Risk Management in Turbulent TimesThe subprime crisis has shown that the sophisticated risk management models used by banks and insurance companies had serious flaws. Some people even suggest that these models are completely useless. Others claim that the crisis was just an unpredictable accident that was largely amplified by the lack of expertise and even naivety of many investors. This book takes the middle view. It shows that these models have been designed for "tranquil times", when financial markets behave smoothly and efficiently. However, we are living in more and more "turbulent times": large risks materialize much more often than predicted by "normal" models, financial models periodically go through bubbles and crashes. Moreover, financial risks result from the decisions of economic actors who can have incentives to take excessive risks, especially when their remunerations are ill designed. The book provides a clear account of the fundamental hypotheses underlying the most popular models of risk management and show that these hypotheses are flawed. However it shows that simple models can still be useful, provided they are well understood and used with caution. |
Contents
The Need for a Proper Methodology | |
PART TWO What is behind risk modeling | |
Leverage and Ruin Theory | |
PART THREE The perfect markets hypothesis and | |
The Case of Incomplete Markets | |
PART FOUR Risk management and shareholder value | iv |
The Shareholder Value Function | xi |
Risk Management and the Shareholder Value Function | xxiv |
PART FIVE What to do in practice | 12-8 |
The Different Steps of the Implementation | 12-10 |
Corp | 12-25 |
Some Simple Messages | 12-41 |
| 81 | |
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Common terms and phrases
arbitrage assumption bank bond captive cash flows cash reserves catastrophe Cauchy distribution Chapter claims coherent risk measures compute Consider contract copula Corp corporation cost cumulative distribution function decisions denotes distribution function diversification dividends earnings economic capital equal expected return expected shortfall expected utility Figure financial frictions financial markets firm firm’s formula fraction future futures contract hedging illustrated impact increase individual insurance and reinsurance insurance company interest rate investment investor level of cash leverage liability liquidity LTCM marginal mean–variance methodology methods million Normal distribution Numerical Example obtain optimal parameter quantile random variable ratio retention risk management risk management policy risk mapping risk measures risk neutral valuation risk premiums risk tolerance index risk transfer riskfree risky asset Ruin Theory Section securitization selfinsured shareholder value function Sharpe ratio simple standard deviation tranche Value at Risk variance vector zero