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9780071407632
Risk Management and Capital Adequacy / Edition 1 available in Hardcover
Risk Management and Capital Adequacy / Edition 1
by Reto Gallati
Reto Gallati
- ISBN-10:
- 0071407634
- ISBN-13:
- 9780071407632
- Pub. Date:
- 03/21/2003
- Publisher:
- McGraw Hill LLC
- ISBN-10:
- 0071407634
- ISBN-13:
- 9780071407632
- Pub. Date:
- 03/21/2003
- Publisher:
- McGraw Hill LLC
Risk Management and Capital Adequacy / Edition 1
by Reto Gallati
Reto Gallati
Hardcover
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Overview
Under the new Basle Guidelines, all financial institutions subject to local banking laws will soon be required to operate under dramatically different risk exposure rules. Risk Management and Capital Adequacy provides details on the key risk approaches under these new guidelines and is the first book to analyze if and how they can be integrated. From conceptual frameworks to analyses of models and approaches, it provides a solid reference source for the information that everyone in risk management will soon need to know.
Product Details
ISBN-13: | 9780071407632 |
---|---|
Publisher: | McGraw Hill LLC |
Publication date: | 03/21/2003 |
Pages: | 550 |
Product dimensions: | 6.30(w) x 9.10(h) x 1.73(d) |
About the Author
Reto Gallati, Ph.D., is deputy chief risk officer at Putnam Investments. A visiting professor at MIT's Sloan School of Management, Dr. Gallati has also worked in risk management at KPMG, Goldman Sachs, and Crédit Suisse and has been an instructor at Boston University, Harvard, and the University of Zurich.
Table of Contents
Acknowledgments | viii | |
Introduction | xvii | |
Chapter 1 | Risk Management: A Maturing Discipline | 1 |
1.1 | Background | 1 |
1.2 | Risks: A View of the Past Decades | 5 |
1.3 | Definition of Risk | 7 |
1.4 | Related Terms and Differentiation | 8 |
1.5 | Degree of Risk | 10 |
1.6 | Risk Management: A Multilayered Term | 11 |
1.6.1 | Background | 11 |
1.6.2 | History of Modern Risk Management | 11 |
1.6.3 | Related Approaches | 13 |
1.6.4 | Approach and Risk Maps | 22 |
1.7 | Systemic Risk | 22 |
1.7.1 | Definition | 22 |
1.7.2 | Causes of Systemic Risk | 26 |
1.7.3 | Factors That Support Systemic Risk | 26 |
1.7.4 | Regulatory Mechanisms for Risk Management | 27 |
1.8 | Summary | 28 |
1.9 | Notes | 30 |
Chapter 2 | Market Risk | 33 |
2.1 | Background | 33 |
2.2 | Definition of Market Risk | 34 |
2.3 | Conceptual Approaches for Modeling Market Risk | 37 |
2.4 | Modern Portfolio Theory | 39 |
2.4.1 | The Capital Asset Pricing Model | 41 |
2.4.2 | The Security Market Line | 43 |
2.4.3 | Modified Form of CAPM by Black, Jensen, and Scholes | 45 |
2.4.4 | Arbitrage Pricing Theory | 46 |
2.4.5 | Approaches to Option Pricing | 47 |
2.5 | Regulatory Initiatives for Market Risks and Value at Risk | 54 |
2.5.1 | Development of an International Framework for Risk Regulation | 56 |
2.5.2 | Framework of the 1988 BIS Capital Adequacy Calculation | 56 |
2.5.3 | Criticisms of the 1988 Approach | 58 |
2.5.4 | Evolution of the 1996 Amendment on Market Risks | 58 |
2.6 | Amendment to the Capital Accord to Incorporate Market Risks | 60 |
2.6.1 | Scope and Coverage of Capital Charges | 60 |
2.6.2 | Countable Capital Components | 61 |
2.6.3 | The de Minimis Rule | 62 |
2.7 | The Standardized Measurement Method | 62 |
2.7.1 | General and Specific Risks for Equity- and Interest-Rate-Sensitive Instruments | 65 |
2.7.2 | Interest-Rate Risks | 66 |
2.7.3 | Equity Position Risk | 79 |
2.7.4 | Foreign-Exchange Risk | 83 |
2.7.5 | Commodities Risk | 84 |
2.7.6 | Treatment of Options | 88 |
2.7.7 | Criticisms of the Standard Approach | 94 |
2.8 | The Internal Model Approach | 95 |
2.8.1 | Conditions for and Process of Granting Approval | 95 |
2.8.2 | VaR-Based Components and Multiplication Factor | 97 |
2.8.3 | Requirement for Specific Risks | 98 |
2.8.4 | Combination of Model-Based and Standard Approaches | 98 |
2.8.5 | Specification of Market Risk Factors to Be Captured | 99 |
2.8.6 | Minimum Quantitative Requirements | 101 |
2.8.7 | Minimum Qualitative Requirements | 102 |
2.9 | The Precommitment Model | 107 |
2.10 | Comparison of Approaches | 108 |
2.11 | Revision and Modification of the Basel Accord on Market Risks | 109 |
2.11.1 | The E.U. Capital Adequacy Directive | 109 |
2.11.2 | New Capital Adequacy Framework to Replace the 1988 Accord | 110 |
2.12 | Regulation of Nonbanks | 110 |
2.12.1 | Pension Funds | 111 |
2.12.2 | Insurance Companies | 111 |
2.12.3 | Securities Firms | 112 |
2.12.4 | The Trend Toward Risk-Based Disclosures | 113 |
2.12.5 | Disclosure Requirements | 113 |
2.12.6 | Encouraged Disclosures | 114 |
2.13 | Market Instruments and Credit Risks | 114 |
2.14 | Summary | 116 |
2.15 | Notes | 117 |
Chapter 3 | Credit Risk | 129 |
3.1 | Background | 129 |
3.2 | Definition | 130 |
3.3 | Current Credit Risk Regulations | 130 |
3.4 | Deficiencies of the Current Regulations | 131 |
3.5 | Deficiencies of the Current Conceptual Approaches for Modeling Credit Risk | 133 |
3.6 | Conceptual Approaches for Modeling Credit Risk | 135 |
3.6.1 | Transaction and Portfolio Management | 136 |
3.6.2 | Measuring Transaction Risk--Adjusted Profitability | 140 |
3.7 | Measuring Credit Risk for Credit Portfolios | 140 |
3.7.1 | Economic Capital Allocation | 141 |
3.7.2 | Choice of Time Horizon | 146 |
3.7.3 | Credit Loss Measurement Definition | 146 |
3.7.4 | Risk Aggregation | 149 |
3.8 | Development of New Approaches to Credit Risk Management | 150 |
3.8.1 | Background | 151 |
3.8.2 | BIS Risk-Based Capital Requirement Framework | 152 |
3.8.3 | Traditional Credit Risk Management Approaches | 154 |
3.8.4 | Option Theory, Credit Risk, and the KMV Model | 159 |
3.8.5 | J. P. Morgan's CreditMetrics and Other VaR Approaches | 167 |
3.8.6 | The McKinsey Model and Other Macrosimulation Models | 178 |
3.8.7 | KPMG's Loan Analysis System and Other Risk-Neutral Valuation Approaches | 183 |
3.8.8 | The CSFB CreditRisk[superscript +] Model | 190 |
3.8.9 | CSFB's CreditRisk[superscript +] Approach | 193 |
3.8.10 | Summary and Comparison of New Internal Model Approaches | 197 |
3.9 | Modern Portfolio Theory and Its Application to Loan Portfolios | 205 |
3.9.1 | Background | 205 |
3.9.2 | Application to Nontraded Bonds and Credits | 208 |
3.9.3 | Nonnormal Returns | 209 |
3.9.4 | Unobservable Returns | 209 |
3.9.5 | Unobservable Correlations | 209 |
3.9.6 | Modeling Risk--Return Trade-off of Loans and Loan Portfolios | 209 |
3.9.7 | Differences in Credit Versus Market Risk Models | 225 |
3.10 | Backtesting and Stress Testing Credit Risk Models | 226 |
3.10.1 | Background | 226 |
3.10.2 | Credit Risk Models and Backtesting | 227 |
3.10.3 | Stress Testing Based on Time-Series Versus Cross-Sectional Approaches | 228 |
3.11 | Products with Inherent Credit Risks | 229 |
3.11.1 | Credit Lines | 229 |
3.11.2 | Secured Loans | 231 |
3.11.3 | Money Market Instruments | 233 |
3.11.4 | Futures Contracts | 237 |
3.11.5 | Options | 240 |
3.11.6 | Forward Rate Agreements | 243 |
3.11.7 | Asset-Backed Securities | 245 |
3.11.8 | Interest-Rate Swaps | 247 |
3.12 | Proposal for a Modern Capital Accord for Credit Risk | 250 |
3.12.1 | Institute of International Finance | 251 |
3.12.2 | International Swaps and Derivatives Association | 252 |
3.12.3 | Basel Committee on Banking Supervision and the New Capital Accord | 253 |
3.13 | Summary | 263 |
3.14 | Notes | 265 |
Chapter 4 | Operational Risk | 283 |
4.1 | Background | 283 |
4.2 | Increasing Focus on Operational Risk | 285 |
4.2.1 | Drivers of Operational Risk Management | 286 |
4.2.2 | Operational Risk and Shareholder Value | 288 |
4.3 | Definition of Operational Risk | 289 |
4.4 | Regulatory Understanding of Operational Risk Definition | 293 |
4.5 | Enforcement of Operational Risk Management | 296 |
4.6 | Evolution of Operational Risk Initiatives | 299 |
4.7 | Measurement of Operational Risk | 302 |
4.8 | Core Elements of an Operational Risk Management Process | 303 |
4.9 | Alternative Operational Risk Management Approaches | 304 |
4.9.1 | Top-Down Approaches | 305 |
4.9.2 | Bottom-Up Approaches | 314 |
4.9.3 | Top-Down vs. Bottom-Up Approaches | 319 |
4.9.4 | The Emerging Operational Risk Discussion | 321 |
4.10 | Capital Issues from the Regulatory Perspective | 321 |
4.11 | Capital Adequacy Issues from an Industry Perspective | 324 |
4.11.1 | Measurement Techniques and Progress in the Industry Today | 327 |
4.11.2 | Regulatory Framework for Operational Risk Overview Under the New Capital Accord | 330 |
4.11.3 | Operational Risk Standards | 335 |
4.11.4 | Possible Role of Bank Supervisors | 336 |
4.12 | Summary and Conclusion | 337 |
4.13 | Notes | 338 |
Chapter 5 | Building Blocks for Integration of Risk Categories | 341 |
5.1 | Background | 341 |
5.2 | The New Basel Capital Accord | 342 |
5.2.1 | Background | 342 |
5.2.2 | Existing Framework | 343 |
5.2.3 | Impact of the 1988 Accord | 345 |
5.2.4 | The June 1999 Proposal | 346 |
5.2.5 | Potential Modifications to the Committee's Proposals | 348 |
5.3 | Structure of the New Accord and Impact on Risk Management | 352 |
5.3.1 | Pillar I: Minimum Capital Requirement | 352 |
5.3.2 | Pillar II: Supervisory Review Process | 353 |
5.3.3 | Pillar III: Market Discipline and General Disclosure Requirements | 354 |
5.4 | Value at Risk and Regulatory Capital Requirement | 356 |
5.4.1 | Background | 356 |
5.4.2 | Historical Development of VaR | 357 |
5.4.3 | VaR and Modern Financial Management | 359 |
5.4.4 | Definition of VaR | 364 |
5.5 | Conceptual Overview of Risk Methodologies | 366 |
5.6 | Limitations of VaR | 368 |
5.6.1 | Parameters for VaR Analysis | 368 |
5.6.2 | Different Approaches to Measuring VaR | 373 |
5.6.3 | Historical Simulation Method | 380 |
5.6.4 | Stress Testing | 382 |
5.6.5 | Summary of Stress Tests | 389 |
5.7 | Portfolio Risk | 389 |
5.7.1 | Portfolio VaR | 390 |
5.7.2 | Incremental VaR | 393 |
5.7.3 | Alternative Covariance Matrix Approaches | 395 |
5.8 | Pitfalls in the Application and Interpretation of VaR | 404 |
5.8.1 | Event and Stability Risks | 405 |
5.8.2 | Transition Risk | 406 |
5.8.3 | Changing Holdings | 406 |
5.8.4 | Problem Positions | 406 |
5.8.5 | Model Risks | 407 |
5.8.6 | Strategic Risks | 409 |
5.8.7 | Time Aggregation | 409 |
5.8.8 | Predicting Volatility and Correlations | 414 |
5.8.9 | Modeling Time-Varying Risk | 415 |
5.8.10 | The RiskMetrics Approach | 423 |
5.8.11 | Modeling Correlations | 427 |
5.9 | Liquidity Risk | 431 |
5.10 | Summary | 436 |
5.11 | Notes | 437 |
Chapter 6 | Case Studies | 441 |
6.1 | Structure of Studies | 441 |
6.2 | Overview of Cases | 441 |
6.3 | Metallgesellschaft | 445 |
6.3.1 | Background | 445 |
6.3.2 | Cause | 448 |
6.3.3 | Risk Areas Affected | 457 |
6.4 | Sumitomo | 461 |
6.4.1 | Background | 461 |
6.4.2 | Cause | 461 |
6.4.3 | Effect | 464 |
6.4.4 | Risk Areas Affected | 464 |
6.5 | LTCM | 466 |
6.5.1 | Background | 466 |
6.5.2 | Cause | 468 |
6.5.3 | Effect | 472 |
6.5.4 | Risk Areas Affected | 473 |
6.6 | Barings | 479 |
6.6.1 | Background | 479 |
6.6.2 | Cause | 480 |
6.6.3 | Effect | 485 |
6.6.4 | Risk Areas Affected | 486 |
6.7 | Notes | 490 |
Glossary | 495 | |
Bibliography | 519 | |
Index | 539 |
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