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Advanced Financial Risk Management outlines an integrated framework
for fully integrated risk management. Credit risk, market risk, asset
and liability management, and performance measurement have historically
been thought of as separate disciplines, but recent developments in
financial theory and computer science now allow these views of risk to
be analyzed on a fully integrated basis.
In Advanced Financial Risk Management Donald R. van Deventer and
Kenji Imai, joined by Mark Mesler, extend the concepts outlined in their
previous book Credit Risk Models and the Basel Accords and update their
1996 work Financial Risk Analytics. The authors lay out a comprehensive
strategy of risk management measures, objectives, and hedging techniques
that apply to all types of institutions. They describe a performance
measurement approach that goes far beyond traditional capital allocation
techniques in measuring risk-adjusted shareholder value creation. Most
important, the authors supplement this strategic view of integrated risk
with step-by-step tools and techniques for constructing a risk
management system that achieves these objectives. The authors start
with an updated review of techniques for constructing the building
blocks of risk management, continuous yield curves that are used in
everything from equity options to mortgage-backed securities analysis.
They show how the creation of smooth credit spreads from bond price data
is an extension of traditional yield curve smoothing technology. The
authors review the primary credit risk models and discuss the
implementation of the most modern form of credit models, the reduced
form models of Jarrow, Duffy and Singleton, at great length. They
present results from a 1.2 million observation data base on default
probabilities in demonstrating how to meet Basel II requirements for
credit model testing. They also show how to estimate default
probabilities from bond prices and credit derivatives prices even when
there is a liquidity "premium" reflected in those prices above and
beyond the risk of expected loss due to default or bankruptcy. The
authors then go on to show how three important topics in finance are
special cases of the credit risk analysis they introduce: prepayment
modeling, valuation of life insurance policies, and the valuation of
property and casualty insurance contracts. Van Deventer, Imai and Mesler
also revisit the critical issue of the valuation of savings deposits and
demand deposits, which have no explicit maturity and a random principal
balance. Finally, the authors present a comprehensive framework for
performance measurement at both the transaction level and the portfolio
level that is consistent with best practice valuation techniques.
Performance measurement has a history of many decades but it is rapidly
evolving beyond simple concepts of "plus alpha" or interest rate margin
to true measures of value generation. Advanced Financial Risk
Management also contains a rich array of formulas for basic and advanced
risk management calculations which will be of enormous use to
practitioners in fund management, pension fund management, banking,
insurance, and the securities industry. Donald R. van Deventer, Kenji
Imai, and Mark Mesler have work for and implemented risk systems for
some of the largest and most sophisticated financial institutions in
Europe, North America, and Asia. Donald R. van Deventer was named to the
RISK Magazine Hall of Fame in December 2002 for his work at Kamakura
Corporation, where Kenji Imai and Mark Mesler are also on the Managing
Committee.
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Advanced Financial Risk Management:
Tools and Techniques for Integrated Credit Risk and Interest Rate Risk
Management