Advances in Risk Management

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ISBN: 9780230019164 | 0230019161
Cover: Hardcover
Copyright: 1/15/2007

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This important new book brings together an edited series of papers about risk management and the latest developments in this field. Covering topics such as Stochastic Volatility, Risk Dynamics, Weather Derivatives and Portfolio Diversification, this fundamental volume will have broad international appeal. It is vital for optimal portfolio allocation for both private and institutional investors worldwide.

Acknowledgements	p. xi
Notes on the Contributors	p. xii
Introduction	p. xxi
Impact of the Collection Threshold on the Determination of the Capital Charge for Operational Risk	p. 1
Introduction	p. 1
Measuring operational risk	p. 3
The collection threshold	p. 8
Empirical analysis	p. 11
Conclusion	p. 16
Incorporating Diversification into Risk Management	p. 22
Introduction	p. 22
Risk measure with diversification	p. 24
Numerical example	p. 31
Implementation	p. 33
Pricing portfolio insurance	p. 37
Conclusion	p. 43
Sensitivity Analysis of Portfolio Volatility: Importance of Weights, Sectors and Impact of Trading Strategies	p. 47
Introduction	p. 47
Sensitivity analysis background	p. 50
Effect of relative weight changes	p. 51
Importance of portfolio weights in GARCH volatility estimation models	p. 53
Empirical results: trading strategies through sensitivity analysis	p. 56
Conclusion	p. 64
Managing Interest Rate Risk under Non-Parallel Changes: An Application of a Two-Factor Model	p. 69
Introduction	p. 69
The model	p. 70
Generalized duration and convexity	p. 72
Hedging ratios	p. 74
A proposal of a solution for the limitations of the conventional duration	p. 75
Conclusion	p. 83
An Essay on Stochastic Volatility and the Yield Curve	p. 86
Introduction	p. 86
Variations on stochastic volatility and conditional volatility	p. 88
Interest rate term structure forecasting	p. 92
Interest rate term structure models	p. 92
Methodology	p. 94
Data and calibration of the Fong and Vasicek model	p. 97
Simulation	p. 98
Empirical results	p. 99
Conclusion	p. 102
Idiosyncratic Risk, Systematic Risk and Stochastic Volatility: An Implementation of Merton's Credit Risk Valuation	p. 107
Introduction	p. 107
The general model	p. 110
A stochastic volatility model	p. 114
Simulation study	p. 118
Conclusion	p. 126
A Comparative Analysis of Dependence Levels in Intensity-Based and Merton-Style Credit Risk Models	p. 132
Introduction	p. 132
Merton-Style models	p. 133
Intensity-based models	p. 136
Comparisons between some dependence indicators	p. 139
Extensions of the basic intensity-based model	p. 143
Conclusion	p. 150
The Modeling of Weather Derivative Portfolio Risk	p. 156
Introduction	p. 156
What are weather derivatives?	p. 157
Defining risk for weather derivative portfolios	p. 159
Basic methods for estimating the risk in weather derivative portfolios	p. 160
The incorporation of sampling error in simulations	p. 162
Accurate estimation of the correlation matrix	p. 162
Dealing with non-normality	p. 163
Estimating model error	p. 164
Incorporating hedging constraints	p. 165
Consistency between the valuation of single contracts and portfolios	p. 166
Estimating sampling error	p. 167
Estimating VaR	p. 167
Conclusion	p. 168
Optimal Investment with Inflation-Linked Products	p. 170
Introduction	p. 170
Modeling the evolution of an inflation index	p. 171
Optimal portfolios with inflation linked products	p. 173
Hedging with inflation linked products	p. 182
Conclusion	p. 189
Model Risk and Financial Derivatives	p. 191
Introduction	p. 191
From mathematical theory to financial practise	p. 194
An illustration of model risk	p. 195
The role of models for derivatives	p. 197
The model-building process and model risk-creation	p. 199
What if the model is wrong? a case study	p. 201
Eleven rules for managing model risk	p. 203
Conclusion	p. 210
Evaluating Value-at-Risk Estimates: A Cross-Section Approach	p. 213
Introduction	p. 213
Value-at-risk	p. 214
Review of existing methods for backtesting	p. 214
An extension: the cross-section approach	p. 217
Applications	p. 219
Conclusion	p. 224
Correlation Breakdowns in Asset Management	p. 226
Introduction	p. 226
Data and descriptive statistics	p. 226
Correlation jumps and volatility behavior	p. 228
Impact on portfolio optimization	p. 237
Conclusion	p. 237
Sequential Procedures for Monitoring Covariances of Asset Returns	p. 241
Introduction	p. 241
Covariance structure of asset returns and optimal portfolio weights	p. 243
Multivariate statistical surveillance	p. 246
Simultaneous statistical surveillance	p. 251
A comparison of the multivariate and simultaneous control charts	p. 253
Conclusion	p. 258
An Empirical Study of Time-Varying Return Correlations and the Efficient Set of Portfolios	p. 265
Introduction	p. 265
Empirical Methodology and Data	p. 267
Results	p. 270
Conclusion	p. 276
The Derivation of the NPV Probability Distribution of Risky Investments with Autoregressive Cash Flows	p. 278
Introduction	p. 278
Systematic risk and the perfect economy	p. 280
Total risk and the real economy	p. 282
The NPV probability distribution and the CLT: theoretical results	p. 285
The NPV probability distribution and the CLT: simulation models and statistical tests	p. 288
The NPV probability distribution and the CLT: simulation results	p. 289
Conclusion	p. 293
Have Volatility Transmission Patterns between the USA and Spain Changed after September 11?	p. 303
Introduction	p. 303
Data	p. 305
The econometric approach	p. 309
Empirical results	p. 312
Conclusion	p. 321
Large and Small Cap Stocks in Europe: Covariance Asymmetry, Volatility Spillovers and Beta Estimates	p. 327
Introduction	p. 327
The econometric framework	p. 329
Data and preliminary analysis	p. 331
Results	p. 335
Asymmetries analysis	p. 342
Volatility spillovers	p. 345
Conclusion	p. 348
On Model Selection and its Impact on the Hedging of Financial Derivatives	p. 353
Introduction	p. 353
Model and Mathematical setup	p. 355
Analytical expression of the total hedging error	p. 357
Numerical results	p. 359
Conclusion	p. 363
Index	p. 365
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