The Fundamentals of Risk Measurement (Hardcover)

by Christopher Marrison (Author)

Editorial Reviews

Product Description
TABLE OF CONTENTS

Chapter 1: The Basics of Risk Management This chapter introduces how banks work. It describes how they make money, how they often lose money, and how they try to manage their losses. It includes thirteen short case studies showing how banks have lost money.

Chapter 2: Risk Measurement at the Corporate Level: Economic Capital and RAROC Chapter Two discusses the meaning of capital and how the risks that a bank faces are related to the amount of capital that the bank should hold. It then describes the two fundamental building blocks of integrated risk measurement: Economic Capital and Risk Adjusted Return on Capital (RAROC).

Chapter 3: Review of Statistics Chapter Three is useful for those readers who do not have a recent working knowledge of statistics. It reviews the statistical relationships that are commonly used in risk measurement and provides reference material for the rest of the book. Examples are provided using financial loss data.

MARKET RISK SECTION

Chapter 4: Background on Traded Instruments This chapter gives an overview of the main types of traded instruments: bonds, equities and derivatives. It gives a qualitative description of the instrument, examples of calculating the instrument's value and the basic risk metrics such as duration and the Greeks. This chapter is useful for those readers who are new to the finance industry.

Chapter 5: Market Risk Measurement This chapter describes the most common ways to measure market risks: Sensitivity analysis, Stress testing, Scenario testing, Sharpe Ratio and Value at Risk. It gives detailed examples of using each of the metrics.

Chapter 6: The Three Common Approaches for Calculating Value at Risk Value at Risk (VaR) has become the standard approach for measuring market risk. This chapter is devoted to explaining the details of the three common approaches to calculating VaR: Parametric VaR, Historical VaR and Monte Carlo VaR. We work though increasingly complex examples and compare the strengths of each approach. (Note: many readers will be particularly interested in this chapter because the name VaR is well known and has a certain mystery)

Chapter 7: Value at Risk Contribution The Value at Risk Contribution (VaRC) is a useful way of pinpointing the source of the portfolio's risk. VaRC can break down the risk by instrument, trading desk or market risk factor. Examples are given for several types of VaRC.

Chapter 8: Testing VaR Results to Ensure Proper Risk Measurement This chapter discusses the procedures required by regulators to backtest VaR calculators to check that their predictions of losses are consistent with market events.

Chapter 9: Calculating Capital for Market Risk VaR is used as the basis for calculating both Regulatory Capital and Economic Capital for Market Risks. In this chapter VaR also extended to measure the risk of Asset Management operations.

Chapter 10: Overcoming VaR Limitations Although VaR is the best single metric for market risks, is has several limitations. The limitations and typical solutions are discussed in this chapter.

Chapter 11: The Management of Market Risk This chapter concludes the market risk section by describing how the results of risk measurement are used by management to identify the sources of risk. It also describes the process of setting VaR Limits. (Note: readers should be particularly interested in VaR Limits because it is difficult and an important element in controlling a bank's risk).

ASSET/LIABILITY MANGEMENT SECTION

Chapter 12: Introduction to Asset Liability Management Asset Liability Management (ALM) is primarily concerned with the interest rate and liquidity risks that are created when commercial banks take in short term deposits from customers and give out long term loans. This chapter describes how those risks arise and the risk characteristics of different types of deposits and loans.

Chapter 13: Measurement of Interest Rate Risk for ALM This chapter discussed the primary techniques used to measure interest rate risk: Gap reports, Rate shift scenarios and Simulations

Chapter 14: Funding Liquidity Risk in ALM The measurement of liquidity risk is broken into three groups: expected, unusual and crisis events. Measurement techniques are given for each group.

Chapter 15: Funds Transfer Pricing and the Management of ALM Risks A key use of asset/liability measurement is the calculation of the fair price at which funds should be lent from one department to another within a bank. This is one of the keys to integrated risk measurement and is a critical component in measuring risk-adjusted profitability and setting prices to customers. A typical balance sheet is used to illustrate how transfer pricing works in detail.

CREDIT RISK SECTION

Chapter 16: Introduction to Credit Risk This chapter discusses the sources of credit risk and how measurement is used to manage the risks

Chapter 17: Types of Credit Structure For readers who are unfamiliar with lending operations, we discuss the ways that credit exposures are structured in commercial and retail lending. It also describes the calculation of credit exposure for derivatives trading operations and gives an overview of credit derivatives.

Chapter 18: Risk Measurement for a Single Facility This chapter shows how the Expected Loss and Unexpected Loss for a loan can be calculated from the Probability of Default, Loss In the Event of Default, Exposure at Default and the Grade Migration Matrix.

Chapter 19: Estimating Parameter Values for Single Facilities One of the main difficulties in credit risk measurement is the estimation of values for Probability of Default, Loss Given Default and Exposure at Default. This chapter discusses estimation techniques such as Discriminant Analysis and the Merton Model. It also gives parameter values that can be used as the basis for the reader's own models. The parameter values are used in examples to demonstrate how the credit risk calculations are used.

Chapter 20: Risk Measurement For A Credit Portfolio: Part One To estimate the overall risk for a portfolio many credit instruments, we must examine the correlation between losses. This chapter describes the Covariance Credit Portfolio Model and the different approaches available for estimating default correlations. It also describes how the correlations can be used to estimate the Unexpected Loss Contribution and the Economic Capital for a single facility within a portfolio.

Chapter 21: Risk Measurement For A Credit Portfolio: Part Two This chapter describes the four other widely used approaches for estimating the risk of credit portfolios: the actuarial model, the Merton-based simulation model, the macro economic default model and the macro economic cashflow model used for structured and project finance. It concludes with a section describing how the models can be combined in a unified framework to create an integrated simulation of all the bank's risks

Chapter 22: Risk Adjusted Performance and Pricing for Loans Knowing the economic capital for a loan, this chapter shows how to calculate the minimum price that should be charged to a loan customer. The analysis shows how to include multi-year effects such as grade migration. Illustrative examples are included. (Note: this chapter should be of interest to readers because loan pricing is another difficult and important subject that is rarely discussed in other books)

Chapter 23: Regulatory Capital for Credit Risk The Basel Committee on Banking Supervision (often called the BIS) is planning fundamental changes to the way that banks must calculate the capital that they hold. The new calculations will be very similar to the calculations described in the rest of this book for economic capital. This chapter summarizes the history of the Capital Accords then compares the different approaches that the BIS will allow. It also gives a standard plan for implementing the new Accords. (Note: this should be of interest to readers because the shift to BIS measurement is of major importance, it will be difficult for most banks, and it must be completed by 2005)

OPERATING RISK SECTION

Chapter 24: Operating risk The quantification of Operating Risks is on the frontier of the industry's understanding of risk measurement. The risk estimation approaches can be categorized as either qualitative, structural or actuarial. These approaches are described including Key Risk Indicators and the BIS approaches.

INTEGRATED RISK SECTION

Chapter 25: Inter-risk Diversification and Bank-Level RAROC This chapter describes how all the models are linked to calculate Economic Capital and Risk Adjusted Profitability for the Bank as a whole. It concludes with of the steps normally required to implement the bank-wide measurement of Economic Capital and RAROC.pital and RAROC.

From the Back Cover
Today's Most Detailed, Step-by-Step Guidebook for Understanding--and Implementing--Integrated Financial Risk Measurement and Management

Banks take financial risks, with their overall profits based on maximizing the returns from those risks. Losses--or in the case of Britain's Barings Bank, utter devastation--can occur when assumed risks are unregulated internally and become too large, either in relation to potential returns or in the bank's ability to cover the risks.

Between the two lies the effective measurement and management of financial risk.

The Fundamentals of Risk Measurement introduces the state-of-the-art tools and practices necessary for planning, executing, and maintaining risk management in today's volatile financial environment. This comprehensive book provides description and analysis of topics including:

• Economic capital
• Risk adjusted return on capital (RAROC)
• Shareholder Value Added (SVA)
• Value at Risk (VaR)
• Asset/liability management (ALM)
• Credit risk for a single facility
• Credit risk for portfolios
• Operating risk
• Inter-risk diversification
• The Basel Committee Capital Accords

The banking world is driven by risk. The Fundamentals of Risk Measurement shows you how to quantify that risk, outlining an integrated framework for risk measurement and management that is straightforward, practical for implementation, and based on the realities of today's tumultuous global marketplace.

Banks make money in one of two ways: providing services to customers and taking risks. In this book, we address the business of making money by taking risk.…--From the Introduction

In The Fundamentals of Risk Measurement,financial industry veteran Chris Marrison examines what banks must do to succeed in the business of making money by taking risk. Encompassing the three primary areas of banking risk--market, credit, and operational--and doing so in a uniquely intuitive, step-by-step format, Marrison provides hands-on details on the primary tools for financial risk measurement and management, including:

• Plain-English evaluation of specific risk measurement tools and techniques
• Use of Value at Risk (VaR) for assessment of market risk for trading operations
• Asset/liability management (ALM) techniques, transfer pricing, and managing market and liquidity risk
• The many available methods for analyzing portfolios of credit risks
• Using RAROC to compare the risk-adjusted profitability of businesses and price transactions

In addition, woven throughout The Fundamentals of Risk Measurement are principles underlying the regulatory capital requirements of the Basel Committee on Banking Supervision, and what banks must do to understand and implement them. The requirements are defined, implications of the New Capital Accord are presented, and the major steps that a bank must take to implement the New Accord are discussed. The resulting thumbnail sketch of the Basel Committee, and specifically the New Capital Accord, is valuable as both a ready reference and a foundation for further study of this important initiative.

Risk is unavoidable in the financial industry. It can, however, be measured and managed to provide the greatest risk-adjusted return, and limit the negative impacts of risk to a bank's shareholders as well as potential borrowers and lenders. The Fundamentals of Risk Management provides risk managers with an approach to risk-taking that is both informed and prudent, one that shows operations managers how to control risk exposures as it allows decision-making executives to direct resources to opportunities that are expected to create maximum return with minimum risk. The result is today's most complete introduction to the business of risk, and a valuable reference for anyone from the floor trader to the officer in charge of overseeing the entire risk management operation.

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Product Details

• Hardcover: 415 pages
• Publisher: McGraw-Hill; 1 edition (June 27, 2002)
• Language: English
• ISBN-10: 0071386270
• ISBN-13: 978-0071386272
• Product Dimensions: 9.2 x 7.4 x 1.3 inches
• Shipping Weight: 2.1 pounds (View shipping rates and policies)
• Average Customer Review: 4.1 out of 5 stars See all reviews (12 customer reviews)
• Amazon.com Sales Rank: #155,437 in Books (See Bestsellers in Books)

Customer Reviews

Most Helpful Customer Reviews

44 of 46 people found the following review helpful:

4.0 out of 5 stars This is a practical guide to risk, August 27, 2002

By	C. I. Marrison (New York, US) - See all my reviews (REAL NAME)

An earlier review suggested that the book's contents are not original and you can find the information elsewhere.

This is not a thesis, it is a text book. The purpose of a thesis is to record original ideas and demonstrate the cleverness of the author. The purpose of a text book is to bring together an existing body of knowledge so that it can be easily understood and used by the reader.

The book was written to be as clear as possible so as to remove the unnecessary mystery from risk management. It was written because most, if not all, other books on risk assume that you already have a good knowledge of the industry and its methodologies. Furthermore, most books deal with only one aspect of risk, rather than taking an integrated view.

I suggest that this book does three things well:

* It gathers information together, so that in one place you can get a good picture of the whole framework of risk measurement. If you want to delve into details later, then of course you should buy books that specialize in those corners.

* For beginners, it gives foundation chapters on banking and statistics so that everyone will be able to understand the later chapters. For example if you have a science PhD you will first want to know how banks work, the meaning of capital and the difference between a credit risk derivative and credit risk for a derivative. If you are an MBA who has not recently done matrix math and statistics, you will probably appreciate the review in Chapter 3.

* The book gives many specific examples so that you can quickly make your own risk calculations. In this respect it is more detailed than many other risk books. It minimizes the discussion of philosophy and history, to give the tools that the reader needs as quickly as possible.

I believe that this book is a good way to quickly get to the heart of risk measurement. In 400 pages it is not possible (or even desirable) to cover every aspect of risk, but you can certainly give a solid introduction and overview. As such, I suggest that The Fundamentals of Risk Measurement does a good job both for the beginner and for those who already know one area of risk, but wish to have an integrated view of risk measurement for the whole bank. Even with several years in the industry, an open minded reader should still enjoy seeing everything brought together in this book.

41 of 43 people found the following review helpful:

5.0 out of 5 stars One of the Best Books for Risk Management, October 22, 2002

By	Guy Odell (New York, NY) - See all my reviews

Marrison has written an outstanding book on risk management. What is attractive about the treatment is the fact that it covers all aspects of risk management for financial institutions. Lots of books focus only on "new" techniques (VaR, portfolio credit risk models) or only on "traditional" techniques (credit analysis, ALM). Marrison treats them all, and uses capital allocation as a unifying theme.

Two previous reviews that suggest Marrison is too basic or merely repeats other authors are, in my humble opinion, dishonest. Marrison is a sophisticated book for sophisticated readers who are new to risk management. This includes MBA students taking courses on the capital markets or risk management. It also includes professionals working in their first risk management position. Marrison did not invent VaR or ALM, but authors of other books did not invent these concepts either. An author's task is to describe established concepts in a manner that is accessible to and useful for his audience. In this respect, Marrison's book is a dramatic step forward. His choice of topics, organization and writing are superb.

One of those previous reviews recommended that you read books by certain other authors instead of Marrison. Of those books, the only one that Marrison competes with is Jorion's Value-at-Risk. Marrison is an order of magnitude better than that book. The other books cover unrelated topics or are more advanced treatises on specific topics. You might graduate to such books from Marrison, but they are not alternatives to Marrison.

Finally, you can't beat the price on this book. Marrison simultaneously offers a bargain AND one of the best books available on risk management.

25 of 26 people found the following review helpful:

4.0 out of 5 stars A great primer, September 10, 2002

By	tmody (Boston, MA) - See all my reviews

Chris Marrison's book is something I have been seeking for a very long time. It is well organized and easy to read. I have spent several years in strategic financial services consulting, wherein a strong foundation in risk measurement concepts and tools is essential for consultants across experience levels. Though having studied undergraduate finance and statistics, I ended up developing my rudimentary (and incomplete) knowledge of risk measurement in a very ad-hoc, context-specific and inefficent fashion. Now an MBA student at Harvard, I come across peers also seeking to understand the business, technical and practical aspects of risk measurement, as conceptually, 'risk management' is a common idea but an abstract practice for many professionals. There is no other textbook I've come across that addresses the essentials of risk measurement in as tangible a manner. I will not hesitate to recommend this book as a great primer to fellow students. The only caveat I offer is that this book is for those truly interested in jumping into the practical applications of risk measurement - for more of an overview of risk management theory, or esoterica for that matter, you're better off looking elsewhere.