Quantitative Financial Risk Management

Preface xvii About the Editors xix SECTION ONE Supervisory Risk Management CHAPTER 1 Measuring Systemic Risk: Structural Approaches 3 Raimund M. Kovacevic and Georg Ch. Pflug Systemic Risk: Definitions 4 From Structural Models to Systemic Risk 6 Measuring Systemic Risk 10 Systemic Risk and Copula Models 15 Conclusions 20 References 20 CHAPTER 2 Supervisory Requirements and Expectations for Portfolio-Level Counterparty Credit Risk Measurement and Management 22 Michael Jacobs Jr., PhD, CFA Introduction 22 Review of the Literature 25 Supervisory Requirements for CCR 26 Conceptual Issues in CCR: Risk versus Uncertainty 41 Conclusions 44 References 44 CHAPTER 3 Nonperforming Loans in the Bank Production Technology 46 Hirofumi Fukuyama and William L. Weber Introduction 46 Selective Literature Review 47 Method 51 Empirical Application 57 Summary and Conclusion 65 Appendix 3.1 Bank Names and Type 66 References 67 SECTION TWO Risk Models and Measures CHAPTER 4 A Practical Guide to Regime Switching in Financial Economics 73 Iain Clacher, Mark Freeman, David Hillier, Malcolm Kemp and Qi Zhang A Brief Look at Markov Regime Switching in Academic Economics and Finance 74 Regime Switching and Interest Rate Processes 75 Regime Switching and Exchange Rates 76 Regime Switching, Stock Returns, and Asset Allocation 77 Single-Asset Markov Models 79 Two-State Estimation 82 Three-State Estimation 84 Markov Models for Multiple Assets 85 Practical Application of Regime Switching Models for Investment Purposes 87 Intuitive Appeal of Such Models 87 Implementation Challenges 89 Selecting the "Right" Model Structure 89 Calibrating the Selected Model Type to Suitable Data 90 Drawing the Right Conclusions from the Model 93 References 95 CHAPTER 5 Output Analysis and Stress Testing for Risk Constrained Portfolios 98 Jitka Dupa¡cová and Milos Kopa Introduction 98 Worst-Case Analysis 107 Stress Testing via Contamination 110 Conclusions and New Problems 122 References 122 CHAPTER 6 Risk Measures and Management in the Energy Sector 126 Marida Bertocchi, Rosella Giacometti and Maria Teresa Vespucci Introduction 126 Uncertainty Characterization via Scenarios 128 Measures of Risks 132 Case Studies 137 Summary 147 References 147 SECTION THREE Portfolio Management CHAPTER 7 Portfolio Optimization: Theory and Practice 155 William T. Ziemba Static Portfolio Theory 155 Importance of Means 163 Stochastic Programming Approach to Asset Liability Management 167 Siemens InnoALM Pension Fund Model 182 Dynamic Portfolio Theory and Practice: The Kelly Capital Growth Approach 194 Transactions Costs 199 Some Great Investors 201 Appendix 7.1: Estimating Utility Functions and Risk Aversion 206 References 208 CHAPTER 8 Portfolio Optimization and Transaction Costs 212 Renata Mansini, Wlodzimierz Ogryczak and M. Grazia Speranza Introduction 212 Literature Review on Transaction Costs 215 An LP Computable Risk Measure: The Semi-MAD 221 Modeling Transaction Costs 223 Non-Unique Minimum Risk Portfolio 232 Experimental Analysis 234 Conclusions 237 Appendix 238 References 239 CHAPTER 9 Statistical Properties and Tests of Efficient Frontier Portfolios 242 C J Adcock Introduction 242 Notation and Setup 245 Distribution of Portfolio Weights 247 Empirical Study 255 Discussion and Concluding Remarks 267 References 268 SECTION FOUR Credit Risk Modelling CHAPTER 10 Stress Testing for Portfolio Credit Risk: Supervisory Expectations and Practices 273 Michael Jacobs Jr. Introduction and Motivation 273 Conceptual Issues in Stress Testing: Risk versus Uncertainty 276 The Function of Stress Testing 277 Supervisory Requirements and Expectations 280 Empirical Methodology: A Simple ST Example 281 Conclusion and Future Directions 291 References 293 CHAPTER 11 A Critique of Credit Risk Models with Evidence from Mid-Cap Firms 296 David E. Allen, Robert J. Powell and Abhay K. Singh Introduction 296 Summary of Credit Model Methodologies 297 Our Empirical Methodology 302 Critique 303 Conclusions 310 References 310 CHAPTER 12 Predicting Credit Ratings Using a Robust Multicriteria Approach 312 Constantin Zopounidis Introduction 312 Credit Scoring and Rating 315 Multicriteria Methodology 319 Empirical Analysis 325 Conclusions and Future Perspectives 330 References 331 SECTION FIVE Financial Markets CHAPTER 13 Parameter Analysis of the VPIN (Volume-Synchronized Probability of Informed Trading) Metric 337 Jung Heon Song, Kesheng Wu and Horst D. Simon Introduction 337 Definition of VPIN 341 Computational Cost 346 Optimization of FPR 348 Uncertainty Quantification (UQ) 353 Conclusion 360 References 362 CHAPTER 14 Covariance Specification Tests for Multivariate GARCH Models 364 Gregory Koutmos Introduction 364 Covariance Specification Tests 365 Application of Covariance Specification Tests 367 Empirical Findings and Discussion 368 Conclusion 370 References 370 CHAPTER 15 Accounting Information in the Prediction of Securities Class Actions 372 Vassiliki Balla Introduction 372 Literature Review 375 Methodology 376 Data 378 Results 387 Conclusions 394 References 395 About the Contributors 399 Glossary 413 Index 421