Risk Management

The course is aimed at providing the main tools for measuring and managing financial risks. We begin by defining the various types of financial risks and stress the need for their management through the analysis of losses and defaults of financial institutions in the recent past. The first type of financial risk we analyze is market risk, measured by the Value-at-Risk (VaR). We discuss the estimation of the main inputs surrounding the calculation of VaR and the possible methodologies available for determining the VaR of individual assets and portfolios. In doing so, we also elaborate on models for time-varying volatility and correlations. Alternative measures of risk are also analyzed.

The second half of the course focuses on credit risk. We first define the objects of interest in evaluating credit risk and explore several classes of models which have been proposed for its measurement. We then look at the derivative products that are available to transfer credit risk, such as credit default swaps, and discuss their pricing.

The course concludes with an overview of the regulatory capital requirements from the Basel Accords.

Content

I. Introduction to financial risks
I.1 Introduction
I.2 Topology of financial risks
I.3 Lessons from financial disasters

II. Measuring and Managing Market Risk
II.1 Value-at-Risk (VaR)
II.1.1 Definition and computation
II.1.2 Estimating volatilities and correlations
II.1.3 Parametric models for VaR
II.1.4 Non-parametric models for VaR
II.1.5 VaR for large portfolios, derivatives, and fixed income portfolios
II.1.6 Stress-testing and Back-testing VaR models
II.2 Alternative measures of risk

III. Measuring and Managing Credit Risk
III.1 Nature of credit risk
III.2 Credit spreads, LGD, and ratings
III.3 Structural models: Merton and KMV
III.4 Credit scoring models: Z-score model
III.5 Extracting default probabilities from observed credit spreads
III.6 Credit derivatives

IV. Regulation of financial institutions

Books

The textbook for the course is
John C. Hull, Risk Management and Financial Institutions (2nd Edition), Prentice Hall

Textbooks

Other relevant sources are

M. Crouhy, D. Galai, R. Mark, Risk Management, McGraw-Hill, New York, 2nd Edition 2013.
J. Hull, Options Futures, and Other Derivatives, Prentice Hall, 2008.
D. Lando, Credit Risk Modeling: Theory and Applications, Princeton University Press, 2004.
A.J. McNeil, R. Frey, P. Embrechts, Quantitative Risk Management: Concepts, Techniques, and Tools, Princeton University Press, Princeton, 2005.
P. Jorion, Value at Risk, McGraw-Hill, 2006.