Financial Risk Management A Practitioner's Guide to Managing Market and Credit Risk

STEVEN ALLEN is a risk management consultant, specializing in risk measurement and valuation with a particular emphasis on illiquid and hard-to-value assets. Until his retirement in 2004, he was Managing Director in charge of risk methodology at JPMorgan Chase, where he was responsible for model validation, risk capital allocation, and the development of new measures of valuation, reserves, and risk for both market and credit risk. Previously, he was in charge of market risk for derivative products at Chase. He has been a key architect of Chase's value-at-risk and stress testing systems. Prior to his work in risk management, Allen was the head of analysis and model building for all Chase trading activities for over ten years. Since 1998, Allen has been associated with the Mathematics in Finance Master's Program at New York University's Courant Institute of Mathematical Sciences. In this program, he has served as Clinical Associate Professor and Deputy Director and has created and taught courses in risk management, derivatives mathematics, and interest rate and credit models. He was a member of the board of directors of the International Association of Financial Engineers and continues to serve as co-chair of their Education Committee.

Foreword

Preface

Acknowledgments

Chapter 1: Introduction

1.1 Lessons from a Crisis

1.2 Financial Risk and Actuarial Risk

1.3 Simulation and Subjective Judgment

Chapter 2: Institutional Background

2.1 Moral Hazard???Insiders and Outsiders

2.2 Ponzi Schemes

2.3 Adverse Selection

2.4 The Winner?s Curse

2.5 Market Making versus Position Taking

Chapter 3: Operational Risk

3.1 Operations Risk

3.2 Legal Risk

3.3 Reputational Risk

3.4 Accounting Risk

3.5 Funding Liquidity Risk

3.6 Enterprise Risk

3.7 The Identification of Risks

3.8 Operational Risk Capital

Chapter 4: Financial Disasters

4.1 Disasters Due to Misleading Reporting

4.2 Disasters Due to Large Market Moves

4.3 Disasters Due to the Conduct of Customer Business

Chapter 5: The Systemic Disaster of 2007-2008

5.1 Overview

5.2 The Crisis in CDOs of Subprime Mortgages

5.3   The Spread of the Crisis

5.4   Lessons from the Crisis for Risk Managers

5.5   Lessons from the Crisis for Regulators

5.6   Broader Lessons from the Crisis

Chapter 6: Managing Financial Risk

6.1 Risk Measurement

6.2 Risk Control

Chapter 7: VaR and Stress Testing

7.1 VaR Methodology

7.2 Stress Testing

7.3 Uses of Overall Measures of Firm Position Risk

Chapter 8: Model Risk

8.1   How Important is Model Risk?

8.2 Model Risk Evaluation and Control

8.3 Liquid Instruments

8.4 Illiquid Instruments

8.5 Trading Models

Chapter 9: Managing Spot Risk

9.1 Overview

9.2 Foreign Exchange Spot Risk

9.3 Equity Spot Risk

9.4 Physical Commodities Spot Risk

Chapter 10: Managing Forward Risk

10.1 Instruments

10.2 Mathematical Models of Forward Risks

10.3 Factors Impacting Borrowing Costs

10.4 Risk-Management Reporting and Limits for Forward Risk

Chapter 11: Managing Vanilla Options Risk

11.1 Overview of Options Risk Management

11.2 The Path Dependence of Dynamic Hedging

11.3 A Simulation of Dynamic Hedging

11.4 Risk Reporting and Limits

11.5 Delta Hedging

11.6 Building a Volatility Surface

11.7 Summary

Chapter 12: Managing Exotic Options Risk

12.1 Single-Payout Options

12.2 Time-Dependent Options

12.3 Path-Dependent Options

12.4 Correlation-Dependent Options

12.5 Correlation-Dependent Interest Rate Options

Chapter 13: Credit Risk

13.1 Short-Term Exposure to Changes in Market Prices

13.2 Modeling Single-name Credit Risk

13.3 Portfolio Credit Risk

Chapter 14: Counterparty Credit Risk

14.1 Overview

14.2 Exchange-traded Derivatives

14.3 Over-the-counter Derivatives

Bibliography

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