Corporate Risk Management

Preface by Denis Kessler Introduction General presentation Contents of the book Acknowledgements General references 1 Risk management: definition and historical development 1.1 History of risk management 1.2 Milestones in financial risk management 1.3 Current definition of corporate risk management 1.4 Conclusion References 2 Theoretical determinants of risk management in non-financial firms 2.1 Value of risk management 2.1.1 Expected default costs 2.1.2 Risk premium to stakeholders 2.1.3 Expected tax payments 2.2 Comparative advantages in risk taking 2.3 Risk management and capital structure 2.4 Risk management and managerial incentives 2.5 Conclusion References 3 Risk management and investment financing 3.1 Basic model 3.2 Illustration with the standard debt contract 3.3 Model with two random variables 3.4 Conclusion References Appendix 1: Value of Appendix 2: Standard debt contract 4 Significant determinants of risk management of non-financial firms 4.1 Rationale for the research 4.2 Significant determinants 4.2.1 Target variable or dependent variable 4.2.2 Main determinants and their measurement 4.2.3 Results of estimations 4.3 Governance and endogeneity of debt 4.3.1 Model 4.3.2 Statistical analysis 4.3.3 Empirical results 4.4 Conclusion References Appendix: Construction of the Tax-save variable 5 Value at risk 5.1 Example of VaR 5.2 Numerical method 5.3 Parametric method 5.4 Taking into consideration time periods 5.5 Confidence interval of the VaR 5.6 CVaR 5.7 Conclusion References 6 Choice of portfolio and VaR constraint 6.1 Optimal benchmark portfolio of the firm 6.2 Optimal portfolio of a constrained manager 6.3 Conclusion References 7 VaR in portfolios of assets and options 7.1 VaR as a risk measure 7.2 Models without derivatives 7.2.1 CAPM 7.2.2 Multifactor model 7.3 VaR with options 7.4 Black and Scholes model and risk management 7.5 Delta-Gamma VaR 7.6 VaR of a general portfolio 7.7 Application 7.8 Conclusion References 8 CVaR or conditional VaR 8.1 Motivation for CVaR and coherence in risk measure 8.2 Notation and VaR 8.3 Definition of CVaR 8.4 Another way to derive CVaR with a return distribution 8.5 Example with a Student t-distribution and other examples 8.6 Conclusion: CVaR in Basel regulation References 9 Regulation of bank risk and use of VaR 9.1 Basel Accords 9.2 Market risk regulation of 1996 9.3 Specific risks 9.4 Total required capital 9.5 Tests 9.6 Comparison between standard and internal methods with interest rate risk 9.6.1 Standard and internal methods 9.6.2 Comparison of the two methods 9.7 Conclusion References 10 Optimal financial contracts and incentives under moral hazard 10.1 Optimal financial contracts and moral hazard 10.2 Theoretical model 10.3 Empirical application to air accident risk 10.4 Conclusion References Appendix: Synthesis of forms of financial contracts 11 Venture capital risk with optimal financing structure 11.1 Some statistics about venture capital 11.2 Role of venture capital firms 11.3 Venture capital firms and added value 11.4 Role of convertible debt 11.5 Information asymmetry and venture capital 11.6 Conclusion References 12 Bank credit: scoring of individual risks 12.1 Theoretical model 12.2 Empirical analysis 12.3 Credit line and loan default 12.4 Conclusion References 13 Portfolio management of credit risk 13.1 CreditMetrics 13.2 Review of chapters 2 and 3 of CreditMetrics 13.2.1 Chapter 2 of CreditMetrics 13.2.2 Chapter 3 of CreditMetrics 13.3 KMV Approach 13.4 Calculation of correlations 13.5 Conclusion References 14 Quantification of banks' operational risk 14.1 Context and presentation of operational risk 14.1.1 Basel Accord and regulation of operational risk 14.1.2 Examples 14.2 Measurement of regulatory capital 14.2.1 Basic approach 14.2.2 Standardized approach 14.2.3 Advanced measurement approach (AMA) 14.3 Calculation of regulatory capital for losses of over $1 million (LDA) 14.3.1 Scaling model in LDA models 14.3.2 Adding business cycles 14.4 Conclusion References 15 Liquidity risk 15.1 Theoretical modelling of CDSs 15.2 Bond yield spread's default portion 15.3 Empirical measurement of yield spreads' default portion 15.4 Non-default portion of yield spreads 15.5 Illiquidity index 15.6 Illiquidity premium 15.7 Data 15.7.1 TRACE database 15.7.2 Markit database 15.8 Principal component analysis of liquidity risk 15.9 Empirical analysis of credit cycles 15.10 Regime detection model 15.11 Detection of default and liquidity regimes 15.12 Conclusion References 16 LTCM 16.1 Brief history of the fund 16.2 Risk management, VaR and required capital 16.3 Portfolio optimization and leverage effect 16.4 Conclusion References 17 Structured finance and financial crisis of 2007-2009 17.1 Structured finance 17.2 Poor risk management linked to the structured finance market 17.2.1 Lack of incentive contracts in the presence of information asymmetry 17.2.2 Poor evaluation of structured products by rating agencies 17.2.3 Poor pricing of complex financial products 17.2.4 Poor regulation of structured finance 17.3 Lessons to retain for risk management References Appendix: How to create an AAA CDO tranche from BBB loans 18 Risk management and corporate governance 18.1 Enron and corporate governance 18.2 Financial crisis and corporate governance 18.3 New 2002 governance rules 18.4 Risk management and governance 18.5 Administrative competence of board members 18.6 New regulation for financial institutions 18.7 Economic analysis of governance effect 18.7.1 Testable hypothesis 18.7.2 Data and variables 18.7.3 Model 18.7.4 Empirical results 18.8 Conclusion References Appendix: Governance of Canadian federal financial institutions 19 Risk management and industrial organization 19.1 Entry, production and hedging 19.2 Commitment to hedging 19.3 Conclusion References 20 Real implications of corporate risk management 20.1 Real implications of corporate risk management: A review 20.2 Methodology 20.2.1 Instrumental variable 20.2.2 Essential heterogeneity models 20.3 U.S. oil producers 20.3.1 Sample construction 20.3.2 Descriptive statistics 20.3.3 Oil hedging activity 20.3.4 Univariate tests 20.4 Multivariate results 20.4.1 Firm value 20.4.2 Firm riskiness and firm accounting performance 20.5 Concluding remarks References Appendix: Estimated MTEs 21 Exercises Exercise 1: Portfolio choice and the notion of value at risk (VaR) Exercise 2: Backtesting of VaR models Exercise 3: Calculation of VaR with different distributions and accuracy of VaR Exercise 4: VaR for an equity portfolio with options Exercise 5: CVaR - Conditional value at risk Conclusion General references Index