Copyright © 2007, Elsevier Inc.
Contents.
Preface.
Chapter 1: Value at Risk, Capital Management, and Capital.
Allocation.
An Introduction to Value at Risk.
Capital Management and Capital Allocation: The Structure of.
the Book.
Chapter 2: What Is Capital Management?
Regulatory Capital and the Evolution of Basel II.
The 1988 Basel I Accord and the 1996 Amendment.
The Concept of Regulatory Capital.
Overview of the Basel II Capital Accord.
Pillar 1: Minimum Capital Requirements — The Main Changes.
ntroduced by Basel II.
Box 2-1: Impact of the Basel II Accord on the Level of.
Minimum Regulatory Capital Requirements.
Pillar 2: Supervisory Review Process.
Pillar 3: Market Discipline.
The Debate about Basel II Adoption and Implementation.
Bank Estimates of Required Capital and the Different Notions of.
Bank Capital.
Book Value of Capital and the Impact of IAS/IFRS.
Market Capitalization and the Double Perspective of Bank.
Managers.
The Impact of Alteative Notions of Capital on Capital.
Management and Allocation.
CONTENTS.
Summary.
Further Reading.
Chapter 3: Market Risk.
The Variance–Covariance Approach.
A Simplifi ed Example.
The Choice of the Relevant Random Variables.
Mapping Exposures.
Box 3-1: Mapping Equity Positions through Beta: An Example.
aR for a Portfolio.
Box 3-2: Calculating VaR for a Three-Stock Portfolio.
Box 3-3: Why Mapping Is Important.
Estimating Volatility and Correlation: Simple Moving Averages.
Estimating Volatility and Correlation: Exponentially Weighted.
Moving Averages and GARCH Models.
aR Estimates and the Relevance of the Time Horizon.
mplied Volatilities and Correlations.
Box 3-4: Deriving Implied Volatility from Option Prices.
Simulation Approaches: Historical Simulation and Monte Carlo.
Simulation.
Historical Simulation.
Hybrid Approach.
Monte Carlo Simulations.
Filtered Historical Simulations.
alue at Risk for Option Positions.
Problems in Option VaR Measurement.
Potential Solutions for Option VaR Measurement.
Extreme-Value Theory and Copulas.
Extreme-Value Theory.
Copulas.
Expected Shortfall and the Problem of VaR Nonsubadditivity.
Back-Testing Market Risk Models.
Which Series Should Be Considered? Actual versus Theoretical.
Portfolio Retus.
Back-Testing VaR Forecasts: Unconditional Accuracy and.
ndependence.
nteal VaR Models and Market Risk Capital Requirements.
Stress Testing.
Summary.
Further Reading.
Chapter 4: Credit Risk.
Defi ning Credit Risk: Expected and Unexpected Losses.
Agency Ratings.
Exteal Rating Assignment.
Transition Matrixes and Cumulative and Marginal Default.
Probabilities.
CONTENTS vii.
Quantitative Techniques for Stand-Alone Credit Risk Evaluation.
Moody’s/KMV EDF and Exteal Scoring Systems.
Merton’s (1974) Model and Moody’s/KMV Expected.
Default Frequency.
Box 4-1: Deriving the Theoretical Credit Spread for Risky.
Bonds in the Merton (1974) Model.
Credit-Scoring Systems.
Capital Requirements for Credit Risk under Basel II.
Standardized Approach.
Foundation and Advanced Inteal Rating–Based Approaches.
nteal Ratings.
nteal Rating Assignment Process.
Rating Quantifi cation and the Defi nition of Default.
Point-in-Time versus Through-the-Cycle Inteal Ratings.
Estimating Loss Given Default.
Estimating Exposure at Default.
nteraction between Basel II and Inteational Accounting.
Standards.
Alteative Approaches to Modeling Credit Portfolio Risk.
CreditMetricsTM.
Moody’s/KMV PortfolioManagerTM.
CreditPortfolio View.
CreditRisk+.
Comparison of Main Credit Portfolio Models.
Box 4-2: Industry Practices Conceing Credit.
Portfolio Models.
Box 4-3: How Close Are Results Obtained from Credit Risk.
Portfolio Models?
Summary.
Further Reading.
Chapter 5: Operational Risk and Business Risk.
Capital Requirements for Operational Risk Measurement under.
Basel II.
Basic Indicator Approach (BIA).
Standardized Approach (SA).
Advanced Measurement Approach (AMA).
Objectives of Operational Risk Management.
Quantifying Operational Risk: Building the Data Sources.
Operational Risk Mapping and the Identifi cation of Key Risk.
ndicators.
Building an Inteal Loss Database.
Exteal Loss Databases.
Scenario Analysis.
Quantifying Operational Risk: From Loss Frequency and Severity to.
Operational Risk Capital.
Modeling Severity Based on Inteal Loss Data.
CONTENTS.
ntegrating Inteal Severity Data with Exteal Data and.
Scenario Analysis.
Estimating Operational Loss Frequency.
Estimating Correlation or Dependence among Operational.
Events.
Deriving Operational Risk Capital Estimates through.
Simulation.
s Risk Measurement the Final Step?
Case Study: U.S. Bank Progress on Measuring Operational Risk, by.
Patrick de Fontnouvelle and Victoria Garrity (Supervision,
Regulation, and Credit Department, Federal Reserve Bank of Boston).
The Role of Measures of Business Risk and Eaings at Risk.
Measuring Business Risk in Practice: Defi ning a Measure of Eaings.
at Risk.
From Eaings at Risk to Capital at Risk.
Summary.
Further Reading.
Chapter 6: Risk Capital Aggregation.
The Need for Harmonization: Time Horizon, Confi dence Level, and the.
Notion of Capital.
Risk Aggregation Techniques.
Choosing the Components to Be Aggregated: Business Units.
ersus Risk Types.
Alteative Risk Aggregation Methodologies.
Estimating Parameters for Risk Aggregation.
Box 6-1: Some Examples of Linear Correlation Coeffi cient.
Estimates from Existing Studies and Their Implication.
on Aggregated Risk Capital.
Case Study: Capital Aggregation within Fortis (by Luc Henrard, Chief.
Risk Offi cer, Fortis, and Ruben Olieslagers, Director, Central Risk.
Management, Fortis).
A Synthetic Comparison of Alteative Risk Aggregation Techniques.
Further Reading.
Chapter 7: Value at Risk and Risk Control for Market and.
Credit Risk.
Defi ning VaR-Based Limits for Market Risk: Identifying Risk-Taking.
Centers.
Box 7-1: Clarifying VaR Measurement Limitations: Deutsche.
Bank’s Example.
Managing VaR Limits for Market Risk: The Links between Daily VaR.
and Annual Potential Losses.
CONTENTS ix.
Translating Actual Daily VaR Values into an Equivalent Ex Post.
Yearly VaR.
Box 7-2: Daily VaR Fluctuations and Their Implications for.
Ex Post Yearly VaR: An Example Based on.
Real Data.
Translating Yearly Ex Ante Acceptable Loss into an Equivalent.
Daily VaR.
The Case of Variable VaR Limits and the Role of Cumulated.
Losses.
Managing VaR-Based Trading Limits.
dentifying Risk Contributions and Inteal Hedges: VaRDelta,
Component VaR, and Incremental VaR.
Box 7-3: Variant for the Calculation of Component VaR.
Managing Risk and Pricing Limits for Credit Risk.
Setting Loan Autonomy Limits: From Notional Size to.
Expected Loss.
Setting Loan-Pricing Limits.
Case 1: Large Borrower Applying for a Loan from an Investment.
Bank.
Case 2: SME Applying for a Loan from a Smaller,
Retail-Oriented Bank.
Summary.
Further Reading.
Chapter 8: Risk-Adjusted Performance Measurement.
Business Areas, Business Units, and the Double Role of Risk-Adjusted.
Performance Measures.
Checking the Measure of Profi t.
Transfer Prices.
Cost Attribution and Its Impact on RAP Measures.
Capital Investment versus Capital Allocation.
Choosing the Measure of Capital at Risk: Allocated Capital versus.
Utilized Capital.
Choosing the Measure of Capital at Risk: Diversifi ed Capital versus.
Undiversifi ed Capital.
Comparison of Alteative Diversifi ed CaR Measures.
Criteria for Choosing between Diversifi ed and Undiversifi ed.
CaR.
Choosing the Risk-Adjusted Performance Measure: EVA vs. RAROC.
ariants and Potential Extensions.
Differentiated Target Retus.
Alteative RAP Measures.
Expected Shortfall and Performance Measurement.
Operational Risk, Business Risk, and Performance.
Measurement.
Risk-Adjusted Performances and Managers’ Performance Evaluation.
Summary.
Further Reading.
CONTENTS.
Chapter 9: Risk-Adjusted Performance Targets, Capital.
Allocation, and the Budgeting Process.
From the Bank’s Cost of Equity Capital to Performance Targets.
for the Bank.
Estimating the Cost of Equity Capital.
Defi ning the Target Rate of Retu.
Should Business Units’ Target Retus Be Different?
Potential Effects of a Single Hurdle Rate.
Estimating Betas for Different Businesses.
Applying Different Costs of Capital: Identifying the Driver.
Capital Allocation and the Planning and Budgeting Process.
Why Should Capital Allocation Be Linked to the Planning.
Process?
Why Should Capital Allocation Not Be Linked to the Planning.
Process?
Case Study: Capital Allocation Process at UniCredit Group (by Elio.
Berti, head of Capital Allocation, CFO Department, UniCredit).
UniCredit Group Capital Allocation Process and Criteria.
Setting of Value-Creation and Capital Allocation Targets within.
Planning and Control Processes.
Summary.
Further Reading.
Final Remarks.
Selected Free Risk Management–Related Websites.
References.
Index.
Contents.
Preface.
Chapter 1: Value at Risk, Capital Management, and Capital.
Allocation.
An Introduction to Value at Risk.
Capital Management and Capital Allocation: The Structure of.
the Book.
Chapter 2: What Is Capital Management?
Regulatory Capital and the Evolution of Basel II.
The 1988 Basel I Accord and the 1996 Amendment.
The Concept of Regulatory Capital.
Overview of the Basel II Capital Accord.
Pillar 1: Minimum Capital Requirements — The Main Changes.
ntroduced by Basel II.
Box 2-1: Impact of the Basel II Accord on the Level of.
Minimum Regulatory Capital Requirements.
Pillar 2: Supervisory Review Process.
Pillar 3: Market Discipline.
The Debate about Basel II Adoption and Implementation.
Bank Estimates of Required Capital and the Different Notions of.
Bank Capital.
Book Value of Capital and the Impact of IAS/IFRS.
Market Capitalization and the Double Perspective of Bank.
Managers.
The Impact of Alteative Notions of Capital on Capital.
Management and Allocation.
CONTENTS.
Summary.
Further Reading.
Chapter 3: Market Risk.
The Variance–Covariance Approach.
A Simplifi ed Example.
The Choice of the Relevant Random Variables.
Mapping Exposures.
Box 3-1: Mapping Equity Positions through Beta: An Example.
aR for a Portfolio.
Box 3-2: Calculating VaR for a Three-Stock Portfolio.
Box 3-3: Why Mapping Is Important.
Estimating Volatility and Correlation: Simple Moving Averages.
Estimating Volatility and Correlation: Exponentially Weighted.
Moving Averages and GARCH Models.
aR Estimates and the Relevance of the Time Horizon.
mplied Volatilities and Correlations.
Box 3-4: Deriving Implied Volatility from Option Prices.
Simulation Approaches: Historical Simulation and Monte Carlo.
Simulation.
Historical Simulation.
Hybrid Approach.
Monte Carlo Simulations.
Filtered Historical Simulations.
alue at Risk for Option Positions.
Problems in Option VaR Measurement.
Potential Solutions for Option VaR Measurement.
Extreme-Value Theory and Copulas.
Extreme-Value Theory.
Copulas.
Expected Shortfall and the Problem of VaR Nonsubadditivity.
Back-Testing Market Risk Models.
Which Series Should Be Considered? Actual versus Theoretical.
Portfolio Retus.
Back-Testing VaR Forecasts: Unconditional Accuracy and.
ndependence.
nteal VaR Models and Market Risk Capital Requirements.
Stress Testing.
Summary.
Further Reading.
Chapter 4: Credit Risk.
Defi ning Credit Risk: Expected and Unexpected Losses.
Agency Ratings.
Exteal Rating Assignment.
Transition Matrixes and Cumulative and Marginal Default.
Probabilities.
CONTENTS vii.
Quantitative Techniques for Stand-Alone Credit Risk Evaluation.
Moody’s/KMV EDF and Exteal Scoring Systems.
Merton’s (1974) Model and Moody’s/KMV Expected.
Default Frequency.
Box 4-1: Deriving the Theoretical Credit Spread for Risky.
Bonds in the Merton (1974) Model.
Credit-Scoring Systems.
Capital Requirements for Credit Risk under Basel II.
Standardized Approach.
Foundation and Advanced Inteal Rating–Based Approaches.
nteal Ratings.
nteal Rating Assignment Process.
Rating Quantifi cation and the Defi nition of Default.
Point-in-Time versus Through-the-Cycle Inteal Ratings.
Estimating Loss Given Default.
Estimating Exposure at Default.
nteraction between Basel II and Inteational Accounting.
Standards.
Alteative Approaches to Modeling Credit Portfolio Risk.
CreditMetricsTM.
Moody’s/KMV PortfolioManagerTM.
CreditPortfolio View.
CreditRisk+.
Comparison of Main Credit Portfolio Models.
Box 4-2: Industry Practices Conceing Credit.
Portfolio Models.
Box 4-3: How Close Are Results Obtained from Credit Risk.
Portfolio Models?
Summary.
Further Reading.
Chapter 5: Operational Risk and Business Risk.
Capital Requirements for Operational Risk Measurement under.
Basel II.
Basic Indicator Approach (BIA).
Standardized Approach (SA).
Advanced Measurement Approach (AMA).
Objectives of Operational Risk Management.
Quantifying Operational Risk: Building the Data Sources.
Operational Risk Mapping and the Identifi cation of Key Risk.
ndicators.
Building an Inteal Loss Database.
Exteal Loss Databases.
Scenario Analysis.
Quantifying Operational Risk: From Loss Frequency and Severity to.
Operational Risk Capital.
Modeling Severity Based on Inteal Loss Data.
CONTENTS.
ntegrating Inteal Severity Data with Exteal Data and.
Scenario Analysis.
Estimating Operational Loss Frequency.
Estimating Correlation or Dependence among Operational.
Events.
Deriving Operational Risk Capital Estimates through.
Simulation.
s Risk Measurement the Final Step?
Case Study: U.S. Bank Progress on Measuring Operational Risk, by.
Patrick de Fontnouvelle and Victoria Garrity (Supervision,
Regulation, and Credit Department, Federal Reserve Bank of Boston).
The Role of Measures of Business Risk and Eaings at Risk.
Measuring Business Risk in Practice: Defi ning a Measure of Eaings.
at Risk.
From Eaings at Risk to Capital at Risk.
Summary.
Further Reading.
Chapter 6: Risk Capital Aggregation.
The Need for Harmonization: Time Horizon, Confi dence Level, and the.
Notion of Capital.
Risk Aggregation Techniques.
Choosing the Components to Be Aggregated: Business Units.
ersus Risk Types.
Alteative Risk Aggregation Methodologies.
Estimating Parameters for Risk Aggregation.
Box 6-1: Some Examples of Linear Correlation Coeffi cient.
Estimates from Existing Studies and Their Implication.
on Aggregated Risk Capital.
Case Study: Capital Aggregation within Fortis (by Luc Henrard, Chief.
Risk Offi cer, Fortis, and Ruben Olieslagers, Director, Central Risk.
Management, Fortis).
A Synthetic Comparison of Alteative Risk Aggregation Techniques.
Further Reading.
Chapter 7: Value at Risk and Risk Control for Market and.
Credit Risk.
Defi ning VaR-Based Limits for Market Risk: Identifying Risk-Taking.
Centers.
Box 7-1: Clarifying VaR Measurement Limitations: Deutsche.
Bank’s Example.
Managing VaR Limits for Market Risk: The Links between Daily VaR.
and Annual Potential Losses.
CONTENTS ix.
Translating Actual Daily VaR Values into an Equivalent Ex Post.
Yearly VaR.
Box 7-2: Daily VaR Fluctuations and Their Implications for.
Ex Post Yearly VaR: An Example Based on.
Real Data.
Translating Yearly Ex Ante Acceptable Loss into an Equivalent.
Daily VaR.
The Case of Variable VaR Limits and the Role of Cumulated.
Losses.
Managing VaR-Based Trading Limits.
dentifying Risk Contributions and Inteal Hedges: VaRDelta,
Component VaR, and Incremental VaR.
Box 7-3: Variant for the Calculation of Component VaR.
Managing Risk and Pricing Limits for Credit Risk.
Setting Loan Autonomy Limits: From Notional Size to.
Expected Loss.
Setting Loan-Pricing Limits.
Case 1: Large Borrower Applying for a Loan from an Investment.
Bank.
Case 2: SME Applying for a Loan from a Smaller,
Retail-Oriented Bank.
Summary.
Further Reading.
Chapter 8: Risk-Adjusted Performance Measurement.
Business Areas, Business Units, and the Double Role of Risk-Adjusted.
Performance Measures.
Checking the Measure of Profi t.
Transfer Prices.
Cost Attribution and Its Impact on RAP Measures.
Capital Investment versus Capital Allocation.
Choosing the Measure of Capital at Risk: Allocated Capital versus.
Utilized Capital.
Choosing the Measure of Capital at Risk: Diversifi ed Capital versus.
Undiversifi ed Capital.
Comparison of Alteative Diversifi ed CaR Measures.
Criteria for Choosing between Diversifi ed and Undiversifi ed.
CaR.
Choosing the Risk-Adjusted Performance Measure: EVA vs. RAROC.
ariants and Potential Extensions.
Differentiated Target Retus.
Alteative RAP Measures.
Expected Shortfall and Performance Measurement.
Operational Risk, Business Risk, and Performance.
Measurement.
Risk-Adjusted Performances and Managers’ Performance Evaluation.
Summary.
Further Reading.
CONTENTS.
Chapter 9: Risk-Adjusted Performance Targets, Capital.
Allocation, and the Budgeting Process.
From the Bank’s Cost of Equity Capital to Performance Targets.
for the Bank.
Estimating the Cost of Equity Capital.
Defi ning the Target Rate of Retu.
Should Business Units’ Target Retus Be Different?
Potential Effects of a Single Hurdle Rate.
Estimating Betas for Different Businesses.
Applying Different Costs of Capital: Identifying the Driver.
Capital Allocation and the Planning and Budgeting Process.
Why Should Capital Allocation Be Linked to the Planning.
Process?
Why Should Capital Allocation Not Be Linked to the Planning.
Process?
Case Study: Capital Allocation Process at UniCredit Group (by Elio.
Berti, head of Capital Allocation, CFO Department, UniCredit).
UniCredit Group Capital Allocation Process and Criteria.
Setting of Value-Creation and Capital Allocation Targets within.
Planning and Control Processes.
Summary.
Further Reading.
Final Remarks.
Selected Free Risk Management–Related Websites.
References.
Index.