VS TRADING BOOK
  12. References
  13. Index