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Crouhy M., Galai D., Mark R. Risk Management (2001)Crouhy M., Galai D., Mark R. 
Contents Foreword xiii By Robert C. Merton Introduction xvii By John Hunkin Preface XiX Chapter 1 1 The Need for Risk Management Systems 1. Introduction 1 2. Historical Evolution 4 3. The Regulatory Environment 19 4. The Academic Background and Technological Changes 21 5. Accounting Systems versus Risk Management Systems 29 6. Lessons from Recent Financial Disasters 31 7. Typology of Risk Exposures 34 _8. Extending Risk Management Systems to Nonfinancial 39 Corporations Notes 41 Chapter 2 45 The New Regulatory and Corporate Environment 1. Introduction 45 2. The Group of 30 (G-30) Policy Recommendations 48 3. The 1988 BIS Accord: The "Accord" 53 4. The "1996 Amendment" or "BIS 98" 62 5. The BIS 2000+ Accord 68 Notes 91 Chapter 3 97 Structuring and Managing the Risk Management Function in a Bank 1. Introduction 97 _2. Organizing the Risk Management Function: Three-Pillar 99 Framework 3. Data and Technological Infrastructure 109 4. Risk Authorities and Risk Control 116 5. Establishing Risk Limits for Gap and Liquidity Management 126 6. Conclusion: Steps to Success 133 Notes 135 Chapter 4 137 The New BIS Capital Requirements for Financial Risks 1. Introduction 137 2. The Standardized Approach 138 3. The Internal Models Approach 150 4. Pros and Cons of the Standardized and Internal Models 162 Approaches: A New Proposal—the "Precommitment Approach" 5. Comparisons of the Capital Charges for Various Portfolios 165 According to the Standardized and the Internal Models Approaches 6. Conclusions 169 Notes 174 Chapter 5 177 Measuring Market Risk: The VaR Approach 1. Introduction 177 2. Measuring Risk: A Historical Perspective 179 3. Defining Value at Risk 187 4. Calculating Value at Risk 196 5. Conclusion: Pros and Cons of the Different Approaches 216 Appendix 1: Duration and Convexity of a Bond 218 Notes 225 Chapter 6 229 Measuring Market Risk: Extensions of the VaR Approach and Testing the Models 1. Introduction 229 2. Incremental-VaR (IVAR), DeltaVar (DVAR), and Most 230 Significant Risks 3. Stress Testing and Scenario Analysis 232 4. Dynamic-VaR 241 5. Measurement Errors and Back-Testing of VaR Models 243 6. Improved Variance-Covariance VaR Model 249 7. Limitations of VaR as a Risk Measure 252 Appendix: Proof of the Deltavar Property 255 Notes 257 Chapter 7 259 Credit Rating Systems 1. Introduction 259 2. Rating Agencies 261 3. Introduction to Internal Risk Rating 269 4. Debt Rating and Migration 275 5. Financial Assessment (Step 1) 282 6. First Group of Adjustment Factors for Obligor Credit Rating 290 7. Second Group of Adjustment Factors for Facility Rating 298 8. Conclusion 301 Appendix 1: Definitions of Key Ratios 302 Appendix 2: Key Financial Analysis Measures 303 Appendix 3A: Prototype Industry Assessment: Telecommunications in Canada 306 Appendix 3B: Prototype Industry Assessment: Footwear and Clothing in Canada 308 Appendix 4: Prototype Country Analysis Report (Condensed Version): Brazil 310 Notes 312 Chapter 8 315 Credit Migration Approach to Measuring Credit Risk 1. Introduction 315 2. CreditMetrics Framework 319 3. Credit VaR for a Bond (Building Block 1) 321 4. Credit VaR for a Loan or Bond Portfolio (Building Block 2) 329 5. Analysis of Credit Diversification (Building Block 2, Continuation) 338 6. Credit VaR and the Calculation of the Capital Charge 339 7. CreditMetrics as a Loan/Bond Portfolio Management Tool: Marginal Risk Measures 340 (Building Block 2, Continuation) 8. Estimation of Asset Correlations (Building Block 3) 342 9. Exposures (Building Block 4) 343 10. Conditional Transition Probabilities: CreditPortfolioView 344 11. Appendix 1: Elements of Merton's Model 347 Appendix 2: Default Prediction—The Econometric Model 350 Appendix 3: Transition Matrix over a Period of Less than One Year 352 Notes 352 Chapter 9 357 The Contingent Claim Approach to Measuring Credit Risk 1. Introduction 357 2. A Structural Model of Default Risk: Merton's (1974) Model 360 3. Probability of Default, Conditional Expected Recovery Value, and Default Spread 364 4. Estimating Credit Risk as a Function of Equity Value 366 5. KMV Approach 368 6. KMV's Valuation Model for Cash Flows Subject to Default Risk 381 7. Asset Return Correlation Model 384 Appendix 1: Integrating Yield Spread with Options Approach 389 Appendix 2: Risk-Neutral Valuation Using "Risk-Neutral" EDFs 392 Appendix 3: Limitations of the Merton Model and Some Extensions 395 Notes 399 Chapter 10 403 Other Approaches: The Actuarial and Reduced-Form Approaches to Measuring Credit Risk 1. Introduction 403 2. The Actuarial Approach: CreditRisk+ 404 3. The Reduced-Form Approach or Intensity-Based Models 411 Notes 422 Chapter 11 425 Comparison of Industry-Sponsored Credit Models and Associated Back-Testing Issues 1. Introduction 425 2. Comparison of Industry-Sponsored Credit Risk Models 427 3. Stress Testing and Scenario Analysis 430 4. Implementation and Validation Issues 436 Notes 438 Chapter 12 441 Hedging Credit Risk 1. Introduction 441 2. Credit Risk Enhancement 443 3. Derivative Product Companies 446 4. Credit Derivatives 448 5. Types of Credit Derivatives 452 6. Credit Risk Securitization for Loans and High Yield Bonds 461 7. Regulatory Issues 466 Notes 470 Chapter 13 475 Managing Operational Risk 1. Introduction 475 2. Typology of Operational Risks 478 3. Who Should Manage Operational Risk? 482 4. The Key to Implementing Bank-Wide Operational Risk Management 486 5. A Four-Step Measurement Process for Operational Risk 489 6. Capital Attribution for Operational Risks 505 7. Self-Assessment versus Risk Management Assessment 509 8. Integrated Operational Risk 511 9. Conclusion 513 Appendix 1: Group of Thirty Recommendations: Derivatives and Operational Risk 514 Appendix 2: Types of Operational Risk Losses 518 Appendix 3: Severity versus Likelihood 519 Appendix 4: Training and Risk Education 519 Appendix 5: Identifying and Quantifying Operational Risk 523 Notes 526 Chapter 14 529 Capital Allocation and Performance Measurement 1. Introduction 529 2. Guiding Principles of RAROC Implementation 538 3. Relationship of RAROC Capital to Market, Credit, and Operational Risks 543 4. Loan Equivalent Approach 549 5. Measuring Exposures and Losses for Derivatives 551 6. Measuring Risk Adjusted Performance: Second Generation of RAROC Model 559 7. Concluding Remarks 566 Appendix 1: First Generation of RAROC Model—Assumptions in Calculating Exposures, 570 Expected Default, and Expected Losses Notes 577 Chapter 15 579 Model Risk 1. Introduction 579 2. Valuation Models and Sources of Model Risk 581 3. Typology of Model Risks 585 4. What Can Go Wrong? 594 5. What Can Market Risk Management Do to Mitigate Model Risk? 606 6. Conclusions 610 Notes 611 Chapter 16 615 Risk Management in Nonbank Corporations 1. Introduction 615 2. Why Manage Risks? 617 3. Procedure for Risk Management 622 4. Accounting Reports 630 5. Reporting Requirements by Securities Authorities 634 Appendix 1: Examples of Reports on Risk Exposure by Nike, Merck, and Microsoft, 1988 645 Notes 659 Chapter 17 66J_ Risk Management in the Future 1. The Total Risk-Enabled Bank 661 2. External Client Profitability . . . A Partner PlusTM Approach 669 3. Process for Reviewing Risk in Extreme Markets Will Become Standardized 674 4. The Credit Analysis Process and the Need for Integrating Risks 678 5. An Idealized Bank of the Future 684 Appendix: The Relationship between Market Risk, Business Risk, and Credit Risk 685 Notes 690 References 693 Index 709 Introduction The traditional role of the risk manager as corporate steward is evolving as organizations face an increasingly complex and uncertain future. The mandate to clearly identify, measure, manage, and control risk has been expanded and integrated into best practice management of a bank. Today's risk manager is a key member of the senior executive team who helps define business opportunities from a risk-return perspective, presents unique ways of looking at them, has direct input into the configuration of products and services, and ensures the transparency of all the risks. Innovation necessitates new yardsticks for measuring and monitoring the resulting activities. The savvy corporate leader uses risk management as both a sword and a shield. At the end of the last millennium, financial institutions and investors experienced increased volatility in the major financial and commodity markets, with many financial crises. At the start of the new millennium, we are in the midst of a technological revolution resulting in changes in the operation of markets, increased access to information, changes in the types of services available to investors, as well as major changes in the production and distribution of financial services. If there is concern about an institution's ability to manage risk, then its share price will be penalized. Risk is a cost of doing business for a financial institution and consequently best practice risk management is a benefit to our shareholders. To manage the risks facing an institution we must have a clearly defined set of risk policies and the ability to measure risk. But what do we measure? And how do we measure such risks? We must also have a best practice infrastructure. The starting point is that we need a framework. This book provides such a framework. The content of the book is consistent with our own risk management strategy and experience. Our risk management strategy is designed to ensure that our senior management operates together in partnership to control risk while ensuring the independence of the risk management function. Improvements in analytic models and systems technology have |
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Risk Management (2001)