Advances in Risk Management

401 Pages·2012·2.04 MB·English

Advances in Risk
Management
Edited by
Greg N. Gregoriou
ADVANCES IN RISK MANAGEMENT
AlsoeditedbyGregN.Gregoriou
ASSETALLOCATIONANDINTERNATIONALINVESTMENTS
DIVERSIFICATIONANDPORTFOLIOMANAGEMENTOFMUTUALFUNDS
PERFORMANCEOFMUTUALFUNDS
Advances in Risk
Management
Edited by
GREG N. GREGORIOU
Selectionandeditorialmatter©GregN.Gregoriou2007
Individualchapters©contributors2007
Allrightsreserved.Noreproduction,copyortransmissionofthispublicationmaybe
madewithoutwrittenpermission.
Noparagraphofthispublicationmaybereproduced,copiedortransmittedsavewith
writtenpermissionorinaccordancewiththeprovisionsoftheCopyright,Designsand
PatentsAct1988,orunderthetermsofanylicencepermittinglimitedcopyingissued
bytheCopyrightLicensingAgency,90TottenhamCourtRoad,LondonW1T4LP.
Anypersonwhodoesanyunauthorizedactinrelationtothispublicationmaybe
liabletocriminalprosecutionandcivilclaimsfordamages.
Theauthorshaveassertedtheirrightstobeidentified
astheauthorsofthisworkinaccordancewiththeCopyright,
DesignsandPatentsAct1988.
Firstpublished2007by
PALGRAVEMACMILLAN
Houndmills,Basingstoke,HampshireRG216XSand
175FifthAvenue,NewYork,N.Y.10010
Companiesandrepresentativesthroughouttheworld
PALGRAVEMACMILLANistheglobalacademicimprintofthePalgraveMacmillan
divisionofSt.Martin’sPress,LLCandofPalgraveMacmillanLtd.Macmillan®isa
registeredtrademarkintheUnitedStates,UnitedKingdomandothercountries.
PalgraveisaregisteredtrademarkintheEuropeanUnionandothercountries.
ISBN-13:978–0–230–01916–4
ISBN-10:0–230–01916–1
Thisbookisprintedonpapersuitableforrecyclingandmadefromfullymanagedand
sustainedforestsources.
AcataloguerecordforthisbookisavailablefromtheBritishLibrary.
LibraryofCongressCataloging-in-PublicationData
Advancesinriskmanagement/editedbyGregN.Gregoriou.
p.cm.—(Financeandcapitalmarketsseries)
Includesbibliographicalreferencesandindex.
ISBN0–230–01916–1(cloth)
1.Investmentanalysis.2.Financialriskmanagement.I.Gregoriou,GregN.,1956–
II.Series:Financeandcapitalmarkets
HG4529.A362006
332.1068’1—dc22 2006045747
10 9 8 7 6 5 4 3 2 1
16 15 14 13 12 11 10 09 08 07
PrintedandboundinGreatBritainby
AntonyRoweLtd,ChippenhamandEastbourne
Contents
Acknowledgements xi
NotesontheContributors xii
Introduction xxi
1 Impact of the Collection Threshold on the
Determination of the Capital Charge for
Operational Risk 1
YvesCrama,GeorgesHübnerandJean-PhilippePeters
1.1 Introduction 1
1.2 Measuringoperationalrisk 3
1.3 Thecollectionthreshold 8
1.4 Empiricalanalysis 11
1.5 Conclusion 16
2 Incorporating Diversification into Risk Management 22
AmiyatoshPurnanandam,MitchWarachka,YongganZhaoand
WilliamT.Ziemba
2.1 Introduction 22
2.2 Riskmeasurewithdiversification 24
2.3 Numericalexample 31
2.4 Implementation 33
2.5 Pricingportfolioinsurance 37
2.6 Conclusion 43
v
vi CONTENTS
3 Sensitivity Analysis of Portfolio Volatility:
Importance of Weights, Sectors and Impact of
Trading Strategies 47
EmanueleBorgonovoandMarcoPercoco
3.1 Introduction 47
3.2 Sensitivityanalysisbackground 50
3.3 Effectofrelativeweightchanges 51
3.4 ImportanceofportfolioweightsinGARCHvolatility
estimationmodels 53
3.5 Empiricalresults:tradingstrategiesthroughsensitivity
analysis 56
3.6 Conclusion 64
4 Managing Interest Rate Risk under Non-Parallel
Changes: An Application of a Two-Factor Model 69
ManuelMoreno
4.1 Introduction 69
4.2 Themodel 70
4.3 Generalizeddurationandconvexity 72
4.4 Hedgingratios 74
4.5 Aproposalofasolutionforthelimitationsofthe
conventionalduration 75
4.6 Conclusion 83
5 An Essay on Stochastic Volatility and the
Yield Curve 86
RaymondThéoret,PierreRostanand
AbdeljalilEl-Moussadek
5.1 Introduction 86
5.2 Variationsonstochasticvolatilityandconditional
volatility 88
5.3 Interestratetermstructureforecasting 92
5.4 Interestratetermstructuremodels 92
5.5 Methodology 94
5.6 DataandcalibrationoftheFongandVasicekmodel 97
5.7 Simulation 98
5.8 Empiricalresults 99
5.9 Conclusion 102
CONTENTS vii
6 Idiosyncratic Risk, Systematic Risk and Stochastic
Volatility: An Implementation of Merton’s Credit
Risk Valuation 107
HayetteGatfaoui
6.1 Introduction 107
6.2 Thegeneralmodel 110
6.3 Astochasticvolatilitymodel 114
6.4 Simulationstudy 118
6.5 Conclusion 126
7 A Comparative Analysis of Dependence
Levels in Intensity-Based and Merton-Style
Credit Risk Models 132
Jean-DavidFermanianandMohammedSbai
7.1 Introduction 132
7.2 Merton-stylemodels 133
7.3 Intensity-basedmodels 136
7.4 Comparisonsbetweensomedependenceindicators 139
7.5 Extensionsofthebasicintensity-basedmodel 143
7.6 Conclusion 150
8 The Modeling of Weather Derivative Portfolio Risk 156
StephenJewson
8.1 Introduction 156
8.2 Whatareweatherderivatives? 157
8.3 Definingriskforweatherderivativeportfolios 159
8.4 Basicmethodsforestimatingtheriskinweather
derivativeportfolios 160
8.5 Theincorporationofsamplingerrorinsimulations 162
8.6 Accurateestimationofthecorrelationmatrix 162
8.7 Dealingwithnon-normality 163
8.8 Estimatingmodelerror 164
8.9 Incorporatinghedgingconstraints 165
8.10 Consistencybetweenthevaluationofsingle
contractsandportfolios 166
8.11 Estimatingsamplingerror 167
8.12 EstimatingVaR 167
8.13 Conclusion 168
viii CONTENTS
9 Optimal Investment with Inflation-Linked Products 170
TarasBeletskiandRalfKorn
9.1 Introduction 170
9.2 Modelingtheevolutionofaninflationindex 171
9.3 Optimalportfolioswithinflationlinkedproducts 173
9.4 Hedgingwithinflationlinkedproducts 182
9.5 Conclusion 189
10 Model Risk and Financial Derivatives 191
François-SergeLhabitant
10.1 Introduction 191
10.2 Frommathematicaltheorytofinancialpractise 194
10.3 Anillustrationofmodelrisk 195
10.4 Theroleofmodelsforderivatives 197
10.5 Themodel-buildingprocessandmodel
risk-creation 199
10.6 Whatifthemodeliswrong?acasestudy 201
10.7 Elevenrulesformanagingmodelrisk 203
10.8 Conclusion 210
11 Evaluating Value-at-Risk Estimates: A Cross-Section
Approach 213
RaffaeleZenti,MassimilianoPallottaandClaudioMarsala
11.1 Introduction 213
11.2 Value-at-risk 214
11.3 Reviewofexistingmethodsforbacktesting 214
11.4 Anextension:thecross-sectionapproach 217
11.5 Applications 219
11.6 Conclusion 224
12 Correlation Breakdowns in Asset Management 226
RiccardoBramanteandGiampaoloGabbi
12.1 Introduction 226
12.2 Dataanddescriptivestatistics 226
12.3 Correlationjumpsandvolatilitybehavior 228
12.4 Impactonportfoliooptimization 237
12.5 Conclusion 237
CONTENTS ix
13 Sequential Procedures for Monitoring Covariances
of Asset Returns 241
OlhaBodnar
13.1 Introduction 241
13.2 Covariancestructureofassetreturnsandoptimal
portfolioweights 243
13.3 Multivariatestatisticalsurveillance 246
13.4 Simultaneousstatisticalsurveillance 251
13.5 Acomparisonofthemultivariateandsimultaneous
controlcharts 253
13.6 Conclusion 258
14 An Empirical Study of Time-Varying Return
Correlations and the Efficient Set of Portfolios 265
ThadavillilJithendranathan
14.1 Introduction 265
14.2 EmpiricalMethodologyandData 267
14.3 Results 270
14.4 Conclusion 276
15 The Derivation of the NPV Probability Distribution
of Risky Investments with Autoregressive Cash Flows 278
Jean-PaulPaquin,AnnickLambertandAlainCharbonneau
15.1 Introduction 278
15.2 Systematicriskandtheperfecteconomy 280
15.3 Totalriskandtherealeconomy 282
15.4 TheNPVprobabilitydistributionandtheCLT:theoretical
results 285
15.5 TheNPVprobabilitydistributionandtheCLT:simulation
modelsandstatisticaltests 288
15.6 TheNPVprobabilitydistributionandtheCLT:
simulationresults 289
15.7 Conclusion 293
16 Have Volatility Transmission Patterns between
the USA and Spain Changed after September 11? 303
HelenaChuliá,FranciscoJ.Climent,PilarSorianoandHipòlitTorró
16.1 Introduction 303
16.2 Data 305