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Risk Management and Shareholders' Value in Banking
From Risk Measurement Models to Capital Allocation Policies
Andrea Sironi (Author), Andrea Resti (Author)
9780470029787, Wiley
Hardback, published 4 April 2007
816 pages
25.2 x 17.8 x 4.9 cm, 1.488 kg
This book presents an integrated framework for risk measurement, capital management and value creation in banks. Moving from the measurement of the risks facing a bank, it defines criteria and rules to support a corporate policy aimed at maximizing shareholders' value.
Parts I - IV discuss different risk types (including interest rate, market, credit and operational risk) and how to assess the amount of capital they absorb by means of up-to-date, robust risk-measurement models. Part V surveys regulatory capital requirements: a special emphasis is given to the Basel II accord, discussing its economic foundations and managerial implications. Part VI presents models and techniques to calibrate the amount of economic capital at risk needed by the bank, to fine-tune its composition, to allocate it to risk-taking units, to estimate the "fair" return expected by shareholders, to monitor the value creation process. Risk Management and Shareholders' Value in Banking includes:
* Value at Risk, Monte Carlo models, Creditrisk+, Creditmetrics and much more
* formulae for risk-adjusted loan pricing and risk-adjusted performance measurement
* extensive, hands-on Excel examples are provided on the companion website www.wiley.com/go/rmsv
* a complete, up-to-date introduction to Basel II
* focus on capital allocation, Raroc, EVA, cost of capital and other value-creation metrics
Foreword xix Motivation and Scope of this Book: A Quick Guided Tour xxi Part I Interest Rate Risk 1 Introduction to Part I 3 1 The Repricing Gap Model 9 1.1 Introduction 9 1.2 The gap concept 9 1.3 The maturity-adjusted gap 12 1.4 Marginal and cumulative gaps 15 1.5 The limitations of the repricing gap model 19 1.6 Some possible solutions 20 Selected Questions and Exercises 25 Appendix 1A The Term Structure of Interest Rates 28 Appendix 1B Forward Rates 32 2 The Duration Gap Model 35 2.1 Introduction 35 2.2 Towards mark-to-market accounting 35 2.3 The duration of financial instruments 39 2.4 Estimating the duration gap 42 2.5 Problems of the duration gap model 45 Selected Questions and Exercises 47 Appendix 2A The Limits of Duration 49 3 Models Based on Cash-Flow Mapping 57 3.1 Introduction 57 3.2 The objectives of cash-flow mapping and term structure 57 3.3 Choosing the vertices of the term structure 58 3.4 Techniques based on discrete intervals 59 3.5 Clumping 64 3.6 Concluding comments 68 Selected Questions and Exercises 69 Appendix 3A Estimating the Zero-Coupon Curve 71 4 Internal Transfer Rates 77 4.1 Introduction 77 4.2 Building an ITR system: a simplified example 77 4.3 Single and multiple ITRs 79 4.4 Setting internal interest transfer rates 84 4.5 ITRs for transactions with embedded options 88 4.6 Summary: the ideal features of an ITR system 93 Selected Questions and Exercises 94 Appendix 4A Derivative Contracts on Interest Rates 96 Part II Market Risks 103 Introduction to Part II 105 5 The Variance-Covariance Approach 115 5.1 Introduction 115 5.2 VaR derivation assuming normal return distribution 115 5.3 Sensitivity of portfolio positions to market factors 126 5.4 Mapping of risk positions 133 5.5 Summary of the variance-covariance approach and main limitations 143 Selected Questions and Exercises 151 Appendix 5A Stockmarket Betas 154 Appendix 5B Option Sensitivity Coefficients: “Greeks” 157 6 Volatility Estimation Models 163 6.1 Introduction 163 6.2 Volatility estimation based upon historical data: simple moving averages 163 6.3 Volatility estimation based upon historical data: exponential moving averages 167 6.4 Volatility prediction: GARCH models 172 6.5 Volatility prediction: implied volatility 179 6.6 Covariance and correlation estimation 181 Selected Questions and Exercises 182 7 Simulation Models 185 7.1 Introduction 185 7.2 Historical simulations 189 7.3 Monte Carlo simulations 205 7.4 Stress testing 218 Selected Questions and Exercises 221 8 Evaluating VaR Models 225 8.1 Introduction 225 8.2 An example of backtesting: a stock portfolio VaR 225 8.3 Alternative VaR model backtesting techniques 232 Selected Questions and Exercises 244 Appendix 8A VaR Model Backtesting According to the Basel Committee 246 9 VaR Models: Summary, Applications and Limitations 251 9.1 Introduction 251 9.2 A summary overview of the different models 251 9.3 Applications of VaR models 253 9.4 Six “False Shortcomings” of VaR 260 9.5 Two real problems of VaR models 263 9.6 An Alternative Risk Measure: Expected Shortfall (ES) 268 Selected Questions and Exercises 269 Appendix 9A Extreme Value Theory 272 Part III Credit Risk 275 Introduction to Part III 277 10 Credit-Scoring Models 287 10.1 Introduction 287 10.2 Linear discriminant analysis 287 10.3 Regression models 299 10.4 Inductive models 301 10.5 Uses, limitations and problems of credit-scoring models 307 Selected Questions and Exercises 309 Appendix 10A The Estimation of the Gamma Coefficients in Linear Discriminant Analysis 311 11 Capital Market Models 313 11.1 Introduction 313 11.2 The approach based on corporate bond spreads 313 11.3 Structural models based on stock prices 321 Selected Questions and Exercises 340 Appendix 11A Calculating the Fair Spread on a Loan 342 Appendix 11B Real and Risk-Neutral Probabilities of Default 343 12 LGD and Recovery Risk 345 12.1 Introduction 345 12.2 What factors drive recovery rates? 346 12.3 The estimation of recovery rates 347 12.4 From past data to LGD estimates 351 12.5 Results from selected empirical studies 353 12.6 Recovery risk 356 12.7 The link between default risk and recovery risk 358 Selected Questions and Exercises 362 Appendix 12A The Relationship between PD and RR in the Merton model 364 13 Rating Systems 369 13.1 Introduction 369 13.2 Rating assignment 370 13.3 Rating quantification 379 13.4 Rating validation 388 Selected Questions and Exercises 398 14 Portfolio Models 401 14.1 Introduction 401 14.2 Selecting time horizon and confidence level 402 14.3 The migration approach: CreditMetricsTM 406 14.4 The structural approach: PortfolioManagerTM 423 14.5 The macroeconomic approach: CreditPortfolioViewTM 426 14.6 The actuarial approach: CreditRisk+TM 428 14.7 A brief comparison of the main models 439 14.8 Some limitations of the credit risk models 442 Selected Questions and Exercises 446 Appendix 14A Asset correlation versus default correlation 449 15 Some Applications of Credit Risk Measurement Models 451 15.1 Introduction 451 15.2 Loan pricing 451 15.3 Risk-adjusted performance measurement 457 15.4 Setting limits on risk-taking units 459 15.5 Optimizing the composition of the loan portfolio 461 Selected Questions and Exercises 462 Appendix 15A Credit Risk Transfer Tools 464 16 Counterparty Risk on OTC Derivatives 473 16.1 Introduction 473 16.2 Settlement and pre-settlement risk 474 16.3 Estimating pre-settlement risk 474 16.4 Risk-adjusted performance measurement 495 16.5 Risk-mitigation tools for pre-settlement risk 496 Selected Questions and Exercises 504 Part IV Operational Risk 505 Introduction to Part IV 507 17 Operational Risk: Definition, Measurement and Management 511 17.1 Introduction 511 17.2 OR: How can we define it? 512 17.3 Measuring OR 517 17.4 Towards an OR management system 533 17.5 Final remarks 535 Selected Questions and Exercises 537 Appendix 17A OR measurement and EVT 539 Part V Regulatory Capital Requirements 543 Introduction to Part V 545 18 The 1988 Capital Accord 547 18.1 Introduction 547 18.2 The capital ratio 549 18.3 Shortcomings of the capital adequacy framework 555 18.4 Conclusions 559 Selected Questions and Exercises 559 Appendix 18A The Basel Committee 563 19 The Capital Requirements for Market Risks 565 19.1 Introduction 565 19.2 Origins and characteristics of capital requirements 565 19.3 The capital requirement on debt securities 568 19.4 Positions in equity securities: specific and generic requirements 575 19.5 The requirement for positions in foreign currencies 576 19.6 The requirement for commodity positions 578 19.7 The use of internal models 578 Selected Questions and Exercises 585 Appendix 19A Capital Requirements Related to Settlement, Counterparty and Concentration Risks 588 20 The New Basel Accord 591 20.1 Introduction 591 20.2 Goals and Contents of the Reform 591 20.3 Pillar One: The Standard Approach to Credit Risk 593 20.4 The Internal Ratings-based Approach 597 20.5 Pillar Two: A New Role for Supervisory Authorities 612 20.6 Pillar Three: Market Discipline 614 20.7 Pros and Cons of Basel II 616 20.8 the Impact of Basel II 619 Selected Questions and Exercises 630 21 Capital Requirements on Operational Risk 633 21.1 Introduction 633 21.2 The capital requirement on operational risk 633 21.3 Weaknesses of the 2004 Accord 645 21.4 Final remarks 647 Selected Questions and Exercises 647 Part VI Capital Management and Value Creation 651 Introduction to Part VI 653 22 Capital Management 657 22.1 Introduction 657 22.2 Defining and measuring capital 658 22.3 Optimizing regulatory capital 675 22.4 Other instruments not included within regulatory capital 685 Selected Questions and Exercises 691 23 Capital Allocation 693 23.1 Introduction 693 23.2 Measuring capital for the individual business units 694 23.3 The relationship between allocated capital and total capital 702 23.4 Capital allocated and capital absorbed 712 23.5 Calculating risk-adjusted performance 715 23.6 Optimizing the allocation of capital 722 23.7 The organizational aspects of the capital allocation process 726 Selected Questions and Exercises 728 Appendix 23A The Correlation Approach 730 Appendix 23B The Virtual Nature of Capital Allocation 731 24 Cost of Capital and Value Creation 735 24.1 Introduction 735 24.2 The link between Risk Management and Capital Budgeting 735 24.3 Capital Budgeting in Banks and in Non-Financial Enterprises 736 24.4 Estimating the Cost of Capital 739 24.4.4 Caveats 744 24.5 Some empirical Examples 745 24.6 Value Creation and RAROC 750 24.7 Value Creation and EVA 753 24.8 Conclusions 756 Selected Questions and Exercises 757 Bibliography 759 Index 771
Subject Areas: Finance & accounting [KF]
