Financial Risk Management (eBook)

JIMMY SKOGLUND is principal product manager of global risk products at SAS. He has more than fifteen years of market experience developing and implementing risk methodo ogies, and his articles have appeared in such publications as the Journal of Risk, Journal of Banking and Finance, and Journal of Risk Management in Financial Institutions. Jimmy holds a PhD from the Stockholm Schooof Economics. WEI CHEN is director of stress testing solutions at SAS. He has more than fifteen years experience in risk analytics and technology in banking and insurance, and he is an associate editor of the Journal of Risk Model Validation. His publications have appeared in severa journals including Journal of Risk and Journal of Risk Model Validation. Wei holds a PhD from the University of Iowa.

Preface i

Acknowledgements vii

1 Introduction 1

1.1 Banks and Risk Management 1

1.2 Evolution of Bank Capital Regulation 4

1.3 Creating Value from Risk Management 9

1.4 Financial Risk Systems 11

1.5 Model Risk Management 18

I Market Risk 23

2 Market Risk with the Normal Distribution 25

2.1 Linear Portfolios 26

2.2 Quadratic Portfolios 47

2.3 Simulation Based Valuation 58

3 Advanced Market Risk Analysis 81

3.1 Risk Measures, Risk Contributions and Risk Information 82

3.2 Modeling the Stylized Facts of Financial Time Series 104

3.3 Scaling VaR and VaR with Trading 143

3.4 Market Liquidity Risk 146

3.5 Scenario Analysis and Stress Testing 152

3.6 Portfolio Optimization 166

3.7 Developments in the Market Risk Internal Models Capital Regulation 175

II Credit Risk 179

4 Portfolio Credit Risk 181

4.1 Issuer Credit Risk in Wholesale Exposures and Trading Book 184

4.2 Credit Models for the Banking Book 247

4.3 Firmwide Portfolio Credit Risk and Credit Risk Dependence 307

4.4 Credit Risk Stress Testing 310

4.5 Features of New Generation Portfolio Credit Risk Models 320

4.6 Hedging Credit Risk 326

4.7 Regulatory Capital for Credit Risk 336

5 Counterparty Credit Risk 345

5.1 Counterparty Pricing and Exposure 347

5.2 CVA Risks 397

5.3 Portfolios of Derivatives 398

5.4 A Note on Recent Counterparty Credit Risk Developments 409

5.5 Counterparty Credit Risk Regulation 411

III Asset and Liability Management 417

6 Liquidity Risk Management 419

6.2 Liquidity Exposure 431

6.3 Hedging the Liquidity Exposure 446

6.4 Structural Liquidity Planning 460

6.5 Components of the Liquidity Hedging Program 468

6.6 Cash Liquidity Risk and Liquidity Risk Measures 468

6.6.3 Allocating Cash Liquidity Risk 471

6.7 Regulation for Liquidity Risk 474

7 Funds Transfer Pricing and Profitability of Cash Flows 481

7.1 Basic Funds Transfer Pricing Concept 484

7.2 Risk Based Funds Transfer Pricing 485

7.3 Funds Transfer Rate and Risk Adjusted Returns 500

7.4 Profitability Measures and Decompositions 501

7.5 Banking Book Fair Value with Funds Transfer Rates 504

7.6 A Note on the Scope of Funds Transfer Pricing 505

7.7 Regulation and Profitability Analysis 506

IV Firmwide Risk 509

8 Firmwide Risk Aggregation 511

8.1 Correlated Aggregation and Firmwide Risk Levels 512

8.2 Capital Allocation in Risk Aggregation 519

8.3 Risk Aggregation and Regulation 521

9 Firmwide Scenario Analysis and Stress Testing 525

9.1 Firmwide Scenario Model Approaches 527

9.2 Firmwide Risk Capital Measures 530

9.3 Regulatory Stress Scenario Approach 535

9.4 The Future of Firmwide Stress Testing 542

References 545