Risk Management in Turbulent Times

Gilles Beneplanc is the Head of Europe, Middle East, and Africa region for the Mercer consulting firm. Jean-Charles Rochet is Professor of Mathematics and Economics at the University of Toulouse.

INTRODUCTION ; I RISK MANAGEMENT: WHAT MUST BE CHANGED ; 1 Lessons From recent Financial Crises ; 1.1 The Basic Goals of Risk Management ; 1.2 When Risk Management Fails ; 1.3 What Should Be Done? ; 2 Living in Turbulent Times ; 2.1 New and Larger Risks ; 2.2 Increased Management Accountability ; 2.3 Need for a Global Approach ; 3 The Need for a Proper Methodology ; 3.1 The Necessary Ingredients ; 3.2 Risk Mapping ; 3.3 Loss Control ; 3.4 Risk Allocation ; II WHAT IS BEHIND RISK MODELING ; 4 The Basic Tools of Risk Modeling ; 4.1 Assessing Probabilities: The Frequentist and Subjective Approaches ; 4.2 Bayesian updating ; 4.3 Estimating Loss Distributions ; 4.4 Combining Event Trees and Monte Carlo Methods ; 4.5 The Dangers of the Stationarity Assumption ; 5 Statistical Risk Measures ; 5.1 The Expectation or Mean ; 5.2 The Variance ; 5.3 Linear Correlation ; 5.4 Copulas ; 5.5 The Value at Risk ; 5.6 Mutualization and Diversification ; 5.7 The Dangers of Using Simple Risk Measures ; Appendix: Extreme Value Theory ; 6 Leverage and Ruin Theory ; 6.1 Leverage and Return on Equity ; 6.2 Economic Capital for a Bank ; 6.3 Economic Capital for an Insurance Company ; 6.4 The Limits of Ruin Theory ; III THE PERFECT MARKETS HYPOTHESIS AND ITS DANGERS ; 7 Risk Neutral Valuation ; 7.1 The Expected Present Value Criterion ; 7.2 The Magic of Perfect Markets ; 7.3 Complete Markets and Absence of Arbitrage Opportunities ; 7.4 A Binomial Example ; 7.5 The Mirages of the Perfect Markets World ; 8 The Case of Incomplete Markets: Relating Risk Premiums to Economic ; Fundamentals ; 8.1 Solving the St Petersburg Paradox ; 8.2 Certainty Equivalent ; 8.3 Markets for Exchanging Risks ; 8.4 The Limits of the Equilibrium Approach ; 9 Risk Management in a Normal World ; 9.1 The Mean-Variance Criterion ; 9.2 Portfolio Choice ; 9.3 The Diversification Principle ; 9.4 Efficient Portfolios and the Sharpe Ratio ; 9.5 The Capital Asset Pricing Model (CAPM) ; 9.6 Futures Contracts and Hedging ; 9.7 Capital Allocation and RaRoc ; 9.8 The Dangers of Viewing the World as <"Normal>" ; Appendix 1: Portfolio Choice with Several Risky Assets ; Appendix 2: Deriving the CAPM Formula ; IV RISK MANAGEMENT AND SHAREHOLDER VALUE ; 10 Why Market Imperfections Matter for Shareholder Value ; 10.1 Standards Methods for Assessing Shareholder Value ; 10.2 Why is the Shareholder Value Function Likely to Be Non Linear: A Simple Example ; 10.3 Incentive Problems Generate Financial Frictions ; 11 The Shareholder Value Function ; 11.1 A Target Level of Cash ; 11.2 A Model for Optimizing Liquidity Management ; 11.3 Liquidity and Shareholder Value ; Appendix 1: Stochastic Differential Calculus ; Appendix 2: Derivation of the Shareholders Value Function ; 12 Risk Management and the Shareholder Value Function ; 12.1 How Much Risk to Take? ; 12.2 Which Risks to Insure? ; 12.3 How Much Liquidity to Keep in Reserves? ; 12.4 How Much hedging to Perform? ; V WHAT TO DO IN PRACTICE? ; 13 The Different Steps of the Implementation ; 13.1 Estimating the Shareholder Value Function ; 13.2 A Unifying Metric for Risk Mapping: The Risk Value Mapping ; 13.3 The New Instruments of Risk Management ; 14 Learning from an Example ; 14.1 Presentation of Med Corp ; 14.2 Risk Analysis ; 14.3 Shareholder Value and RM for Med Corp ; 14.4 A Risk Transfer Policy for Med Corp ; 15 Conclusion: Some Simple Messages ; 15.1 Message # 1: Quantitative models are needed but they have to be used ; with precaution ; 15.2 Message # 2: Risk Management creates value for shareholders ; 15.3 Message # 3: Things to do in practice ; 15.4 Message # 4: Key Ingredients for a successful RM approach ; Index