Financial Enterprise Risk Management (International Series on Actuarial Science)

565 Pages·2011·2.76 MB·English

by  Paul Sweeting

FinancialEnterpriseRiskManagement
FinancialEnterpriseRiskManagementprovidesallthetoolsneededtobuildandmain-
tainacomprehensiveERMframework.Aswellasoutliningtheconstructionofsuch
frameworks,itdiscussestheinternalandexternalcontextswithinwhichriskmanage-
mentmustbecarriedout.Italsocoversarangeofqualitativeandquantitativetechniques
thatcanbeusedtoidentify,modelandmeasurerisks,anddescribesarangeofriskmit-
igationstrategies.Over100diagramsareusedtohelpdescribetherangeofapproaches
available,andriskmanagementissuesarefurtherhighlightedbyvariouscasestudies.A
numberofproprietary,advisoryandmandatoryriskmanagementframeworksarealso
discussed,includingSolvencyII,BaselIIIandISO31000:2009.
Thisbookisanexcellentresourceforactuarialstudentsstudyingforexaminations,for
riskmanagementpractitionersandforanyacademiclookingforanup-to-datereference
tocurrenttechniques.
paul sweetingisaManagingDirectoratJPMorganAssetManagement.Priorto
this,hewasaProfessorofActuarialScienceattheUniversityofKentandhestillholds
achairattheuniversity.Beforemovingtoacademia,Paulheldanumberofrolesin
pensions,insuranceandinvestment.Mostrecentlyhewasresponsiblefordeveloping
thelongevityreinsurancestrategyforMunichReinsurance,beforewhichhewasDirector
ofResearchatFidelityInvestments’RetirementInstitute.
Inhisearlycareer,Paulgainedextensiveexperienceasaconsultingactuaryadvising
onpensionsandinvestmentissuesforarangeofpensionschemesandtheircorporate
sponsors.HeisaffiliatedtoanumberofprofessionalbodiesbeingaFellowoftheInstitute
ofActuaries,aFellowoftheRoyalStatisticalSociety,aFellowoftheSecuritiesand
InvestmentInstituteandaCFACharterholder.Paulhaswrittenextensivelyonarange
of pensions, investment and risk issues and is a regular contributor to the print and
broadcastmedia.
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INTERNATIONAL SERIES ON ACTUARIAL SCIENCE
EditorialBoard
ChristopherDaykin(IndependentConsultantandActuary)
AngusMacdonald(Heriot-WattUniversity)
TheInternationalSeriesonActuarialScience,publishedbyCambridgeUniversityPress
inconjunctionwiththeInstituteandFacultyofActuaries,containstextbooksforstu-
dentstakingcoursesinorrelatedtoactuarialscience,aswellasmoreadvancedworks
designedforcontinuingprofessionaldevelopmentorfordescribingandsynthesizing
research.Theseriesisavehicleforpublishingbooksthatreflectchangesanddevelop-
mentsinthecurriculum,thatencouragetheintroductionofcoursesonactuarialscience
inuniversities,andthatshowhowactuarialsciencecanbeusedinallareaswherethere
islong-termfinancialrisk.
Acomplete list of books in the series can be found at www.cambridge.org/statistics.
Recenttitlesincludethefollowing:
RegressionModelingwithActuarialandFinancialApplications
EDWARDW.FREES
ActuarialMathematicsforLifeContingentRisks
DAVIDC.M.DICKSON,MARYR.HARDY&HOWARDR.WATERS
NonlifeActuarialModels
YIU-KUENTSE
GeneralizedLinearModelsforInsuranceData
PIETDEJONG&GILLIANZ.HELLER
Market-ValuationMethodsinLifeandPensionInsurance
THOMASMØLLER&MOGENSSTEFFENSEN
InsuranceRiskandRuin
DAVIDC.M.DICKSON
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FINANCIAL ENTERPRISE
RISK MANAGEMENT
PAUL SWEETING
UniversityofKent,Canterbury
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cambridge university press
Cambridge,NewYork,Melbourne,Madrid,CapeTown,
Singapore,Sa˜oPaulo,Delhi,Tokyo,MexicoCity
CambridgeUniversityPress
TheEdinburghBuilding,CambridgeCB28RU,UK
PublishedintheUnitedStatesofAmericabyCambridgeUniversityPress,NewYork
www.cambridge.org
Informationonthistitle:www.cambridge.org/9780521111645
(cid:1)c P.Sweeting2011
Thispublicationisincopyright.Subjecttostatutoryexception
andtotheprovisionsofrelevantcollectivelicensingagreements,
noreproductionofanypartmaytakeplacewithoutthewritten
permissionofCambridgeUniversityPress.
Firstpublished2011
PrintedintheUnitedKingdomattheUniversityPress,Cambridge
AcataloguerecordforthispublicationisavailablefromtheBritishLibrary
LibraryofCongressCataloguinginPublicationdata
Sweeting,Paul.
Financialenterpriseriskmanagement/PaulSweeting.
p.cm.–(Internationalseriesonactuarialscience)
Includesbibliographicalreferencesandindex.
ISBN978-0-521-11164-5(hardback)
1. Financialinstitutions–Riskmanagement. 2. Financialservicesindustry–Risk
management. I. Title.
HG173.S942011
332.1068(cid:2)1–dc23 2011025050
ISBN978-0-521-11164-5Hardback
CambridgeUniversityPresshasnoresponsibilityforthepersistenceor
accuracyofURLsforexternalorthird-partyinternetwebsitesreferredtoin
thispublication,anddoesnotguaranteethatanycontentonsuch
websitesis,orwillremain,accurateorappropriate.
SWEETING: “FM” — 2011/7/27 — 11:52 — PAGE iv — #4
Contents
Preface page xi
1 Anintroductiontoenterpriseriskmanagement 1
1.1 Definitionsandconceptsofrisk 1
1.2 Whymanagerisk? 3
1.3 Enterpriseriskmanagementframeworks 5
1.4 Corporategovernance 6
1.5 Modelsofriskmanagement 8
1.6 Theriskmanagementtimehorizon 9
1.7 Furtherreading 10
2 Typesoffinancialinstitution 11
2.1 Introduction 11
2.2 Banks 11
2.3 Insurancecompanies 14
2.4 Pensionschemes 16
2.5 Foundationsandendowments 18
2.6 Furtherreading 18
3 Stakeholders 20
3.1 Introduction 20
3.2 Principals 20
3.3 Agents 31
3.4 Controlling 41
3.5 Advisory 48
3.6 Incidental 51
3.7 Furtherreading 53
v
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vi Contents
4 Theinternalenvironment 54
4.1 Introduction 54
4.2 Internalstakeholders 54
4.3 Culture 55
4.4 Structure 57
4.5 Capabilities 60
4.6 Furtherreading 60
5 Theexternalenvironment 61
5.1 Introduction 61
5.2 Externalstakeholders 61
5.3 Politicalenvironment 62
5.4 Economicenvironment 62
5.5 Socialandculturalenvironment 64
5.6 Competitiveenvironment 65
5.7 Regulatoryenvironment 66
5.8 Professionalenvironment 85
5.9 Industryenvironment 88
5.10 Furtherreading 90
6 Processoverview 91
7 Definitionsofrisk 93
7.1 Introduction 93
7.2 Marketandeconomicrisk 93
7.3 Interestraterisk 94
7.4 Foreignexchangerisk 94
7.5 Creditrisk 95
7.6 Liquidityrisk 96
7.7 Systemicrisk 97
7.8 Demographicrisk 99
7.9 Non-lifeinsurancerisk 101
7.10 Operationalrisks 102
7.11 Residualrisks 110
7.12 Furtherreading 111
8 Riskidentification 112
8.1 Introduction 112
8.2 Riskidentificationtools 112
8.3 Riskidentificationtechniques 115
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Contents vii
8.4 Assessmentofrisknature 119
8.5 Riskregister 119
8.6 Furtherreading 120
9 Someusefulstatistics 121
9.1 Location 121
9.2 Spread 122
9.3 Skew 124
9.4 Kurtosis 125
9.5 Correlation 126
9.6 Furtherreading 132
10 Statisticaldistributions 134
10.1 Univariatediscretedistributions 134
10.2 Univariatecontinuousdistributions 137
10.3 Multivariatedistributions 171
10.4 Copulas 195
10.5 Furtherreading 220
11 Modellingtechniques 221
11.1 Introduction 221
11.2 Fittingdatatoadistribution 223
11.3 Fittingdatatoamodel 228
11.4 Smoothingdata 237
11.5 Usingmodelstoclassifydata 245
11.6 Uncertainty 259
11.7 Credibility 262
11.8 Modelvalidation 270
11.9 Furtherreading 271
12 Extremevaluetheory 272
12.1 Introduction 272
12.2 Thegeneralisedextremevaluedistribution 272
12.3 ThegeneralisedParetodistribution 275
12.4 Furtherreading 279
13 Modellingtimeseries 280
13.1 Introduction 280
13.2 Deterministicmodelling 280
13.3 Stochasticmodelling 281
13.4 Timeseriesprocesses 285
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viii Contents
13.5 Datafrequency 305
13.6 Discounting 306
13.7 Furtherreading 310
14 Quantifyingparticularrisks 311
14.1 Introduction 311
14.2 Marketandeconomicrisk 311
14.3 Interestraterisk 325
14.4 Foreignexchangerisk 337
14.5 Creditrisk 338
14.6 Liquidityrisk 360
14.7 Systemicrisks 362
14.8 Demographicrisk 363
14.9 Non-lifeinsurancerisk 372
14.10 Operationalrisks 379
14.11 Furtherreading 381
15 Riskassessment 382
15.1 Introduction 382
15.2 Riskappetite 383
15.3 Upsideanddownsiderisk 386
15.4 Riskmeasures 387
15.5 Unquantifiablerisks 401
15.6 Returnmeasures 403
15.7 Optimisation 404
15.8 Furtherreading 411
16 Responsestorisk 413
16.1 Introduction 413
16.2 Marketandeconomicrisk 416
16.3 Interestraterisk 430
16.4 Foreignexchangerisk 434
16.5 Creditrisk 435
16.6 Liquidityrisk 442
16.7 Systemicrisk 442
16.8 Demographicrisk 444
16.9 Non-lifeinsurancerisk 446
16.10 Operationalrisks 447
16.11 Furtherreading 456
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Contents ix
17 Continuousconsiderations 457
17.1 Introduction 457
17.2 Documentation 457
17.3 Communication 458
17.4 Audit 460
17.5 Furtherreading 461
18 Economiccapital 462
18.1 Introduction 462
18.2 Definitionofeconomiccapital 462
18.3 Economiccapitalmodels 463
18.4 Designinganeconomiccapitalmodel 464
18.5 Runninganeconomiccapitalmodel 465
18.6 Calculatingeconomiccapital 466
18.7 Economiccapitalandriskoptimisation 467
18.8 Capitalallocation 469
18.9 Furtherreading 471
19 Riskframeworks 472
19.1 Mandatoryriskframeworks 472
19.2 Advisoryriskframeworks 483
19.3 Proprietaryriskframeworks 499
19.4 Furtherreading 504
20 Casestudies 505
20.1 Introduction 505
20.2 The2007–2011globalfinancialcrisis 505
20.3 BaringsBank 511
20.4 EquitableLife 514
20.5 KoreanAir 517
20.6 LongTermCapitalManagement 519
20.7 BernardMadoff 521
20.8 RobertMaxwell 522
20.9 SpaceShuttleChallenger 523
20.10 Conclusion 525
20.11 Furtherreading 525
References 527
Index 540
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