Advanced Financial Risk Management by Kenji Imai and Mark Mesler

Advanced Financial Risk Management by Kenji Imai and Mark Mesler

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Contents of Advanced Financial Risk Management

  • Introduction: Wall Street Lessons from Bubbles
  • Key Fallacies in Risk Management
  • Selected Events in the Credit Crisis
  • PART ONE Risk Management: Definitions and Objectives
  • CHAPTER A Risk Management Synthesis: Market Risk, Credit Risk, Liquidity Risk,
  • and Asset and Liability Management
  • Risk Management: Definitions and Objectives
  • Advances in Integrated Risk Management and Institutional
  • Barriers to Progress
  • Measuring the Trade-Offs between Risk and Return
  • When Bad Things Happen to Good People
  • U.S. Savings and Loan Crisis
  • Long-Term Capital Management
  • The Credit Crisis
  • A Thousand Cuts
  • CHAPTER Risk, Return, Performance Measurement, and Capital Regulation
  • Practical Quantification of Risk
  • Perils and Pitfalls in the Measurement of Risk: The Impact
  • of Selection Bias
  • Biases in Return vs. a Relative Benchmark
  • Historical Value at Risk: Selection Bias Again
  • Monte CarloBased Value at Risk
  • Expected Losses on Tranches of Collateralized Debt Obligations
  • Measuring Return: Market vs. Accounting Returns
  • Introduction to Transfer Pricing: Extracting Interest Rate Risk
  • in a Financial Accounting Context
  • Bank of America,
  • First Interstate,
  • Performance Measurement and Capital Regulation
  • Perspectives on Measuring Risk: One Source of Risk or Many
  • Sources of Risk?
  • Interest Rate Risk Management Evolution
  • Equity Risk Management Evolution
  • vii
  • Option Risk Management Evolution
  • Credit Risk Management Evolution
  • Managing Risk and Strategy, Business by Business
  • Risk and Strategy Management in a Complex Financial Institution
  • What Causes Financial Institutions to Fail?
  • The Role of Capital in Risk Management and Business Strategy
  • Capital-Based Risk Management in Banking Today: Pros and Cons
  • History of Capital-Based Regulations in Commercial Banking
  • PART TWO Risk Management Techniques for Interest Rate Analytics
  • CHAPTER Interest Rate Risk Introduction and Overview
  • Background Information on Movements in the U.S. Treasury
  • Yield Curve
  • A Step-by-Step Approach to Analyzing Interest Rate Risk
  • The Interest Rate Risk Safety Zone
  • CHAPTER Fixed Income Mathematics: The Basic Tools
  • Modern Implications of Present Value
  • Price, Accrued Interest, and Value
  • Calculation of Accrued Interest
  • Present Value
  • The Basic Present Value Calculation
  • Example
  • Calculating the Value of a Fixed Coupon Bond with
  • Principal Paid at Maturity
  • Calculating the Coupon of a Fixed Coupon Bond with
  • Principal Paid at Maturity When the Value Is Known
  • Example
  • The Value of an Amortizing Loan
  • Calculating the Payment Amount of an Amortizing Bond
  • When the Value Is Known
  • Risk Management Implications
  • Calculating the Value of a Floating-Rate Bond or Loan with
  • Principal Paid at Maturity
  • Example
  • Risk Management Implications
  • Compound Interest Conventions and Formulas
  • Future Value of an Invested Amount Earning at a Simple Interest
  • Rate of y Compounded m Times per Year for n Periods
  • Future Value of an Invested Amount Earning at a Simple Interest
  • Rate of y Compounded Continuously for n Years
  • Example
  • Present Value of a Future Amount If Funds Are Invested at a
  • Simple Interest Rate of y Compounded m Times per
  • Year for n Periods
  • Present Value of a Future Amount If Funds Are Invested at a Simple
  • Interest Rate of y Compounded Continuously for n Years
  • Compounding Formulas and Present Value Factors P(t)
  • Yields and Yield-to-Maturity Calculations
  • The Formula for Yield to Maturity
  • Yield to Maturity for Long or Short First Coupon Payment Periods
  • Calculating Forward Interest Rates and Bond Prices
  • Implied Forward Interest Rates on Zero-Coupon Bonds
  • Example
  • Implied Forward Zero-Coupon Bond Prices
  • Present Value of Forward Fixed Coupon Bond
  • Implied Forward Price on a Fixed Coupon Bond
  • Implied Forward Coupon on a Fixed Coupon Bond
  • Other Forward Calculations
  • Summary
  • CHAPTER Yield Curve Smoothing
  • Example A: Stepwise Constant Yields and Forwards vs. Nelson-Siegel
  • Deriving the Form of the Yield Curve Implied by Example A
  • Fitting the Nelson-Siegel Approach to Sample Data
  • Example D: Quadratic Yield Splines and Related Forward Rates
  • Deriving the Form of the Yield Curve Implied by Example D
  • Example F: Cubic Yield Splines and Related Forwards
  • Deriving the Form of the Yield Curve Implied by
  • Example F Assumptions
  • Example H: Maximum Smoothness Forward
  • Rates and Related Yields
  • Deriving the Parameters of the Quartic Forward Rate Curves
  • Implied by Example H Assumptions
  • Comparing Yield Curve and Forward Rate Smoothing Techniques
  • Ranking Smoothing Techniques by Smoothness of the
  • Forward Rate Curve
  • Ranking Smoothing Techniques by Length of the
  • Forward Curve
  • Trading Off Smoothness vs. the Length of the Forward Rate Curve
  • The Shimko Test for Measuring Accuracy of Smoothing Techniques
  • Smoothing Yield Curves Using Coupon-Bearing Bond Prices as Inputs
  • Appendix: Proof of the Maximum Smoothness Forward Rate Theorem
  • CHAPTER Introduction to Heath, Jarrow, and Morton Interest Rate Modeling
  • Objectives of the Example and Key Input Data
  • Key Implications and Notation of the HJM Approach
  • Pseudo-Probabilities
  • The Formula for Zero-Coupon Bond Price Shifts
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Valuation in the HJM Framework
  • Valuation of a Zero-Coupon Bond Maturing at Time T
  • Valuation of a Coupon-Bearing Bond Paying Annual Interest
  • Valuation of a Digital Option on the One-Year U.S. Treasury Rate
  • Conclusion
  • CHAPTER HJM Interest Rate Modeling with Rate and Maturity-Dependent Volatility
  • Objectives of the Example and Key Input Data
  • Key Implications and Notation of the HJM Approach
  • Pseudo-Probabilities
  • The Formula for Zero-Coupon Bond Price Shifts
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Valuation in the HJM Framework
  • Valuation of a Zero-Coupon Bond Maturing at Time T
  • Valuation of a Coupon-Bearing Bond Paying Annual Interest
  • Valuation of a Digital Option on the One-Year U.S. Treasury Rate
  • Conclusion
  • CHAPTER HJM Interest Rate Modeling with Two Risk Factors
  • Probability of Yield Curve Twists in the U.S. Treasury Market
  • Objectives of the Example and Key Input Data
  • Introducing a Second Risk Factor Driving Interest Rates
  • Key Implications and Notation of the HJM Approach
  • Pseudo-Probabilities
  • The Formula for Zero-Coupon Bond Price Shifts with
  • Two Risk Factors
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Valuation in the HJM Framework
  • Valuation of a Zero-Coupon Bond Maturing at Time T
  • Valuation of a Coupon-Bearing Bond Paying Annual Interest
  • Valuation of a Digital Option on the One-Year
  • U.S. Treasury Rate
  • Replication of HJM Example in Common Spreadsheet Software
  • Conclusion
  • CHAPTER HJM Interest Rate Modeling with Three Risk Factors
  • Probability of Yield Curve Twists in the U.S. Treasury Market
  • Objectives of the Example and Key Input Data
  • Risk Factor : Annual Changes in the One-Year U.S.
  • Treasury Spot Rate
  • Alternative Specifications of the Interest Rate Volatility Surface
  • Key Implications and Notation of the HJM Approach
  • Pseudo-Probabilities
  • The Formula for Zero-Coupon Bond Price Shifts with
  • Three Risk Factors
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Building the Bushy Tree for Zero-Coupon Bonds
  • Maturing at Time T
  • Valuation in the HJM Framework
  • Valuation of a Zero-Coupon Bond Maturing at Time T
  • Valuation of a Coupon-Bearing Bond Paying Annual Interest
  • Valuation of a Digital Option on the One-Year
  • U.S. Treasury Rate
  • Conclusion
  • CHAPTER Valuation, Liquidity, and Net Income
  • How Many Risk Factors Are Necessary to Accurately
  • Model Movements in the Risk-Free Yield Curve?
  • Revisiting the Phrase “No Arbitrage”
  • Valuation, Liquidity Risk, and Net Income
  • Risk-Neutral and Empirical Probabilities of Interest
  • Rate Movements
  • Monte Carlo Simulation Using HJM Modeling
  • Common Pitfalls in Interest Rate Risk Management
  • Pitfalls in the Use of One-Factor Term Structure Models
  • Common Pitfalls in Asset and Liability Management
  • Summarizing the Problems with Interpolated Monte Carlo
  • Simulation for Risk Analysis
  • CHAPTER Interest Rate Mismatching and Hedging
  • Political Factions in Interest Rate Risk Management
  • Pension Fund Considerations
  • Life Insurance Companies and Property and Casualty Insurance
  • Companies
  • Commercial Banks
  • Making a Decision on Interest Rate Risk and Return:
  • The Safety Zone
  • Obvious Interest Rate Risk Decisions
  • Assessing the Risk and Return Trade-Offs from a
  • Change in Interest Rate Risk
  • CHAPTER Legacy Approaches to Interest Rate Risk Management
  • Gap Analysis and Simulation Models
  • Measuring Interest Rate Risk: A Review
  • Legacy Rate Risk Tools: Interest Rate Sensitivity Gap Analysis
  • The Safety Zone
  • What’s Wrong with Gap Analysis?
  • Legacy Rate Risk Tools: Multiperiod Simulation
  • Key Assumptions in Simulation
  • Data Aggregation in Simulation Modeling
  • Constraining the Model
  • Modeling the Maturity Structure of a Class of Assets
  • Periodicity of the Analysis
  • Exceptions to the Exact Day Count Trend
  • Legacy Rate Risk Tools: Duration and Convexity
  • Macaulay’s Duration: The Original Formula
  • Using Duration for Hedging
  • Comparing a Duration Hedge with Hedging in the HJM Framework
  • Duration: The Traditional Market Convention
  • The Formula for Yield to Maturity
  • Yield to Maturity for Long or Short First Coupon Payment Periods
  • Applying the Yield-to-Maturity Formula to Duration
  • Modified Duration
  • The Perfect Duration Hedge: The Difference between the
  • Original Macaulay and Conventional Durations
  • Convexity and Its Uses
  • Convexity: A General Definition
  • Convexity for the Present Value Formula
  • Hedging Implications of the Convexity Concept
  • Conclusion
  • CHAPTER Special Cases of Heath, Jarrow, and Morton Interest Rate Modeling
  • What Is an Academic Term Structure Model and Why
  • Was It Developed?
  • The Vocabulary of Term Structure Models
  • Ito’s Lemma
  • Ito’s Lemma for More Than One Random Variable
  • Using Ito’s Lemma to Build a Term Structure Model
  • Duration as a Term Structure Model
  • Conclusions about the Use of Duration’s Parallel Shift Assumptions
  • The Vasicek and Extended Vasicek Models
  • The Merton Term Structure Model: Parallel Yield Curve Shifts
  • The Extended Merton Model
  • The Vasicek Model
  • The Extended VasicekHull and White Model
  • Alternative Term Structure Models
  • Alternative One-Factor Interest Rate Models
  • Two-Factor Interest Rate Models
  • Chen’s Three-Factor Term Structure Model
  • Reprising the HJM Approach
  • Appendix A: Deriving Zero-Coupon Bond Prices in the
  • Extended Merton/Ho and Lee Model
  • Appendix B: Deriving Zero-Coupon Bond Prices in the
  • Vasicek Model
  • Appendix C: Valuing Zero-Coupon Bonds in the Extended
  • Vasicek Model
  • CHAPTER Estimating the Parameters of Interest Rate Models
  • Revisiting the Meaning of No Arbitrage
  • A Framework for Fitting Term Structure Models
  • Fitting Zero-Coupon Bond Prices and Volatility Parameters Jointly
  • Steps in Fitting the Interest Rate Volatility Assumptions
  • Example : Fitting Interest Rate Volatility When
  • Six Callable Bonds Are Observable
  • Example : The Consequences of Fewer Inputs
  • Example : The Case of One Input
  • Interest Rate Parameter Fitting in Practical Application
  • PART THREE Risk Management Techniques for Credit Risk Analytics
  • CHAPTER An Introduction to Credit Risk: Using Market Signals in Loan
  • Pricing and Performance Measurement
  • Market Prices for Credit Risk
  • Critical Sources of Market Data on Credit Risk
  • Bond Prices
  • Credit Default Swap Prices
  • First to Default Swaps
  • Collateralized Debt Obligations
  • Interest Rate Swap Prices
  • Equity Prices
  • Increased Accuracy in Pricing
  • Increased Clarity in Corporate Strategy
  • Increased Sophistication in Risk Management
  • Increased Precision in Measuring the Safety and
  • Soundness of Financial Institutions
  • Credit Default Swaps: The Dangers of Market Manipulation
  • Daily Nondealer Trading Volume for , Reference Names
  • Credit Default Swap Trading Volume in Municipals and
  • Sub-Sovereigns
  • Credit Default Swap Trading Volume in Sovereign Credits
  • Implications of CDS Trading Volume Data
  • CHAPTER Reduced Form Credit Models and Credit Model Testing
  • The Jarrow-Turnbull Model
  • The Jarrow-Turnbull Framework
  • The Jarrow Model
  • Zero-Coupon Bond Prices in the Jarrow Model
  • The Jarrow Model and the Issue of Liquidity in the Bond Market
  • The Jarrow-Merton Put Option as a Risk Index and a Practical Hedge
  • Fitting the Jarrow Model to Bond Prices, Credit Derivatives
  • Prices, and Historical Default Databases
  • Fitting the Jarrow Model to Debt Prices
  • Fitting to Current Price Data and Historical Price Data
  • Fitting the Jarrow Model to Credit Derivatives Prices
  • Fitting the Jarrow Model to a Historical Database of Defaults
  • Fitting the Jarrow Model to Retail, Small Business, and
  • Governmental Counterparties
  • Correlations in Default Probabilities
  • The Jarrow and Jarrow-Turnbull Models: A Summary
  • Tests of Credit Models Using Historical Data
  • An Introduction to Credit Model Testing
  • Misunderstandings about Credit Model Testing
  • The Two Components of Credit Model Performance
  • Measuring Ordinal Ranking of Companies by Credit Risk
  • The Predictive ROC Accuracy Ratio: Techniques and Results
  • The Predictive Capability of the Jarrow-Chava Reduced
  • Form Model Default Probabilities
  • Measuring the Predictive ROC Accuracy Ratio
  • Reduced Form Model vs. Merton Model Performance
  • Consistency of Estimated and Actual Defaults
  • Recent Results from North America
  • The Falkenstein and Boral Test
  • Performance of Credit Models vs. Naïve Models of Risk
  • ROC Accuracy Ratios for Merton Model Theoretical
  • Version vs. Selected Naïve Models
  • Tests of Credit Models Using Market Data
  • Testing Credit Models: The Analogy with Interest Rates
  • Market Data Test : Accuracy in Fitting Observable
  • Yield Curves and Credit Spreads
  • Market Data Test : Tests of Hedging Performance
  • Market Data Test : Consistency of Model Implications with Model Performance
  • Market Data Test : Comparing Performance with Credit
  • Spreads and Credit Default Swap Prices
  • Appendix: Converting Default Intensities to Discrete
  • Default Probabilities
  • Converting Monthly Default Probabilities to Annual Default
  • Probabilities
  • Converting Annual Default Probabilities to Monthly Default
  • Probabilities
  • Converting Continuous Instantaneous Probabilities of
  • Default to an Annual Default Probability or Monthly
  • Default Probability
  • Converting Continuous Default Probability to an
  • Annual Default Probability
  • Converting Continuous Default Probability to a
  • Monthly Default Probability
  • Converting an Annual Default Probability to a Continuous
  • Default Intensity
  • Converting a Monthly Default Probability to a Continuous
  • Default Intensity
  • CHAPTER Credit Spread Fitting and Modeling
  • Introduction to Credit Spread Smoothing
  • The Market Convention for Credit Spreads
  • A Better Convention for Credit ModelIndependent Credit Spreads
  • Deriving the Full Credit Spread of a Risky Issuer
  • Credit Spread Smoothing Using Yield CurveSmoothing Techniques
  • Setting the Scene: Smoothing Results for the Risk-Free Curve
  • A Naïve Approach: Smoothing ABC Yields by Ignoring
  • the Risk-Free Curve
  • Fitting Credit Spreads with Cubic Splines
  • Maximum Smoothness Forward Credit Spreads
  • Comparing Results
  • Data Problems with Risky Issuers
  • The Case of LIBOR
  • Determinants of Credit Spread Levels
  • The Credit Risk Premium: The Supply and Demand for Credit
  • Conclusion
  • CHAPTER Legacy Approaches to Credit Risk
  • The Rise and Fall of Legacy Ratings
  • Ratings: What They Do and Don’t Do
  • Through the Cycle vs. Point in Time, a Distinction
  • without a Difference
  • Stress Testing, Legacy Ratings, and Transition Matrices
  • Transition Matrices: Analyzing the Random Changes in
  • Ratings from One Level to Another
  • Moral Hazard in “Self-Assessment” of Ratings Accuracy
  • by Legacy Rating Agencies
  • Comparing the Accuracy of Ratings and Reduced Form Default
  • Probabilities
  • Problems with Legacy Ratings in the to Credit Crisis
  • The Jarrow-Merton Put Option and Legacy Ratings
  • The Merton Model of Risky Debt
  • The Intuition of the Merton Model
  • The Basic Merton Model
  • Valuing Multipayment Bonds with the Merton Model of Risky Debt
  • Estimating the Probability of Default in the Merton Model
  • Implying the Value of Company Assets and Their Return Volatility σ
  • Mapping the Theoretical Merton Default Probabilities to
  • Actual Defaults
  • The Merton Model When Interest Rates Are Random
  • The Merton Model with Early Default
  • Loss Given Default in the Merton Model
  • Copulas and Correlation between the Events of Default of
  • Two Companies
  • Back to the Merton Case
  • Problems with the Merton Model: Summing Up
  • Appendix
  • Assumptions
  • Using Ito’s Lemma to Expand Changes in the Value of
  • Company Equity
  • CHAPTER Valuing Credit Risky Bonds
  • The Present Value Formula
  • Valuing Bonds with No Credit Risk
  • Simulating the Future Values of Bonds with No Credit Risk
  • Current and Future Values of Fixed Income Instruments:
  • HJM Background and a Straight Bond Example
  • Valuation of a Straight Bond with a Bullet
  • Principal Payment at Maturity
  • Valuing an Amortizing Loan
  • Valuing Risk-Free, Floating-Rate Loans
  • Valuing Bonds with Credit Risk
  • Simulating the Future Values of Bonds with Credit Risk
  • Valuing the Jarrow-Merton Put Option
  • CHAPTER Credit Derivatives and Collateralized Debt Obligations
  • Credit Default Swaps: Theory
  • Credit Default Swaps: Practice
  • Collateralized Debt Obligations: Theory
  • Collateralized Debt Obligations: A Worked Example of
  • Reduced Form Simulation
  • Collateralized Debt Obligations: Practice
  • The Copula Method of CDO Valuation: A Postmortem
  • Valuing the JarrowMerton Put Option
  • PART FOUR Risk Management Applications: Instrument by Instrument
  • CHAPTER European Options on Bonds
  • Example: European Call Option on Coupon-Bearing Bond
  • Example: Coupon-Bearing Bond with Embedded
  • European Call Option
  • European Options on Defaultable Bonds
  • HJM Special Case: European Options in the One-Factor
  • Vasicek Model
  • Options on Coupon-Bearing Bonds
  • The Jarrow-Merton Put Option
  • CHAPTER Forward and Futures Contracts
  • Forward Contracts on Zero-Coupon Bonds
  • Forward Rate Agreements
  • Eurodollar Futures-Type Forward Contracts
  • Futures on Zero-Coupon Bonds: The Sydney
  • Futures Exchange Bank Bill Contract
  • Futures on Coupon-Bearing Bonds: Dealing with the
  • Cheapest to Deliver Option
  • Eurodollar and Euroyen Futures Contracts
  • Defaultable Forward and Futures Contracts
  • CHAPTER European Options on Forward and Futures Contracts
  • Valuing Options on Forwards and Futures:
  • Notations and Useful Formulas
  • European Options on Forward Contracts on Zero-Coupon Bonds
  • European Options on Forward Rate Agreements
  • European Options on a Eurodollar Futures-Type Forward Contract
  • European Options on Futures on Coupon-Bearing Bonds
  • European Options on Money Market Futures Contracts
  • Defaultable Options on Forward and Futures Contracts
  • CHAPTER Caps and Floors
  • Caps as European Options on Forward Rate Agreements
  • Forming Other Cap-Related Securities
  • Valuing a Cap
  • Valuing a Floor
  • Valuing a Floating Rate Loan with a Cap
  • Value of a Loan with a Cap and a Floor
  • Variations on Caps and Floors
  • Measuring the Credit Risk of Counterparties on Caps and Floors
  • CHAPTER Interest Rate Swaps and Swaptions
  • Interest Rate Swap Basics
  • Valuing the Interest Rate Swaps
  • The Observable Fixed Rate in the Swap Market
  • An Introduction to Swaptions
  • Valuation of European Swaptions
  • Valuation of American Swaptions
  • Defaultable Interest Rate Swaps and Swaptions
  • CHAPTER Exotic Swap and Options Structures
  • Arrears Swaps
  • Digital Option
  • Digital Range Notes
  • Range Floater
  • Other Derivative Securities
  • Credit Risk and Exotic Derivatives Structures
  • CHAPTER American Fixed Income Options
  • An Overview of Numerical Techniques for Fixed
  • Income Option Valuation
  • An Example of Valuation of a Callable Bond with a
  • Three-Factor HJM Bushy Tree
  • What Is the Par Coupon on a Callable Bond?
  • An Example of Valuation of a Rationally Prepaid
  • Amortizing Loan
  • Monte Carlo Simulation
  • Conclusions
  • Finite Difference Methods
  • Binomial Lattices
  • Trinomial Lattices
  • HJM Valuation of American Fixed Income Options
  • When Default Risk Is Present
  • CHAPTER Irrational Exercise of Fixed Income Options
  • Analysis of Irrationality: Criteria for a Powerful Explanation
  • The Transactions Cost Approach
  • Irrational Exercise of European Options
  • The Irrational Exercise of American Options
  • A Worked Example Using an Amortizing Loan with
  • Rational and Irrational Prepayment Behavior
  • Implied Irrationality and Hedging
  • Credit Risk and Irrational Prepayment Behavior
  • CHAPTER Mortgage-Backed Securities and Asset-Backed Securities
  • Transactions Costs, Prepayments, Default, and Multinomial Logit
  • Legacy Prepayment Analysis of Mortgage-Backed Securities
  • Legacy Approaches: Prepayment Speeds and the
  • Valuation of Mortgages
  • Constant Prepayment Speeds Are Simply a Principal
  • Amortization Assumption
  • Legacy Approaches: Option-Adjusted Spread
  • Implications for OAV Spread, CMOs, and ARMs
  • Logistic Regression, Credit Risk, and Prepayment
  • Mortgage-Servicing Rights: The Ultimate Structured Product
  • An Introduction to the Valuation of Mortgage-Servicing Rights
  • Comparing Best Practice and Common Practice in
  • Valuing and Hedging Mortgage-Servicing Rights
  • Valuation Yield Curve for Cash Flows
  • Simulation of Random Movements in Yields
  • The Role of Home Prices in Defaults and Prepayments
  • Other Sources of Cash Flow Related to
  • Mortgage-Servicing Rights
  • Incorrect Hedging of Mortgage-Servicing Rights
  • Conclusion
  • CHAPTER Nonmaturity Deposits
  • The Value of the Deposit Franchise
  • Total Cash Flow of Nonmaturity Deposits
  • Specifying the Rate and Balance Movement Formulas
  • The Impact of Bank Credit Risk on Deposit Rates and Balances
  • Case Study: German Three-Month Notice Savings Deposits
  • The Regulators’ View
  • Conclusion
  • CHAPTER Foreign Exchange Markets
  • Setting the Stage: Assumptions for the Domestic and
  • Foreign Economies
  • Foreign Exchange Forwards
  • Numerical Methods for Valuation of Foreign Currency Derivatives
  • Legacy Approaches to Foreign Exchange Options Valuation
  • Implications of a Term Structure Model-Based FX Options Formula
  • The Impact of Credit Risk on Foreign Exchange Risk Formulas
  • CHAPTER Impact of Collateral on Valuation Models: The Example of
  • Home Prices in the Credit Crisis
  • The Impact of Changing Home Prices on Collateral Values
  • in the Credit Crisis
  • Modeling Variations in Collateral Values
  • The Impact of Collateral Values on a Rationally Prepaid Mortgage
  • Conclusions about the Impact of Collateral Values
  • CHAPTER Pricing and Valuing Revolving Credit and Other Facilities
  • Analyzing Revolving Credit and Other Facilities
  • Fluctuating Credit Risk and Revolving Credit Drawdowns
  • Incorporating Links between Credit Quality and Line Usage
  • Is a Line of Credit a Put Option on the Debt of the Issuer?
  • CHAPTER Modeling Common Stock and Convertible Bonds on a Default-Adjusted Basis
  • Modeling Equities: The Traditional Fund Management Approach
  • Modeling Equities: The Derivatives Approach
  • Modeling Equities: A Credit RiskAdjusted Approach
  • Options on the Common Stock of a Company That Can Go Bankrupt
  • Convertible Bonds of a Company That Can Go Bankrupt
  • CHAPTER Valuing Insurance Policies and Pension Obligations
  • Life Insurance: Mortality Rates vs. Default Probabilities
  • Cyclicality in Default Probabilities and Mortality Rates
  • Valuing Life Insurance Policies
  • Pension Obligations
  • Property and Casualty Insurance
  • The Jarrow-Merton Put Option
  • PART FIVE Portfolio Strategy and Risk Management
  • CHAPTER Value-at-Risk and Risk Management Objectives Revisited at the
  • Portfolio and Company Level
  • The Jarrow-Merton Put Option as a Measure of Total Risk:
  • An Example
  • A Four-Question PassFail Test for Financial Institutions’
  • CEOs and Boards of Directors
  • Why Do These Four Questions Matter?
  • An Alphabet of Extra-Credit Questions
  • Is Your Value-at-Risk from Value-at-Risk?
  • VaR vs. the Put Option for Capital Allocation
  • Why Are the VaR and Put Approaches So Different:
  • Self-Insurance vs. Third-Party Insurance
  • Calculating the Jarrow-Merton Put Option Value and
  • Answering the Key Questions
  • Valuing and Simulating the Jarrow-Merton Put Option
  • What’s the Hedge?
  • Liquidity, Performance, Capital Allocation, and
  • Own Default Risk
  • CHAPTER Liquidity Analysis and Management: Examples from the Credit Crisis
  • Liquidity Risk Case Studies from the Credit Crisis
  • Case Studies in Liquidity Risk
  • Largest Funding Shortfalls
  • American International Group (AIG)
  • Consolidated JPMorgan Chase, Bear Stearns, and
  • Washington Mutual
  • State Street
  • Morgan Stanley
  • Dexia Credit Local New York Branch
  • Implications of the Credit Crisis History for Liquidity
  • Risk Management and Analysis
  • Types of Liquidity Events
  • Liquidity Risk and Credit Risk Linkages
  • Measuring Liquidity Risk as a Line of Credit in the
  • Jarrow-Merton Put Option Sense
  • Integrating Managerial Behavior and Market Funds Supply
  • in Liquidity Risk Measurement
  • Determining the Optimal Liquidity Strategy
  • Summing Up
  • CHAPTER Performance Measurement: Plus Alpha vs. Transfer Pricing
  • Transaction-Level Performance Measurement vs. Portfolio-
  • Level Performance Measurement
  • Plus Alpha Benchmark Performance vs. Transfer Pricing
  • Why Default Risk Is Critical in Performance Measurement
  • of Equity Portfolios
  • “Plus Alpha” Performance Measurement in Insurance and Banking
  • Decomposing the Reasons for Plus or Minus Alpha in a Fixed
  • Income Portfolio
  • A Worked Example of Modern Fixed Income Performance Attribution
  • The Jarrow-Merton Put Option and Capital
  • Using the Jarrow-Merton Put Option for Capital Allocation
  • Introduction
  • Using the Jarrow-Merton Put Option Concept for Capital Allocation
  • Extending the Jarrow-Merton Capital Allocation
  • to a Multiperiod Framework
  • Summing Up
  • CHAPTER Managing Institutional Default Risk and Safety and Soundness
  • Step : Admitting the Possibility of Failure
  • Managing the Probability of Failure
  • Are Ratings a Useful Guide?
  • Are CDS Spreads a Useful Guide?
  • Using Quantitative Default Probabilities
  • Controlling the Probability of Failure through the Credit Cycle
  • Hedging Total Risk to Maximize Shareholder Value
  • Implications for Basel II, Basel III, and Solvency II
  • Simulating Your Own Probability of Default
  • CHAPTER Information Technology Considerations
  • Common Practice in Risk Management Systems: Dealing with
  • Legacy Systems
  • Upgrading the Risk Infrastructure: The Request for Proposal Process
  • Paid Pilots as Final Proof of Concept
  • Keys to Success in Software Installation
  • Vendor Size: Larger Vendor or Small Vendor?
  • Being a Best Practice User
  • CHAPTER Shareholder Value Creation and Destruction
  • Do No Harm
  • Measure the Need to Change
  • Rating Your Primary Risk System
  • Master the Politics and Exposition of Risk Management:
  • Shareholder Value Creation
  • Daily Management Reporting of Total Risk
  • Moving from Common Practice to Best Practice
  • The Senior Management Perspective
  • The Middle Management Perspective
  • The Working-Level Perspective
  • Getting Help to Create Shareholder Value
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Advanced Financial Risk Management by Kenji Imai and Mark Mesler

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