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Beyond Value at Risk The New Science of Risk Management A Comprehensive Guide to Value at Risk and Risk Management Risk management and measurement are now, without doubt, the hottest topics in the finance world. Today, quantifying risk management is not only a management tool - but is also used by regulators for banks and finance houses. Beyond Value at Risk provides a comprehensive guide to recent developments and existing approaches to VaR and risk management, going beyond traditional approaches to the subject and offering a new, far-reaching perspective on investment, hedging and portfolio decision-making. The key to this distinctive approach is a new decision rule - the 'Generalised Sharpe Rule', and its practical applications. Beyond Value at Risk provides the answers to key questions, including: How to implement VaR and related systems in the real world How to make vital investment decisions and estimate their effect How to make hedging decisions How to manage a portfolio It offers financial professionals, academics and students comprehensive coverage of VaR both in theory and practice.

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CONTENTS

PREFACE = ⅸ

PART ONE : INTRODUCTION TO VaR = 1

 CHAPTER 1 : THE RISK MANAGEMENT REVOLUTION = 3

  1. Introduction = 3

  2. Background Factors = 5

  3. Developments in Risk Management = 9

  4. Outline of the Book = 23

  Appendix to Chapter 1 : A Quick Primer on Derivatives = 30

 CHAPTER 2 : VaR BASICS = 38

  1. Numerical VaR = 38

  2. Parametric VaR = 42

  3. VaR Estimation Error = 43

  4. Decomposing the Portfolio into its Constituents = 45

  5. Incremental VaR = 48

  6. Choice of VaR Parameters = 50

  Appendix to Chapter 2 : Verifying VaR Systems = 55

PART TWO : DIFFERENT APPROACHES TO MEASURING VaR = 61

 CHAPTER 3 : THE VARIANCE-COVARIANCE APPROACH = 63

  1. Advantages of Normality = 64

  2. The Delta-Normal Approach = 66

  3. Delta-Gamma Approaches = 68

  4. Adjusting for Fat Tails = 74

  5. Mapping Positions = 76

  6. VaR for Specific Positions = 79

  7. Are Portfolio Returns Normal? = 87

  8. Conclusions = 88

  Appendix to Chapter 3 : Forecasting Volatilities and Correlations = 94

 CHAPTER 4 : THE HISTORICAL SIMULATION APPROACH = 99

  1. Advantages of the Historical Simulation Approach = 99

  2. Problems with the Historical Simulation Approach = 101

  3. Conclusions = 104

 CHAPTER 5 : MONTE CARLO SIMULATION AND RELATED APPROACHES = 108

  1. Introduction = 108

  2. The Monte Carlo Simulation Approach = 109

  3. Quasi-Monte Carlo Approaches = 116

  4. Scenario Simulation = 116

  5 Conclusions = 118

 CHAPTER 6 : STRESS TESTING = 121

  1. Scenario Analysis = 121

  2. Mechanical Approaches to Stress Testing = 126

  3. Conclusions = 129

  First Appendix to Chapter 6 : The Extreme Value Approach = 131

  Second Appendix to Chapter 6 : Different Approaches Compared = 133

PART THREE : RISK MANAGEMENT = 139

 CHAPTER 7 : RISK-ADJUSTING RETURNS AND EVALUATING PERFORMANCE = 141

  1. The Need for Risk Adjustment and Performance Evaluation = 141

  2. General Issues = 142

  3. The Sharpe Ratio Approach = 143

  4. Some Flawed Alternatives = 151

  5. Conclusions = 153

  Appendix to Chapter 7 : Different Risk-Adjustment Rules = 156

 CHAPTER 8 : DECISION MAKING = 157

  1 Introduction = 157

  2. Using the Generalised Sharpe Rule to Make Decisions = 157

  3. Investment Decisions = 158

  4. Hedge Decisions = 160

  5. Managing Portfolios = 163

  6. Conclusions = 163

 CHAPTER 9 : CREDIT RISK = 166

  1. Credit Risk Measurement = 166

  2. Credit Risk Management = 175

  3. integrating Default VaR and Market VaR = 179

  4. Conclusions = 183

 CHAPTER 10 : LIQUIDITY, OPERATIONAL AND LEGAL RISKS = 187

  1. Liquidity Risk = 187

  2. Operational Risk = 191

  3. Legal Risk = 199

 CHAPTER 11 : ALLOCATING CAPITAL = 203

  1. Allocating Capital within the Institution = 203

  2. Internal Capital Requirements = 209

  3. Dealing with Regulatory Capital Requirements = 214

  Appendix to Chapter 11 : Regulatory Capital Requirements = 219

 CHAPTER 12 : FIRM-WIDE RISK MANAGEMENT = 228

  1. Strategic Risk Management = 229

  2. Enterprise-wide Risk Management = 230

  3. VaR for Corporates = 237

  4. Conclusions = 241

  Appendix to Chapter 12 : Risk Management Advice for Senior Managers = 243

GLOSSARY OF MAIN TERMS = 250

BIBLIOGRAPHY = 256

AUTHOR INDEX = 267

SUBJECT INDEX = 270