HANDBOOK OF. Market Risk CHRISTIAN SZYLAR WILEY

Transcription

1 HANDBOOK OF Market Risk CHRISTIAN SZYLAR WILEY

2 Contents FOREWORD ACKNOWLEDGMENTS ABOUT THE AUTHOR INTRODUCTION XV XVII XIX XXI 1 INTRODUCTION TO FINANCIAL MARKETS t 1.1 The Money Market The Capital Market The Bond Market The Present Value Concept Types of Bonds The Stock Market The Futures and Options Market The Foreign Exchange Market The Commodity Market 22 Further Reading 26 2 THE EFFICIENT MARKETS THEORY Assumptions behind a Perfectly Competitive Market The Efficient Market Hypothesis Strong EMH Semi-Strong EMH Weak-Form EMH Critics of Efficient Markets Theory Development of Behavioral Finance Beating the Market: Fundamental versus Technical Fundamental Methods Price Earnings Ratio Price to Book 37 vii

3 viii Contents Price to Cash Flow Return on Equity Price to Earnings to Growth Ratio Technical Analysis Average True Range Rate of Change Relative Strength Index Money Flow Index Moving Averages 41 Further Reading 42 RETURN AND VOLATILITY ESTIMATES Standard Deviation Standard Deviation with a Moving Observation Window Exponentially Weighted Moving Average (EWMA) Double (Holt) Exponential Smoothing Model (DES) Principal Component Analysis (PCA) Models The VIX Geometric Brownian Motion Process GARCH Estimator Using the Highest and Lowest Parkinson Estimator Rogers Satchell Estimator Garman-Klass Estimator 57 Further Reading 58 4 DIVERSIFICATION, PORTFOLIOS OF RISKY ASSETS, AND THE EFFICIENT FRONTIER Variance and Covariance Two-Asset Portfolio: Expected Return and Risk Correlation Coefficient Correlation Coefficient and Its Impact on Portfolio Risk Zero Correlation Case Perfect Negative Correlation Case Perfect Positive Correlation Case The Number of Assets in a Portfolio and Its Impact on Portfolio Risk The Effect of Diversification on Risk The Efficient Frontier Correlation Regime Shifts and Correlation Estimates Increased Correlation Severity of Correlation Changes Correlation Estimates Copulas Moving Average 91

4 Contents ix Correlation Estimators in Matrix Notation Bollerslev's Constant Conditional Correlation Model Engle's Dynamic Conditional Correlation Model Estimating the Parameters of the DCC Model Implementing the DCC Model 97 Further Reading 100 THE CAPITAL ASSET PRICING MODEL AND THE ARBITRAGE PRICING THEORY lot 5.1 Implications of the CAPM Assumptions The Same Linear Efficient Frontier for All Investors Everyone Holds the Market Portfolio The Separation Theorem Relationships Defined by the CAPM The Capital Market Line The Security Market Line Interpretation of Beta Determining the Level of Diversification of a Portfolio Investment Implications of the CAPM Introduction to the Arbitrage Pricing Theory (APT) 115 Further Reading 119 MARKET RISK AND FUNDAMENTAL MULTIFACTORS MODEL Why a Multifactors Model? The Returns Model The Least-Squares Regression Solution Assumptions of the Least-Squares Solution Solving the Problem of Heteroskedasticity Outliers Robust Regression Statistical Approaches Principal Components Asymptotic Principal Components Maximum-Likelihood Estimation Hybrid Solutions Estimation Universe Model Factors Market Factor or Intercept Industry Factors Thin Industries Treatment of Thin Industries 137

5 X Contents Style Factors Standardization of Style Factors Country Factors Currency Factors The Problem of Multicollinearity The Risk Model Factor Covariance Matrix Autocorrelation in the Factor Returns 145 Further Reading 147 MARKET RISK: A HISTORICAL PERSPECTIVE FROM MARKET EVENTS AND DIVERSE MATHEMATICS TO THE VALUE-AT-RlSK A Brief History of Market Events Toward the Development of the Value-at-Risk Diverse Mathematics Safety-First Principli Condorcet Tetens Actuarial Works Laplace Lacro ix Political Economy s England Financial Theory The VaR Concept 7.3 Definition of the Value-at-Risk VaR Calculation Models Variance Covariance The Standard Normal Distribution or Z Distribution Skew and Kurtosis Standard Deviation and Correlation VaR Calculation Using Variance-Covariance Historical Simulation Monte Carlo Simulation Incremental VaR 1 gg Marginal VaR Component VaR Expected Shortfall VaR Models Summary 190

6 Contents xi Mapping of Complex Instruments Cornish Fisher VaR Extreme Value Theory (EVT) 193 Further Reading FINANCIAL DERIVATIVE INSTRUMENTS Introducing Financial Derivatives Instruments Swap Total Return Swap (TRS) Credit-Default Swap (CDS) First to Default (FTD) Collateralized Debt Obligation (CDO) Credit Linked Note (CLN) Currency Swap Swaption Variance Swap Contract for Difference (CFD) The Forward Contract The Futures Contract Currency Future Interest Rate Future Bond Future Options Currency Option Equity Option Interest Rate Option Warrant Market Risk and Global Exposure Global Exposure Sophisticated versus Nonsophisticated UCITS The Commitment Approach with Examples on Some Financial Derivatives Calculation of Global Exposure Using VaR Options Different Strategies Using Options Black Scholes Formula The Greeks Delta Delta Hedging Gamma Vega Theta Option Value and Risk under Monte Carlo Simulation 227

7 xii Contents Evaluating Options and Taylor Expansion The Binomial and Trinomial Option Pricing Models 228 Further Reading FIXED INCOME AND INTEREST RATE RISK Bond Valuation The Yield Curve Risk of Holding a Bond Duration Modified Duration Convexity Factor Models for Fixed Income Hedge Ratio Duration Hedging 246 Further Reading LIQUIDITY RISK Traditional Methods and Techniques to Measure Liquidity Risk Average Traded Volume Bid Ask Spread Liquidity and VaR Liquidity at Risk Incorporation of Endogenous Liquidity Risk into the VaR Model Incorporation of Exogenous Liquidity Risk into the VaR Model Exogenous and Endogenous Liquidity Risk in VaR Model Other Liquidity Risk Metrics Methods to Measure Liquidity Risk on the Liability Side 264 Further Reading ALTERNATIVES INVESTMENT: TARGETING ALPHA, IDIOSYNCRATIC RISK Passive Investing Active Management Main Alternative Strategies Specific Hedge Fund Metrics Market Factor versus Multifactor Regression The Sharpe Ratio 275

8 Contents xiii The Information Ratio i?-square (Ä 2 ) Downside Risk 276 Farther Reading STRESS TESTING AND BACK TESTING Definition and Introduction to Stress Testing Stress Test Approaches Piecewise Approach Integrated Approach Designing and Calibrating a Stress Test Historical Stress Testing Some Examples of Historical Stress Test Scenarios Other Stress Test Scenarios Interest Rate Scenarios Relative FX Scenarios Dynamic FX Scenarios Progression Scenarios Reverse Stress Test Stress Testing Correlation and Volatility Multivariate Stress Testing What Is Back Testing? VaR Is Not Always an Accurate Measure Back Testing: A Rigorous Approach Is Required Test of Frequency of Tail Losses or Kupiec's Test Conditional Coverage of Frequency and Independence of Tail Losses Clean and Dirty Back Testing 313 Further Reading BANKS AND BASEL II/III A Brief History of Banking Regulations The 1988 Basel Accord Definition of Capital Credit Risk Charge Off-Balance Sheet Items Drawbacks from the Basel Accord Amendment Basel II The Credit Risk Charge The Standardized Approach The Internal Ratings-Based (IRB) Approach 328

9 xiv Contents Operational Risk Charge The Basic Indicator Approach The Standardized Approach The Advanced Measurement Approach The Market Risk Charge The Standardized Method The Internal Models Approach Example of the Calculation of the Capital Ratio Basel III and the New Definition of Capital; The Introduction of Liquidity Ratios 365 Further Reading CONCLUSION 373 INDEX 378