Readings for the Financial Risk Manager Volume Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis as well as much more For a list of available titles, visit our web site at www.WileyFinance.com Readings for the Financial Risk Manager Volume RENÉ M STULZ, EDITOR RICH APOSTOLIK, EDITOR GLOBAL ASSOCIATION OF RISK PROFESSIONALS, INC John Wiley & Sons, Inc Copyright © 2005 by Global Association of Risk Professionals, Inc All rights reserved Please see Credits for additional copyright and source information In all instances, permission credits and source information appear directly on any reprinted chapter Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com ISBN-13 978-0-471-78297-1 ISBN-10 0-471-78297-1 Printed in the United States of America Contents Editors’ Note Acknowledgments READING 57 Computing Value-at-Risk Philippe Jorion Reproduced with permission from Value at Risk, 2nd ed (New York: McGraw-Hill, 2001): 107–128 READING 58 VaR Methods Philippe Jorion Reproduced with permission from Value at Risk, 2nd ed (New York: McGraw-Hill, 2001): 205–230 READING 59 Liquidity Risk Philippe Jorion Reproduced with permission from Value at Risk, 2nd ed (New York: McGraw-Hill, 2001): 339–357 READING 60 Credit Risks and Credit Derivatives René M Stulz Reproduced with permission from Risk Management and Derivatives (Mason, Ohio: South-Western, 2003): 571–604 READING 61 Extending the VaR Approach to Operational Risk Linda Allen, Jacob Boudoukh, and Anthony Saunders Reproduced with permission from Understanding Market, Credit and Operational Risk: The Value at Risk Approach (Oxford: Blackwell Publishing, 2004): 158–199 v vi READINGS FOR THE FINANCIAL RISK MANAGER READING 62 Case Studies Reto Gallati Reproduced with permission from Risk Management and Capital Adequacy (New York: McGraw-Hill, 2003): 441–493 READING 63 What Is Operational Risk? Douglas G Hoffman Reproduced with permission from Managing Operational Risk (New York: John Wiley & Sons, 2002): 29–55 READING 64 Risk Assessment Strategies Douglas G Hoffman Reproduced with permission from Managing Operational Risk (New York: John Wiley & Sons, 2002): 181–212 READING 65 Operational Risk Analysis and Measurement: Practical Building Blocks Douglas G Hoffman Reproduced with permission from Managing Operational Risk (New York: John Wiley & Sons, 2002): 257–304 READING 66 Economic Risk Capital Modeling Douglas G Hoffman Reproduced with permission from Managing Operational Risk (New York: John Wiley & Sons, 2002): 375–403 READING 67 Capital Allocation and Performance Measurement Michel Crouhy, Dan Galai, and Robert Mark Reproduced with permission from Risk Management (New York: McGraw-Hill, 2001): 529–578 Contents READING 68 The Capital Asset Pricing Model and Its Application to Performance Measurement Noël Amenc and Véronique Le Sourd Reproduced with permission from Portfolio Theory and Performance Analysis (West Sussex: John Wiley & Sons, 2003): 95–102, 108–116 READING 69 Multi-Factor Models and Their Application to Performance Measurement Noël Amenc and Véronique Le Sourd Reproduced with permission from Portfolio Theory and Performance Analysis (West Sussex: John Wiley & Sons, 2003): 149–194 READING 70 Fixed Income Security Investment Noël Amenc and Véronique Le Sourd Reproduced with permission from Portfolio Theory and Performance Analysis (West Sussex: John Wiley & Sons, 2003): 229–252 READING 71 Funds of Hedge Funds Jaffer Sohail Reproduced with permission Lars Jaeger, ed., The New Generation of Risk Management for Hedge Funds and Private Equity Investments (London: Euromoney Books, 2003): 88–107 READING 72 Style Drifts: Monitoring, Detection and Control Pierre-Yves Moix Reproduced with permission Lars Jaeger, ed., The New Generation of Risk Management for Hedge Funds and Private Equity Investments (London: Euromoney Books, 2003): 387–398 vii viii READINGS FOR THE FINANCIAL RISK MANAGER READING 73 Risk Control Strategies: The Manager’s Perspective Pierre-Yves Moix and Stefan Scholz Reproduced with permission Jaffer Sohail, ed., Funds of Hedge Funds (London: Euromoney Books, 2003): 219–233 APPENDIX FRM Suggested Readings for Further Study Credits About the CD-ROM Editors’ Note he objective of this volume is to provide core readings recommended by the Global Association of Risk Professionals’ Financial Risk Manager (FRM®) Committee for the 2005 exam that are not available on the first Readings for the Financial Risk Manager CD-ROM The FRM Committee, which oversees the selection of reading materials for the FRM Exam, suggests 100 readings for those registered for the FRM Exam and any other risk professionals interested in the critical knowledge essential to their profession Fifty-five of these recommended readings appear on the Readings for the Financial Risk Manager CD-ROM* and 17 appear on this CD-ROM While every attempt has been made by GARP to obtain permissions from authors and their respective publishers to reprint all materials on the FRM Committee’s recommended reading list, not all readings were available for reprinting A list of those readings that are not reprinted on either the Readings for the Financial Risk Manager CD-ROM or this CD-ROM can be found in the Appendix of this CD-ROM In every instance, full bibliographic information is provided for those interested in referencing these materials for study, citing them in their own research, or ultimately acquiring the volumes in which the readings first appeared for their own risk management libraries GARP thanks all authors and publishers mentioned—particularly those who graciously agreed to allow their materials to be reprinted here as a companion text to the Financial Risk Manager Handbook, Third Edition, by Philippe Jorion We hope these books of readings prove to be of great convenience and use to all risk professionals, including those enrolled for the FRM Exam T *The Editors note that Reading 56, which appears on the first Readings for the Financial Risk Manager CD-ROM, is not on the suggested reading list for the 2005 FRM Exam To avoid confusion, we have labeled the first reading on Volume as Reading 57, so that each suggested reading, whether current or dormant, has its own unique assigned number ix Acknowledgments his second volume of Readings for the Financial Risk Manager was made possible through the work of the Global Association of Risk Professionals’ FRM Committee To choose the readings for the FRM Exam, the Committee reviewed an extremely large number of published works The readings selected were chosen because they meet high expositional standards and together provide coverage of the issues the Committee expects candidates to master GARP’s FRM Exam has attained global benchmark status in large part because of the hard work and dedication of this core group of risk management professionals These highly regarded professionals have volunteered their time to develop, without a historical road map, the minimum standards that risk managers must meet The challenge to successfully implement this approach on a global basis cannot be overstated GARP’s FRM Committee meets regularly via e-mail, through conference calls, and in person to identify and discuss financial risk management trends and theories Its objective is to ensure that what is tested each year in the FRM Exam is timely, comprehensive, and relevant The results of these discussions are memorialized in the FRM Study Guide The Study Guide, which is revised annually, clearly delineates in a topical outline the base level of knowledge that a financial risk manager should possess in order to provide competent financial risk management advice to a firm’s senior management and directors FRM Committee members represent some of the industry’s most knowledgeable financial risk professionals The following individuals were the Committee members responsible for developing the 2005 FRM Study Guide: T Dr René Stulz (Chairman) Richard Apostolik Juan Carlos Garcia Cespedes Dr Marcelo Cruz Dr James Gutman Kai Leifert Steve Lerit, CFA x Ohio State University Global Association of Risk Professionals Banco Bilbao Vizcaya Argentaria Risk Maths, Inc Goldman Sachs International Credit Suisse Asset Management New York Life Investment Management ... Market, Credit and Operational Risk: The Value at Risk Approach (Oxford: Blackwell Publishing, 20 04): 158–199 v vi READINGS FOR THE FINANCIAL RISK MANAGER READING 62 Case Studies Reto Gallati Reproduced... Wiley & Sons, 20 02) : 29 –55 READING 64 Risk Assessment Strategies Douglas G Hoffman Reproduced with permission from Managing Operational Risk (New York: John Wiley & Sons, 20 02) : 181 21 2 READING 65... McGraw-Hill, 20 01): 107– 128 READING 58 VaR Methods Philippe Jorion Reproduced with permission from Value at Risk, 2nd ed (New York: McGraw-Hill, 20 01): 20 5 23 0 READING 59 Liquidity Risk Philippe