Practical tools and advice for managing financial risk, updated for a post-crisis world Advanced Financial Risk Management bridges the gap between the idealized assumptions used for risk valuation and the realities that must be reflected in management actions. It explains, in detailed yet easy-to-understand terms, the analytics of these issues from A to Z, and lays out a comprehensive strategy for risk management measurement, objectives, and hedging techniques that apply to all types of institutions. Written by experienced risk managers, the book covers everything from the basics of present value, forward rates, and interest rate compounding to the wide variety of alternative term structure models. Revised and updated with lessons from the 2007-2010 financial crisis, Advanced Financial Risk Management outlines a framework for fully integrated risk management. Credit risk, market risk, asset and liability management, and performance measurement have historically been thought of as separate disciplines, but recent developments in financial theory and computer science now allow these views of risk to be analyzed on a more integrated basis. The book presents a performance measurement approach that goes far beyond traditional capital allocation techniques to measure risk-adjusted shareholder value creation, and supplements this strategic view of integrated risk with step-by-step tools and techniques for constructing a risk management system that achieves these objectives. Practical tools for managing risk in the financial world Updated to include the most recent events that have influenced risk management Topics covered include the basics of present value, forward rates, and interest rate compounding; American vs. European fixed income options; default probability models; prepayment models; mortality models; and alternatives to the Vasicek model Comprehensive and in-depth, Advanced Financial Risk Management is an essential resource for anyone working in the financial field.
Introduction: Wall Street Lessons from Bubbles xxiii Key Fallacies in Risk Management xxiii Selected Events in the Credit Crisis xxviii PART ONE Risk Management: Definitions and Objectives CHAPTER 1 A Risk Management Synthesis: Market Risk, Credit Risk, Liquidity Risk, and Asset and Liability Management 3 CHAPTER 2 Risk, Return, Performance Measurement, and Capital Regulation 15 PART TWO Risk Management Techniques for Interest Rate Analytics CHAPTER 3 Interest Rate Risk Introduction and Overview 45 CHAPTER 4 Fixed Income Mathematics: The Basic Tools 59 CHAPTER 5 Yield Curve Smoothing 73 CHAPTER 6 Introduction to Heath, Jarrow, and Morton Interest Rate Modeling 123 CHAPTER 7 HJM Interest Rate Modeling with Rate and Maturity-Dependent Volatility 142 CHAPTER 8 HJM Interest Rate Modeling with Two Risk Factors 161 CHAPTER 9 HJM Interest Rate Modeling with Three Risk Factors 190 CHAPTER 10 Valuation, Liquidity, and Net Income 230 CHAPTER 11 Interest Rate Mismatching and Hedging 250 CHAPTER 12 Legacy Approaches to Interest Rate Risk Management 257 CHAPTER 13 Special Cases of Heath, Jarrow, and Morton Interest Rate Modeling 283 CHAPTER 14 Estimating the Parameters of Interest Rate Models 316 PART THREE Risk Management Techniques for Credit Risk Analytics CHAPTER 15 An Introduction to Credit Risk: Using Market Signals in Loan Pricing and Performance Measurement 335 CHAPTER 16 Reduced Form Credit Models and Credit Model Testing 359 CHAPTER 17 Credit Spread Fitting and Modeling 396 CHAPTER 18 Legacy Approaches to Credit Risk 421 CHAPTER 19 Valuing Credit Risky Bonds 453 CHAPTER 20 Credit Derivatives and Collateralized Debt Obligations 473 PART FOUR Risk Management Applications: Instrument by Instrument CHAPTER 21 European Options on Bonds 495 CHAPTER 22 Forward and Futures Contracts 513 CHAPTER 23 European Options on Forward and Futures Contracts 531 CHAPTER 24 Caps and Floors 548 CHAPTER 25 Interest Rate Swaps and Swaptions 567 CHAPTER 26 Exotic Swap and Options Structures 580 CHAPTER 27 American Fixed Income Options 596 CHAPTER 28 Irrational Exercise of Fixed Income Options 622 CHAPTER 29 Mortgage-Backed Securities and Asset-Backed Securities 639 CHAPTER 30 Nonmaturity Deposits 656 CHAPTER 31 Foreign Exchange Markets 675 CHAPTER 32 Impact of Collateral on Valuation Models: The Example of CHAPTER 33 Pricing and Valuing Revolving Credit and Other Facilities 694 CHAPTER 34 Modeling Common Stock and Convertible Bonds on a Default-Adjusted Basis 700 CHAPTER 35 Valuing Insurance Policies and Pension Obligations 708 PART FIVE Portfolio Strategy and Risk Management CHAPTER 36 Value-at-Risk and Risk Management Objectives Revisited at the Portfolio and Company Level 719 CHAPTER 37 Liquidity Analysis and Management: Examples from the Credit Crisis 735 CHAPTER 38 Performance Measurement: Plus Alpha vs. Transfer Pricing 765 CHAPTER 39 Managing Institutional Default Risk and Safety and Soundness 783 CHAPTER 40 Information Technology Considerations 793 CHAPTER 41 Shareholder Value Creation and Destruction 800 Postscript 808 Bibliography 809 Index 819
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