By Donald van Deventer on
4/13/2009 6:46 AM
On April 9, 2009, under a firestorm of political pressure, the Financial Accounting Standards Board staff put forth the enticingly titled document "FSP FAS 115-2 and FAS 124-2." If only the "and" were replaced with "&," the FASB staff could have outdone poet e. e. cummings with a written work whose title contained no words. Among this blog's readers is a very, very bright risk manager, working in disguise as his bank's chief operating officer, someone we'll call Vandy. Vandy has gone through the (here comes the real title) "Financial Accounting Standards Board Staff Position Number 115-2 and Number 124-2: Recognition and Presentation of Other-Than-Temporary Impairments" and pointed out that this FSP (FASB Staff Position) document seems to contain some very bad financial analysis, specifically with respect to the discount rate used for valuation. We examine that issue in this post.&l
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By Donald van Deventer on
4/9/2009 6:28 PM
The copula approach to valuation of collateralized debt obligations has been blamed for much of the credit crisis. Recent articles in Wired ("Recipe for Disaster: The Formula that Killed Wall Street," by Felix Salmon, February 23, 2009), Mother Jones ("The Gaussian Copula," by Kevin Drum, February 24, 2009), and the Financial Times (Sam Jones, "Of Couples and Copulas,," April 24, 2009) are three very entertaining examples of this genre. Rather than placing blame, other commentators emphasize the positive, saying "There's plenty of blame to go around, let's not waste time assigning blame, let's move forward." This post takes a different view than either group. We argue "Formulas don't cause losses, people cause losses." There are lots of lessons to be learned from the copula formula's uses and abuses.
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By Donald van Deventer on
4/7/2009 6:30 PM
The risk management techniques in common use for equity portfolio management include Nobel prize winning concepts like the capital asset pricing model, arbitrage pricing theory, and the efficient frontier concept. The list of researchers behind these concepts reads like a who's who of finance: William Sharpe, Harry Markowitz, John V. Lintner, Jr., Jan Mossin, Steven Ross, and many other key contributors. Like any theory, however, the CAPM, APT and efficient portfolio concept are based on the same flaw that has doomed simple implementations of value at risk (see the April 6 blog entry) and the copula approach for CDO valuation: a normal distribution of equity returns is at the heart of CAPM, APT, and the efficient frontier. Default risk is ignored. The current credit crisis makes a more sophisticated and realistic assessment of risk in equity portfolios a mission critical function. We talk about how to do that in this post.
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By Donald van Deventer on
4/6/2009 6:06 PM
The current world-wide credit crisis has triggered a much needed examination of risk management technology to determine which techniques worked and which did not. Value at Risk technology ("VAR") is probably the first risk management technique to be tied to a specific firm. In fact, the J.P. Morgan "brand" probably did more than anything else to popularize VAR. VAR, however, has not fared as well in the credit crisis as J.P. Morgan Chase has. This post tells why.
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By Donald van Deventer on
4/3/2009 7:37 PM
The failures of firms like Countrywide, Washington Mutual, IndyMac, Lehman Brothers, Citigroup and FNMA have convinced many that it is dangerous to take a silo approach to interest rate risk management ("ALM" or asset and liability management) and to rely on legacy risk vendors that address that aspect of risk alone. This post explores how the concept of funds transfer pricing, originated by Wm. Mack Terry's team in the Financial Analysis and Planning group at Bank of America in 1973, is evolving to give a more accurate and more holistic view of total risk, not just interest rate risk alone.
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