BlackRock's Guide to Fixed-Income Risk Management

Bennett W. Golub is one of the original founders of BlackRock. During his 34-year career at BlackRock, Dr. Golub was a member of BlackRock’s Global Executive Committee, co-head of its Risk & Quantitative Analysis group and served as BlackRock’s Chief Risk Officer from 2009—2022. Additionally, he co-founded BlackRock Solutions. Currently, Dr. Golub serves as a Senior Advisor to BlackRock.

Frequently Used Abbreviations xvii

Foreword xxi

Preface xxiii

Acknowledgments xxxi

SECTION I An Approach to Fixed-Income Investment Risk Management 1

CHAPTER 1 An Investment Risk Management Paradigm 3
Bennett W. Golub and Rick Flynn

1.1 Introduction 3

1.2 Elements of Risk Management 4

1.3 BlackRock’s Investment and Risk Management Approach 6

1.4 Introduction to the BlackRock Investment Risk Management Paradigm 7

CHAPTER 2 Parametric Approaches to Risk Management 11
Bennett W. Golub and Leo M. Tilman

2.1 Introduction 11

2.2 Measuring Interest Rate Exposure: Analytical Approaches 12

2.3 Measuring Interest Rate Exposure: Empirical Approaches 30

2.4 Measuring Yield Curve Exposure 34

2.5 Measuring and Managing Volatility Related Risks 40

2.6 Measuring Credit Risk 47

2.7 Measuring Mortgage-Related Risks 50

2.8 Measuring Impact of Time 52

CHAPTER 3 Modeling Yield Curve Dynamics 59
Bennett W. Golub and Leo M. Tilman

3.1 Probability Distributions of Systematic Risk Factors 59

3.2 Principal Component Analysis: Theory and Applications 61

3.3 Probability Distributions of Interest Rate Shocks 75

CHAPTER 4 Portfolio Risk: Estimation and Decomposition 81
Amandeep Dhaliwal and Tom Booker

4.1 Introduction 81

4.2 Portfolio Volatility and Factor Structure 83

4.3 Covariance Matrix Estimation 85

4.4 Ex Ante Risk and VaR Methodologies 93

4.5 Introduction to Risk Decomposition 103

4.6 Alternative Approaches to Risk Decomposition 104

4.7 Risk Decomposition Using CTR 108

4.8 Risk Decomposition Through Time 116

4.9 Risk Decomposition: Summary 119

CHAPTER 5 Market-Driven Scenarios: An Approach for Plausible Scenario Construction 125
Bennett W. Golub, David Greenberg, and Ronald Ratcliffe

5.1 Introduction 125

5.2 Implied Stress Testing Framework 127

5.3 Developing Useful Scenarios 134

5.4 A Market-Driven Scenario Example: Brexit 136

5.5 Conclusion 142

CHAPTER 6 A Framework to Quantify and Price Geopolitical Risks 145
Catherine Kress, Carl Patchen, Ronald Ratcliffe, Eric Van Nostrand, and Kemin Yang

6.1 Introduction 145

6.2 Setting the Scene 146

6.3 BlackRock’s Framework for Analyzing Geopolitical Risks 149

6.4 Global Trade Deep Dive 149

6.5 What Is Already Priced In? 153

6.6 Taking Action 156

6.7 Caveats and Cautions 159

CHAPTER 7 Liquidity Risk Management 163
Bennett W. Golub, Philip Sommer, Stefano Pasquali, Michael Huang, Kristen Walters, and Nikki Azznara

7.1 Introduction 163

7.2 A Brief History of Liquidity Risk Management 164

7.3 A Fund Liquidity Risk Framework 166

7.4 Asset Liquidity 166

7.5 Redemption Risk 169

7.6 Liquidity Stress Testing 170

7.7 Extraordinary Measures 171

7.8 Fixed-Income Data Availability Limitations 171

7.9 Conclusion 181

CHAPTER 8 Using Portfolio Optimization Techniques to Manage Risk 183
Alex Ulitsky, Bennett W. Golub, Leo M. Tilman, and Jack Hattem

8.1 Risk Measurement Versus Risk Management 183

8.2 Typical Fixed-Income Hedges 185

8.3 Parametric Hedging Techniques 187

8.4 Generalized Approach to Hedging 189

8.5 Advanced Portfolio Optimization and Risk Management Techniques 207

CHAPTER 9 Risk Governance 219
Bennett W. Golub

9.1 Introduction 219

9.2 Risk Scan Standard Framework 219

9.3 Risk and Performance Target (RPT) Framework 221

9.4 Governance 223

CHAPTER 10 Risk-Return Awareness and Behavioral Finance 225
Emily Haisley and Nicky Lai

10.1 Introduction 225

10.2 Portfolio and Risk Manager Partnership 226

10.3 Behavioral Risk Management for Fixed Income 227

10.4 Decision-Making Analytics 229

10.5 Investment Process 235

10.6 Conclusion 241

CHAPTER 11 Performance Attribution 243
Reade Ryan and Carol Yu

11.1 Introduction 243

11.2 Brinson Attribution and Beyond 244

11.3 Factor-Based Attribution 252

11.4 Equity Fundamental Factor-Based Attribution 256

CHAPTER 12 Performance Analysis 259
Mark Paltrowitz, Mark Temple-Jones, Viola Dunne, and Christopher Calingo

12.1 Introduction 259

12.2 Performance Governance 260

12.3 Performance Metrics 260

12.4 Conclusion 266

CHAPTER 13 Evolving the Risk Management Paradigm 267
Bennett W. Golub, Michael Huang, and Joe Buehlmeyer

13.1 Introduction 267

13.2 Traditional Buy-Side Risk Management Framework 268

13.3 Evolving the IRMP: In Pursuit of Investment Risk Management at Scale 268

13.4 Risk Governance 270

13.5 Supporting Risk Governance Through Technology 270

13.6 Implementing a Risk Governance Framework Through Aladdin 271

13.7 Aladdin's Risk Radar Example 271

13.8 Conclusion 276

SECTION II Fixed-Income Risk Management—Then and Now 277

CHAPTER 14 The Modernization of the Bond Market 279
Daniel Veiner, Stephen Laipply, Carolyn Weinberg, Samara Cohen, Vasiliki Pachatouridi, and Hui Sien Koay

14.1 Charting the Evolution of Bond Markets 279

14.2 The Development of an Index-Based Ecosystem 285

14.3 Implications for Investing, Portfolio Management, and Risk Management 289

14.4 The Future State of Portfolio Construction 290

14.5 Conclusion 290

CHAPTER 15 The LIBOR Transition 293
Jack Hattem

15.1 Introduction 293

15.2 Implications to Portfolio and Risk Management 295

15.3 Shift from LIBOR to SOFR 295

15.4 Risk Management Impact and Coordination 297

15.5 Reflections on a Benchmark Reforms 298

CHAPTER 16 Derivatives Reform: The Rise of Swap Execution Facilities and Central Counterparties 301
Eileen Kiely and Jack Hattem

16.1 The Call for Change: 2008 Global Financial Crisis 301

16.2 The Value of Derivatives in Fixed-Income Portfolios 302

16.3 Trading Fixed-Income Derivatives: The Rise of SEFs 304

16.4 Clearing Fixed-Income Derivatives: The Rise of CCPs 305

16.5 CCP Risk Mitigation Techniques 306

16.6 The Call for Change: Market Participants Ask for Stronger CCPs 308

16.7 Conclusion 311

SECTION III Lessons from the Credit Crisis and Coronavirus Pandemic 313

CHAPTER 17 Risk Management Lessons Worth Remembering from the Credit Crisis of 2007–2009 315
Bennett W. Golub and Conan Crum

17.1 Introduction 315

17.2 The Paramount Importance of Liquidity 316

17.3 Investors in Securitized Products Need to Look Past the Data to the Underlying Behavior of the Assets 326

17.4 Certification Is Useless During Systemic Events 331

17.5 Market Risk Can Change Dramatically 332

17.6 The Changing Nature of Market Risk 336

17.7 By the Time a Crisis Strikes, It’s Too Late to Start Preparing 337

17.8 Conclusion 338

CHAPTER 18 Reflections on Buy-Side Risk Management After (or Between) the Storms 341
Bennett W. Golub and Conan Crum

18.1 Introduction 341

18.2 Risk Management Requires Institutional Buy-In 341

18.3 The Alignment and Management of Institutional Interests 342

18.4 Getting Risk Takers to Think Like Risk Managers 345

18.5 Independent Risk Management Organizations 345

18.6 Clearly Define Fiduciary Obligations 347

18.7 Bottom-Up Risk Management 348

18.8 Risk Models Require Constant Vigilance 349

18.9 Risk Management Does Not Mean Risk Avoidance 350

CHAPTER 19 Lessons Worth Considering from the COVID-19 Crisis 353
Barbara Novick, Joanna Cound, Kate Fulton, and Winnie Pun

19.1 Introduction 353

19.2 Background 354

19.3 Core Principles Underpinning Recommendations 354

19.4 March 2020: Capital Markets Highlights and Official Sector Intervention 355

19.5 COVID-19 Lessons: What Worked and What Needs to be Addressed 357

19.6 Recommendations to Enhance the Resilience of Capital Markets 363

19.7 Concerns with Macroprudential Controls 368

19.8 Conclusion 369

19.9 Postscript 369

Notes 370

Bibliography 373

About the Website 383

About the Editor 385

About the Contributors 387

Index 391